Chapter 10 Standard Costing, Operational Performance Measures, and the Balanced Scorecard

Chapter 10Chapter 10

Standard Costing, Operational

Performance Measures, and the

Balanced Scorecard

Standard Costing, Operational

Performance Measures, and the

Balanced Scorecard

Definition of TermsDefinition of Terms

10-3

Standard Costs

- are usually associated with a manufacturing company's costs of direct material, direct labor, and manufacturing overhead.

10-4

Standard Costing

• is a control method involving the preparation of detailed cost and sales budgets

• It is then compared with the actual results for a specific account period and any significant variances between the actual and the budgeted results are investigated

10-5

Standard Costing

• Unexpected trends are corrected if they are not acceptable or they cannot be accommodated.

10-6

Cost variance (CV)

is the amount of money that was actually spent on a project or a part of a project compared to the amount of work that was actually accomplished. Cost variance is the budgeted cost of work performed minus the actual cost of work performed.

Learning Objective

1

Learning Objective

1

10-8

Managing Costs

Standardcost

Actualcost

Comparison between standard and actual

performancelevel

Costvariance

10-9

Management by Exception

DirectMaterial

Type of Product CostType of Product Cost

Am

ou

nt

Am

ou

nt

DirectLabor

Standard

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

management by exception.

Learning Objective

2

Learning Objective

2

10-11

Setting Standards

Analysis ofHistorical Data

TaskAnalysis

CostStandards

10-12

Accountants, engineers, personnel administrators, and production managers combine efforts to set standards

based on experience and expectations.

Participation in Setting Standards

10-13

Perfection versus Practical Standards: A Behavioral Issue

Should we usepractical standards

or perfection standards?

Practical standardsshould be set at levels

that are currentlyattainable with reasonable andefficient effort.

10-14

I agree. Perfection standards are

unattainable and therefore discouraging

to most employees.

Perfection versus Practical Standards: A Behavioral Issue

10-15

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

Learning Objective

3

10-17

Standard Cost Variances

Cost Variance Analysis

Quantity VariancePrice Variance

The difference betweenthe actual price and the

standard price

The difference betweenthe actual quantity andthe standard quantity

10-18

A General Model for Variance Analysis

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

Price Variance Quantity Variance

Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance

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

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

10-19




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

10-20




Standard quantity is the quantity that should have been used.

10-21

Standard Costs

Let’s use the concepts

of the general model to

calculate standard cost

variances, starting with

direct material.

10-22

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

10-23

What is the actual price per pound paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.


10-24

What is the actual price per pound paid 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.


10-25

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

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.


10-26

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


b. $170 favorable.


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


10-27

The standard quantity of material thatshould have been used to produce

1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.


10-28

The standard quantity of material thatshould have been used to produce

1,000 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


10-29

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


b. $170 favorable.


d. $800 favorable.


10-30

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


b. $170 favorable.


d. $800 favorable.

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


10-31


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

Material Variances Summary

10-32

The price variance is computed on the entire

quantity purchased.

The quantity variance is computed only on the

quantity used.

Hanson purchased and used 1,700 pounds.

How are the variances computed if the amount purchased differs from

the amount used?

ZippyMaterial Variances

10-33

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.


10-34

Material Variances

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.

Zippy

MPV = AQ(AP - SP)MPV = 2,800 lbs. × ($3.90 - 4.00)MPV = $280 Favorable

10-35

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.


MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs

- 1,500 lbs) MQV = $800unfavor.

10-36

Isolation of Material Variances

I need the variances as soonas possible so that I canbetter identify problems

and control costs.

You accountants just don’tunderstand the problems

we production managers have.

Okay. I’ll start computingthe price variance when

material is purchased andthe quantity variance assoon as material is used.

10-37

Standard Costs

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

10-38

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

10-39

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

a. $10.20 per hour.

b. $10.10 per hour.

c. $9.90 per hour.

d. $9.80 per hour.


10-40

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

a. $10.20 per hour.

b. $10.10 per hour.

c. $9.90 per hour.

d. $9.80 per hour.


AR = $15,810 ÷ 1,550 hours AR = $10.20 per hour

10-41

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


b. $310 favorable.


d. $300 favorable.


10-42

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


b. $310 favorable.


d. $300 favorable.

Labor Variances

LRV = AH(AR - SR) LRV = 1,550 hrs($10.20 - $10.00) LRV = $310 unfavorable

Zippy

10-43

The standard hours (SH) of labor thatshould have been worked to produce

1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.


10-44

The standard hours (SH) of labor thatshould have been worked to produce

1,000 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

10-45

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


b. $510 favorable.


d. $500 favorable.


10-46

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


b. $510 favorable.


d. $500 favorable.

Labor Variances

LEV = SR(AH - SH) LEV = $10.00(1,550 hrs - 1,500 hrs) LEV = $500 unfavorable

Zippy

10-47

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

Labor Variances Summary

Rate variance$310 unfavorable

Efficiency variance$500 unfavorable

1,550 hours 1,550 hours 1,500 hours × × ×$10.20 per hour $10.00 per hour $10.00 per hour

$15,810 $15,500 $15,000

Learning Objective

4

Learning Objective

4

10-49

Costs and benefits of investigation

Favorable variances

Controllability

Trends

Significance of Cost Variances

What clues help me to determine the

variances that I should investigate?

Recurring variances

Size of varianceDollar/Monetary amount and

Percentage of standard

10-50

Statistical Control Chart

1 2 3 4 5 6 7 8 9

Variance Measurements

Favorable Limit

Unfavorable Limit

Desired Value • • •• •

••

••

Warning signals for investigation

10-51

Unfavorable Variance

• If actual costs are greater than standard costs

• tells management that if everything else stays constant the company's actual profit will be less than planned.

10-52

Favorable variance

• If actual costs are less than standard costs the variance is favorable

• tells management that if everything else stays constant the actual profit will likely exceed the planned profit.

Learning Objective

5

Learning Objective

5

10-54

Behavioral Impact of Standard Costing

• Variances evaluate personnel:– Variances may be used to evaluate personnel,

often with regard to salary increases, bonuses, and promotions

10-55


• Negative and positive incentives created– Such incentives can have positive and negative

effects, as a bonus plan may prompt a manager to pursue actions that are not in the best interests of the organization.

10-56

If I buy cheaper materials, my direct-materials expenses will be lower than

what is budgeted. Then I’ll get my bonus. But we may lose customers because of

lower quality.


10-57

Controllability of Variances

• Importance of identifying who controls: It is rare that one person controls any event; however, it is often possible to identify the manager who is most able to influence a particular variance.

10-58

Controllability of Variances

Direct-Material Price Variance

Direct-Labor Rate Variance

Direct-Material Quantity Variance

Direct-Labor Efficiency Variance

Purchasing managerProduction supervisor and/or production engineers

Production supervisor Production supervisor

10-59

Controllability of Variances• Variance often affect more than one

input: Variances often interact, making investigation and controllability difficult.

– For example, a labor efficiency variance may be caused by problems not only with labor but by problems with machinery and material as well.

– In addition, managers sometimes trade-off variances, purposely incurring an unfavorable variance that is more than offset by favorable variances.

10-60

Interaction among 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.

Learning Objective

6

Learning Objective

6

10-62

Standard Costs Variances Cost flows

• In a standard-cost system, costs flow thought the same accounts in the general ledger

• however, they flow through at standard cost.

• In other words, Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold are carried at standard cost.

10-63

Standard Costs and Variances Differences recorded in variance

accounts• The differences between standard costs and

the actual costs incurred are recorded in variance accounts instead of actual costs.

• Unfavorable variances are recorded as debits

• favorable variances are recorded as credits.

10-64

Standard Costs and Variances

• Variances are normally closed at the end of the accounting period to Cost of Goods Sold.

Learning Objective

7

Learning Objective

7

10-66

Advantages of Standard Costing

Management byException

Stable Product Costs

Sensible method

Advantages

PerformanceEvaluation

EmployeeMotivation

10-67

Sensible method

• It provides a sensible method to compare budgeted costs to actual costs at the actual level of output.

10-68

Management by exception• Managers can practice management by exception.

• (MBE) "policy by which management devotes its time to investigating only those situations in which actual results differ significantly from planned results. The idea is that management should spend its valuable time concentrating on the more important items (such as shaping the company's future strategic course). Attention is given only to material deviations requiring investigation."

10-69

Benchmark for performance

• It provides a benchmark for performance evaluation and employee rewards.

10-70

Stable product cost

• Standard costs provide a stable product cost. Actual costs may fluctuate erratically, whereas standard costs are changed only periodically.

10-71

Less expensive

• Standard systems are usually less expensive to operate than actual or normalized systems

Learning Objective

8

Learning Objective

8

10-73

Criticisms of Standard Costing

Not specific

Focus on cost minimization

Too aggregate, and untimely

DisadvantagesToo much focus on direct-labor

Narrow definition

Stable production required

Shorter life cycles

10-74

Too aggregated and untimely

• Variances are too aggregated and arrive too late to be useful. Variances should focus on activities, specific product lines, production batches, and/or FMS cells.

Barry

Constituting or amounting to a whole; total

10-75

Focuses on less important production factors

• Variances focus too much on the cost and efficiency of labor, which is becoming relatively unimportant factor of production.

10-76

Less stability of manufacturing environment

• Standard costs rely on a stable production environment, and flexible manufacturing systems have reduced the stability, with frequent switching among a variety of products on the same manufacturing line.

10-77

Too focused on costs rather than quality

• Standards focus too much on cost minimization and not enough on product quality, customer service, and other contemporary issues.

Learning Objective

9

Learning Objective

9

10-79

Operational Control Measures in Today’s Manufacturing Environment

10-80

Operational Performance Measures in Today’s Manufacturing Environment

Raw Material & Scrap Control

Quality Lead timeCost of scrapTotal cost

Inventory Control Average value Average holding time Ratio of inventory

value to sales revenue

10-81

Machine Performance Availability Downtime Maintenance records Setup time

Product Quality Warranty claims Customer complaints Defective products Cost of rework


10-82


Production• Manufacturing cycle

time• Velocity• Manufacturing cycle

efficiency

Delivery• % of on-time deliveries• % of orders filled• Delivery cycle time

10-83

Productivity Aggregate

productivity Partial productivity

Innovation and Learning

Percentage of sales from new products

Cost savings from process improvements


Learning Objective

10

Learning Objective

10

10-85

The Balanced ScorecardFinancial

Learning and Growth

Internal OperationsCustomer

Vision and

Strategy

10-86

Balanced scorecard

• a strategic planning and management system to align business activities to the:– vision and strategy of the organization– improve internal and external communications – monitor organization performance against

strategic goals.

10-87

Balanced Score card

• It is used extensively in:– business and industry– Government– and nonprofit organizations worldwide

10-88

The four perspectives

• Financial

• Customer

• Internal Business Processes

• Learning and Growth

10-89

Financial Perspective

• encourages the identification of a few relevant high-level financial measures. In particular, designers were encouraged to choose measures that helped inform the answer to the question "How do we look to shareholders?"

10-90

Customer

• encourages the identification of measures that answer the question "How do customers see us?"

10-91

Internal Business Processes

• encourages the identification of measures that answer the question "What must we excel at?"

10-92

Learning and Growth

• encourages the identification of measures that answer the question "Can we continue to improve and create value?".

Learning Objective

11

Learning Objective

11

10-94

Use of Standard Costsfor Product Costing

Raw Material Inventory

Actual quantity atstandard cost

Account Payable

Actual quantity atactual cost

Direct Material Price Variance

Favorable VarianceUnfavorable Variance

10-95

Unfavorable Favorablevariance variance

Direct-Material Quantity Variance

Standard quantityat standard price

Work-in-Process Inventory


Actual quantity atstandard cost

Raw-material Inventory

10-96


Direct-Labor Rate Variance

Actual quantity atactual cost

Wages Payable

Standard quantityat standard price

Work-in-Process Inventory



Direct-Labor Efficiency Variance

10-97



Cost of Goods Sold

10-98

End of Chapter 10Thank you very much

• To download the updated presentationplease go to: barryf1.wordpress.com

Jessie Montealegre Barry Pualengco

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Chapter 10 Standard Costing, Operational Performance Measures, and the Balanced Scorecard