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## Standard Costing, Variance Analysis and Kaizen Costing

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**16**Standard Costing,Variance Analysis and Kaizen Costing**Standard costs are**Using Standard-Costing Systems for Control based on carefullypredetermined amounts. used for planning labor and material requirements. the expected levelof performance. benchmarks formeasuring performance.**STANDARD COST**a budget for the production of one unit of product or service ACTUAL COST incurred and recorded in the production of the product or service Using Standard-Costing Systems for Control COST VARIANCE the difference between the actual cost and the standard cost**This variance is unfavorable because the actual cost exceeds**the standard cost. Using Standard-Costing Systems for Control Standard A standard cost varianceis the amount by whichan actual cost differs fromthe standard cost. Product cost**Management by Exception**Managers focus on quantities and coststhat deviate significantly from standards (a practice known as management by exception). Standard Amount Directmaterials Directlabor Type of Product Cost**Take the time to investigate only significant cost**variances. Management by Exception What is significant? Depends on the size of the organization Depends on the production process Depends on the type of the organization**Variance Analysis Cycle**Takecorrective actions Identifyquestions Receive explanations Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin**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 Combined approach Analyze the process for the step that has changed, but use historical data for the steps that have not changed**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**PERFECTION STANDARDS PRACTICAL OR ATTAINABLE STANDARDS Can only be attained under near perfect conditions Tight as practical, but still expected to be attained • Peak efficiency • Lowest possible input prices • Best-quality material • No disruption in • production • Occasional machine • breakdowns • Normal amounts • of raw material • waste**Practical standardsshould be set at levelsthat are**currentlyattainable with reasonable and efficient effort. Should we usepractical standardsor perfection standards? Perfection versus Practical Standards: A Behavioral Issue**Perfection versus Practical Standards: A Behavioral Issue**I agree.Perfection standardsareunattainable and therefore discouraging to most employees.**Setting Standards – Direct Materials**PriceStandards QuantityStandards Use competitivebids for the qualityand quantity desired. Use product design specifications.**Setting Standards – Direct Materials**The standard materials cost for one unit of product is: Standard quantity Standard price for of material one unit of material required for one unit of product ×**Setting Standards – Direct Labor**Ratestandards Efficiencystandards Use wage surveys andlabor contracts. Use time and motion studies foreach labor operation.**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 ×**Examples**Examples Standard Cost in Service Industries • Jobs with repetitive tasks lend themselves to efficiency measures. • Computing non-manufacturing efficiency variances requires some assumed relationship between input and output activity.**Costs and Benefits ofStandard-Costing Systems**Benefits Costs IMPROVED DECISION MAKING, BUT: Implementing and maintaining cost standards can be time-consuming, labor-intensive, and expensive.**Standard cost variances**Price variance Quantity variance The difference betweenthe actual price and thestandard price The difference betweenthe actual quantity andthe standard quantity Cost Variance Analysis**A General Model for Variance Analysis**Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price Price / Ratevariance Quantity / Efficiency variance**A General Model forVariance Analysis**Actual quantity Actual quantity Standard quantity × × × Actual price Standard price Standard price Price / Ratevariance Quantity / Efficiency variance Standard price is the amount that should have been paid for the resources acquired.**A General Model forVariance Analysis**Actual quantity Actual quantityStandard quantity × × × Actual price Standard price Standard price Price / Ratevariance Quantity / Efficiency variance Standard quantity is the quantityallowed for the actual good output.**A General Model forVariance Analysis**Actualquantity ActualquantityStandardquantity× × × Actualprice Standardprice Standardprice Price / Ratevariance Quantity / Efficiency variance Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overhead spending variance efficiency variance AQ(AP - SP) SP(AQ - SQ) AQ = Actual Quantity SP= Standard PriceAP = Actual Price SQ = Standard Quantity**Standard Costs**Let’s use the concepts of the general model to calculate standard cost variances, starting withdirect materials.**Materials Variances**Koala Camp Gear Company in MelbourneAustralia has the following direct materialstandard to manufacture one Tree Line tent: 12 square meters per tent at$8.00 per square meter (sq m) Last month Koala purchased 40,000 squaremeters at $8.15 per square meter and used36,400 square meters to make 3,000 tents.**We should compute the price variance using the actual**quantity purchased. Materials Variances Actual quantity Actual quantity purchased purchased × × Actual price Standard price 40,000 sq m 40,000 sq m × × $8.15 per sq m $8.00 per sq m $326,000 $320,000 Price variance$6,000 Unfavorable**Materials Variances**SQ = 3,000 tents × 12 sq m per tent SQ = 36,000 sq m Actual quantityused Standard quantity × × Standard price Standard price We should compute the quantity variance using the actual quantity used. 36,400 sq m 36,000 sq m × × $8.00 per sq m $8.00 per sq m $291,200 $288,000 Quantity variance$3,200 Unfavorable**Materials Variances**We may also calculate materialsvariances using formulas: MPV = AQp(AP – SP) MPV = 40,000 sq m × ($8.15 – $8.00) MPV = $6,000 Unfavorable MQV = SP(AQu – SQ) MQV = $8.00(36,400 sq m – 36,000 sq m) MQV = $3,200 Unfavorable**I need the variances as soonas possible so that I canbetter**identify problems and control costs. You accountants just don’tunderstand the problems weproduction managers have. Okay. I’ll computethe price variance whenmaterials are purchased, and the usage variance assoon as material is used. Reporting Materials Variances**Your poorly trained workers and poorly maintained equipment**caused the problems. Also, your poor scheduling requires rush orders of materials at higher prices, causing unfavorable price variances. Responsibility for Materials Variances I am not responsiblefor this unfavorablematerials usagevariance. You bought poor qualitymaterials, so my peoplehad to use more of it.**Standard Costs**Now let’s calculate standard cost variances for direct labor.**Labor Variances**Koala has the following direct laborstandard to manufacture one Tree Line tent: 2 standard hours per tent at$18.00 per direct labor hour Last month 5,900 direct labor hours were worked at $19.00 per hour to make 3,000 tents.**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 variance$5,900 Unfavorable Efficiency variance$1,800 Favorable**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**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.**Poorlytrainedworkers**Poorqualitymaterials Poorsupervisionof workers Poorlymaintainedequipment Labor Efficiency Variance –A Closer Look UnfavorableEfficiencyVariance**You used too much time because of poorly trained workers and**poor supervision. Responsibility for Labor Variances I am not responsible for the unfavorable laborefficiency variance! You bought poor qualitymaterials, so my people tookmore time to process them.**Responsibility for Labor Variances**Maybe I can attribute the laborand materials variances to personnel for hiring the wrong peopleand training them poorly.**Good output quantity**= 80% X Input quantity Good output quantity ÷ 80% = Input quantity allowed 5,000 liters of good output ÷ 80% = 6,250 liters of input allowed 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?**Absolute amount**Relative amount 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 ?**What clues help me to determine the variances that I should**investigate? Significance of Cost Variances • Size of variance • Dollar amount • Percentage of standard • Recurring variances • Trends • Controllability • Favorable variances • Costs and benefits of investigation**Larger variances, in dollar amount or as a percentage of the**standard, are investigated first. Significance of Cost Variances: When to Follow Up How do I know which variances to investigate? We could use a rule of thumb such as:investigate all variances that are over $10,000or over 10 percent of the standard cost.**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.**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.**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