1. Cost Variances and Quality Management
Chapter M9
Cost Variances and Quality Management
PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University
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2. The Manufacturing Process at MetalArt
Ingram Overland
Exhibit 1
The Manufacturing Process at MetalArt

3. Once you have completed this chapter, you should be able to:
Objective 1
Calculate and evaluate cost variances for direct materials and direct labor.

4. Variance Analysis for Direct Materials and Direct Labor
Standard costs represent the cost of the material and labor that should have been used to achieve actual production levels.

5. Variance Analysis for Direct Materials and Direct Labor
Standards are based on engineering studies to determine the amount of a resource necessary to manufacture a product.

6. Variance Analysis for Direct Materials and Direct Labor
Total Actual Costs
Total Standard Costs
Price Variance
materials price
labor rate
Quantity Variance
materials quantity
labor efficiency
Total Variance
Exhibit 4

7. Variance Analysis for Direct Materials and Direct Labor
Total Actual Costs
Total Standard Costs
Price Variance
Quantity Variance
Actual Quantity x Standard Price
materials price
labor rate
materials quantity
labor efficiency
Actual Quantity x Actual Price
Standard Quantity x Standard Price
Total Variance
Exhibit 4

8. Variances–Materials Total Actual Costs Total Standard Costs
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
Actual Quantity x Actual Price
500,000 pounds x $0.25
= $125,000
$125,000
MetalArt

9. Variances–Materials Total Actual Costs Total Standard Costs
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
Standard Quantity x Standard Price
460,000 pounds x $0.30
= $138,000
$125,000
$138,000
MetalArt

10. Variances–Materials Total Actual Costs Total Standard Costs
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
Total Material Variance
$125,000
$138,000
MetalArt
$13,000 Favorable

11. Variances–Materials
The total actual costs are $13,000 less than total standard costs. This results in a $13,000 favorable material variance.
MetalArt

12. Variances–Materials Actual Quantity x Standard Price
500,000 pounds x $0.30
= $150,000
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
$125,000
$150,000
$138,000
MetalArt

13. Variances–Materials First, let’s look at material price variance.
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
$125,000
$138,000
$150,000
First, let’s look at material price variance.
Material Price Variance
MetalArt

14. Variances–Materials $150,000 –125,000 $ 25,000 Total Actual Costs
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
$125,000
$138,000
$150,000
$150,000
–125,000
$ 25,000
Material Price Variance
MetalArt

15. Variances–Materials
The actual price paid for materials was less than the standard price, so the material price variance is favorable.
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
$125,000
$138,000
$150,000
Material Price Variance
MetalArt

16. Variances–Materials
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
Total Variance
Standard Quantity x Standard Price
Next, let’s look at the material quantity variance.
Material Quantity Variance
$125,000
$150,000
$138,000
MetalArt

17. Variances–Materials $150,000 –138,000 $ 12,000 Total Actual Costs
Total Standard Costs
$150,000
–138,000
$ 12,000
Material Quantity Variance
Actual Quantity x Standard Price
$125,000
$150,000
$138,000
Actual Quantity x Actual Price
Standard Quantity x Standard Price
MetalArt
$12,000
Total Variance

18. Variances–Materials
MetalArt used 500,000 pounds of material when only 460,000 should have been used for the actual production.
Actual Quantity x Standard Price
Total Actual Costs
Total Standard Costs
Actual Quantity x Actual Price
$12,000
Standard Quantity x Standard Price
Material Quantity Variance
$125,000
$150,000
$138,000
MetalArt

19. Variances–Materials
These 40,000 additional pounds at 30 cents per pound resulted in a $12,000 unfavorable material quantity variance.
Total Actual Costs
Total Standard Costs
Material Quantity Variance
Actual Quantity x Standard Price
$125,000
$150,000
$138,000
Actual Quantity x Actual Price
Standard Quantity x Standard Price
MetalArt
$12,000
Total Variance

20. Variances–Labor Actual Hours x Actual Rate 5,300 hours x $29
Total Actual Costs
Total Standard Costs
Actual Hours x Actual Rate
5,300 hours x $29
= $153,700
Actual Hours x Standard Rate
$153,700
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
Total Labor Variance

21. Variances–Labor Standard Hours x Standard Rate 4,600 hours x $24
Total Actual Costs
Total Standard Costs
Standard Hours x Standard Rate
4,600 hours x $24
= $110,400
Actual Hours x Standard Rate
$153,700
$153,700
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
Total Labor Variance

22. Variances–Labor Total Actual Costs Total Standard Costs
Total Labor Variance
Actual Hours x Standard Rate
$153,700
$153,700
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
$43,300 Unfavorable
Total Labor Variance

23. Variances–Labor Actual Hours x Standard Rate 5,300 hours x $24
= $127,200
Total Actual Costs
Total Standard Costs
Labor Rate Variance
Actual Hours x Standard Rate
$153,700
$153,700
$127,200
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
$26, 500

24. Variances–Labor
The actual labor rate per hour was $5 more than the standard, so the $26,500 labor rate variance is unfavorable.
Total Actual Costs
Total Standard Costs
Labor Rate Variance
Actual Hours x Standard Rate
$153,700
$153,700
$127,200
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
$26, 500

25. Variances–Labor Total Actual Costs Total Standard Costs $153,700
Labor Efficiency Variance
Actual Hours x Standard Rate
$153,700
$153,700
$127,200
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt

26. Variances–Labor $127,200 –110,400 $ 16,800 Total Actual Costs
Total Standard Costs
$127,200
–110,400
$ 16,800
Labor Efficiency Variance
Actual Hours x Standard Rate
$153,700
$153,700
$127,200
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
$16,800

27. Variances–Labor
The actual hours worked to produce the goods were 700 more than standard, so the $16,800 labor efficiency variance is unfavorable.
Total Actual Costs
Total Standard Costs
Labor Efficiency Variance
Actual Hours x Standard Rate
$153,700
$153,700
$127,200
$110,400
Actual Hours x Actual Rate
Standard Hours x Standard Rate
MetalArt
$16,800

28. Once you have completed this chapter, you should be able to:
Objective 2
Explain how variance analysis can enhance managerial decision making.

29. MetalArt Material price variance $25,000 favorable
Material quantity variance (12,000) unfavorable
Labor rate variance (26,500) unfavorable
Labor efficiency variance (16,800) unfavorable
Net variance $(30,300) unfavorable

30. MetalArt
The overall variance picture indicates that inferior material has been purchased to reduce cost. This policy resulted in excessive waste and additional labor time.

31. MetalArt
The unfavorable labor variances also may indicate that, despite paying higher than standard wages, the workers are receiving poor training or there are problems with scheduling.

32. Once you have completed this chapter, you should be able to:
Objective 3
Identify four types of quality costs and explain how managers use these costs to improve performance.

33. Quality Cost Concepts
Quality costs are costs incurred because poor quality can or does exist in a particular product, function or business.

34. Failure costs are costs incurred because poor quality exists.
Quality Cost Concepts
Prevention costs are costs incurred to prevent the production of poor-quality units or poor-quality services.
Appraisal costs are costs incurred to identify poor-quality products before a customer receives the goods or services.
Failure costs are costs incurred because poor quality exists.

35. Quality Cost Mix
Exhibit 6

36. Once you have completed this chapter, you should be able to:
Objective 4
Describe how variability can affect production costs.

37. Lower Specification Limit Upper Specification Limit
Taguchi Quality Loss Function
Traditional Cost Function
$ Loss
Lower Specification Limit
Upper Specification Limit
Loss incurred
No loss incurred
Loss incurred
Specification Limit
Exhibit 7

38. Lower Specification Limit Upper Specification Limit
Taguchi Quality Loss Function
Taguchi Cost Function
$ Loss
Quality loss curve
Target Value
Lower Specification Limit
Upper Specification Limit
Exhibit 8
Specification Limit

39. Taguchi Quality Loss Function
Dr. Genichi Taguchi

40. MetalArt Quality loss = K(y – T)²
Y = actual value of quality measurement
T = target value of a quality
measurement
K = dollar value of loss associated with
deviation from target. The value is
based on estimated cost of rework,
scrap, and customer ill will.

41. MetalArt Loss of color density = 95 Quality loss = K(y – T)²
$5(95 – 100)²
$5(25)
$125

42. MetalArt Loss of color density = 135 Quality loss = K(y – T)²
$5(135 – 100)²
$5(1,225)
$6,125

43. Unit and Total Costs: The Taguchi Quality Loss Function
Exhibit 11
Continued

44. Unit and Total Costs: The Taguchi Quality Loss Function
Exhibit 11

45. Once you have completed this chapter, you should be able to:
Objective 5
Explain how statistical process control provides useful information to managers of both production and administrative functions.

46. Statistical Process Control
A special cause variation has an identifiable source, such as faulty equipment or processes.
A common cause variation is the result of randomness inherent in a process.

47. Statistical Process Control
Statistical process control charts usually include--
(a) a center line, representing the expected value of a characteristic,
(b) a line above and another below the expected value, indicating the limits within which a characteristic is considered to be in control,
(c) a horizontal axis, indicating the time order of observations of the characteristics, and
(d) a vertical axis, measuring the values of observations.

48. Flow Volume (Per Second)-
Exhibit 12
Example of a Statistical Process Control Chart
115
110
105
l00 95 90 85 80 75 70 65 60 55 50 45 40 35
Upper Control Limit = 109
Process Average = 77.9
Flow Volume (Per Second)
Lower Control Limit = 47.2
| | | | | | | | | | | | |
Observation

49. Statistical Process Control
Control charts are designed to signal when a process is out of control.

50. Once you have completed this chapter, you should be able to:
Objective 6
Explain the application of performance evaluation methods in service organizations.

51. Performance Evaluation for Service Organizations
Service organizations such as CPA firms, law firms, hospitals, etc. face performance issues similar to those encountered by manufacturing organizations.

52. Performance Evaluation for Service Organizations
Statistical process control charts are commonly used within service organizations to determine if a service process is “in control.”

53. Performance Evaluation for Service Organizations
Many service organizations use quality cost systems that attempt to measure the cost of external failure.

54. Chapter M9
THE END