1. Hilton Maher Selto

2. 16 Standard Costing, Variance Analysis, and Kaizen Costing McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

3. 16-3 STANDARD COST a budget for the production of one unit of product or service STANDARD COST a budget for the production of one unit of product or service ACTUAL COST used in the production of the product or service ACTUAL COST used in the production of the product or service COST VARIANCE the difference between the actual cost and the standard cost COST VARIANCE the difference between the actual cost and the standard cost Using Standard-Costing Systems for Control

4. 16-4 Take the time to investigate only significant cost variances What is significant? Depends on the Size of the Organization Depends on the Size of the Organization Depends on the Type of the Organization Depends on the Production Process Depends on the Production Process Management by Exception

5. 16-5 Analysis of Historical Data Analysis of Historical Data Task Analysis Task Analysis Used in a mature production Process Used in a mature production Process Analyze the process of manufacturing the product Analyze the process of manufacturing the product What DID the product cost? What DID the product cost? What SHOULD the product cost? What SHOULD the product cost? A Combined Approach A Combined Approach Analyze the process for the step that has changed, but use historical data for the steps that have not changed Analyze the process for the step that has changed, but use historical data for the steps that have not changed Setting Standards

6. 16-6 Perfection Vs. Practical Standards PERFECTION STANDARDS PERFECTION STANDARDS PRACTICAL OR ATTAINABLE STANDARDS PRACTICAL OR ATTAINABLE STANDARDS Can only be attained under near perfect conditions Tight as practical, but still are expected to be attained Tight as practical, but still are expected to be attained Occasional machine breakdowns Normal amounts of raw material waste Occasional machine breakdowns Normal amounts of raw material waste Peak efficiency Lowest possible input prices best-quality material no disruption in production Peak efficiency Lowest possible input prices best-quality material no disruption in production

7. 16-7 Standards can be used by service firms, nonprofit organizations, and governmental units Standards can be used by service firms, nonprofit organizations, and governmental units Implementing and maintaining cost standards can be time-consuming, labor-intensive, and expensive. Implementing and maintaining cost standards can be time-consuming, labor-intensive, and expensive. Use Of Standards COST BENEFITS COST BENEFITS

8. 16-8 Koala Camp Gear Company Koala Camp Gear Company DIRECT MATERIAL STANDARDS The total amount of material normally required to produce a finished product including allowances for normal waste or efficiency The total delivered cost, after subtracting any purchase discounts The total delivered cost, after subtracting any purchase discounts Cost Variance Analysis

9. 16-9 Koala Camp Gear Company Koala Camp Gear Company DIRECT LABOR STANDARDS Cost Variance Analysis

10. 16-10 Koala Camp Gear Company Koala Camp Gear Company The standard cost for the direct-material and direct-labor inputs is based upon Koala’s actual output of 3,000 tents The standard cost for the direct-material and direct-labor inputs is based upon Koala’s actual output of 3,000 tents They should incur a cost of $396,000 ($288,000 + $108,000) to make 3,000 tents They should incur a cost of $396,000 ($288,000 + $108,000) to make 3,000 tents Standard Costs Given Actual Output

11. 16-11 40,000 sq. meters purchased $8.15 per sq. meter 40,000 sq. meters purchased $8.00 per sq. meter 36,000 sq. meters allowed $8.00 per sq. meter $326,000$320,000$288,000 $6,000U 36,400 sq. meters used $8.00 per sq. meter $291,200 Direct-material price variance $3,200U Direct- material quantity variance xxx Analysis Of Material VariancesActualquantityActualpriceActualquantityStandardpriceStandardquantityStandardpricexxx Exh. 16-1

12. 16-12 What caused Koala to spend more than the anticipated amount on direct material? What caused Koala to spend more than the anticipated amount on direct material? First, the company purchased fabric at a higher price ($8.15 per square meter) than the standard price ($8.00 per square meter). First, the company purchased fabric at a higher price ($8.15 per square meter) than the standard price ($8.00 per square meter). Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased AP = Actual price SP = Standard price Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased AP = Actual price SP = Standard price Koala’s direct- material price variance for June is computed as follows: Direct-material price variance = PQ(AP - SP) = 40,000 ($8.15 - $8.00) = $6,000 unfavorable Koala’s direct- material price variance for June is computed as follows: Direct-material price variance = PQ(AP - SP) = 40,000 ($8.15 - $8.00) = $6,000 unfavorable Direct-Material Variances

13. 16-13 Second, the company used more fabric than the standard price. (36,400 sq. meters actually used, instead of the standard amount of 36,000 sq. meters) Second, the company used more fabric than the standard price. (36,400 sq. meters actually used, instead of the standard amount of 36,000 sq. meters) Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where: AQ = Actual quantity used SQ = Standard quantity allowed Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where: AQ = Actual quantity used SQ = Standard quantity allowed Koala’s direct- material quantity variance for June is computed as follows: Direct-material quantity variance = SP(AQ - SQ) = $8.00(36,400 - 36,000) =$3,200 unfavorable Koala’s direct- material quantity variance for June is computed as follows: Direct-material quantity variance = SP(AQ - SQ) = $8.00(36,400 - 36,000) =$3,200 unfavorable What caused Koala to spend more than the anticipated amount on direct material? What caused Koala to spend more than the anticipated amount on direct material? Direct-Material Variances

14. 16-14 XXX Actual Labor CostStandard Labor Cost Actual hours Standard price Actual rate Actual hours Standard rate Standard rate XXX 5,900 hours used $19 per hour 5,900 hours used $18 per hour 6,000 hours allowed $18 per hour $112,100$106,200$108,000 $5,900 Unfavorable$1,800 Favorable Direct-labor rate variance Direct-labor efficiency variance $4,100 Unfavorable Direct-labor variance Analysis of Direct-Labor Variances Exh. 16-2

15. 16-15 What caused Koala to spend more than the anticipated amount on direct labor? What caused Koala to spend more than the anticipated amount on direct labor? First, the company incurred a cost of $19 per hour for direct labor instead of the standard amount of $18 per hour First, the company incurred a cost of $19 per hour for direct labor instead of the standard amount of $18 per hour Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where: AH = Actual hours used AR = Actual rate per hour SR = Standard rate per hour Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where: AH = Actual hours used AR = Actual rate per hour SR = Standard rate per hour Koala’s direct-labor rate variance for June is computed as follows: Direct-labor rate variance = AH(AR - SR) = 5,900 ($19 - $18) =$5,900 unfavorable Koala’s direct-labor rate variance for June is computed as follows: Direct-labor rate variance = AH(AR - SR) = 5,900 ($19 - $18) =$5,900 unfavorable Direct-Labor Variances

16. 16-16 Koala used only 5,900 hours of direct labor, which is < standard quantity of 6,000 hours, given actual output of 3,000 tents. The increased efficiency does not fully offset the unexpectedly high wage rate. Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where: AH = Actual hours used SH = Standard hours allowed Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where: AH = Actual hours used SH = Standard hours allowed Koala’s direct - labor efficiency variance for June is computed as follows: Direct - labor efficiency variance = SR(AH - SH) = $18 (5,900 - 6,000) = $1,800 favorable Koala’s direct - labor efficiency variance for June is computed as follows: Direct - labor efficiency variance = SR(AH - SH) = $18 (5,900 - 6,000) = $1,800 favorable What caused Koala to spend more than the anticipated amount on direct labor? What caused Koala to spend more than the anticipated amount on direct labor? Direct-Labor Variances

17. 16-17 When there are several types of direct material or direct labor, price and quantity variances are computed for each type, and then added to obtain a total price variance and a total quality variance Multiple Types Of Direct Material Or Direct Labor

18. 16-18 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% 5,000 liters of good output ÷ 80% = 6,250 liters of input allowed = 6,250 liters of input allowed Allowance For Defects Of Spoilage

19. 16-19?? What constitutes an exception? How does a manager know when to follow up on a cost variance and when to ignore it? How does a manager know when to follow up on a cost variance and when to ignore it? RULE OF THUMB: Investigate variances that are either greater than $10,000 or greater than 10 percent of standard cost RULE OF THUMB: Investigate variances that are either greater than $10,000 or greater than 10 percent of standard cost Size of Variance Absolute Amount Relative Amount Management by Exception

20. 16-20 None of the variances are greater than $10,000 or 10%, but this variance should be investigated because it has occurred at a reasonably high amount for four months None of the variances are greater than $10,000 or 10%, but this variance should be investigated because it has occurred at a reasonably high amount for four months Standard direct labor cost is $100,000 Standard direct labor cost is $100,000 Recurring Variances

21. 16-21 None of the variances are greater than $10,000 or 10%, but this variance should be investigated because it has an unfavorable trend. None of the variances are greater than $10,000 or 10%, but this variance should be investigated because it has an unfavorable trend. Standard direct labor is $100,000 Standard direct labor is $100,000 Trends

22. 16-22 Controllability A manager is more likely to investigate a variance that is controllable by someone in the organization than one that is not 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 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 Cost and Benefits of Investigation The decision whether to investigate a variance is a cost - benefit decision Additional Issues

23. 16-23 A STATISTICAL CONTROL CHART plots cost variances across time and compares them with a statistically determined critical value that triggers an investigation A STATISTICAL CONTROL CHART plots cost variances across time and compares them with a statistically determined critical value that triggers an investigation Statistical Analysis Exh. 16-4 1 standard deviation 1 standard deviation X X X X X X Time Jan.Feb.MarchAprilMayJune Favorable variances Unfavorable variances Critical value Investigate

24. 16-24 Behavioral Effects Of Standard Costing Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments 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 They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions

25. 16-25 Direct-material price variance Direct-material quantity variance Direct-labor rate variance Direct- labor efficiency variance The purchasing manager The production supervisor Get the best prices available for purchased goods and services through skillful purchasing practices Skillful supervision and motivation of production employees, coupled with the careful use and handling of materials, contribute to minimal waste Generally results from using a different mix of employees than that anticipated when the standard were set Motivating employees toward production goals and effective work schedules improves efficiency Which Managers Generally Influence Cost Variances?

26. 16-26 Research and develop- ment Design Supply Produc- tion Marketing Distri- bution Customer service Human resources Human resources Physical resources Physical resources Variances in one part of the value chain can be due to root causes in another part of the chain Variances in one part of the value chain can be due to root causes in another part of the chain Interaction among variances often occur making it difficult to determine the responsibility for a particular variance Interaction among variances often occur making it difficult to determine the responsibility for a particular variance Interaction Among Variances Value Chain Perspective Exh. 16-5

27. 16-27 Work-in-Process Inventory Direct-material cost Direct-labor cost Manufacturing Overhead Finished-Goods Inventory Cost of Goods SoldIncome Summary Product cost transferred when product is finished Product cost transferred when product is sold Expense closed into Income Summary at end of accounting period Exh. 16-6 Using Standard Costs For Product Costing

28. 16-28 Variances are temporary accounts, like revenue and expense accounts, and they are closed out at the end of the accounting period. Variances are temporary accounts, like revenue and expense accounts, and they are closed out at the end of the accounting period. Cost of Goods Sold Unfavorable variances represent costs of operating inefficiently, relative to the standards, and thus cause the Cost of Goods Sold to be higher Favorable variances represent costs of operating efficiently, relative to the standards, and thus cause the Cost of Goods Sold to be lower Disposition Of Variances

29. 16-29 Impact of Information Technology on Standard Costing

30. 16-30 Standard Costing: Advantages Allows managers to use management by exception Provides a basis for sensible cost comparisons Provides a means of performance evaluation and rewards for employees Allows managers to use management by exception Provides a basis for sensible cost comparisons Provides a means of performance evaluation and rewards for employees Provides motivation for employees to adhere to standards Results in more stable product costs Is less expensive than actual- or normal- costing systems Provides motivation for employees to adhere to standards Results in more stable product costs Is less expensive than actual- or normal- costing systems

31. 16-31 Criticisms Of Standard Costing In Today’s Environment Shorter product life cycles mean that standards are only relevant for a short time Too much focus on cost minimization rather than increasing product quality or customer service Automated manufacturing processes tend to be more consistent in meeting production specifications. Not defined broadly enough to capture important aspect of ownership Shorter product life cycles mean that standards are only relevant for a short time Too much focus on cost minimization rather than increasing product quality or customer service Automated manufacturing processes tend to be more consistent in meeting production specifications. Not defined broadly enough to capture important aspect of ownership Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system Variances are often too late to be useful Standard costing out of step with the philosophy of cost management systems and activity-based management Too much focus on the cost and efficiency of direct labor Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system Variances are often too late to be useful Standard costing out of step with the philosophy of cost management systems and activity-based management Too much focus on the cost and efficiency of direct labor

32. 16-32 Adaptation of Standard- Costing Systems Reduced importance of labor standards Shifting Cost Structures Cost Drivers Emphasis on Material and O/H costs Shorter Product Life Cycles Non-Value- Added Costs High Quality/Zero Defects Real-time Information Systems Benchmarkin g

33. 16-33 KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and responsibility of each worker. Cost per product unit 12/31/x012/31/x1 Time Cost base for next year Actual cost reduction achieved Current year cost base Kaizen goal: cost reduction rate Actual cost performance of the current year Exh. 16-7 Kaizen Costing

34. 16-34 END OF CHAPTER 16