principles of accounting/ financial and managerial accounting chapter 23

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Standard Cost SystemsChapter

23


Benchmarks formeasuring performance.

The expected levelof performance.

Based on carefullypredetermined amounts.

Used for planning labor, materialand overhead requirements.Standard

Costs are

Standard Cost SystemsStandard Cost Systems


DirectMaterial

Type of Product Cost

Am

ou

nt

DirectLabor

ManufacturingOverhead

Standard cost

A standard cost varianceis the amount by which

an actual cost differs fromthe standard cost.



Type of Product Cost

Am

ou

nt

This variance is unfavorable because the actual cost

exceeds the standard cost.

This variance isfavorable because

the actual costis less than thestandard cost.

Standard cost


DirectLabor

ManufacturingOverhead

DirectMaterial


Prepare standard cost performance

report

Conduct next period’s

operations

Analyze variances

Identifyquestions

Receive explanations

Takecorrective

actions

Begin

Variance AnalysisVariance Analysis


Should we usenormal standards

or ideal standards?

EngineerManagerialAccountant

Establishing and RevisingStandard Costs


Normal standards should beset at levels that are currentlyattainable with reasonable and

efficient effort.

Productionmanager


I agree. Ideal standards, that are based on perfection, are

unattainable and therefore discouraging to most employees.

HumanResourcesManager




Are standards the same as budgets?

A standard is the expected cost for one

unit.

A budget is the expected cost for all

units.

Use of Standard Costs in Developing Budgets

Use of Standard Costs in Developing Budgets


Use product design specifications.

Use competitivebids for the quality

and quantity desired.

QuantityStandards

Direct Material Standards Direct Material Standards

PriceStandards


The standard material cost for one unit of product is:

standard quantity standard price for of material one unit of material required for one

unit of product

×

Direct Material Standards Direct Material Standards


TimeStandards

RateStandards

Direct Labor Standards Direct Labor Standards

Use time and motion studies for

each labor operation.

Use wage surveys and

labor contracts.


The standard labor cost for one unit of product is:

standard number standard wage rate of labor hours for one hour for one unit of product

×

Setting Direct Labor StandardsSetting Direct Labor Standards


ActivityStandards

RateStandards

Manufacturing Overhead Standards Manufacturing Overhead Standards

The activity is the cost driver used to

calculate the overhead rate.

The rate is basedon an estimate of totaloverhead at the normal

level of activity.


×

The standard overhead cost for one unit of product is:

standard variable standard number overhead rate for of activity units one unit of for one unit of activity product

×

Manufacturing Overhead Standards Manufacturing Overhead Standards


Standard Cost Variances

Quantity VariancePrice Variance

A General Model forVariance Analysis


The difference betweenthe actual price and the

standard price

The difference betweenthe actual quantity andthe standard quantity


Standard price is the amount that should have been paid for the resources acquired.

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Quantity Variance








Standard quantity is the quantity that should have been used for the actual good output.


Let’s use the concepts of the

general model to calculate standard

cost variances, starting with

direct material.

Standard Costs and Variance Analysis: An Illustration



Hanson Inc. has the following material standard to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Records last week show 1,700 pounds of material were purchased on May 10 at a

total cost of $6,630. The material was used to make 1,000 Zippies that were completed

on May 15.



Zippy




Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

Material Price and Quantity Variances

Material Price and Quantity Variances


The actual price per pound paid forthe material was

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.


a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

Material VariancesQuestion 1


Zippy



a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.


a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

AP = $6,630 ÷ 1,700 lbs.AP = $3.90 per lb.



Zippy




Hanson’s material price variance (MPV)for the week was

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.



b. $170 favorable.


d. $800 favorable.

Zippy




b. $170 favorable.


d. $800 favorable.



b. $170 favorable.


d. $800 favorable.

MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($3.90 - 4.00) MPV = $170 favorable



Zippy


The standard quantity of material thatshould have been used to produce

1,000 Zippies is

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.


1,000 Zippies is

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.



Zippy



1,000 Zippies is

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.


1,000 Zippies is

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.

SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs



Zippy


Hanson’s material quantity variance (MQV) for the week was


b. $170 favorable.


d. $800 favorable.



b. $170 favorable.


d. $800 favorable.



Zippy




b. $170 favorable.


d. $800 favorable.



b. $170 favorable.


d. $800 favorable.

MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable



Zippy



1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb.

$6,630 $ 6,800 $6,000

Price variance$170 favorable

Quantity variance$800 unfavorable

Material VariancesSummary

Material VariancesSummary

Zippy


I am not responsible for this unfavorable material

quantity variance.

You purchased cheapmaterial, so my peoplehad to use more of it.

Responsibility forMaterial VariancesResponsibility forMaterial Variances

You used too much material because of poorly trained

workers and poorly maintained equipment.

Also, your poor scheduling sometimes requires me to

rush order material at a higher price, causing

unfavorable price variances.


Let’s turn our

attention to labor

variances.

Labor Rate and Efficiency Variances



Hanson Inc. has the following labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $8.00 per hour

Payroll records last week show 1,450 hours were worked at a total labor cost of $11,890 to make 1,000 Zippies that

were completed on May 15.



Zippy


Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

Rate Variance Efficiency Variance

Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance

AH(AR - SR) SR(AH - SH)

AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours




Hanson’s actual rate (AR) for laborfor the week was

a. $8.20 per hour.

b. $8.00 per hour.

c. $7.80 per hour.

d. $7.60 per hour.


a. $8.20 per hour.

b. $8.00 per hour.

c. $7.80 per hour.

d. $7.60 per hour.

Labor VariancesQuestion 1


Zippy



a. $8.20 per hour.

b. $8.00 per hour.

c. $7.80 per hour.

d. $7.60 per hour.


a. $8.20 per hour.

b. $8.00 per hour.

c. $7.80 per hour.

d. $7.60 per hour.

AR = $11,890 ÷ 1,450 hours AR = $8.20 per hour



Zippy


Hanson’s labor rate variance (LRV) forthe week was


b. $290 favorable.


d. $400 favorable.



b. $290 favorable.


d. $400 favorable.



Zippy




b. $290 favorable.


d. $400 favorable.



b. $290 favorable.


d. $400 favorable.

LRV = AH(AR - SR) LRV = 1,450 hrs($8.20 - $8.00) LRV = $290 unfavorable



Zippy


The standard hours (SH) of labor thatshould have been worked to produce

1,000 Zippies is

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.


1,000 Zippies is

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.



Zippy



1,000 Zippies is

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.


1,000 Zippies is

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours



Zippy


Hanson’s labor efficiency variance (LEV) for the week was


b. $290 favorable.


d. $400 favorable.



b. $290 favorable.


d. $400 favorable.



Zippy




b. $290 favorable.


d. $400 favorable.



b. $290 favorable.


d. $400 favorable.

LEV = SR(AH - SH) LEV = $8.00(1,450 hrs - 1,500 hrs) LEV = $400 favorable



Zippy


Rate variance$290 unfavorable

Efficiency variance$400 favorable

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

1,450 hours 1,450 hours 1,500 hours × × × $8.20 per hour $8.00 per hour $8.00 per hour

$11,890 $11,600 $12,000

Labor VariancesSummary

Labor VariancesSummary

Zippy


High skill,high rate

Low skill,low rate

Using highly paid skilled workers toperform unskilled tasks results in an

unfavorable rate variance.

Production managers who make work assignmentsare generally responsible for rate variances.

Production managers who make work assignmentsare generally responsible for rate variances.

Labor Rate VarianceLabor Rate Variance


UnfavorableEfficiencyVariance

Poorlytrainedworkers

Poorsupervisionof workers

Poorquality

materials

Poorlymaintainedequipment

Labor Efficiency VarianceLabor Efficiency Variance


I am not responsible for the unfavorable labor

efficiency variance!

You purchased cheapmaterial, so it took more

time to process it.

You used too much time because of poorly

trained workers and poor supervision.

Responsibility for Labor VariancesResponsibility for Labor Variances


Maybe I can attribute the laborand material variances to personnel

for hiring the wrong peopleand training them poorly.

Responsibility for Labor VariancesResponsibility for Labor Variances


Let’s turn our attention to

manufacturing overhead

Manufacturing Overhead VariancesManufacturing Overhead Variances


Recall that overhead costs are applied to products and services using a

predetermined overhead rate (POHR):

POHR =

Applied Overhead = POHR × Standard Activity

Estimated total overhead costs

Estimated activity



Overhead Rate

Contains variableoverhead thatincreases as

activity increases.

Contains fixedoverhead that

remains constant asactivity changes.

Function of activity levelchosen to determine rate.



Hanson, Inc. has the following manufacturing overhead at three different levels of activity:

Hanson applies overhead based on machine hour activity.

Machine Hours 2,000 3,000 4,000 Zippies 1,000 1,500 2,000

Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$

Manufacturing OverheadVariances Example


Zippy


Overhead Variances Question 1


Zippy

The total overhead rate for an estimated activity of 3,000 machine hours (MH) is:

a. $5.00 per machine hour.

b. $4.00 per machine hour.

c. $3.00 per machine hour.

d. $2.00 per machine hour.

















$15,000 ÷ 3,000 machine hours



Zippy












$15,000 ÷ 3,000 machine hours

The $5.00 overhead rate containsa variable portion:

$6,000 ÷ 3,000 MH = $2.00 per MHand a fixed portion:

$9,000 ÷ 3,000 MH = $3.00 per MH



Zippy


Budgeted Applied Actual Overhead at Overhead at Overhead Actual Activity Standard Hours

Spending Variance

VolumeVariance




Spending Variance

VolumeVariance


Shows how economicallyoverhead services were

purchased and howefficiently overheadservices were used.

Contains both fixedand variable costs.

A controllable variance.



Spending Variance

VolumeVariance


Caused by producing ata level other than that

used for computing thestandard overhead rate.

Contains only fixed costs.


Hanson’s actual production for theperiod was 1,600 Zippies resulting in

3,200 standard machine hours. Actual total overhead cost for the period was

$15,450.

Compute the overhead spending and volume variances.



Zippy


Budgeted Applied Actual Overhead at Overhead at Overhead Standard Hours Standard Hours $15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.

$2.00 per hr. × 3,200 hrs.



Zippy


Budgeted Applied Actual Overhead at Overhead at Overhead Standard Hours Standard Hours

Spending variance$50 unfavorable

Volume variance$600 favorable

$15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.

$15,450 $15,400 $16,000



Zippy


Standard Cost Variances

Immaterial Amounts

Close toCost of Goods Sold

Work in ProcessFinished GoodsCost of Goods Sold.

Material Amounts

Close byapportioning to:

Disposing of VariancesDisposing of Variances


Advantages

Improved cost control and performance

evaluation.

Better informationfor planning anddecision making.

Possible reductionsin production costs.

Advantages of Standard CostsAdvantages of Standard Costs


DisadvantagesEmphasis onnegative

exceptions mayimpact morale.

Emphasis on negativeexceptions may

lead to under-reporting.

It may be difficultto determine

which variancesare significant.

Disadvantages of Standard CostsDisadvantages of Standard Costs


JIT systems may reduce unfavorable variances.

Long-term agreementswith suppliers eliminate

price variances.

Emphasis on qualityreduces material

quantity variances.

Well-trained flexiblework force reduces labor

efficiency variance.

JIT Systems and Variance AnalysisJIT Systems and Variance Analysis


End of Chapter 23End of Chapter 23

principles of accounting/ financial and managerial accounting chapter 23

Education

total overhead

purchased

standard cost

manufacturing

manufacturing

labor rate

variance analysis

standard costs