Chapter 10

Standard Costing,
Operational
Performance
Measures, and the
Balanced Scorecard

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning
Objective
1

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Managing Costs
Standard
cost

Actual
cost
Comparison between
standard and actual
performance
level

Cost
variance
1-3

Management by Exception

Amount

Managers focus on quantities and costs

that exceed standards, a practice known as
management by exception.

Standard

Direct
Labor

Direct
Material

Type of Product Cost

1-4

Learning
Objective
2

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Setting Standards
Cost
Standards

Analysis of
Historical Data

Task
Analysis
1-6

Participation in Setting Standards

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

1-7

Perfection versus Practical

Standards: A Behavioral Issue

Should we use
practical standards
or perfection
standards?

Practical standards
should be set at levels
that are currently
attainable with
reasonable and
efficient effort.

1-8

Perfection versus Practical

Standards: A Behavioral Issue
I agree. Perfection
standards are
unattainable and
therefore discouraging
to most employees.

1-9

Use of Standards by
Service Organizations
Standard cost
analysis may be used
in any organization
with repetitive tasks.
A relationship
between tasks and
output measures
must be established.
1-10

Learning
Objective
3

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Cost Variance Analysis

Standard Cost Variances

Price Variance

Quantity Variance

The difference between

the actual price and the
standard price

The difference between

the actual quantity and
the standard quantity
1-12

A General Model for Variance

Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance
Materials
price- SP)
variance
AQ(AP
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP = spending
Actual Price
variance

Standard Quantity

Standard Price

Quantity Variance
Materials
quantity
variance
SP(AQ
- SQ)
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQ
= Standard
Quantity
efficiency
variance
1-13

A General Model for Variance

Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard price is the amount that should

have been paid for the resources acquired.

1-14

A General Model for Variance

Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard quantity is the quantity that should

have been used.

1-15

Standard Costs

Lets use the concepts

of the general model to
calculate standard cost
variances, starting with

direct material.

1-16

Material Variances
Zippy

Hanson Inc. has the following direct material

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were
purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.

1-17

Material Variances

Zippy

What is the actual price per pound

paid for the material?
a.
b.
c.
d.

$4.00 per pound.

$4.10 per pound.
$3.90 per pound.
$6.63 per pound.
1-18

Material Variances

Zippy

What is the actual price per pound

paid for the material?
a.
b.
c.
d.

$4.00 per pound.

$4.10 per pound.
$3.90 per pound.
$6.63 per pound.

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

1-19

Material Variances

Zippy

Hansons direct-material price variance (MPV)

for the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.

1-20

Material Variances

Zippy

Hansons direct-material price variance (MPV)

for the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
MPV = AQ(AP - SP)
$800 favorable. MPV = 1,700 lbs. ($3.90 4.00)
MPV = $170 Favorable
1-21

Material Variances

Zippy

The standard quantity of material that

should have been used to produce
1,000 Zippies is:
a.
b.
c.
d.

1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.
1-22

Material Variances

Zippy

The standard quantity of material that

should have been used to produce
1,000 Zippies is:
SQ = 1,000 units 1.5 lbs per unit
a.
b.
c.
d.

SQ = 1,500 lbs

1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.

1-23

Material Variances

Zippy

Hansons direct-material quantity variance

(MQV) for the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.

1-24

Material Variances

Zippy

Hansons direct-material quantity variance

(MQV) for the week was:

MQV = SP(AQ - SQ)

MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
a. $170 unfavorable.

b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

1-25

Material Variances Summary

Actual Quantity

Actual Price
1,700 lbs.

$3.90 per lb.

Actual Quantity

Standard Price
1,700 lbs.

$4.00 per lb.

$6,630

Price variance
$170 favorable

$ 6,800

Standard Quantity

Standard Price
1,500 lbs.

$4.00 per lb.

$6,000

Quantity variance
$800 unfavorable
1-26

Material Variances

Hanson purchased and

used 1,700 pounds.
How are the variances
computed if the amount
purchased differs from
the amount used?

Zippy

The price variance is

computed on the entire
quantity purchased.

The quantity variance is

computed only on the
quantity used.
1-27

Material Variances

Zippy

Hanson Inc. has the following material

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound

Last week 2,800 pounds of material were

purchased at a total cost of $10,920, and
1,700 pounds were used to make 1,000
Zippies.
1-28

Material Variances
Actual Quantity
Purchased

Actual Price
2,800 lbs.

$3.90 per lb.

Zippy

Actual Quantity
Purchased

MPV = AQ(AP - SP)

Standard Price
MPV = 2,800 lbs.
($3.90 - 4.00)
2,800 lbs.
MPV = $280

Favorable
$4.00 per lb.

$10,920

Price variance
$280 favorable

$11,200
Price variance increases
because quantity
purchased increases.
1-29

Material Variances
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs
- 1,500 lbs)
MQV = $800unfavor.

Actual Quantity
Used
Standard Quantity

Standard Price
Standard Price
1,700 lbs.

$4.00 per lb.

$6,800

Quantity variance is
unchanged because
actual and standard
quantities are unchanged.

Zippy

1,500 lbs.

$4.00 per lb.

$6,000

Quantity variance
$800 unfavorable
1-30

Isolation of Material Variances

I need the variances as soon
as possible so that I can
better identify problems
and control costs.

You accountants just dont

understand the problems
we production managers have.

Okay. Ill start computing

the price variance when
material is purchased and
the quantity variance as
soon as material is used.

1-31

Standard Costs

Now lets calculate

standard cost
variances for
direct labor.

1-32

Labor Variances

Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at $10.00 per direct
labor hour

Last week 1,550 direct labor hours were

worked at a total labor cost of $15,810 to
make 1,000 Zippies.
1-33

Labor Variances

Zippy

What was Hansons actual rate (AR)

for labor for the week?
a.
b.
c.
d.

$10.20 per hour.

$10.10 per hour.
$9.90 per hour.
$9.80 per hour.

1-34

Labor Variances

Zippy

What was Hansons actual rate (AR)

for labor for the week?
a.
b.
c.
d.

$10.20 per hour.

$10.10 per hour.
AR = $15,810 1,550
$9.90 per hour. hours
$9.80 per hour. AR = $10.20 per hour

1-35

Labor Variances

Zippy

Hansons labor rate variance (LRV)

for the week was:

a.
b.
c.
d.

$310 unfavorable.
$310 favorable.
$300 unfavorable.
$300 favorable.

1-36

Labor Variances

Zippy

Hansons labor rate variance (LRV)

for the week was:

a.
b.
c.
d.

$310 unfavorable.
$310 favorable.
LRV = AH(AR - SR)
$300 unfavorable.
LRV = 1,550 hrs($10.20 - $10.00)
$300 favorable.
LRV = $310 unfavorable

1-37

Labor Variances

Zippy

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:
a.
b.
c.
d.

1,550 hours.
1,500 hours.
1,700 hours.
1,800 hours.
1-38

Labor Variances

Zippy

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:
a.
b.
c.
d.

1,550 hours.
1,500 hours.
1,700 hours.
SH = 1,000 units 1.5 hours per unit
SH = 1,500 hours
1,800 hours.
1-39

Labor Variances

Zippy

Hansons labor efficiency variance (LEV)

for the week was:
a.
b.
c.
d.

$510 unfavorable.
$510 favorable.
$500 unfavorable.
$500 favorable.

1-40

Labor Variances

Zippy

Hansons labor efficiency variance (LEV)

for the week was:
LEV = SR(AH - SH)
LEV = $10.00(1,550 hrs - 1,500 hrs)
a. $510 unfavorable.
LEV = $500 unfavorable

b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.

1-41

Labor Variances Summary

Actual Hours

Actual Rate
1,550 hours

$10.20 per hour

$15,810

Actual Hours

Standard Rate
1,550 hours

$10.00 per hour

$15,500

Rate variance
$310 unfavorable

Standard Hours

Standard Rate
1,500 hours

$10.00 per hour

$15,000

Efficiency variance
$500 unfavorable
1-42

Learning
Objective
4

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Significance of Cost Variances

1. Size of variance
1. Dollar amount
2. Percentage of standard

What clues help me

to determine the
variances that I should
investigate?

2.
3.
4.
5.
6.

Recurring variances
Trends
Controllability
Favorable variances
Costs and benefits
of investigation
1-44

Statistical Control Chart

Warning signals for investigation
Favorable Limit

Desired Value

Unfavorable Limit

Variance Measurements
1-45

Learning
Objective
5

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Behavioral Impact of Standard

Costing
If I buy cheaper materials, my directmaterials expenses will be lower than
what is budgeted. Then Ill get my bonus.
But we may lose customers because of
lower quality.

1-47

Controllability of Variances
Direct-Material
Price Variance

Direct-Material
Quantity Variance

Direct-Labor
Rate Variance

Direct-Labor
Efficiency Variance
1-48

Interaction among Variances

I am not responsible for
the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.

You used too much

time because of poorly
trained workers and
poor supervision.

1-49

Learning
Objective
6

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Standard Costs and Product

Costing
Standard material and labor costs
are entered into Work-in-Process
inventory instead of actual costs.
Standard cost variances
are closed directly to
Cost of Goods Sold.

1-51

Learning
Objective
7

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Advantages of Standard Costing

Sensible Cost
Comparisons

Management by
Exception

Performance
Evaluation

Advantages

Employee
Motivation

Stable Product
Costs

1-53

Learning
Objective
8

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Criticisms of Standard Costing

Too aggregate,
too late
Too much focus
on direct-labor

Disadvantages

Shorter life
cycles

Not specific

Stable production
required

Narrow
definition
Focus on cost
minimization
1-55

Learning
Objective
9

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Operational Control Measures in Todays

Manufacturing Environment

1-57

Operational Performance Measures in

Todays Manufacturing Environment
Raw Material &
Scrap Control
Quality
Lead time
Cost of scrap
Total cost

Inventory Control
Average value
Average holding time
Ratio of inventory
value to sales
revenue

1-58

Operational Performance Measures in

Todays Manufacturing Environment
Machine Performance
Availability
Downtime
Maintenance records
Setup time

Product Quality

Warranty claims

Customer complaints

Defective products

Cost of rework

1-59

Operational Performance Measures in

Todays Manufacturing Environment
Production
Manufacturing
cycle time
Velocity
Manufacturing
cycle efficiency

Delivery
% of on-time deliveries
% of orders filled
Delivery cycle time

1-60

Operational Performance Measures in

Todays Manufacturing Environment

Productivity
Aggregate
productivity
Partial productivity

Innovation and
Learning

Percentage of sales
from new products

Cost savings from

process
improvements

1-61

Learning
Objective
10

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

The Balanced Scorecard

Financial

Customer

Vision and
Strategy

Internal
Operations

Learning and Growth

1-63

Learning
Objective
11

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Use of Standard Costs

for Product Costing
Account Payable

Raw-material Inventory

Actual quantity at
actual cost

Actual quantity at
standard cost

Direct-Material Price Variance

Unfavorable
variance

Favorable
variance

1-65

Use of Standard Costs

for Product Costing
Raw-material Inventory

Work-in-Process Inventory

Actual quantity at
standard cost

Standard quantity
at standard price

Direct-Material Quantity Variance

Unfavorable
variance

Favorable
variance

1-66

Use of Standard Costs

for Product Costing
Work-in-Process Inventory

Wages Payable

Standard quantity
at standard price

Actual quantity at
actual cost

Direct-Labor Rate Variance

Unfavorable
variance

Favorable
variance

Direct-Labor Efficiency Variance

Unfavorable
variance

Favorable
variance

1-67

Use of Standard Costs

for Product Costing
Cost of Goods Sold
Unfavorable
variance

Favorable
variance

1-68

End of Chapter 10
Lets set the
standard a
little higher.

1-69