2. Controlling Manufacturing Costs: Standard Costs
Chapter 29
Controlling Manufacturing Costs: Standard Costs
Section 1: Cost Behavior
and the Budget
Section Objectives
In Chapter 29 we will explore various cost behavior patterns, and prepare fixed and flexible budgets for manufacturing costs.
Explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes.
Use the high-low point method to determine the fixed and variable components of a semivariable cost.
Prepare a fixed budget for manufacturing costs.
Develop a flexible budget for manufacturing costs.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3. Why do managers need information on the variability of costs?
QUESTION:
Understanding the variability of costs—how costs change as the volume of output changes—helps managers to control costs and make effective decisions.
ANSWER:
The first objective of Chapter 29 is to explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes.

4. Classifications of Manufacturing Costs
Objective 1
Explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes
Classifications of Manufacturing Costs
Variable
Fixed
Semivariable
The first objective of Chapter 29 is to explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes. Manufacturing cost can be classified as variable, fixed or semivariable.

5. Variable Costs
Variable costs vary in total in direct proportion to the changes in the level of activity.
Direct materials and direct labor are examples of variable costs.
Direct Materials
1 unit = $
1,000 units = $ 4,000
5,000 units = $20,000
The total variable cost change, but the cost per unit does not change.
Variable cost by definition are costs that vary in total in direct proportion to the changes in the level of activity. Direct materials and direct labor are examples of variable costs. Notice in this example, while the total variable cost change with an increase in the level of activity, the cost per unit does not change.

6. Fixed Costs
Fixed costs do not change in total as the total level of activity changes.
Although fixed costs do not change in total as the level of activity changes, the cost per unit does change.
Factory Supervisory Salaries Units Produced Cost Per Unit
$8,000/month 2,000 $4.00
$8,000/month 2,500 $3.20
Fixed costs by definition do not change in total as the level of activity changes. While total fixed costs do not change as the level of activity changes, the cost per unit does change. Notice in this example, the fixed cost per unit decreased from $4 per unit at an activity level of 2,000 units produced, to $3.20 per unit at an activity level of 2,500 units produced.

7. Semivariable Costs
Semivariable costs vary with, but not in direct proportion to, the volume of activity.
Utilities are an example of a semivariable cost:
Fixed portion
Needed no matter how many units produced.
Semivariable costs vary with, but not in direct proportion to, the volume of activity. Utilities are an example of a semivariable cost. There is a fixed portion of utilities cost that will be incurred no matter how many units are produced, and there is a variable component of utilities cost that will increase in proportion to the level of production.
Variable portion
Usage will vary in proportion to level of production.

8. Objective 2
Use the high-low point method to determine the fixed and variable components of a semivariable cost.
The second objective of Chapter 29 is to use the high-low point method to determine the fixed and variable components of a semivariable cost.

9. High-Low Point Method Semivariable expense: utilities
Step 1. Determine the production and cost data for the months of highest and lowest production during the past year.
Step 2. Compute the difference in direct labor hours, and the difference in utilities costs, in the months of highest and lowest production.
Step 3. Compute the variable cost per direct labor hour.
This slide highlights the four steps utilized to determine semivariable utility costs using the high-low point method. We will explore each step in more detail over the next several slides.
Difference in utilities costs ÷ Difference in direct labor hours
Step 4. Compute the fixed cost for a month.
Total cost – (direct labor hours x cost per direct labor hour)

10. High-Low Point Method
Step 1: Determine the production and cost data for the months of highest and lowest production during the past year.
January
1,700
$1,900
June
3,200
3,400
Month
Direct Labor Hours
Utilities Cost
February
2,160
2,360
March
2,580
2,780
April
2,800
3,000
May
2,950
3,050
July
2,200
2,400
August
2,040
2,240
September
2,120
2,320
October
November
2,060
2,260
December
1,800
2,000
The first step is to determine the production and cost data for the months of highest and lowest production during the past year. An examination of the data presented shows that June had the highest number of direct labor hours worked, while January had the lowest.

11. High-Low Point Method
Step 1: Highest production: June ,200 DL hours $3, Lowest production: January 1,700 DL hours ,900
Step 2: Compute the difference in direct labor hours, and the difference in utilities costs, in the months of highest and lowest production.
January
1,700
1,900
June
3,200
$3,400
Month
Direct Labor Hours
Utilities Cost
1,500
$1,500
The second step in the high-low point method is to compute the difference in direct labor hours, and the difference in utilities costs, in the months of highest and lowest production. The difference in direct labor hours work was 1,500 hours, and the difference in utilities costs was 1,500 dollars.

12. High-Low Point Method
Step 1: Highest production: June ,200 DL hours $3, Lowest production: January 1,700 DL hours ,900
Step 2: Difference: ,500 DL hours $1,500
Step 3: Compute the variable cost per direct labor hour.
Difference in utilities costs ÷ Difference in DL hours
= $1,500 ÷ 1,500 DL hours = $1 per DL hour
Step three requires us to compute the variable cost per direct labor hour. This is done by taking the difference in utilities costs and dividing that by the difference in direct labor hours. In this example, the cost per direct labor hour is one dollar.

13. High-Low Point Method
Step 1: Highest production: June ,200 DL hours $3, Lowest production: January 1,700 DL hours ,900
Step 2: Difference: ,500 DL hours $1,500
Step 3: Variable cost per DL hour:
= $1,500 ÷ 1,500 DL hours = $1 per DL hour
Step 4: Compute the fixed cost for a month.
June:
Total cost $3,400
In step four we compute the fixed cost for a month. The formula for this calculation is: Total cost – (direct labor hours x cost per direct labor hour). In our example, the total utility cost for June was $3,400. From this we subtract the variable cost of $3,200, to give us fixed costs of $200.
Variable cost (3,200 DL hours x $1) 3,200
Fixed costs $ 200

14. Fixed Budget of Manufacturing Costs
Objective 3
Prepare a fixed budget for manufacturing costs
Fixed Budget of Manufacturing Costs
Ohio Manufacturing Company
Budget of Manufacturing Costs
Month Ended January 29, 2010
Direct materials ,000.00
Direct labor ,000.00
Manufacturing overhead
Supervision and clerical wages 5,000.00
Other indirect labor (1,000 X $2) 2,000.00
Payroll taxes and fringe benefits
[$500 + (1,000 X $2.50)] 3,000.00
Manufacturing supplies
[$100 + (1,000 X $0.20)]
Depreciation 1,500.00
Repairs and maintenance
[$400 + (1,000 X $0.50)]
Insurance and taxes
Total manufacturing overhead ,200.00
Total manufacturing cost ,200.00
Our third objective is to prepare a fixed budget for manufacturing costs. A budget is an operating plain in monetary units. A manufacturing cost budget is a budget for each manufacturing cost during the budget period. In the fixed budget of manufacturing costs for Ohio Manufacturing Company, only one level of activity is used – 1,000 direct labor hours.
Shows one level of activity – 1,000 direct labor hours

15. Budget Performance Report
Ohio Manufacturing Company
Budget of Manufacturing Costs
Month of January 2010
(Over)
Budget Actual Under
Direct materials 25, ,
Direct labor , ,
Manufacturing overhead
Supervision and clerical wages , ,
Other indirect labor 2, , (150)
Payroll taxes and fringe benefits 3, ,
Manufacturing supplies (10)
Depreciation , , ( 100)
Repairs and maintenance
Insurance and taxes (25)
Total manufacturing overhead 13, ,
Total manufacturing cost 53, , ,995
A budget performance report is a comparison of actual costs and budgeted costs. This budget performance report highlights the differences between budgeted and actual direct materials, direct labor and manufacturing overhead costs. The third column in this report shows if actual costs incurred were over or under budget.
Highlights differences between budgeted and actual amounts

16. Flexible Budget of Manufacturing Costs
Objective 4
Develop a flexible budge for manufacturing costs
Flexible Budget of Manufacturing Costs
Ohio Manufacturing Company
Budget of Manufacturing Costs
Month of January 2010
Activity Level
Number of direct labor hours , ,050
Percent of expected activity
Variable Costs
Other indirect labor , , ,100
Payroll taxes and fringe benefits 2, , ,520
Manufacturing supplies
Repairs and maintenance
Total variable costs , , ,355
Fixed Costs
Supervision and clerical wages 5, , ,000
Payroll taxes and fringe benefits
Manufacturing supplies
Depreciation , , ,500
Repairs and maintenance
Insurance and taxes
Total fixed costs , , ,900
Total manufacturing overhead 12, , ,255
The fourth objective of Chapter 29 is to develop a flexible budget for manufacturing costs. A flexible budget is a budget that shows the budgeted costs at various levels of activity.
This flexible budget for Ohio Manufacturing Company shows different variable and fixed costs for different levels of activity.

17. Flexible Budget
Used when the level of activity fluctuates from month to month.
Shows fixed and variable costs separately.
The different levels of activity are called the relevant range of activity.
A flexible budget is used when the level of activity fluctuates from month to month The different levels of activity are called the relevant range of activity.

18. Budget Performance Report
(80)
2,000
1,920
Other indirect labor (960 x $2)
5,000
Supervision and clerical wages
(Over)
Under
Actual
Budget for
960 hours
Ohio Manufacturing Company
Manufacturing Overhead Budget Performance Report
Month Ended February 28, 2010 50
2,850
2,900
Payroll taxes and fringe benefits [$500 + (960 x $2.50)]
(33)
325
292
Manufacturing supplies [$100 + (960 x $0.20)]
1,500
Depreciation
180
700
880
Repairs and maintenance
[$400 + (960 x $0.50)] 25
375
400
Insurance and taxes
142
12,750
12,892
Total manufacturing overhead
This budget performance report for Ohio Manufacturing Company compares overhead expenses at an actual activity level of 960 hours. Each component of manufacturing overhead is analyzed to see if it was over or under budget.
Compares overhead expenses at an actual activity level of 960 hours

19. Controlling Manufacturing Costs: Standard Costs
Chapter 29
Controlling Manufacturing Costs: Standard Costs
Section 2: Standard Costs
As a Control Tool
Section Objectives
In the second section of Chapter 29 we will develop standard costs per unit of product; compute the standard costs of products manufactured during the period and determine cost variances between actual costs and standard costs; and compute the amounts and analyze the nature of variances from standard for raw materials, labor, and overhead.
Develop standard costs per unit of product.
Compute the standard costs of products manufactured during the period and determine cost variances between actual costs and standard costs.
Compute the amounts and analyze the nature of variances from standard for raw materials, labor, and manufacturing overhead.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

20. Standard Costs Develop standard costs per unit of product Objective 5
Reflect what costs should be per unit under normal, efficient operating conditions.
Used to measure the effectiveness of operations.
Should be set at an achievable level.
Our fifth objective is to develop standard costs per unit of product. Standard costs reflect what costs should be per unit under normal operating conditions. Standard costs are often used to measure the effectiveness of operations and should be set at an achievable level.

21. Developing Standard Costs
Raw Materials Standards
Direct Labor Standards
Manufacturing Overhead Standards
In the following slides, we will develop standard costs for raw materials, direct labor and manufacturing overhead.

22. Raw Materials Standard
Standard Quantity: Number of units of each type of raw material required to manufacture one unit of finished product.
Standard Cost: Cost of each unit of raw material required to make the product.
The raw materials standard is calculated by multiplying the standard quantity by the standard cost. The standard quantity is the number of units of each type of raw material required to manufacture one unit of finished product. The standard cost is the cost of each unit of raw material required to make the product.
Raw Materials Standard = Standard Quantity x Standard Cost

23. Direct Labor Standard = Standard Quantity x Standard Cost
Standard Quantity: Number of hours of each type of labor needed to manufacture one unit of finished product.
Standard Cost: Cost of each type of labor used to make the product.
The direct labor standard is calculated by multiplying the standard quantity by the standard cost. The standard quantity is the number of hours of each type of labor needed to manufacture one unit of finished product. The standard cost is the cost of each type of labor used to make the product.
Direct Labor Standard = Standard Quantity x Standard Cost

24. Standard Overhead Cost
The standard overhead cost per unit of product is usually based on the overhead application rate used to assign overhead costs to products.
Overhead application rate can be based on:
Direct labor cost,
Direct labor hours, or
Some other measure.
The standard overhead cost per unit of product is usually based on the overhead application rate used to assign overhead costs to products. That overhead application rate can be based on direct labor costs, direct labor hours, or some other measure.

25. Objective 6
Compute the standard costs of products manufactured during the period and determine cost variances between actual costs and standard costs.
The sixth objective of Chapter 29 is to compute the standard costs of products manufactured during the period and determine cost variances between actual costs and standard costs.

26. Preparing a Standard Cost Card
Item: Toy Car—Product DC 24
Materials
Base material: 1 $1.60/lb. $1.60
Finishing material: 3 $0.05/ounce
Total Materials $1.75
Labor
1/10 $15/hour $1.50
Manufacturing Overhead
1/10 $10 per hour $1.00
Total Standard Cost per Unit $4.25
In this example, we see a standard cost card which shows the per unit standard costs for one product.
Shows the per-unit standard costs for one product

27. Comparing Actual and Standard Costs
Compute actual costs.
Compare actual costs to standard costs.
Analyze the cost variance.
When comparing actual and standard costs, we compute actual costs, compare them to standard costs, and analyze the cost variance.

28. Comparing Actual and Standard Costs
Job Order Cost Sheet:
Manufacturing costs:
Materials:
Base material: 1,475 $1.62/lb $2,389.50
Job X2–16
Product: Toy Car—Product DC 24
Number of units manufactured: 1,500
Total manufacturing costs $6,411.70
Finishing material: 4,600 $.045/ounce
Total materials $2,596.50
Direct labor: 152 $15.10 per hour ,295.20
Manufacturing overhead: 152 $10.00 per hour ,520.00
In this example we compute the actual manufacturing costs to be $6, Standard cost for 1,500 units is calculated to be $6,375. Therefore, there is an unfavorable variance of $36.70.
Compute the variance:
Standard cost of 1,500 units: 1,500 units X $4.25 per unit $6,375.00
Manufacturing costs charged to job ,411.70
Unfavorable Variance $ (36.70)

29. Objective 7
Compute the amounts and analyze the nature of variances from standard for raw materials, labor, and manufacturing overhead.
Our seventh objective is to compute the amounts and analyze the nature of variances from standard for raw materials, labor and manufacturing overhead.

30. Variances Between Standard and Actual Costs
Materials Variance
Labor Variance
Manufacturing Overhead Variance
In the following slides we will calculate variances between standard and actual costs for materials, labor and manufacturing overhead.

31. Materials Variance Materials Quantity Variance:
Results from a difference between the actual quantity of materials consumed and the standard quantity allowed for the job.
Formula:
(Actual Quantity – Standard Quantity) x Standard Cost
There are two materials variances. The materials quantity variance results from a difference between the actual quantity of materials consumed and the standard quantity allowed for the job. The formula to calculate this variance is: (Actual Quantity – Standard Quantity) x standard cost. The materials price variance results from a difference between the actual cost and standard cost allowed. The formula to calculate this variance is: (Actual Cost – Standard Cost) x Actual Quantity.
Materials Price Variance:
Results from a difference between the actual cost and the standard cost allowed.
Formula:
(Actual Cost – Standard Cost) x Actual Quantity

32. How is the materials quantity variance
Determining Materials Quantity Variance
QUESTION:
How is the materials quantity variance
calculated?
Base Material
Actual quantity ,475 pounds
Standard quantity (1,500 units x 1lb./unit) 1,500 pounds
(Actual Quantity – Standard Quantity)
x Standard Cost
Base material under standard pounds
Times standard price per pound $ 1.60
In this example, the actual quantity of material used is 1,475 pounds. The standard quantity for units produced is 1,500 pounds. With a standard price of $1.60 per pound, we have a $40 favorable quantity variance.
Favorable quantity variance $40.00

33. How is the materials price variance
Determining Materials Price Variance
QUESTION:
How is the materials price variance
calculated?
Base Material
Actual price per pound $
Standard price per pound $
(Actual Cost – Standard Cost)
x Actual Quantity
Excess of actual over standard price $
Times actual number of pounds consumed ,475
In this example, we have an actual price per pound of $1.62 and a standard price per pound of $1.60. The number of actual pounds consumed was 1,475, therefore, we have a $29.50 unfavorable materials price variance.
Unfavorable materials price variance $29.50

34. Summary of Materials Variances
Favorable or
(Unfavorable)
Variance
Base Material
Quantity variance $
Price variance (29.50) $10.50
When we combine the materials quantity variance with the materials price variance, we have a combined favorable variance of $10.50.

35. Labor Variance Labor Time Variance: Labor Rate Variance:
Results from a difference between the actual hours worked and the standard labor hours allowed for the job.
Formula:
(Actual Hours – Standard Hours) x Standard Rate
There are two labor variances. The labor time variance results from a difference between the actual hours worked and the standard labor hours allowed for the job. The formula to calculate this variance is: (Actual Hours – Standard Hours) x Standard Rate. The labor rate variance results from a difference between the actual labor rate per hour and the standard labor rate per hour. The formula to calculate this variance is: (Actual Rate – Standard Rate) x Actual Hours.
Labor Rate Variance:
Results from a difference between the actual labor rate per hour and the standard labor rate per hour.
Formula:
(Actual Rate – Standard Rate) x Actual Hours

36. Determining Labor Time Variance
Actual hours worked
Standard hours allowed
(1,500 units x 1/10 hour per unit) 150
Excess of standard over actual hours
Times standard rate per hour $
Unfavorable labor time variance $
In this example there were two more hours worked than the number allowed by the standard. Therefore, there is a $30 unfavorable labor time variance.
Because more hours were worked than the number of hours allowed by the standard, the variance is unfavorable.

37. Determining Labor Rate Variance
Actual rate per hour $ 15.10
Standard rate per hour
Excess of actual over standard rate $
Times actual number of hours worked
Unfavorable labor rate variance $(15.20)
In this example, the actual labor rate was ten cents over the standard rate allowed for the product. Therefore, there was a $15.20 unfavorable labor rate variance. It should be noted that Human Resources is responsible for the labor rate variance.
Human resources is responsible for labor rate variance, though labor market conditions and operating decisions may also affect the rate at which employees can be hired.

38. Manufacturing Overhead Variances
Applied overhead and standard overhead are analyzed to determine the variance.
Because it is difficult to determine actual overhead for individual jobs, the overhead variance analysis is usually based on the total actual overhead and total standard overhead for the products manufactured.
Because it is difficult to determine actual overhead for individual jobs, the overhead variance is usually based on the total actual overhead and total standard overhead for the products manufactured.

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