Chapter 10

Standard Costing, Operational Performance Measures, and the Balanced Scorecard

McGraw-Hill/Irwin

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

Learning Objective 1

McGraw-Hill/Irwin

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

Managing Costs
Standard cost Comparison between standard and actual performance level Actual cost

Cost variance

Management by Exception
Managers focus on quantities and costs that exceed standards, a practice known as management by exception.

Amount

Standard Direct Material

Direct Labor

Type of Product Cost

Learning Objective 2

McGraw-Hill/Irwin

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

Setting Standards
Cost Standards

Analysis of Historical Data

Task Analysis

Participation in Setting Standards

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

Perfection versus Practical Standards: A Behavioral Issue

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

Should we use practical standards or perfection standards?

Perfection versus Practical Standards: A Behavioral Issue

I agree. Perfection standards are unattainable and therefore discouraging to most employees.

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.

Learning Objective 3

McGraw-Hill/Irwin

Copyright 2008 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

A General Model for Variance Analysis

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

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

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

A General Model for Variance Analysis

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

Price Variance

Quantity Variance

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

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 that should have been used.

Standard Costs

Lets use the concepts of the general model to calculate standard cost variances, starting with direct material.

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.

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.

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.

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.

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

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.

Material Variances

Zippy

The standard quantity of material that should have been used to produce 1,000 = 1,000 units 1.5 lbs per unit Zippies is: SQ a. b. c. d. 1,700 pounds. 1,500 pounds. 2,550 pounds. 2,000 pounds.
SQ = 1,500 lbs

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.

Material Variances

Zippy

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

Hansons direct-material quantity variance (MQV) for the week was:

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

Material Variances Summary

Actual Quantity Actual Price 1,700 lbs. $3.90 per lb. $6,630 Actual Quantity Standard Price 1,700 lbs. $4.00 per lb. $ 6,800 Standard Quantity Standard Price 1,500 lbs. $4.00 per lb. $6,000

Price variance $170 favorable

Quantity variance $800 unfavorable

Material Variances

Zippy

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

The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used.

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.

Material Variances
Actual Quantity Purchased Actual Price 2,800 lbs. $3.90 per lb. $10,920

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. $11,200 Price variance increases because quantity purchased increases.

Price variance $280 favorable

Material Variances

Zippy

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 1,500 lbs. $4.00 per lb. $6,000

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

Quantity variance $800 unfavorable

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.

Standard Costs

Now lets calculate standard cost variances for direct labor.

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.

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.

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 hours $9.90 per hour. AR = $10.20 per hour $9.80 per hour.

Labor Variances

Zippy

Hansons labor rate variance (LRV) for the week was: a. b. c. d. $310 unfavorable. $310 favorable. $300 unfavorable. $300 favorable.

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

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.

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. = 1,000 units 1.5 hours per unit SH SH 1,800 hours. = 1,500 hours

Labor Variances

Zippy

Hansons labor efficiency variance (LEV) for the week was: a. b. c. d. $510 unfavorable. $510 favorable. $500 unfavorable. $500 favorable.

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.= $500 unfavorable LEV

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

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 Standard Hours Standard Rate 1,500 hours $10.00 per hour $15,000

Rate variance $310 unfavorable

Efficiency variance $500 unfavorable

Learning Objective 4

McGraw-Hill/Irwin

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

Significance of Cost Variances

Size of variance
Dollar amount Percentage of standard

What clues help me to determine the variances that I should investigate?

Recurring variances Trends Controllability Favorable variances Costs and benefits of investigation

Statistical Control Chart

Warning signals for investigation Favorable Limit

Desired Value

Unfavorable Limit

8 9

Variance Measurements

Learning Objective 5

McGraw-Hill/Irwin

Copyright 2008 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.

Controllability of Variances
Direct-Material Price Variance Direct-Material Quantity Variance

Direct-Labor Rate Variance

Direct-Labor Efficiency Variance

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.

Learning Objective 6

McGraw-Hill/Irwin

Copyright 2008 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.

Learning Objective 7

McGraw-Hill/Irwin

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

Advantages of Standard Costing

Sensible Cost Comparisons Management by Exception

Performance Evaluation

Advantages
Stable Product Costs

Employee Motivation

Less Expensive

Learning Objective 8

McGraw-Hill/Irwin

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

Criticisms of Standard Costing

Too aggregate, too late Too much focus on direct-labor Not specific

Disadvantages

Stable production required

Shorter life cycles Focus on cost minimization

Narrow definition Consistency due to automation

Adapting Standard-Costing Systems StandardReduced focus on labor Identify Cost Drivers Impact of TQM and JIT Shorter product life cycles Nonfinancial Measures Focus on material and overhead Shifting cost structures Elimination of nonvalue added costs Real-Time Information Systems Benchmarking

Learning Objective 9

McGraw-Hill/Irwin

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

Operational Control Measures in Todays Manufacturing Environment

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

  

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

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

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

Learning Objective 10

McGraw-Hill/Irwin

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

The Balanced Scorecard

Financial

Customer

Vision and Strategy

Internal Operations

Learning and Growth

Learning Objective 11

McGraw-Hill/Irwin

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

Use of Standard Costs for Product Costing

Raw-material Inventory Actual quantity at standard cost Account Payable Actual quantity at actual cost

Direct-Material Price Variance Unfavorable variance Favorable variance

Use of Standard Costs for Product Costing

Work-in-Process Inventory Standard quantity at standard price
Raw-material Inventory Actual quantity at standard cost

Direct-Material Quantity Variance Unfavorable variance Favorable variance

Use of Standard Costs for Product Costing

Work-in-Process Inventory Standard quantity at standard price Wages Payable Actual quantity at actual cost

Direct-Labor Rate Variance Unfavorable variance Favorable variance

Direct-Labor Efficiency Variance Unfavorable variance Favorable variance

Use of Standard Costs for Product Costing

Cost of Goods Sold Unfavorable variance Favorable variance

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