1. Standard Costs and Operating Performance Measures
Chapter 11
Standard Costs and Operating Performance Measures

2. Standard Costs Based on carefully predetermined amounts.
Used for planning labor, material and overhead requirements.
Standard Costs are
The expected level of performance.
Benchmarks for measuring performance.

3. Manufacturing Overhead
Standard Costs
Managers focus on quantities and costs that exceed standards, a practice known as management by exception.
Standard
Amount
Direct Material
Direct Labor
Manufacturing Overhead
Type of Product Cost

4. Setting Direct Material Standards
Price Standards
Quantity Standards
Final, delivered cost of materials, net of discounts.
Use product design specifications.

5. Setting Direct Labor Standards
Rate Standards
Time Standards
Use wage surveys and labor contracts.
Use time and motion studies for each labor operation.

6. Setting Variable Overhead Standards
Rate Standards
Activity Standards
The rate is the variable portion of the predetermined overhead rate.
The activity is the base used to calculate the predetermined overhead.

7. Standard Cost Card – Variable Production Cost
A standard cost card for one unit of product might look like this:

8. Standards vs. Budgets A standard is the expected cost for one unit.
A budget is the expected cost for all units.
Are standards the same as budgets?

9. Standard Cost Variances
A standard cost variance is the amount by which an actual cost differs from the standard cost.
Standard
This variance is unfavorable because the actual cost exceeds the standard cost.
Product Cost

10. Standard Cost Variances
First, they point to causes of problems and directions for improvement.
Second, they trigger investigations in departments having responsibility for incurring the costs.
I see that there is an unfavorable variance.
But why are variances important to me?

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

12. 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

13. Practice Question Price Variance plus Quantity Variance equals:
Usage Variance.
Rate Variance.
Total Variance.
Standard Variance.

14. A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
Standard price is the amount that should have been paid for the resources acquired.

15. A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
Standard quantity is the quantity allowed for the actual good output.

16. A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

17. A General Model for Variance Analysis
Std Price $
Std Qnty

18. A General Model for Variance Analysis
Std Price $
Quantity Variance
Std Qnty
Act Qnty

19. A General Model for Variance Analysis
Actual Price
Price Variance
Std Price $
Quantity Variance
Std Qnty
Act Qnty

20. Standard Costs
Let’s use the general model to calculate standard cost variances, starting with direct material.

21. Material Variances Example
Zippy
Hanson Inc. has the following direct material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630.

22. Material Variances
Zippy
What is the actual price per pound paid for the material?
a. $4.00 per pound.
b. $4.10 per pound.
c. $3.90 per pound.
d. $6.63 per pound.

23. Material Variances
Zippy
What is the actual price per pound paid for the material?
a. $4.00 per pound.
b. $4.10 per pound.
c. $3.90 per pound.
d. $6.63 per pound.
AP = $6,630 ÷ 1,700 lbs. AP = $3.90 per lb.

24. Material Variances
Zippy
Hanson’s material price variance (MPV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

25. Material Variances
Zippy
Hanson’s material price variance (MPV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($ ) MPV = $170 Favorable

26. Material Variances
Zippy
The standard quantity of material that should have been used to produce 1,000 Zippies is:
a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.

27. Material Variances
Zippy
The standard quantity of material that should have been used to produce 1,000 Zippies is:
a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.
SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs

28. Material Variances
Zippy
Hanson’s material quantity variance (MQV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

29. Material Variances
Zippy
Hanson’s material quantity variance (MQV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable

30. Material Variances Summary
Zippy
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
1,700 lbs ,700 lbs ,500 lbs × × × $3.90 per lb $4.00 per lb $4.00 per lb.
= $6, = $ 6, = $6,000
Price variance $170 favorable
Quantity variance $800 unfavorable

31. Material Variances
The price variance is computed on the entire quantity purchased.
The quantity variance is computed only on the quantity used.
Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used?

32. Material Variances Continued
Zippy
Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies.

33. Material Variances Continued
Zippy
Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price
2,800 lbs ,800 lbs × × $3.90 per lb $4.00 per lb.
= $10, = $11,200
Price variance increases because quantity purchased increases.
Price variance $280 favorable

34. Material Variances Continued
Zippy
Actual Quantity Used Standard Quantity × × Standard Price Standard Price
1,700 lbs ,500 lbs × × $4.00 per lb $4.00 per lb.
= $6, = $6,000
Quantity variance is unchanged because actual and standard quantities are unchanged.
Quantity variance $800 unfavorable

35. Isolation of Material Variances
I’ll start computing the price variance when material is purchased rather than when it’s used.
I need the price variance sooner so that I can better identify purchasing problems.
You accountants just don’t understand the problems that purchasing managers have.

36. Responsibility for Material Variances
You used too much material because of poorly trained workers and poorly maintained equipment.
Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances.
I am not responsible for this unfavorable material quantity variance.
You purchased cheap material, so my people had to use more of it.

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

38. Labor Variances Example
Zippy
Hanson Inc. has the following direct labor standard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 per direct labor hour
Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to make 1,000 Zippies.

39. Labor Variances
Zippy
What was Hanson’s actual rate (AR) for labor for the week?
a. $6.20 per hour.
b. $6.00 per hour.
c. $5.80 per hour.
d. $5.60 per hour.

40. Labor Variances
Zippy
What was Hanson’s actual rate (AR) for labor for the week?
a. $6.20 per hour.
b. $6.00 per hour.
c. $5.80 per hour.
d. $5.60 per hour.
AR = $9,610 ÷ 1,550 hours AR = $6.20 per hour

41. Labor Variances Hanson’s labor rate variance (LRV) for the week was:
Zippy
Hanson’s labor rate variance (LRV) for the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.

42. Labor Variances Hanson’s labor rate variance (LRV) for the week was:
Zippy
Hanson’s labor rate variance (LRV) for the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
LRV = AH(AR - SR) LRV = 1,550 hrs($ $6.00) LRV = $310 unfavorable

43. Labor Variances
Zippy
The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is:
a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
d. 1,800 hours.

44. Labor Variances
Zippy
The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is:
a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
d. 1,800 hours.
SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours

45. Labor Variances
Zippy
Hanson’s labor efficiency variance (LEV) for the week was:
a. $290 unfavorable.
b. $290 favorable.
c. $300 unfavorable.
d. $300 favorable.

46. Labor Variances
Zippy
Hanson’s labor efficiency variance (LEV) for the week was:
a. $290 unfavorable.
b. $290 favorable.
c. $300 unfavorable.
d. $300 favorable.
LEV = SR(AH - SH) LEV = $6.00(1,550 hrs - 1,500 hrs) LEV = $300 unfavorable

47. Labor Variances Summary
Zippy
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
1,550 hours ,550 hours ,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour
= $9, = $9, = $9,000
Rate variance $310 unfavorable
Efficiency variance $300 unfavorable

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

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

50. Responsibility for Labor Variances
I am not responsible for the unfavorable labor efficiency variance!
You purchased cheap material, so it took more time to process it.
You used too much time because of poorly trained workers and poor supervision.

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

52. Standard Costs
Now let’s calculate standard cost variances for the last of the variable production costs – variable manufacturing overhead.

53. Variable Manufacturing Overhead Variances Example
Zippy
Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy:
1.5 standard hours per Zippy at $3.00 per direct labor hour
Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead.

54. Variable Manufacturing Overhead Variances
Zippy
What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?
a. $3.00 per hour.
b. $3.19 per hour.
c. $3.30 per hour.
d. $4.50 per hour.

55. Variable Manufacturing Overhead Variances
Zippy
What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?
a. $3.00 per hour.
b. $3.19 per hour.
c. $3.30 per hour.
d. $4.50 per hour.
AR = $5,115 ÷ 1,550 hours AR = $3.30 per hour

56. Variable Manufacturing Overhead Variances
Zippy
Hanson’s spending variance (SV) for variable manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.

57. Variable Manufacturing Overhead Variances
Zippy
Hanson’s spending variance (SV) for variable manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.
SV = AH(AR - SR) SV = 1,550 hrs($ $3.00) SV = $465 unfavorable

58. Variable Manufacturing Overhead Variances
Zippy
Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.

59. Variable Manufacturing Overhead Variances
Zippy
Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.
1,000 units × 1.5 hrs per unit
EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable

60. Variable Manufacturing Overhead Variances
Zippy
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
1,550 hours ,550 hours ,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour
= $5, = $4, = $4,500
Spending variance $465 unfavorable
Efficiency variance $150 unfavorable

61. Variable Manufacturing Overhead Variances – A Closer Look
If variable overhead is applied on the basis of direct labor hours, the labor efficiency and variable overhead efficiency variances will move in tandem.

62. Variance Analysis and Management by Exception
Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
How do I know which variances to investigate?

63. Advantages of Standard Costs
Possible reductions in production costs
Management by exception
Advantages
Improved cost control and performance evaluation
Better Information for planning and decision making

64. Potential Problems Emphasis on negative may impact morale.
Favorable variances may be misinterpreted.
Potential Problems
Continuous improvement may be more important than meeting standards.
Standard cost reports may not be timely.
Labor quantity standards and efficiency variances may not be appropriate.
Emphasizing standards may exclude other important objectives.

65. The Balanced Scorecard
Management translates its strategy into performance measures that employees understand and accept.
Customers
Financial
Performance measures
Learning and growth
Internal business processes

66. The Balanced Scorecard
How do we look to the owners?
In which internal business processes must we excel?
How can we continually learn, grow, and improve?
How do we look to customers?

67. The Balanced Scorecard
Learning improves business processes.
Improved business processes improve customer satisfaction.
Improving customer satisfaction improves financial results.

68. Delivery Performance Measures
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Queue Time
Wait Time
Throughput Time
Delivery Cycle Time
Process time is the only value-added time.

69. Delivery Performance Measures
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Queue Time
Wait Time
Throughput Time
Delivery Cycle Time
Manufacturing
Cycle
Efficiency
Value-added time Manufacturing cycle time =