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Hilton • Maher • Selto
16Standard Costing, Variance
Analysis, and Kaizen Costing
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-3
STANDARD COSTa budget for the
production of one unit of product or
service
STANDARD COSTa budget for the
production of one unit of product or
service
ACTUAL COSTused in the
production of the product or service
ACTUAL COSTused in the
production of the product or service
COST VARIANCE the differencebetween the
actual cost andthe standard cost
COST VARIANCE the differencebetween the
actual cost andthe standard cost
Using Standard-Costing Systems for Control
16-4
Take the time to investigate only significant cost variancesTake the time to investigate only significant cost variances
What is significant?What is significant?
Depends on the Size of theOrganization
Depends on the Size of theOrganization
Depends on the Type of
the Organization
Depends on the Type of
the Organization
Depends on the
Production Process
Depends on the
Production Process
Management by Exception
16-5
Analysis ofHistorical
Data
Analysis ofHistorical
Data
TaskAnalysis
TaskAnalysis
Used in a mature production Process
Used in a mature production Process
Analyze the processof manufacturing
the product
Analyze the processof manufacturing
the product
What DIDthe product
cost?
What DIDthe product
cost?
What SHOULD the
product cost?
What SHOULD the
product cost?
A CombinedApproach
A CombinedApproach
Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed
Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed
Setting Standards
16-6
Perfection Vs. Practical Standards
PERFECTIONSTANDARDS
PERFECTIONSTANDARDS
PRACTICAL ORATTAINABLESTANDARDS
PRACTICAL ORATTAINABLESTANDARDS
Can only be attained under near perfect
conditions
Can only be attained under near perfect
conditions
Tight as practical,but still are expected
to be attained
Tight as practical,but still are expected
to be attained
•Occasional machinebreakdowns
•Normal amountsof raw material
waste
•Occasional machinebreakdowns
•Normal amountsof raw material
waste
•Peak efficiency•Lowest possible
input prices•best-quality material
•no disruption in production
•Peak efficiency•Lowest possible
input prices•best-quality material
•no disruption in production
16-7
Standards can be used by service firms, nonprofit organizations, and governmental units
Standards can be used by service firms, nonprofit organizations, and governmental units
Implementing and maintaining cost standards canbe time-consuming, labor-intensive, and expensive.
Implementing and maintaining cost standards canbe time-consuming, labor-intensive, and expensive.
Use Of Standards
COSTBENEFITS
COSTBENEFITS
16-8
Standard quantity:
Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. meters
Standard quantity:
Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. metersKoala Camp
Gear CompanyKoala Camp
Gear Company
DIRECT MATERIAL STANDARDSDIRECT MATERIAL STANDARDS
The total amount of material normally required to produce a finished product including allowances for normal waste
or efficiency
The total amount of material normally required to produce a finished product including allowances for normal waste
or efficiency
The total delivered cost, after
subtracting any purchase discounts
The total delivered cost, after
subtracting any purchase discounts
Cost Variance Analysis
16-9
Koala CampGear Company
Koala CampGear Company
DIRECT LABOR STANDARDSDIRECT LABOR STANDARDS
Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3
Total standard rate per hour $18
Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3
Total standard rate per hour $18
Cost Variance Analysis
16-10
Direct material:
Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000
Direct material:
Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000
Direct labor:Direct labor cost per tent (2 hours x $16 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000
Direct labor:Direct labor cost per tent (2 hours x $16 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000
Koala CampGear Company
Koala CampGear Company
The standard cost forthe direct-material
and direct-labor inputsis based upon Koala’s
actual output of 3,000 tents
The standard cost forthe direct-material
and direct-labor inputsis based upon Koala’s
actual output of 3,000 tents
They should incura cost of $396,000
($288,000 + $108,000)to make 3,000 tents
They should incura cost of $396,000
($288,000 + $108,000)to make 3,000 tents
Standard Costs Given Actual Output
16-11
40,000 sq.meters
purchased
$8.15 persq. meter
40,000 sq.meters
purchased
$8.00 persq. meter
36,000sq. meters
allowed
$8.00 per sq. meter
$326,000 $320,000 $288,000
$6,000U
36,400 sq.meters
used
$8.00per sq.meter
$291,200
Direct-material price variance
$3,200U
Direct-materialquantity variance
xx x
Analysis Of Material VariancesActualActual
quantityquantityActualActualpriceprice
ActualActualquantityquantity
StandardStandardpriceprice
StandardStandardquantityquantity
StandardStandardpricepricexxxx xx
Exh.16-1
16-12
What caused Koala to spend more than the anticipated amount on direct material?
What caused Koala to spend more than the anticipated amount on direct material?
First, the company purchased fabric at a higher price ($8.15 persquare meter) than the standard price ($8.00 per square meter).
First, the company purchased fabric at a higher price ($8.15 persquare meter) than the standard price ($8.00 per square meter).
Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased
AP = Actual priceSP = Standard price
Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased
AP = Actual priceSP = Standard price
Koala’s direct- material price variance for June is computed as follows:Direct-material price variance = PQ(AP - SP)= 40,000 ($8.15 - $8.00) = $6,000 unfavorable
Koala’s direct- material price variance for June is computed as follows:Direct-material price variance = PQ(AP - SP)= 40,000 ($8.15 - $8.00) = $6,000 unfavorable
Direct-Material Variances
16-13
Second, the company used more fabric than the standard price.(36,400 sq. meters actually used, instead of the standard amount of
36,000 sq. meters)
Second, the company used more fabric than the standard price.(36,400 sq. meters actually used, instead of the standard amount of
36,000 sq. meters)
Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where:
AQ = Actual quantity used SQ = Standard quantity allowed
Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where:
AQ = Actual quantity used SQ = Standard quantity allowed
Koala’s direct- material quantity variance for June is computed as follows:
Direct-material quantity variance = SP(AQ - SQ)= $8.00(36,400 - 36,000)
=$3,200 unfavorable
Koala’s direct- material quantity variance for June is computed as follows:
Direct-material quantity variance = SP(AQ - SQ)= $8.00(36,400 - 36,000)
=$3,200 unfavorable
What caused Koala to spend more than the anticipated amount on direct material?
What caused Koala to spend more than the anticipated amount on direct material?
Direct-Material Variances
16-14
X X X
Actual Labor Cost Standard Labor Cost
Actualhours
Standardprice
Actualrate
Actualhours
Standardrate
Standardrate
XXX
5,900 hoursused
$19per
hour
5,900hoursused
$18per
hour
6,000 hours
allowed
$18 per
hour
$112,100 $106,200 $108,000
$5,900 Unfavorable $1,800 Favorable
Direct-laborrate variance
Direct-laborefficiency variance
$4,100 Unfavorable
Direct-labor variance
Analysis of Direct-Labor VariancesExh.16-2
16-15
What caused Koala to spend more than the anticipated amount on direct labor?
What caused Koala to spend more than the anticipated amount on direct labor?
First, the company incurred a cost of $19 per hour for directlabor instead of the standard amount of $18 per hour
First, the company incurred a cost of $19 per hour for directlabor instead of the standard amount of $18 per hour
Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where:
AH = Actual hours used AR = Actual rate per hour
SR = Standard rate per hour
Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where:
AH = Actual hours used AR = Actual rate per hour
SR = Standard rate per hour
Koala’s direct-labor rate variance for June is computed as follows:
Direct-labor rate variance = AH(AR - SR)= 5,900 ($19 - $18)
=$5,900 unfavorable
Koala’s direct-labor rate variance for June is computed as follows:
Direct-labor rate variance = AH(AR - SR)= 5,900 ($19 - $18)
=$5,900 unfavorable
Direct-Labor Variances
16-16
Koala used only 5,900 hours of direct labor, which is < standard quantity of 6,000 hours, given actual output of 3,000 tents. The increased efficiency does not fully offset the unexpectedly high
wage rate.
Koala used only 5,900 hours of direct labor, which is < standard quantity of 6,000 hours, given actual output of 3,000 tents. The increased efficiency does not fully offset the unexpectedly high
wage rate.
Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where:
AH = Actual hours used SH = Standard hours allowed
Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where:
AH = Actual hours used SH = Standard hours allowed
Koala’s direct - labor efficiency variance for June is computed as follows:
Direct - labor efficiency variance = SR(AH - SH)= $18 (5,900 - 6,000) = $1,800 favorable
Koala’s direct - labor efficiency variance for June is computed as follows:
Direct - labor efficiency variance = SR(AH - SH)= $18 (5,900 - 6,000) = $1,800 favorable
What caused Koala to spend more than the anticipated amount on direct labor?
What caused Koala to spend more than the anticipated amount on direct labor?
Direct-Labor Variances
16-17
Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U
Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U
When there are several types of direct material or direct labor, price and quantity variances are computed for
each type, and then added to obtain a total price variance and a total quality variance
When there are several types of direct material or direct labor, price and quantity variances are computed for
each type, and then added to obtain a total price variance and a total quality variance
Multiple Types Of Direct Material Or Direct Labor
16-18
In some manufacturing processes, a certain amount of defective production or spoilage is normal.
In some manufacturing processes, a certain amount of defective production or spoilage is normal.
Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output.
If total good output in February is 5,000 liters, what is the standard allowed quantity of input?
Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output.
If total good output in February is 5,000 liters, what is the standard allowed quantity of input?
Good output quantityGood output quantity = 80% X Input quantity= 80% X Input quantity
Good output quantity ÷ 80%Good output quantity ÷ 80% = Input quantity allowed= Input quantity allowed
5,000 liters of good output ÷ 80%
5,000 liters of good output ÷ 80%
= 6,250 liters of input allowed
= 6,250 liters of input allowed
Allowance For Defects Of Spoilage
16-19
????
What constitutes an exception?What constitutes an exception?
How does a manager know when to follow up on a cost variance and when to ignore it?
How does a manager know when to follow up on a cost variance and when to ignore it?
RULE OF THUMB:Investigate variances that are either greater than $10,000 or
greater than 10 percent of standard cost
RULE OF THUMB:Investigate variances that are either greater than $10,000 or
greater than 10 percent of standard cost
Size of VarianceSize of Variance
Absolute AmountAbsolute Amount Relative AmountRelative Amount
Management by Exception
16-20
MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%
MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%
None of the variances are greater than $10,000 or10%, but this variance should be investigated
because it has occurred at a reasonably high amount for four months
None of the variances are greater than $10,000 or10%, but this variance should be investigated
because it has occurred at a reasonably high amount for four months
Standarddirect
labor costis $100,000
Standarddirect
labor costis $100,000
Recurring Variances
16-21
None of the variances are greater than $10,000 or10%, but this variance should be investigated
because it has an unfavorable trend.
None of the variances are greater than $10,000 or10%, but this variance should be investigated
because it has an unfavorable trend.
Standarddirect labor
is $100,000
Standarddirect labor
is $100,000
MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%
MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%
Trends
16-22
ControllabilityA manager is more likely to investigate a variance
that is controllable by someone in the
organization than one that is not
ControllabilityA manager is more likely to investigate a variance
that is controllable by someone in the
organization than one that is not
Favorable VariancesIt is as important to investigate
significant favorable variances as well as significant unfavorable
variances
Favorable VariancesIt is as important to investigate
significant favorable variances as well as significant unfavorable
variances
Cost and Benefits of Investigation
The decision whether to investigate a variance is a cost -
benefit decision
Cost and Benefits of Investigation
The decision whether to investigate a variance is a cost -
benefit decision
Additional Issues
16-23
A STATISTICAL CONTROL CHART plots cost variancesacross time and compares them with a statistically
determined critical value that triggers an investigation
A STATISTICAL CONTROL CHART plots cost variancesacross time and compares them with a statistically
determined critical value that triggers an investigation
Statistical AnalysisExh.16-4
1 standarddeviation
1 standarddeviation
X
XX
XX
X
Time
Jan. Feb. March April May June
Favorablevariances
Unfavorablevariances
Criticalvalue
Investigate
16-24
Behavioral Effects Of Standard Costing
Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments
Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments
They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions
They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions
16-25
Direct-material price variance
Direct-material quantity variance
Direct-labor rate variance
Direct- labor efficiency variance
The purchasing manager
The production supervisor
The production supervisor
The production supervisor
Get the best prices available for purchased goods and services throughskillful purchasing practices
Skillful supervision and motivation of production employees, coupled withthe careful use and handling of materials, contribute to minimal waste
Generally results from using a different mix of employees than that anticipatedwhen the standard were set
Motivating employees toward production goals and effective work schedulesimproves efficiency
Which Managers Generally Influence Cost Variances?
16-26
Researchand
develop-ment
Design Supply Produc-
tion Marketing
Distri- bution
Customer service
HumanresourcesHuman
resources
PhysicalresourcesPhysical
resources
Variances in one part of the value chain can be due to root causes in another part of the chain
Variances in one part of the value chain can be due to root causes in another part of the chain
Interaction among variances often occur making it difficult to determine the responsibility for a particular variance
Interaction among variances often occur making it difficult to determine the responsibility for a particular variance
Interaction Among Variances
Value ChainValue Chain
PerspectivePerspective
Exh.16-5
16-27
Work-in-Process Inventory
Direct-material cost
Direct-labor cost
Manufacturing Overhead
Finished-Goods Inventory
Cost of Goods Sold Income Summary
Product cost transferredwhen product is finished
Product cost transferred when product is sold
Expense closed into
Income Summary at endof accounting period
Exh.16-6
Using Standard Costs For Product Costing
16-28
Variances are temporary
accounts, like revenue and
expense accounts, and
they are closed out at the end of the accounting
period.
Variances are temporary
accounts, like revenue and
expense accounts, and
they are closed out at the end of the accounting
period.
Cost of Goods Sold
Unfavorablevariancesrepresentcosts of
operatinginefficiently,
relative to thestandards, and
thus cause the Cost ofGoods Sold
to be higher
Favorablevariancesrepresentcosts of
operatingefficiently,
relative to thestandards, and
thus cause the Cost ofGoods Sold
to be lower
Disposition Of Variances
16-29
Impact of Information Technology on Standard Costing
16-30
Standard Costing: Advantages
Allows managers to use management by exception
Provides a basis for sensible cost comparisons
Provides a means of performance evaluation and rewards for employees
Allows managers to use management by exception
Provides a basis for sensible cost comparisons
Provides a means of performance evaluation and rewards for employees
Provides motivation for employees to
adhere to standards Results in more stable product costs
Is less expensive than actual- or normal- costing
systems
Provides motivation for employees to
adhere to standards Results in more stable product costs
Is less expensive than actual- or normal- costing
systems
16-31
Criticisms Of Standard Costing In Today’s Environment
Shorter product life cycles mean that standards are only relevant for a short time
Too much focus on cost minimization rather than increasing product quality or customer service
Automated manufacturing processes tend to be more consistent in meeting production specifications.
Not defined broadly enough to capture important aspect of ownership
Shorter product life cycles mean that standards are only relevant for a short time
Too much focus on cost minimization rather than increasing product quality or customer service
Automated manufacturing processes tend to be more consistent in meeting production specifications.
Not defined broadly enough to capture important aspect of ownership
Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system
Variances are often too late to be useful
Standard costing out of step with the philosophy of cost management systems and activity-based management
Too much focus on the cost and efficiency of direct labor
Variances are often too aggregated. They are not tied to specific product lines, production batches, or to the flexible management system
Variances are often too late to be useful
Standard costing out of step with the philosophy of cost management systems and activity-based management
Too much focus on the cost and efficiency of direct labor
16-32
Adaptation of Standard-Costing Systems
Reduced importance of
labor standards
Reduced importance of
labor standards
Shifting Cost Structures
Shifting Cost Structures
Cost Drivers
Cost Drivers
Emphasis on Material and
O/H costs
Emphasis on Material and
O/H costs
Shorter Product Life
Cycles
Shorter Product Life
Cycles
Non-Value-Added Costs
Non-Value-Added Costs
High Quality/Zero
Defects
High Quality/Zero
Defects
Real-time Information
Systems
Real-time Information
Systems
Benchmarking
Benchmarking
16-33
KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and
responsibility of each worker.
KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and
responsibility of each worker.
Cost per product unit
12/31/x0 12/31/x1
Time
Cost basefor next
year
Actual costreductionachieved
Current yearcost base
Kaizen goal:cost reduction
rate
Actual costperformance
of the current year
Exh.16-7
Kaizen Costing
16-34
END OF CHAPTER 16
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