Chapter 11

Standard Costs and Operating Performance

Standard Costing Agenda Standard costs: Definition & Theory

Setting standards Standard Cost Variances
Materials variance  Labor variance  VMOH

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Standard Costs Defined

An estimate of what the costs of production should be Based on history, competition, engineering, supplier research, etc. Example:  Our standard cost for pretzel dough is $4 per pound.  Our standard dough quantity per pretzel is pound.  Standard cost for dough used in one pretzel is $1.00.
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Standard Costs Defined

Predetermined.

Standard Costs are

Used for planning labor, material and overhead requirements. Benchmarks for measuring performance.

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Standard Costs Defined

Management by exception: Managers focus on quantities and costs that differ from standards. . Dollars Spent Standard Pretzel Dough

Direct Labor

Manufacturing Overhead

Type of Product Cost

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Standard Costing Theory

Standard Costing origin
Company focus: Product Attributes driven by internal costs

Target Costing origin

Customer Focus: Internal costs driven by customer requirements

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Standard Costing Theory

Standard Costing origin
Company focus: Product Attributes driven by internal costs

Target Costing origin

Customer Focus: Internal costs driven by customer requirements

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Standard Costing Theory

Watch Your Focus

"Those who do not remember the past are condemned to repeat it. -George Santayana

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Standard Cost Theory

What can standard costing concepts do for todays businesses?
 Competition
 If

is quick and plentiful

you dont find your wasteful areas quickly, your competitors and your customers will!

 Responsibility
 Objective
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accounting
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feedback to the responsible folks

Standard Cost Introduction Agenda

Standard costs: Definition & Theory

Setting standard costs

Standard Cost Variances
Materials variance  Labor variance  VMOH


Balanced Scorecard
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Setting Standard Costs Ideal vs. Practical Standards

Ideal Standards
oAbsolute perfection oThe goal: constant improvement oHow can management by exception work when everything is a *%&^#! exception?
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Practical Standards
Attainable Exceptions will be fewer and more meaningful Best negotiators get the most slack built in to their standards
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Setting Standard Costs Ideal vs. Practical Standards

The gap between ideal and practical standards is shrinking. Ideal standards are more attainable, and their use more common Why is this happening?
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Setting Direct Material Standards

Price Standards
Final, delivered cost of materials

Quantity Standards
Use product design specifications and history of defects

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Exercise 11-1: Setting Standards Example

1. Standard cost for one quart of Echol.

1. Cost per 15-gallon container ............................... $115.00 LessOn the board or on the screen? You choose? 2.30 2% cash discount ....................................... Net 1) Compute standard purchase cost cost ............................................................ 112.70 Add shipping cost per container ($130 100) ...... 1.30 2) Compute standard quantity Total cost per 15-gallon container (a)................... $114.00 Number of quarts per container (15 gallons 4the materials part of a cost card 60 3) Create quarts per gallon) (b)................ Standard cost per quart purchased (a) (b) ........ $1.90

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Exercise 11-1: Setting Standards

2. Standard Quantity of Echol per salable bottle of the cleaning solvent.

2. Content per bill of materials ............................ 7.6 quarts Add On the board or on the and spillage allowance for evaporation screen? You choose? (7.6 quarts 0.95standard purchase cost 1) Compute = 8.0 quarts; 8.0 quarts 7.6 quarts = 0.4 quarts) ........... 0.4 quarts 2) Compute standard quantity Total ............................................................. 8.0 quarts Add allowance for rejected units (8.0 quarts 40 bottles).............................. card quarts 0.2 3) Create the materials part of a cost Standard quantity per salable bottle of solvent.. 8.2 quarts

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Exercise 11-1: Setting Standards

3. Standard cost card for one bottle of cleaning solution: Only one line show just for the Echol. What else goes in there? What can we do with this information?

Item Echol
.. ..

Standard Quantity 8.2 quarts

Standard Cost per Bottle Standard Price $1.90 per quart $15.58

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Setting Standards
Completed Pretzel Cost Card Example:
A
Standard Quantity or Hours

B
Standard Price or Rate

AxB
Standard Cost per Unit
1.00 1.00 0.30 2.30

Inputs

Direct materials .25 lbs Direct labor .1 hours Variable mfg. overhead .1 hours Total standard unit cost
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$ 4.00 per lb. $ 10.00 per hour 3.00 per hour $

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Standard Cost Introduction Agenda

Standard costs: Definition & Theory Setting standard costs

Standard Cost Variances

 Materials


variance

Labor variance  VMOH

Balanced Scorecard
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Standard Cost Variances

A standard cost variance is the amount by which an actual cost differs from the standard cost.

Standard Cost

This variance is unfavorable because the actual cost exceeds the standard cost.

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Standard Cost Variances

A standard cost variance is the amount by which an actual cost differs from the standard cost.

Standard Cost

This variance is favorable because the actual cost is below the standard cost.

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Variance Analysis Cycle

Identify questions Receive explanations You planned to spend $2,000 on supplies. You spent $3,000. Prepare standard cost performance report Take corrective actions

Analyze variances
Price vs. Qty

Conduct next periods operations

Begin
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Standard Cost Variances

What Causes Standard Cost Variances?

Price Variance

Quantity Variance

Difference between the actual price and the standard price

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Difference between the actual quantity used and the standard quantity
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A General Model for Variance Analysis

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

Price Variance The cost difference due to the price paid

Quantity Variance The cost difference due to the amount USED

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A General Model for Variance Analysis

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

Price Variance Quantity Variance Standard quantity is the quantity allowed for the actual output quantity. Standard input per unit of output times amount of output quantity.
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A General Model for Variance Analysis: Formulas

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

Price Variance
AQ(AP - SP) AQ = Actual Quantity AP = Actual Price
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Quantity Variance
SP(AQ - SQ) SP = Standard Price SQ = Standard Quantity
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Standard Cost Introduction Agenda

Standard costs: Definition & Theory Setting standard costs

Standard Cost Variances

 Materials


variance

Labor variance  VMOH

Balanced Scorecard
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Material Variances Forget me not

What if materials purchases dont match production usage? How does this change the variance calculations?
The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used.

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Quick Check
Purchased quantity or Used quantity? Which quantity is the price variance based on? Whats it trying to measure?
Purchased

Which quantity is the Quantity variance based on? Whats it trying to measure?
Used
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Material Variances Exercise 11-2.1

1. Made Number of helmets ........................................ Standard kilograms of plastic per helmet ...... Total standard kilograms allowed .................. Standard cost per kilogram............................ Total standard cost ........................................ Actual cost incurred (given)........................... Total standard cost (above) ........................... Total material variance unfavorable ............ 35,000 0.6 21,000 RM 8 RM 168,000 RM 171,000 168,000 RM 3,000

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Material Variances Exercise 11-2.1.a

Helmet materials variances data Materials Standards:
0.6 kg of plastic per helmet  RM 8 per kg of plastic


Actual data:
Produced 35,000 helmets  Purchased & used 22,500 kg of plastic  Total plastic cost RM 171,000

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Material Variances Exercise 11-2.2

Actual Quantity Purchased Actual Price 22,500 kg ? = RM 171,000 Actual Quantity Purchased Standard Price 22,500 kg RM 8 per kg = RM 180,000

Price variance RM 9,000 favorable

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Material Variances Exercise 11-2.2

Actual Quantity Used Standard Price 22,500 kg RM 8 per kg = RM 180,000 Standard Quantity allowed for output level Standard Price 0.6kg x 35,000 RM 8 per kg = RM 168,000

Quantity variance RM 12,000 unfavorable

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BIG NOTE: This only holds for Material Variances materials variances when Exercise 11-2.2 purchased/used quantities are the same Standard Quantity Actual Quantity Actual Quantity allowed for output Purchased/ Used Purchased level Standard Price Actual Price Standard Price 22,500 kg ? = RM 171,000 22,500 kg RM 8 per kg = RM 180,000 0.6kg x 35,000 RM 8 per kg = RM 168,000

Price variance RM 9,000 favorable

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Quantity variance RM 12,000 unfavorable

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Material Variances Exercise 10-2.1

Made 1. Number of chopping blocks................................. Number of board feet per chopping block............. Standard board feet allowed ............................... Standard cost per board foot............................... Total standard cost.............................................
Actual cost incurred............................................ Standard cost above........................................... Total variance unfavorable ................................ 4,000 2.5 10,000 $1.80 $18,000 $18,700 18,000 $ 700

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Material Variances Exercise 11-2

Chopping block materials variances data Materials Standards:
2.5 feet of wood per block  $1.80 per foot of wood


Actual data:
Produced 4,000 chopping blocks  Purchased & used 11,000 feet  Total wood cost $18,700

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Material Variances Exercise 10-2.2

Actual Quantity Purchased Actual Price 11,000 ft ? = $18,700 Actual Quantity Purchased/ Used Standard Price 11,000 ft $1.80 / ft = $19,800 Standard Quantity allowed for output level Standard Price 2.5 ft x 4,000 blocks $1.80 / ft = $18,000

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Material Variances Exercise 10-2.2

Actual Quantity Purchased Actual Price 11,000 ft ? = $18,700 Actual Quantity Purchased Standard Price 11,000 ft $1.80 / ft = $19,800

Price variance $1,100 favorable !

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Material Variances Exercise 10-2.2

Actual Quantity Used Standard Price 11,000 ft $1.80 / ft = $19,800 Standard Quantity allowed for output level Standard Price 2.5 ft x 4,000 blocks $1.80 / ft = $18,000

Quantity variance $1,800 unfavorable

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BIG NOTE: This only holds for Material Variances materials variances when Exercise 10-2.2 purchased/used quantities are the same Standard Quantity Actual Quantity Actual Quantity allowed for output Purchased/ Used Purchased level Standard Price Actual Price Standard Price 11,000 ft ? = $18,700 11,000 ft $1.80 / ft = $19,800 2.5 ft x 4,000 blocks $1.80 / ft = $18,000

Price variance $1,100 favorable !

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Quantity variance $1,800 unfavorable

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Responsibility for Material Variances You used too much material

because of your poorly run production department. You are responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. AND, your poor planning always makes me rush order material at a higher price than I could otherwise negotiate.

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Material Variance A Closer Look

Using low price, low quality materials may cause more waste. The favorable pricing variance may cause the unfavorable quantity variance.

Cheap Inputs

High Waste

Where should the corrective action take place?

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A General Model for Variance Analysis: Formulas

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

Price Variance
AQ(AP - SP) AQ = Actual Quantity AP = Actual Price
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Quantity Variance
SP(AQ - SQ) SP = Standard Price SQ = Standard Quantity
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Problem 11-15: DM Variances

NOTES for the materials price/quantity variances:


Use the actual purchased quantity to calculate the price variance. Remember, the point of this variance is to see how much we over/under spent because of the price we paid for all that we bought. Use the actual used quantity in production and the standard for the given level of production output to calculate the quantity variance. Remember, the quantity variance is supposed to measure how much we wasted/saved in the production process so you dont count good materials that are still on the shelf just count the production quantities.
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Problem 11-15: Direct Materials Variances

Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ AP) (AQ SP) (SQ SP) 12,000 plates 8,400 plates $2.50 per plate $2.50 per plate = $30,000 = $21,000 $28,200 o o o Price Variance, $1,800 F Qty 10,500 plates $2.50 per plate = $26,250 Variance o Work Quantity Variance, Price $5,250 U Variance

Work
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Final Exam Study Topics

Cost of goods manufactured/Sold 3 Separating fixed & Variable costs 5 CVP analysis: Your choice of tools 6 Variable vs. Absorption costing 7 ABC costing case 8 Budgeting raw materials or similar 9 Variance analysis 10 Flexible budgeting 11 Relevant cost analysis: eg cutting a division 12/13 Capital budgeting: Present value 14
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Standard Cost Introduction Agenda

Standard costs: Definition & Theory Setting standard costs

Standard Cost Variances



Materials variance

 Labor


variance

VMOH Balanced Scorecard

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Labor Variances Note: Same thing, different labels

Materials variances:


Material price variance  MPV = AQ (AP - SP) Material quantity variance  MQV = SP (AQ - SQ) Labor rate variance  LRV = AH (AR - SR) Labor efficiency variance  LEV = SR (AH - SH)

Actual hours Actual rate Standard rate Standard hours allowed for the actual good output
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Labor variances:


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Exercise 11-3: Total Direct Labor Variance

Number of meals prepared....................... 4,000 Standard direct labor-hours per meal ...... 0.25 Total direct labor-hours allowed .............. 1,000 Standard direct labor cost per hour.......... $9.75 Total standard direct labor cost ............... $9,750 Actual cost incurred ................................. Total standard direct labor cost (above) .................................................. Total direct labor variance ....................... $9,600 9,750 $ 150 Favorable

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Labor Variances Standard Example: Exercise 11-3.2allowed forhours output

Actual Hours Actual Rate 960 hours $10.00 per hour = $9,600 Actual Hours Standard Rate 960 hours $9.75 per hour = $9,360 level Standard Hours Standard Rate Standard Rate $9.75 per hour = $9,750
.25 hrs x 4,000meals

Rate variance $240 Unfavorable

Efficiency variance $390 Favorable

Total Variance $150 Favorable

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Problem 11.15: Labor Variances

NOTE: Since we didnt buy any more labor than we used, the ACTUAL quantity is the same for both the rate and efficiencies.

Yeah!
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Labor Variances
Your Turn: Problem 11-15
Actual Hours Actual Rate 1,150 hours $12.00 per hour = $13,800 Actual Hours Standard Rate 1,150 hours $14.00 per hour = $16,100 Standard hours allowed for output level Standard Hours Standard Rate Standard Rate 900 hours $14.00 per hour = $12,600

Rate variance $2,300 Favorable

Efficiency variance $3,500 Unfavorable

Total Variance $1,200 Unfavorable

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Labor Rate Variance A Closer Look

What variances would you expect if. Using high-paid labor to perform low skill tasks. High skill, high rate Using low-paid labor to perform high skill tasks. Using one high skill person to mentor a team of low skill workers. Low skill, low rate

Production managers who make work assignments are generally responsible for all labor variances.
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Labor Efficiency Variance A Closer Look at causation

Poorly trained workers Low volume Poor quality materials

Unfavorable Efficiency Variance

Poor supervision of workers
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Poorly maintained equipment

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Responsibility for Labor Variances

Maybe I can attribute the labor and material variances to personnel for hiring the wrong people and training them poorly.

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Standard Cost Introduction Agenda

Standard costs: Definition & Theory Setting standard costs

Standard Cost Variances



Materials variance

 Labor

variance  VMOH
Balanced Scorecard
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VMOH Variance Note

Labor variances:


Labor rate variance  LRV = AH (AR - SR) Labor efficiency variance  LEV = SR (AH - SH)

Actual hours of the allocation base Actual variable overhead rate Standard variable overhead rate

Variable overhead variances:



Variable overhead spending variance  VOSV = AH (AR - SR) Variable overhead efficiency variance  VOEV = SR (AH SH) Standard hours allowed for the actual good output The McGraw-Hill Companies, Inc., 2003

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Variable Manufacturing Overhead Variances Ex. 11-4.1

1. Number of items shipped ........................................ Standard direct labor-hours per item ...................... Total direct labor-hours allowed ............................. Standard variable overhead cost per hour .............. Total standard variable overhead cost .................... Actual variable overhead cost incurred ................... Total standard variable overhead cost (above) ....... Total variable overhead variance ............................ 120,000 0.02 2,400 $3.25 $ 7,800 $7,360 7,800 $ 440 Favorable

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Variable Manufacturing Overhead Variances Ex. 11-4 Standard hours

Actual Hours Actual Rate Actual Hours Standard Rate

allowed for output level Standard Hours Standard Rate Standard Rate

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Variable Manufacturing Overhead Variances Ex. 11-4 Standard hours

Actual Hours Actual Rate 2,300 hours $3.20 per hour = $7,360 Actual Hours Standard Rate 2,300 hours $3.25 per hour = $7,475

allowed for output level Standard Hours Standard Rate Standard Rate 2,400 hours $3.25 per hour = $7,800

Spending variance $115 Favorable

Efficiency variance $325 Favorable

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Total variance $440 Favorable

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Variable Manufacturing Overhead Variances A Closer Look

If variable overhead is applied on the basis of direct labor hours, the labor efficiency and variable overhead efficiency variances will move in tandem. The causal relationship may go both ways.

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Problem 11-15: Variable MOH Variances

Actual Hours of Input, at the Actual Rate (AH AR) Standard Hours Actual Hours of Input, Allowed for Output, at the Standard Rate at the Standard Rate (AH SR) (SH SR) 1,150 hours 900 hours $6.00 per hour $6.00 per hour = $6,900 = $5,400 $7,820 o o o Spending Variance, Efficiency Variance, $920 U $1,500 U Total Variance, $2,420 U

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Variance Analysis and Management by Exception

How do I know which variances to investigate?

Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
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Advantages of Standard Costs

Improved cost control Management by exception

Advantages
Improved performance evaluation
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Better planning and decision making

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Disadvantages of Standard Costs

Emphasis on negative tendency may impact morale.

Potential Problems

Continuous improvement may be impaired

Expensive in time and money.

Emphasizing standards may exclude other important objectives.

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Generalizing Disadvantages of Standard Costing

Measured and rewarded goals/objectives are performed to. Those goals/objectives are usually not perfectly aligned with corporate mission

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Airline hires temps to fill plane

DUBLIN (Reuters) - Flybe has given the term low-fare airline an entirely new meaning: it is paying 172 people to fly back and forth across England and the Irish Sea to help it meet a target for passenger numbers at Norwich airport. Flybe was narrowly falling short of a target to deliver at least 15,000 passengers on the Dublin-Norwich route in the 12 months ending on Monday, which meant it would have to forego a 280,000 pound ($550,000) rebate from the airport. After the airport rejected a request for a partial rebate for almost hitting the target, Flybe hired 172 temps for 30-40 pounds each, plus a free bar and inflight entertainment, though it admitted "it probably sounds like an early April fool." But Richard Jenner, managing director of the airport in eastern England, called the British carrier's move "ludicrous" and said the target had to be met by regular fare-paying passengers. "The ludicrousness is on the Norwich side who in essence have tried to hold us to ransom, putting at risk routes into Norwich," Flybe Chief Commercial Officer Mike Rutter replied in a joint interview with Jenner on Irish public broadcaster RTE. (Reporting by Andras Gergely; Editing by Jon Boyle) The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
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The Balanced Scorecard

Management translates its strategy into performance measures that align with the company mission
Customers

Financial

Performance measures
Internal Operating processes
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Learning and growth

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Benefits of Balance Scorecard

If implemented well:


Forces management to build a coherent strategy Strategy is communicated throughout organization. Performance measures convert the mission into actionable & measureable objectives. Portfolio of measures aligns performance with company well being reduced gaming
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The Balanced Scorecard

Corporate Performance

Financial

Customers

Internal Operating Processes

Learn and Grow

Reduce Defects
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Reduce Delivery Cycle Time

Improve Product Quality

Reduce Costs

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Some Possible Problems

  

Program fatigue. Culture shock/resistance. Every existing performance measure has a champion. Gaming still possible. This is NOT keeping it simple

 

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Problem 10-21: Team Effort

Analyze ONE of the FOUR situations. Evaluate the effects the proposed change would have upon all categories of the balanced scorecard. How do you expect the whole combination of effects to impact your firm overall? Propose other measures that will help induce successful behavior across the balanced scorecard. Be prepared within 6 minutes to share your findings for each of the above questions.


You will have about 1-2 minutes to present.

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Standard Costing vs. Lean Manufacturing & Throughput

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Delivery Performance Measures

Order Received Production Started Goods Shipped

Wait Time

Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time

Process time is the only value-added time.

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Delivery Performance Measures

Order Received Production Started Goods Shipped

Wait Time

Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time

Manufacturing Cycle = Efficiency

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Value-added time Throughput time

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Exercise 11-5 Business Process Performance

1.Throughput time =

Process time + Inspection time + Move time + Queue time

= 2.7 days + 0.3 days + 1.0 days + 5.0 days = 9.0 days
2. Only process time is value-added time; therefore the manufacturing cycle efficiency (MCE) is:

Value-added time 2.7 days MCE = = = 0.30 Throughput time 9.0 days
3. If the MCE is 30%, then the complement of this figure, or 70% of the time, was spent in non-value-added activities.
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Exercise 11-5 Business Process Performance

4. Delivery cycle time = Wait time + Throughput time = 14.0 days + 9.0 days = 23.0 days

Question: If you are the customer, what do you care about? the 9 days or the 23 days?

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Exercise 11-5 Business Process Performance

The effect of shifting from a labor efficiency focus to a Just in time (JIT), lean manufacturing focus:
5. If all queue time in production is eliminated, then the throughput time drops to only 4 days (2.7 + 0.3 + 1.0). The MCE becomes:

Value-added time 2.7 days MCE = = = 0.675 Throughput time 4.0 days
Thus, the MCE increases to 67.5%. JIT can improve the efficiency of operations and reduce throughput time. Depending on how JIT is applied to raw materials ordering, could it actually increase delivery cycle time?
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Internal Business Focus vs. Customer Centric Focus

Internal Focus
Company focus: Price competition may be all thats left.

Customer Centric
Customer Focus: Innovation, Customers happy to pay, margins

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Unfair Comparison ?

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End of Chapter 11

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