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Chapter 10
Standard Costing,
Operational
Performance
Measures, and the
Balanced Scorecard
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning
Objective
1
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Managing Costs
Standard
cost
Actual
cost
Comparison between
standard and actual
performance
level
Cost
variance
Management by Exception
Amount
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.
Standard
Direct
Labor
Direct
Material
Type of Product Cost
Learning
Objective
2
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Setting Standards
Cost
Standards
Analysis of
Historical Data
Task
Analysis
Participation in Setting Standards
Accountants, engineers, personnel
administrators, and production managers
combine efforts to set standards based on
experience and expectations.
Perfection versus Practical
Standards: A Behavioral Issue
Should we use
practical standards
or perfection
standards?
Practical standards
should be set at levels
that are currently
attainable with
reasonable and
efficient effort.
Perfection versus Practical
Standards: A Behavioral Issue
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.
Learning
Objective
3
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Variance Analysis
Standard Cost Variances
Price Variance
Quantity Variance
The difference between
the actual price and the
standard price
The difference between
the actual quantity and
the standard quantity
A General Model for Variance
Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Materials
price- SP)
variance
AQ(AP
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP = spending
Actual Price
variance
Standard Quantity
×
Standard Price
Quantity Variance
Materials
quantity
variance
SP(AQ
- SQ)
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQ
= Standard
Quantity
efficiency
variance
A General Model for Variance
Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Standard price is the amount that should
have been paid for the resources acquired.
A General Model for Variance
Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Standard quantity is the quantity that should
have been used.
Standard Costs
Let’s use the concepts
of the general model to
calculate standard cost
variances, starting with
direct material.
Material Variances
Zippy
Hanson Inc. has the following direct material
standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were
purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.
Material Variances
Zippy
What is the actual price per pound
paid for the material?
a.
b.
c.
d.
$4.00 per pound.
$4.10 per pound.
$3.90 per pound.
$6.63 per pound.
Material Variances
Zippy
What is the actual price per pound
paid for the material?
a.
b.
c.
d.
$4.00 per pound.
$4.10 per pound.
$3.90 per pound.
$6.63 per pound.
AP = $6,630 ÷ 1,700 lbs.
AP = $3.90 per lb.
Material Variances
Zippy
Hanson’s direct-material price variance (MPV)
for the week was:
a.
b.
c.
d.
$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.
Material Variances
Zippy
Hanson’s direct-material price variance (MPV)
for the week was:
a.
b.
c.
d.
$170 unfavorable.
$170 favorable.
$800 unfavorable.
MPV = AQ(AP - SP)
$800 favorable. MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable
Material Variances
Zippy
The standard quantity of material that
should have been used to produce
1,000 Zippies is:
a.
b.
c.
d.
1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.
Material Variances
Zippy
The standard quantity of material that
should have been used to produce
1,000
Zippies is:
SQ = 1,000 units × 1.5 lbs per unit
a.
b.
c.
d.
SQ = 1,500 lbs
1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.
Material Variances
Zippy
Hanson’s direct-material quantity variance
(MQV) for the week was:
a.
b.
c.
d.
$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.
Material Variances
Zippy
Hanson’s direct-material quantity variance
(MQV) for the week was:
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
Material Variances Summary
Actual Quantity
×
Actual Price
1,700 lbs.
×
$3.90 per lb.
Actual Quantity
×
Standard Price
1,700 lbs.
×
$4.00 per lb.
$6,630
Price variance
$170 favorable
$ 6,800
Standard Quantity
×
Standard Price
1,500 lbs.
×
$4.00 per lb.
$6,000
Quantity variance
$800 unfavorable
Material Variances
Hanson purchased and
used 1,700 pounds.
How are the variances
computed if the amount
purchased differs from
the amount used?
Zippy
The price variance is
computed on the entire
quantity purchased.
The quantity variance is
computed only on the
quantity used.
Material Variances
Zippy
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.
Material Variances
Actual Quantity
Purchased
×
Actual Price
2,800 lbs.
×
$3.90 per lb.
Zippy
Actual Quantity
Purchased
×
MPV = AQ(AP - SP)
Standard Price
MPV = 2,800 lbs.
× ($3.90 - 4.00)
2,800 lbs.
MPV = $280
×
Favorable
$4.00 per lb.
$10,920
Price variance
$280 favorable
$11,200
Price variance increases
because quantity
purchased increases.
Material Variances
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs
- 1,500 lbs)
MQV = $800unfavor.
Actual Quantity
Used
Standard Quantity
×
×
Standard Price
Standard Price
1,700 lbs.
×
$4.00 per lb.
$6,800
Quantity variance is
unchanged because
actual and standard
quantities are unchanged.
Zippy
1,500 lbs.
×
$4.00 per lb.
$6,000
Quantity variance
$800 unfavorable
Isolation of Material Variances
I need the variances as soon
as possible so that I can
better identify problems
and control costs.
You accountants just don’t
understand the problems
we production managers have.
Okay. I’ll start computing
the price variance when
material is purchased and
the quantity variance as
soon as material is used.
Standard Costs
Now let’s calculate
standard cost
variances for
direct labor.
Labor Variances
Zippy
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.
Labor Variances
Zippy
What was Hanson’s actual rate (AR)
for labor for the week?
a.
b.
c.
d.
$10.20 per hour.
$10.10 per hour.
$9.90 per hour.
$9.80 per hour.
Labor Variances
Zippy
What was Hanson’s actual rate (AR)
for labor for the week?
a.
b.
c.
d.
$10.20 per hour.
$10.10 per hour.
AR = $15,810 ÷ 1,550 hours
$9.90 per hour. AR = $10.20 per hour
$9.80 per hour.
Labor Variances
Zippy
Hanson’s labor rate variance (LRV)
for the week was:
a.
b.
c.
d.
$310 unfavorable.
$310 favorable.
$300 unfavorable.
$300 favorable.
Labor Variances
Zippy
Hanson’s labor rate variance (LRV)
for the week was:
a.
b.
c.
d.
$310 unfavorable.
$310 favorable.
LRV = AH(AR - SR)
$300 unfavorable.
LRV = 1,550 hrs($10.20 - $10.00)
$300 favorable.
LRV = $310 unfavorable
Labor Variances
Zippy
The standard hours (SH) of labor that
should have been worked to produce
1,000 Zippies is:
a.
b.
c.
d.
1,550 hours.
1,500 hours.
1,700 hours.
1,800 hours.
Labor Variances
Zippy
The standard hours (SH) of labor that
should have been worked to produce
1,000 Zippies is:
a.
b.
c.
d.
1,550 hours.
1,500 hours.
1,700 hours.
SH = 1,000 units × 1.5 hours per unit
SH = 1,500 hours
1,800 hours.
Labor Variances
Zippy
Hanson’s labor efficiency variance (LEV)
for the week was:
a.
b.
c.
d.
$510 unfavorable.
$510 favorable.
$500 unfavorable.
$500 favorable.
Labor Variances
Zippy
Hanson’s labor efficiency variance (LEV)
for the week was:
LEV = SR(AH - SH)
LEV = $10.00(1,550 hrs - 1,500 hrs)
a. $510 unfavorable.
LEV = $500 unfavorable
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.
Labor Variances Summary
Actual Hours
×
Actual Rate
1,550 hours
×
$10.20 per hour
$15,810
Actual Hours
×
Standard Rate
1,550 hours
×
$10.00 per hour
$15,500
Rate variance
$310 unfavorable
Standard Hours
×
Standard Rate
1,500 hours
×
$10.00 per hour
$15,000
Efficiency variance
$500 unfavorable
Learning
Objective
4
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Significance of Cost Variances
• Size of variance
– Dollar amount
– Percentage of standard
What clues help me
to determine the
variances that I should
investigate?
•
•
•
•
•
Recurring variances
Trends
Controllability
Favorable variances
Costs and benefits of
investigation
Statistical Control Chart
Warning signals for investigation
Favorable Limit
•
Desired Value
•
•
•
•
•
•
Unfavorable Limit
1
2
3
4
5
6
7
Variance Measurements
•
8
•
9
Learning
Objective
5
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Behavioral Impact of Standard
Costing
If I buy cheaper materials, my directmaterials expenses will be lower than
what is budgeted. Then I’ll get my bonus.
But we may lose customers because of
lower quality.
Controllability of Variances
Direct-Material
Price Variance
Direct-Material
Quantity Variance
Direct-Labor
Rate Variance
Direct-Labor
Efficiency Variance
Interaction among Variances
I am not responsible for
the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
You used too much
time because of poorly
trained workers and
poor supervision.
Learning
Objective
6
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Standard Costs and Product
Costing
Standard material and labor costs
are entered into Work-in-Process
inventory instead of actual costs.
Standard cost variances
are closed directly to
Cost of Goods Sold.
Learning
Objective
7
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Advantages of Standard Costing
Sensible Cost
Comparisons
Management by
Exception
Performance
Evaluation
Advantages
Stable Product
Costs
Employee
Motivation
Less
Expensive
Learning
Objective
8
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Criticisms of Standard Costing
Too aggregate,
too late
Too much focus
on direct-labor
Not specific
Disadvantages
Shorter life
cycles
Focus on cost
minimization
Stable production
required
Narrow
definition
Consistency due
to automation
Adapting Standard-Costing Systems
Reduced focus
on labor
Identify Cost
Drivers
Impact of TQM
and JIT
Shorter product
life cycles
Nonfinancial
Measures
Focus on material
and overhead
Shifting cost
structures
Elimination of nonvalue added costs
Real-Time
Information Systems
Benchmarking
Learning
Objective
9
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Operational Control Measures in
Today’s Manufacturing Environment
Operational Performance Measures in
Today’s Manufacturing Environment
Raw Material &
Scrap Control
Quality
Lead time
Cost of scrap
Total cost



Inventory Control
Average value
Average holding time
Ratio of inventory
value to sales
revenue
Operational Performance Measures in
Today’s Manufacturing Environment
Machine Performance
 Availability
 Downtime
 Maintenance records
 Setup time
Product Quality

Warranty claims

Customer complaints

Defective products

Cost of rework
Operational Performance Measures in
Today’s Manufacturing Environment
Production
• Manufacturing cycle
time
• Velocity
• Manufacturing cycle
efficiency
Delivery
• % of on-time deliveries
• % of orders filled
• Delivery cycle time
Operational Performance Measures in
Today’s Manufacturing Environment


Productivity
Aggregate
productivity
Partial productivity
Innovation and
Learning

Percentage of sales
from new products

Cost savings from
process
improvements
Learning
Objective
10
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Balanced Scorecard
Financial
Customer
Vision and
Strategy
Learning and Growth
Internal
Operations
Learning
Objective
11
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Use of Standard Costs
for Product Costing
Account Payable
Raw-material Inventory
Actual quantity at
actual cost
Actual quantity at
standard cost
Direct-Material Price Variance
Unfavorable
variance
Favorable
variance
Use of Standard Costs
for Product Costing
Raw-material Inventory
Work-in-Process Inventory
Actual quantity at
standard cost
Standard quantity
at standard price
Direct-Material Quantity Variance
Unfavorable
variance
Favorable
variance
Use of Standard Costs
for Product Costing
Work-in-Process Inventory
Wages Payable
Standard quantity
at standard price
Actual quantity at
actual cost
Direct-Labor Rate Variance
Unfavorable
variance
Favorable
variance
Direct-Labor Efficiency Variance
Unfavorable
variance
Favorable
variance
Use of Standard Costs
for Product Costing
Cost of Goods Sold
Unfavorable
variance
Favorable
variance
End of Chapter 10
Let’s set the
standard a
little higher.