Accounting 6310

1. Accounting 6310 Chapter 12 – Standard Costs: Direct Labor and Materials

2. Standard Costs • Actual costs detail materials, labor, overhead, and expense costs that actually happened. • Standard cost systems detail what costs SHOULD BE as determined by designated teams of employees. • Standard costs are benchmarks.

3. Standard Cost Systems • Can be used for planning or control purposes • Comparable to a budget broken down to a unit figure • Like predetermined OH rates • Developed for DM, DL, and OH or any cost you want

4. Variances • Difference between actual and standard cost is called a VARIANCE. • For costs: • Variances are FAVORABLE if Actual < Standard • Variances are UNFAVORABLE if Actual > Standard • For revenues, the opposite holds true. • FAVORABLE: Actual > Standard • UNFAVORABLE: Actual < Standard

5. Standard Cost SystemsBenefits • Used for decision management • Planning • Product pricing • Contract bidding • Outsourcing decisions • Used for decision control • Easier bookkeeping • Motivation • Control costs • Performance Evaluation • Transfer pricing

6. Standard Cost Systems • Who develops standard costs? • Engineers • Cost accountants • Managers • Workers • Types of standards • Expected standards • Practical standards • Ideal standards

7. Traditional Costing: DM +DL +OH =Total Cost +Profit Markup =Price charged Target Costing Price charged less profit markup =Target Cost (DM, DL, + OH must not be more than the target cost Traditional Cost-Plus Costing versus Target Costing

8. Direct Labor Variances • Price (Wage) Variance - difference in rates actually paid and standard wage rates per hour • Quantity (Efficiency) Variance - difference in actual hours worked and standard hours that should have been worked. • Causes

9. Direct Labor Variances • AR x AH SR x AH SR x SH • |__________________| |_____________| • Wage Variance Efficiency Variance • |_________________________________| • Total Labor Variance

10. Standard Quantity Allowed • Standard Quantity per unit • X units produced • = Standard Quantity Allowed • Example: • 4 hours per sleeping bag • X 100 bags produced • = 400 hours allowed for production

11. Direct Material Variances • Price Variance • Purchase price variance (when purchased) • Usage price variance (when used) • Quantity (Efficiency) Variance • Causes

12. Direct Material Variances • AP x AQ SP x AQ pur. • |__________________| • Price Variance • SP x AQ used SP x SQ • |______________| • Quantity Variance

13. Incentive Effects of DL and DM Variances • Control costs • Purchasing manager • If purchasing manager is only evaluated on DM price variance, they will buy in bulk, unnecessarily building costly inventories • Should charge cost of inventory holding costs to purchasing department

14. Incentive Effects of DL and DM Variances • Poor quality materials often affect production causing more wasted materials and more direct labor hours • Have quality specifications and do not allow deviations • Tie purchasing manager’s evaluation to amount of rework

15. Incentive Effects of DL and DM Variances • Rush orders are more costly for purchasing • Have production (sales) bear the cost of rush orders • Engineering change orders cause wasted materials and more labor hours • Make sure changes are needed • Note these changes in production variances

16. Incentive Effects of DL and DM Variances • Mutual Monitoring • Production and Purchasing work together for the overall company good • Satisficing • Rewarding workers for achieving a standard may cause them to slack once goal is met • Encourage workers to continuously improve

17. Disposition of Variances • At end of the period, variances are usually closed into cost of goods sold • They can be allocated among WIP and FG inventories and COGS. • If there are lots of unfavorable (favorable) variances, this will increase (decrease) expenses • This can be manipulated.

18. Responsibility for Variances • Materials price - Purchasing • Materials Quantity - Production, Purchasing • Labor rate - Personnel, Production • Labor efficiency - Production, Purchasing • BUT: • Must investigate the variance to see who is actually responsible

19. Three Conditions Necessary to Use Standard Costs • There must be a way to measure outputs. • A predetermined standard of performance must exist. • There must be an ability to use variance information as feedback to make corrections and improvements.

20. Variance Analysis Cycle

21. Uses of Variance Analysis • Calculation of variances do not explain causes • Variances should be investigated • Often reasons for variances are explained beside the calculated variance • Favorable variances are not always good • Unfavorable variances are not always bad • It is not good to net variances • Netting of variances may cancel out large favorable variances against large unfavorable variances

22. Uses of Variance Analysis • Management by exception – allows managers to focus only on those variances which are truly out of the ordinary • Management by exception allows managers to focus on certain areas • Maximizes return on management • Variance analysis should be performed often in order to make corrections as early as possible – at least every month if possible

23. Limitations on Standards • Make sure you determine the cause of the variances; do not just mindlessly calculate them. • Any variance is only as good as the standards or planned activity to which actual is compared!!!!!! • Changing conditions may warrant changing the standards. • Variances should always be used for feedback and continuous improvement.

24. Homework • P12-3 – Alexander Products • P12-4 – Oaks Auto Supply • P12-10 – Marian Health Care System • DUE THURSDAY, MARCH 6