Standard Costs and Operating Performance

Measures

Chapter

11

Standard Costs

Benchmarks formeasuring performance.

The expected levelof performance.

Based on carefullypredetermined amounts.

Used for planning labor, materialand overhead requirements.Standard

Costs are

Standard Costs

DirectMaterial

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

management by exception.

Type of Product Cost

Am

ou

nt

DirectLabor

ManufacturingOverhead

Standard

Setting Direct Material Standards

QuantityStandards

Use product design specifications.

PriceStandards

Final, deliveredcost of materials,net of discounts.

Setting Direct Labor Standards

RateStandards

Use wage surveys and

labor contracts.

TimeStandards

Use time and motion studies for

each labor operation.

Setting Variable Overhead Standards

RateStandards

The rate is the variable portion of the

predetermined overhead rate.

ActivityStandards

The activity is the base used to calculate

the predetermined overhead.

Standard Cost Card – Variable Production Cost

A standard cost card for one unit of product might look like this:

A A x BStandard Standard StandardQuantity Price Cost

Inputs or Hours or Rate per Unit

Direct materials 3.0 lbs. 4.00$ per lb. 12.00$ Direct labor 2.5 hours 14.00 per hour 35.00 Variable mfg. overhead 2.5 hours 3.00 per hour 7.50 Total standard unit cost 54.50$

B

Are standards the same as budgets?

A standard is the expected cost for one

unit.

A budget is the expected cost for all

units.

Standards vs. Budgets

Standard Cost VariancesP

rod

uct

Co

st

Standard

This variance is unfavorablebecause the actual cost

exceeds the standard cost.

A standard cost variance is the amount by whichan actual cost differs from the standard cost.

Standard Cost Variances

I see that thereis an unfavorable

variance.

But why arevariances

important to me?

First, they point to causes ofproblems and directions

for improvement.

Second, they trigger investigations in departments

having responsibility for incurring the costs.

Variance Analysis Cycle

Prepare standard cost performance

report

Conduct next period’s

operations

Analyze variances

Identifyquestions

Receive explanations

Takecorrective

actions

Begin

Standard Cost Variances

Price Variance

The difference betweenthe actual price and the

standard price

Standard Cost Variances

Quantity Variance

The difference betweenthe actual quantity andthe standard quantity

Practice Question

1. Price Variance plus Quantity Variance equals: 

a) Usage Variance.

b) Rate Variance.

c) Total Variance.

d) Standard Variance.

A General Model for Variance Analysis

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

Price Variance Quantity Variance

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

Price Variance Quantity Variance

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

A General Model for Variance Analysis

Standard quantity is the quantity allowed for the actual good output.

A General Model for Variance Analysis

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

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

Price Variance Quantity Variance

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

A General Model for Variance Analysis

$

Std Price

Std Q

nty

A General Model for Variance Analysis

$

Std Price

Std Q

nty

Act Q

ntyQ

uantity V

ariance

A General Model for Variance Analysis

$

Std PriceActual Price

Std Q

nty

Act Q

ntyPrice Variance

Quantity

Variance

Standard Costs

Let’s use the general model to

calculate standard cost variances,

starting withdirect material.

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 Example Zippy

What is the actual price per poundpaid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

What is the actual price per poundpaid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

Material Variances Zippy

What is the actual price per poundpaid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

What is the actual price per poundpaid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

AP = $6,630 ÷ 1,700 lbs.AP = $3.90 per lb.

Material Variances Zippy

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

Material Variances Zippy

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($3.90 - 4.00) MPV = $170 Favorable

Material Variances Zippy

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.

Material Variances Zippy

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds. SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs

Material Variances Zippy

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

Material Variances Zippy

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

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

Material Variances Zippy

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

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

Material Variances Summary Zippy

Material Variances

Hanson purchased and used 1,700 pounds.

How are the variances computed if the amount purchased differs from

the amount used?

The price variance is computed on the entire

quantity purchased.

The quantity variance is computed only on the

quantity used.

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 ContinuedZippy

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.

Material Variances ContinuedZippy

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.

Material Variances ContinuedZippy

Isolation of Material Variances

I need the price variancesooner so that I can better

identify purchasing problems.

You accountants just don’tunderstand the problems thatpurchasing managers have.

I’ll start computingthe price variancewhen material is

purchased rather thanwhen it’s used.

Responsibility for Material Variances

I am not responsible for this unfavorable material

quantity variance.

You purchased cheapmaterial, so my peoplehad to use more of it.

You used too much material because of poorly trained

workers and poorly maintained equipment.

Also, your poor scheduling sometimes requires me to

rush order material at a higher price, causing

unfavorable price variances.

Standard Costs

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

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

1.5 standard hours per Zippy at $6.00 perdirect labor hour

Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to

make 1,000 Zippies.

Labor Variances Example Zippy

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

a. $6.20 per hour.

b. $6.00 per hour.

c. $5.80 per hour.

d. $5.60 per hour.

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

a. $6.20 per hour.

b. $6.00 per hour.

c. $5.80 per hour.

d. $5.60 per hour.

Labor Variances Zippy

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

a. $6.20 per hour.

b. $6.00 per hour.

c. $5.80 per hour.

d. $5.60 per hour.

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

a. $6.20 per hour.

b. $6.00 per hour.

c. $5.80 per hour.

d. $5.60 per hour.

Labor Variances

AR = $9,610 ÷ 1,550 hours AR = $6.20 per hour

Zippy

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

a. $310 unfavorable.

b. $310 favorable.

c. $300 unfavorable.

d. $300 favorable.

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

a. $310 unfavorable.

b. $310 favorable.

c. $300 unfavorable.

d. $300 favorable.

Labor Variances Zippy

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

a. $310 unfavorable.

b. $310 favorable.

c. $300 unfavorable.

d. $300 favorable.

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

a. $310 unfavorable.

b. $310 favorable.

c. $300 unfavorable.

d. $300 favorable.

Labor Variances

LRV = AH(AR - SR) LRV = 1,550 hrs($6.20 - $6.00) LRV = $310 unfavorable

Zippy

The standard hours (SH) of labor thatshould have been worked to produce1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

The standard hours (SH) of labor thatshould have been worked to produce1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

Labor Variances Zippy

The standard hours (SH) of labor thatshould have been worked to produce1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

The standard hours (SH) of labor thatshould have been worked to produce1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

Labor Variances

SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours

Zippy

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

a. $290 unfavorable.

b. $290 favorable.

c. $300 unfavorable.

d. $300 favorable.

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

a. $290 unfavorable.

b. $290 favorable.

c. $300 unfavorable.

d. $300 favorable.

Labor Variances Zippy

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

a. $290 unfavorable.

b. $290 favorable.

c. $300 unfavorable.

d. $300 favorable.

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

a. $290 unfavorable.

b. $290 favorable.

c. $300 unfavorable.

d. $300 favorable.

Labor Variances

LEV = SR(AH - SH) LEV = $6.00(1,550 hrs - 1,500 hrs) LEV = $300 unfavorable

Zippy

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

Labor Variances Summary

Rate variance$310 unfavorable

Efficiency variance$300 unfavorable

1,550 hours 1,550 hours 1,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour

= $9,610 = $9,300 = $9,000

Zippy

Labor Rate Variance – A Closer Look

High skill,high rate

Low skill,low rate

Using highly paid skilled workers toperform unskilled tasks results in an

unfavorable rate variance.

Production managers who make work assignmentsare generally responsible for rate variances.

Production managers who make work assignmentsare generally responsible for rate variances.

Labor Efficiency Variance –A Closer Look

UnfavorableEfficiencyVariance

Poorlytrainedworkers

Poorquality

materials

Poorlymaintainedequipment

Poorsupervisionof workers

Responsibility for Labor Variances

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.

Responsibility for Labor Variances

Maybe I can attribute the laborand material variances to personnel

for hiring the wrong peopleand training them poorly.

Standard Costs

Now let’s calculate standard cost

variances for the last of the variable production costs –

variable manufacturing

overhead.

Hanson Inc. has the following variable manufacturing overhead standard to

manufacture one Zippy:

1.5 standard hours per Zippy at $3.00 perdirect labor hour

Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for

variable manufacturing overhead.

Variable ManufacturingOverhead Variances Example Zippy

What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?

a. $3.00 per hour.

b. $3.19 per hour.

c. $3.30 per hour.

d. $4.50 per hour.

What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?

a. $3.00 per hour.

b. $3.19 per hour.

c. $3.30 per hour.

d. $4.50 per hour.

Variable ManufacturingOverhead Variances Zippy

What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?

a. $3.00 per hour.

b. $3.19 per hour.

c. $3.30 per hour.

d. $4.50 per hour.

What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week?

a. $3.00 per hour.

b. $3.19 per hour.

c. $3.30 per hour.

d. $4.50 per hour.

Variable ManufacturingOverhead Variances

AR = $5,115 ÷ 1,550 hours AR = $3.30 per hour

Zippy

Hanson’s spending variance (SV) for variable manufacturing overhead forthe week was:

a. $465 unfavorable.

b. $400 favorable.

c. $335 unfavorable.

d. $300 favorable.

Hanson’s spending variance (SV) for variable manufacturing overhead forthe week was:

a. $465 unfavorable.

b. $400 favorable.

c. $335 unfavorable.

d. $300 favorable.

Variable ManufacturingOverhead Variances Zippy

Hanson’s spending variance (SV) for variable manufacturing overhead forthe week was:

a. $465 unfavorable.

b. $400 favorable.

c. $335 unfavorable.

d. $300 favorable.

Hanson’s spending variance (SV) for variable manufacturing overhead forthe week was:

a. $465 unfavorable.

b. $400 favorable.

c. $335 unfavorable.

d. $300 favorable.

Variable ManufacturingOverhead Variances

SV = AH(AR - SR) SV = 1,550 hrs($3.30 - $3.00) SV = $465 unfavorable

Zippy

Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:

a. $435 unfavorable.

b. $435 favorable.

c. $150 unfavorable.

d. $150 favorable.

Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:

a. $435 unfavorable.

b. $435 favorable.

c. $150 unfavorable.

d. $150 favorable.

Variable ManufacturingOverhead Variances Zippy

Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:

a. $435 unfavorable.

b. $435 favorable.

c. $150 unfavorable.

d. $150 favorable.

Hanson’s efficiency variance (EV) for variable manufacturing overhead for the week was:

a. $435 unfavorable.

b. $435 favorable.

c. $150 unfavorable.

d. $150 favorable.

Variable ManufacturingOverhead Variances

EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable

1,000 units × 1.5 hrs per unit

Zippy

Spending variance$465 unfavorable

Efficiency variance$150 unfavorable

1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour

= $5,115 = $4,650 = $4,500

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

Variable ManufacturingOverhead Variances Zippy

Variable Manufacturing Overhead Variances – A Closer Look

If variable overhead is applied on the basisof direct labor hours, the labor efficiency

and variable overhead efficiency varianceswill move in tandem.

If variable overhead is applied on the basisof direct labor hours, the labor efficiency

and variable overhead efficiency varianceswill move in tandem.

Larger variances, in dollar amount or as a percentage of the

standard, are investigated first.

Variance Analysis and Management by Exception

How do I know which variances to investigate?

Advantages of Standard Costs

Management byexception

Improved cost control and performance

evaluation

Better Informationfor planning anddecision making

Possible reductionsin production costs

Advantages

PotentialProblems

Emphasis on negativemay impact morale.

Emphasizing standardsmay exclude other

important objectives.

Favorable variancesmay be misinterpreted.

Continuous improvementmay be moreimportant than

meeting standards.

Standard costreports may

not be timely.

Labor quantity standardsand efficiency variancesmay not be appropriate.

The Balanced Scorecard

Management translates its strategy into performance measures that employees

understand and accept.

Management translates its strategy into performance measures that employees

understand and accept.

Performancemeasures

Financial Customers

Learningand growth

Internalbusiness

processes

The Balanced Scorecard

How do we lookto the owners?

How can wecontinually learn,

grow, and improve?

In which internalbusiness processes

must we excel?

How do we lookto customers?

The Balanced Scorecard

Learning improvesbusiness processes.

Improved businessprocesses improve

customer satisfaction.

Improving customersatisfaction improves

financial results.

Process time is the only value-added time.

Delivery Performance Measures

Wait TimeProcess Time + Inspection Time

+ Move Time + Queue Time

Order Received

ProductionStarted

Goods Shipped

Delivery Cycle Time

Throughput Time

Delivery Performance Measures

ManufacturingCycle

Efficiency

Value-added time

Manufacturing cycle time=

Wait Time

Throughput Time

Process Time + Inspection Time+ Move Time + Queue Time

Order Received

ProductionStarted

Goods Shipped

Delivery Cycle Time