Managerial Accounting: A Decision Focus, 8e Chapter 8: Control Through Standard Costs Chapter 8 Standard Costs l Standard Costs are: – Based on carefully predetermined amounts – Used for planning labor, material, and overhead requirements – The expected level of performance – Benchmarks for measuring performance l A Standard Cost Variance is: – The amount by which an actual cost differs from the standard cost – Is Unfavorable if the actual cost exceeds the standard cost – Is Favorable if the actual cost is less than the standard cost Chapter 8 Standard Cost Variances l Standard Cost Variances are important because: – They point to causes of problems and directions for improvement – They trigger investigations in the departments having the responsibility for incurring the costs. l Management by Exception is a practice where managers focus on quantities and costs that differ from standards. Chapter 8 Setting Standard Costs l Practical standards l Ideal standards Chapter 8 Setting Direct Materials Standards l Price – generally based on competitive bids for the quality and quantity desired. l Usage(Quantity) – based on the product design specifications. The standard material cost for one unit of product is: standard quantity standard price for × of material one unit of material required for one unit of product Chapter 8 Setting Direct Labor Standards l Rate – typically based on wage surveys and labor contracts l Efficiency – generally based on time and motion studies for each labor operation The standard labor cost for one unit of product is: standard number standard wage rate of labor hours for one hour × for one unit of product Chapter 8 The Use of Standard Costs in Developing Budgets l A standard is the expected cost for one unit. l A budget is the expected cost for all units. Chapter 8 Advantages and Disadvantages of Standard Costs l Advantages of Standard Costs: – Improved cost control and performance evaluation – Better information for planning and decision-making – Possible reductions in production costs – More reasonable and easier inventory measurements – Cost savings in record keeping l Disadvantages of Standard Costs: – Emphasis on negative exceptions may impact morale – It may be difficult to determine which variances are significant – Emphasis on negative exceptions may lead to under-reporting Chapter 8 A General Model for Variance Analysis Standard Cost Variances Price Variance Quantity Variance The difference between The difference between the actual price and the the actual quantity and standard price the standard quantity Chapter 8 A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Chapter 8 Computing Variances Direct Material Example Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased on May 10 at a total cost of $6,630. The material was used to make 1,000 Zippies that were completed on May 15. Chapter 8 Material Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Usage Variance AQ(AP - SP) SP(AQ - SQ) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity Chapter 8 Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb. $6,630 $ 6,800 $6,000 Price variance Quantity variance $170 favorable $800 unfavorable Chapter 8 Computing Variances Direct Labor Example Hanson Inc. has the following labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per hour Payroll records last week show 1,450 hours were worked at a total labor cost of $8,990 to make 1,000 Zippies that were completed on May 15. Chapter 8 Labor Variance Analysis Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Rate Variance Efficiency Variance AH(AR - SR) SR(AH - SH) AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours Chapter 8 Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,450 hours 1,450 hours 1,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour $8,990 $8,700 $9,000 Rate variance Efficiency variance $290 unfavorable $300 favorable Chapter 8 Overhead Variances Overhead is applied to goods produced using a standard overhead rate. The overhead rate is set prior to the start of the period. Standard Total budgeted overhead cost = overhead rate Estimated activity Chapter 8 Standard Overhead Rate Contains a fixed Contains a variable overhead rate which unit rate which stays declines as activity constant at all levels level increases. of activity. Standard Overhead Rate Function of standard activity level chosen to determine rate. Chapter 8 Overhead Variances Example Hanson, Inc. has the following flexible budget for overhead: Hanson applies overhead based on machine hour activity. Chapter 8 Overhead Variances Budgeted Applied Actual Overhead at Overhead at Overhead Actual Activity Standard Hours Budget Volume Variance Variance AOH - BOH FOHR(BH - SH) AOH = Actual Overhead BH = Budgeted Hours BOH = Budgeted Overhead SH = Standard Hours FOHR = Fixed Overhead Rate Chapter 8 Meaning of Overhead Variances l Budget Variance – Shows how economically overhead services were purchased and how efficiently overhead services were used. – Contains both fixed and variable costs. l Volume Variance – Caused by producing at a level other than that used for computing the standard overhead rate. – Contains only fixed costs. Chapter 8 Zippy Overhead Variances Example Hanson’s actual production for the period was 1,600 Zippies resulting in 3,200 standard machine hours. Actual total overhead cost for the period was $15,450. Compute the overhead budget and volume variances. Chapter 8 Overhead Variances Example Budgeted Applied Actual Overhead at Overhead at Overhead Standard Hours Standard Hours $15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr. $15,450 $15,400 $16,000 Budget variance Volume variance $50 unfavorable $600 favorable Chapter 8 Management By Exception l In deciding which variances to investigate, possible guidelines include: – Dollar amount or percentage of the standard – Controllability of the cost variance Chapter 8 Disposing of Variances Standard Cost Variances Attainable Standard Unattainable Standard ®Variance is due to ®Charge to cost of inefficient operation. goods sold or prorate ®Treat as a loss and to cost of goods sold, close to income work in process, and summary. finished goods. Chapter 8 Nonfinancial Performance Measures Ê Quality control Ë Material control Ì Inventory control Í Customer complaints Î Delivery performance The focus is on customer service rather than meeting a particular standard.
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