standard costing, variance analysis and kaizen costing

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

16Standard Costing,Variance Analysis

and Kaizen Costing

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Learning Objective 1

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benchmarks formeasuring performance.

the expected levelof performance.

used for planning laborand material requirements.Standard

costs are

based on carefullypredetermined amounts.

Using Standard-Costing Systems for Control

16-4

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 COSTincurred and

recorded in the production of the product or service

ACTUAL COSTincurred and

recorded 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


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Pro

du

ct c

ost

Standard

A standard cost varianceis the amount by which

an actual cost differs fromthe standard cost.

This variance is unfavorable because the actual cost

exceeds the standard cost.


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Directmaterials

Managers focus on quantities and coststhat deviate significantly from standards

(a practice known as management by exception).

Type of Product Cost

Am

ou

nt

Directlabor

Standard

Management by Exception

16-7

Take the time to investigate only significant cost variances.Take 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

16-8

Prepare standard cost performance

report

Conduct next period’s

operations

Analyze variances

Identifyquestions

Receive explanations

Takecorrective

actions

Begin

Variance Analysis Cycle

16-9

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?

Combinedapproach

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

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Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on

experience and expectations.

Participation in Setting Standards

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16-12

Perfection versus Practical Standards: A Behavioral Issue

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 expected to

be attained

Tight as practical,but still 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

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Should we usepractical standards

or perfection standards?

Practical standardsshould be set at levels

that are currentlyattainable with reasonable andefficient effort.


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I agree. Perfection standards are

unattainable and therefore discouraging

to most employees.


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QuantityStandards

PriceStandards

Use product design specifications.

Use competitivebids for the quality

and quantity desired.

Setting Standards – Direct Materials

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The standard materials cost for one unit of product is:

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

unit of product

×

Setting Standards – Direct Materials

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Efficiencystandards

Ratestandards

Use time and motion studies for

each labor operation.

Use wage surveys and

labor contracts.

Setting Standards – Direct Labor

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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 Standards – Direct Labor

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Jobs with repetitive tasks lend themselves to efficiency measures.

Computing non-manufacturing efficiency variances requires some assumed relationship between input and output activity. Examples Examples

Standard Cost in Service Industries

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Department Input Output

Mailing Labor hours Number of pieces mailed

Personnel Labor hours Number of personnel changes processed

Food service Labor hours Number of meals served

Consulting Billable hours Customer revenues

Nursing Labor hours Number of patients and/or procedures

Check processing Computer hours Number of checks processed

Standard Cost in Service Industries

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

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

Costs and Benefits ofStandard-Costing Systems

IMPROVEDDECISION

MAKING, BUT:

IMPROVEDDECISION

MAKING, BUT:

Costs Benefits

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Quantity variancePrice variance

The difference betweenthe actual price and the

standard price

The difference betweenthe actual quantity andthe standard quantity

Standard cost variances

Cost Variance Analysis

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A General Model for Variance Analysis

Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price

Price / Ratevariance

Quantity / Efficiency variance

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A General Model forVariance Analysis


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



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Standard quantity is the quantityallowed for the actual good output.

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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



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Let’s use the concepts of the

general model to calculate standard

cost variances, starting with

direct materials.

Standard Costs

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Koala Camp Gear Company in MelbourneAustralia has the following direct material

standard to manufacture one Tree Line tent:

12 square meters per tent at$8.00 per square meter (sq m)

Last month Koala purchased 40,000 squaremeters at $8.15 per square meter and used36,400 square meters to make 3,000 tents.

Materials Variances

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We should compute the price variance using the actual

quantity purchased.

Price variance$6,000 Unfavorable

40,000 sq m 40,000 sq m × × $8.15 per sq m $8.00 per sq m

$326,000 $320,000

Actual quantity Actual quantity purchased purchased × × Actual price Standard price

Materials Variances

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We should compute the quantity variance

using the actual quantity used.

Quantity variance$3,200 Unfavorable

36,400 sq m 36,000 sq m × × $8.00 per sq m $8.00 per sq m

$291,200 $288,000

Actual quantity used Standard quantity × × Standard price Standard price

SQ = 3,000 tents × 12 sq m per tent SQ = 36,000 sq m

Materials Variances

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MPV = AQp(AP – SP) MPV = 40,000 sq m × ($8.15 – $8.00) MPV = $6,000 Unfavorable

MQV = SP(AQu – SQ) MQV = $8.00(36,400 sq m – 36,000 sq m) MQV = $3,200 Unfavorable

We may also calculate materialsvariances using formulas:

We may also calculate materialsvariances using formulas:

Materials Variances

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Okay. I’ll computethe price variance when

materials are purchased, and the usage variance assoon as material is used.

I need the variances as soonas possible so that I canbetter identify problems

and control costs.

You accountants just don’tunderstand the problems weproduction managers have.

Reporting Materials Variances

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Responsibility for Materials Variances

I am not responsiblefor this unfavorable

materials usagevariance.

You bought poor qualitymaterials, so my people

had to use more of it.

Your poorly trained workers and poorly maintained equipment

caused the problems.

Also, your poor scheduling requires rush orders of

materials at higher prices, causing unfavorable price

variances.

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Now let’s calculate standard cost variances for direct labor.

Standard Costs

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Koala has the following direct laborstandard to manufacture one Tree Line tent:

2 standard hours per tent at$18.00 per direct labor hour

Last month 5,900 direct labor hours were worked at $19.00 per hour to make 3,000 tents.

Labor Variances

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Actual hours Actual hours Standard hours × × × Actual rate Standard rate Standard rate

Rate variance$5,900 Unfavorable

Efficiency variance$1,800 Favorable

5,900 hours 5,900 hours 6,000 hours × × ×$19.00 per hour $18.00 per hour $18.00 per hour

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

SH = 3,000 tents × 2 hours per tent SH = 6,000 hours

Labor Variances

16-38

LRV = AH(AR - SR) LRV = 5,900 hrs($19.00 - $18.00) LRV = $5,900 Unfavorable

LEV = SR(AH - SH) LEV = $18.00(5,900 hrs - 6,000 hrs) LEV = $1,800 Favorable

We may also calculate laborvariances using formulas:

We may also calculate laborvariances using formulas:

Labor Variances

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Labor Rate Variance – A Closer Look

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

High skill,high rate

Low skill,low rate

Using highly paid skilled workers toperform unskilled tasks results in an

unfavorable price variance.

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Labor Efficiency Variance –A Closer Look

UnfavorableEfficiencyVariance

Poorlytrainedworkers

Poorquality

materials

Poorlymaintainedequipment

Poorsupervisionof workers

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You used too much time because of poorly

trained workers and poor supervision.

I am not responsible for the unfavorable labor

efficiency variance!

You bought poor qualitymaterials, so my people tookmore time to process them.

Responsibility for Labor Variances

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Maybe I can attribute the laborand materials variances to personnel

for hiring the wrong peopleand training them poorly.

Responsibility for Labor Variances

16-43

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 or Spoilage

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16-45

????

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?

Size of varianceSize of variance

Absolute amountAbsolute amount Relative amountRelative amount

Significance of Cost Variances: When to Follow Up

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Size of variance Dollar amount Percentage of standard

Recurring variances Trends Controllability Favorable variances Costs and benefits of

investigation

What clues help me to determine the

variances that I should investigate?

Significance of Cost Variances

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How do I know which variances to investigate?

Larger variances, in dollar amount or as a

percentage of the standard, are

investigated first.

We could use a rule of thumb such as:investigate all variances that are over $10,000

or over 10 percent of the standard cost.

We could use a rule of thumb such as:investigate all variances that are over $10,000

or over 10 percent of the standard cost.

16-48

Month VariancePercentage of standard cost

September $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%


September $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% for any one month, but they should be investigated

because of they have continued for several months.

None of the variances are greater than $10,000 or10% for any one month, but they should be investigated

because of they have continued for several months.


What about recurring variances?

16-49


September $ 250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%


September $ 250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%


What about trends?

None of the variances are greater than $10,000 or10% for any one month, but they should be

investigated because of the unfavorable trend.

None of the variances are greater than $10,000 or10% for any one month, but they should be

investigated because of the unfavorable trend.

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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


16-51

Display variations in a process and help to

analyze the variationsover time.

Distinguish between random variationsand variations that

should be investigated.

Provide a warning signal when variationsare beyond a specified level.

Controlcharts

Statistical Analysis

16-52

1 2 3 4 5 6 7 8 9

Variance measurements

Favorable limit

Unfavorable limit

Desired value • • •• •

••

••

Warning signals for investigation

Statistical Analysis

16-53


16-54

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

16-55

Direct-materials price variance

Direct-materials quantity variance

Direct-labor rate variance

Direct-labor efficiency variance

Purchasing manager

Production supervisor



Get the best prices available for purchased goods andservices through skillful 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 employeesthan that anticipated when the standard were set

Motivating employees toward production goals andeffective work schedules improves efficiency

Which Managers Influence Cost Variances?

16-56

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 bedue to root causes in another part of the chain.Variances in one part of the value chain can bedue to root causes in another part of the chain.

Interaction among variances often occurs, making it difficult to determine the responsibility for a particular variance.

Interaction among variances often occurs, making it difficult to determine the responsibility for a particular variance.

Interaction among Variances

Value chainValue chain

perspectiveperspective

Exh.16-5

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16-58

Work-in-process inventory

Direct-materials costDirect-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

16-59

Standard Cost Journal Entries

Inventories are recorded at standard cost. Variances are recorded as follows:

Favorable variances are credits, representing savings in production costs.

Unfavorable variances are debits, representing excess production costs.

Standard cost variances are usually closed to cost of goods sold. Favorable variances decrease cost of goods sold. Unfavorable variances increase cost of goods sold.

Inventories are recorded at standard cost. Variances are recorded as follows:

Favorable variances are credits, representing savings in production costs.

Unfavorable variances are debits, representing excess production costs.

Standard cost variances are usually closed to cost of goods sold. Favorable variances decrease cost of goods sold. Unfavorable variances increase cost of goods sold.

16-60

Impact of Information Technology on Standard Costing

Materials purchasesand uses are recorded

at standard,using bar codes.

Labor time and rate are recorded at standard,

using bar codesand employee IDs.

CAD designers can accessthe data base for instantdesign cost estimates.

Standard costdata base

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16-62

Standard Costing: Its Traditional Advantages

Managementby exception

Performanceevaluation

Employeemotivation

Sensible costcomparisons

Advantages

More stableproduct costs

Less expensive thanactual- or normal-costing systems

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16-64

Criticisms of Standard Costing in Today’s Manufacturing Environment

There is too much focus on the cost and efficiency of direct labor.

Automation reduces labor costs and the significance of labor variances.

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

Variance reports are often provided too late to be useful to managers.

There is too much focus on the cost and efficiency of direct labor.

Automation reduces labor costs and the significance of labor variances.

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

Variance reports are often provided too late to be useful to managers.

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

Standard costing may not be applicable in flexible manufacturing operationswith short life-cycle products.

There is too much focus on cost minimization rather than increasing product quality or customer service.

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

Standard costing may not be applicable in flexible manufacturing operationswith short life-cycle products.

There is too much focus on cost minimization rather than increasing product quality or customer service.

16-65

Adaptation of Standard-Costing Systems

Applications of standard costing have adapted tochanges in the manufacturing environment and the

resulting criticisms leveled at standard costing.



Automation means more overhead,

less labor.

Automation means more overhead,

less labor.

Reduced importance of

labor standards.

Reduced importance of

labor standards.

More emphasis on material and

overhead costs.

More emphasis on material and

overhead costs.

Less use of laboras a cost driver.

Less use of laboras a cost driver.

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Reduces labor efficiency variance

Reduces labor efficiency variance

Reduces material quantity variance

Reduces material quantity variance

AutomationAutomation

Reduces variation in qualityand increases quality

Reduces variation in qualityand increases quality

16-67






Shorter product life

cycles

Shorter product life

cycles

Elimination of non-value-added costs

Elimination of non-value-added costs

More frequent revisions of

standard costs

More frequent revisions of

standard costs

More frequent benchmarking

More frequent benchmarking

Real-time information systems provide more timely

variance reports

Real-time information systems provide more timely

variance reports

Non-financial measures such a delivery times are

more important

Non-financial measures such a delivery times are

more important

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16-69

Comparing Standard Costing and Kaizen Costing

Standard costing – the use of carefully predetermined product costs for budgeting and performance evaluation. Standard costs are typically used in established

production processes.

Kaizen costing – the emphasis is on continuous reduction of production costs. Rather than standards or targets, the goal is current

costs that are less than previous costs.

Standard costing – the use of carefully predetermined product costs for budgeting and performance evaluation. Standard costs are typically used in established

production processes.

Kaizen costing – the emphasis is on continuous reduction of production costs. Rather than standards or targets, the goal is current

costs that are less than previous costs.

16-70

Co

st p

er p

rod

uct

un

it

12/31/x0 12/31/x1Time

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

Kaizen goal:cost reduction

amount

16-71


16-72

Production Mix and Yield Variances Nearly all production processes require

multiple materials and labor inputs. A summary quantity variance for materials

and labor would hide the individual effects of these inputs.

The quantity variances can be analyzed into two further variances: Mix (the difference between actual and

standard input proportions) Yield (the difference between actual and

standard input used) The analysis assumes, of course, that the

inputs can be substituted for each other.

16-73

End of Chapter 16

standard costing, variance analysis and kaizen costing

Documents

standard labor cost

unit of product standard

standard materials cost

cost standards c

practical standards

perfection standards

setting standards accountants

significant cost variances