Chapter 10

Standard Costing,
Operational
Performance
Measures, and the
Balanced Scorecard

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning
Objective
1

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
 Managing Costs
Standard Actual
cost cost

Comparison between
standard and actual
performance
level

Cost
variance
 Management by Exception
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.

Standard
Amount

Direct
Material
Direct
Labor

Type of Product Cost

 Learning
Objective
2

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 Setting Standards

Cost
Standards

Analysis of Task
Historical Data Analysis
Participation in Setting Standards
Accountants, engineers, personnel
administrators, and production managers
combine efforts to set standards based on
experience and expectations.
 Perfection versus Practical
Standards: A Behavioral Issue
Practical standards
should be set at levels
that are currently
attainable with
Should we use reasonable and
practical standards efficient effort.
or perfection
standards?
 Perfection versus Practical
Standards: A Behavioral Issue
I agree. Perfection
standards are
unattainable and
therefore discouraging
to most employees.
 Use of Standards by
Service Organizations

• Standard cost
analysis may be used
in any organization
with repetitive tasks.
• A relationship
between tasks and
output measures
must be established.
 Learning
Objective
3

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 Cost Variance Analysis

Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity
 A General Model for Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

AQ(AP
Materials price- SP)
variance SP(AQ
Materials - SQ)
quantity variance
Labor rate variance Labor efficiency variance
AQ =Variable
Actual overhead
Quantity SP = Standard
Variable Price
overhead
AP = spending
Actual Price
variance SQ = Standard
efficiency Quantity
variance
 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.
 A General Model for Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard quantity is the quantity that should

have been used.
Standard Costs

Let’s use the concepts

of the general model to
calculate standard cost
variances, starting with
direct material.
 Material Variances Zippy

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 Variances Zippy

What is the actual price per pound

paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.
c. $3.90 per pound.
d. $6.63 per pound.
 Material Variances Zippy

What is the actual price per pound

paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.
c. $3.90 per pound. AP = $6,630 ÷ 1,700 lbs.
AP = $3.90 per lb.
d. $6.63 per pound.
 Material Variances Zippy

Hanson’s direct-material price variance (MPV)

for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 Material Variances Zippy

Hanson’s direct-material price variance (MPV)

for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
MPV = AQ(AP - SP)
d. $800 favorable. MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable
 Material Variances Zippy

The standard quantity of material that

should have been used to produce
1,000 Zippies is:

a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.
 Material Variances Zippy

The standard quantity of material that

should have been used to produce
1,000 Zippies is:
SQ = 1,000 units × 1.5 lbs per unit
SQ = 1,500 lbs
a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.
 Material Variances Zippy

Hanson’s direct-material quantity variance

(MQV) for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 Material Variances Zippy

Hanson’s direct-material quantity variance

(MQV) for the week was:
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
a. $170 unfavorable.
MQV = $800 unfavorable
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 Material Variances Summary

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price
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

Price variance Quantity variance

$170 favorable $800 unfavorable
 Material Variances Zippy

The price variance is

Hanson purchased and
computed on the entire
used 1,700 pounds.
quantity purchased.
How are the variances
computed if the amount The quantity variance is
purchased differs from computed only on the
the amount used? quantity used.
 Material Variances Zippy

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 Variances Zippy

Actual Quantity Actual Quantity

Purchased Purchased
× × MPV = AQ(AP - SP)
Actual Price Standard Price
MPV = 2,800 lbs.
2,800 lbs. 2,800 lbs. × ($3.90 - 4.00)
× × MPV = $280
$3.90 per lb. $4.00 per lb. Favorable
$10,920 $11,200

Price variance increases

Price variance because quantity
$280 favorable purchased increases.
 Material Variances Zippy

Actual Quantity
Used Standard Quantity
× ×
MQV = SP(AQ - SQ) Standard Price Standard Price
MQV = $4.00(1,700 lbs
- 1,500 lbs) 1,700 lbs. 1,500 lbs.
MQV = $800unfavor. × ×
$4.00 per lb. $4.00 per lb.
$6,800 $6,000
Quantity variance is
unchanged because
actual and standard Quantity variance
quantities are unchanged. $800 unfavorable
 Isolation of Material Variances
I need the variances as soon
as possible so that I can
better identify problems Okay. I’ll start computing
and control costs. the price variance when
You accountants just don’t material is purchased and
understand the problems the quantity variance as
we production managers have. soon as material is used.
Standard Costs

Now let’s calculate

standard cost
variances for
direct labor.
 Labor Variances Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at $10.00 per direct
labor hour

Last week 1,550 direct labor hours were

worked at a total labor cost of $15,810 to
make 1,000 Zippies.
 Labor Variances Zippy

What was Hanson’s actual rate (AR)

for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.
c. $9.90 per hour.
d. $9.80 per hour.
 Labor Variances Zippy

What was Hanson’s actual rate (AR)

for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.
AR = $15,810 ÷ 1,550 hours
c. $9.90 per hour. AR = $10.20 per hour
d. $9.80 per hour.
 Labor Variances Zippy

Hanson’s labor rate variance (LRV)

for the week was:

a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
 Labor Variances Zippy

Hanson’s labor rate variance (LRV)

for the week was:

a. $310 unfavorable.
b. $310 favorable.
LRV = AH(AR - SR)
c. $300 unfavorable.
LRV = 1,550 hrs($10.20 - $10.00)
d. $300 favorable.
LRV = $310 unfavorable
 Labor Variances Zippy

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:

a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
d. 1,800 hours.
 Labor Variances Zippy

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:

a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
SH = 1,000 units × 1.5 hours per unit
d. SH = 1,500 hours
1,800 hours.
 Labor Variances Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:

a. $510 unfavorable.
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.
 Labor Variances Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
LEV = SR(AH - SH)
LEV = $10.00(1,550 hrs - 1,500 hrs)
a. $510 unfavorable.
LEV = $500 unfavorable
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.
 Labor Variances Summary

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$10.20 per hour $10.00 per hour $10.00 per hour
$15,810 $15,500 $15,000

Rate variance Efficiency variance

$310 unfavorable $500 unfavorable
 Learning
Objective
4

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 Significance of Cost Variances

• Size of variance
– Dollar amount
– Percentage of standard
• Recurring variances
• Trends
• Controllability
What clues help me • Favorable variances
to determine the
variances that I should • Costs and benefits of
investigate? investigation
 Statistical Control Chart
Warning signals for investigation

Favorable Limit
• •
• • •
Desired Value
• •
Unfavorable Limit •
•
1 2 3 4 5 6 7 8 9
Variance Measurements
 Learning
Objective
5

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Behavioral Impact of Standard
Costing
If I buy cheaper materials, my direct-
materials expenses will be lower than
what is budgeted. Then I’ll get my bonus.
But we may lose customers because of
lower quality.
 Controllability of Variances

Direct-Material Direct-Material
Price Variance Quantity Variance

Direct-Labor Direct-Labor
Rate Variance Efficiency Variance
 Interaction among Variances

I am not responsible for

the unfavorable labor You used too much
efficiency variance! time because of poorly
trained workers and
You purchased cheap poor supervision.
material, so it took more
time to process it.
 Learning
Objective
6

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Standard Costs and Product
Costing
Standard material and labor costs
are entered into Work-in-Process
inventory instead of actual costs.

Standard cost variances

are closed directly to
Cost of Goods Sold.
 Learning
Objective
7

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Advantages of Standard Costing
Sensible Cost Management by
Comparisons Exception

Performance Employee
Evaluation Motivation
Advantages

Stable Product Less

Costs Expensive
 Learning
Objective
8

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 Criticisms of Standard Costing
Too aggregate, Not specific
too late

Too much focus Disadvantages Stable production

on direct-labor required

Shorter life Narrow

cycles definition

Focus on cost Consistency due

minimization to automation
Adapting Standard-Costing Systems
Reduced focus Focus on material
on labor and overhead

Identify Cost Shifting cost

Drivers structures

Impact of TQM Elimination of non-

and JIT value added costs

Shorter product Real-Time

life cycles Information Systems

Nonfinancial
Benchmarking
Measures
 Learning
Objective
9

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 Operational Control Measures in
Today’s Manufacturing Environment
 Operational Performance Measures in
Today’s Manufacturing Environment
Raw Material & Inventory Control
Scrap Control  Average value
Quality  Average holding time
Lead time  Ratio of inventory
Cost of scrap value to sales
Total cost revenue
 Operational Performance Measures in
Today’s Manufacturing Environment
Machine Performance Product Quality
 Availability  Warranty claims
 Downtime  Customer complaints
 Maintenance records  Defective products
 Setup time
 Cost of rework
 Operational Performance Measures in
Today’s Manufacturing Environment
Production Delivery
• Manufacturing cycle • % of on-time deliveries
time • % of orders filled
• Velocity • Delivery cycle time
• Manufacturing cycle
efficiency
 Operational Performance Measures in
Today’s Manufacturing Environment
Productivity Innovation and
 Aggregate Learning
productivity  Percentage of sales
 Partial productivity from new products
 Cost savings from
process
improvements
 Learning
Objective
10

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 The Balanced Scorecard
Financial

Vision and Internal

Customer Strategy Operations

Learning and Growth

 Learning
Objective
11

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 Use of Standard Costs
for Product Costing
Raw-material Inventory Account Payable

Actual quantity at Actual quantity at

standard cost actual cost

Direct-Material Price Variance

Unfavorable Favorable
variance variance
 Use of Standard Costs
for Product Costing
Work-in-Process Inventory Raw-material Inventory

Standard quantity Actual quantity at

at standard price standard cost

Direct-Material Quantity Variance

Unfavorable Favorable
variance variance
 Use of Standard Costs
for Product Costing
Work-in-Process Inventory Wages Payable

Standard quantity Actual quantity at

at standard price actual cost

Direct-Labor Rate Variance Direct-Labor Efficiency Variance

Unfavorable Favorable Unfavorable Favorable

variance variance variance variance
Use of Standard Costs
for Product Costing

Cost of Goods Sold

Unfavorable Favorable
variance variance
End of Chapter 10
Let’s set the
standard a
little higher.