1. May 25, 2009 Standard Costs Chapter 8: Standard Costs.
This chapter begins our study of management control and performance measures. It explains how standard costs are used by managers to control costs.

2. Today’s Agenda What is Standard Cost and what is its purpose?
How are they set?
Direct Material Standard
Direct Labour Standard
Variable Overhead Standard
Standard Cost versus Actual Cost
Variance Analysis
Benefits and Problems with Standard Cost

3. Standard Cost
Standard Costs are benchmark costs that management believes are appropriate for measuring performance
Quantity Standards
How many units of an input should be used to produce a unit of output
E.g., it should take 20 minutes of Direct Labour to produce one cell phone
Price Standards
What is the appropriate price of a unit I
E.g., an hour of labour should cost $5
In this case, the Direct Labour Standard is .33 * 5, or $1.67 per unit

4. Standard Cost Standard Cost information is used for several purposes:
Budgeting
Build up of expected appropriate costs are input into budgets
Monitoring costs
Budgets are tracked on a regular basis
Controlling costs
With budgeted inputs in place, managers are incentivized to work to and exceed targets
Isolating problems
When compared to actual costs, it is helpful in identifying problem areas and isolating the source

5. Variance Deviations from Standard Cost are called “Variances”
Variances can be “Favourable” or “Unfavourable”
In the case of the cell phone manufacturer, any Direct Labour cost per unit which is
above the Standard Cost of $1.67 would be described as an Unfavourable Variance
Below the Standard Cost of $1.67 would be described as a Favourable Variance
Managers can focus in particular on Unfavourable Variances
There could be a problem in the production process
There could be a problem with the application of the methodology

6. Variance Analysis Cycle
Identify questions
Receive explanations
Take corrective actions
Conduct next period’s operations
Analyze variances
The variance analysis cycle is a continuous five-step process:
The cycle begins with the preparation of standard cost performance reports in the accounting department.
These reports highlight variances that are differences between actual results and what should have occurred according to standards.
Variances raise questions such as: a. Why did this variance occur? b. Why is this variance larger than it was last period?
Significant variances are investigated to discover their root causes.
Corrective actions are taken and the next period’s operations are carried out.
Prepare standard cost performance report
Begin

7. Who Sets Standard Costs
Setting appropriate Standard Costs requires the input of several people
Purchasing Managers
Pricing of Direct Materials
Production Managers
Quantity of Direct Materials
Required Labour
Engineers
Optimizing processes and determining impact on Standard Cost
Accountants
Verification
Calculation and monitoring
Exception reporting
As managers will be held to account for Variances, therefore Standard Costs should be “reasonable” and achievable
Additional incentive can be provided for reducing costs, designing out high value parts and processes, etc.

8. Standard Costs Objects
Direct Materials
Quantity Standard
Quantity or each component required
Lead times – impacts inventory financing costs (as apposed to standard cost)
Price Standard
Price of the components at the volume required
Net of discounts, shipping etc. – “landed cost”
Direct Labour
Time Standard
Time required from Direct Labour to “Convert” the Direct Materials into a Finished Product
Rate Standard
Variable Manufacturing Overhead
Price Standards
Quantity Standards

9. Standard Cost Card – Variable Production Cost
A Standard Cost Card is produced for each SKU
The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.

10. A General Model for Variance Analysis
Price Variance
Difference between actual price and standard price
Quantity Variance
Difference between actual quantity and standard quantity
Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of computing and interpreting variances is called variance analysis.

11. A General Model for Variance Analysis
Price Variance
Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Although price and quantity variances are known by different names, they are computed exactly the same way (as shown on this slide) for direct materials, direct labor, and variable manufacturing overhead.
(AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

12. General Variance Analysis Applied
Assumptions:
Standard Rate = $104
Standard Quantity = 1,000
Actual Quantity = 900
Actual Cost = $110,000
What is the Price and quantity Variance?

13. General Variance Analysis Applied
Actual Rate = 900 units / $110,000 = $122
Price Variance = 93,600 – 110,000 = -$16,400 (unfavourable)
Quantity Variance = 104,000 – 93,600 = $10,400 (favourable)

14. Detailed Variance Analysis Applied
Variance Analysis is applied in the same way for detailed accounts as it is in general
Direct Materials, Direct Labour, Variable Overhead
Direct Materials Variance
Assume:
Standard Quantity = 5,000 pieces (5 pieces x 1,000 products)
Standard Rate = $10 per piece
Actual Quantity Used 4,500 pieces
Actual Cost = $60,000

15. Detailed Variance Analysis Applied
Actual Rate = $13 per piece ($60,000/4,500 pieces)
Price Variance = -$15,000 unfavourable
Quantity Variance = $5,000 favourable

16. Tutorial Assignment Study Review Problems
Prepare for Group Project Final Section