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CHAPTER 24

CHAPTER 24. C ONTROL THROUGH S TANDARD C OSTS. . CHAPTER 24. C ONTROL THROUGH S TANDARD C OSTS. Caution! This chapter is second only to Chapter 15 (bonds) for the amount of grief it causes most students in this course. Nature of Standard Costs.

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CHAPTER 24

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  1. CHAPTER 24 CONTROL THROUGH STANDARD COSTS .

  2. CHAPTER 24 CONTROL THROUGH STANDARD COSTS Caution! This chapter is second only to Chapter 15 (bonds) for the amount of grief it causes most students in this course.

  3. Nature of Standard Costs • Up to this point in the course, we have been using actual costs. • This chapter considers standard costs (i.e., what costs shouldbe under stated conditions). • The achievement of standard represents a reasonable and acceptable level of performance. • Standards for materials, labor, and overhead are determined through engineering studies and time and motion studies.

  4. Based on carefullypredetermined amounts. Used for budgeting labor, materialand overhead requirements. Standard Costs are Benchmarks formeasuring performance. Used for variance analysis. Nature of Standard Costs

  5. Standard costs - what costs shouldbe under stated conditions. Actual costs Amount Type of Product Cost Nature of Standard Costs DirectMaterial DirectLabor ManufacturingOverhead

  6. Standard cost variances -amounts by which actual costs differs fromstandard costs. Amount DirectMaterial DirectLabor ManufacturingOverhead Type of Product Cost Standard Cost Variances

  7. Amount Type of Product Cost Standard Cost Variances The overhead variance is favorable becausethe actual cost is less than the standard cost. The materials variance is unfavorable because theactual costexceeds thestandard cost. DirectMaterial DirectLabor ManufacturingOverhead

  8. Managers focus on standard cost variances, a practice known asmanagement by exception. Amount Type of Product Cost Standard Cost Variances DirectMaterial DirectLabor ManufacturingOverhead

  9. They point to causes ofproblems and directionsfor improvement. • They trigger investigations in departments having responsibility for incurringthe costs. Why are variancesimportant to me? Standard Cost Variances

  10. Should we usepractical standardsor ideal standards? Setting Standard Costs Engineer

  11. Practical standards should beset at levels that are currentlyattainable with reasonable and efficient effort. Setting Standard Costs Productionmanager

  12. I agree. Ideal standards,that are based on perfection, areunattainable and therefore discouraging to most employees. Setting Standard Costs HumanResourcesManager

  13. This is your decision. I’m here to advise you and account for the resulting transactions. Setting Standard Costs ManagerialAccountant

  14. Advantages Advantages of Standard Costs Improved cost control and performanceevaluation More reasonableand easier inventorymeasurements Better Informationfor planning anddecision making Possible reductionsin production costs Cost savings inrecord-keeping

  15. Disadvantages Disadvantages of Standard Costs Emphasis onnegativeexceptions maylower morale. It may be difficultto determinewhich variancesare significant. Emphasis on negativeexceptions maylead to under-reporting.

  16. A standard is the expected cost for one unit. • A budget is the expected cost forallunits. Are standards the same as budgets? Use of Standard Costs in Developing Budgets

  17. Specifics O.K., let’s get down and dirty with some specifics!

  18. Types of Standard Costs The total standard cost for one unit of finished product is the sum of: • Standard cost for directmaterials • Standard cost for directlabor • Standard cost for manufacturingoverhead necessary to produce one unit of the product.

  19. Setting StandardsDirect Materials PriceStandards UsageStandards Use competitivebids for the qualityand quantity desired Use product design specifications

  20. Standard CostsDirect Materials Standard cost for direct materials is standard price for one unit of raw material (pound, yard, etc.) multiplied by the standard quantity of raw material to produce one unit of product

  21. Standard CostsDirect Materials The standard material costforone unitof product is: standard quantity standard price for of materialone unitof material required for one unitof product • Standard price is the amount that shouldbe paid for each unit of raw material. • Standard quantity is the amount of raw material that shouldbeused to produce one unit offinished product. ×

  22. 863 Standard CostsDirect Materials Example • Standard price is the amount that should be paid for each unit of raw material. e.g.., each sheet of plywood should cost $6 • Standard quantity is the amount of material that should be used to produce one unit of finished product. e.g., each table should take 5 sheets The High Point Furniture Company makes top quality tables from sheets of plywood.

  23. Standard CostsDirect Materials Example • Standard price is the amount that should be paid for each unit of raw material. e.g.., each sheet of plywood should cost $6 • Standard quantity is the amount of material that should be used to produce one unit of finished product. e.g., each table should take 5 sheets • Standard cost is standard price times standard quantity for one unit of product e.g., $6 X 5 sheets = $30

  24. Setting StandardsDirect Labor RateStandards EfficiencyStandards Use wage surveys andlabor contracts Use time and motion studies foreach labor operation

  25. Standard CostsDirect Labor Standard cost for direct labor is standard wagerate for one hour of labor multiplied by the standard number of labor hours needed to produce one unit of product.

  26. Standard CostsDirect Labor The standard labor cost for one unitof product is: standard number standard wage rateof labor hours for one hourfor one unit of product • Standard wage rate is theamount that shouldbe paidfor each hour of labor. • Standard number of hoursis the number of hours thatshouldbe worked to produceone unit of finished product. ×

  27. Standard CostsDirect Labor Example The High Point Furniture Company’s dining room tables are made by highly skilled, hourly paid carpenters. • Standard wage rate is the amount that should be paid for each hour of labor. e.g.., each hour should cost $10 • Standard number of hours is the number of hours that should be worked to produce one unit of finished product. e.g., each table should take 2 hours

  28. Standard CostsDirect Labor Example • Standard wage rate is the amount that should be paid for each hour of labor. e.g.., each hour should cost $10 • Standard number of hours is the number of hours that should be worked to produce one unit of finished product. e.g., each table should take 2 hours • Standard labor cost is standard wage rate times standard number of hours for one unit of finished product e.g., $10 X 2 hours = $20

  29. Setting StandardsManufacturing Overhead Standard Rate Select a standard level of output and definea basis for activity

  30. Total budgeted overhead costat the standard level of outputStandard level of output Standard overheadrate per unit = Standard CostsManufacturing Overhead A standard manufacturing overhead rate is applied for each unit of activity. . If, however, the overhead rate is based on units of input such as direct labor hours, the denominator is based on the input labor hours. The above calculation is really what?

  31. Total budgeted overhead costat the standard level of outputStandardlevel of output Standard overheadrate per unit = Standard CostsManufacturing Overhead • Budgeted overhead cost is thetotal amount of overhead cost that shouldbe incurred for the year to produce at the standard level of output. • Standardlevel of output is what the activity level for the cost driver shouldbe for the year.

  32. Standard CostsManufacturing Overhead Example The High Point Furniture Company applies overhead to tables based on machine hours. • Budgeted overhead costis the amount of overhead cost that shouldbe incurred to produce at the standard level of output. e.g., total overhead cost = $100,000 • Standardlevel of outputis what the activity level for the cost driver shouldbe. e.g., total labor hours should be 20,000

  33. Total budgeted overhead costat the standard level of outputStandardlevel of output Standard overheadrate per unit = Standard CostsManufacturing Overhead Example • Budgeted overhead costis the amount of overhead cost that shouldbe incurred to produce at the standard level of output. e.g., total overhead cost = $100,000 • Standardlevel of outputis what the activity level for the cost driver shouldbe. e.g., total labor hours should be 20,000

  34. Standard CostsManufacturing Overhead Example • Budgeted overhead costis the amount of overhead cost that shouldbe incurred to produce at the standard level of output. e.g., total overhead cost = $100,000 • Standardlevel of outputis what the activity level for the cost driver shouldbe. e.g., total labor hours should be 20,000 $100,000 20,000 Standard overheadrate per unit (i.e, hour) = $5 =

  35. Standard CostsManufacturing Overhead Example • Budgeted overhead costis the amount of overhead cost that shouldbe incurred to produce at the standard level of output. e.g., total overhead cost = $100,000 • Standardlevel of outputis what the activity level for the cost driver shouldbe. e.g., total labor hours should be 20,000 • Standard overhead cost is standard overhead rate times number of activity units for each unit of finished product e.g., $5 X 2 labor hours = $10

  36. Standard CostsSummary of Examples Standard Costs For One Table Direct materials - $6 X 5 sheets $30 Direct labor - $10 X 2 hours 20 Manufacturing overhead - $5 X 2 labor hours 10 Total standard cost $60

  37. Computing Variances • Standard cost variance Amount by which actual cost differs from standard cost for the actual volume level attained • Favorable variance Actual cost is less than standard cost • Unfavorable variance Actual cost is greater than standard cost

  38. 872 * * * * * Computing Variances Know how to calculate all six cost variances and what causes each. * For the actual volume level attained

  39. Computing Variances Let’s use what we have learned to calculate the six standard cost variances for a different company, starting withdirect materials.

  40. Zippy Computing VariancesMaterials Price Variance Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased in May at a total cost of $6,630. The material was used to make 1,000 Zippies in May. AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable Materials Price Variance

  41. Zippy Computing VariancesMaterials Price Variance Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased in May at a total cost of $6,630. The material was used to make 1,000 Zippies in May. AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable Note that the authors’ use of +/- is counter- intuitive

  42. * Materials inventory must always be debited for the actual quantityX standard price 1,700 lbs. X $4.00 = $6,800 Recording VariancesMaterials Price Variance * Price variance is recorded at time of purchase.

  43. Zippy Computing VariancesMaterials Usage Variance Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Records last week show 1,700 pounds of material were purchased in May at a total cost of $6,630. The material was used to make 1,000 Zippies in May. SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs MUV = (AQ - SQ) x SP MUV = (1,700lbs - 1,500lbs) x $4.00 MUV = +$800 unfavorable Materials Usage Variance

  44. * Materials inventory must always be relieved for the actual quantityX standard price 1,700 lbs. X $4.00 = $6,800 Recording VariancesMaterials Usage Variance *

  45. Recording VariancesMaterials Usage Variance * Usage variance is recorded at time of use. * Work in Process Inventory must always be debited for the standard quantityX standard price (1,000 units X 1.5 lbs.) X $4.00 = $6,000 Can materials price and usage variances be added to get a total materials variance?

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

  47. Zippy Computing VariancesLabor Rate Variance Hanson Inc. has the following labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per hour Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to make 1,000 Zippies. AR = $8,990 ÷ 1450 hours AR = $6.20 per hour LRV = (AR - SR) X AH LRV = ($6.20 - $6.00) X 1,450 hrs LRV = +$290 unfavorable Labor Rate Variance

  48. Zippy Computing VariancesLabor Efficiency Variance Hanson Inc. has the following labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per hour Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to make 1,000 Zippies. SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours LEV = (AH - SH) X SR LEV = (1,450 hrs - 1,500 hrs) X $6.00 LEV = -$300 favorable Labor Efficiency Variance

  49. Recording VariancesLabor Rate & Efficiency Variances Note that unlike materials variances, both labor variances are recorded at the same time. (i.e., when the payroll summary account is cleared out.)

  50. Recording VariancesLabor Rate & Efficiency Variances * Source? . * * Work in Process Inventory must always be debited for the standard quantityX standard price (1,000 units X 1.5 lbs.) X $6.00 = $9,000

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