chap016 standard costing

Hilton • Maher • Selto

16Standard Costing, Variance

Analysis, and Kaizen Costing

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

16-3

STANDARD COSTa budget for the

production of one unit of product or

service

STANDARD COSTa budget for the

production of one unit of product or

service

ACTUAL COSTused in the

production of the product or service

ACTUAL COSTused in the

production of the product or service

COST VARIANCE the differencebetween the

actual cost andthe standard cost

COST VARIANCE the differencebetween the

actual cost andthe standard cost

Using Standard-Costing Systems for Control

16-4

Take the time to investigate only significant cost variancesTake the time to investigate only significant cost variances

What is significant?What is significant?

Depends on the Size of theOrganization

Depends on the Size of theOrganization

Depends on the Type of

the Organization

Depends on the Type of

the Organization

Depends on the

Production Process

Depends on the

Production Process

Management by Exception

16-5

Analysis ofHistorical

Data

Analysis ofHistorical

Data

TaskAnalysis

TaskAnalysis

Used in a mature production Process

Used in a mature production Process

Analyze the processof manufacturing

the product

Analyze the processof manufacturing

the product

What DIDthe product

cost?

What DIDthe product

cost?

What SHOULD the

product cost?

What SHOULD the

product cost?

A CombinedApproach

A CombinedApproach

Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed

Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed

Setting Standards

16-6

Perfection Vs. Practical Standards

PERFECTIONSTANDARDS

PERFECTIONSTANDARDS

PRACTICAL ORATTAINABLESTANDARDS

PRACTICAL ORATTAINABLESTANDARDS

Can only be attained under near perfect

conditions

Can only be attained under near perfect

conditions

Tight as practical,but still are expected

to be attained

Tight as practical,but still are expected

to be attained

•Occasional machinebreakdowns

•Normal amountsof raw material

waste

•Occasional machinebreakdowns

•Normal amountsof raw material

waste

•Peak efficiency•Lowest possible

input prices•best-quality material

•no disruption in production

•Peak efficiency•Lowest possible

input prices•best-quality material

•no disruption in production

16-7

Standards can be used by service firms, nonprofit organizations, and governmental units

Standards can be used by service firms, nonprofit organizations, and governmental units

Implementing and maintaining cost standards canbe time-consuming, labor-intensive, and expensive.

Implementing and maintaining cost standards canbe time-consuming, labor-intensive, and expensive.

Use Of Standards

COSTBENEFITS

COSTBENEFITS

16-8

Standard quantity:

Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. meters

Standard quantity:

Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. metersKoala Camp

Gear CompanyKoala Camp

Gear Company

DIRECT MATERIAL STANDARDSDIRECT MATERIAL STANDARDS

The total amount of material normally required to produce a finished product including allowances for normal waste

or efficiency

The total amount of material normally required to produce a finished product including allowances for normal waste

or efficiency

The total delivered cost, after

subtracting any purchase discounts

The total delivered cost, after

subtracting any purchase discounts

Cost Variance Analysis

16-9

Koala CampGear Company


DIRECT LABOR STANDARDSDIRECT LABOR STANDARDS

Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3

Total standard rate per hour $18

Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3

Total standard rate per hour $18

Cost Variance Analysis

16-10

Direct material:

Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000

Direct material:

Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000

Direct labor:Direct labor cost per tent (2 hours x $16 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000

Direct labor:Direct labor cost per tent (2 hours x $16 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000



The standard cost forthe direct-material

and direct-labor inputsis based upon Koala’s

actual output of 3,000 tents

The standard cost forthe direct-material

and direct-labor inputsis based upon Koala’s

actual output of 3,000 tents

They should incura cost of $396,000

($288,000 + $108,000)to make 3,000 tents

They should incura cost of $396,000

($288,000 + $108,000)to make 3,000 tents

Standard Costs Given Actual Output

16-11

40,000 sq.meters

purchased

$8.15 persq. meter

40,000 sq.meters

purchased

$8.00 persq. meter

36,000sq. meters

allowed

$8.00 per sq. meter

$326,000 $320,000 $288,000

$6,000U

36,400 sq.meters

used

$8.00per sq.meter

$291,200

Direct-material price variance

$3,200U

Direct-materialquantity variance

xx x

Analysis Of Material VariancesActualActual

quantityquantityActualActualpriceprice

ActualActualquantityquantity

StandardStandardpriceprice

StandardStandardquantityquantity

StandardStandardpricepricexxxx xx

Exh.16-1

16-12

What caused Koala to spend more than the anticipated amount on direct material?


First, the company purchased fabric at a higher price ($8.15 persquare meter) than the standard price ($8.00 per square meter).

First, the company purchased fabric at a higher price ($8.15 persquare meter) than the standard price ($8.00 per square meter).

Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased

AP = Actual priceSP = Standard price

Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased

AP = Actual priceSP = Standard price

Koala’s direct- material price variance for June is computed as follows:Direct-material price variance = PQ(AP - SP)= 40,000 ($8.15 - $8.00) = $6,000 unfavorable

Koala’s direct- material price variance for June is computed as follows:Direct-material price variance = PQ(AP - SP)= 40,000 ($8.15 - $8.00) = $6,000 unfavorable

Direct-Material Variances

16-13

Second, the company used more fabric than the standard price.(36,400 sq. meters actually used, instead of the standard amount of

36,000 sq. meters)

Second, the company used more fabric than the standard price.(36,400 sq. meters actually used, instead of the standard amount of

36,000 sq. meters)

Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where:

AQ = Actual quantity used SQ = Standard quantity allowed

Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where:

AQ = Actual quantity used SQ = Standard quantity allowed

Koala’s direct- material quantity variance for June is computed as follows:

Direct-material quantity variance = SP(AQ - SQ)= $8.00(36,400 - 36,000)

=$3,200 unfavorable

Koala’s direct- material quantity variance for June is computed as follows:

Direct-material quantity variance = SP(AQ - SQ)= $8.00(36,400 - 36,000)

=$3,200 unfavorable



Direct-Material Variances

16-14

X X X

Actual Labor Cost Standard Labor Cost

Actualhours

Standardprice

Actualrate

Actualhours

Standardrate

Standardrate

XXX

5,900 hoursused

$19per

hour

5,900hoursused

$18per

hour

6,000 hours

allowed

$18 per

hour

$112,100 $106,200 $108,000

$5,900 Unfavorable $1,800 Favorable

Direct-laborrate variance

Direct-laborefficiency variance

$4,100 Unfavorable

Direct-labor variance

Analysis of Direct-Labor VariancesExh.16-2

16-15

What caused Koala to spend more than the anticipated amount on direct labor?


First, the company incurred a cost of $19 per hour for directlabor instead of the standard amount of $18 per hour

First, the company incurred a cost of $19 per hour for directlabor instead of the standard amount of $18 per hour

Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where:

AH = Actual hours used AR = Actual rate per hour

SR = Standard rate per hour

Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where:

AH = Actual hours used AR = Actual rate per hour

SR = Standard rate per hour

Koala’s direct-labor rate variance for June is computed as follows:

Direct-labor rate variance = AH(AR - SR)= 5,900 ($19 - $18)

=$5,900 unfavorable

Koala’s direct-labor rate variance for June is computed as follows:

Direct-labor rate variance = AH(AR - SR)= 5,900 ($19 - $18)

=$5,900 unfavorable

Direct-Labor Variances

16-16

Koala used only 5,900 hours of direct labor, which is < standard quantity of 6,000 hours, given actual output of 3,000 tents. The increased efficiency does not fully offset the unexpectedly high

wage rate.

Koala used only 5,900 hours of direct labor, which is < standard quantity of 6,000 hours, given actual output of 3,000 tents. The increased efficiency does not fully offset the unexpectedly high

wage rate.

Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where:

AH = Actual hours used SH = Standard hours allowed

Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where:

AH = Actual hours used SH = Standard hours allowed

Koala’s direct - labor efficiency variance for June is computed as follows:

Direct - labor efficiency variance = SR(AH - SH)= $18 (5,900 - 6,000) = $1,800 favorable

Koala’s direct - labor efficiency variance for June is computed as follows:

Direct - labor efficiency variance = SR(AH - SH)= $18 (5,900 - 6,000) = $1,800 favorable



Direct-Labor Variances

16-17

Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U

Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U

When there are several types of direct material or direct labor, price and quantity variances are computed for

each type, and then added to obtain a total price variance and a total quality variance

When there are several types of direct material or direct labor, price and quantity variances are computed for

each type, and then added to obtain a total price variance and a total quality variance

Multiple Types Of Direct Material Or Direct Labor

16-18

In some manufacturing processes, a certain amount of defective production or spoilage is normal.

In some manufacturing processes, a certain amount of defective production or spoilage is normal.

Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output.

If total good output in February is 5,000 liters, what is the standard allowed quantity of input?

Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output.

If total good output in February is 5,000 liters, what is the standard allowed quantity of input?

Good output quantityGood output quantity = 80% X Input quantity= 80% X Input quantity

Good output quantity ÷ 80%Good output quantity ÷ 80% = Input quantity allowed= Input quantity allowed

5,000 liters of good output ÷ 80%

5,000 liters of good output ÷ 80%

= 6,250 liters of input allowed

= 6,250 liters of input allowed

Allowance For Defects Of Spoilage

16-19

????

What constitutes an exception?What constitutes an exception?

How does a manager know when to follow up on a cost variance and when to ignore it?

How does a manager know when to follow up on a cost variance and when to ignore it?

RULE OF THUMB:Investigate variances that are either greater than $10,000 or

greater than 10 percent of standard cost

RULE OF THUMB:Investigate variances that are either greater than $10,000 or

greater than 10 percent of standard cost

Size of VarianceSize of Variance

Absolute AmountAbsolute Amount Relative AmountRelative Amount

Management by Exception

16-20

MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%

MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%

None of the variances are greater than $10,000 or10%, but this variance should be investigated

because it has occurred at a reasonably high amount for four months


because it has occurred at a reasonably high amount for four months

Standarddirect

labor costis $100,000

Standarddirect

labor costis $100,000

Recurring Variances

16-21


because it has an unfavorable trend.


because it has an unfavorable trend.

Standarddirect labor

is $100,000

Standarddirect labor

is $100,000

MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%

MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%

Trends

16-22

ControllabilityA manager is more likely to investigate a variance

that is controllable by someone in the

organization than one that is not

ControllabilityA manager is more likely to investigate a variance

that is controllable by someone in the

organization than one that is not

Favorable VariancesIt is as important to investigate

significant favorable variances as well as significant unfavorable

variances

Favorable VariancesIt is as important to investigate

significant favorable variances as well as significant unfavorable

variances

Cost and Benefits of Investigation

The decision whether to investigate a variance is a cost -

benefit decision

Cost and Benefits of Investigation

The decision whether to investigate a variance is a cost -

benefit decision

Additional Issues

16-23

A STATISTICAL CONTROL CHART plots cost variancesacross time and compares them with a statistically

determined critical value that triggers an investigation

A STATISTICAL CONTROL CHART plots cost variancesacross time and compares them with a statistically

determined critical value that triggers an investigation

Statistical AnalysisExh.16-4

1 standarddeviation

1 standarddeviation

X

XX

XX

X

Time

Jan. Feb. March April May June

Favorablevariances

Unfavorablevariances

Criticalvalue

Investigate

16-24

Behavioral Effects Of Standard Costing

Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments

Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments

They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions

They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions

16-25

Direct-material price variance

Direct-material quantity variance

Direct-labor rate variance

Direct- labor efficiency variance

The purchasing manager

The production supervisor



Get the best prices available for purchased goods and services throughskillful purchasing practices

Skillful supervision and motivation of production employees, coupled withthe careful use and handling of materials, contribute to minimal waste

Generally results from using a different mix of employees than that anticipatedwhen the standard were set

Motivating employees toward production goals and effective work schedulesimproves efficiency

Which Managers Generally Influence Cost Variances?

16-26

Researchand

develop-ment

Design Supply Produc-

tion Marketing

Distri- bution

Customer service

HumanresourcesHuman

resources

PhysicalresourcesPhysical

resources

Variances in one part of the value chain can be due to root causes in another part of the chain

Variances in one part of the value chain can be due to root causes in another part of the chain

Interaction among variances often occur making it difficult to determine the responsibility for a particular variance

Interaction among variances often occur making it difficult to determine the responsibility for a particular variance

Interaction Among Variances

Value ChainValue Chain

PerspectivePerspective

Exh.16-5

16-27

Work-in-Process Inventory

Direct-material cost

Direct-labor cost

Manufacturing Overhead

Finished-Goods Inventory

Cost of Goods Sold Income Summary

Product cost transferredwhen product is finished

Product cost transferred when product is sold

Expense closed into

Income Summary at endof accounting period

Exh.16-6

Using Standard Costs For Product Costing

16-28

Variances are temporary

accounts, like revenue and

expense accounts, and

they are closed out at the end of the accounting

period.

Variances are temporary

accounts, like revenue and

expense accounts, and

they are closed out at the end of the accounting

period.

Cost of Goods Sold

Unfavorablevariancesrepresentcosts of

operatinginefficiently,

relative to thestandards, and

thus cause the Cost ofGoods Sold

to be higher

Favorablevariancesrepresentcosts of

operatingefficiently,

relative to thestandards, and

thus cause the Cost ofGoods Sold

to be lower

Disposition Of Variances

16-29

Impact of Information Technology on Standard Costing

16-30

Standard Costing: Advantages

Allows managers to use management by exception

Provides a basis for sensible cost comparisons

Provides a means of performance evaluation and rewards for employees

Allows managers to use management by exception

Provides a basis for sensible cost comparisons

Provides a means of performance evaluation and rewards for employees

Provides motivation for employees to

adhere to standards Results in more stable product costs

Is less expensive than actual- or normal- costing

systems

Provides motivation for employees to

adhere to standards Results in more stable product costs

Is less expensive than actual- or normal- costing

systems

16-31

Criticisms Of Standard Costing In Today’s Environment

Shorter product life cycles mean that standards are only relevant for a short time

Too much focus on cost minimization rather than increasing product quality or customer service

Automated manufacturing processes tend to be more consistent in meeting production specifications.

Not defined broadly enough to capture important aspect of ownership

Shorter product life cycles mean that standards are only relevant for a short time

Too much focus on cost minimization rather than increasing product quality or customer service

Automated manufacturing processes tend to be more consistent in meeting production specifications.

Not defined broadly enough to capture important aspect of ownership

Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system

Variances are often too late to be useful

Standard costing out of step with the philosophy of cost management systems and activity-based management

Too much focus on the cost and efficiency of direct labor

Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system

Variances are often too late to be useful

Standard costing out of step with the philosophy of cost management systems and activity-based management

Too much focus on the cost and efficiency of direct labor

16-32

Adaptation of Standard-Costing Systems

Reduced importance of

labor standards

Reduced importance of

labor standards

Shifting Cost Structures

Shifting Cost Structures

Cost Drivers

Cost Drivers

Emphasis on Material and

O/H costs

Emphasis on Material and

O/H costs

Shorter Product Life

Cycles

Shorter Product Life

Cycles

Non-Value-Added Costs

Non-Value-Added Costs

High Quality/Zero

Defects

High Quality/Zero

Defects

Real-time Information

Systems

Real-time Information

Systems

Benchmarking

Benchmarking

16-33

KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and

responsibility of each worker.

KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and

responsibility of each worker.

Cost per product unit

12/31/x0 12/31/x1

Time

Cost basefor next

year

Actual costreductionachieved

Current yearcost base

Kaizen goal:cost reduction

rate

Actual costperformance

of the current year

Exh.16-7

Kaizen Costing

16-34

END OF CHAPTER 16

chap016 standard costing

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