Hilton • Maher • Selto

Standard Costing, Variance

16
Analysis, and Kaizen Costing

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

16-3

Using Standard-Costing
Systems for Control
STANDARDCOST
STANDARD COST
ACTUALCOST
ACTUAL COST
aabudget
budgetforfor the
the
used in
inthe
the
production of
of one
one used
production productionof of the
the
unit of
of product
product or or production
unit product or
or service
service
service product
service

COSTVARIANCE
COST VARIANCE
thedifference
the difference
betweenthe
between the
actualcost
actual costand
and
thestandard
the standardcost
cost
16-4

Management by Exception

Takethe
Take thetime
timeto
toinvestigate
investigateonly
onlysignificant
significant cost
costvariances
variances

Whatis
What issignificant?
significant?

Dependson
Depends on
Dependson
Depends on
the
the
theSize
the Sizeof
ofthe
the
Production
Production
Organization
Organization
Dependson
Depends on Process
Process
theType
the Typeof
of
the
the
Organization
Organization
16-5

Setting Standards

Analysis of What
WhatDID
DID Used
Usedin
inaamature
mature
Historical the
theproduct
product production
cost? productionProcess
Process
Data cost?

What
What Analyze
Analyzethe
theprocess
process
Task SHOULD
SHOULDthe the of
ofmanufacturing
manufacturing
Analysis product
product the
theproduct
product
cost?
cost?

A Analyze
Analyzethetheprocess
processfor
forthe
thestep
stepthat
that
Combined has
haschanged,
changed,but
butuse
usehistorical
historicaldata
data
Approach for
forthe
thesteps
steps that
thathave
havenot
notchanged
changed
16-6

Perfection Vs. Practical

Standards
PRACTICAL
PRACTICALOR
OR
PERFECTION
PERFECTION ATTAINABLE
ATTAINABLE
STANDARDS
STANDARDS STANDARDS
STANDARDS
Can
Canonly
onlybe
beattained
attained Tight
Tightas aspractical,
practical,
under
undernear
nearperfect
perfect but
butstill
stillare
areexpected
expected
conditions
conditions to
tobe
beattained
attained

••Peak
Peakefficiency
efficiency ••Occasional
Occasionalmachine
machine
••Lowest
Lowestpossible
possible breakdowns
breakdowns
input
inputprices
prices ••Normal
Normalamounts
amounts
••best-quality
best-qualitymaterial
material of
ofraw
rawmaterial
material
••no
nodisruption
disruptionin
in waste
waste
production
production
16-7

Use Of Standards

Standards
Standardscan
canbebeused
usedby
byservice
servicefirms,
firms,nonprofit
nonprofit
organizations,
organizations,and
andgovernmental
governmentalunits
units

COST
COST
BENEFITS
BENEFITS

Implementing
Implementingand
andmaintaining
maintainingcost
coststandards
standardscan
can
be
betime-consuming,
time-consuming,labor-intensive,
labor-intensive,and
andexpensive.
expensive.
16-8

Cost Variance Analysis

DIRECT
DIRECTMATERIAL
MATERIALSTANDARDS
STANDARDS
The
Thetotal
totalamount
amountof ofmaterial
material Standard
Standardquantity:
quantity:
normally
normallyrequired
requiredtotoproduce
produce Fabric
Fabricin infinished
finished
aafinished
finishedproduct
productincluding
including
product
product 11
11sq.
sq. meters
meters
Allowance
Allowance for for
allowances
allowancesforfornormal
normalwaste
waste normal
normal waste
waste 11sq.
sq.meters
meters
or
orefficiency
efficiency Total
Total standard
standard
quantity
quantityrequired
required
per tent
per tent 12
12sq.
sq. meters
meters
Koala
KoalaCamp
Camp
Gear
GearCompany
Company

The
Thetotal
totaldelivered
delivered
cost,
cost,after
after
subtracting
subtractingany
any
purchase
purchasediscounts
discounts
16-9

Cost Variance Analysis

DIRECT
DIRECTLABOR
LABORSTANDARDS
STANDARDS

Standard
Standard
Koala
KoalaCamp
Camp quantity:
quantity:
Gear
GearCompany
Company Direct
Direct labor
labor
required
required per
per tent
tent 22 hours
hours
Standard
Standard rate:
rate:
Hourly
Hourly w age rate
wage rate $15
$15
Fringe
Fringe benefits
benefits
(20%
(20%of
of wages)
wages) 3
3
Total
Total standard
standard
rate
rate per
per hour
hour $18
$18
16-10

Standard Costs Given Actual

Output
The
Thestandard
standardcost
costfor
for
the Direct
Directmaterial:
material:
thedirect-material
direct-material
and Standard
Standarddirect-material
anddirect-labor
direct-laborinputs
inputs direct-material
is cost
costper
pertent
tent(12
(12sq.
isbased
basedupon
uponKoala’s
Koala’s sq.
actual meters
metersxx $8
$8prprsq.
sq.meter) $96
actualoutput
outputofof meter) $96
3,000 Actual
Actualoutput x3,000
3,000tents
tents output x3,000
Total
Totalstandard
standarddirect-
direct-
They material
materialcost $288,000
Theyshould
shouldincur
incur cost $288,000
aacost
costof
of$396,000
$396,000
($288,000 Direct
Direct labor:
($288,000++$108,000)
$108,000) labor:
to Direct
Direct labor
labor cost
tomake
make3,000
3,000tents
tents cost
per
per tent
tent (2
(2 hours
hours xx
$16
$16 per
per hour)
hour) $36
$36
Koala
Koala Camp
Camp Actual
Actual output
output X
X 3,000
3,000
Gear Total
Total standard
GearCompany
Company standard
direct-labor
direct-labor cost
cost $108,000
$108,000
 Exh.
16-11 16-1

Analysis Of Material Variances

Actual Actual Actual Standard Standard Standard
x x x
quantity price quantity price quantity price
40,000 sq. 40,000 sq. 36,000
$8.15 per $8.00 per $8.00 per
meters x meters x sq. meters x
sq. meter sq. meter sq. meter
purchased purchased allowed

$326,000 $320,000 $288,000

$6,000U
Direct-material price variance
36,400 sq. $8.00
meters per sq.
used meter Direct-
material
quantity
$291,200 $3,200U variance
16-12

Direct-Material Variances

What
What caused
causedKoala
Koalato
tospend
spendmore
morethan
thanthe
the
anticipated
anticipatedamount
amount on
on direct
directmaterial?
material?

First,
First,the
thecompany
companypurchased
purchasedfabric
fabricat
ataahigher
higherprice
price($8.15
($8.15per
per
square
squaremeter)
meter)than
thanthe
thestandard
standardprice
price($8.00
($8.00per
persquare
squaremeter).
meter).
Direct-material
Direct-materialprice
pricevariance
variance==(PQ
(PQXXAP)
AP)--(PQ
(PQXXSP)
SP)==PQ(AP
PQ(AP--SP)
SP)
where:
where: PQPQ==Quantity
Quantitypurchased
purchased
AP
AP==Actual
Actualprice
price
SP
SP==Standard
Standardprice
price
Koala’s
Koala’sdirect-
direct-material
materialprice
pricevariance
variancefor
forJune
Juneis
iscomputed
computedas
asfollows:
follows:
Direct-material
Direct-materialprice
pricevariance
variance==PQ(AP
PQ(AP--SP)
SP)
==40,000
40,000($8.15
($8.15--$8.00)
$8.00)==$6,000
$6,000unfavorable
unfavorable
16-13

Direct-Material Variances

What
What caused
causedKoala
Koalato
tospend
spendmore
morethan
thanthe
the
anticipated
anticipatedamount
amount on
on direct
directmaterial?
material?
Second,
Second,the
thecompany
companyusedusedmore
more fabric
fabricthan
thanthe
thestandard
standardprice.
price.
(36,400
(36,400sq.
sq.meters
metersactually
actuallyused,
used,instead
insteadofofthe
thestandard
standardamount
amountof of
36,000
36,000sq.
sq.meters)
meters)
Direct-material
Direct-materialquantity
quantityvariance
variance==(AQ
(AQXXSP)SP)--(SQ
(SQXXSP)
SP)==
SQ(AQ
SQ(AQ--SQ)SQ) where:
where:
AQ
AQ==Actual
Actualquantity
quantityused
used
SQ
SQ==Standard
Standardquantity
quantityallowed
allowed
Koala’s
Koala’sdirect-
direct-material
materialquantity
quantityvariance
variancefor
forJune
June
is
iscomputed
computedas asfollows:
follows:
Direct-material
Direct-materialquantity
quantityvariance
variance==SP(AQ
SP(AQ--SQ)
SQ)
== $8.00(36,400
$8.00(36,400--36,000)
36,000)
=$3,200
=$3,200 unfavorable
unfavorable
 Exh.
16-14 16-2

Analysis of Direct-Labor Variances

Actual Labor Cost Standard Labor Cost

Actual Actual Actual Standard Standard Standard
X X X
hours rate hours price rate rate
5,900 $19 5,900 $18 6,000 $18
hours X per hours X per hours X per
used hour used hour allowed hour

$112,100 $106,200 $108,000

$5,900 Unfavorable $1,800 Favorable

Direct-labor Direct-labor
rate variance efficiency variance

$4,100 Unfavorable

Direct-labor variance
16-15

Direct-Labor Variances
What
What caused
causedKoala
Koalato
tospend
spendmore
morethan
thanthe
the
anticipated
anticipatedamount
amount on
on direct
direct labor?
labor?
First,
First,the
thecompany
companyincurred
incurred aacost
costof
of$19
$19per
perhour
hourfor
fordirect
direct
labor
laborinstead
insteadof
ofthe
thestandard
standard amount
amountof
of$18
$18per
perhour
hour
Direct-labor
Direct-laborrate
ratevariance
variance==(AH(AHXXAR)
AR)--(AH
(AHXXSR)
SR)==
AH(AR
AH(AR--SR)SR) where:
where:
AH
AH==Actual
Actualhours
hoursused
used
AR
AR==Actual
Actualrate
rateper
perhour
hour
SR
SR==Standard
Standardrate
rateper
perhour
hour
Koala’s
Koala’sdirect-labor
direct-laborrate
ratevariance
variancefor
forJune
June
is
iscomputed
computedas asfollows:
follows:
Direct-labor
Direct-laborrate
ratevariance
variance==AH(AR
AH(AR--SR)
SR)
== 5,900
5,900($19
($19--$18)
$18)
=$5,900
=$5,900unfavorable
unfavorable
16-16

Direct-Labor Variances
What
What caused
causedKoala
Koalato
tospend
spendmore
morethan
thanthe
the
anticipated
anticipatedamount
amount on
on direct
direct labor?
labor?
Koala
Koalaused
usedonly
only5,900
5,900hours
hoursofofdirect
directlabor,
labor,which
whichisis<<standard
standard
quantity
quantityofof6,000
6,000hours,
hours,given
givenactual
actualoutput
outputofof3,000
3,000tents.
tents. The
The
increased
increasedefficiency
efficiencydoes
doesnot
notfully
fullyoffset
offsetthe
theunexpectedly
unexpectedlyhighhigh
wage
wagerate.
rate.
Direct-labor
Direct-laborefficiency
efficiencyvariance
variance==(AH
(AHXXSR)SR)--(SH
(SHXXSR)
SR)==
SR(AH
SR(AH--SH)SH) where:
where:
AH
AH==Actual
Actualhours
hoursused
used
SH
SH==Standard
Standardhours
hoursallowed
allowed
Koala’s
Koala’sdirect
direct--labor
laborefficiency
efficiencyvariance
varianceforforJune
June
is
iscomputed
computedas asfollows:
follows:
Direct
Direct--labor
laborefficiency
efficiencyvariance
variance==SR(AH
SR(AH--SH)
SH)
== $18
$18(5,900
(5,900--6,000)
6,000)==$1,800
$1,800 favorable
favorable
16-17

Multiple Types Of Direct

Material Or Direct Labor
When
Whenthere
thereare
areseveral
several types
typesof ofdirect
directmaterial
materialorordirect
direct
labor,
labor, price
priceand
andquantity
quantityvariances
variancesarearecomputed
computedfor for
each
eachtype,
type, and
and then
thenadded
addedto toobtain
obtainaatotal
total price
price
variance
varianceand
andaatotal
total quality
qualityvariance
variance

Direct
Direct material
material XX $1,500
$1,500 FF $1,900
$1,900 UU
Direct
Direct material
material YY 2,400
2,400 UU 300
300 UU
Direct
Direct material
material ZZ 900
900 UU 400
400 FF
Total
Total variance
variance $1,800
$1,800 UU $1,800
$1,800 UU
16-18

Allowance For Defects Of Spoilage

In
Insome
somemanufacturing
manufacturing processes,
processes, aacertain
certainamount
amount
of
of defective
defective production
productionor
or spoilage
spoilageis
is normal.
normal.

Example:
Example:1,0001,000liters
litersof
ofchemicals
chemicalsare
arenormally
normallyrequired
requiredin
inaa
chemical
chemicalprocess
processin inorder
ordertotoobtain
obtain800
800liters
litersofofgood
goodoutput.
output.
IfIftotal
totalgood
goodoutput
outputininFebruary
Februaryisis5,000
5,000liters,
liters,what
whatis
isthe
the
standard
standardallowed
allowedquantity
quantityof
ofinput?
input?

Good
Goodoutput
outputquantity
quantity ==80%
80%XXInput
Inputquantity
quantity

Good
Goodoutput
outputquantity
quantity÷÷80%
80% ==Input
Inputquantity
quantityallowed
allowed

5,000
5,000liters
litersof
ofgood
good ==6,250
6,250liters
litersof
of
output
output÷÷80%
80% input
inputallowed
allowed
16-19

Management by Exception

What
Whatconstitutes
constitutesan
anexception?
exception?
How
Howdoes
doesaamanager
managerknow
knowwhen
whento
tofollow
followup
up
on
onaacost
costvariance
varianceand
andwhen
whento
toignore
ignoreit?
it?

Size
Size of
of Variance
Variance

Absolute
AbsoluteAmount
Amount

RULE
RULEOF
?OFTHUMB:
THUMB:
Relative
RelativeAmount
Amount

Investigate
Investigatevariances
variancesthat
thatare
areeither
eithergreater
greaterthan
than$10,000
$10,000or
or
greater
greaterthan
than10
10percent
percentofofstandard
standardcost
cost
16-20

Recurring Variances

MONTH
MONTH VARIANCE
VARIANCE % %OF
OF STANDARD
STANDARD COST
COST
September
September $6,000
$6,000 FF 6.0%
6.0%
October
October 6,400
6,400 FF 6.4%
6.4%
November
November 3,200
3,200 FF 3.2%
3.2%
December
December 6,200
6,200 FF 6.2%
6.2%

None Standard
Noneofofthe
thevariances
variancesare
aregreater
greaterthan
than$10,000
$10,000or
or Standard
10%, direct
10%, but
butthis
thisvariance
varianceshould
shouldbe beinvestigated
investigated labor
direct
because laborcost
cost
becauseitithas
hasoccurred
occurred atataareasonably
reasonably isis$100,000
high $100,000
highamount
amountforforfour
fourmonths
months
16-21

Trends

MONTH
MONTH VARIANCE
VARIANCE % %OF
OF STANDARD
STANDARD COST
COST
September
September $250
$250 UU 0.25%
0.25%
October
October 840
840 UU 0.84%
0.84%
November
November 4,000
4,000 UU 4.0%
4.0%
December
December 9,300
9,300 UU 9.3%
9.3%

None
Noneofofthe
thevariances
variancesare
aregreater
greaterthan
than$10,000
$10,000or
or Standard
Standard
10%, direct
10%, but
butthis
thisvariance
varianceshould
shouldbe
beinvestigated
investigated direct
because labor
becauseitithas
hasan
anunfavorable
unfavorabletrend.
trend. labor
isis$100,000
$100,000
16-22

Additional Issues

Controllability Favorable
FavorableVariances
Variances
Controllability ItItis
AAmanager
manageris ismore
morelikely
likely isas
asimportant
importanttotoinvestigate
investigate
to significant
significantfavorable
favorablevariances
variancesas
as
toinvestigate
investigateaavariance
variance well
that
thatis
iscontrollable
controllableby by wellas assignificant
significantunfavorable
unfavorable
someone variances
variances
someonein inthe
the
organization
organizationthan
thanone
one
that
thatis
isnot
not

Cost
Cost and
and Benefits
Benefitsof
of
Investigation
Investigation
The
Thedecision
decisionwhether
whethertoto
investigate
investigateaavariance
variance is
isaacost
cost--
benefit
benefitdecision
decision
 Exh.
16-23 16-4

Statistical Analysis

AASTATISTICAL
STATISTICALCONTROL
CONTROLCHARTCHARTplots
plotscost
costvariances
variances
across
acrosstime
timeand
andcompares
comparesthemthemwith
withaastatistically
statistically
determined
determinedcritical
criticalvalue
valuethat
thattriggers
triggersan
aninvestigation
investigation

Favorable
variances Investigate
1 standard
deviation
X
Critical X
X Time
value
X X
1 standard X
deviation
Unfavorable Jan. Feb. March April May June
variances
16-24

Behavioral Effects Of
Standard Costing
Standard
Standard costs,
costs,budgets,
budgets,and
andvariances
variancesare
areused
usedto
to
evaluate
evaluatethe
theperformance
performanceofofindividuals
individualsand
anddepartments
departments

They
Theycan
canprofoundly
profoundlyinfluence
influencebehavior
behaviorwhen
whenthey
theyare
areused
usedto
to
determine
determinesalary
salaryincreases,
increases,bonuses,
bonuses,and
andpromotions
promotions
16-25

Which Managers Generally

Influence Cost Variances?
Direct-material price variance The purchasing manager
Get the best prices available for purchased goods and services 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 employees than that anticipated
when the standard were set

Direct- labor efficiency variance The production supervisor

Motivating employees toward production goals and effective work schedules
improves efficiency
 Exh.
16-26 16-5

Interaction Among Variances

Interactionamong
Interaction amongvariances
variancesoften
oftenoccur
occurmaking
makingititdifficult
difficultto
to
determinethe
determine theresponsibility
responsibilityfor
foraaparticular
particularvariance
variance

Variancesin
Variances inone
onepart
partof
ofthe
thevalue
valuechain
chaincan
canbe
bedue
dueto
toroot
rootcauses
causes
inanother
in anotherpart
partof
ofthe
thechain
chain

Value Chain
Physical
Physical Human
Human
resources
resources resources
resources
Perspective

Research
and Produc- Distri- Customer
Design Supply Marketing
develop- tion bution service
ment
 Exh.
16-27 16-6

Using Standard Costs For

Product Costing
Work-in-Process Inventory Finished-Goods Inventory

Direct-material cost

Direct-labor cost Product cost transferred

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
16-28

Disposition Of Variances
Cost of Goods Sold

Variances
Variancesare are
temporary
temporary Unfavorable Favorable
accounts, variances variances
accounts, likelike represent represent
revenue
revenueand and costs of costs of
expense
expense operating operating
accounts,
accounts,and and inefficiently, efficiently,
they
theyare areclosed
closed relative to the relative to the
out standards, and standards, and
out at at the
theend
endofof thus cause thus cause
the
theaccounting
accounting the Cost of the Cost of
period.
period. Goods Sold Goods Sold
to be to be
higher lower
16-29

Impact of Information
Technology on Standard Costing
16-30

Standard Costing:
Advantages
 Allows
Allowsmanagers
managersto touse
use  Provides
Provides motivation
motivation
management
management by by for
for employees
employees to to
exception
exception adhere
adhere to to standards
standards
 Provides
Providesaabasis
basisfor
for  Results
Results in in more
more
sensible
sensiblecost stable
cost stable product
product costs
costs
comparisons
comparisons  Is
Provides
Is less
less expensive
expensive

Providesaameans
meansof of than
than actual-
actual- or
or
performance
performanceevaluation
evaluation normal-
and normal- costing
costing
andrewards
rewardsforfor systems
employees systems
employees
16-31

Criticisms Of Standard Costing In

Today’s Environment
 Variances
Variancesare areoften
oftentootoo  Shorter
Shorterproduct
productlife
lifecycles
cycles
aggregated.
aggregated. TheyTheyare
arenotnottied
tied mean
meanthat
thatstandards
standardsare areonly
only
to
tospecific
specificproduct
productlines,
lines, relevant
relevantfor
foraashort
shorttime
time
production
productionbatches,
batches,or orto
tothe Too
the 
Toomuch
muchfocus
focusononcost
cost
flexible
flexiblemanagement
managementsystem minimization
system minimizationrather
ratherthan
than
 Variances
Variancesare areoften
oftentootoolate
lateto
to increasing
increasingproduct
productquality
qualityor
or
be
beuseful
useful customer
customerservice
service
 Standard
Standardcosting
costingout
outofofstep
step  Automated
Automatedmanufacturing
manufacturing
with
withthe
thephilosophy
philosophyof ofcost
cost processes
processestend
tendtotobebemore
more
management
managementsystems
systemsand and consistent
consistentininmeeting
meeting
activity-based
activity-basedmanagement
management production
productionspecifications.
specifications.
 Too
Toomuch
muchfocus
focuson
onthethecost
cost  Not
Notdefined
definedbroadly
broadlyenough
enoughto to
and
andefficiency
efficiencyofofdirect
directlabor
labor capture
captureimportant
importantaspect
aspectof of
ownership
ownership
16-32

Adaptation of Standard-
Costing Systems
Reduced
Reduced Emphasis
Emphasison on
importance
importanceof
of Material
Materialand
and
labor
laborstandards
standards Real-time
Real-time O/H
O/Hcosts
costs
Information
Information
Shorter Systems
Systems
Shorter
Product
ProductLife
Life Cost
Cost
Cycles
Cycles Drivers
Drivers
Shifting
ShiftingCost
Cost
Benchmarkin Structures
Structures
Benchmarkin
gg High
High
Quality/Zero
Quality/Zero
Non-Value-
Non-Value- Defects
Defects
Added
AddedCosts
Costs
 Exh.
16-33 16-7

Kaizen Costing
KAIZEN
KAIZENCOSTING
COSTINGis isthe
theprocess
processof ofcost
costreduction
reductionduring
duringthe
the
manufacturing
manufacturingphase
phaseofofaaproduct.
product. Improvement
Improvementis isthe
thegoal
goaland
and
responsibility
responsibilityof
ofeach
eachworker.
worker.

Cost per product unit

Current year
cost base Actual cost
reduction
Kaizen goal: achieved
cost reduction
rate
Actual cost
performance
of the Cost base
current year for next
Time
year
12/31/x0 12/31/x1
16-34

END OF CHAPTER 16