Control Through Standard Costs

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CHAPTER 24
CONTROL THROUGH STANDARD COSTS
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CHAPTER 24
CONTROL THROUGH STANDARD COSTS
Caution! This chapter is second only to Chapter
15 (bonds) for the amount of grief it causes most
students in this course.
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Nature of Standard Costs

• Up to this point in the course, we have been
  using actual costs.
• This chapter considers standard costs (i.e., what
  costs should be under stated conditions).
• The achievement of standard represents a
  reasonable and acceptable level of performance.
• Standards for materials, labor, and overhead are
  determined through engineering studies and time
  and motion studies.

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Nature of Standard Costs
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Nature of Standard Costs
DirectMaterial
DirectLabor
ManufacturingOverhead
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Standard Cost Variances
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Standard Cost Variances
The overhead variance is favorable becausethe
actual cost is less than the standard cost.
The materials variance is unfavorable because the
actual cost exceeds the standard cost.
DirectMaterial
DirectLabor
ManufacturingOverhead
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Standard Cost Variances
DirectMaterial
DirectLabor
ManufacturingOverhead
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Standard Cost Variances
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Setting Standard Costs
Engineer
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Setting Standard Costs
Productionmanager
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Setting Standard Costs
HumanResourcesManager
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Setting Standard Costs
ManagerialAccountant
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Advantages of Standard Costs
Improved cost control and performanceevaluation
Better Informationfor planning anddecision
making
More reasonableand easier inventorymeasurements
Cost savings inrecord-keeping
Possible reductionsin production costs
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Disadvantages of Standard Costs
Emphasis onnegativeexceptions maylower morale.
It may be difficultto determinewhich
variancesare significant.
Emphasis on negativeexceptions maylead to
under-reporting.
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Use of Standard Costs in Developing Budgets
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Specifics
O.K., lets get down and dirty with some
specifics!
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Types of Standard Costs

• The total standard cost for one unit of finished
  product is the sum of
• Standard cost for direct materials
• Standard cost for direct labor
• Standard cost for manufacturing overhead
• necessary to produce one unit of the product.

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Setting StandardsDirect Materials
UsageStandards
PriceStandards
Use competitivebids for the qualityand quantity
desired
Use product design specifications
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Standard CostsDirect Materials

• Standard cost for direct materials is standard
  price for one unit of raw material (pound, yard,
  etc.) multiplied by the standard quantity of raw
  material to produce one unit of product

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Standard CostsDirect Materials
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

• Standard price is the amount that should be paid
  for each unit of raw material.
• Standard quantity is the amount of raw material
  that should be used to produce one unit
  offinished product.

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Standard CostsDirect Materials Example
The High Point Furniture Company makes top
quality tables from sheets of plywood.

• Standard price is the amount that should be paid
  for each unit of raw material.
• e.g.., each sheet of plywood should cost 6
• Standard quantity is the amount of material that
  should be used to produce one unit of finished
  product.
• e.g., each table should take 5 sheets

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Standard CostsDirect Materials Example

• Standard price is the amount that should be paid
  for each unit of raw material.
• e.g.., each sheet of plywood should cost 6
• Standard quantity is the amount of material that
  should be used to produce one unit of finished
  product.
• e.g., each table should take 5 sheets
• Standard cost is standard price times standard
  quantity for one unit of product
• e.g., 6 X 5 sheets 30

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Setting StandardsDirect Labor
EfficiencyStandards
RateStandards
Use wage surveys andlabor contracts
Use time and motion studies foreach labor
operation
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Standard CostsDirect Labor
Standard cost for direct labor is standard wage
rate for one hour of labor multiplied by the
standard number of labor hours needed to produce
one unit of product.
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Standard CostsDirect Labor
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

• Standard wage rate is theamount that should be
  paidfor each hour of labor.
• Standard number of hoursis the number of hours
  thatshould be worked to produceone unit of
  finished product.

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Standard CostsDirect Labor Example
The High Point Furniture Companys dining room
tables are made by highly skilled, hourly paid
carpenters.

• Standard wage rate is the amount that should be
  paid for each hour of labor.
• e.g.., each hour should cost 10
• Standard number of hours is the number of hours
  that should be worked to produce one unit of
  finished product.
• e.g., each table should take 2 hours

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Standard CostsDirect Labor Example

• Standard wage rate is the amount that should be
  paid for each hour of labor.
• e.g.., each hour should cost 10
• Standard number of hours is the number of hours
  that should be worked to produce one unit of
  finished product.
• e.g., each table should take 2 hours
• Standard labor cost is standard wage rate times
  standard number of hours for one unit of finished
  product
• e.g., 10 X 2 hours 20

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Setting StandardsManufacturing Overhead
Standard Rate
Select a standard level of output and definea
basis for activity
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Standard CostsManufacturing Overhead
A standard manufacturing overhead rate is
applied for each unit of activity.
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If, however, the overhead rate is based on units
of input such as direct labor hours, the
denominator is based on the input labor
hours. The above calculation is really what?
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Standard CostsManufacturing Overhead

• Budgeted overhead cost is thetotal amount of
  overhead cost that should be incurred for the
  year to produce at the standard level of output.
• Standard level of output is what the activity
  level for the cost driver should be for the year.

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Standard CostsManufacturing Overhead Example
The High Point Furniture Company applies
overhead to tables based on
machine hours.

• Budgeted overhead cost is the amount of overhead
  cost that should be incurred to produce at the
  standard level of output.
• e.g., total overhead cost 100,000
• Standard level of output is what the activity
  level for the cost driver should be.
• e.g., total labor hours should be 20,000

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Standard CostsManufacturing Overhead Example

• Budgeted overhead cost is the amount of overhead
  cost that should be incurred to produce at the
  standard level of output.
• e.g., total overhead cost 100,000
• Standard level of output is what the activity
  level for the cost driver should be.
• e.g., total labor hours should be 20,000

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Standard CostsManufacturing Overhead Example

• Budgeted overhead cost is the amount of overhead
  cost that should be incurred to produce at the
  standard level of output.
• e.g., total overhead cost 100,000
• Standard level of output is what the activity
  level for the cost driver should be.
• e.g., total labor hours should be 20,000

100,000 20,000
Standard overheadrate per unit (i.e, hour)

5

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Standard CostsManufacturing Overhead Example

• Budgeted overhead cost is the amount of overhead
  cost that should be incurred to produce at the
  standard level of output.
• e.g., total overhead cost 100,000
• Standard level of output is what the activity
  level for the cost driver should be.
• e.g., total labor hours should be 20,000

• Standard overhead cost is standard overhead rate
  times number of activity units for each unit of
  finished product
• e.g., 5 X 2 labor hours 10

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Standard CostsSummary of Examples
Standard Costs For One Table Direct materials -
6 X 5 sheets 30 Direct labor - 10 X
2 hours 20 Manufacturing overhead -
5 X 2 labor hours 10 Total
standard cost 60
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Computing Variances

• Standard cost variance
• Amount by which actual cost differs from
  standard cost for the actual volume level
  attained
• Favorable variance
• Actual cost is less than standard cost
• Unfavorable variance
• Actual cost is greater than standard cost

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Computing Variances
Know how to calculate all six cost variances and
what causes each.
For the actual volume level attained
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Computing Variances
Lets use what we have learned to calculate the
six standard cost variances for a different
company, starting withdirect materials.
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Computing VariancesMaterials Price Variance

• 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 in May at a total cost of 6,630.
  The material was used to make 1,000 Zippies in
  May.

AP 6,630 1,700 lbs AP 3.90 per lb MPV
(AP - SP) x AQ MPV (3.90 - 4.00) x 1,700
lbs. MPV -170 Favorable
Materials Price Variance
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Computing VariancesMaterials Price Variance

• 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 in May at a total cost of 6,630.
  The material was used to make 1,000 Zippies in
  May.

AP 6,630 1,700 lbs AP 3.90 per lb MPV
(AP - SP) x AQ MPV (3.90 - 4.00) x 1,700
lbs. MPV -170 Favorable
Note that the authors use of /- is counter-
intuitive
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Recording VariancesMaterials Price Variance

Price variance is recorded at time of purchase.
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Computing VariancesMaterials Usage Variance

• 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 in May at a total cost of 6,630.
  The material was used to make 1,000 Zippies in
  May.

SQ 1,000 units 1.5 lbs per unit SQ 1,500
lbs MUV (AQ - SQ) x SP MUV (1,700lbs -
1,500lbs) x 4.00 MUV 800 unfavorable
Materials Usage Variance
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Recording VariancesMaterials Usage Variance

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Recording VariancesMaterials Usage Variance

Usage variance is recorded at time of use.

Work in Process Inventory must always be debited
for the standard quantity X standard price (1,000
units X 1.5 lbs.) X 4.00 6,000
Can materials price and usage variances be added
to get a total materials variance?
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Computing Variances
Now lets calculate standard cost variances for
direct labor.
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Computing VariancesLabor Rate Variance
Hanson Inc. has the following labor standard to
manufacture one Zippy 1.5 standard hours per
Zippy at 6.00 per hour Payroll records show
1,450 hours were worked at a total labor cost of
8,990 to make 1,000 Zippies.
AR 8,990 1450 hours AR 6.20 per hour
LRV (AR - SR) X AH LRV (6.20 - 6.00) X
1,450 hrs LRV 290 unfavorable
Labor Rate Variance
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Computing VariancesLabor Efficiency Variance
Hanson Inc. has the following labor standard to
manufacture one Zippy 1.5 standard hours per
Zippy at 6.00 per hour Payroll records show
1,450 hours were worked at a total labor cost of
8,990 to make 1,000 Zippies.
SH 1,000 units 1.5 hours per unit SH
1,500 hours LEV (AH - SH) X SR LEV (1,450
hrs - 1,500 hrs) X 6.00 LEV -300 favorable
Labor Efficiency Variance
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Recording VariancesLabor Rate Efficiency
Variances
Note that unlike materials variances, both labor
variances are recorded at the same time. (i.e.,
when the payroll summary account is cleared out.)
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Recording VariancesLabor Rate Efficiency
Variances

Source?
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Work in Process Inventory must always be debited
for the standard quantity X standard price (1,000
units X 1.5 lbs.) X 6.00 9,000
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Computing Variances
Now lets calculate standard cost variances for
manufacturing overhead.
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Standard Overhead Rate

• Overhead is applied to goods produced using a
  standard overhead rate.
• Overhead rate is set prior to the start of the
  period.

Total budgeted overhead costat the standard
level of outputStandard level of output
Standard overhead rate per unit

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Standard Overhead Rate
Contains a variable per unit component which
stays constant at all levels of activity.
Contains a fixed per unit component
whichdeclines as activitylevel increases.
Is a function of the projected volumelevel
chosen to determine the rate. (i.e., standard
level of output)
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Overhead Variances

• Budget Variance
• Is calculated as the difference between total
  actual overhead cost and budgeted amount of
  overhead for the actual volume attained
• Volume Variance
• Is calculated as the difference between the
  budgeted amount of overhead for the actual
  volume level attained and the applied overhead
  at the standard level of output

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Overhead Variances
AOH - BOH BOH -
Applied OH
AOH Actual Overhead BOH Budgeted Overhead
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Overhead Variances
Budget Variance
VolumeVariance
Total Overhead Variance
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Overhead Variances
Budget Variance
VolumeVariance
Total Overhead Variance
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Overhead Variances
Budget Variance
VolumeVariance
Total Overhead Variance
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Overhead Variances

• Flexible budgets, showing budgeted amount of
  overhead for various levels of activity, are used
  to analyze overhead costs.

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Overhead VariancesExample

• Hanson, Inc. has the following flexible budget
  for overhead

Hanson applies overhead based on machine hour
activityand expects to produce 1,500 Zippies.
(i.e., a standard activity level of 3,000
machine hours)
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Overhead VariancesExample
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Overhead VariancesExample

• Hansons actual production for the period was
  1,600 Zippies resulting in 3,200 standard machine
  hours. Actual total overhead cost for the period
  was 15,450.

Compute the overhead budget and volume variances.
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Overhead VariancesExample
15,450
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Overhead VariancesExample
15,450 9,000 fixed
3,200 hrs.


6,400 variable 5.00 per hr.
15,450 15,400
16,000
Budget variance50 unfavorable
Volume variance600 favorable
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Overhead VariancesExample
Hansons flexible budget for overhead
Standard activity level
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Overhead VariancesExample
Hansons flexible budget for overhead
Standard activity level
Actual volume level attained
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Recording Overhead Variances
Overhead account is closed and both variances
are recorded at end of period in the same entry.
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Investigating Variances

• The decision to investigate a variance is based
  on
• Dollar amount of variance.
• Size of variance relative to cost incurred.
• Controllability of cost associated with variance.
• All of these relate to the Management by
  Exception concept
• Variances may be interdependent.
• Performance reports contain variances along with
  budgeted and actual cost data.

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Variance Analysis andManagement by Exception
Now that I know all aboutstandard cost
variances, howdo I apply that managementby
exception concept?
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Variance Analysis andManagement by Exception
DirectMaterial
Amount
DirectLabor
ManufacturingOverhead
Type of Product Cost
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Variance Analysis andManagement by Exception

• Possible guidelines are
• Dollar amount or percentage of the standard
• Controllability of the cost variance

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Reporting Variances
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Disposing of Variances

• Variance may be closed entirely to Cost of Goods
  Sold (normal case for small variances) or
• Variance may be closed by
  prorating to Work in Process, Finished Goods, and
  Cost of Goods Sold based on relative size of
  these accounts.

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THE END