Chapter 22

Copyright © by Houghton Miffin Company. All rights reserved. 1

Financial & Managerial Financial & Managerial Accounting 2002eAccounting 2002e

Belverd E. Needles, Jr.Belverd E. Needles, Jr.Marian PowersMarian PowersSusan CrossonSusan Crosson

- - - - - - - - - - -Multimedia Slides by:

Harry Hooper Santa Fe Community College


Chapter 22Chapter 22Performance Performance

Measurement Using Measurement Using Standard CostingStandard Costing


1. Define standard costs and describe how managers use standard costs in the management cycle.

2. Identify the six elements of, and compute, a standard unit cost.

3. Describe how to control costs through variance analysis.

LEARNING OBJECTIVESLEARNING OBJECTIVES


4. Compute and analyze direct materials variances.

5. Compute and analyze direct labor variances.

6. Define and prepare a flexible budget.7. Compute and analyze manufacturing

overhead variances.8. Explain how variances are used to

evaluate managers’ performance.

LEARNING OBJECTIVESLEARNING OBJECTIVES


Standard Costs in Today’s Standard Costs in Today’s Business EnvironmentBusiness Environment

OBJECTIVE 1

Define standard costs and describe how managers use standard costs in the management cycle.


Standard CostingStandard Costing

A budgeting control technique with 3 components:

1. A standard, predetermined performance level.

2. A measure of actual performance.

3. A measure of the variance, the difference, between the standard and the actual.


Standard CostsStandard Costs

Standard costs are predetermined costs that are developed from analyses of both: Past operating costs, quantities,

and times. Future costs and operating

conditions..


Standard Cost FlowStandard Cost Flow

In a standard costing system, standard costs for direct materials, direct labor, and manufacturing overhead flow through the inventory accounts and eventually into the Cost of Goods Sold account.

The difference from normal costing systems is that under standard costing systems, standard costs instead of actual costs are used to record all of these flows.


The Management CycleThe Management Cycle

Managers use standard costs throughout the management cycle. In the planning stage of the management

cycle, standard costs aid in the development of budgets and as yardsticks for evaluating capital expenditures.

During the executing stage, standard costs, quantities, and times are applied to work performed.



During the reviewing stage, actual costs are compared with standard costs to compute variances, and managers analyze the causes of those variances to improve operations. Both favorable and unfavorable variances should be investigated.

During the reporting stage, a variance report provides information on operations and managerial performance.


Standard Costing, Variance Analysis, and the Management CycleStandard Costing, Variance Analysis, and the Management Cycle


Standard Costing SystemsStandard Costing Systems

The primary difference between a standard costing system in service versus manufacturing organizations is that there are no direct materials variances in service organizations.

The importance of labor-related standards and variances has been reduced because direct labor costs as a proportion of product costs has decreased over time.



In today’s globally competitive environment, new standards or measurements are necessary to help managers: Reduce processing time. Improve quality. Improve customer satisfaction. Improve on-time deliveries.


A.A. The primary difference between a standard costing system in service versus manufacturing organizations is that there are no direct materials variances in service organizations.

Discussion Discussion

Q.Q. What is the difference between a standard costing system in service versus manufacturing organizations?


The Development The Development of Standard Costsof Standard Costs

OBJECTIVE 2

Identify the six elements of,

and compute, a standard cost.


A Standard Costing SystemA Standard Costing System

Standard costs replace actual costs in all accounts.

Materials Inventory, Work in Process, Finished Goods and Cost of Goods Sold balances are based on standard costs.

Separate records are kept of actual costs for comparison.


Standard Cost per UnitStandard Cost per Unit

There are six standards used to determine the standard cost per unit:

1. Direct materials price standard.

2. Direct materials quantity standard.

3. Direct labor time standard.

4. Direct labor rate standard.

5. Standard variable manufacturing overhead rate.

6. Standard fixed manufacturing overhead rate.


Direct Materials Price StandardDirect Materials Price Standard

The direct materials price

standard is calculated by carefully

considering: Expected price changes. Changes in available quantities. Possible new sources of supply.


Direct Materials Quantity StandardDirect Materials Quantity Standard

The direct materials quantity standard

is affected by: Product engineering specifications.

Quality of direct materials.

Age and productivity of machines.

Quality and experience of the work force.


Direct Labor Time StandardDirect Labor Time Standard

The direct labor time standard is

based on:

Current time and motion studies of

workers and machines.

Past performance.


Direct Labor Rate StandardDirect Labor Rate Standard

The direct labor rate standards are

affected by:

Labor union contracts.

Company personnel policies.


Standard Direct Materials and Standard Direct Materials and Standard Direct Labor CostsStandard Direct Labor Costs

Standard direct materials cost =Direct materials price standard x Direct materials quantity standard

Standard direct labor cost = Direct labor time standard x

Direct labor rate standard


Standard Manufacturing Standard Manufacturing Overhead CostsOverhead Costs

Standard manufacturing overhead cost =

(Standard variable overhead rate x

Variable overhead application basis)

+ (Standard fixed overhead rate x

Fixed overhead application basis)


Standard RatesStandard Rates

Standard variable manufacturing overhead rate = Total budgeted variable manufacturing overhead

costs ÷ Expected number of standard machine hours

Standard fixed manufacturing overhead rate =

Total budgeted fixed manufacturing overhead costs

÷ Normal capacity in terms of standard machine hours


Standard Unit CostStandard Unit Cost

A product’s standard unit cost is

determined by adding: Standard direct materials cost.

Standard direct labor cost.

Standard manufacturing overhead cost.


A.A.1. Direct materials price standard.2. Direct materials quantity standard.3. Direct labor time standard.4. Direct labor rate standard.5. Standard variable manufacturing overhead rate.6. Standard fixed manufacturing overhead rate.


Q.Q. What are the six standards used in determining the standard cost per unit?


Using Variance Analysis Using Variance Analysis to Control Operationsto Control Operations

OBJECTIVE 3

Describe how to control costs

through variance analysis.


Standard Costing SystemsStandard Costing Systems

A standard costing system has

traditionally been associated with: Cost control activities.

Evaluation of operating performance.


Manufacturing OperationsManufacturing Operations

Managers of manufacturing operations,

as well as those responsible for selling

and service functions, constantly

compare the costs of what was expected

to happen with the costs of what did

happen.


Variance AnalysisVariance Analysis

Variance analysis is a four-step approach.1. Compute the variance.

If the variance is insignificant, actual operating results are close to or equal to anticipated operating conditions, no corrective action is needed.

2. Determine the cause of any significant variance.


Variance AnalysisVariance Analysis

3. Identify and analyze the

performance measures that track

those activities.

4. Take action to correct the problem

or continue to improve operations.


Using Variance Analysis to Control CostsUsing Variance Analysis to Control Costs


A.A.

1. Compute the variance.

2. Determine the cause.

3. Identify the performance measures.

4. Take action to correct or continue.


Q.Q. What are the four steps of variance analysis?


Direct Materials VariancesDirect Materials Variances

OBJECTIVE 4

Compute and analyze direct

materials variances.


Variance analysis need not be limited to the following 6 variances.

Companies may use dozens of variances for many different types of activities.


Direct Materials Cost VarianceDirect Materials Cost Variance

Direct materials cost variance is the sum of:

1. Direct materials price variance.= (Standard Price - Actual Price) x Actual Quantity.

2. Direct materials quantity variance.= (Standard Quantity - Actual Quantity) x Standard Price.


Direct Materials Price VarianceDirect Materials Price Variance

Possible causes of a direct materials price variance are:

1. Changes in vendor prices.

2. Inaccurate or outdated direct materials price standards.

3. Differences between the quality of direct materials purchased and the quality desired.


Direct Materials Price VarianceDirect Materials Price Variance

4. Differences between quantity discounts received and those anticipated.

5. The purchase of substitute direct materials that differ from product specifications.


Direct Materials Quantity VarianceDirect Materials Quantity Variance

Possible causes of a direct materials

quantity variance are:

1. Inaccurate or outdated direct materials

quantity standards.

2. Poor workmanship or excellent

workmanship.


Direct Materials Quantity VarianceDirect Materials Quantity Variance

3. Faulty equipment.

4. Inferior or superior quality of direct materials.

5. Poor materials handling.


Direct Materials Variance AnalysisDirect Materials Variance Analysis


A.A.

1. Inaccurate or outdated direct materials quantity standards.

2. Poor/excellent workmanship.

3. Faulty equipment.

4. Inferior/superior direct material quality.

5. Poor materials handling.


Q.Q. What are some possible causes of a direct materials quantity variance?


Direct Labor VariancesDirect Labor Variances

OBJECTIVE 5

Compute and analyze direct

labor variances.


Direct Labor Cost VarianceDirect Labor Cost Variance

Direct labor cost variance is the sum of:

1. Direct labor rate variance.= (Standard Rate – Actual Rate) x Actual Quantity (hours)

2. Direct labor efficiency variance.= Standard Rate x (Standard Hours Allowed – Actual Hours)


Direct Labor Rate VarianceDirect Labor Rate Variance

A direct labor rate variance can occur because:

1. A worker is hired at a pay rate that is higher or lower than expected.

2. An employee performed the duties of a higher- or lower-paid position.


Direct Labor Rate VarianceDirect Labor Rate Variance

3. Overall wage rates changed due to:

• New labor agreements.

• Labor strikes that cause the temporary hiring of unskilled help.

• Large layoffs that result in unusual usage of remaining workers.


Favorable Direct Labor Efficiency Favorable Direct Labor Efficiency VarianceVariance

A favorable direct labor efficiency variance can be caused by:

1. Improved training of employees.

2. New machinery.

3. Higher quality of materials.


Unfavorable Direct Labor Efficiency Unfavorable Direct Labor Efficiency VarianceVariance

An unfavorable direct labor efficiency variance can be caused by:

1. Machine breakdowns.

2. Inferior direct materials.

3. Poor supervision.

4. Slow materials handling.

5. Poor employee performance.


Direct Labor Variance AnalysisDirect Labor Variance Analysis


A.A.

1. Improved training of employees.

2. New machinery.

3. Higher quality of materials.


Q.Q. What are the causes of favorable direct labor

efficiency variance?


Manufacturing Manufacturing Overhead VariancesOverhead Variances

OBJECTIVE 6

Define and prepare a

flexible budget.


Flexible BudgetFlexible Budget

The budgets discussed earlier were static or fixed budgets, which forecast revenues and expenses for one level of sales and production.

A flexible budget is a summary of anticipated costs for a range of activity levels, geared to changes in productive output.


Flexible Budget FormulaFlexible Budget Formula

The flexible budget formula:1. Includes a budgeted variable cost per

unit, which is the same for all levels of output within the range chosen.

2. Includes a budgeted total fixed cost, which stays constant for the range.


Flexible Budget FormulaFlexible Budget Formula

Total budget costs =

(Variable cost per unit x

Number of units produced) +

Budgeted fixed costs


A.A. Total budget costs =

(Variable cost per unit x Number of units produced)

+

Budgeted fixed costs.


Q.Q. What is the format of the flexible budget formula?


Analyzing ManufacturingAnalyzing ManufacturingOverhead VariancesOverhead Variances

OBJECTIVE 7

Compute and analyze

manufacturing overhead

variances.


Manufacturing Manufacturing Overhead VarianceOverhead Variance

The total manufacturing overhead variance is equal to the difference between: The actual manufacturing overhead

costs incurred and The standard manufacturing overhead

costs applied to production.


Total Manufacturing Total Manufacturing Overhead VarianceOverhead Variance

The total manufacturing overhead variance is then divided into two parts: Controllable manufacturing overhead

variance. Manufacturing overhead volume

variance.


Controllable Manufacturing Controllable Manufacturing Overhead VarianceOverhead Variance

Is the difference between the actual manufacturing overhead costs incurred and the manufacturing overhead costs budgeted for the level of production achieved.

Can occur because too much or too little is spent on manufacturing overhead items such as indirect materials, indirect labor, supervision, or machine maintenance.


Manufacturing Overhead Variance AnalysisManufacturing Overhead Variance Analysis


Manufacturing Overhead Volume Manufacturing Overhead Volume VarianceVariance

Is the difference between the manufacturing overhead budgeted for the level of production achieved and the total manufacturing overhead costs applied to production using the standard variable and fixed manufacturing overhead rates.

Will occur if more or less capacity than normal is used.


DiscussionDiscussion

A.A.

1. Unfavorable

2. Unfavorable

Q.Q.1. If machine operators were inefficient and took

longer to perform their work than expected, what would be the resulting controllable variance?

2. If less fixed manufacturing overhead was applied than expected, what would be the resulting volume variance?


Using Variances inUsing Variances inPerformance EvaluationPerformance Evaluation

OBJECTIVE 8

Explain how variances are used to



Management EvaluationManagement Evaluation

The effective evaluation of managers’ performance depends on both human factors and company policies.

To ensure effectiveness and fairness when establishing a performance evaluation process, management should develop appropriate policies and seek input from managers and employees.


Policies and ProceduresPolicies and Procedures Policies and procedures should

address:1. Preparing operational plans.2. Assigning responsibility for

performance.3. Communicating operational plans to key

personnel.4. Evaluating each area of responsibility.5. Identifying causes of significant

variances.6. Taking corrective action to eliminate

problems.


Performance ReportsPerformance Reports

The keys to preparing a performance report are to: Identify the personnel responsible for

each variance. Determine the causes for each significant

variance. Develop a reporting format suited to the

task.


Performance ReportsPerformance Reports

The management accountant should tailor

performance to each manager’s

responsibilities so that each report contains

those cost items controllable by that

manager. Managers should be held accountable for

only those cost areas under their control.


A.A.

1. Human factors.

2. Company policies.


Q.Q. The effective evaluation of managers’

performance depends on what two things?


OK, LET’S REVIEW . . .OK, LET’S REVIEW . . .

1. Define standard costs and describe how managers use standard costs in the management cycle.

2. State the purposes for using standard costs.

3. Identify the six elements of, and compute, a standard unit cost.

4. Describe how to control costs through variance analysis.


AND FINALLY . . .AND FINALLY . . .

5. Compute and analyze direct materials variances.

6. Compute and analyze direct labor variances.

7. Define and prepare a flexible budget.8. Compute and analyze manufacturing

overhead variances.9. Explain how variances are used to


Chapter 22

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