Standard Costing, Variance Analysis, and Kaizen Costing

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• Standard Costing,Variance Analysis, and Kaizen
  Costing

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Using Standard-Costing Systems for Control
Based on carefullypredetermined amounts.
Used for planning labor and material requirements.
The expected levelof performance.
Benchmarks formeasuring performance.
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Using Standard-Costing Systems for Control
COST VARIANCE the difference between the actual
cost and the standard cost
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Using Standard-Costing Systems for Control
Standard
A standard cost varianceis the amount by
whichan actual cost differs fromthe standard
cost.
Product Cost
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Management by Exception
Managers focus on quantities and coststhat
exceed standards, a practice known as management
by exception.
Standard
Amount
DirectMaterial
DirectLabor
Type of Product Cost
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Management by Exception

• Take the time to investigate only significant
  cost variances.

What is significant?
Depends on the Size of the Organization
Depends on the Production Process
Depends on the Type of the Organization
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Variance Analysis Cycle


Takecorrective actions
Identifyquestions
Receive explanations
Conduct next periods operations

Analyze variances
Prepare standard cost performance report
Begin
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Setting Standards
What DID the product cost?
Analysis of Historical Data
Used in a mature production Process
What SHOULD the product cost?
Task Analysis
Analyze the process of manufacturing the product
A Combined Approach
Analyze the process for the step that has
changed, but use historical data for the steps
that have not changed
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Participation in Setting Standards

• Accountants, engineers, personnel
  administrators, and production managers combine
  efforts to set standards based on experience and
  expectations.

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Perfection Versus Practical Standards A
Behavioral Issue
PERFECTION STANDARDS
PRACTICAL OR ATTAINABLE STANDARDS
Can only be attained under near perfect conditions
Tight as practical, but still are expected to be
attained

• Occasional machine
• breakdowns
• Normal amounts
• of raw material
• waste

• Peak efficiency
• Lowest possible input prices
• best-quality material
• no disruption in
• production

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Perfection Versus Practical Standards A
Behavioral Issue
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Perfection Versus Practical Standards A
Behavioral Issue
I agree. Perfection standards areunattainable
and therefore discouraging to most employees.
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Setting Standards Direct Materials
QuantityStandards
PriceStandards
Use competitivebids for the qualityand quantity
desired.
Use product design specifications.
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Setting Standards Direct Materials
The standard material cost for one unit of
product is standard quantity
standard price for of material
one unit of material
required for one unit of product

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Setting Standards Direct Labor
EfficiencyStandards
RateStandards
Use wage surveys andlabor contracts.
Use time and motion studies foreach labor
operation.
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Setting Standards Direct Labor
The standard labor cost for one unit of product
is standard number standard wage
rate of labor hours
for one hour for one
unit
of product

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Standard Cost in Service Industries

• Jobs with repetitive tasks lend themselves to
  efficiency measures.
• Computing nonmanufacturing efficiency variances
  requires some assumed relationship between input
  and output activity.

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Standard Cost in Service Industries
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Costs and Benefits ofStandard-Costing Systems
Costs
Benefits
COST BENEFITS
Implementing and maintaining cost standards
can be time-consuming, labor-intensive, and
expensive.
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Cost Variance Analysis
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A General Model for Variance Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual Price Standard Price
Standard Price
Price or RateVariance
Quantity or Efficiency Variance
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A General Model forVariance Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual Price Standard Price
Standard Price
Price or RateVariance
Quantity or Efficiency Variance
Standard price is the amount that should have
been paid for the resources acquired.
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A General Model forVariance Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual Price Standard Price
Standard Price
Quantity or Efficiency Variance
Price or RateVariance
Standard quantity is the quantityallowed for the
actual good output.
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A General Model forVariance Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual Price Standard Price
Standard Price
Price or RateVariance
Quantity or Efficiency Variance
Materials price variance Materials
quantity variance Labor rate variance
Labor efficiency variance
Variable overhead Variable
overhead spending variance
efficiency variance
AQ(AP - SP)
SP(AQ - SQ) AQ Actual Quantity
SP Standard Price AP Actual Price
SQ Standard Quantity
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Standard Costs
Lets use the concepts of the general model to
calculate standard cost variances, starting
withdirect material.
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Material Variances

• Koala Camp Gear Company in MelbourneAustralia
  has the following direct materialstandard to
  manufacture one Tree Line tent
• 12 square meters per tent at8.00 per square
  meter
• Last month Koala purchased 40,000
  squaremeters at 8.15 per square meter and
  used36,400 square meters to make 3,000 tents.

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Material Variances
Actual Quantity Actual Quantity
Purchased Purchased

Actual Price Standard Price

40,000 sqm. 40,000 sqm.

8.15 per sqm.
8.00 per sqm. 326,000
320,000
Price variance6,000 Unfavorable
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Material Variances
SQ 3,000 tents 12 sqm. per tent SQ 36,000
sqm.
Actual
Quantity
Used Standard Quantity


Standard Price
Standard Price
We should compute the quantity variance using the
actual quantity used.
36,400
sqm. 36,000 sqm.


8.00 per sqm. 8.00 per
sqm.
291,200 288,000
Quantity variance3,200 Unfavorable
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Material Variances
We may also calculate materialvariances using
formulas
MPV AQp(AP SP) MPV 40,000 sqm. (8.15
8.00) MPV 6,000 Unfavorable
MQV SP(AQu SQ) MQV 8.00(36,400 sqm.
36,000 sqm.) MQV 3,200 Unfavorable
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Reporting Material Variances
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Responsibility forMaterial Variances
I am not responsiblefor this unfavorablematerial
usagevariance. You bought poor
qualitymaterial, so my peoplehad to use more of
it.
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Standard Costs
Now lets calculate standard cost variances for
direct labor.
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Labor Variances
Koala has the following direct laborstandard
to manufacture one Tree Line tent 2 standard
hours per tent at18.00 per direct labor hour
Last month 5,900 direct labor hours were worked
at 19.00 per hour to make 3,000 tents.
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Labor Variances
SH 3,000 tents 2 hours per tent SH 6,000
hours
Actual Hours Actual Hours
Standard Hours

Actual Rate Standard Rate
Standard Rate
5,900 hours 5,900 hours
6,000 hours

19.00 per hour 18.00 per
hour 18.00 per hour 112,100
106,200
108,000
Rate variance5,900 Unfavorable
Efficiency variance1,800 Favorable
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Labor Variances
We may also calculate laborvariances using
formulas
LRV AH(AR - SR) LRV 5,900 hrs(19.00 -
18.00) LRV 5,900 Unfavorable
LEV SR(AH - SH) LEV 18.00(5,900 hrs -
6,000 hrs) LEV 1,800 Favorable
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Labor Rate Variance A Closer Look
Using highly paid skilled workers toperform
unskilled tasks results in anunfavorable price
variance.
High skill,high rate
Low skill,low rate
Production managers who make work assignmentsare
generally responsible for price variances.
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Labor Efficiency Variance A Closer Look
UnfavorableEfficiencyVariance
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Responsibility for Labor Variances
I am not responsible for the unfavorable
laborefficiency variance! You bought poor
qualitymaterial, so my people usedmore time to
process it.
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Responsibility for Labor Variances
Maybe I can attribute the laborand material
variances to personnel for hiring the wrong
peopleand training them poorly.
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Allowance for Defects or Spoilage
In some manufacturing processes, a certain amount
of defective production or spoilage is normal.
Example 1,000 liters of chemicals are normally
required in a chemical process in order to obtain
800 liters of good output. If total good output
in February is 5,000 liters, what is the standard
allowed quantity of input?
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Significance of Cost Variances When to follow Up
How does a manager know when to follow up on a
cost variance and when to ignore it?
Size of Variance
?
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Significance of Cost Variances

• Size of variance
• Dollar amount
• Percentage of standard
• Recurring variances
• Trends
• Controllability
• Favorable variances
• Costs and benefits of investigation

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Significance of Cost Variances When to follow Up
How do I know which variances to investigate?
We could use a rule of thumb such asinvestigate
all variances that are over 10,000or over 10
percent of the standard cost.
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Significance of Cost Variances When to follow Up
What about recurring variances?
None of the variances are greater than 10,000
or 10 for any one month, but they should be
investigated because of they have continued for
several months.
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Significance of Cost Variances When to follow Up
What about trends?
None of the variances are greater than 10,000
or 10 for any one month, but they should
beinvestigated because of the unfavorable trend.
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Significance of Cost Variances When to follow Up
Controllability A manager is more likely to
investigate a variance that is controllable by
someone in the organization than one that is not.
Favorable Variances It is as important to
investigate significant favorable variances as
well as significant unfavorable variances.
Cost and Benefits of Investigation The decision
whether to investigate a variance is a cost -
benefit decision
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Statistical Analysis
ControlCharts
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Statistical Analysis
Warning signals for investigation


Favorable Limit





Desired Value

Unfavorable Limit

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Variance Measurements
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Behavioral Effects Of Standard Costing
Standard costs, budgets, and variances are used
to evaluate the performance of individuals and
departments
They can profoundly influence behavior when they
are used to determine salary increases, bonuses,
and promotions
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Which Managers Influence Cost Variances?
Direct-material price variance
The purchasing manager
Get the best prices available for purchased goods
andservices through skillful purchasing practices
Direct-material quantity variance
The production supervisor
Skillful supervision and motivation of production
employees, coupled with the careful use and
handling of materials, contribute to minimal waste
Direct-labor rate variance
The production supervisor
Generally results from using a different mix of
employeesthan that anticipated when the standard
were set
Direct-labor efficiency variance
The production supervisor
Motivating employees toward production goals
andeffective work schedules improves efficiency
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Interaction Among Variances
Exh. 16-5
Interaction among variances often occur making it
difficult to determine the responsibility for a
particular variance.
Variances in one part of the value chain can
bedue to root causes in another part of the
chain.
Value Chain
Perspective
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Using Standard Costs For Product Costing
Exh. 16-6
Work-in-Process Inventory
Finished-Goods Inventory
Direct-material cost
Product cost transferred
Direct-labor cost
when product is finished
Manufacturing Overhead
Product cost transferred when product is sold
Cost of Goods Sold
Income Summary
Expense closed into
Income Summary at end of accounting period
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Standard Cost Journal Entries

• Inventories are recorded at standard cost.
• Variances are recorded as follows
• Favorable variances are credits, representing
  savings in production costs.
• Unfavorable variances are debits, representing
  excess production costs.
• Standard cost variances are usually closed to
  cost of goods sold.
• Favorable variances decrease cost of goods sold.
• Unfavorable variances increase cost of goods sold.

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Impact of Information Technology on Standard
Costing
Labor time and rate recorded at standard,using
bar codesand employee IDs.
CAD designs accessdata base for instantdesign
cost estimates.
Standard costdata base
Material purchases and uses recordedat
standard,using bar codes.
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Standard Costing Its Traditional Advantages
Managementby Exception
Sensible CostComparisons
PerformanceEvaluation
EmployeeMotivation
Less expensive thanactual- or normal-costing
systems
More stableproduct costs
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Criticisms of Standard Costing in Todays
Manufacturing Environment

• Too much focus on the cost and efficiency of
  direct labor.
• Automation reduces labor costs and the
  significance of labor variances.
• Automated manufacturing processes tend to be more
  consistent in meeting production specifications.
• Variances are often too late to be useful.

• Variances are often too aggregated. They are not
  tied to specific product lines, production
  batches, or to the flexible management system.
• Standard costing may not be applicable in
  flexible manufacturing operationswith short
  life-cycle products.
• Too much focus on cost minimization rather than
  increasing product quality or customer service.

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Adaptation of Standard-Costing Systems
Applications of standard costing have adapted
tochanges in the manufacturing environment and
theresulting criticisms leveled at standard
costing.
Automation means more overhead, less labor.
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Adaptation of Standard-Costing Systems
Applications of standard costing have adapted
tochanges in the manufacturing environment and
theresulting criticisms leveled at standard
costing.
Automation
Reduces labor efficiency variance
Reduces material quantity variance
Reduces variation in qualityand increases quality
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Adaptation of Standard-Costing Systems
Applications of standard costing have adapted
tochanges in the manufacturing environment and
theresulting criticisms leveled at standard
costing.
Benchmarking affects standard costs
Shorter Product Life Cycles
Eliminating Non-Value-Added Costs
More frequent revisions of standard costs
Real-time information systems provide more timely
variance reports
Non-financial measures such a delivery times are
more important
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Comparing Standard Costing and Kaizen Costing

• Standard costing the use of carefully
  predetermined product costs for budgeting and
  performance evaluation.
• Standard costs are typically used in established
  production processes.
• Kaizen costing the emphasis is on continuous
  reduction of production costs.
• Rather than standards or targets, the goal is
  current costs that are less than previous costs.

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Kaizen Costing
Exh. 16-7
Kaizen goal cost reduction amount
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End of Chapter 16