1. Standard Costing, Variance Analysis and Kaizen Costing16
Standard Costing, Variance Analysis and Kaizen Costing

2. Learning Objective 1

3. Using Standard-Costing Systems for Control
based on carefully predetermined amounts.
Standard costs are
used for planning labor
and material requirements.
the expected level of performance.
benchmarks for measuring performance.

4. Using Standard-Costing Systems for Control
a budget for the production of one unit of product or
service
ACTUAL COST
incurred and recorded in the production of the product or service
COST VARIANCE
the difference
between the
actual cost and
the standard cost

5. Using Standard-Costing Systems for Control
This variance is unfavorable because the actual cost exceeds the standard cost.
Standard
A standard cost variance is the amount by which an actual cost differs from the standard cost.
Product cost

6. Management by Exception
Managers focus on quantities and costs that deviate significantly from standards
(a practice known as management by exception).
Standard
Amount
Direct materials
Direct labor
Type of Product Cost

7. Management by Exception
Take the time to investigate only significant cost variances.
What is significant?
Depends on the size of the
organization
Depends on the production
process
Depends on the type of the organization

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

9. Setting Standards Analysis of historical data Task analysis Combined
What DID
the product
cost?
Used in a mature
production process
What
SHOULD the product cost?
Task
analysis
Analyze the process
of manufacturing
the product
Combined
approach
Analyze the process for the step that
has changed, but use historical data
for the steps that have not changed

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

11. Learning Objective 2

12. Perfection versus Practical Standards: A Behavioral Issue
PRACTICAL OR
ATTAINABLE
STANDARDS
Can only be attained under near perfect conditions
Tight as practical,
but still expected to be attained
Peak efficiency
Lowest possible input prices
Best-quality material
No disruption in
production
Occasional machine
breakdowns
Normal amounts
of raw material
waste

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

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

15. Setting Standards – Direct Materials
Price Standards
Quantity Standards
Use competitive bids for the quality and quantity desired.
Use product design specifications.

16. Setting Standards – Direct Materials
The standard materials cost for one unit of product is:
Standard quantity Standard price for of material one unit of material required for one unit of product ×

17. Setting Standards – Direct Labor
Rate standards
Efficiency standards
Use wage surveys and labor contracts.
Use time and motion studies for each labor operation.

18. Setting Standards – Direct Labor
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 ×

19. Standard Cost in Service Industries
Jobs with repetitive tasks lend themselves to efficiency measures.
Computing non-manufacturing efficiency variances requires some assumed relationship between input and output activity.
Examples
Examples

20. Standard Cost in Service Industries

21. Costs and Benefits of Standard-Costing Systems
IMPROVED
DECISION
MAKING, BUT:
Implementing and maintaining cost standards can
be time-consuming, labor-intensive, and expensive.

22. Cost Variance Analysis
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

23. A General Model for Variance Analysis
Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price
Price / Rate variance
Quantity / Efficiency variance

24. A General Model for Variance Analysis
Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price
Price / Rate variance
Quantity / Efficiency variance
Standard price is the amount that should have been paid for the resources acquired.

25. A General Model for Variance Analysis
Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price
Price / Rate variance
Quantity / Efficiency variance
Standard quantity is the quantity allowed for the actual good output.

26. A General Model for Variance Analysis
Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price
Price / Rate variance
Quantity / Efficiency 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

27. Standard Costs
Let’s use the concepts of the general model to calculate standard cost variances, starting with direct materials.

28. Learning Objective 3

29. 12 square meters per tent at $8.00 per square meter (sq m)
Materials Variances
Koala Camp Gear Company in Melbourne Australia has the following direct material standard to manufacture one Tree Line tent:
12 square meters per tent at $8.00 per square meter (sq m)
Last month Koala purchased 40,000 square meters at $8.15 per square meter and used 36,400 square meters to make 3,000 tents.

30. Price variance $6,000 Unfavorable
Materials Variances
Actual quantity Actual quantity purchased purchased × × Actual price Standard price
We should compute the price variance using the actual quantity purchased.
40,000 sq m ,000 sq m × × $8.15 per sq m $8.00 per sq m
$326, $320,000
Price variance $6,000 Unfavorable

31. Quantity variance $3,200 Unfavorable
Materials Variances
SQ = 3,000 tents × 12 sq m per tent SQ = 36,000 sq m
Actual quantity used Standard quantity × × Standard price Standard price
We should compute the quantity variance using the actual quantity used.
36,400 sq m ,000 sq m × × $8.00 per sq m $8.00 per sq m
$291, $288,000
Quantity variance $3,200 Unfavorable

32. We may also calculate materials variances using formulas:
MPV = AQp(AP – SP) MPV = 40,000 sq m × ($8.15 – $8.00) MPV = $6,000 Unfavorable
MQV = SP(AQu – SQ) MQV = $8.00(36,400 sq m – 36,000 sq m) MQV = $3,200 Unfavorable

33. Reporting Materials 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 compute the price variance when materials are purchased, and the usage variance as soon as material is used.

34. Responsibility for Materials Variances
Your poorly trained workers and poorly maintained equipment caused the problems.
Also, your poor scheduling requires rush orders of materials at higher prices, causing unfavorable price variances.
I am not responsible for this unfavorable materials usage variance.
You bought poor quality materials, so my people had to use more of it.

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

36. 2 standard hours per tent at $18.00 per direct labor hour
Labor Variances
Koala has the following direct labor standard to manufacture one Tree Line tent:
2 standard hours per tent at $18.00 per direct labor hour
Last month 5,900 direct labor hours were worked at $19.00 per hour to make 3,000 tents.

37. Labor Variances SH = 3,000 tents × 2 hours per tent SH = 6,000 hours
Actual hours Actual hours Standard hours × × × Actual rate Standard rate Standard rate
5,900 hours ,900 hours ,000 hours × × × $19.00 per hour $18.00 per hour $18.00 per hour
$112, $106, $108,000
Rate variance $5,900 Unfavorable
Efficiency variance $1,800 Favorable

38. We may also calculate labor variances using formulas:
LRV = AH(AR - SR) LRV = 5,900 hrs($ $18.00) LRV = $5,900 Unfavorable
LEV = SR(AH - SH) LEV = $18.00(5,900 hrs - 6,000 hrs) LEV = $1,800 Favorable

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

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

41. Responsibility for Labor Variances
I am not responsible for the unfavorable labor efficiency variance!
You bought poor quality materials, so my people took more time to process them.
You used too much time because of poorly trained workers and poor supervision.

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

43. Allowance for Defects or Spoilage
In some manufacturing processes, a certain amount of defective production or spoilage is normal.
Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output. If total good output in February is 5,000 liters, what is the standard allowed quantity of input?
Good output quantity
= 80% X Input quantity
Good output quantity ÷ 80%
= Input quantity allowed
5,000 liters of good
output ÷ 80%
= 6,250 liters of
input allowed

44. Learning Objective 4

45. Significance of Cost Variances: When to Follow Up
How does a manager know when to follow up
on a cost variance and when to ignore it?
Size of variance
Absolute amount
Relative amount ?

46. Significance of Cost Variances
What clues help me to determine the variances that I should investigate?
Size of variance
Dollar amount
Percentage of standard
Recurring variances
Trends
Controllability
Favorable variances
Costs and benefits of investigation

47. Significance of Cost Variances: When to Follow Up
Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
How do I know which variances to investigate?
We could use a rule of thumb such as: investigate all variances that are over $10,000 or over 10 percent of the standard cost.

48. Significance of Cost Variances: When to Follow Up
What about recurring variances?
None of the variances are greater than $10,000 or
10% for any one month, but they should be investigated because of they have continued for several months.

49. Significance of Cost Variances: When to Follow Up
What about trends?
None of the variances are greater than $10,000 or
10% for any one month, but they should be investigated because of the unfavorable trend.

50. Significance of Cost Variances: When to Follow Up
Controllability
A manager is more likely to investigate a variance that is controllable by someone in the organization than one that is not.
Favorable variances
It is as important to investigate significant favorable variances as well as significant unfavorable variances.
Cost and benefits of investigation
The decision whether to investigate a variance is a cost - benefit decision

51. Provide a warning signal when variations are beyond a specified level.
Statistical Analysis
Control charts
Display variations in a process and help to analyze the variations over time.
Distinguish between random variations and variations that should be investigated.
Provide a warning signal when variations are beyond a specified level.

52. Variance measurements
Statistical Analysis
Warning signals for investigation • •
Favorable limit • • • •
Desired value • •
Unfavorable limit • 1 2 3 4 5 6 7 8 9
Variance measurements

53. Learning Objective 5

54. Behavioral Effects of Standard Costing
Standard costs, budgets and variances are used to
evaluate the performance of individuals and departments
They can profoundly influence behavior when they are used to
determine salary increases, bonuses and promotions

55. Which Managers Influence Cost Variances?
Direct-materials price variance
Purchasing manager
Get the best prices available for purchased goods and services through skillful purchasing practices
Direct-materials quantity variance
Production supervisor
Skillful supervision and motivation of production employees, coupled with
the careful use and handling of materials, contribute to minimal waste
Direct-labor rate variance
Production supervisor
Generally results from using a different mix of employees than that anticipated when the standard were set
Direct-labor efficiency variance
Production supervisor
Motivating employees toward production goals and effective work schedules improves efficiency

56. Interaction among Variances
Exh.
16-5
Interaction among Variances
Interaction among variances often occurs, making it difficult to
determine the responsibility for a particular variance.
Variances in one part of the value chain can be due to root causes in another part of the chain.
Value chain
Research
and
develop-
ment
Design
Supply
Produc-
tion
Marketing
Distri-
bution
Customer
service
Human
resources
Physical
perspective

57. Learning Objective 6

58. Using Standard Costs for Product Costing
Exh.
16-6
Using Standard Costs for Product Costing
Work-in-process inventory
Finished-goods inventory
Direct-materials cost
Product cost transferred
Direct-labor cost
when product is finished
Manufacturing
overhead
Product cost transferred when product is sold
Cost of goods sold
Income summary
Expense closed into
Income summary at end
of accounting period

59. Standard Cost Journal Entries
Inventories are recorded at standard cost.
Variances are recorded as follows:
Favorable variances are credits, representing savings in production costs.
Unfavorable variances are debits, representing excess production costs.
Standard cost variances are usually closed to cost of goods sold.
Favorable variances decrease cost of goods sold.
Unfavorable variances increase cost of goods sold.

60. Impact of Information Technology on Standard Costing
Labor time and rate
are recorded at standard, using bar codes and employee IDs.
CAD designers can access the data base for instant design cost estimates.
Standard cost data base
Materials purchases
and uses are recorded at standard, using bar codes.

61. Learning Objective 7

62. Standard Costing: Its Traditional Advantages
Sensible cost comparisons
Advantages
Management by exception
Performance evaluation
Employee motivation
Less expensive than actual- or normal- costing systems
More stable product costs

63. Learning Objective 8

64. Criticisms of Standard Costing in Today’s Manufacturing Environment
Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system.
Standard costing may not be applicable in flexible manufacturing operations with short life-cycle products.
There is too much focus on cost minimization rather than increasing product quality or customer service.
There is too much focus on the cost and efficiency of direct labor.
Automation reduces labor costs and the significance of labor variances.
Automated manufacturing processes tend to be more consistent in meeting production specifications.
Variance reports are often provided too late to be useful to managers.

65. Adaptation of Standard-Costing Systems
Applications of standard costing have adapted to changes in the manufacturing environment and the resulting criticisms leveled at standard costing.
Reduced importance of labor standards.
More emphasis on material and overhead costs.
Automation means more overhead, less labor.
Less use of labor as a cost driver.

66. Adaptation of Standard-Costing Systems
Applications of standard costing have adapted to changes in the manufacturing environment and the resulting criticisms leveled at standard costing.
Automation
Reduces labor efficiency variance
Reduces material quantity variance
Reduces variation in quality and increases quality

67. Adaptation of Standard-Costing Systems
Applications of standard costing have adapted to changes in the manufacturing environment and the resulting criticisms leveled at standard costing.
More frequent benchmarking
Shorter product life cycles
Elimination of non-value-added costs
More frequent revisions of standard costs
Non-financial measures such a delivery times are more important
Real-time information systems provide more timely variance reports

68. Learning Objective 9

69. Comparing Standard Costing and Kaizen Costing
Standard costing – the use of carefully predetermined product costs for budgeting and performance evaluation.
Standard costs are typically used in established production processes.
Kaizen costing – the emphasis is on continuous reduction of production costs.
Rather than standards or targets, the goal is current costs that are less than previous costs.

70. Kaizen Costing Cost per product unit 12/31/x0 12/31/x1 Time Cost base
Exh.
16-7
Kaizen Costing
Cost per product unit
12/31/x0
12/31/x1
Time
Cost base
for next
year
Actual cost
reduction
achieved
Current year
cost base
Kaizen goal:
cost reduction
rate
performance
of the
current year
Kaizen goal:
cost reduction
amount

71. Learning Objective 10

72. Production Mix and Yield Variances
Nearly all production processes require multiple materials and labor inputs.
A summary quantity variance for materials and labor would hide the individual effects of these inputs.
The quantity variances can be analyzed into two further variances:
Mix (the difference between actual and standard input proportions)
Yield (the difference between actual and standard input used)
The analysis assumes, of course, that the inputs can be substituted for each other.

73. End of Chapter 16