Standard Costs and the Balanced Scorecard Chapter 10.

Standard Costs and the Balanced

Scorecard

Chapter 10

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

Standard Costs

Standard Costs are

Predetermined.

Used for planning labor, materialand overhead requirements.

Benchmarks formeasuring performance.

Used to simplify theaccounting system.


Standard Costs

DirectMaterial

Managers focus on quantities and coststhat exceed standards, a practice known as

management by exception.

Type of Product Cost

Am

ou

nt

DirectLabor

ManufacturingOverhead

Standard


Accountants, engineers, personnel administrators, and production managers combine efforts to set standards

based on experience and expectations.

Setting Standard Costs


Setting Standard Costs

Should we usepractical standardsor ideal standards?

Engineer ManagerialAccountant


Setting Standard CostsPractical standards should be set at levels that are currently attainable with reasonable and

efficient effort.

Productionmanager


Setting Standard CostsI agree. Ideal standards,

based on perfection,are unattainable and

discourage mostemployees.

Human ResourcesManager


Note

The argument that ideal standards are discouraging has been persuasive for many years. So “normal” defects and waste were built into the standards.

In recent years, TQM and other initiatives have sought to eliminate all defects and waste. Ideal standards, that allow for no waste, have

become more popular. The emphasis is on improvement over time, not

attaining the ideal standards right now.

The argument that ideal standards are discouraging has been persuasive for many years. So “normal” defects and waste were built into the standards.

In recent years, TQM and other initiatives have sought to eliminate all defects and waste. Ideal standards, that allow for no waste, have

become more popular. The emphasis is on improvement over time, not

attaining the ideal standards right now.


Setting Direct Material Standards

PriceStandards

Final, deliveredcost of materials,net of discounts.

QuantityStandards

Use product design specifications.


Setting Direct Labor Standards

RateStandards

Use wage surveys and

labor contracts.

TimeStandards

Use time and motion studies for

each labor operation.


Setting Variable Overhead Standards

RateStandards

The rate is the variable portion of the

predetermined overhead rate.

ActivityStandards

The activity is the base used to calculate

the predetermined overhead.


Standard Cost Card – Variable Production Cost

A standard cost card for one unit of product might look like this:

A A x BStandard Standard StandardQuantity Price Cost

Inputs or Hours or Rate per Unit

Direct materials 3.0 lbs. 4.00$ per lb. 12.00$ Direct labor 2.5 hours 14.00 per hour 35.00 Variable mfg. overhead 2.5 hours 3.00 per hour 7.50 Total standard unit cost 54.50$

B


Are standards the same as budgets?

A budget is set for total costs.

Standards vs. Budgets

A standard is a per unit cost.

Standards are often used when

preparing budgets.


Standard Cost VariancesC

ost

Standard

This variance is unfavorablebecause the actual cost

exceeds the standard cost.

A standard cost variance is the amount by whichan actual cost differs from the standard cost.


Standard Cost Variances

I see that thereis an unfavorable

variance.

But why arevariances

important to me?

First, they point to causes ofproblems and directions

for improvement.

Second, they trigger investigations in departments

having responsibility for incurring the costs.


Variance Analysis Cycle

Prepare standard cost performance

report

Analyze variances

Begin

Identifyquestions

Receive explanations

Takecorrective

actions

Conduct next period’s

operations




Price Variance

The difference betweenthe actual price and the

standard price

Quantity Variance

The difference betweenthe actual quantity andthe standard quantity


A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard price is the amount that should have been paid for the resources acquired.





Standard quantity is the quantity allowed for the actual good output.

Standard input per unit of outputtimes amount of good output.



AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity




Standard Costs

Let’s use the general model to calculate standard cost

variances for direct material.


Glacier Peak Outfitters has the following direct material standard for the fiberfill in its

mountain parka.

0.1 kg. of fiberfill per parka at $5.00 per kg.

Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas.

The material cost a total of $1,029.

Material VariancesExample


210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg.

= $1,029 = $1,050 = $1,000

Price variance$21 favorable

Quantity variance$50 unfavorable


Material VariancesSummary



= $1,029 = $1,050 = $1,000




$1,029 210 kgs = $4.90 per

kg




= $1,029 = $1,050 = $1,000




0.1 kg per parka 2,000 parkas = 200 kgs



Note: Using the formulas

Materials price varianceMPV = AQ (AP - SP)

= 210 kgs ($4.90/kg - $5.00/kg)

= 210 kgs (-$0.10/kg)

= $21 F

Materials quantity varianceMQV = SP (AQ - SQ)

= $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas))

= $5.00/kg (210 kgs - 200 kgs)

= $5.00/kg (10 kgs)

= $50 U


Quick Check

Suppose only 190 kgs of fiberfill were used to make 2,000 parkas. What is the materials quantity variance? Remember that the standards call for 0.1 kg of fiberfill per parka at a cost of $5 per kg of fiberfill.

a. $50 F

b. $50 U

c. $100 F

d. $100 U


a. $50 F

b. $50 U

c. $100 F

d. $100 U



a. $50 F

b. $50 U

c. $100 F

d. $100 U


a. $50 F

b. $50 U

c. $100 F

d. $100 U

Quick Check

MQV = SP (AQ - SQ) = $5.00/kg (190 kgs-(0.1 kg/parka 2,000 parkas)) = $5.00/kg (190 kgs - 200 kgs) = $5.00/kg (-10 kgs) = $50 F


If the material quantity standard specifies exactly how much material should be in the final product without any wastage, is a favorable (F) materials quantity variance a good thing?

a. Yes

b. No


a. Yes

b. No

Quick Check


Quick Check


a. Yes

b. No


a. Yes

b. No


Standard Costs

Let’s use the general model to calculate all standard cost

variances, starting withdirect material.


Hanson Inc. has the following direct material standard to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Last week 1,700 pounds of material were purchased and used to make 1,000 Zippies.

The material cost a total of $6,630.

Material VariancesExample

Zippy


What is the actual price per poundpaid for the material?

a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.


a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

Quick Check Zippy



a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.


a. $4.00 per pound.

b. $4.10 per pound.

c. $3.90 per pound.

d. $6.63 per pound.

AP = $6,630 ÷ 1,700 lbs.AP = $3.90 per lb.

Quick Check Zippy


Hanson’s material price variance (MPV)for the week was:

a. $170 unfavorable.

b. $170 favorable.

c. $800 unfavorable.

d. $800 favorable.



b. $170 favorable.


d. $800 favorable.

Quick Check Zippy




b. $170 favorable.


d. $800 favorable.



b. $170 favorable.


d. $800 favorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($3.90 - 4.00) MPV = $170 Favorable

Quick Check Zippy


The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.


a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.

Quick Check Zippy



a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds.


a. 1,700 pounds.

b. 1,500 pounds.

c. 2,550 pounds.

d. 2,000 pounds. SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs

Quick Check Zippy


Quick Check

Hanson’s material quantity variance (MQV)for the week was:


b. $170 favorable.


d. $800 favorable.

Hanson’s material quantity variance (MQV)for the week was:


b. $170 favorable.


d. $800 favorable.

Zippy


1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb.

= $6,630 = $ 6,800 = $6,000





Zippy


Material Variances

Hanson purchased and used 1,700 pounds.

How are the variances computed if the amount purchased differs from

the amount used?

The price variance is computed on the entire

quantity purchased.

The quantity variance is computed only on

the quantity used.


Hanson Inc. has the following material standard to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000

Zippies.

Material VariancesContinued

Zippy


Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb.

= $10,920 = $11,200


Price variance increases because quantity

purchased increases.

ZippyMaterial Variances

Continued


Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb.

= $6,800 = $6,000


Quantity variance is unchanged because actual and standard

quantities are unchanged.

Material VariancesContinued

Zippy


Isolation of Material Variances

I need the price variancesooner so that I can better

identify purchasing problems.

You accountants just don’tunderstand the problems thatpurchasing managers have.

I’ll start computingthe price variancewhen material is

purchased rather thanwhen it’s used.


Responsibility for Material Variances

I am not responsible for this unfavorable material

quantity variance.

You purchased cheapmaterial, so my peoplehad to use more of it.

You used too much material because of poorly trained

workers and poorly maintained equipment.

Also, your poor scheduling sometimes requires me to

rush order material at a higher price, causing

unfavorable price variances.


Standard Costs

Now let’s calculate standard cost variances for direct labor.


Note

Materials variances: Material price variance

MPV = AQ (AP - SP) Material quantity variance

MQV = SP (AQ - SQ)

Labor variances: Labor rate variance

LRV = AH (AR - SR) Labor efficiency variance

LEV = SR (AH - SH)

Actual hours

Actual rate

Standard rate

Standard hours allowed for the actual good output


Hanson Inc. has the following direct labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $12.00 perdirect labor hour

Last week 1,550 direct labor hours were worked at a total labor cost of $18,910

to make 1,000 Zippies.

Labor Variances Example Zippy


What was Hanson’s actual rate (AR)for labor for the week?

a. $12.20 per hour.

b. $12.00 per hour.

c. $11.80 per hour.

d. $11.60 per hour.


a. $12.20 per hour.

b. $12.00 per hour.

c. $11.80 per hour.

d. $11.60 per hour.

Quick Check Zippy



a. $12.20 per hour.

b. $12.00 per hour.

c. $11.80 per hour.

d. $11.60 per hour.


a. $12.20 per hour.

b. $12.00 per hour.

c. $11.80 per hour.

d. $11.60 per hour.

Quick Check

AR = $18,910 ÷ 1,550 hours AR = $12.20 per hour

Zippy


Hanson’s labor rate variance (LRV) for the week was:


b. $310 favorable.


d. $300 favorable.



b. $310 favorable.


d. $300 favorable.

Quick Check Zippy




b. $310 favorable.


d. $300 favorable.



b. $310 favorable.


d. $300 favorable.

Quick Check

LRV = AH(AR - SR) LRV = 1,550 hrs($12.20 - $12.00) LRV = $310 unfavorable

Zippy


The standard hours (SH) of labor thatshould have been worked to produce1,000 Zippies is:

a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.


a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

Quick Check Zippy



a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.


a. 1,550 hours.

b. 1,500 hours.

c. 1,700 hours.

d. 1,800 hours.

Quick Check

SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours

Zippy


Hanson’s labor efficiency variance (LEV)for the week was:


b. $590 favorable.


d. $600 favorable.



b. $590 favorable.


d. $600 favorable.

Quick Check Zippy




b. $590 favorable.


d. $600 favorable.



b. $590 favorable.


d. $600 favorable.

Quick Check

LEV = SR(AH - SH) LEV = $12.00(1,550 hrs - 1,500 hrs) LEV = $600 unfavorable

Zippy


Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

Labor VariancesSummary

Rate variance$310 unfavorable

Efficiency variance$600 unfavorable

1,550 hours 1,550 hours 1,500 hours × × × $12.20 per hour $12.00 per hour $12.00 per hour

= $18,910 = $18,600 = $18,000

Zippy


Labor Rate Variance – A Closer Look

Production managers who make work assignmentsare generally responsible for rate variances.

Production managers who make work assignmentsare generally responsible for rate variances.

High skill,high rate

Low skill,low rate

Using highly paid skilled workers toperform unskilled tasks results in an

unfavorable rate variance.


Labor Efficiency Variance –A Closer Look

UnfavorableEfficiencyVariance

Poorsupervisionof workers

Poorlymaintainedequipment

Poorlytrainedworkers

Poorquality

materials

Insufficientdemand


Responsibility forLabor Variances

I am not responsible for the unfavorable labor

efficiency variance!

You purchased cheapmaterial, so it took more

time to process it.

You used too much time because of poorly

trained workers and poor supervision.


Responsibility forLabor Variances

Maybe I can attribute the laborand material variances to personnel

for hiring the wrong peopleand training them poorly.


Standard Costs

Now let’s calculate standard cost

variances for the last of the variable production costs –

variable manufacturing

overhead.


Note

Labor variances: Labor rate variance

LRV = AH (AR - SR) Labor efficiency variance

LEV = SR (AH - SH)

Variable overhead variances: Variable overhead spending variance

VOSV = AH (AR - SR) Variable overhead efficiency variance

VOEV = SR (AH Quick Check

Actual hours of the allocation base

Actual variable overhead rate

Standard variable overhead rate

Standard hours allowed for the actual good output


Hanson’s spending variance (VOSV) for variable manufacturing overhead forthe week was:


b. $400 favorable.


d. $300 favorable.



b. $400 favorable.


d. $300 favorable.

Quick Check Zippy




b. $400 favorable.


d. $300 favorable.



b. $400 favorable.


d. $300 favorable.

Quick Check

SV = AH(AR - SR) SV = 1,550 hrs($3.30 - $3.00) SV = $465 unfavorable

Zippy


Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was:


b. $435 favorable.


d. $150 favorable.



b. $435 favorable.


d. $150 favorable.

Quick Check Zippy




b. $435 favorable.


d. $150 favorable.



b. $435 favorable.


d. $150 favorable.

Quick Check

EV = SR(AH - SH) EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable

1,000 units × 1.5 hrs per unit

Zippy


Spending variance$465 unfavorable

Efficiency variance$150 unfavorable

1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour

= $5,115 = $4,650 = $4,500

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

Variable ManufacturingOverhead Variances

Zippy


Variable Manufacturing Overhead Variances – A Closer Look

If variable overhead is applied on the basisof direct labor hours, the labor efficiency

and variable overhead efficiency varianceswill move in tandem.

If variable overhead is applied on the basisof direct labor hours, the labor efficiency

and variable overhead efficiency varianceswill move in tandem.


Variance Analysis and Management by Exception

How do I know which variances to investigate?

Larger variances, in dollar amount or as a percentage of the

standard, are investigated first.


Advantages of Standard Costs

Management byexception

Improved cost control and performance

evaluation

Better Informationfor planning anddecision making

Possible reductionsin production costs

Advantages


PotentialProblems

Emphasis onnegative may

impact morale.

Emphasizing standardsmay exclude other

important objectives.

Favorable variancesmay be

misinterpreted.

Continuous improvementmay be moreimportant than

meeting standards.

Standard costreports may

not be timely.

Incentives to buildinventories.

Disadvantages ofStandard Costs


The Balanced Scorecard

Management translates its strategy into performance measures that employees

understand and accept.

Management translates its strategy into performance measures that employees

understand and accept.

Performancemeasures

Customers

Learningand growth

Internalbusiness

processes

Financial



How do we lookto the owners?

How can wecontinually learn,

grow, and improve?

In which internalbusiness processes

must we excel?

How do we lookto customers?



Learning improvesbusiness processes.

Improved businessprocesses improve

customer satisfaction.

Improving customersatisfaction improves

financial results.


Benefits of Balance Scorecard

If implemented well:Forces management to articulate a coherent

strategy.Strategy is communicated throughout

organization.Performance measures are more likely to be

consistent with strategy and actionable.Portfolio of measures reduces gaming

problems.Feedback loop makes strategy dynamic.

If implemented well:Forces management to articulate a coherent

strategy.Strategy is communicated throughout

organization.Performance measures are more likely to be

consistent with strategy and actionable.Portfolio of measures reduces gaming

problems.Feedback loop makes strategy dynamic.


Some Possible Problems

Cultural/behavioralProgram fatigue.

Culture shock/resistance.

Every existing performance measurehas a champion.

Gaming still possible.

Cultural/behavioralProgram fatigue.

Culture shock/resistance.

Every existing performance measurehas a champion.

Gaming still possible.


Process time is the only value-added time.

Delivery Performance Measures

Wait TimeProcess Time + Inspection Time

+ Move Time + Queue Time

Delivery Cycle Time

Order Received

ProductionStarted

Goods Shipped

Throughput Time


Delivery Performance Measures

ManufacturingCycle

Efficiency

Value-added time

Manufacturing cycle time=

Wait TimeProcess Time + Inspection Time

+ Move Time + Queue Time

Delivery Cycle Time

Order Received

ProductionStarted

Goods Shipped

Throughput Time


Quick Check

A TQM team at Narton Corp has recorded the following average times for production:

Wait 3.0 days Move 0.5 days Inspection 0.4 days Queue 9.3 days Process 0.2 days

What is the throughput time? a. 10.4 daysb. 0.2 daysc. 4.1 daysd. 13.4 days











Quick Check

Throughput time = Process + Inspection + Move + Queue = 0.2 days + 0.4 days + 0.5 days + 9.3 days = 10.4 days


Quick Check



What is the MCE? a. 50.0%b. 1.9%c. 52.0%d. 5.1%











Quick Check

MCE = Value-added time ÷ Throughput time

= Process time ÷ Throughput time

= 0.2 days ÷ 10.4 days = 1.9%


Quick Check



What is the delivery cycle time? a. 0.5 daysb. 0.7 daysc. 13.4 daysd. 10.4 days











Quick Check Delivery cycle time = Wait time + Throughput time = 3.0 days + 10.4 days = 13.4 days


End of Chapter 10

Standard Costs and the Balanced Scorecard Chapter 10.

Documents

ideal standards

time standards

activity standards

quantity standards

standard slide

mcgrawhill companies

mcgrawhillirwin accountants

production manager slide