1. 11-1 Control and Evaluation of Cost Centers Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University 11

2. 11-2  Develop standard variable costs for a product.  Calculate direct labor, variable overhead, and materials variances.  Discuss the advantages and disadvantages of approaches to setting standards.  Describe new approaches to cost control and management, as described by proponents of JIT and other continuous improvement approaches. ObjectivesObjectives After reading this chapter, you should be able to:

3. 11-3 Cost control is important for companies following a cost leadership strategy where total demand for the product is not growing.

4. 11-4 A standard cost is the per-unit cost a company should incur to make a unit of product.

5. 11-5 A standard cost has two components: a standard price, or rate, and a standard quantity.

6. 11-6 Standard Variable Costs Cost Factor Std. QuantityStd. PriceStd. Cost Materials10.00$0.80$8.00 Direct labor0.5016.008.00 Variable overhead0.506.00 3.00 Total standard variable cost$19.00 Actual results: Production1,000units Materials purchased, 11,000 at $0.78.$8,580 Materials used10,200gallons Direct labor, 480 hours at $16.20$7,776 Variable overhead incurred$3,100

7. 11-7 Labor Variances Actual production (units) Standard direct labor cost per unit Total standard direct labor cost x = 1,000 x $8.00 = $8,000

8. 11-8 Labor Variances Actual input quantity Actual rate for input factor Actual cost of input factor x = 480 hours x $16.20 = $7,776

9. 11-9 Labor Variances Actual input quantity Standard rate for input factor Budget allowance for actual quantity of input factor x = 480 hours x $16 = $7,680

10. 11-10 Labor Variances Standard input quantity Standard rate for input factor Budget allowance for actual quantity of output x = 1,000 units x ½ hour per unit = 500 hours x $16 = $8,000

11. 11-11 Labor Variances Labor rate variance$ 96unfavorable Labor efficiency variance 320favorable Total labor variance$224favorable

12. 11-12 Actual Quantity at Actual Rates (Total Actual Costs) Flexible Budget For Actual Quantity at Standard Rate Flexible Budget for Standard Quantity at Standard Rate (Total Standard Cost) Rate variance Efficiency variance $96 U $320 F $224 F Total Variance Labor Variances 480 x $16.20 480 x $16.00 1,000 x 1/2 x $16.00 $7,776 $7,680 $8,000

13. 11-13 Variable Overhead Variances Actual Quantity at Actual Rate (Total Actual Cost) Flexible Budget for Actual Quantity at Standard Rate Flexible Budget for Standard Quantity at Standard Rate (Total Standard Cost) $220 U Budget variance Efficiency variance $120 F $100 U Total Variance 480 x $6 1,000 x 0.50 x $6 $2,880 $3,000 $3,100

14. 11-14 Variable Overhead Variances The variable overhead efficiency variance reflects the efficient or inefficient use of the item used as the cost driver.

15. 11-15 Actual Quantity Purchased at Standard Price Actual Quantity Purchased at Actual Price Materials Variances $8,580 $8,800 11,000 x $0.7811,000 x $0.80 $220 F Material Price Variance

16. 11-16 Materials Variances Material price variance Actual quantity purchased Standard price Actual price – = x $220 F = 11,000 x ($0.80 – $0.78)

17. 11-17 Materials Variances Flexible Budget for Standard Quantity at Standard Price (Total Standard Cost) Flexible Budget for Actual Quantity Used at Standard Price $8,160 $8,000 10,200 x $0.801,000 x 10 x $0.80 $160 U Material Use Variance

18. 11-18 Materials Variances Material use variance Standard price Standard quantity for actual output Actual quantity – = x $160 U = $0.80 x (10,000 – 10,200)

19. 11-19 Material use variance— is calculated the same as the labor and overhead efficiency variances Material price variance— differs from its counterparts in labor and variable overhead because materials,unlike labor, can be stored. Purchases made in one period are not necessarily used in that period, but the economic effect of paying more or less than standard prices for materials occurs at the time of purchase. So the material price variance is based on the quantity of materials purchased, not the quantity used. Materials Variances

20. 11-20 There are two principle variable overhead cost pools. One is driven by machine time, while the other is driven by the number of machine setups. The two rates are $6.00 per machine hour and $140 per setup. Continued Standard Costs and Activity- Based Costing Example

21. 11-21 The standard machine hours and number of setups for 1 batch (1,000 units) is 1,500 hours and 20 setups, respectively. Actual machine hours and number of setups for 10 batches (10,000 units) are 14,000 hours and 210 setups, respectively. The actual overhead costs driven by machine hours and number of setups are $85,000 and $27,500, respectively. Standard Costs and Activity- Based Costing Example

22. 11-22 Actual Cost Budget for Actual Use Standard Cost Standard Costs and Activity- Based Costing Example $1,000 U Budget variance Efficiency variance $6,000 F $5,000 F Total Variance 14,000 x $6.00 10 x 1,500 x $6.00 $84,000 $90,000 $85,000 Machine-driven variable overhead

23. 11-23 Actual Cost Budget for Actual Use Standard Cost Standard Costs and Activity- Based Costing Example $1,900 F Budget variance Efficiency variance $1,400 U $500 F Total Variance 210 x $140 10 x 20 x $140 $29,400 $28,000 $27,500 Setup-driven variable overhead

24. 11-24 Variances and Performance Evaluation Variances signal nonstandard performance only if they are based on up-to-date standards that reflect current production methods and current prices of input factors. Many variances are interdependent.

25. 11-25 Setting Standards—Behavioral Problems Engineering methods Managerial estimates Benchmarking and best practices

26. 11-26 Setting Standards—Behavioral Problems Engineering Methods Some companies develop standard quantities for materials and labor by carefully examining production methods and determining how much of an input factor is necessary to obtain a finished unit.

27. 11-27 Setting Standards—Behavioral Problems Managerial Estimates Some companies rely on the judgment of managers closest to the task to determine quantities of input needed to produce a unit of product. Managers who participate in setting standards are more likely to commit to meeting them.

28. 11-28 Benchmarking is a relatively recent development that companies use to determine whether their operations and costs compare favorably to those of world-class companies. Setting Standards—Behavioral Problems Benchmarking

29. 11-29 What Standard? An ideal standard can be attained only under perfect conditions. Setting a currently attainable standard recognizes expectations about efficiency under normal working conditions. An historical standard is based on experience.

30. 11-30 Kaizen Costing and Target Costing Kaizen costing stresses continuous improvement in the production process. Under kaizen, performance standards are continually raised (standard costs lowered), so the objective is to meet targeted reductions, not standard costs.

31. 11-31 Kaizen Costing and Target Costing Value engineering refers to design and re-design that focuses on customer value. Value engineering is redesigning products so that they will cost less. Value engineering is an optimizing technique where people seek exactly what features the product needs, how to make it, what materials to use, and so on.

32. 11-32 Kaizen Costing and Target Costing Target costing is price- driven; market prices determine cost instead of vice versa. Companies reduce cost through systemic analyses of the features and functions deemed most important to customers. Much of target costing takes place during product design.

33. 11-33 The End Chapter 11

34. 11-34