CHAPTER 22 Standard Costs and Balanced Scorecard

After studying this chapter, you should be able to:

Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how standards are set. Use standards to determine budget amounts and analyze variances. Discuss the reporting of variances.

The Need for Standards

Standards
Are common in business Sometimes imposed by government agencies (regulations)

Standard costs

Are predetermined unit costs Used as measures of performance

Distinguishing Between Standards and Budgets

Standards and budgets are both
Pre-determined costs Part of management planning and control

A standard is a unit amount whereas a budget is a total amount

Standard costs may be incorporated into a cost accounting system

The Need for Standards

Lets think about standards.. how much does it cost to make a.? DM DL OH

In Class Exercise on Standards

Lets think about standards.. how much does it cost to make a.?
SP Standard DM Cost

Standard P

Standard Q

+
Standard Cost per unit

Standard DL Cost

= =

Standard P

Standard Q

+
Standard OH Cost Standard P (Pre-determined OH rate)

Standard Q (Activity)

Use your product to create example costs

Advantages of Standard Costs

Setting Standard Costs

Setting standard costs
Requires input from all persons who have responsibility for costs and quantities Standards costs need to be current and should be under continuous review

There are two levels of standard costs

Ideal standards represent optimum levels of performance under perfect operating conditions Normal standards represent efficient levels of performance attainable under expected operating conditions (rigorous but attainable)

Setting Standard Costs

on a per unit level

PRICE P

QUANTITY

x
Q

= STANDARD

We can do this for DM, DL & OH.

Direct Materials Price Standard

Direct materials price standard
Cost per unit which should be incurred Based on the purchasing departments best estimate of the cost of raw materials Includes related costs such as receiving, storing, and handling

Direct Materials Quantity Standard

Direct materials quantity standard
Quantity of direct materials used per unit of finished goods Based on physical measure such as pounds, barrels, etc.
Considers both the quantity and quality of materials required

Includes allowances for unavoidable waste and normal storage

Materials

Total Direct Materials Cost/Unit

The standard direct materials cost per unit is calculated as follows:
PRICE
P

QUANTITY Q

= STANDARD

STANDARD DIRECT MATERIALS PRICE

STANDARD DIRECT MATERIALS QUANTITY

STANDARD DIRECT MATERIALS COST PER UNIT

Direct Labor Price Standard

Direct labor price standard
Rate per hour incurred for direct labor Based on current wage rates adjusted for anticipated changes, such as cost of living adjustments Includes employer payroll taxes, and fringe benefits

Direct Labor Quantity Standard

Direct labor quantity standard
Time required to make one unit of the product Critical in labor-intensive companies Allowances should be made for rest periods, cleanup, machine setup and machine downtime

Direct Labor
The standard direct labor cost per unit is calculated as follows:
PRICE P QUANTITY Q

= STANDARD

STANDARD DIRECT LABOR RATE

STANDARD DIRECT LABOR HOURS

STANDARD DIRECT LABOR COST PER UNIT

Manufacturing Overhead Standard

For manufacturing overhead, a standard predetermined overhead rate is used.
The predetermined rate is computed by dividing budgeted overhead costs by an expected standard activity index. The standard manufacturing overhead rate per unit is the predetermined overhead rate times the activity index quantity standard (for example, direct labor hours).

Standard Cost Per Unit

Standard cost per unit
Sum of the standard costs for direct materials, direct labor, and manufacturing overhead Is determined for each product and often recorded on a standard cost card which provides the basis for determining variances from standards

Factory Labor Materials Manufacturing Overhead

Variances from Standards

Variances from standards
Differences between total actual costs and total standard costs Unfavorable variances occur when too much is paid for materials and labor or when there are inefficiencies in using materials and labor. Favorable variances occur when there are efficiencies in incurring costs and in using materials and labor.
A variance is not favorable if quality control standards are sacrificed.

Analyzing variances
Variances must be analyzed to determine their significance
First, determine the cost elements that comprise the variance. For each manufacturing cost element, a total dollar variance is computed. Then this variance is analyzed into a price variance and a quantity variance.

Variance Relationships

Determining Materials Variance

The total materials variance is computed from the following formula:
Actual Quantity x Actual Price (AQ) x ($AP)

Standard Quantity x Standard Price (SQ) x ($SP)

Total Materials Variance (TMV) U or F

What did you actually pay??

What should you have paid based on the Standard (consider how much is produced)?

Analyzing Materials Variance Isolate Price Component

Break the materials variance down into price and quantity. Compute P variance as follows:
Actual Unit Price Standard Price ($AP- $SP)U or F

Actual Quantity

Materials Price Variance (MPV) U or F

Analyzing Materials Variance Isolate Quantity Component

Break the materials variance down into price and quantity. Compute Q variance as follows:
Actual Total Quantity Used - Standard Total Quantity (AQ) - (SQ) U or F

$ Standard Price

Materials Quantity Variance (MQV) U or F

For SQ : consider how much Q should have been purchased for how much is produced (SQ per unit x units produced).

Check your answer: Cross Foot Materials Variances

Q variance + P variance = total variance

Materials Price Variance U or F

Quantity + Materials Variance = U or F

Total Materials Variance (TMV) U or F

Is your answer correct???

Causes of Materials Variances

Materials variances may be caused by a variety of factors, including both internal and external factors.
Investigating materials price variances begins in the purchasing department, but the variance may be beyond the control of purchasing (for ex., prices rise faster than expected). Investigating materials quantity variance begins in the production department, but the variance may be beyond the control of production (for ex., faulty machinery).

Determining LaborVariance
The total Labor variance is computed from the following formula:
Actual (Q) Hours x Actual (P) Rate (AQ) x ($AP) Standard Hours (Q) _x Standard Rate (P) = (SQ) x ($SP) Total Labor Variance (TLV) U or F

What did you actually pay For Labor??

What should you have paid based on the Standard (consider how much is produced)?

Analyzing Labor Variance Isolate Price Component

Break the Labor variance down into price and quantity.
Compute Labor Price variance as follows:
Actual Rate/hr Standard Rate/hr ($AP- $SP)U or F

Actual hours (AQ)

Labor Price Variance (LPV) U or F

Analyzing Labor Variance Isolate Quantity Component

Break the labor variance down into price and quantity.
Compute Labor Quantity variance as follows:
Actual Total Hours used (AQ) Standard Total Hours (SQ) (AQ) - (SQ) U or F

$ Standard Rate (P)

Labor Quantity Variance (LQV) U or F

For SQ : consider how many hours should have been worked for how much is produced (SQ or hours per unit x units produced).

Check your answer: Cross Foot Labor Variances

Q variance + P variance = total variance

Labor Price Variance U or F

Labor Quantity Variance U or F

Total Labor Variance (TLV) U or F

Is your answer correct???

Causes of Labor Variances

Labor variances may be caused by a variety of factors.
Labor price variances usually result from either paying workers higher wages than expected or misallocating workers (for ex., using skilled workers in place of unskilled workers). Labor quantity variances relate to the efficiency of workers and are usually related to the production department.

Actual Overhead Costs

The total overhead variance is the difference between actual overhead costs and overhead costs applied to work done.

Reporting Variances
Reporting variances
All variances should be reported to appropriate levels of management as soon as possible so that corrective action can be taken. The form, content, and frequency of variance reports vary considerably among companies. Variance reports facilitate the principle of management by exception. In using variance reports, top management normally looks for significant variances.

Formula for Total Overhead Variance

With standard costs, manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done. Standard hours allowed are the hours that should have been worked for the units produced. The formula for the total overhead variance is:

Actual Overhead

Overhead Applied based on Standard Hours Allowed

Total Overhead Variance

Lets Review
The setting of standards is:
a. A managerial accounting decision. b. A management decision c. A worker decision.

d. Preferably set at the ideal level of performance.

Lets Review
The setting of standards is:
a. A managerial accounting decision. b. A management decision c. A worker decision.

d. Preferably set at the ideal level of performance.

The Need for Standards

Lets think about standards.. how much does it cost to make a.? DM DL OH

In Class Exercise on Standards

Lets think about standards.. how much does it cost to make a.?
SP Standard DM Cost

Standard P

Standard Q

+
Standard Cost per unit

Standard DL Cost

= =

Standard P

Standard Q

+
Standard OH Cost Standard P (Pre-determined OH rate)

Standard Q (Activity)

Use your product to create example costs