22-1 Copyright Houghton Mifflin Company. All rights reserved. Chapter 22 Cost Control Using Standard Costing and Variance Analysis Belverd E. Needles,

22-22-11Copyright Houghton Mifflin Company. All rights reserved.

Chapter 22Chapter 22Cost Control Using Standard Cost Control Using Standard

Costing and Variance AnalysisCosting and Variance Analysis

Belverd E. Needles, Jr.Belverd E. Needles, Jr.

Marian PowersMarian Powers

Sherry K. MillsSherry K. Mills

Henry R. AndersonHenry R. Anderson- - - - - - - - - - -- - - - - - - - - - -

Multimedia Slides by:Multimedia Slides by:

Dr. Paul J. RobertsonDr. Paul J. RobertsonNew Mexico State UniversityNew Mexico State University

Steve LeaskSteve LeaskNew Mexico State UniversityNew Mexico State University


Standard Costs in Today’s Standard Costs in Today’s Business EnvironmentBusiness Environment

OBJECTIVE 1OBJECTIVE 1

Define Define standard costsstandard costs and and describe how managers use describe how managers use standard costs in the standard costs in the management cycle.management cycle.


Standard CostsStandard Costs» Standard costsStandard costs are predetermined are predetermined

costs that are developed from costs that are developed from analyses of both:analyses of both:

Past operating costs, quantities, and Past operating costs, quantities, and

times.times.

Future costs and operating conditions.Future costs and operating conditions.


Standard Cost FlowStandard Cost Flow

» In a standard costing system, In a standard costing system,

standard costs for direct materials, standard costs for direct materials,

direct labor, and manufacturing direct labor, and manufacturing

overhead flow through the inventory overhead flow through the inventory

accounts and eventually into the accounts and eventually into the

Cost of Goods Sold account.Cost of Goods Sold account.


The Management CycleThe Management Cycle» Managers use standard costs Managers use standard costs

throughout the management cycle.throughout the management cycle.

In the In the planning stageplanning stage of the management of the management

cycle, standard costs aid in the cycle, standard costs aid in the

development of budgets.development of budgets.

During the During the executing stage,executing stage, standard standard

costs, quantities, and time are applied to costs, quantities, and time are applied to

work performed.work performed.


The Management CycleThe Management Cycle During the During the reviewing stage,reviewing stage, actual costs actual costs

are compared with standard costs to are compared with standard costs to

compute variances, and managers compute variances, and managers

analyze the causes of those variances to analyze the causes of those variances to

improve operations.improve operations.

During the During the reporting stage,reporting stage, a variance a variance

report provides information on report provides information on

operations and managerial performance.operations and managerial performance.


The Management CycleThe Management Cycle» In today’s globally competitive In today’s globally competitive

environment, new standards or environment, new standards or measurements are necessary to help measurements are necessary to help managers:managers:

Reduce processing time. Reduce processing time.

Improve quality.Improve quality.

Improve customer satisfaction.Improve customer satisfaction.

Improve on-time deliveries.Improve on-time deliveries.


A.A. The primary difference between a The primary difference between a standard costing system in service standard costing system in service versus manufacturing organizations versus manufacturing organizations is that there are no direct materials is that there are no direct materials variances in service organizations.variances in service organizations.

Discussion Discussion

Q.Q. What is the difference between a What is the difference between a standard costing system in service standard costing system in service versus manufacturing organizations?versus manufacturing organizations?


The Nature and Purpose The Nature and Purpose of Standard Costingof Standard Costing


State the purposes for using State the purposes for using

standard costs.standard costs.


Standard CostsStandard Costs

» Standard costs are used with existing Standard costs are used with existing

job order or process costing systems.job order or process costing systems.

» Standard costs are usually Standard costs are usually

expressed as the cost per unit of a expressed as the cost per unit of a

finished product or process.finished product or process.


Standard CostsStandard Costs» Standard costs are based on:Standard costs are based on:

Engineering estimates. Engineering estimates.

Forecasted demand.Forecasted demand.

Worker input.Worker input.

Time and motion studies.Time and motion studies.

Type and quality of direct materials.Type and quality of direct materials.


Standard CostingStandard Costing

» Standard costing is expensive to Standard costing is expensive to

use because the management use because the management

accounting system must keep accounting system must keep

separate records of actual costs to separate records of actual costs to

compare with what should have compare with what should have

been spent.been spent.


Using Standard CostsUsing Standard Costs» Standard costs are used in several ways:Standard costs are used in several ways:

Preparing operating budgets. Preparing operating budgets. Identifying production costs and Identifying production costs and

processes that must be managed to processes that must be managed to reduce waste and inefficiency.reduce waste and inefficiency.

Evaluating the performance of managers Evaluating the performance of managers and workers.and workers.

Setting prices.Setting prices. Simplifying inventory and product Simplifying inventory and product

costing procedures.costing procedures.


The Development The Development of Standard Costsof Standard Costs


Identify the six elements of, Identify the six elements of,

and compute, a standard cost.and compute, a standard cost.


Standard Cost per UnitStandard Cost per Unit» There are six standards used to There are six standards used to

determine the standard cost per unit:determine the standard cost per unit:1.1. Direct materials price standard. Direct materials price standard.

2.2. Direct materials quantity standard.Direct materials quantity standard.

3.3. Direct labor time standard.Direct labor time standard.

4.4. Direct labor rate standard.Direct labor rate standard.

5.5. Standard variable manufacturing Standard variable manufacturing overhead rate.overhead rate.

6.6. Standard fixed manufacturing overhead Standard fixed manufacturing overhead rate.rate.


Direct Materials Direct Materials Price StandardPrice Standard

» The direct materials price standard The direct materials price standard

is found by carefully considering:is found by carefully considering:

Expected price increases.Expected price increases.

Changes in available quantities.Changes in available quantities.

Possible new sources of supply.Possible new sources of supply.


Direct Materials Direct Materials Quantity StandardQuantity Standard

Product engineering specifications.Product engineering specifications.

Quality of direct materials.Quality of direct materials.

Age and productivity of machines.Age and productivity of machines.

Quality and experience of the work force.Quality and experience of the work force.

» The direct materials quantity standard The direct materials quantity standard is affected by:is affected by:


Direct Labor Direct Labor Time StandardTime Standard

» The direct labor time standard is The direct labor time standard is

based on:based on:

Current time and motion studies of Current time and motion studies of

workers and machines.workers and machines.

Past performance.Past performance.


Direct Labor Direct Labor Rate StandardRate Standard

» The direct labor rate standards are The direct labor rate standards are

affected by:affected by:

Labor union contracts.Labor union contracts.

Company personnel policies.Company personnel policies.


Standard Direct Materials and Standard Direct Materials and Standard Direct Labor CostsStandard Direct Labor Costs

Standard direct materials cost =Standard direct materials cost = Direct materials price standard x Direct materials price standard x Direct materials quantity standardDirect materials quantity standard

Standard direct labor cost =Standard direct labor cost = Direct labor time standard x Direct labor time standard x

Direct labor rate standardDirect labor rate standard


Standard Manufacturing Standard Manufacturing Overhead CostsOverhead Costs

Standard manufacturing overhead cost =Standard manufacturing overhead cost =

(Standard variable overhead rate +(Standard variable overhead rate +

Standard fixed overhead rate) x Standard fixed overhead rate) x

Application basisApplication basis


Standard RatesStandard RatesStandard variable manufacturing Standard variable manufacturing

overhead rate =overhead rate = TTotal budgeted variable manufacturing otal budgeted variable manufacturing

overhead costs ÷ Expected number of overhead costs ÷ Expected number of standard machine hoursstandard machine hours

Standard fixed manufacturing Standard fixed manufacturing overhead rate =overhead rate =

TTotal budgeted fixed manufacturing otal budgeted fixed manufacturing overhead costs ÷ Normal capacity in overhead costs ÷ Normal capacity in

terms of standard machine hoursterms of standard machine hours


Standard Unit CostStandard Unit Cost

» A product’s standard unit cost is A product’s standard unit cost is

determined by adding:determined by adding: Standard direct materials cost.Standard direct materials cost.

Standard direct labor cost.Standard direct labor cost.

Standard manufacturing overhead rate.Standard manufacturing overhead rate.


Using Variance Analysis Using Variance Analysis to Control Operationsto Control Operations


Describe how to control costs Describe how to control costs

through variance analysis.through variance analysis.


Standard Costing SystemsStandard Costing Systems

» A standard costing system has A standard costing system has

traditionally been associated with:traditionally been associated with:

Cost control activities. Cost control activities.

Evaluation of operating performance.Evaluation of operating performance.


Using Variance Analysis to Using Variance Analysis to Control CostsControl Costs

Compute Variance

No CorrectiveAction Needed

NoIs the Variance Material Significant?

Take Corrective Action

Determine Cause(s)of Variance

Yes

Identify and Analyze Performance Measures

to DetermineCorrective Action


Direct Materials VariancesDirect Materials Variances


Compute and analyze direct Compute and analyze direct

materials variances.materials variances.


Direct Materials Direct Materials Cost VarianceCost Variance

» Direct materials cost variance is the Direct materials cost variance is the sum of:sum of:

1. Direct materials price variance.1. Direct materials price variance. (Standard Price - Actual Price) x(Standard Price - Actual Price) x

Actual Quantity.Actual Quantity.

2. Direct materials quantity variance.2. Direct materials quantity variance. (Standard Quantity - Actual Quantity) x(Standard Quantity - Actual Quantity) x

Standard Price.Standard Price.


Direct MaterialsDirect MaterialsPrice VariancePrice Variance

» Possible causes of a direct materials Possible causes of a direct materials price variance are:price variance are:

1.1. Changes in vendor prices.Changes in vendor prices.

2.2. Inaccurate or outdated direct Inaccurate or outdated direct materials price standards.materials price standards.

3.3. Differences between the quality of Differences between the quality of direct materials purchased and the direct materials purchased and the quality desired.quality desired.


Direct MaterialsDirect MaterialsPrice VariancePrice Variance

4.4. Differences between quantity Differences between quantity discounts received and those discounts received and those anticipated.anticipated.

5.5. The purchase of substitute direct The purchase of substitute direct materials that differ from product materials that differ from product specifications.specifications.


Direct MaterialsDirect MaterialsQuantity VarianceQuantity Variance

» Possible causes of a direct materials Possible causes of a direct materials

quantity variance are:quantity variance are:

1.1. Inaccurate or outdated direct Inaccurate or outdated direct materials quantity standards.materials quantity standards.

2.2. Poor workmanship or excellent Poor workmanship or excellent workmanship.workmanship.


Direct MaterialsDirect MaterialsQuantity VarianceQuantity Variance

3.3. Faulty equipment. Faulty equipment.

4.4. Inferior or superior quality of direct Inferior or superior quality of direct materials.materials.

5.5. Poor materials handling.Poor materials handling.


Direct Materials Direct Materials Variance AnalysisVariance Analysis

Direct MaterialsPurchased

(Actual quantity times actual price)

Direct MaterialsInventory

(Actual quantity times standard price)

Work in ProcessInventory

(Standard quantity times standard price)

Total Direct Materials Cost Variance

Direct MaterialsPrice Variance

Differenceequals

Direct MaterialsQuantity Variance

Differenceequals


Direct Labor VariancesDirect Labor Variances


Compute and analyze direct Compute and analyze direct

labor variances.labor variances.


Direct Labor Cost VarianceDirect Labor Cost Variance

» Direct labor cost variance is the sum Direct labor cost variance is the sum of:of:

1. Direct labor rate variance.1. Direct labor rate variance.

2. Direct labor efficiency variance.2. Direct labor efficiency variance.


Direct Labor Rate VarianceDirect Labor Rate Variance» A direct labor rate variance can A direct labor rate variance can

occur because:occur because:

1.1. A worker is hired at a pay rate A worker is hired at a pay rate that is higher or lower than that is higher or lower than expected.expected.

2.2. An employee performed the An employee performed the duties of a higher- or lower-paid duties of a higher- or lower-paid position.position.


Direct Labor Rate VarianceDirect Labor Rate Variance

New labor agreements. New labor agreements.

Labor strikes that cause the temporary Labor strikes that cause the temporary hiring of unskilled help.hiring of unskilled help.

Large layouts that result in unusual Large layouts that result in unusual usage of remaining workers.usage of remaining workers.

3. Overall wage rates changed due to:3. Overall wage rates changed due to:


Favorable Direct Labor Favorable Direct Labor Efficiency VarianceEfficiency Variance

» A favorable direct labor efficiency A favorable direct labor efficiency variance can be caused by:variance can be caused by:

1. Improved training of employees.1. Improved training of employees.

2. New machinery.2. New machinery.

3. Higher quality of materials.3. Higher quality of materials.


Unfavorable Direct Labor Unfavorable Direct Labor Efficiency VarianceEfficiency Variance

» An unfavorable direct labor efficiency An unfavorable direct labor efficiency variance can be caused by:variance can be caused by:

1. Machine breakdowns.1. Machine breakdowns.

2. Inferior direct materials.2. Inferior direct materials.

3. Poor supervision.3. Poor supervision.

4. Slow materials handling.4. Slow materials handling.

5. Poor employee performance.5. Poor employee performance.


Direct Labor Variance AnalysisDirect Labor Variance Analysis

Wages Paid toEmployees

(Actual direct laborhours times actual

direct labor rate)

Labor BudgetBased on Actual

Direct Labor Hours(Actual direct labor

hours times standard direct labor rate)

Work in ProcessInventory

(Standard direct labor hours allowed times

standard direct labor rate)

Total Direct Labor Cost Variance

Direct LaborRate Variance

Differenceequals

Direct LaborEfficiency Variance

Differenceequals


Manufacturing Manufacturing Overhead VariancesOverhead Variances


Define and prepare a Define and prepare a

flexible budget.flexible budget.


Flexible BudgetFlexible Budget» The budgets discussed earlier were The budgets discussed earlier were

static or fixed budgets, which static or fixed budgets, which forecast revenues and expenses for forecast revenues and expenses for one level of sales and production.one level of sales and production.

» A flexible budget is a summary of A flexible budget is a summary of anticipated costs for a range of anticipated costs for a range of activity levels, geared to changes in activity levels, geared to changes in product output.product output.


Flexible Budget FormulaFlexible Budget Formula» The flexible budget formula:The flexible budget formula:

1.1. Includes a budgeted variable cost Includes a budgeted variable cost per unit, which is the same for all per unit, which is the same for all levels of output within the range levels of output within the range chosen.chosen.

2.2. Includes a budgeted total fixed Includes a budgeted total fixed cost, which stays constant for the cost, which stays constant for the range.range.


Flexible Budget FormulaFlexible Budget Formula

3. Has the format:3. Has the format:

Total budget costs =Total budget costs =

(Variable cost per unit x (Variable cost per unit x

Number of units produced) +Number of units produced) +

Budgeted fixed costsBudgeted fixed costs


Analyzing ManufacturingAnalyzing ManufacturingOverhead VariancesOverhead Variances

OBJECTIVE 8OBJECTIVE 8Compute and analyze Compute and analyze

manufacturing overhead manufacturing overhead

variances.variances.


Manufacturing Manufacturing Overhead VarianceOverhead Variance

» The total manufacturing overhead variance The total manufacturing overhead variance is equal to the difference between:is equal to the difference between:

The actual manufacturing overhead The actual manufacturing overhead

costs incurred andcosts incurred and

The standard manufacturing overhead The standard manufacturing overhead

costs applied to production.costs applied to production.


Total Manufacturing Total Manufacturing Overhead VarianceOverhead Variance

» The total manufacturing overhead variance The total manufacturing overhead variance is then divided into two parts:is then divided into two parts:

Controllable manufacturing overhead Controllable manufacturing overhead variance.variance.

Manufacturing overhead volume Manufacturing overhead volume variance.variance.


Controllable Manufacturing Controllable Manufacturing Overhead VarianceOverhead Variance

» Is the difference between the actual Is the difference between the actual manufacturing overhead costs incurred and manufacturing overhead costs incurred and the manufacturing overhead costs budgeted the manufacturing overhead costs budgeted for the level of production achieved.for the level of production achieved.

» Can occur because too much or too little is Can occur because too much or too little is spent on manufacturing overhead items spent on manufacturing overhead items such as indirect materials, indirect labor, such as indirect materials, indirect labor, supervision, or machine maintenance.supervision, or machine maintenance.


Manufacturing Overhead Manufacturing Overhead Variance AnalysisVariance Analysis

ActualManufacturing

OverheadCosts Incurred

Flexible Budgetat Level ofAchieved

Performance

TotalManufacturing

Overhead CostsApplied to Products

Total Manufacturing Overhead Variance

ManufacturingOverhead

Volume Variance

Differenceequals

Differenceequals

ControllableManufacturingOverhead Rate


Manufacturing Overhead Manufacturing Overhead Volume VarianceVolume Variance

» Is the difference between the Is the difference between the manufacturing overhead budgeted for the manufacturing overhead budgeted for the level of production achieved and the total level of production achieved and the total manufacturing overhead costs applied to manufacturing overhead costs applied to production using the standard variable and production using the standard variable and fixed manufacturing overhead rates.fixed manufacturing overhead rates.

» Will occur if more or less capacity than Will occur if more or less capacity than normal is used.normal is used.


Setup Activity

Controllable Setup

Overhead Variance


Repairs & Maintenance

Activity

Controllable Repairs& Maintenance

Overhead Variance

Activity-BasedStandard CostingSystem

Work Cell Activity

Controllable Work Cell

Overhead Variance

Controllable ManufacturingOverhead Variance


Setup Activity

Setup OverheadVolume Variance


Repairs & Maintenance

Activity

Repairs & MaintenanceOverhead Volume

Variance

Work Cell Activity

Work Cell OverheadVolume Variance

Manufacturing OverheadVolume Variance


Activity-Based CostingActivity-Based Costing

» Activity-based costing changes the Activity-based costing changes the

analysis of overhead.analysis of overhead.

Each activity has a different cost driver, Each activity has a different cost driver,

so the basis of the variance analysis so the basis of the variance analysis

changes from one activity to another.changes from one activity to another.


Using Variances inUsing Variances inPerformance EvaluationPerformance Evaluation


Explain how variances are used to Explain how variances are used to

evaluate managers’ performance.evaluate managers’ performance.


Management EvaluationManagement Evaluation

» To ensure effectiveness and fairness when To ensure effectiveness and fairness when establishing a performance evaluation establishing a performance evaluation process, management should develop process, management should develop appropriate policies and seek input from appropriate policies and seek input from managers and employees.managers and employees.

» The effective evaluation of managers’ The effective evaluation of managers’ performance depends on both human performance depends on both human factors and company policies.factors and company policies.


Performance ReportsPerformance Reports» The keys to preparing a performance The keys to preparing a performance

report are to:report are to:

Identify the personnel responsible for Identify the personnel responsible for each variance.each variance.

Determine the causes for each significant Determine the causes for each significant variance.variance.

Develop a reporting format suited to the Develop a reporting format suited to the task.task.


Performance ReportsPerformance Reports

» The management accountant should The management accountant should

tailor performance to each manager’s tailor performance to each manager’s

responsibilities so that each report responsibilities so that each report

contains those cost items contains those cost items

controllable by that manager.controllable by that manager.

Documents

22-1 Copyright Houghton Mifflin Company. All rights reserved. Chapter 22 Cost Control Using Standard Costing and Variance Analysis Belverd E. Needles,