Standard Costing and Analysis of Direct Costs CHAPTER 10 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Managing Costs Standard cost Actual cost Comparison between standard and actual performance level Cost variance 10-2

Management by Exception Direct Material Managers focus on quantities and costs that exceed standards, a practice known as management by exception.. Type of Product Cost Amount Direct Labor Standard 10-3

Setting Standards Analysis of Historical Data Task Analysis Cost Standards 10-4

Participation in Setting Standards Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations. 10-5

Perfection versus Practical Standards: A Behavioral Issue Should we use practical standards or perfection standards? Practical standards should be set at levels that are currently attainable with reasonable and efficient effort. 10-6

I agree. Perfection standards are unattainable and therefore discouraging to most employees. Perfection versus Practical Standards: A Behavioral Issue 10-7

Standard Cost Variances Cost Variance Analysis Quantity Variance Price Variance The difference between the actual price and the standard price. The difference between the actual quantity and the standard quantity. 10-8

A General Model for Variance Analysis 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 10-9

A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity 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 VarianceQuantity 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

Material Variances 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. Zippy 10-13

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 10-14

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? Zippy Material Variances 10-15

Material Variances 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. Zippy 10-16

Material Variances 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 $280 favorable Price variance increases because quantity purchased increases. Zippy MPV = AQ(AP - SP) MPV = 2,800 lbs. × ($ ) MPV = $280 Favorable 10-17

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 $800 unfavorable Quantity variance is unchanged because actual and standard quantities are unchanged. Material Variances Zippy MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavor

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

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

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. Labor Variances Zippy 10-21

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Labor Variances Summary Rate variance $310 unfavorable Efficiency variance $500 unfavorable 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,

Significance of Cost Variances 1. Size of variance 1. Dollar amount 2. Percentage of standard 2. Recurring variances 3. Trends 4. Controllability 5. Favorable variances 6. Costs and benefits of investigation What clues help me to determine the variances that I should investigate? 10-23

Controllability of Variances Direct-Material Price Variance Direct-Labor Rate Variance Direct-Material Quantity Variance Direct-Labor Efficiency Variance 10-24

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. Behavioral Impact of Standard Costing 10-25

Interaction among 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

Standard Costs and Product Costing Standard material and labor costs are entered into Work-in-Process inventory instead of actual costs. Standard cost variances are closed directly to Cost of Goods Sold

Use of Standard Costs for Product Costing 10-28

Use of Standard Costs for Product Costing 10-29

Use of Standard Costs for Product Costing 10-30

Use of Standard Costs for Product Costing 10-31

End of Chapter 10 Let’s set the standard a little higher