Cost Variances and Quality Management Chapter M9 Cost Variances and Quality Management PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2005 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

The Manufacturing Process at MetalArt Ingram Overland Exhibit 1 The Manufacturing Process at MetalArt

Once you have completed this chapter, you should be able to: Objective 1 Calculate and evaluate cost variances for direct materials and direct labor.

Variance Analysis for Direct Materials and Direct Labor Standard costs represent the cost of the material and labor that should have been used to achieve actual production levels.

Variance Analysis for Direct Materials and Direct Labor Standards are based on engineering studies to determine the amount of a resource necessary to manufacture a product.

Variance Analysis for Direct Materials and Direct Labor Total Actual Costs Total Standard Costs Price Variance materials price labor rate Quantity Variance materials quantity labor efficiency Total Variance Exhibit 4

Variance Analysis for Direct Materials and Direct Labor Total Actual Costs Total Standard Costs Price Variance Quantity Variance Actual Quantity x Standard Price materials price labor rate materials quantity labor efficiency Actual Quantity x Actual Price Standard Quantity x Standard Price Total Variance Exhibit 4

Variances–Materials Total Actual Costs Total Standard Costs Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price Actual Quantity x Actual Price 500,000 pounds x $0.25 = $125,000 $125,000 MetalArt

Variances–Materials Total Actual Costs Total Standard Costs Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price Standard Quantity x Standard Price 460,000 pounds x $0.30 = $138,000 $125,000 $138,000 MetalArt

Variances–Materials Total Actual Costs Total Standard Costs Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price Total Material Variance $125,000 $138,000 MetalArt $13,000 Favorable

Variances–Materials The total actual costs are $13,000 less than total standard costs. This results in a $13,000 favorable material variance. MetalArt

Variances–Materials Actual Quantity x Standard Price 500,000 pounds x $0.30 = $150,000 Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price $125,000 $150,000 $138,000 MetalArt

Variances–Materials First, let’s look at material price variance. Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price $125,000 $138,000 $150,000 First, let’s look at material price variance. Material Price Variance MetalArt

Variances–Materials $150,000 –125,000 $ 25,000 Total Actual Costs Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price $125,000 $138,000 $150,000 $150,000 –125,000 $ 25,000 Material Price Variance MetalArt

Variances–Materials The actual price paid for materials was less than the standard price, so the material price variance is favorable. Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price $125,000 $138,000 $150,000 Material Price Variance MetalArt

Variances–Materials Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price Total Variance Standard Quantity x Standard Price Next, let’s look at the material quantity variance. Material Quantity Variance $125,000 $150,000 $138,000 MetalArt

Variances–Materials $150,000 –138,000 $ 12,000 Total Actual Costs Total Standard Costs $150,000 –138,000 $ 12,000 Material Quantity Variance Actual Quantity x Standard Price $125,000 $150,000 $138,000 Actual Quantity x Actual Price Standard Quantity x Standard Price MetalArt $12,000 Total Variance

Variances–Materials MetalArt used 500,000 pounds of material when only 460,000 should have been used for the actual production. Actual Quantity x Standard Price Total Actual Costs Total Standard Costs Actual Quantity x Actual Price $12,000 Standard Quantity x Standard Price Material Quantity Variance $125,000 $150,000 $138,000 MetalArt

Variances–Materials These 40,000 additional pounds at 30 cents per pound resulted in a $12,000 unfavorable material quantity variance. Total Actual Costs Total Standard Costs Material Quantity Variance Actual Quantity x Standard Price $125,000 $150,000 $138,000 Actual Quantity x Actual Price Standard Quantity x Standard Price MetalArt $12,000 Total Variance

Variances–Labor Actual Hours x Actual Rate 5,300 hours x $29 Total Actual Costs Total Standard Costs Actual Hours x Actual Rate 5,300 hours x $29 = $153,700 Actual Hours x Standard Rate $153,700 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt Total Labor Variance

Variances–Labor Standard Hours x Standard Rate 4,600 hours x $24 Total Actual Costs Total Standard Costs Standard Hours x Standard Rate 4,600 hours x $24 = $110,400 Actual Hours x Standard Rate $153,700 $153,700 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt Total Labor Variance

Variances–Labor Total Actual Costs Total Standard Costs Total Labor Variance Actual Hours x Standard Rate $153,700 $153,700 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt $43,300 Unfavorable Total Labor Variance

Variances–Labor Actual Hours x Standard Rate 5,300 hours x $24 = $127,200 Total Actual Costs Total Standard Costs Labor Rate Variance Actual Hours x Standard Rate $153,700 $153,700 $127,200 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt $26, 500

Variances–Labor The actual labor rate per hour was $5 more than the standard, so the $26,500 labor rate variance is unfavorable. Total Actual Costs Total Standard Costs Labor Rate Variance Actual Hours x Standard Rate $153,700 $153,700 $127,200 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt $26, 500

Variances–Labor Total Actual Costs Total Standard Costs $153,700 Labor Efficiency Variance Actual Hours x Standard Rate $153,700 $153,700 $127,200 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt

Variances–Labor $127,200 –110,400 $ 16,800 Total Actual Costs Total Standard Costs $127,200 –110,400 $ 16,800 Labor Efficiency Variance Actual Hours x Standard Rate $153,700 $153,700 $127,200 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt $16,800

Variances–Labor The actual hours worked to produce the goods were 700 more than standard, so the $16,800 labor efficiency variance is unfavorable. Total Actual Costs Total Standard Costs Labor Efficiency Variance Actual Hours x Standard Rate $153,700 $153,700 $127,200 $110,400 Actual Hours x Actual Rate Standard Hours x Standard Rate MetalArt $16,800

Once you have completed this chapter, you should be able to: Objective 2 Explain how variance analysis can enhance managerial decision making.

MetalArt Material price variance $25,000 favorable Material quantity variance (12,000) unfavorable Labor rate variance (26,500) unfavorable Labor efficiency variance (16,800) unfavorable Net variance $(30,300) unfavorable

MetalArt The overall variance picture indicates that inferior material has been purchased to reduce cost. This policy resulted in excessive waste and additional labor time.

MetalArt The unfavorable labor variances also may indicate that, despite paying higher than standard wages, the workers are receiving poor training or there are problems with scheduling.

Once you have completed this chapter, you should be able to: Objective 3 Identify four types of quality costs and explain how managers use these costs to improve performance.

Quality Cost Concepts Quality costs are costs incurred because poor quality can or does exist in a particular product, function or business.

Failure costs are costs incurred because poor quality exists. Quality Cost Concepts Prevention costs are costs incurred to prevent the production of poor-quality units or poor-quality services. Appraisal costs are costs incurred to identify poor-quality products before a customer receives the goods or services. Failure costs are costs incurred because poor quality exists.

Quality Cost Mix Exhibit 6

Once you have completed this chapter, you should be able to: Objective 4 Describe how variability can affect production costs.

Lower Specification Limit Upper Specification Limit Taguchi Quality Loss Function Traditional Cost Function $ Loss Lower Specification Limit Upper Specification Limit Loss incurred No loss incurred Loss incurred Specification Limit Exhibit 7

Lower Specification Limit Upper Specification Limit Taguchi Quality Loss Function Taguchi Cost Function $ Loss Quality loss curve Target Value Lower Specification Limit Upper Specification Limit Exhibit 8 Specification Limit

Taguchi Quality Loss Function Dr. Genichi Taguchi

MetalArt Quality loss = K(y – T)² Y = actual value of quality measurement T = target value of a quality measurement K = dollar value of loss associated with deviation from target. The value is based on estimated cost of rework, scrap, and customer ill will.

MetalArt Loss of color density = 95 Quality loss = K(y – T)² $5(95 – 100)² $5(25) $125

MetalArt Loss of color density = 135 Quality loss = K(y – T)² $5(135 – 100)² $5(1,225) $6,125

Unit and Total Costs: The Taguchi Quality Loss Function Exhibit 11 Continued

Unit and Total Costs: The Taguchi Quality Loss Function Exhibit 11

Once you have completed this chapter, you should be able to: Objective 5 Explain how statistical process control provides useful information to managers of both production and administrative functions.

Statistical Process Control A special cause variation has an identifiable source, such as faulty equipment or processes. A common cause variation is the result of randomness inherent in a process.

Statistical Process Control Statistical process control charts usually include-- (a) a center line, representing the expected value of a characteristic, (b) a line above and another below the expected value, indicating the limits within which a characteristic is considered to be in control, (c) a horizontal axis, indicating the time order of observations of the characteristics, and (d) a vertical axis, measuring the values of observations.

Flow Volume (Per Second) - Exhibit 12 Example of a Statistical Process Control Chart 115 110 105 l00 95 90 85 80 75 70 65 60 55 50 45 40 35 Upper Control Limit = 109 Process Average = 77.9 Flow Volume (Per Second) Lower Control Limit = 47.2 | | | | | | | | | | | | | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Observation

Statistical Process Control Control charts are designed to signal when a process is out of control.

Once you have completed this chapter, you should be able to: Objective 6 Explain the application of performance evaluation methods in service organizations.

Performance Evaluation for Service Organizations Service organizations such as CPA firms, law firms, hospitals, etc. face performance issues similar to those encountered by manufacturing organizations.

Performance Evaluation for Service Organizations Statistical process control charts are commonly used within service organizations to determine if a service process is “in control.”

Performance Evaluation for Service Organizations Many service organizations use quality cost systems that attempt to measure the cost of external failure.

Chapter M9 THE END