Standard Costs and The Balanced Scorecard

Chapter
10
Standard Costs and The Balanced Scorecard
10-2
LEARNING OBJECTIVES
After studying this chapter, you should be able to: 1. Explain how direct materials standards and direct labour standards are set. 2. Compute the direct materials price and quantity variances and explain their significance. 3. Compute mix and yield variances for materials and explain their significance. 4. Compute the direct labour rate and efficiency variances and explain their significance. 5. Compute the variable manufacturing overhead spending and efficiency variances.
McGraw-Hill Ryerson Limited., 2001
10-3
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
6. Understand the advantages of and the potential problems with using standard costs. 7. Understand how a balanced scorecard fits together and how it supports a companys strategy. 8. Compute the delivery cycle time, the throughput time and the manufacturing cycle efficiency (MCE). 9. (Appendix 10A) Prepare journal entries to record standard costs and variances. 10. (Appendix 10B) Explain the value of learning curves.
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Standard Costs
based on carefully predetermined amounts. used for planning labour, material and overhead requirements. the expected level of performance. benchmarks for measuring performance.
Standard Costs are:
10-5
Standard Costs
Managers focus on quantities and costs that exceed standards, a practice known as management by exception.
Amount
Standard Direct Material
Direct Labour
Manufacturing Overhead
Type of Product Cost

10-6
Setting Standard Costs

Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations.
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Should we use practical standards or ideal standards?
Engineer
Managerial Accountant
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Practical standards should be set at levels that are currently attainable with reasonable and efficient effort.
Production manager
Managerial Accountant
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I agree. Ideal standards, that are based on perfection, are unattainable and discourage most employees.
Human Resources Managerial Manager Accountant

10-10
Setting Direct Material Standards

Price Standards Quantity Standards
Final, delivered cost of materials, net of discounts.
Use product design specifications.
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Setting Direct Labour Standards

Rate Standards Time Standards
Use wage surveys and labour contracts.
Use time and motion studies for each labour operation.
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Setting Variable Overhead Standards

Rate Standards Activity Standards
The rate is the variable portion of the predetermined overhead rate.
The activity is the base used to calculate the predetermined overhead.
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Standard Cost Card Variable Production Cost

A standard cost card for one unit of product might look like this:
A Standard Quantity or Hours
3.0 kg. 2.5 hours 2.5 hours
Inputs
Direct materials Direct labour Variable mfg. overhead Total standard unit cost
B Standard Price or Rate
AxB Standard Cost per Unit

12.00 35.00 7.50 54.50
$ 4.00 per kg. $ 14.00 per hour 3.00 per hour $
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Standards vs. Budgets
Are standards the same as budgets?
A standard is the expected cost for one unit. A budget is the expected cost for all units.
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Standard Cost Variances

A standard cost variance is the amount by which an actual cost differs from the standard cost.
Standard Product Cost
This variance is unfavourable because the actual cost exceeds the standard cost.
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I see that there is an unfavourable variance. But why are variances important to me? First, they point to causes of problems and directions for improvement. Second, they trigger investigations in departments having responsibility for incurring the costs.
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Variance Analysis Cycle

Identify questions Receive explanations Take corrective actions
Analyze variances Prepare standard cost performance report
Conduct next periods operations
Begin
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Price Variance
Quantity Variance
The difference between the actual price and the standard price
The difference between the actual quantity and the standard quantity
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A General Model for Variance Analysis

Actual Quantity Actual Price Actual Quantity Standard Price Standard Quantity Standard Price
Price Variance
Quantity Variance
Standard price is the amount that should have been paid for the resources acquired.
10-20

Price Variance
Quantity Variance
Standard quantity is the quantity allowed for the actual good output.
10-21

Price Variance
AQ(AP - SP) AQ = Actual Quantity AP = Actual Price
Quantity Variance
SP(AQ - SQ) SP = Standard Price SQ = Standard Quantity
10-22
Standard Costs
Lets use the general model to calculate standard cost variances, starting with direct material.
10-23
Material Variances Example
Zippy
Hanson Inc. has the following direct material standard to manufacture one Zippy:
1.5 kilograms per Zippy at $4.00 per kilogram
Last week 1,700 kilograms of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630.
10-24
Material Variances
Zippy
What What is is the the actual actual price price per per kilogram kilogram paid paid for for the the material? material? a. a. $4.00 $4.00 per per kilogram. kilogram. b. b. $4.10 $4.10 per per kilogram. kilogram. c. c. $3.90 $3.90 per per kilogram. kilogram. d. d. $6.63 $6.63 per per kilogram. kilogram.
10-25
Material Variances
Zippy
What What is is the the actual actual price price per per kilogram kilogram paid paid for for the the material? material? a. a. $4.00 $4.00 per per kilogram. kilogram. b. b. $4.10 $4.10 per per kilogram. kilogram. c. c. $3.90 $3.90 per per kilogram. kilogram. d. d. $6.63 $6.63 per per kilogram. kilogram. AP = $6,630 1,700 kg.
AP = $3.90 per kg.
10-26
Material Variances
Zippy
Hansons Hansons material material price price variance variance (MPV) (MPV) for for the the week week was: was: a. a. $170 $170 unfavourable. unfavourable. b. b. $170 $170 favourable. favourable. c. c. $800 $800 unfavourable. unfavourable. d. d. $800 $800 favourable. favourable.
10-27
Material Variances
Zippy
Hansons Hansons material material price price variance variance (MPV) (MPV) for for the the week week was: was: a. a. $170 $170 unfavourable. unfavourable. b. b. $170 $170 favourable. favourable. c. c. $800 $800 unfavourable. unfavourable. MPV = AQ(AP - SP) MPV = 1,700 kg. ($3.90 - 4.00) d. d. $800 $800 favourable. favourable.
MPV = $170 Favourable
10-28
Material Variances
Zippy
The The standard standard quantity quantity of of material material that that should should have have been been used used to to produce produce 1,000 1,000 Zippies Zippies is: is: a. a. 1,700 1,700 kilograms. kilograms. b. b. 1,500 1,500 kilograms. kilograms. c. c. 2,550 2,550 kilograms. kilograms. d. d. 2,000 2,000 kilograms. kilograms.
10-29
Material Variances
Zippy
The The standard standard quantity quantity of of material material that that should should have have been been used used to to produce produce 1,000 1,000 Zippies Zippies is: is: a. a. 1,700 1,700 kilograms. kilograms. b. b. 1,500 1,500 kilograms. kilograms. c. c. 2,550 2,550 kilograms. kilograms. SQ = 1,000 units 1.5 kg per unit d. 2,000 kilograms. d. 2,000 kilograms. SQ = 1,500 kg
10-30
Material Variances
Zippy
Hansons Hansons material material quantity quantity variance variance (MQV) (MQV) for for the the week week was: was: a. a. $170 $170 unfavourable. unfavourable. b. b. $170 $170 favourable. favourable. c. c. $800 $800 unfavourable. unfavourable. d. d. $800 $800 favourable. favourable.
10-31
Material Variances
Zippy
Hansons Hansons material material quantity quantity variance variance (MQV) (MQV) for for the the week week was: was: a. a. $170 $170 unfavourable. unfavourable. b. b. $170 $170 favourable. favourable. c. c. $800 $800 unfavourable. unfavourable. d. d. $800 $800 favourable. favourable.
MQV = SP(AQ - SQ) MQV = $4.00(1,700 kg - 1,500 kg) MQV = $800 unfavourable
10-32
Material Variances Summary

Actual Quantity Actual Price 1,700 kg. $3.90 per kg. = $6,630 Actual Quantity Standard Price 1,700 kg. $4.00 per kg. = $ 6,800
Zippy
Standard Quantity Standard Price 1,500 kg. $4.00 per kg. = $6,000
Price variance $170 favourable
Quantity variance $800 unfavourable

10-33
Material Variances
Hanson purchased and used 1,700 kilograms. 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.
10-34
Material Variances Continued
Zippy
Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 kilograms per Zippy at $4.00 per kilogram
Last week 2,800 kilograms of material were purchased at a total cost of $10,920, and 1,700 kilograms were used to make 1,000 Zippies.
10-35

Actual Quantity Purchased Actual Price 2,800 kg. $3.90 per kg. = $10,920 Actual Quantity Purchased Standard Price 2,800 kg. $4.00 per kg. = $11,200
Zippy
Price variance $280 favourable
Price variance increases because quantity purchased increases.

10-36

Actual Quantity Used Standard Price 1,700 kg. $4.00 per kg. = $6,800 Quantity variance is unchanged because actual and standard quantities are unchanged.
Zippy
Standard Quantity Standard Price 1,500 kg. $4.00 per kg. = $6,000
Quantity variance $800 unfavourable

10-37
Isolation of Material Variances

I need the price variance sooner so that I can better identify purchasing problems. You accountants just dont understand the problems that purchasing managers have. Ill start computing the price variance when material is purchased rather than when its used.
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Responsibility for Material Variances You used too much material

because of poorly trained workers and poorly maintained equipment. I am not responsible for this unfavourable material quantity variance. You purchased cheap material, so my people had to use more of it. Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavourable price variances.
10-39
Standard Costs
Now lets calculate standard cost variances for direct labour.
10-40
Labour Variances Example
Zippy
Hanson Inc. has the following direct labour standard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 per direct labour hour
Last week 1,550 direct labour hours were worked at a total labour cost of $9,610 to make 1,000 Zippies.
10-41
Labour Variances
Zippy
What What was was Hansons Hansons actual actual rate rate (AR) (AR) for for labour labour for for the the week? week? a. a. $6.20 $6.20 per per hour. hour. b. b. $6.00 $6.00 per per hour. hour. c. c. $5.80 $5.80 per per hour. hour. d. d. $5.60 $5.60 per per hour. hour.
10-42
Labour Variances
Zippy
What What was was Hansons Hansons actual actual rate rate (AR) (AR) for for labour labour for for the the week? week? AR = $9,610 1,550 hours a. $6.20 per hour. a. $6.20 per hour. AR = $6.20 per hour b. b. $6.00 $6.00 per per hour. hour. c. c. $5.80 $5.80 per per hour. hour. d. d. $5.60 $5.60 per per hour. hour.
10-43
Labour Variances
Zippy
Hansons Hansons labour labour rate rate variance variance (LRV) (LRV) for for the the week week was: was: a. a. $310 $310 unfavourable. unfavourable. b. b. $310 $310 favourable. favourable. c. c. $300 $300 unfavourable. unfavourable. d. d. $300 $300 favourable. favourable.
10-44
Labour Variances
Zippy
Hansons Hansons labour labour rate rate variance variance (LRV) (LRV) for for the the week week was: was: a. a. $310 $310 unfavourable. unfavourable. b. b. $310 $310 favourable. favourable. LRV = AH(AR - SR) c. c. $300 $300 unfavourable. unfavourable. LRV = 1,550 hrs($6.20 - $6.00) d. d. $300 $300 favourable. favourable. LRV = $310 unfavourable
10-45
Labour Variances
Zippy
The The standard standard hours hours (SH) (SH) of of labour labour that that should should have have been been worked worked to to produce produce 1,000 1,000 Zippies Zippies is: is: a. a. 1,550 1,550 hours. hours. b. b. 1,500 1,500 hours. hours. c. c. 1,700 1,700 hours. hours. d. d. 1,800 1,800 hours. hours.
10-46
Labour Variances
Zippy
The The standard standard hours hours (SH) (SH) of of labour labour that that should should have have been been worked worked to to produce produce 1,000 1,000 Zippies Zippies is: is: a. a. 1,550 1,550 hours. hours. b. b. 1,500 1,500 hours. hours. c. c. 1,700 1,700 hours. hours. d. d. 1,800 1,800 hours. hours. SH = 1,000 units 1.5 hours per unit
SH = 1,500 hours
10-47
Labour Variances
Zippy
Hansons Hansons labour labour efficiency efficiency variance variance (LEV) (LEV) for for the the week week was: was: a. a. $290 $290 unfavourable. unfavourable. b. b. $290 $290 favourable. favourable. c. c. $300 $300 unfavourable. unfavourable. d. d. $300 $300 favourable. favourable.
10-48
Labour Variances
Zippy
Hansons Hansons labour labour efficiency efficiency variance variance (LEV) (LEV) for for the the week week was: was: a. a. $290 $290 unfavourable. unfavourable. b. b. $290 $290 favourable. favourable. c. c. $300 $300 unfavourable. unfavourable. d. d. $300 $300 favourable. favourable.
LEV = SR(AH - SH) LEV = $6.00(1,550 hrs - 1,500 hrs) LEV = $300 unfavourable
10-49
Labour Variances Summary

Actual Hours Actual Rate 1,550 hours $6.20 per hour = $9,610 Actual Hours Standard Rate 1,550 hours $6.00 per hour = $9,300
Zippy
Standard Hours Standard Rate 1,500 hours $6.00 per hour = $9,000
Rate variance $310 unfavourable
Efficiency variance $300 unfavourable

10-50
Labour Rate Variance A Closer Look

Using highly paid skilled workers to perform unskilled tasks results in an unfavourable rate variance.
High skill, high rate
Low skill, low rate
Production Production managers managers who who make make work work assignments assignments are are generally generally responsible responsible for for rate rate variances. variances.
10-51
Labour Efficiency Variance A Closer Look

Poorly trained workers Poor quality materials
Unfavourable Efficiency Variance

Poor supervision of workers Poorly maintained equipment
10-52
Responsibility for Labour Variances

I am not responsible for the unfavourable labour 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.
10-53
Responsibility for Labour Variances

Maybe I can attribute the labour and material variances to personnel for hiring the wrong people and training them poorly.
10-54
Standard Costs
Now lets calculate standard cost variances for the last of the variable production costs variable manufacturing overhead.
10-55
Variable Manufacturing Overhead Variances Example
Zippy
Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy:
1.5 standard hours per Zippy at $3.00 per direct labour hour
Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead.
10-56
Variable Manufacturing Overhead Variances
Zippy
What What was was Hansons Hansons actual actual rate rate (AR) (AR) for for variable variable manufacturing manufacturing overhead overhead rate rate for for the the week? week? a. a. $3.00 $3.00 per per hour. hour. b. b. $3.19 $3.19 per per hour. hour. c. c. $3.30 $3.30 per per hour. hour. d. d. $4.50 $4.50 per per hour. hour.
10-57
Zippy
What What was was Hansons Hansons actual actual rate rate (AR) (AR) for for variable variable manufacturing manufacturing overhead overhead rate rate for for the the week? week? a. a. $3.00 $3.00 per per hour. hour. b. b. $3.19 $3.19 per per hour. hour. AR = $5,115 1,550 hours c. $3.30 per hour. c. $3.30 per hour. AR = $3.30 per hour d. d. $4.50 $4.50 per per hour. hour.
10-58

Hansons Hansons spending spending variance variance (SV) (SV) for for variable variable manufacturing manufacturing overhead overhead for for the the week week was: was: a. a. $465 $465 unfavourable. unfavourable. b. b. $400 $400 favourable. favourable. c. c. $335 $335 unfavourable. unfavourable. d. d. $300 $300 favourable. favourable.
Zippy
10-59
Zippy
Hansons Hansons spending spending variance variance (SV) (SV) for for variable variable manufacturing manufacturing overhead overhead for for the the week week was: was: a. a. $465 $465 unfavourable. unfavourable. b. b. $400 $400 favourable. favourable. SV = AH(AR - SR) c. c. $335 $335 unfavourable. unfavourable. SV = 1,550 hrs($3.30 - $3.00) SV = $465 unfavourable d. d. $300 $300 favourable. favourable.
10-60
Zippy
Hansons Hansons efficiency efficiency variance variance (EV) (EV) for for variable variable manufacturing manufacturing overhead overhead for for the the week week was: was: a. a. $435 $435 unfavourable. unfavourable. b. b. $435 $435 favourable. favourable. c. c. $150 $150 unfavourable. unfavourable. d. d. $150 $150 favourable. favourable.
10-61
Zippy
Hansons Hansons efficiency efficiency variance variance (EV) (EV) for for variable variable manufacturing manufacturing overhead overhead for for the the week week was: was: a. a. $435 $435 unfavourable. unfavourable. b. b. $435 $435 favourable. favourable. 1,000 units 1.5 hrs per unit c. c. $150 $150 unfavourable. unfavourable. d. d. $150 $150 favourable. favourable. EV = SR(AH - SH)
EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavourable
10-62

Actual Hours Actual Rate 1,550 hours $3.30 per hour = $5,115 Actual Hours Standard Rate 1,550 hours $3.00 per hour = $4,650
Zippy
Standard Hours Standard Rate 1,500 hours $3.00 per hour = $4,500
Spending variance $465 unfavourable
Efficiency variance $150 unfavourable

10-63
Variable Manufacturing Overhead Variances A Closer Look

If If variable variable overhead overhead is is applied applied on on the the basis basis of of direct direct labour labour hours, hours, the the labour labour efficiency efficiency and and variable variable overhead overhead efficiency efficiency variances variances will will move move in in tandem. tandem.
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Variance Analysis and Management by Exception
How do I know which variances to investigate?
Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
10-65
Advantages of Standard Costs

Possible reductions in production costs Management by exception
Advantages
Improved cost control and performance evaluation Better Information for planning and decision making
10-66
Emphasis on negative may impact morale.
Favourable variances may be misinterpreted.
Standard cost reports may not be timely.
Potential Problems
Continuous improvement may be more important than meeting standards.
Labour quantity standards and efficiency variances may not be appropriate.
Emphasizing standards may exclude other important objectives.

10-67
The Balanced Scorecard

Management Management translates translates its its strategy strategy into into performance performance measures measures that that employees employees understand understand and and accept. accept.
Customers
Financial
Performance measures
Internal business processes Learning and growth
10-68

How do we look to the owners?
In which internal business processes must we excel?
How can we continually learn, grow, and improve?
How do we look to customers?

10-69

Learning improves business processes.
Improved business processes improve customer satisfaction.
Improving customer satisfaction improves financial results.

10-70
Delivery Performance Measures

Order Received Production Started Goods Shipped
Wait Time
Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time
Process time is the only value-added time.

10-71
Delivery Performance Measures

Order Received Production Started Goods Shipped
Wait Time
Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time
Manufacturing Cycle = Efficiency
Value-added time Throughput time

Appendix
10A
General Ledger Entries to Record Variances
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Journal Entries - Material Variances

Price variance Dr Raw Materials Dr Materials Price Variance (U) Cr Materials Price Variance (F) Cr Accounts Payable Quantity variance Dr Work in Process Dr Materials Quantity Variance (U) Cr Materials Quantity Variance (F) Cr Raw Materials
10-74
Journal Entries - Labour Variances

Rate variance Dr Work in Process Dr Labour Rate Variance (U) Cr Labour Rate Variance (F) Cr Wages Payable Efficiency variance Dr Work in Process Dr Labour Efficiency Variance (U) Cr Labour Efficiency Variance (F) Cr Wages Payable
Appendix
10B
The Learning Curve
10-76
The Learning Curve

! Productivity in hours per unit will
decrease as an employee produces more units. ! Used to set and revise standard labour hours in a repetitive task environment. ! Used for labour intensive manufacturing.
10-77
End of Chapter 10

Standard Costs and The Balanced Scorecard

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Chapter

Standard Costs are:

McGraw-Hill Ryerson Limited., 2001

Standard Direct Material

Type of Product Cost

Setting Standard Costs

McGraw-Hill Ryerson Limited., 2001

Setting Standard Costs

Setting Standard Costs

Setting Standard Costs

Human Resources Managerial Manager Accountant

Setting Direct Material Standards

Final, delivered cost of materials, net of discounts.

Use product design specifications.

McGraw-Hill Ryerson Limited., 2001

Setting Direct Labour Standards

Use wage surveys and labour contracts.

Use time and motion studies for each labour operation.

McGraw-Hill Ryerson Limited., 2001

Setting Variable Overhead Standards

The rate is the variable portion of the predetermined overhead rate.

The activity is the base used to calculate the predetermined overhead.

McGraw-Hill Ryerson Limited., 2001

Standard Cost Card Variable Production Cost

B Standard Price or Rate

AxB Standard Cost per Unit

$ 4.00 per kg. $ 14.00 per hour 3.00 per hour $

McGraw-Hill Ryerson Limited., 2001

Standards vs. Budgets

Are standards the same as budgets?

McGraw-Hill Ryerson Limited., 2001

Standard Cost Variances

Standard Product Cost

McGraw-Hill Ryerson Limited., 2001

Standard Cost Variances

McGraw-Hill Ryerson Limited., 2001

Variance Analysis Cycle

Analyze variances Prepare standard cost performance report

Conduct next periods operations

McGraw-Hill Ryerson Limited., 2001

Standard Cost Variances

A General Model for Variance Analysis

McGraw-Hill Ryerson Limited., 2001

A General Model for Variance Analysis

McGraw-Hill Ryerson Limited., 2001

A General Model for Variance Analysis

McGraw-Hill Ryerson Limited., 2001

Material Variances Example

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

McGraw-Hill Ryerson Limited., 2001

Material Variances Summary

Price variance $170 favourable

Quantity variance $800 unfavourable

Material Variances Continued

McGraw-Hill Ryerson Limited., 2001

Material Variances Continued

Price variance $280 favourable

Price variance increases because quantity purchased increases.