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Performance Evaluation Through Performance Evaluation Through Standard CostsStandard Costs
Chapter 21Chapter 21
Prepared by Barbara MullerPrepared by Barbara MullerArizona State University WestArizona State University West
Principles of AccountingKimmel • Weygandt • Kieso
CHAPTER 21Performance Evaluation Through Standard Costs
After studying this chapter, you should be able to: Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how standards are set. State the formulas for determining direct
materials and direct labor variances. State the formulas for determining
manufacturing overhead variances. Discuss the reporting of variances. Prepare an income statement for management
under a standard cost system.
The Need for Standards
Standards• Are common in business• Are often imposed by government agencies (and
called regulations)
Standard costs• Are predetermined unit costs• Used as measures of performance
Distinguishing Between Standards and Budgets
STUDY OBJECTIVE 1
Standards and budgets are both• Pre-determined costs
• Part of management planning and control
A standard is a unit amount whereas a budget is a total amount
• Standard costs may be incorporated into a cost accounting system
Advantages of Standard CostsSTUDY OBJECTIVE 2
Setting Standard CostsSTUDY OBJECTIVE 3
Setting standard costs• Requires input from all persons who have responsibility for
costs and quantities
• Standards costs need to be current and should be under continuous review
There are two levels of standard costs• Ideal standards represent optimum levels of performance
under perfect operating conditions
• Normal standards represent efficient levels of performance attainable under expected operating conditions
Direct Materials Price Standard
Direct materials price standard• Cost per unit which should be incurred
• Based on the purchasing department’s best estimate of the cost of raw materials
• Includes related costs such as receiving, storing, and handling
Direct Materials Quantity Standard
Direct materials quantity standard• Quantity of direct materials used per unit of finished goods
• Based on physical measure such as pounds, barrels, etc.
• Includes allowances for unavoidable waste and normal storage
Materials
Total Direct Materials Cost/Unit
STANDARD DIRECT
MATERIALSPRICE
x =
STANDARDDIRECT
MATERIALSQUANTITY
STANDARDDIRECT
MATERIALS COSTPER UNIT
The standard direct materials cost per unit is calculated as follows
Direct Labor Price Standard
Direct labor price standard • Rate per hour incurred for direct labor• Based on current wage rates adjusted for anticipated
changes, such as cost of living adjustments• Includes employer payroll taxes,and fringe benefits
Direct Labor Quantity Standard
Direct labor quantity standard• Time required to make one unit of the product• Critical in labor-intensive companies• Allowances should be made for rest periods,
cleanup, machine setup and machine downtime
Direct Labor
STANDARD DIRECTLABOR RATE
STANDARD DIRECTLABOR HOURS
STANDARD DIRECTLABOR COST
PER UNIT
The standard direct labor cost per unit is calculated as follows
Manufacturing Overhead Standard
For manufacturing overhead, a standard predetermined overhead rate is used
• The predetermined rate is computed by dividing budgeted overhead costs by an expected standard activity index
• The standard manufacturing overhead rate per unit is the predetermined overhead rate times the direct labor quantity standard (or other activity index, if used)
Standard Cost Per Unit
Standard cost per unit• Sum of the standard costs for direct materials, direct labor, and
manufacturing overhead
• Is determined for each product and often recorded on a standard cost card which provides the basis for determining variances from standards
Manufacturing Overhead
Factory Labor
Materials
Variances from StandardsVariances from Standards Variances from standards• Differences between total actual costs and total
standard costs
• Unfavorable variances occur when too much is paid for materials and labor or when there are inefficiencies in using materials and labor
• Favorable variances occur when there are efficiencies in incurring costs and in using materials and labor
Analyzing variances Variances must be analyzed to
determine their significance• First, determine the cost elements that comprise the
variance• For each manufacturing cost element, a total dollar
variance is computed. Then this variance is analyzed into a price variance and a quantity variance
Variance Relationships
Formula for Total Materials Variance
STUDY OBJECTIVE 4
Actual Quantityx Actual Price
(AQ) x (AP)
Standard Quantityx Standard Price
(SQ) x (SP)
Total MaterialsVariance
(TMV)=_
The total materials variance is computed from the following formula:
Formula for Materials Price Variance
Actual Quantityx Actual Price
(AQ) x (AP)
Actual Quantityx Standard Price
(SQ) x (SP)
Materials PriceVariance
(MPV)=_
The materials price variance is computed from the following formula:
Formula for Materials Quantity Variance
Actual Quantityx Standard Price
(AQ) x (SP)
Standard Quantityx Standard Price
(SQ) x (SP)
MaterialsQuantityVariance
(MQV)
=_
The materials quantity variance is determined from the following formula:
Matrix for Direct Materials Variance
Causes of Materials Variances
Materials variances may be caused by a variety of factors, including both internal and external factors
• Investigating materials price variances begins in the purchasing department, but the variance may be beyond the control of purchasing (for ex., prices rise faster than expected)
• Investigating materials quantity variance begins in the production department, but the variance may be beyond the control of production (for ex., faulty machinery)
Formula for Total Labor Variance
Actual Hoursx Actual Rate(AH) x (AR)
Standard Hoursx Standard Rate
(SH) x (SR)
Total LaborVariance
(TLV)=
_
The total labor variance is obtained from the following formula:
Formula for Labor Price Variance
Actual Hoursx Actual Rate(AH) x (AR)
Actual HoursX Standard Rate
(AH) x (SR)
Labor PriceVariance
(LPV)=
_
The formula for the labor price variance is as follows:
Formula for Labor Quantity Variance
Actual Hoursx Standard Rate
(AH) x (SR)
Standard Hoursx Standard Rate
(SH) x (SR)
LaborQuantityVariance
(LQV)
=_
The labor quantity variance is derived from the following formula:
Matrix for Direct Labor Variances
Actual Overhead CostsSTUDY OBJECTIVE 5
The total overhead variance is the difference between actual overhead costs and overhead costs applied to work done.
Formula for Total Overhead Variance
Actual Overhead
OverheadApplied basedon Standard
Hours Allowed
Total OverheadVariance
=_
With standard costs, manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done. Standard hours allowed are the hours that should have been worked for the units produced. The formula for the total overhead variance is:
Formula for OverheadControllable Variance
Actual Overhead
OverheadBudgeted based
on Standard Hours Allowed
OverheadControllable
Variance=_
The formula for the Overhead Controllable Variance is shown below:
Formula for OverheadVolume Variance
OverheadBudgeted based
on StandardHours Allowed
Overhead Applied basedon Standard
Hours Allowed
Overhead Volume
Variance=
_
The Overhead Volume Variance indicates whether plant facilities were efficiently used during the period. The formula for computing the volume variance is as follows:
Alternative Formula forOverhead Volume Variance
FixedOverhead
Rate
Normal CapacityHours - Standard
Hours Allowed
Overhead Volume
Variance=X
An alternative formula for computing the volume variance is shown below:
Matrix for Manufacturing Overhead Variance
Reporting VariancesSTUDY OBJECTIVE 6
Reporting variances• All variances should be reported to appropriate levels of
management as soon as possible so that corrective action can be taken
• The form, content, and frequency of variance reports vary considerably among companies
• Variance reports facilitate the principle of “management by exception”
• In using variance reports, top management normally looks for significant variances
Statement Presentation of Variances
STUDY OBJECTIVE 7 Variances reported on income statements prepared
for management• Show cost of goods sold stated at standard cost with variances are
separately disclosed Variances reported on statements prepared for
stockholders and other external users• Inventories may be reported at standard costs when there are no
significant differences between standard and actual costs
Let’s ReviewLet’s Review
The setting of standards is:The setting of standards is:
a. A managerial accounting decisiona. A managerial accounting decision..
d.d. Preferably set at the ideal level of Preferably set at the ideal level of performance.performance.
c.c. A worker decision.
b.b. A management decisionA management decision
Let’s ReviewLet’s Review
The setting of standards is:The setting of standards is:
a. A managerial accounting decisiona. A managerial accounting decision..
d.d. Preferably set at the ideal level of Preferably set at the ideal level of performance.performance.
c.c. A worker decision.
b.b. A management decisionA management decision
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