Cornerstones of Managerial Accounting 2e Chapter Nine Standard Costing: A Managerial Control Tool Mowen/Hansen Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Objective # 1 Explain how units standards are set and why standard cost systems are adopted.

Unit Standards Developing standards enhances control. Need to determine the unit standard cost for a particular input Two decisions: Quantity decision Pricing decision

Called “Quantity Standard” Quantity Decision The amount of input that should be used per unit of output Called “Quantity Standard”

Called “Price Standard” Price Decision The amount that should be paid for the quantity of input to be used. Called “Price Standard” Quantity Standard x Price Standard = Unit Standard

Used to enhance cost control Are budgeted ‘unit’ costs Unit Standard Used to enhance cost control Are budgeted ‘unit’ costs Unlike budgets which contain aggregate amounts of total revenue and total costs

Development of Standards Quantity Standards are developed by: Historical experience Engineering studies Input from operating personnel

Development of Standards Price Standards are the joint responsibility of: Operations Purchasing Personnel Accounting

Types of Standards Ideal standards --- demand maximum efficiency and can be achieved only if everything operates perfectly Currently attainable standards --- can be achieved under efficient operating conditions

Why Standard Cost Systems Are Adopted Two reasons: To improve planning and control To facilitate product costing

Actual costs are compared to budgeted costs and variances are computed Planning and Control Standards: Enhance planning and control Improve performance management Fundamental requirement for a flexible budgeting system Actual costs are compared to budgeted costs and variances are computed

Costs are assigned to products using standards for: Product Costing Costs are assigned to products using standards for: Direct materials quantity Direct materials price Direct labor quantity Direct labor price Overhead quantity Overhead price

Standard Costing Advantages: Greater capacity for control Provides readily available unit cost information Simplifies cost assignments in both process and job costing systems

Explain the purpose of a standard cost sheet. Objective # 2 Explain the purpose of a standard cost sheet.

Unit Quantity Standard Actual Output SQ = x Example Corn allowed: Unit Quantity Standard Actual Output SQ = x Standard quantity of materials allowed

Unit Quantity Standard Example Unit Quantity Standard Actual Output SQ = x SQ = 18 x 100,000 SQ = 1,800,000 ounces

Unit Quantity Standard Actual Output SH = x Example Operator hours allowed: Unit Quantity Standard Actual Output SH = x Standard hours allowed

Unit Quantity Standard Example Operator hours allowed: Unit Quantity Standard Actual Output SH = x SH = 0.01 x 100,000 SH = 1,000 direct labor hours

Objective # 3 Describe the basic concepts underlying variance analysis, and explain when variances should be investigated.

Variance Analysis Components SP = Standard unit price of an input SQ = Standard quantity of input for the actual output AP = Actual price per unit of the input AQ = Actual quantity of the input used

Total Budget Variance Total Variance Actual Cost Planned Cost = – (AP x AQ) – (SP x SQ)

Price (Rate) Variance Actual Price Standard Price Number of inputs used x - Favorable variance = Actual price is less than standard price Unfavorable variance = Actual price is greater than standard price

Usage (Efficiency) Variance Actual Quantity Standard Quantity Standard Unit Price x - Favorable variance = Actual quantity is less than standard quantity Unfavorable variance = Actual quantity is greater than standard quantity

The Decision to Investigate Performance rarely meets established standards exactly Random variations around the standard are expected Management should determine an acceptable range of performance

HOW TO Use Control Limits to Trigger a Variance Investigation Cornerstone 9-2 HOW TO Use Control Limits to Trigger a Variance Investigation

Example Information: Standard cost: $100,000; allowable deviation: $10,000; actual costs for six months: June $97,500 September $102,500 July 105,000 October 107,500 August 95,000 November 112,500 Required: Plot the actual costs over time against the upper and lower control limits. Determine when a variance should be investigated.

Acceptable Range (Don’t Investigate) Example $120,000 110,000 Acceptable Range (Don’t Investigate) Standard 100,000 90,000 June July August September October November

Example $120,000 Investigate 110,000 100,000 90,000 June July August September October November

Objective # 4 Compute the materials variances, and explain how they are used for control.

Direct Material Variances Materials Price Variance Measures the difference between what should have been paid for raw materials and what was actually paid MPV = (AP – SP) x AQ

Direct Material Variances Materials Usage Variance Measures the difference between the direct materials actually used and the direct materials that should have been used for the actual output MUV = (AQ – SQ) SP

Responsibility for the Materials Price Variance Belongs to the purchasing agent Price can be influenced by: Quality Quantity discounts Distance of the source from the plant

Responsibility for the Materials Usage Variance Belongs to the production manager Variance can be influenced by minimizing: Scrap Waste Rework

Analysis of the Variances First step: Decide whether the variance is significant Second step: Find out why it occurred

Accounting and Disposition of Materials Variances Materials variances are ADDED to cost of goods sold if they are UNFAVORABLE. Materials variances are SUBTRACTED from cost of goods sold if FAVORABLE

Direct Labor Variances Labor Rate Variance Computes the difference between what was paid to direct laborers and what should have been paid LRV = (AR - SR) AH

Direct Labor Variances Labor Efficiency Variance Measures the difference between the labor hours that were actually used and the labor hours that should have been used LEV = (AH – SH) SR

Compute the labor variances and explain how they are used for control. Objective # 5 Compute the labor variances and explain how they are used for control.

Causes of Labor Rate Variance Labor rates are largely determined by such external forces as labor markets and union contracts. Labor rates can vary when: More skilled and more highly paid laborers are used for less skilled tasks Unexpected overtime occurs

Responsibility for the Labor Efficiency Variance Generally speaking, production managers are responsible for the use of direct labor But once the cause is discovered, responsibility may be assigned elsewhere.