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Standard Costs

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  1. Standard Costs Standards are benchmarks or “norms”for measuring performance. Two typesof standards are commonly used. Quantity standardsspecify how much of aninput should be used tomake a product orprovide a service. Cost (price)standards specify how much should be paid for each unitof the input. LO 1

  2. Deviations from standards deemed significantare brought to the attention of management, apractice known as management by exception. Standard Costs Standard Amount DirectMaterial DirectLabour ManufacturingOverhead Type of Product Cost LO 1

  3. Exhibit 10-1 Takecorrective actions Identifyquestions Receive explanations Conduct next period’s operations Analyze variances Variance Analysis Cycle Prepare standard cost performance report Begin LO 1

  4. Setting Standard Costs Accountants, engineers, purchasingagents, and production managerscombine efforts to set standards that encourage efficient future production. LO 1

  5. Standard Quantityper Unit Final, deliveredcost of materials,net of discounts. Summarized in a Bill of Materials. Setting Direct Material Standards Standard Priceper Unit LO 1

  6. Standard Rateper Hour Standard Hoursper Unit Often a singlerate is used that reflectsthe mix of wages earned. Use time and motion studies foreach labour operation. Setting Direct Labour Standards LO 1

  7. PriceStandards QuantityStandards The rate is the variable portion of the predetermined overhead rate. The quantity is the activity in the allocation base used to calculate the predetermined overhead. Setting Variable Overhead Standards LO 1

  8. Standard Cost Card – Variable Production Cost A standard cost card for one unit of product might look like this: LO 1

  9. Astandardis a per unit cost. • Standards are often used when preparing budgets. Standards vs. Budgets Are standards the same as budgets? A budget is set for total costs. LO 1

  10. The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. • The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. Price and Quantity Standards Price and quantity standards are determined separately for two reasons: LO 1

  11. Price Variance Quantity Variance Difference betweenactual price and standard price Difference betweenactual quantity andstandard quantity A General Model for Variance Analysis Variance Analysis LO 1

  12. Price Variance Quantity Variance Materials price varianceLabour rate varianceVOH spending variance A General Model for Variance Analysis Variance Analysis Materials quantity variance Labour efficiency variance VOH efficiency variance LO 1

  13. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Spending Variance LO 1

  14. A General Model for Variance Analysis (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Spending Variance LO 1

  15. Material Variances Example Glacier Peak Outfitters has the following direct material standard for the fibrefill in its mountain parka. 0.1 kg. of fibrefill per parka at $5.00 per kg. Last month 210 kgs of fibrefill were purchased and used to make 2,000 parkas. The material cost a total of $1,029. LO 2

  16. Price variance$21 favourable Quantity variance$50 unfavourable $29 unfavourable Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 LO 2

  17. Material Variances:Using the Factored Equations Materials price variance MPV = AQ (AP – SP) = 210 kgs ($4.90/kg – $5.00/kg) = 210 kgs (-$0.10/kg) = $21 F Materials quantity variance MQV = SP (AQ – SQ) = $5.00/kg (210 kgs – (0.1 kg/parka  2,000 parkas)) = $5.00/kg (210 kgs – 200 kgs) = $5.00/kg (10 kgs) = $50 U LO 2

  18. Purchasing Manager Production Manager Responsibility for Material Variances Materials Quantity Variance Materials Price Variance The standard price is used to compute the quantity varianceso that the production manager is not held responsible forthe purchasing manager’s performance. LO 2

  19. Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavourable price variances. I am not responsible for this unfavourable materialquantity variance. You purchased cheapmaterial, so my peoplehad to use more of it. Responsibility for Material Variances LO 2

  20. Zippy Quick Check  Hanson Inc. has the following direct material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week, 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630. LO 2

  21. Zippy Quick Check  Hanson’s material price variance (MPV)for the week was: a. $170 unfavourable. b. $170 favourable. c. $800 unfavourable. d. $800 favourable. LO 2

  22. Zippy Quick Check  Hanson’s material quantity variance (MQV)for the week was: a. $170 unfavourable. b. $170 favourable. c. $800 unfavourable. d. $800 favourable. LO 2

  23. Zippy Price variance$170 favourable Quantity variance$800 unfavourable $630 unfavourable Quick Check  Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb. = $6,630 = $ 6,800 = $6,000 LO 2

  24. The price variance is computed on the entire quantitypurchased. • The quantity variance is computed only on the quantityused. Material Variances Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchaseddiffers from the amount used? LO 2

  25. Zippy Quick Check  Continued 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. LO 2

  26. Zippy Price variance increases because quantity purchased increases. Price variance$280 favourable Quick Check  Continued Actual Quantity Actual QuantityPurchased Purchased× ×Actual Price Standard Price 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb. = $10,920 = $11,200 LO 2

  27. Zippy Quantity variance is unchanged because actual and standard quantities are unchanged. Quantity variance$800 unfavourable Quick Check  Continued Actual QuantityUsed Standard Quantity × × Standard Price Standard Price 1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb. = $6,800 = $6,000 LO 2

  28. Labour Variances Example Glacier Peak Outfitters has the following direct labour standard for its mountain parka. 1.2 standard hours per parka at $10.00 per hour Last month, employees actually worked 2,500 hours at a total labour cost of $26,250 to make 2,000 parkas. LO 3

  29. Rate variance$1,250 unfavourable Efficiency variance$1,000 unfavourable $2,250 unfavourable Labour Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × ×$10.50 per hour $10.00 per hour $10.00 per hour = $26,250 = $25,000 = $24,000 LO 3

  30. Labour Variances:Using the Factored Equations Labour rate variance LRV = AH (AR – SR) = 2,500 hours ($10.50 per hour – $10.00 per hour) = 2,500 hours ($0.50 per hour) = $1,250 unfavourable Labour efficiency variance LEV = SR (AH – SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavourable LO 3

  31. Mix of skill levelsassigned to work tasks. Level of employee motivation. Quality of production supervision. Production Manager Quality of training provided to employees. Responsibility for Labour Variances Production managers areusually held accountablefor labour variancesbecause they caninfluence the: LO 3

  32. Zippy Quick Check  Hanson Inc. has the following direct labour standard to manufacture one Zippy: 1.5 standard hours per Zippy at $12.00 perdirect labour hour Last week, 1,550 direct labour hours were worked at a total labour cost of $18,910to make 1,000 Zippies. LO 3

  33. Zippy Quick Check  Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable. LO 3

  34. Zippy Quick Check  Hanson’s labour efficiency variance (LEV)for the week was: a. $590 unfavourable. b. $590 favourable. c. $600 unfavourable. d. $600 favourable. LO 3

  35. Zippy Rate variance$310 unfavourable Efficiency variance$600 unfavourable $910 unfavourable Quick Check  Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $12.20 per hour $12.00 per hour $12.00 per hour = $18,910 = $18,600 = $18,000 LO 3

  36. Variable Manufacturing Overhead Variances Example Glacier Peak Outfitters has the following direct variable manufacturing overhead labour standard for its mountain parka. 1.2 standard hours per parka at $4.00 per hour Last month, employees actually worked 2,500 hours to make 2,000 parkas. Actual variable manufacturing overhead for the month was $10,500. LO 4

  37. Spending variance$500 unfavourable Efficiency variance$400 unfavourable $900 unfavourable Variable Manufacturing Overhead Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10,500 = $10,000 = $9,600 LO 4

  38. Variable Manufacturing Overhead Variances: Using Factored Equations Variable manufacturing overhead spending variance VMSV = AH (AR – SR) = 2,500 hours ($4.20 per hour – $4.00 per hour) = 2,500 hours ($0.20 per hour) = $500 unfavourable Variable manufacturing overhead efficiency variance VMEV = SR (AH – SH) = $4.00 per hour (2,500 hours – 2,400 hours) = $4.00 per hour (100 hours) = $400 unfavourable LO 4

  39. Zippy Quick Check  Hanson Inc. has the following variable manufacturing overhead standard tomanufacture one Zippy: 1.5 standard hours per Zippy at $3.00 perdirect labour hour Last week, 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent forvariable manufacturing overhead. LO 4

  40. Zippy Quick Check  Hanson’s spending variance (VOSV) for variable manufacturing overhead forthe week was: a. $465 unfavourable. b. $400 favourable. c. $335 unfavourable. d. $300 favourable. LO 4

  41. Zippy Quick Check  Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavourable. b. $435 favourable. c. $150 unfavourable. d. $150 favourable. LO 4

  42. Zippy Spending variance$465 unfavourable Efficiency variance$150 unfavourable $615 unfavourable Quick Check  Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour = $5,115 = $4,650 = $4,500 LO 4

  43. Overhead Rates and Overhead Analysis Recall that overhead costs are assigned to products and services using apredetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity Overhead from theflexible budget for thedenominator level of activity POHR = Denominator level of activity LO 5

  44. Overhead Rates and Overhead Analysis The predetermined overhead ratecan be broken down into fixedand variable components. The variablecomponent is usefulfor preparing and analyzingvariable overheadvariances. The fixedcomponent is usefulfor preparing and analyzingfixed overheadvariances. LO 5

  45. In a standard costsystem, overhead isapplied to work inprocess based onthe standard hoursallowed for the actualoutput of the period. Normal versus Standard Cost Systems In a normal costsystem, overhead isapplied to work inprocess based onthe actual numberof hours workedin the period. LO 6

  46. Fixed Overhead Variances Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied DH × FR SH × FR Budget Variance VolumeVariance FR = Standard Fixed Overhead RateSH = Standard Hours AllowedDH = Denominator Hours LO 6

  47. Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead: Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 $ 6,000 ? $ 9,000 ? 4,000 8,000 ? 9,000 ? Let’s calculate overhead rates. ColaCo applies overhead basedon machine-hour activity. LO 6

  48. Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 $ 6,000 $ 2.00 $ 9,000 ? 4,000 8,000 2.00 9,000 ? Rate = TotalVariable Overhead ÷ Machine Hours Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead: This rate is constant at all levels of activity. LO 6

  49. Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00 4,000 8,000 2.00 9,000 2.25 Rate = TotalFixedOverhead ÷ Machine Hours Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead: This rate decreases when activity increases. LO 6

  50. Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00 4,000 8,000 2.00 9,000 2.25 The total POHR is the sum ofthe fixed and variable ratesfor a given activity level. Overhead Rates and OverheadAnalysis – Example ColaCo prepared this budget for overhead: LO 6