Chapter 10 Standard Costs and the Balanced Scorecard Learning Objectives LO1 Explain how direct materials standards and direct labor standards are set LO2 Compute the direct materials price and quantity variances and explain their significance LO3 Compute the direct labor rate and efficiency variances and explain their significance LO4 Compute the variable manufacturing overhead spending and efficiency variances LO5 Understand how a balanced scorecard fits together and how it supports a company’s strategy LO6 Compute the delivery cycle time, the throughput time, and the manufacturing cycle efficiency (MCE) LO7 (Appendix 10A) Prepare journal entries to record standard costs and variances New in this Edition • A number of new In Business boxes have been written for this edition • Several new exercises have been added, each of which focuses on a single learning objective • New problems covering the Balanced Scorecard have been added Lecture Notes A Standard Costs—Management by Exception A standard is a benchmark or “norm” for measuring performance In managerial accounting, standards relate to the prices and quantities of inputs used in making goods or providing services Quantity standards A quantity standard specifies how much of an input, such as labor time or raw materials, should be used to make a unit of product or to provide a unit of service To measure performance, the actual quantity of an input that is used is compared to the standard quantity allowed for the actual output of the period Price standards A price standard specifies how much each unit of input should cost Actual costs of inputs are compared to these standards B Setting Standard Costs (Exercises 10-1, 10-8.) Standards should be set so that they encourage efficient operations Ideal versus practical standard Standards tend to fall into one of two categories—either ideal or practical • Ideal standards allow for no machine breakdowns or work interruptions, and require that workers operate at peak efficiency 100% of the time Since ideal standards are 604 • rarely met, most managers believe they tend to discourage even the most diligent workers On the other hand, some critics maintain that only ideal standards are appropriate in an era of continual improvement Any other standard may breed complacency Practical standards are “tight, but attainable.” They allow for normal machine downtime and employee rest periods and can be attained through reasonable, but highly efficient, efforts by the average worker Setting direct materials standards Separate standards are prepared for the price and quantity of each type of material input • The standard price per unit for a direct material should reflect the final, delivered cost of the material, net of any discounts taken The standard price is for a particular grade of material, purchased in a particular lot size, and delivered by a particular type of carrier • The standard quantity of a direct material per unit of output in a traditional standard cost system reflects the amount of material going into each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies However, it is worth pointing out that some experts argue that “normal” inefficiency can no longer be tolerated and that companies that build waste into their operations will ultimately face serious problems competing with companies that don’t Setting direct labor standards • The standard rate per hour for direct labor should include not only wages, but also fringe benefits and other labor-related costs Ordinarily, the standard rate is an average that assumes a specific mix of higher and lower paid workers • The standard direct labor-hours per unit of output is the direct labor time allowed to complete a unit of product In traditional standard cost systems this standard time includes allowances for coffee breaks, personal needs of employees, clean-up, and machine downtime Setting variable manufacturing overhead standards Standards for variable manufacturing overhead are usually expressed in terms of direct labor-hours or machinehours The rate represents the variable portion of the predetermined overhead rate that is discussed in Chapter The standard hours for variable overhead represent the standard hours for whatever base is used to apply overhead cost to products or services If direct labor-hours is the basis for applying overhead to products, then the quantity standard for variable manufacturing overhead will be the quantity standard for direct labor Standard cost card A standard cost card is a summary of the standard costs of inputs required to complete one unit of product For each input, the standard cost card lists the standard price of the input, the standard quantity of the input allowed per unit of output, and the standard cost of the input per unit of output The latter is equal to the standard price per unit of input multiplied by the standard quantity of the input allowed for each unit of product Standards and budgets One distinction between a standard and a budget is that a standard is a unit amount, whereas a budget is a total amount In effect, a standard can be viewed as the budgeted cost for one unit 605 C A General Model for Variance Analysis A variance is the difference between standard prices and actual prices or between standard quantities and actual quantities A general model that describes the variable cost variances is found in Exhibit 10-3 Price variance A price variance is the difference between the how much should have been paid to acquire an input and how much was actually paid Quantity variance A quantity variance is the difference between how much of an input should have been used to produce the actual output of the period and how much was actually used, multiplied by the standard price of the input Alternative methods As an alternative to the general model, variances can be computed using formulas The formulas for the price variance are: Price (rate) variance = (AQ × AP) – (AQ × SP) or Price (rate) variance = AQ (AP – SP) The formulas for the quantity variance are: Quantity (efficiency) variance = (AQ × SP) – (SQ × SP) or Quantity (efficiency) variance = SP (AQ – SQ) Where: AQ = Actual quantity of inputs purchased (or used) AP = Actual price per unit of inputs purchased SP = Standard price per unit of input SQ = Standard input allowed for the actual output This equals the standard input per unit of output multiplied by the actual output of the period D Computation and Interpretation of Standard Cost Variances Since direct material, direct labor, and variable overhead are all variable manufacturing costs, the process of computing price and quantity variances for each of these cost categories is the same The general model, or the formulas, can be used in each case to compute the variances The only complication is deciding in each case whether the actual quantity of inputs refers to the actual quantity purchased or the actual quantity used Direct material variances (Exercises 10-2, 10-9, 10-12, 10-13, 10-15.) a The materials price variance is the difference between what is paid for a given quantity of materials and what should have been paid according to the standard Most companies compute the material price variance when materials are purchased rather than when the materials are placed into production Generally speaking, the purchasing manager has control over the price to be paid for goods and is therefore responsible for any price variance However, some other individual may be responsible in some instances For example, the production manager might be responsible if an unfavorable price variance occurs as the result of rush orders for material due to poor production scheduling For purposes of control, it is best to recognize a materials price variance immediately rather than wait until the materials are withdrawn for use in production Also, if the 606 material price variance is recognized when the materials are placed into production, their actual costs must be tracked after they are purchased If the variance is recognized when the materials are purchased, materials inventories can be carried at standard cost—which enormously simplifies the bookkeeping b The materials quantity variance is the difference between the quantity of materials used in production and the quantity that should have been used according to the standard— all multiplied by the standard price per unit of input Ordinarily, the materials quantity variance is the responsibility of the production department However, other individuals may in some instances be responsible For example, the purchasing department would be responsible for an unfavorable material quantity variance that occurs because of the purchase of inferior quality materials Direct labor variances (Exercises 10-3, 10-9, 10-10, 10-11, 10-12, 10-15.) a The labor rate variance measures any deviation from standard in the average hourly rate paid to direct labor workers Students often wonder how there can be a labor rate variance since companies generally know each employee’s wage rate in advance A labor rate variance can arise for a number of reasons The mix of workers, and hence of lower and higher wage rates, can be different from what was planned due to absences, changes in the composition of the work force, and a variety of other circumstances Additionally, overtime can give rise to a labor rate variance b The quantity variance for direct labor is called the labor efficiency variance Traditionally, this has been the most closely monitored variance by management When the direct labor workforce is adjusted to changes in workloads, the main causes of the labor efficiency variance include poorly trained workers, poorly motivated workers, poor quality materials which require more labor time and processing, faulty equipment which causes breakdowns and work interruptions, and poor supervision However, many companies not adjust the workforce to the workload in the short-term In such companies, the major cause of a labor efficiency variance is likely to be fluctuations in demand for the company’s products rather than the efficiency with which workers their jobs If the workforce is basically fixed, a reduction in output will result in less favorable labor efficiency variances Likewise, an increase in output when the workforce is basically fixed will result in more favorable labor efficiency variances When demand is down or when a workstation is not a bottleneck, excessive emphasis on labor efficiency variances can create tremendous pressure to build inventories Take the case of a workstation that is not a bottleneck If the labor force is basically fixed and the standards are tight, the workstation can only attain a favorable labor efficiency variance by producing at capacity However, if the workstation is not the bottleneck and it is operating at capacity, it will produce more output than the bottleneck can process That will result in work in process inventory that cannot be completed As the JIT movement attests, work in process inventory is the enemy of efficient operations It leads to long and erratic manufacturing cycle times, high defect rates, obsolescence, and high overhead due to expediting and the problems of coordinating production schedules amongst the general chaos on the factory floor A very strong argument can be made that the labor efficiency variance should be unfavorable in workstations that are not bottlenecks when the work force is fixed 607 Variable overhead variances (Exercises 10-4, 10-11.) These variances will be discussed in greater depth in the next chapter You may want to defer all discussion of the interpretations of these variances a The variable overhead spending variance is computed as follows when the variable overhead rate is expressed in terms of direct labor-hours: Variable overhead spending variance = Actual overhead cost – Actual direct labor-hours × Variable overhead rate The variable overhead spending variance compares actual spending on variable overhead to the amount of spending that would be expected, given the actual direct labor-hours for the period The critical assumption inherent in this calculation is that variable overhead spending should be proportional to the actual direct labor-hours The usefulness of this variance depends on the validity of this assumption If in fact the optimal level of variable overhead spending is not proportional to actual direct laborhours, then this variance has little meaning b The variable overhead efficiency variance is computed as follows when the variable overhead rate is expressed in terms of direct labor-hours: Variable overhead efficiency variance = (Actual direct labor-hours – Standard direct labor-hours allowed) × Variable overhead rate Note the similarity between the direct labor efficiency variance and the variable overhead efficiency variance In both cases, the actual direct labor-hours are compared to the standard direct labor-hours allowed for the actual output The only difference between the variances is the standard rate that is applied to difference between the actual and standard hours In the case of the direct labor efficiency variance, the rate is the standard labor rate In the case of the variable overhead efficiency variance, the rate is the standard (predetermined) variable overhead rate per direct labor-hour Therefore, these two variances really measure the same thing Those who criticize the labor efficiency variance as irrelevant or counter-productive would likewise criticize the variable overhead efficiency variance E Variance Analysis and Management by Exception Management by exception means that management’s attention should be directed towards areas where plans are not being met Standard cost variances signal performance different from what was expected Since not all variances require management attention, some method of identifying those variances that require attention is required Statistical analysis can be useful in this task and the basics of this approach are sketched in the text F General Ledger Entries to Record Variances (Appendix 10A) (Exercises 10-7, 10-15.) The appendix covers the journal entries to record standard costs in inventories and to record the standard cost variances Formal entry of variances in the accounting records gives variances greater emphasis and simplifies the bookkeeping process It is important to note that unfavorable variances are debit entries and favorable variances are credit entries 608 G Potential Problems with Using Standard Costs Some of the potential disadvantages of standard costs have been mentioned above A more complete list follows: Standard cost variance reports are usually prepared on a monthly basis and are released long after the end of the month As a consequence, the information in the reports may be so stale that it is almost useless It is better to have timely, frequent reports that are approximately correct than to have untimely, infrequent reports that are very precise Some companies are now reporting variances and other key operating data daily or even more frequently Management by exception, by its nature, tends to focus on the negative Moreover, if variances are used as a club, subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interests of the company to make sure the variances are favorable For example, workers may put on a crash effort to increase output at the end of the month to avoid an unfavorable labor efficiency variance During such crash efforts, quality may not be a major concern It is claimed that in the old Soviet Union, workers used hammers instead of screwdrivers at the end of the month to meet production quotas Labor quantity standards and labor efficiency variances make two important assumptions First, they assume that the production process is labor-paced; if labor works faster, output will go up However, output in many companies is no longer determined by how fast labor works; rather, it is determined by the processing speed of machines Second, these computations assume that labor is a variable cost However, as discussed in earlier chapters, in many companies direct labor may be more of a fixed cost than a variable cost And if labor is a fixed cost, then an undue emphasis on labor efficiency variances creates pressure to build excess work-in-process and finished goods inventories as discussed above If every workstation is being evaluated based on its labor efficiency variance, then every workstation will attempt to produce at capacity But if the workstations in front of the bottleneck produce at capacity, the inevitable result will be a build up of work in process inventories in front of the bottleneck This reasoning applies to any two successive workstations with differing capacities If the first workstation has greater capacity that the second work station and attempts to produce to its capacity, the result will be everincreasing piles of work in process inventory in front of the second workstation In some cases, a “favorable” variance can be worse than an “unfavorable” variance For example, vaccines have standard doses A favorable quantity variance means that less vaccine was used than the standard specifies The result may be an ineffective inoculation There may be a tendency with standard cost reporting systems to emphasize meeting the standards to the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction Continual improvement—not just meeting standards—may be necessary to survive in the current competitive environment For that reason, some companies focus on the trends in the standard cost variances—aiming for continual improvement rather than just meeting the standards H Balanced Scorecard (Exercises 10-5, 10-14.) A balanced scorecard consists of an integrated set of performance measures that are derived from and support the company’s strategy 609 throughout the organization Since each company’s strategy and operating environment is different, each company’s balanced scorecard will be unique However, they will have some common characteristics Common characteristics of balanced scorecards a It should be possible, by examining a company’s balanced scorecard, to infer its strategy and the assumptions underlying that strategy (See Exhibit 10-13 for an example.) b The balanced scorecard should emphasize continuous improvement rather than just meeting present standards or targets c Some of the performance measures on the balanced scorecard should be non-financial Financial measures tend to be lagging rather than leading indicators In addition, for most employees, non-financial measures may be easier to understand and to influence than financial measures d The entire company has a comprehensive scorecard, but the scorecards for individuals should contain only those performance measures they can actually influence As you go lower in the organization, you are likely to observe fewer performance measures on individuals’ scorecards and that more of them will be non-financial e Most, but certainly not all, balanced scorecards will contain performance measures that fall into at least four main categories: financial, customer, internal business process, and learning and growth The ultimate objectives of the organization are usually financial, but financial results depend on customers’ perceptions of the company’s products and services In order to improve customers’ perceptions of products and services, it is usually necessary to improve internal business processes so that the products and services are actually better And in order to improve the business processes, it is necessary that employees learn The balanced scorecard as a motivation and feedback mechanism The performance measures on the balanced scorecard provide motivation and feedback If an employee does something to improve a performance measure and the measure actually improves, the employee is encouraged If the performance measure does not improve, the employee can adjust what he or she was doing and try again Learning to shoot baskets is a good analogy If you could not see whether a shot actually went into the basket, you would quickly lose interest and would not be able to improve Only by seeing what works and does not work can you improve The balanced scorecard provides a reality check for the company’s strategy Suppose employees work very hard and make dramatic improvements in internal business processes but customer satisfaction and financial results not improve Rather than throwing up one’s hands in despair, this is a golden opportunity to examine the company’s strategy If improvement in one area does not lead to expected improvement elsewhere, something may be wrong with the theory underlying the strategy Indeed, strategy can be thought of as hypotheses about the effects of particular actions on desired outcomes If those desired outcomes not occur, the hypotheses should be discarded and the strategy reconsidered If no attempt is made to systematically collect data that can disprove the assumptions underlying the company’s strategy, the company may stagger on indefinitely—unaware 610 that its cherished assumptions are invalid This extremely important aspect of the balanced scorecard should be emphasized Some internal business process performance measures (Exercise 10-6.) Exhibit 10-12 in the text contains a rather long list of potential performance measures that could be included on a balanced scorecard These should be viewed only as examples Most companies are likely to use some of these measures or measures that are very similar to some on the list Most companies will add many other performance measures that are not on the list As a consequence, you should not place a great deal of emphasis on this list Nevertheless, several measures of internal business process performance on the list are quite common and are not self-explanatory A discussion of these measures follows: a Delivery Cycle Time This is the total elapsed time between when an order is placed by a customer and when it is shipped to the customer Part of this time is wait time that occurs before the order is placed into production The remainder of this time is the throughput time, which is defined below b Throughput (Manufacturing Cycle) Time This is the total elapsed time between when an order is started into production and when it is shipped to the customer It consists of process time, inspection time, move time, and queue time The only element that adds value is processing time Inspection time, move time, queue time, and their associated activities not add value and should be minimized c Manufacturing Cycle Efficiency (MCE) MCE is the ratio of value-added time (i.e., process time) to total throughput time It represents the percentage of time an order is in production in which useful work is being done The rest of the time represents nonvalue-added time (i.e., inspection time, move time, and queue time) 611 Assignment Materials Assignment Exercise 10-1 Exercise 10-2 Exercise 10-3 Exercise 10-4 Exercise 10-5 Exercise 10-6 Exercise 10-7 Exercise 10-8 Exercise 10-9 Exercise 10-10 Exercise 10-11 Exercise 10-12 Exercise 10-13 Exercise 10-14 Exercise 10-15 Problem 10-16 Problem 10-17 Problem 10-18 Problem 10-19 Problem 10-20 Problem 10-21 Problem 10-22 Problem 10-23 Problem 10-24 Problem 10-25 Problem 10-26 Problem 10-27 Problem 10-28 Problem 10-29 Problem 10-30 Problem 10-31 Problem 10-32 Case 10-33 Case 10-34 Case 10-35 Case 10-36 Topic Setting standards; preparing a standard cost card Material variances Direct labor variances Variable overhead variances Creating a balanced scorecard Measures of internal business process performance Recording variances in the general ledger Setting standards Material and labor variances Working backwards from labor variances Labor and variable overhead variances Material and labor variances Material variances Creating a balanced scorecard (Appendix) Material and labor variances; journal entries Variance analysis in a hospital Basic variance analysis (Appendix) Comprehensive variance analysis; journal entries Comprehensive variance analysis Creating balanced scorecards that support different strategies Measures of internal business process performance Setting standards Variance analysis with multiple lots Materials and labor variances; computations from incomplete data (Appendix) Comprehensive variance analysis with incomplete data; journal entries Comprehensive variance analysis Variance analysis and internal business process performance measures Building a balanced scorecard Perverse effects of some performance measures Internal business process performance measures Comprehensive variance analysis Developing standard costs Balanced scorecard Ethics and the manager; rigging standards (Appendix) Variances and journal entries from incomplete data Behavioral impact of standard costs and variances 612 Level of Difficulty Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Basic Suggested Time 20 20 20 20 45 20 20 20 30 20 30 20 15 45 45 45 45 Basic Basic 60 45 Basic Basic Medium Medium 60 30 30 45 Difficult 45 Difficult Difficult 75 60 Medium Medium Medium Medium Difficult Difficult Difficult Difficult 75 45 45 30 45 45 60 30 Difficult Medium 90 30 Essential Problems: Problem 10-16 or Problem 10-17, Problem 10-19, Problem 10-21 or Problem 10-30, Problem 10-20 or 10-28 Supplementary Problems: Problem 10-22 or Problem 10-32, Problem 10-23, Problem 10-24, Problem 10-26, Problem 10-27, Problem 10-29, Problem 10-31, Case 10-33, Case 10-34, Case 10-36 Appendix 10A Essential Problems: Problem 10-18 or Problem 10-25 Appendix 10A Supplementary Problems: Case 10-35 613 TM 10-9 THE GENERAL VARIANCE MODEL (Exhibit 10-3) The standard quantity allowed (standard hours allowed in the case of labor and overhead) is the amount of materials (or labor) that should have been used to complete the output of the period © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-10 DIRECT MATERIAL VARIANCES To illustrate variance analysis, refer to the standard cost card for Speeds, Inc.’s jogging suit The following data are for last month’s production: Number of suits completed Cost of material purchased (20,000 yards × $5.40 per yard) Yards of material used 5,000 units $108,000 20,000 yards Using these data and the data from the standard cost card, the material price and quantity variances are: Actual Quantity of Input, at Actual Price (AQ × AP) 20,000 yards × $5.40 per yard = $108,000 ↑ Actual Quantity of Input, at Standard Price (AQ × SP) 20,000 yards × $6.00 per yard = $120,000 Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 17,500 yards* × $6.00 per yard = $105,000 ↑ Price Variance, Quantity Variance, $12,000 F $15,000 U Total Variance, $3,000 U * 5,000 suits × 3.5 yards per suit = 17,500 yards F = Favorable U = Unfavorable © The McGraw-Hill Companies, Inc., 2006 All rights reserved ↑ TM 10-11 DIRECT MATERIAL VARIANCES (cont’d) The direct material variances can also be computed as follows: MATERIAL PRICE VARIANCE: • Method one: MPV = (AQ × AP) – (AQ × SP) = ($108, 000) – (20,000 yards × $6.00 per yard) = $12,000 F • Method two: MPV = AQ (AP – SP) = 20,000 yards ($5.40 per yard – $6.00 per yard) = $12,000 F The material price variance should be recorded at the time materials are purchased This permits: • Early recognition of the variance • Recording materials at standard cost MATERIAL QUANTITY VARIANCE: • Method one: MQV = (AQ × SP) – (SQ × SP) = (20,000 yards × $6.00 per yard) – (17,500 yards* × $6.00 per yard) = $15,000 U *5,000 suits × 3.5 yards per suit = 17,500 standard yards • Method two: MQV = SP (AQ – SQ) = $6.00 per yard (20,000 yards – 17,500 yards) = $15,000 U © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-12 DIRECT LABOR VARIANCES The following data are for last month’s production: Number of suits completed (as before) Cost of direct labor (10,500 hours @ $20 per hour) 5,000 units $210,000 Using these data and the data from the standard cost card, the labor rate and efficiency variances are: Actual Hours of Input, at the Actual Rate (AH × AR) 10,500 hours × $20 per hour = $210,000 ↑ Actual Hours of Input, at the Standard Rate (AH × SR) 10,500 hours × $18 per hour = $189,000 Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 10,000 hours* × $18 per hour = $180,000 ↑ ↑ Rate Variance, Efficiency Variance, $21,000 U $9,000 U Total Variance, $30,000 U * 5,000 suits × 2.0 hours per suit = 10,000 hours F = Favorable U = Unfavorable © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-13 DIRECT LABOR VARIANCES (cont’d) The direct labor variances can also be computed as follows: LABOR RATE VARIANCE: • Method one: LRV = (AH × AR) – (AH × SR) = ($210,000) – (10,500 hours × $18 per hour) = $21,000 U • Method two: LRV = AH (AR – SR) = 10,500 hours ($20 per hour – $18 per hour) = $21,000 U LABOR EFFICIENCY VARIANCE: • Method one: LEV = (AH × SR) – (SH × SR) = (10,500 hours × $18 per hour) – (10,000 hours* × $18 per hour) = $9,000 U *5,000 suits × 2.0 hours per suit = 10,000 hours • Method two: LEV = SR (AH – SH) = $18 per hour (10,500 hours – 10,000 hours) = $9,000 U © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-14 VARIABLE MANUFACTURING OVERHEAD VARIANCES The following data are for last month’s production: Number of suits completed (as before) Actual direct labor-hours (as before) Variable overhead costs incurred 5,000 units 10,500 hours $40,950 Using these data and the data from the standard cost card, the variable overhead variances are: Actual Hours of Input, at the Actual Rate (AH × AR) $40,950 ↑ Actual Hours of Input, at the Standard Rate (AH × SR) 10,500 hours × $4 per hour = $42,000 Spending Variance, $1,050 F ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 10,000 hours* × $4 per hour = $40,000 Efficiency Variance, $2,000 U Total Variance, $950 U * 5,000 suits × 2.0 hours per suit = 10,000 hours F = Favorable U = Unfavorable © The McGraw-Hill Companies, Inc., 2006 All rights reserved ↑ TM 10-15 VARIABLE OVERHEAD VARIANCES (cont’d) The variable manufacturing overhead variances can also be computed as follows: OVERHEAD SPENDING VARIANCE: • Method one: VOSV = (AH × AR) – (AH × SR) = ($40,950) – (10,500 hours × $4.00 per hour) = $1,050 F • Method two: VOSV = AH (AR – SR) = 10,500 hours ($3.90 per hour* – $4.00 per hour) = $1,050 F * $40,950 ÷ 10,500 hours = $3.90 per hour OVERHEAD EFFICIENCY VARIANCE: • Method one: VOEV = (AH × SR) – (SH × SR) = (10,500 hours × $4.00 per hour) – (10,000 hours** × $4.00 per hour) = $2,000 U ** 5,000 suits × 2.0 hours per suit = 10,000 hours • Method two: VOEV = SR (AH – SH) = $4.00 per hour (10,500 hours – 10,000 hours) = $2,000 U © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-16 JOURNAL ENTRIES FOR VARIANCES (Appendix) Materials, work-in-process, and finished goods are all carried in inventory at their respective standard costs in a standard costing system Purchase of materials: Raw Materials (20,000 yards × $6.00 per yard) 120,000 Materials Price Variance (20,000 yards × $0.60 per yard F) 12,000 Accounts Payable (20,000 yards × $5.40 per yard) 108,000 Use of materials: Work-In-Process (17,500 yards × $6 per yard) 105,000 Materials Quantity Variance (2,500 yards U × $6 per yard) 15,000 Raw Materials (20,000 yards × $6 per yard) 120,000 Direct labor cost: Work-In-Process (10,000 hours × $18 per hour) 180,000 Labor Rate Variance (10,500 hours × $2 per hour U) 21,000 Labor Efficiency Variance (500 hours U × $18 per hour) 9,000 Wages Payable (10,500 hours × $20 per hour) 210,000 Note: Favorable variances are credit entries and unfavorable variances are debit entries © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-17 POTENTIAL PROBLEMS WITH STANDARD COSTS • Variances are often reported too late to be useful • If used as a tool for punishing people, standards can undermine morale • Labor efficiency standards encourage high output This may lead to excessive work-in-process if a workstation is not a bottleneck • A favorable quantity variance may be worse than an unfavorable quantity variance • Quality may suffer if undue emphasis is placed on just meeting the standards • Just meeting standards may not be sufficient; continual improvement is often necessary © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-18 THE BALANCED SCORECARD • A balanced scorecard consists of an integrated set of performance measures—financial and non-financial—that are derived from the company’s strategy and that support the company’s strategy throughout the organization • Financial measures tend to be lagging indicators of performance • Because strategies and operating environments are different, each company’s balanced scorecard will be different • A variety of different performance measures helps guard against potential problems that result from over-reliance on one performance measure However, too many performance measures may lead to a lack of focus • The emphasis is on continuous improvement rather than on meeting some preset target or standard • An individual should be able to strongly influence the performance measures that appear on his or her scorecard © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-19 THE BALANCED SCORECARD (cont’d) © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-20 THE BALANCED SCORECARD (cont’d) © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-21 THE BALANCED SCORECARD (cont’d) The performance measures on the company’s balanced scorecard should tell a coherent story of the cause and effect links that lead from actions by individuals to the objectives of the organization © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-22 SOME IMPORTANT MEASURES OF INTERNAL BUSINESS PROCESS PERFORMANCE © The McGraw-Hill Companies, Inc., 2006 All rights reserved TM 10-23 MANUFACTURING CYCLE EFFICIENCY Manufacturing cycle efficiency (MCE) is a measure of how much throughput time actually adds value MCE is defined by: MCE= Value-added time Process time = Throughput time Throughput time If the MCE is less than 1, the production process contains “nonvalue-added” time An MCE of 0.4 indicates that 60% (1.0 – 0.4 = 0.6) of the total production time consists of queuing, inspection, and move time, and therefore only 40% of the total time is productive Reducing the non-value-added activities of queuing, inspection, and moving will lead to improvement in MCE © The McGraw-Hill Companies, Inc., 2006 All rights reserved [...]...1 614 Chapter 10 Lecture Notes Helpful Hint: Before beginning the lecture, show students the tenth and eleventh segments from the second tape of the McGraw-Hill/ Irwin Managerial/ Cost Accounting video library These segments discuss many of the concepts presented in chapter 10 The lecture notes reinforce the concepts in the video 1 Chapter theme: This chapter begins our study of... how the key numbers are used to assess their performance I Standard costs – management by exception A Basic definitions/concepts i 2 A standard is a benchmark or “norm” for measuring performance In managerial accounting, two types of standards are commonly used by manufacturing, service, food, and not-for-profit organizations: 1 Quantity standards specify how much of an input should be used to make a... to the attention of management as “exceptions.” 1 This chapter applies the management by exception principle to quantity and cost (price) standards with an emphasis on manufacturing applications iii The variance analysis cycle is a continuous fourstep process: 4 1 The cycle begins with the preparation of standard cost performance reports in the accounting department 2 These reports highlight variances