Standard Costs and Operating Performance Measures Chapter 11 McGraw­Hill/Irwin       Copyright © 2010 by The McGraw­Hill Companies, Inc. All rights reserved Standard Costs Standards are benchmarks or “norms” for measuring performance In managerial accounting, two types of standards are commonly used Quantity standards specify how much of an input should be used to make a product or provide a service Price standards specify how much should be paid for each unit of the input Examples: Firestone, Sears, McDonald’s, hospitals, construction and manufacturing companies 11-2 Standard Costs Amount Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception Standard Direct Labor Direct Material Manufacturing Overhead Type of Product Cost 11-3 Variance Analysis Cycle Identify questions Receive explanations Take corrective actions Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin 11-4 Setting Standard Costs Should we use ideal standards that require employees to work at 100 percent peak efficiency? Engineer I recommend using practical standards that are currently attainable with reasonable and efficient effort Managerial Accountant 11-5 Setting Direct Material Standards Price Standards Quantity Standards Final, delivered cost of materials, net of discounts Summarized in a Bill of Materials 11-6 Setting Direct Labor Standards Rate Standards Time Standards Often a single rate is used that reflects the mix of wages earned Use time and motion studies for each labor operation 11-7 Setting Variable Manufacturing Overhead Standards Rate Standards Quantity Standards The rate is the variable portion of the predetermined overhead rate The quantity is the activity in the allocation base for predetermined overhead 11-8 Price and Quantity Standards Price and quantity standards are determined separately for two reasons:  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 11-9 A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Difference between actual price and standard price Difference between actual quantity and standard quantity 11-10 A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Materials price variance Labor rate variance VOH rate variance Materials quantity variance Labor efficiency variance VOH efficiency variance 11-11 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance 11-12 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used 11-13 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Standard quantity is the standard quantity allowed for the actual output of the period 11-14 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Actual price is the amount actually paid for the input used 11-15 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance Standard price is the amount that should have been paid for the input used 11-16 A General Model for Variance Analysis Actual Quantity × Actual Price Actual Quantity × Standard Price Price Variance Standard Quantity × Standard Price Quantity Variance (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity AP = Actual Price SP = Standard Price SQ = Standard Quantity 11-17 Responsibility for Material Variances Materials Quantity Variance Production Manager Materials Price Variance Purchasing Manager The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance 11-18 Responsibility for Labor Variances Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks Level of employee motivation Quality of production supervision Production Manager Quality of training provided to employees 11-19 Advantages of Standard Costs Management by exception Promotes economy and efficiency Advantages Simplified bookkeeping Enhances responsibility accounting 11-20 Potential Problems with Standard Costs Emphasizing standards may exclude other important objectives Standard cost reports may not be timely Invalid assumptions about the relationship between labor cost and output Potential Problems Favorable variances may be misinterpreted Emphasis on negative may impact morale Continuous improvement may be more important than meeting standards 11-21 Delivery Performance Measures Order Received Wait Time Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time Process time is the only value-added time 11-22 Delivery Performance Measures Order Received Wait Time Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time Manufacturing Cycle = Efficiency Value-added time Manufacturing cycle time 11-23 End of Chapter 11 11-24 ...Standard Costs Standards are benchmarks or “norms” for measuring performance In managerial accounting, two types of standards are commonly used Quantity standards specify how much of... 11-19 Advantages of Standard Costs Management by exception Promotes economy and efficiency Advantages Simplified bookkeeping Enhances responsibility accounting 11-20 Potential Problems with Standard... recommend using practical standards that are currently attainable with reasonable and efficient effort Managerial Accountant 11-5 Setting Direct Material Standards Price Standards Quantity Standards