Information about Standrad costing

Finance, Standard Costing

Standard and Standard Cost Standard is a precise measure of what should occur if the performance is efficient. For example a certain number of products (say 10) in one hour by a shop floor worker is a standard or certain marks (absolute or percentage) to obtain a certain grade say A. A worker and student is said to be efficient if they achieve ( 8 and A) the given conditions. Standards are set for repetitive tasks, that is, for work which is repeated again and again. It can not be for the task which are not repetitive or performed regularly or continuously.

Standard and Budget Scope of budget is as a whole activity or entire operation i.e. Rs 5000 for producing 1000 units, on the other hand, standard are on unit basis, say Rs 5 per unit. Standards are prepared by Management Account in consultation with other people, while budget are usually prepared by Budget committee. Budgets are used for planning & coordination purposes, whereas standards are primarily used as control.

Managing Costs Standard cost Actual cost Comparison between standard and actual performance level Cost variance 1-4

Management by Exception Amount Managers focus on quantities and costs that exceed standards, a practice known as management by exception. Standard Direct Labor Direct Material Type of Product Cost 1-5

Setting Standards Cost Standards Analysis of Historical Data Task Analysis 1-6

Analysis of Historical Data One Indicator of future costs is historical cost data. In a mature production process, where the firm has a lot of production experience, historical costs can provide a good basis for predicting future costs. Cost on the basis of behavior is used to analyze and making predictions. These predictions need to be adjusted to reflect movements in price levels or technological changes in the production process 1-7

Task Analysis Another method for setting standards is task analysis, which is the analysis of a production process to determine what it should cost to produce a product or service. The emphasis shifts from what the product did cost in the past to what it should cost in the future. An example of task analysis is a time-and-motion study conducted to determine how long each step performed by direct laborers should require. 1-8

Participation in Setting Standards Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations. 1-9

Perfection versus Practical Standards: A Behavioral Issue Should we use practical standards or perfection standards? Practical standards should be set at levels that are currently attainable with reasonable and efficient effort. 1-10

Perfection Standard A perfection (or ideal) standard is one that can be attained only under nearly perfect operating conditions. Such standard assume peak efficiency, the lowest possible input prices, the best quality material obtainable and no disruptions in the production due to such causes as machine breakdowns or power failures. Some managers feel that such standard motivate employees to achieve the lowest cost possible. They claim that since the standard is theoretically attainable, employees will have an incentive to come as close as possible to achieving it. 1-11

Practical Standard Standard that are as tight as practical, but still are expected to be attained, are called practical or attainable standard. Such standard assume a production process that is as efficient as practical under normal operating conditions. Practical standards allow for such occurrences as occasional machine breakdowns and normal amounts of raw-material waste. Attaining a practical standard keeps employees on their toes, without demanding miracles. Most behavioral theorist believe that such standard encourage more positive and productive employee attitude than do perfection standard. 1-12

Perfection versus Practical Standards: A Behavioral Issue I agree. Perfection standards are unattainable and therefore discouraging to most employees. 1-13

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. 1-14

Cost Variance Analysis Standard Cost Variances Price Variance Quantity Variance The difference between the actual price and the standard price The difference between the actual quantity and the standard quantity 1-15

A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Materials price SP) AQ(AP - variance Labor rate variance AQ =Variable overhead Actual Quantity AP = spending variance Actual Price Standard Quantity × Standard Price Quantity Variance Materials quantity variance SP(AQ - SQ) Labor efficiency variance SP = Standard Price Variable overhead SQ = Standard Quantity efficiency variance 1-16

A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Standard price is the amount that should have been paid for the resources acquired. 1-17

A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Standard quantity is the quantity that should have been used. 1-18

Standard Costs Let’s use the concepts of the general model to calculate standard cost variances, starting with direct material. 1-19

Direct Material Standard The total amount of direct material normally required to produce a finished products, including allowances for normal waste or inefficiency is called Standard direct material quantity

Material Variances Hanson Inc. has the following direct material standard to manufacture one product: 1.5 pounds per product at $ 4.00 per pound Last week 1,700 pounds of material were purchased and used to make 1,000 products. The material cost a total of $6,630. 1-21

Material Variances Zippy What is the actual price per pound paid for the material? a. b. c. d. $4.00 per pound. $4.10 per pound. $3.90 per pound. $6.63 per pound. 1-22

Material Variances What is the actual price per pound paid for the material? a. b. c. d. $4.00 per pound. $4.10 per pound. $3.90 per pound. $6.63 per pound. AP = $6,630 ÷ 1,700 AP = $3.90 per product 1-23

Material Variances Hanson’s direct-material price variance (MPV) for the week was: a. b. c. d. $170 unfavorable. $170 favorable. $800 unfavorable. $800 favorable. 1-24

Material Variances Hanson’s direct-material price variance (MPV) for the week was: a. b. c. d. $170 unfavorable. $170 favorable. $800 unfavorable. MPV = AQ(AP - SP) $800 favorable. MPV = 1,700 lbs. × ($3.90 - 4.00) MPV = $170 Favorable 1-25

Material Variances The standard quantity of material that should have been used to produce 1,000 product is: a. b. c. d. 1,700 pounds. 1,500 pounds. 2,550 pounds. 2,000 pounds. 1-26

Material Variances The standard quantity of material that should have been used to produce 1,000 = 1,000 units × 1.5 lbs per unit Zippies is: SQ a. b. c. d. SQ = 1,500 lbs 1,700 pounds. 1,500 pounds. 2,550 pounds. 2,000 pounds. 1-27

Material Variances Zippy Hanson’s direct-material quantity variance (MQV) for the week was: a. b. c. d. $170 unfavorable. $170 favorable. $800 unfavorable. $800 favorable. 1-28

Material Variances Zippy Hanson’s direct-material quantity variance (MQV) for the week was: MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV a. $170 unfavorable. = $800 unfavorable b. $170 favorable. c. $800 unfavorable. d. $800 favorable. 1-29

Material Variances Summary Actual Quantity × Actual Price 1,700 lbs. × $3.90 per lb. Actual Quantity × Standard Price 1,700 lbs. × $4.00 per lb. $6,630 Price variance $170 favorable $ 6,800 Standard Quantity × Standard Price 1,500 lbs. × $4.00 per lb. $6,000 Quantity variance $800 unfavorable 1-30

Material Variances Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used? Zippy The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used. 1-31

Material Variances 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. 1-32

Material Variances Actual Quantity Purchased × Actual Price 2,800 lbs. × $3.90 per lb. Zippy Actual Quantity Purchased × MPV = AQ(AP - SP) Standard Price MPV = 2,800 lbs. × ($3.90 - 4.00) 2,800 lbs. MPV = $280 × Favorable $4.00 per lb. $10,920 Price variance $280 favorable $11,200 Price variance increases because quantity purchased increases. 1-33

Material Variances MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800unfavor. Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs. × $4.00 per lb. $6,800 Quantity variance is unchanged because actual and standard quantities are unchanged. 1,500 lbs. × $4.00 per lb. $6,000 Quantity variance $800 unfavorable 1-34

Isolation of Material Variances I need the variances as soon as possible so that I can better identify problems and control costs. You accountants just don’t understand the problems we production managers have. Okay. I’ll start computing the price variance when material is purchased and the quantity variance as soon as material is used. 1-35

Standard Costs Now let’s calculate standard cost variances for direct labor. 1-36

Labor Variances Zippy 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. 1-37

Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. b. c. d. $10.20 per hour. $10.10 per hour. $9.90 per hour. $9.80 per hour. 1-38

Labor Variances Zippy What was Hanson’s actual rate (AR) for labor for the week? a. b. c. d. $10.20 per hour. $10.10 per hour. AR = $15,810 ÷ 1,550 hours $9.90 per hour. AR = $10.20 per hour $9.80 per hour. 1-39

Labor Variances Zippy Hanson’s labor rate variance (LRV) for the week was: a. b. c. d. $310 unfavorable. $310 favorable. $300 unfavorable. $300 favorable. 1-40

Labor Variances Zippy Hanson’s labor rate variance (LRV) for the week was: a. b. c. d. $310 unfavorable. $310 favorable. LRV = AH(AR - SR) $300 unfavorable. LRV = 1,550 hrs($10.20 - $10.00) $300 favorable. = $310 unfavorable LRV 1-41

Labor Variances Zippy The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. b. c. d. 1,550 hours. 1,500 hours. 1,700 hours. 1,800 hours. 1-42

Labor Variances Zippy The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. b. c. d. 1,550 hours. 1,500 hours. 1,700 hours. = 1,000 units × 1.5 hours per unit SH SH 1,800 hours. = 1,500 hours 1-43

Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. b. c. d. $510 unfavorable. $510 favorable. $500 unfavorable. $500 favorable. 1-44

Labor Variances Zippy Hanson’s labor efficiency variance (LEV) for the week was: LEV = SR(AH - SH) LEV = $10.00(1,550 hrs - 1,500 hrs) a. $510 unfavorable.= $500 unfavorable LEV b. $510 favorable. c. $500 unfavorable. d. $500 favorable. 1-45

Labor Variances Summary Actual Hours × Actual Rate 1,550 hours × $10.20 per hour $15,810 Actual Hours × Standard Rate 1,550 hours × $10.00 per hour $15,500 Rate variance $310 unfavorable Standard Hours × Standard Rate 1,500 hours × $10.00 per hour $15,000 Efficiency variance $500 unfavorable 1-46

Significance of Cost Variances Size of variance – Amount – Percentage of standard What clues help me to determine the variances that I should investigate? Recurring variances Trends Controllability Favorable variances Costs and benefits of investigation 1-47

Statistical Control Chart Warning signals for investigation Favorable Limit • Desired Value • • • • • • Unfavorable Limit 1 2 3 4 5 6 7 • 8 • 9 Variance Measurements 1-48

Behavioral Impact of Standard Costing If I buy cheaper materials, my directmaterials expenses will be lower than what is budgeted. Then I’ll get my bonus. But we may lose customers because of lower quality. 1-49

Controllability of Variances Direct-Material Price Variance Direct-Material Quantity Variance Direct-Labor Rate Variance Direct-Labor Efficiency Variance 1-50

Interaction among Variances I am not responsible for the unfavorable labor 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. 1-51

Advantages of Standard Costing Sensible Cost Comparisons Management by Exception Performance Evaluation Advantages Stable Product Costs Employee Motivatio n 1-52

Criticisms of Standard Costing Too aggregate, too late Too much focus on direct-labor Disadvantages Not tied to specific product line Shorter product life cycles Focus on cost minimization Stable production required 1-53

Adapting Standard-Costing Systems Reduced focus on labor Identify Cost Drivers Impact of TQM and JIT Shorter product life cycles Nonfinancial Measures Focus on material and overhead Shifting cost structures Elimination of nonvalue added costs Real-Time Information Systems Benchmarking 1-54

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