© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-1 STANDARD COST SYSTEMS Chapter 24

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-2 Benchmarks for measuring performance. The expected level of performance. Based on carefully predetermined amounts. Used for planning labor, material and overhead requirements. Standard Costs are Standard Cost Systems

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-3 Direct Material Type of Product Cost Amount Direct Labor Manufacturing Overhead Standard cost A standard cost variance is the amount by which an actual cost differs from the standard cost. Standard Cost Systems

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-4 Type of Product Cost Amount This variance is unfavorable because the actual cost exceeds the standard cost. This variance is favorable because the actual cost is less than the standard cost. Standard cost Standard Cost Systems Direct Labor Manufacturing Overhead Direct Material

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-5 Prepare standard cost performance report Conduct next period’s operations Analyze variances Identify questions Receive explanations Take corrective actions Begin Variance Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-6 Should we use normal standards or ideal standards? Engineer Managerial Accountant Establishing and Revising Standard Costs Normal standards should be set at levels that are currently attainable with reasonable and efficient effort. Production manager

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-7 I agree. Ideal standards, that are based on perfection, are unattainable and therefore discouraging to most employees. Human Resources Manager Establishing and Revising Standard Costs

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-8 Are standards the same as budgets? A standard is the expected cost for one unit. A budget is the expected cost for all units. Use of Standard Costs in Developing Budgets

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 24-9 Use product design specifications. Use competitive bids for the quality and quantity desired. Quantity Standards Direct Material Standards Price Standards

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The standard material cost for one unit of product is: standard quantity standard price for of material one unit of material required for one unit of product × Direct Material Standards

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Time Standards Rate Standards Direct Labor Standards Use time and motion studies for each labor operation. Use wage surveys and labor contracts.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The standard labor cost for one unit of product is: standard number standard wage rate of labor hours for one hour for one unit of product × Setting Direct Labor Standards

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Activity Standards Rate Standards Manufacturing Overhead Standards The activity is the cost driver used to calculate the overhead rate. The rate is based on an estimate of total overhead at the normal level of activity.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin × The standard overhead cost for one unit of product is: standard variable standard number overhead rate for of activity units one unit of for one unit of activity product × Manufacturing Overhead Standards

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Standard Cost Variances Quantity VariancePrice Variance A General Model for Variance Analysis The difference between the actual price and the standard price The difference between the actual quantity and the standard quantity

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Standard price is the amount that should have been paid for the resources acquired. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance A General Model for Variance Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance A General Model for Variance Analysis Standard quantity is the quantity that should have been used for the actual good output.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Let’s use the concepts of the general model to calculate standard cost variances, starting with direct material. Standard Costs and Variance Analysis: An Illustration

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity 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 Material Price and Quantity Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased on May 10 at a total cost of $6,630. The material was used to make 1,000 Zippies that were completed on May 15. Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased on May 10 at a total cost of $6,630. The material was used to make 1,000 Zippies that were completed on May 15. Standard Costs and Variance Analysis: An Illustration Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The actual price per pound paid for the material was a.$4.00 per pound. b.$4.10 per pound. c.$3.90 per pound. d.$6.63 per pound. The actual price per pound paid for the material was a.$4.00 per pound. b.$4.10 per pound. c.$3.90 per pound. d.$6.63 per pound. Material Variances Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The actual price per pound paid for the material was a.$4.00 per pound. b.$4.10 per pound. c.$3.90 per pound. d.$6.63 per pound. The actual price per pound paid for the material was 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 Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Material Variances Question 2 Hanson’s material price variance (MPV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. Hanson’s material price variance (MPV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s material price variance (MPV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. Hanson’s material price variance (MPV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($ ) MPV = $170 favorable Material Variances Question 2 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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. 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 Question 3 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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. 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 Question 3 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s material quantity variance (MQV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. Hanson’s material quantity variance (MQV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. Material Variances Question 4 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s material quantity variance (MQV) for the week was a.$170 unfavorable. b.$170 favorable. c.$800 unfavorable. d.$800 favorable. 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 Question 4 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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 Summary Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. 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.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Let’s turn our attention to labor variances. Labor Rate and Efficiency Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Rate VarianceEfficiency Variance Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance AH(AR - SR) SR(AH - SH) AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours Labor Rate and Efficiency Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson Inc. has the following labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $8.00 per hour Payroll records last week show 1,450 hours were worked at a total labor cost of $11,890 to make 1,000 Zippies that were completed on May 15. Hanson Inc. has the following labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $8.00 per hour Payroll records last week show 1,450 hours were worked at a total labor cost of $11,890 to make 1,000 Zippies that were completed on May 15. Standard Costs and Variance Analysis: An Illustration Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s actual rate (AR) for labor for the week was a.$8.20 per hour. b.$8.00 per hour. c.$7.80 per hour. d.$7.60 per hour. Hanson’s actual rate (AR) for labor for the week was a.$8.20 per hour. b.$8.00 per hour. c.$7.80 per hour. d.$7.60 per hour. Labor Variances Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s actual rate (AR) for labor for the week was a.$8.20 per hour. b.$8.00 per hour. c.$7.80 per hour. d.$7.60 per hour. Hanson’s actual rate (AR) for labor for the week was a.$8.20 per hour. b.$8.00 per hour. c.$7.80 per hour. d.$7.60 per hour. AR = $11,890 ÷ 1,450 hours AR = $8.20 per hour Labor Variances Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s labor rate variance (LRV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Hanson’s labor rate variance (LRV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Labor Variances Question 2 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s labor rate variance (LRV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Hanson’s labor rate variance (LRV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. LRV = AH(AR - SR) LRV = 1,450 hrs($ $8.00) LRV = $290 unfavorable Labor Variances Question 2 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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. 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 Question 3 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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. 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 Question 3 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s labor efficiency variance (LEV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Hanson’s labor efficiency variance (LEV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Labor Variances Question 4 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s labor efficiency variance (LEV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. Hanson’s labor efficiency variance (LEV) for the week was a.$290 unfavorable. b.$290 favorable. c.$400 unfavorable. d.$400 favorable. LEV = SR(AH - SH) LEV = $8.00(1,450 hrs - 1,500 hrs) LEV = $400 favorable Labor Variances Question 4 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Rate variance $290 unfavorable Efficiency variance $400 favorable Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,450 hours 1,450 hours 1,500 hours × × × $8.20 per hour $8.00 per hour $8.00 per hour $11,890 $11,600 $12,000 Labor Variances Summary Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin High skill, high rate Low skill, low rate Using highly paid skilled workers to perform unskilled tasks results in an unfavorable rate variance. Production managers who make work assignments are generally responsible for rate variances. Labor Rate Variance

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Unfavorable Efficiency Variance Poorly trained workers Poor supervision of workers Poor quality materials Poorly maintained equipment Labor Efficiency Variance

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 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

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Maybe I can attribute the labor and material variances to personnel for hiring the wrong people and training them poorly. Responsibility for Labor Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Let’s turn our attention to manufacturing overhead Manufacturing Overhead Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Recall that overhead costs are applied to products and services using a predetermined overhead rate (POHR): POHR = Applied Overhead = POHR × Standard Activity Estimated total overhead costs Estimated activity Manufacturing Overhead Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Overhead Rate Contains variable overhead that increases as activity increases. Contains fixed overhead that remains constant as activity changes. Function of activity level chosen to determine rate. Manufacturing Overhead Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson, Inc. has the following manufacturing overhead at three different levels of activity: Hanson applies overhead based on machine hour activity. Manufacturing Overhead Variances Example Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Overhead Variances Question 1 Zippy The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour. The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour. The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour. $15,000 ÷ 3,000 machine hours Overhead Variances Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour. The total overhead rate for an estimated activity of 3,000 machine hours (MH) is: a. $5.00 per machine hour. b. $4.00 per machine hour. c. $3.00 per machine hour. d. $2.00 per machine hour. $15,000 ÷ 3,000 machine hours The $5.00 overhead rate contains a variable portion: $6,000 ÷ 3,000 MH = $2.00 per MH and a fixed portion: $9,000 ÷ 3,000 MH = $3.00 per MH Overhead Variances Question 1 Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Budgeted Applied Actual Overhead at Overhead at Overhead Actual Activity Standard Hours Spending Variance Volume Variance Manufacturing Overhead Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Budgeted Applied Actual Overhead at Overhead at Overhead Actual Activity Standard Hours Spending Variance Volume Variance Manufacturing Overhead Variances Shows how economically overhead services were purchased and how efficiently overhead services were used. Contains both fixed and variable costs. A controllable variance.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Budgeted Applied Actual Overhead at Overhead at Overhead Actual Activity Standard Hours Spending Variance Volume Variance Manufacturing Overhead Variances Caused by producing at a level other than that used for computing the standard overhead rate. Contains only fixed costs.

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Hanson’s actual production for the period was 1,600 Zippies resulting in 3,200 standard machine hours. Actual total overhead cost for the period was $15,450. Compute the overhead spending and volume variances. Hanson’s actual production for the period was 1,600 Zippies resulting in 3,200 standard machine hours. Actual total overhead cost for the period was $15,450. Compute the overhead spending and volume variances. Manufacturing Overhead Variances Example Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Budgeted Applied Actual Overhead at Overhead at Overhead Standard Hours Standard Hours $15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr. $2.00 per hr. × 3,200 hrs. Manufacturing Overhead Variances Example Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Budgeted Applied Actual Overhead at Overhead at Overhead Standard Hours Standard Hours Spending variance $50 unfavorable Volume variance $600 favorable $15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr. $15,450 $15,400 $16,000 Manufacturing Overhead Variances Example Zippy

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Standard Cost Variances Immaterial Amounts Close to Cost of Goods Sold  Work in Process  Finished Goods  Cost of Goods Sold Material Amounts Close by apportioning to: Disposing of Variances

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Advantages Improved cost control and performance evaluation. Better information for planning and decision making. Possible reductions in production costs. Advantages of Standard Costs

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Disadvantages Emphasis on negative exceptions may impact morale. Emphasis on negative exceptions may lead to under-reporting. It may be difficult to determine which variances are significant. Disadvantages of Standard Costs

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin JIT systems may reduce unfavorable variances. Long-term agreements with suppliers eliminate price variances. Emphasis on quality reduces material quantity variances. Well-trained flexible work force reduces labor efficiency variance. JIT Systems and Variance Analysis

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin End of Chapter 24