Control and Evaluation of Cost Centers

1. 1 1 Control and Evaluation of Cost Centers Prepared by Douglas Cloud Pepperdine University

2. Objectives • Develop standard variable costs for a product. • Calculate direct labor, variable overhead, and materials variances. • Discuss the advantages and disadvantages of approaches to setting standards. • Describe new approaches to cost control and management, as described by proponents of JIT and other continuous improvement approaches. After reading this chapter, you should be able to:

3. Cost control is important for companies following a cost leadership strategy where total demand for the product is not growing.

4. A standard cost is the per-unit cost a company should incur to make a unit of product.

5. A standard cost has two components: a standard price, or rate, and a standard quantity.

6. Cost FactorStd. QuantityStd. PriceStd. Cost Materials 10.00 $0.80 $8.00 Direct labor 0.50 16.00 8.00 Variable overhead 0.50 6.00 3.00 Total standard variable cost $19.00 Standard Variable Costs Actual results: Production 1,000 units Materials purchased, 11,000 at $0.78. $8,580 Materials used 10,200 gallons Direct labor, 480 hours at $16.20 $7,776 Variable overhead incurred $3,100

7. Labor Variances Total standard direct labor cost Standard direct labor cost per unit Actual production (units) x = 1,000 x $8.00 = $8,000

8. Labor Variances Actual cost of input factor Actual input quantity Actual rate for input factor x = 480 hours x $16.20 = $7,776

9. Labor Variances Budget allowance for actual quantity of input factor Actual input quantity Standard rate for input factor x = 480 hours x $16 = $7,680

10. 1,000 units x ½ hour per unit = 500 hours = $8,000 x $16 Labor Variances Budget allowance for actual quantity of output Standard input quantity Standard rate for input factor x =

11. Labor Variances Labor rate variance $ 96 unfavorable Labor efficiency variance 320 favorable Total labor variance $224 favorable

12. $7,776 $7,680 $8,000 480 x $16.20 480 x $16.00 1,000 x 1/2 x $16.00 $320 F $96 U $224 F Total Variance Labor Variances Flexible Budget for Standard Quantity at Standard Rate (Total Standard Cost) Actual Quantity at Actual Rates (Total Actual Costs) Flexible Budget For Actual Quantity at Standard Rate Rate varianceEfficiency variance

13. 480 x $6 1,000 x 0.50 x $6 $3,100 $2,880 $3,000 $120 F $220 U Budget variance Efficiency variance $100 U Total Variance Variable Overhead Variances Actual Quantity at Actual Rate (Total Actual Cost) Flexible Budget for Standard Quantity at Standard Rate (Total Standard Cost) Flexible Budget for Actual Quantity at Standard Rate

14. Variable Overhead Variances The variable overhead efficiency variance reflects the efficient or inefficient use of the item used as the cost driver.

15. 11,000 x $0.78 11,000 x $0.80 $8,580 $8,800 $220 F Material Price Variance Materials Variances Actual Quantity Purchased at Actual Price Actual Quantity Purchased at Standard Price

16. Materials Variances Material price variance Actual quantity purchased Actual price Standard price x – = $220 F = 11,000 x ($0.80 – $0.78)

17. $160 U Material Use Variance Materials Variances Flexible Budget for Actual Quantity Used at Standard Price Flexible Budget for Standard Quantity at Standard Price (Total Standard Cost) 10,200 x $0.80 1,000 x 10 x $0.80 $8,160 $8,000

18. Materials Variances Material use variance Standard quantity for actual output Standard price Actual quantity x – = $160 U = $0.80 x (10,000 – 10,200)

19. Materials Variances Material price variance—differs from its counterparts in labor and variable overhead because materials,unlike labor, can be stored. Purchases made in one period are not necessarily used in that period, but the economic effect of paying more or less than standard prices for materials occurs at the time of purchase. So the material price variance is based on the quantity of materials purchased, not the quantity used. Material usevariance—is calculated the same as the labor and overhead efficiency variances

20. Standard Costs and Activity-Based Costing Example • There are two principle variable overhead cost pools. • One is driven by machine time, while the other is driven by the number of machine setups. • The two rates are $6.00 per machine hour and $140 per setup. Continued

21. Standard Costs and Activity-Based Costing Example • The standard machine hours and number of setups for 1 batch (1,000 units) is 1,500 hours and 20 setups, respectively. • Actual machine hours and number of setups for 10 batches (10,000 units) are 14,000 hours and 210 setups, respectively. • The actual overhead costs driven by machine hours and number of setups are $85,000 and $27,500, respectively.

22. 14,000 x $6.00 10 x 1,500 x $6.00 $85,000 $84,000 $90,000 $6,000 F $1,000 U Budget variance Efficiency variance $5,000 F Total Variance Standard Costs and Activity-Based Costing Example Actual Cost Budget for Actual Use Standard Cost Machine-driven variable overhead

23. 210 x $140 10 x 20 x $140 $27,500 $29,400 $28,000 $1,400 U $1,900 F Budget variance Efficiency variance $500 F Total Variance Standard Costs and Activity-Based Costing Example Actual Cost Budget for Actual Use Standard Cost Setup-driven variable overhead

24. Variances and Performance Evaluation • Variances signal nonstandard performance only if they are based on up-to-date standards that reflect current production methods and current prices of input factors. • Many variances are interdependent.

25. Setting Standards—Behavioral Problems Engineering methods Managerial estimates Benchmarking and best practices

26. Setting Standards—Behavioral Problems Engineering Methods Some companies develop standard quantities for materials and labor by carefully examining production methods and determining how much of an input factor is necessary to obtain a finished unit.

27. Setting Standards—Behavioral Problems Managerial Estimates Some companies rely on the judgment of managers closest to the task to determine quantities of input needed to produce a unit of product. Managers who participate in setting standards are more likely to commit to meeting them.

28. Setting Standards—Behavioral Problems Benchmarkingis a relatively recent development that companies use to determine whether their operations and costs compare favorably to those of world-class companies. Benchmarking

29. What Standard? • An ideal standard can be attained only under perfect conditions. • Setting a currently attainable standard recognizes expectations about efficiency under normal working conditions. • An historical standard is based on experience.

30. Kaizen Costing and Target Costing Kaizen costing stresses continuous improvement in the production process. Under kaizen, performance standards are continually raised (standard costs lowered), so the objective is to meet targeted reductions, not standard costs.

31. Kaizen Costing and Target Costing Value engineering refers to design and re-design that focuses on customer value. Value engineering is redesigning products so that they will cost less. Value engineering is an optimizing technique where people seek exactly what features the product needs, how to make it, what materials to use, and so on.

32. Kaizen Costing and Target Costing Target costing is price-driven; market prices determine cost instead of vice versa. Companies reduce cost through systemic analyses of the features and functions deemed most important to customers. Much of target costing takes place during product design.

33. Chapter 11 The End