Standard Costs and Operating Performance Measures

Standard Costs Standards are benchmarks or “norms” for measuring performance. In managerial accounting, two types of standards are commonly used. Quantity standards specify how much of an input should be used to make a product or provide a service. Price standards specify how much should be paid for each unit of the input. Examples: Firestone, Sears, McDonald’s, hospitals, construction and manufacturing companies.

Key performance indicators VS Actual performance KPI/Pre cost targetActual/Post costVariance Direct material per unit (A) Direct labour 5.00 per unit (A) Variable overhead 2.00 per unit2.00- Fixed overhead 1.00 per unit1.00- Full cost per unit18.50

Standard Costs Direct Material Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception. Type of Product Cost Amount Direct Labor Manufacturing Overhead Standard

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

PDCA P=PLAN D=DO C=CHECK A=ACTION

Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future operations. Setting Standard Costs

Should we use ideal standards that require employees to work at 100 percent peak efficiency? Engineer Managerial Accountant I recommend using practical standards that are currently attainable with reasonable and efficient effort.

Setting Direct Material Standards Price Standards Summarized in a Bill of Materials. Final, delivered cost of materials, net of discounts. Quantity Standards

Setting Standards Six Sigma advocates have sought to eliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste and spoilage that are built into standards should be reduced over time. Six Sigma advocates have sought to eliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste and spoilage that are built into standards should be reduced over time.

Setting Direct Labor Standards Rate Standards Often a single rate is used that reflects the mix of wages earned. Time Standards Use time and motion studies for each labor operation.

Setting Variable Manufacturing Overhead Standards Rate Standards The rate is the variable portion of the predetermined overhead rate. Quantity Standards The quantity is the activity in the allocation base for predetermined overhead.

Price and Quantity Standards Price and quantity standards are determined separately for two reasons:  The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.  The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

A General Model for Variance Analysis Variance Analysis Price Variance Difference between actual price and standard price Quantity Variance Difference between actual quantity and standard quantity

Variance Analysis Materials price variance Labor rate variance VOH rate variance Materials quantity variance Labor efficiency variance VOH efficiency variance A General Model for Variance Analysis Price VarianceQuantity Variance

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

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

Actual results for the month of March Actual production 5000 units Actual material used and purchased 17500Kg Actual material cost Rs Labour hours produced 11250hours Labour cost incurred Rs Variable overhead Rs Calculate all possible variances from the pre cost standard

Variance analysis Ultra Shine Company Ultra Shine Company manufactures a cleaning solvent. The company employs both skilled and unskilled workers. The standard and actual material and labor information is presented below. Budgted production sales units. Standard: Material A: Rs.1.25 per gallon = Skilled Labor: 4 Rs. 12 per hour = Variable production overhead 4 Rs per hour= Fixed production overhead = Full cost per unit = Profit margin per unit = Selling price = Post order costing: Material A: 10,716 gallons purchased and Rs.1.50 per gallon Skilled labor hours: Rs per hour Variable production cost Rs Fixed production overhead cost Rs.310, During the current month Ultra Shine Company manufactured gallon drums and total revenue earned Rs.7,508, Calculate all possible variances