Standrad costing

Standard Costing and Variance Analysis

Standard and Standard Cost

Standard is a precise measure of what should occur if the performance is efficient.

For example a certain number of products (say 10) in one hour by a shop floor worker is a standard or certain marks (absolute or percentage) to obtain a certain grade say A.

A worker and student is said to be efficient if they achieve ( 8 and A) the given conditions.

Standards are set for repetitive tasks, that is, for work which is repeated again and again. It can not be for the task which are not repetitive or performed regularly or continuously.

Standard and Budget

Scope of budget is as a whole activity or entire operation i.e. Rs 5000 for producing 1000 units, on the other hand, standard are on unit basis, say Rs 5 per unit.

Standards are prepared by Management Account in consultation with other people, while budget are usually prepared by Budget committee.

Budgets are used for planning & coordination purposes, whereas standards are primarily used as control.

Managing Costs

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Standardcost

Actualcost

Comparison between standard and actual

performancelevel

Costvariance

Management by Exception

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DirectMaterial

Managers focus on quantities and coststhat exceed standards, a practice known as

management by exception.

Type of Product Cost

Am

ou

nt

DirectLabor

Standard

Setting Standards

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Analysis ofHistorical Data

TaskAnalysis

CostStandards

Analysis of Historical Data

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One Indicator of future costs is historical cost data.

In a mature production process, where the firm has a lot of production experience, historical costs can provide a good basis for predicting future costs.

Cost on the basis of behavior is used to analyze and making predictions.

These predictions need to be adjusted to reflect movements in price levels or technological changes in the production process

Task Analysis

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Another method for setting standards is task analysis, which is the analysis of a production process to determine what it should cost to produce a product or service.

The emphasis shifts from what the product did cost in the past to what it should cost in the future.

An example of task analysis is a time-and-motion study conducted to determine how long each step performed by direct laborers should require.

Participation in Setting Standards

Accountants, engineers, personnel administrators, and production managers combine efforts to set standards

based on experience and expectations.

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Perfection versus Practical Standards: A Behavioral Issue

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Should we usepractical standards

or perfection standards?

Practical standardsshould be set at levels

that are currentlyattainable with reasonable andefficient effort.

Perfection Standard

A perfection (or ideal) standard is one that can be attained only under nearly perfect operating conditions.

Such standard assume peak efficiency, the lowest possible input prices, the best quality material obtainable and no disruptions in the production due to such causes as machine breakdowns or power failures.

Some managers feel that such standard motivate employees to achieve the lowest cost possible.

They claim that since the standard is theoretically attainable, employees will have an incentive to come as close as possible to achieving it.

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Practical Standard

Standard that are as tight as practical, but still are expected to be attained, are called practical or attainable standard.

Such standard assume a production process that is as efficient as practical under normal operating conditions.

Practical standards allow for such occurrences as occasional machine breakdowns and normal amounts of raw-material waste.

Attaining a practical standard keeps employees on their toes, without demanding miracles.

Most behavioral theorist believe that such standard encourage more positive and productive employee attitude than do perfection standard.

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Perfection versus Practical Standards: A Behavioral Issue

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I agree. Perfection standards are

unattainable and therefore discouraging

to most employees.

Use of Standards by Service Organizations

Standard cost analysis may be used in any organization with repetitive tasks.

A relationship between tasks and output measures must be established.

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Cost Variance Analysis

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Standard Cost Variances

Quantity VariancePrice Variance

The difference betweenthe actual price and the

standard price

The difference betweenthe actual quantity andthe standard quantity

A General Model for Variance Analysis

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Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity


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Standard price is the amount that should have been paid for the resources acquired.


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Standard quantity is the quantity that should have been used.

Standard Costs

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Let’s use the concepts

of the general model to

calculate standard cost

variances, starting with

direct material.

Direct Material Standard

The total amount of direct material normally required to produce a finished products, including allowances for normal waste or inefficiency is called Standard direct material quantity

Material Variances

Hanson Inc. has the following direct material standard to manufacture one product:

1.5 pounds per product at $ 4.00 per pound

Last week 1,700 pounds of material were purchased and used to make 1,000 products. The

material cost a total of $6,630.

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Material Variances

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.

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Zippy

Material VariancesMaterial VariancesWhat 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.

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AP = $6,630 ÷ 1,700 AP = $3.90 per product

Material Variances

Hanson’s direct-material price variance (MPV)for the week was:

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

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Material Variances

Hanson’s direct-material price variance (MPV)for the week was:


b. $170 favorable.


d. $800 favorable.

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MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($3.90 - 4.00) MPV = $170 Favorable

Material Variances

The standard quantity of material thatshould have been used to produce

1,000 product is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.1-26

Material Variances

The standard quantity of material thatshould 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.1-27

SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs

Material Variances

Hanson’s direct-material quantity variance (MQV) for the week was:


b. $170 favorable.


d. $800 favorable.

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Zippy

Material Variances

Hanson’s direct-material quantity variance (MQV) for the week was:


b. $170 favorable.


d. $800 favorable.

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MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable

Zippy

Material Variances Summary

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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$170 favorable

Quantity variance$800 unfavorable

Material Variances

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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?

Zippy

Material Variances

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.

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Material Variances

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Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price

2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb.

$10,920 $11,200

Price variance$280 favorable

Price variance increases because quantity

purchased increases.

Zippy

MPV = AQ(AP - SP)MPV = 2,800 lbs. × ($3.90 - 4.00)MPV = $280 Favorable

Material Variances

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Actual Quantity Used Standard Quantity × × Standard Price Standard Price

1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb.

$6,800 $6,000

Quantity variance$800 unfavorable

Quantity variance is unchanged because actual and standard

quantities are unchanged.

MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs

- 1,500 lbs) MQV = $800unfavor.

Isolation of Material Variances

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I need the variances as soonas possible so that I canbetter identify problems

and control costs.

You accountants just don’tunderstand the problems

we production managers have.

Okay. I’ll start computingthe price variance when

material is purchased andthe quantity variance assoon as material is used.

Standard Costs

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

Labor Variances

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Hanson Inc. has the following direct labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $10.00 per direct labor hour

Last week 1,550 direct labor hours were worked at a total labor cost of $15,810 to

make 1,000 Zippies.

Zippy

Labor Variances

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What was Hanson’s actual rate (AR)for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.

c. $9.90 per hour.

d. $9.80 per hour.

Zippy

Labor Variances

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What was Hanson’s actual rate (AR)for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.

c. $9.90 per hour.

d. $9.80 per hour.

Zippy

AR = $15,810 ÷ 1,550 hours AR = $10.20 per hour

Labor Variances

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Hanson’s labor rate variance (LRV)for the week was:


b. $310 favorable.


d. $300 favorable.

Zippy

Labor Variances

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Hanson’s labor rate variance (LRV)for the week was:


b. $310 favorable.


d. $300 favorable.

LRV = AH(AR - SR) LRV = 1,550 hrs($10.20 - $10.00) LRV = $310 unfavorable

Zippy

Labor Variances

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The standard hours (SH) of labor thatshould 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.

Zippy

Labor Variances

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The standard hours (SH) of labor thatshould 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

Zippy

Labor Variances

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Hanson’s labor efficiency variance (LEV)for the week was:


b. $510 favorable.


d. $500 favorable.

Zippy

Labor Variances

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Hanson’s labor efficiency variance (LEV)for the week was:


b. $510 favorable.


d. $500 favorable.

LEV = SR(AH - SH) LEV = $10.00(1,550 hrs - 1,500 hrs) LEV = $500 unfavorable

Zippy

Labor Variances Summary

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Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

Rate variance$310 unfavorable

Efficiency variance$500 unfavorable

1,550 hours 1,550 hours 1,500 hours × × ×$10.20 per hour $10.00 per hour $10.00 per hour

$15,810 $15,500 $15,000

Significance of Cost Variances

Size of variance– Amount– Percentage of standard

Recurring variances Trends Controllability Favorable variances Costs and benefits of

investigation

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What clues help me to determine the

variances that I should investigate?

Statistical Control Chart

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1 2 3 4 5 6 7 8 9

Variance Measurements

Favorable Limit

Unfavorable Limit

Desired Value • • •• •

••

••

Warning signals for investigation

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If I buy cheaper materials, my direct-materials expenses will be lower than

what is budgeted. Then I’ll get my bonus. But we may lose customers because of

lower quality.

Behavioral Impact of Standard Behavioral Impact of Standard CostingCosting

Controllability of Variances

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Direct-Material Price Variance

Direct-Labor Rate Variance

Direct-Material Quantity Variance

Direct-Labor Efficiency Variance

Interaction among Variances

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I am not responsible for the unfavorable labor

efficiency variance!

You purchased cheapmaterial, so it took more

time to process it.

You used too much time because of poorly

trained workers and poor supervision.

Advantages of Standard Costing

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Management byException

Stable Product Costs

Sensible CostComparisons

Advantages

PerformanceEvaluation

EmployeeMotivatio

n

Criticisms of Standard Costing

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Not tied to specific product line

Focus on cost minimization

Too aggregate, too late

DisadvantagesToo much focus on direct-labor

Stable production required

Shorter product life cycles

Adapting Standard-Costing Systems

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Reduced focus on labor

Focus on material and overhead

Identify Cost Drivers

Shifting cost structures

Elimination of non-value added costs

Shorter product life cycles

Impact of TQM and JIT

Real-Time Information Systems

Nonfinancial Measures

Benchmarking

Business

Standrad costing