Performance Evaluation Through Standard Costs Principles of Accounting Kimmel • Weygandt • Kieso Chapter 21 Performance Evaluation Through Standard Costs Prepared by Barbara Muller Arizona State University West

Performance Evaluation Through Standard Costs CHAPTER 21 Performance Evaluation Through Standard Costs After studying this chapter, you should be able to: Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how standards are set. State the formulas for determining direct materials and direct labor variances. State the formulas for determining manufacturing overhead variances. Discuss the reporting of variances. Prepare an income statement for management under a standard cost system.

The Need for Standards Standards Standard costs Are common in business Are often imposed by government agencies (and called regulations) Standard costs Are predetermined unit costs Used as measures of performance

Distinguishing Between Standards and Budgets STUDY OBJECTIVE 1 Standards and budgets are both Pre-determined costs Part of management planning and control A standard is a unit amount whereas a budget is a total amount Standard costs may be incorporated into a cost accounting system

Advantages of Standard Costs STUDY OBJECTIVE 2

Setting Standard Costs STUDY OBJECTIVE 3 Requires input from all persons who have responsibility for costs and quantities Standards costs need to be current and should be under continuous review There are two levels of standard costs Ideal standards represent optimum levels of performance under perfect operating conditions Normal standards represent efficient levels of performance attainable under expected operating conditions

Direct Materials Price Standard Cost per unit which should be incurred Based on the purchasing department’s best estimate of the cost of raw materials Includes related costs such as receiving, storing, and handling

Direct Materials Quantity Standard Quantity of direct materials used per unit of finished goods Based on physical measure such as pounds, barrels, etc. Includes allowances for unavoidable waste and normal storage Materials

Total Direct Materials Cost/Unit The standard direct materials cost per unit is calculated as follows STANDARD DIRECT MATERIALS PRICE x = QUANTITY MATERIALS COST PER UNIT

Direct Labor Price Standard Rate per hour incurred for direct labor Based on current wage rates adjusted for anticipated changes, such as cost of living adjustments Includes employer payroll taxes,and fringe benefits

Direct Labor Quantity Standard Time required to make one unit of the product Critical in labor-intensive companies Allowances should be made for rest periods, cleanup, machine setup and machine downtime

Direct Labor The standard direct labor cost per unit is calculated as follows STANDARD DIRECT LABOR RATE STANDARD DIRECT LABOR HOURS STANDARD DIRECT LABOR COST PER UNIT

Manufacturing Overhead Standard For manufacturing overhead, a standard predetermined overhead rate is used The predetermined rate is computed by dividing budgeted overhead costs by an expected standard activity index The standard manufacturing overhead rate per unit is the predetermined overhead rate times the direct labor quantity standard (or other activity index, if used)

Manufacturing Overhead Standard Cost Per Unit Standard cost per unit Sum of the standard costs for direct materials, direct labor, and manufacturing overhead Is determined for each product and often recorded on a standard cost card which provides the basis for determining variances from standards Materials Factory Labor Manufacturing Overhead

Variances from Standards Differences between total actual costs and total standard costs Unfavorable variances occur when too much is paid for materials and labor or when there are inefficiencies in using materials and labor Favorable variances occur when there are efficiencies in incurring costs and in using materials and labor

Analyzing variances Variances must be analyzed to determine their significance First, determine the cost elements that comprise the variance For each manufacturing cost element, a total dollar variance is computed. Then this variance is analyzed into a price variance and a quantity variance

Variance Relationships

Formula for Total Materials Variance STUDY OBJECTIVE 4 The total materials variance is computed from the following formula: Actual Quantity x Actual Price (AQ) x (AP) _ Standard Quantity x Standard Price (SQ) x (SP) Total Materials Variance (TMV) =

Formula for Materials Price Variance The materials price variance is computed from the following formula: Actual Quantity x Actual Price (AQ) x (AP) _ Actual Quantity x Standard Price (SQ) x (SP) Materials Price Variance (MPV) =

Formula for Materials Quantity Variance The materials quantity variance is determined from the following formula: Actual Quantity x Standard Price (AQ) x (SP) Materials Quantity Variance (MQV) _ Standard Quantity x Standard Price (SQ) x (SP) =

Matrix for Direct Materials Variance

Causes of Materials Variances Materials variances may be caused by a variety of factors, including both internal and external factors Investigating materials price variances begins in the purchasing department, but the variance may be beyond the control of purchasing (for ex., prices rise faster than expected) Investigating materials quantity variance begins in the production department, but the variance may be beyond the control of production (for ex., faulty machinery)

Formula for Total Labor Variance The total labor variance is obtained from the following formula: Actual Hours x Actual Rate (AH) x (AR) Standard Hours x Standard Rate (SH) x (SR) Total Labor Variance (TLV) = _

Formula for Labor Price Variance The formula for the labor price variance is as follows: Actual Hours x Actual Rate (AH) x (AR) X Standard Rate (AH) x (SR) Labor Price Variance (LPV) = _

Formula for Labor Quantity Variance The labor quantity variance is derived from the following formula: Actual Hours x Standard Rate (AH) x (SR) Labor Quantity Variance (LQV) _ Standard Hours x Standard Rate (SH) x (SR) =

Matrix for Direct Labor Variances

Actual Overhead Costs STUDY OBJECTIVE 5 The total overhead variance is the difference between actual overhead costs and overhead costs applied to work done.

Formula for Total Overhead Variance With standard costs, manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done. Standard hours allowed are the hours that should have been worked for the units produced. The formula for the total overhead variance is: Overhead Applied based on Standard Hours Allowed _ Total Overhead Variance Actual Overhead =

Formula for Overhead Controllable Variance The formula for the Overhead Controllable Variance is shown below: Overhead Budgeted based on Standard Hours Allowed _ Actual Overhead Overhead Controllable Variance =

Formula for Overhead Volume Variance The Overhead Volume Variance indicates whether plant facilities were efficiently used during the period. The formula for computing the volume variance is as follows: Overhead Budgeted based on Standard Hours Allowed Applied based Volume Variance = _

Alternative Formula for Overhead Volume Variance An alternative formula for computing the volume variance is shown below: Fixed Overhead Rate Normal Capacity Hours - Standard Hours Allowed Overhead Volume Variance = X

Matrix for Manufacturing Overhead Variance

Reporting Variances STUDY OBJECTIVE 6 All variances should be reported to appropriate levels of management as soon as possible so that corrective action can be taken The form, content, and frequency of variance reports vary considerably among companies Variance reports facilitate the principle of “management by exception” In using variance reports, top management normally looks for significant variances

Statement Presentation of Variances STUDY OBJECTIVE 7 Variances reported on income statements prepared for management Show cost of goods sold stated at standard cost with variances are separately disclosed Variances reported on statements prepared for stockholders and other external users Inventories may be reported at standard costs when there are no significant differences between standard and actual costs

Let’s Review The setting of standards is: a. A managerial accounting decision. b. A management decision c. A worker decision. d. Preferably set at the ideal level of performance.

Let’s Review The setting of standards is: a. A managerial accounting decision. b. A management decision c. A worker decision. d. Preferably set at the ideal level of performance.

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