Accounting 6310

Chapter 12 – Standard Costs: Direct Labor and Materials

Standard Costs

• Actual costs detail materials, labor, overhead, and expense costs that actually happened.

• Standard cost systems detail what costs SHOULD BE as determined by designated teams of employees.

• Standard costs are benchmarks.

Standard Cost Systems

• Can be used for planning or control purposes

• Comparable to a budget broken down to a unit figure

• Like predetermined OH rates

• Developed for DM, DL, and OH or any cost you want

Variances

• Difference between actual and standard cost is called a VARIANCE.

• For costs:– Variances are FAVORABLE if Actual < Standard– Variances are UNFAVORABLE if Actual > Standard

• For revenues, the opposite holds true.– FAVORABLE: Actual > Standard– UNFAVORABLE: Actual < Standard

Standard Cost SystemsBenefits

• Used for decision management– Planning– Product pricing– Contract bidding– Outsourcing decisions

• Used for decision control– Easier bookkeeping– Motivation– Control costs– Performance Evaluation– Transfer pricing

Standard Cost Systems

• Who develops standard costs?– Engineers– Cost accountants– Managers– Workers

• Types of standards– Expected standards– Practical standards– Ideal standards

Traditional Cost-Plus Costing versus Target Costing

• Traditional Costing:– DM

– +DL

– +OH

– =Total Cost

– +Profit Markup

– =Price charged

• Target Costing– Price charged

– less profit markup

– =Target Cost

– (DM, DL, + OH must not be more than the target cost

Direct Labor Variances

• Price (Wage) Variance - difference in rates actually paid and standard wage rates per hour

• Quantity (Efficiency) Variance - difference in actual hours worked and standard hours that should have been worked.

• Causes

Direct Labor Variances

• AR x AH SR x AH SR x SH

• |__________________| |_____________|

• Wage Variance Efficiency Variance

• |_________________________________|

• Total Labor Variance

Standard Quantity Allowed

• Standard Quantity per unit

• X units produced

• = Standard Quantity Allowed

• Example:

• 4 hours per sleeping bag

• X 100 bags produced

• = 400 hours allowed for production

Direct Material Variances

• Price Variance– Purchase price variance (when purchased)– Usage price variance (when used)

• Quantity (Efficiency) Variance

• Causes

Direct Material Variances

• AP x AQ SP x AQ pur.

• |__________________|

• Price Variance

• SP x AQ used SP x SQ

• |______________|

• Quantity Variance

Incentive Effects of DL and DM Variances

• Control costs

• Purchasing manager– If purchasing manager is only evaluated on DM

price variance, they will buy in bulk, unnecessarily building costly inventories

– Should charge cost of inventory holding costs to purchasing department

Incentive Effects of DL and DM Variances

• Poor quality materials often affect production causing more wasted materials and more direct labor hours– Have quality specifications and do not allow

deviations– Tie purchasing manager’s evaluation to amount

of rework

Incentive Effects of DL and DM Variances

• Rush orders are more costly for purchasing– Have production (sales) bear the cost of rush

orders

• Engineering change orders cause wasted materials and more labor hours– Make sure changes are needed– Note these changes in production variances

Incentive Effects of DL and DM Variances

• Mutual Monitoring – Production and Purchasing work together for

the overall company good

• Satisficing– Rewarding workers for achieving a standard

may cause them to slack once goal is met– Encourage workers to continuously improve

Disposition of Variances

• At end of the period, variances are usually closed into cost of goods sold

• They can be allocated among WIP and FG inventories and COGS.

• If there are lots of unfavorable (favorable) variances, this will increase (decrease) expenses– This can be manipulated.

Responsibility for Variances

• Materials price - Purchasing

• Materials Quantity - Production, Purchasing

• Labor rate - Personnel, Production

• Labor efficiency - Production, Purchasing

• BUT:

• Must investigate the variance to see who is actually responsible

Three Conditions Necessary to Use Standard Costs

• There must be a way to measure outputs.

• A predetermined standard of performance must exist.

• There must be an ability to use variance information as feedback to make corrections and improvements.

Variance Analysis Cycle

Uses of Variance Analysis

• Calculation of variances do not explain causes• Variances should be investigated

– Often reasons for variances are explained beside the calculated variance

• Favorable variances are not always good• Unfavorable variances are not always bad• It is not good to net variances

– Netting of variances may cancel out large favorable variances against large unfavorable variances

Uses of Variance Analysis

• Management by exception – allows managers to focus only on those variances which are truly out of the ordinary– Management by exception allows managers to focus on

certain areas

– Maximizes return on management

• Variance analysis should be performed often in order to make corrections as early as possible – at least every month if possible

Limitations on Standards

• Make sure you determine the cause of the variances; do not just mindlessly calculate them.

• Any variance is only as good as the standards or planned activity to which actual is compared!!!!!!

• Changing conditions may warrant changing the standards.

• Variances should always be used for feedback and continuous improvement.

Homework

• P12-3 – Alexander Products

• P12-4 – Oaks Auto Supply

• P12-10 – Marian Health Care System

• DUE WEDNESDAY, MARCH 18