Standard Costs and Operating Performance Measures Chapter 11 Standard Costs and Operating Performance Measures

Standard Costs Based on carefully predetermined amounts. Used for planning labor, material and overhead requirements. Standard Costs are The expected level of performance. Benchmarks for measuring performance.

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

Setting Direct Material Standards Price Standards Quantity Standards Final, delivered cost of materials, net of discounts. Use product design specifications.

Setting Direct Labor Standards Rate Standards Time Standards Use wage surveys and labor contracts. Use time and motion studies for each labor operation.

Setting Variable Overhead Standards Rate Standards Activity Standards The rate is the variable portion of the predetermined overhead rate. The activity is the base used to calculate the predetermined overhead.

Standard Cost Card – Variable Production Cost A standard cost card for one unit of product might look like this:

Standards vs. Budgets A standard is the expected cost for one unit. A budget is the expected cost for all units. Are standards the same as budgets?

Standard Cost Variances A standard cost variance is the amount by which an actual cost differs from the standard cost. Standard This variance is unfavorable because the actual cost exceeds the standard cost. Product Cost

Standard Cost Variances First, they point to causes of problems and directions for improvement. Second, they trigger investigations in departments having responsibility for incurring the costs. I see that there is an unfavorable variance. But why are variances important to me?

Variance Analysis Cycle Take corrective actions Identify questions Receive explanations Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin

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

Practice Question Price Variance plus Quantity Variance equals: Usage Variance. Rate Variance. Total Variance. Standard Variance.

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price 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 Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Standard quantity is the quantity allowed for the actual good output.

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity 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 Std Price $ Std Qnty

A General Model for Variance Analysis Std Price $ Quantity Variance Std Qnty Act Qnty

A General Model for Variance Analysis Actual Price Price Variance Std Price $ Quantity Variance Std Qnty Act Qnty

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

Material Variances Example 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. $4.00 per pound. b. $4.10 per pound. c. $3.90 per pound. d. $6.63 per pound.

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.

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

Material Variances Zippy Hanson’s 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

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

Material Variances Zippy Hanson’s 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 Zippy 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 The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used. Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used?

Material Variances Continued 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 Continued Zippy Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb. = $10,920 = $11,200 Price variance increases because quantity purchased increases. Price variance $280 favorable

Material Variances Continued Zippy Actual Quantity Used Standard Quantity × × Standard Price Standard Price 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’ll start computing the price variance when material is purchased rather than when it’s used. I need the price variance sooner so that I can better identify purchasing problems. You accountants just don’t understand the problems that purchasing managers have.

Responsibility for Material Variances You used too much material because of poorly trained workers and poorly maintained equipment. Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances. I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it.

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

Labor Variances Example Zippy Hanson Inc. has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per direct labor hour Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to make 1,000 Zippies.

Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. $6.20 per hour. b. $6.00 per hour. c. $5.80 per hour. d. $5.60 per hour.

Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. $6.20 per hour. b. $6.00 per hour. c. $5.80 per hour. d. $5.60 per hour. AR = $9,610 ÷ 1,550 hours AR = $6.20 per hour

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

Labor Variances Hanson’s labor rate variance (LRV) for the week was: 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($6.20 - $6.00) 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

Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $290 unfavorable. b. $290 favorable. c. $300 unfavorable. d. $300 favorable.

Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $290 unfavorable. b. $290 favorable. c. $300 unfavorable. d. $300 favorable. LEV = SR(AH - SH) LEV = $6.00(1,550 hrs - 1,500 hrs) LEV = $300 unfavorable

Labor Variances Summary Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour = $9,610 = $9,300 = $9,000 Rate variance $310 unfavorable Efficiency variance $300 unfavorable

Labor Rate Variance – A Closer Look Using highly paid skilled workers to perform unskilled tasks results in an unfavorable rate variance. High skill, high rate Low skill, low rate Production managers who make work assignments are generally responsible for rate variances.

Labor Efficiency Variance – A Closer Look Poorly trained workers Poor quality materials Unfavorable Efficiency Variance Poor supervision of workers Poorly maintained equipment

Responsibility for Labor 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.

Responsibility for Labor Variances Maybe I can attribute the labor and material variances to personnel for hiring the wrong people and training them poorly.

Standard Costs Now let’s calculate standard cost variances for the last of the variable production costs – variable manufacturing overhead.

Variable Manufacturing Overhead Variances Example Zippy Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy: 1.5 standard hours per Zippy at $3.00 per direct labor hour Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead.

Variable Manufacturing Overhead Variances Zippy What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week? a. $3.00 per hour. b. $3.19 per hour. c. $3.30 per hour. d. $4.50 per hour.

Variable Manufacturing Overhead Variances Zippy What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week? a. $3.00 per hour. b. $3.19 per hour. c. $3.30 per hour. d. $4.50 per hour. AR = $5,115 ÷ 1,550 hours AR = $3.30 per hour

Variable Manufacturing Overhead Variances Zippy Hanson’s spending variance (SV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable.

Variable Manufacturing Overhead Variances Zippy Hanson’s spending variance (SV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. SV = AH(AR - SR) SV = 1,550 hrs($3.30 - $3.00) SV = $465 unfavorable

Variable Manufacturing Overhead Variances Zippy Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable.

Variable Manufacturing Overhead Variances Zippy Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. 1,000 units × 1.5 hrs per unit EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable

Variable Manufacturing Overhead Variances Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour = $5,115 = $4,650 = $4,500 Spending variance $465 unfavorable Efficiency variance $150 unfavorable

Variable Manufacturing Overhead Variances – A Closer Look If variable overhead is applied on the basis of direct labor hours, the labor efficiency and variable overhead efficiency variances will move in tandem.

Variance Analysis and Management by Exception Larger variances, in dollar amount or as a percentage of the standard, are investigated first. How do I know which variances to investigate?

Advantages of Standard Costs Possible reductions in production costs Management by exception Advantages Improved cost control and performance evaluation Better Information for planning and decision making

Potential Problems Emphasis on negative may impact morale. Favorable variances may be misinterpreted. Potential Problems Continuous improvement may be more important than meeting standards. Standard cost reports may not be timely. Labor quantity standards and efficiency variances may not be appropriate. Emphasizing standards may exclude other important objectives.

The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Customers Financial Performance measures Learning and growth Internal business processes

The Balanced Scorecard How do we look to the owners? In which internal business processes must we excel? How can we continually learn, grow, and improve? How do we look to customers?

The Balanced Scorecard Learning improves business processes. Improved business processes improve customer satisfaction. Improving customer satisfaction improves financial results.

Delivery Performance Measures Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Delivery Cycle Time Process time is the only value-added time.

Delivery Performance Measures Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Delivery Cycle Time Manufacturing Cycle Efficiency Value-added time Manufacturing cycle time =