Standard Costs and Operating Performance Measures

1. Chapter 10 Standard Costs and Operating Performance Measures

2. Standard Costs Standards are benchmarks or “norms” formeasuring performance. In managerial accounting, two types of standards are commonly used. Quantity standardsspecify how much of aninput should be used tomake a product orprovide a service. Price standardsspecify how muchshould be paid foreach unit of theinput. Examples: Firestone, Sears, McDonald’s, hospitals, construction and manufacturing companies.

3. Deviations from standards deemed significantare brought to the attention of management, apractice known as management by exception. Standard Costs Standard Amount DirectMaterial DirectLabor ManufacturingOverhead Type of Product Cost

4. Takecorrective actions Identifyquestions Receive explanations Conduct next period’s operations Analyze variances Variance Analysis Cycle Prepare standard cost performance report Begin

5. I recommend using practical standards that are currently attainable with reasonable and efficient effort. Should we useideal standards that require employees towork at 100 percent peak efficiency? Setting Standard Costs Accountants, engineers, purchasing agents, and production managerscombine efforts to set standards that encourage efficient future operations. Engineer Managerial Accountant

6. QuantityStandards Final, deliveredcost of materials,net of discounts. Summarized in a Bill of Materials. Setting Direct Material Standards PriceStandards

7. Setting Standards Six Sigma advocates have sought toeliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste andspoilage that are built into standardsshould be reduced over time.

8. RateStandards TimeStandards Often a singlerate is used that reflectsthe mix of wages earned. Use time and motion studies foreach labor operation. Setting Direct Labor Standards

9. RateStandards QuantityStandards The rate is the variable portion of the predetermined overhead rate. The quantity is the activity in the allocation base for predetermined overhead. Setting Variable Manufacturing Overhead Standards

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

11. The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. • The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. Price and Quantity Standards Price and quantity standards are determined separately for two reasons:

12. Price Variance Quantity Variance Difference betweenactual price and standard price Difference betweenactual quantity andstandard quantity A General Model for Variance Analysis Variance Analysis

13. Materials price varianceLabor rate varianceVOH rate variance A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Materials quantity variance Labor efficiency variance VOH efficiency variance

14. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance A General Model for Variance Analysis

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

16. Material Variances – An Example Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka. 0.1 kg. of fiberfill per parka at $5.00 per kg. Last month 210 kgs. of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029.

17. Price variance$21 favorable Quantity variance$50 unfavorable Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000

18. $1,029  210 kgs = $4.90 per kg Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance$21 favorable Quantity variance$50 unfavorable

19. 0.1 kg per parka  2,000 parkas = 200 kgs Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance$21 favorable Quantity variance$50 unfavorable

20. Material Variances:Using the Factored Equations Materials price variance MPV = AQ (AP - SP) = 210 kgs ($4.90/kg - $5.00/kg) = 210 kgs (-$0.10/kg) = $21 F Materials quantity variance MQV = SP (AQ - SQ) = $5.00/kg (210 kgs-(0.1 kg/parka  2,000 parkas)) = $5.00/kg (210 kgs - 200 kgs) = $5.00/kg (10 kgs) = $50 U

21. I’ll start computingthe price variancewhen material ispurchased rather than when it’s used. I need the price variancesooner so that I can betteridentify purchasing problems. You accountants just don’tunderstand the problems thatpurchasing managers have. Isolation of Material Variances

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

23. Purchasing Manager Production Manager Responsibility for Material Variances Materials Quantity Variance Materials Price Variance The standard price is used to compute the quantity varianceso that the production manager is not held responsible forthe purchasing manager’s performance.

24. 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 materialquantity variance. You purchased cheapmaterial, so my peoplehad to use more of it. Responsibility for Material Variances

25. Labor Variances – An Example Glacier Peak Outfitters has the following direct labor standard for its mountain parka. 1.2 standard hours per parka at $10.00 per hour Last month, employees actually worked 2,500 hours at a total labor cost of $26,250 to make 2,000 parkas.

26. Rate variance$1,250 unfavorable Efficiency variance$1,000 unfavorable Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × ×$10.50 per hour $10.00 per hour. $10.00 per hour = $26,250 = $25,000 = $24,000

27. $26,250  2,500 hours = $10.50 per hour Rate variance$1,250 unfavorable Efficiency variance$1,000 unfavorable Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × ×$10.50 per hour $10.00 per hour. $10.00 per hour = $26,250 = $25,000 = $24,000

28. 1.2 hours per parka  2,000 parkas = 2,400 hours Rate variance$1,250 unfavorable Efficiency variance$1,000 unfavorable Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × ×$10.50 per hour $10.00 per hour. $10.00 per hour = $26,250 = $25,000 = $24,000

29. Labor Variances:Using the Factored Equations Labor rate variance LRV = AH (AR - SR) = 2,500 hours ($10.50 per hour – $10.00 per hour) = 2,500 hours ($0.50 per hour) = $1,250 unfavorable Labor efficiency variance LEV = SR (AH - SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavorable

30. Mix of skill levelsassigned to work tasks. Level of employee motivation. Quality of production supervision. Production Manager Quality of training provided to employees. Responsibility for Labor Variances Production managers areusually held accountablefor labor variancesbecause they caninfluence the:

31. I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. I am not responsible for the unfavorable laborefficiency variance! You purchased cheapmaterial, so it took moretime to process it. Responsibility for Labor Variances

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

33. A Statistical Control Chart Warning signals for investigation • • Favorable Limit • • • • • Desired Value • Unfavorable Limit • 1 2 3 4 5 6 7 8 9 Variance Measurements

34. Advantages Advantages of Standard Costs Promotes economy and efficiency Management byexception Enhances responsibilityaccounting Simplifiedbookkeeping

35. PotentialProblems Potential Problems with Standard Costs Emphasizing standardsmay exclude otherimportant objectives. Favorablevariances maybe misinterpreted. Standard costreports maynot be timely. Emphasis onnegative mayimpact morale. Continuous improvement maybe more importantthan meeting standards. Invalid assumptionsabout the relationshipbetween laborcost and output.

36. Learning Objective 5 Compute delivery cycle time, throughput time, and manufacturing cycle efficiency (MCE).

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

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