Chapter 10 Standard Costing, Operational Performance Measures, and the Balanced Scorecard

Definition of Terms

Standard Costs - are usually associated with a manufacturing company's costs of direct material, direct labor, and manufacturing overhead.

Standard Costing is a control method involving the preparation of detailed cost and sales budgets It is then compared with the actual results for a specific account period and any significant variances between the actual and the budgeted results are investigated

Standard Costing Unexpected trends are corrected if they are not acceptable or they cannot be accommodated.

Cost variance (CV) is the amount of money that was actually spent on a project or a part of a project compared to the amount of work that was actually accomplished. Cost variance is the budgeted cost of work performed minus the actual cost of work performed.

Learning Objective 1

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

Management by Exception Managers focus on quantities and costs that exceed standards, a practice known as management by exception. Standard Amount Direct Material Direct Labor Type of Product Cost

Learning Objective 2

Analysis of Historical Data 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

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 Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance AQ(AP - SP) SP(AQ - SQ) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Standard price is the amount that should have been paid for the resources acquired. Price Variance Quantity Variance

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Standard quantity is the quantity that should have been used.

Standard Costs Let’s use the concepts of the general model to calculate standard cost variances, starting with direct material.

1.5 pounds per Zippy at $4.00 per pound 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.

What is the actual price per pound paid for the material? Material Variances Zippy What is the actual price per pound paid for the material? a. $4.00 per pound. b. $4.10 per pound. c. $3.90 per pound. d. $6.63 per pound.

What is the actual price per pound paid for the material? Material Variances Zippy What is the actual price per pound paid for the material? a. $4.00 per pound. b. $4.10 per pound. c. $3.90 per pound. d. $6.63 per pound. AP = $6,630 ÷ 1,700 lbs. AP = $3.90 per lb.

Hanson’s direct-material price variance (MPV) for the week was: Material Variances Zippy Hanson’s direct-material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable.

Hanson’s direct-material price variance (MPV) for the week was: Material Variances Zippy Hanson’s direct-material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. MPV = AQ(AP - SP) 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. 1,700 pounds. b. 1,500 pounds. c. 2,550 pounds. d. 2,000 pounds.

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

Hanson’s direct-material quantity variance (MQV) for the week was: Material Variances Zippy Hanson’s direct-material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable.

Hanson’s direct-material quantity variance (MQV) for the week was: Material Variances Zippy Hanson’s direct-material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable

Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb. $6,630 $ 6,800 $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.

1.5 pounds per Zippy at $4.00 per pound 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.

Price variance $280 favorable Material Variances Zippy Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price MPV = AQ(AP - SP) MPV = 2,800 lbs. × ($3.90 - 4.00) MPV = $280 Favorable 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb. $10,920 $11,200 Price variance $280 favorable Price variance increases because quantity purchased increases.

Quantity variance $800 unfavorable Material Variances Zippy Actual Quantity Used Standard Quantity × × Standard Price Standard Price MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800unfavor. 1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb. $6,800 $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 don’t understand the problems we production managers have. Okay. I’ll start computing the price variance when material is purchased and the quantity variance as soon as material is used.

Now let’s calculate standard cost variances for direct labor. Standard Costs Now let’s calculate standard cost variances for direct labor.

1.5 standard hours per Zippy at $10.00 per direct labor hour 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.

What was Hanson’s actual rate (AR) for labor for the week? Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. $10.20 per hour. b. $10.10 per hour. c. $9.90 per hour. d. $9.80 per hour.

What was Hanson’s actual rate (AR) for labor for the week? Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. $10.20 per hour. b. $10.10 per hour. c. $9.90 per hour. d. $9.80 per hour. AR = $15,810 ÷ 1,550 hours AR = $10.20 per hour

Hanson’s labor rate variance (LRV) for the week was: Labor Variances Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable.

Hanson’s labor rate variance (LRV) for the week was: Labor Variances Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable. LRV = AH(AR - SR) LRV = 1,550 hrs($10.20 - $10.00) LRV = $310 unfavorable

Labor Variances Zippy The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. 1,550 hours. b. 1,500 hours. c. 1,700 hours. d. 1,800 hours.

Labor Variances Zippy The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. 1,550 hours. b. 1,500 hours. c. 1,700 hours. d. 1,800 hours. SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours

Hanson’s labor efficiency variance (LEV) for the week was: Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $510 unfavorable. b. $510 favorable. c. $500 unfavorable. d. $500 favorable.

Hanson’s labor efficiency variance (LEV) for the week was: Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $510 unfavorable. b. $510 favorable. c. $500 unfavorable. d. $500 favorable. LEV = SR(AH - SH) LEV = $10.00(1,550 hrs - 1,500 hrs) LEV = $500 unfavorable

Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $10.20 per hour $10.00 per hour $10.00 per hour $15,810 $15,500 $15,000 Rate variance $310 unfavorable Efficiency variance $500 unfavorable

Learning Objective 4

Significance of Cost Variances Size of variance Dollar/Monetary amount and 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 • 1 2 3 4 5 6 7 8 9 Variance Measurements

Unfavorable Variance If actual costs are greater than standard costs tells management that if everything else stays constant the company's actual profit will be less than planned.

Favorable variance If actual costs are less than standard costs the variance is favorable tells management that if everything else stays constant the actual profit will likely exceed the planned profit.

Learning Objective 5

Behavioral Impact of Standard Costing Variances evaluate personnel: Variances may be used to evaluate personnel, often with regard to salary increases, bonuses, and promotions

Behavioral Impact of Standard Costing Negative and positive incentives created Such incentives can have positive and negative effects, as a bonus plan may prompt a manager to pursue actions that are not in the best interests of the organization.

Behavioral Impact of Standard Costing If I buy cheaper materials, my direct-materials expenses will be lower than what is budgeted. Then I’ll get my bonus. But we may lose customers because of lower quality.

Controllability of Variances Importance of identifying who controls: It is rare that one person controls any event; however, it is often possible to identify the manager who is most able to influence a particular variance.

Controllability of Variances Production supervisor and/or production engineers Purchasing manager Direct-Material Price Variance Direct-Material Quantity Variance Direct-Labor Rate Variance Direct-Labor Efficiency Variance Production supervisor Production supervisor

Controllability of Variances Variance often affect more than one input: Variances often interact, making investigation and controllability difficult. For example, a labor efficiency variance may be caused by problems not only with labor but by problems with machinery and material as well. In addition, managers sometimes trade-off variances, purposely incurring an unfavorable variance that is more than offset by favorable variances.

Interaction among Variances You used too much time because of poorly trained workers and poor supervision. I am not responsible for the unfavorable labor efficiency variance! You purchased cheap material, so it took more time to process it.

Learning Objective 6

Standard Costs Variances Cost flows In a standard-cost system, costs flow thought the same accounts in the general ledger however, they flow through at standard cost. In other words, Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold are carried at standard cost.

Standard Costs and Variances Differences recorded in variance accounts The differences between standard costs and the actual costs incurred are recorded in variance accounts instead of actual costs. Unfavorable variances are recorded as debits favorable variances are recorded as credits.

Standard Costs and Variances Variances are normally closed at the end of the accounting period to Cost of Goods Sold.

Learning Objective 7

Advantages of Standard Costing Sensible method Management by Exception Performance Evaluation Employee Motivation Advantages Stable Product Costs

Sensible method It provides a sensible method to compare budgeted costs to actual costs at the actual level of output.

Management by exception Managers can practice management by exception. (MBE) "policy by which management devotes its time to investigating only those situations in which actual results differ significantly from planned results. The idea is that management should spend its valuable time concentrating on the more important items (such as shaping the company's future strategic course). Attention is given only to material deviations requiring investigation."

Benchmark for performance It provides a benchmark for performance evaluation and employee rewards.

Stable product cost Standard costs provide a stable product cost. Actual costs may fluctuate erratically, whereas standard costs are changed only periodically.

Less expensive Standard systems are usually less expensive to operate than actual or normalized systems

Learning Objective 8

Criticisms of Standard Costing Too aggregate, and untimely Not specific Disadvantages Too much focus on direct-labor Stable production required Shorter life cycles Narrow definition Focus on cost minimization

Too aggregated and untimely Variances are too aggregated and arrive too late to be useful. Variances should focus on activities, specific product lines, production batches, and/or FMS cells.

Focuses on less important production factors Variances focus too much on the cost and efficiency of labor, which is becoming relatively unimportant factor of production.

Less stability of manufacturing environment Standard costs rely on a stable production environment, and flexible manufacturing systems have reduced the stability, with frequent switching among a variety of products on the same manufacturing line.

Too focused on costs rather than quality Standards focus too much on cost minimization and not enough on product quality, customer service, and other contemporary issues.

Learning Objective 9

Operational Control Measures in Today’s Manufacturing Environment

Operational Performance Measures in Today’s 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 Today’s 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 Today’s 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 Today’s Manufacturing Environment Productivity Aggregate productivity Partial productivity Innovation and Learning Percentage of sales from new products Cost savings from process improvements

Learning Objective 10

The Balanced Scorecard Financial Vision and Strategy Customer Internal Operations Learning and Growth

Balanced scorecard a strategic planning and management system to align business activities to the: vision and strategy of the organization improve internal and external communications monitor organization performance against strategic goals.

Balanced Score card It is used extensively in: business and industry Government and nonprofit organizations worldwide

The four perspectives Financial Customer Internal Business Processes Learning and Growth

Financial Perspective encourages the identification of a few relevant high-level financial measures. In particular, designers were encouraged to choose measures that helped inform the answer to the question "How do we look to shareholders?"

Customer encourages the identification of measures that answer the question "How do customers see us?"

Internal Business Processes encourages the identification of measures that answer the question "What must we excel at?"

Learning and Growth encourages the identification of measures that answer the question "Can we continue to improve and create value?".

Learning Objective 11

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 Favorable Variance Unfavorable Variance

Use of Standard Costs for Product Costing

Use of Standard Costs for Product Costing

Use of Standard Costs for Product Costing

End of Chapter 10 Thank you very much Jessie Montealegre Barry Pualengco To download the updated presentation please go to: barryf1.wordpress.com