Understanding Standard Cost Systems for Effective Management

1. 3020 - Chapter 11 Standard Costs and Operating Performance Measures

2. Standard Cost Systems • Benchmark or norm used for planning and control purposes; a model or budget against which actual results are compared and evaluated. • Comparable to a budget broken down to a unit figure • Like predetermined OH rates • Developed for DM, DL, and OH

3. Standard Cost Systems • Who uses standard costs? • Manufacturers • Service firms • Restaurants • Who develops standard costs? • Engineers • Cost accountants • Managers • Workers • Types of standards • Ideal standards • Practical standards

4. Standard costs • Developed for DM, DL, and OH (both variable and fixed) • Each category involves a price and quantity element

5. Variance Analysis • Difference between actual and budget is called a VARIANCE. • Variances are FAVORABLE if Actual < Budget • Variances are UNFAVORABLE if Actual > Budget • Management by exception – allows managers to focus on large variances only.

6. Direct Material Variances • Price Variance – difference in actual price paid for direct materials and the standard price • Quantity Variance – difference in actual direct materials used and the standard DM that should have been used • Causes

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

8. Standard Quantity Allowed • Standard Quantity per unit • X units produced • = Standard Quantity Allowed • Example: • 4 yards per sleeping bag • X 100 bags produced • = 400 yards of fabric allowed

9. Direct Labor Variances • Rate Variance - difference in rates actually paid and standard wage rates per hour • Efficiency Variance - difference in actual hours worked and standard hours that should have been worked. • Causes

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

11. Variable OH Variances • Spending Variance - difference in amount actually paid and standard rates that should have been paid for the actual cost driver • Efficiency Variance - difference in actual cost driver and standard cost driver. • Cost driver is often labor hours • Causes

12. Variable OH Variances • AR x AH SR x AH SR x SH • |__________________| |_____________| • Spending Variance Efficiency Var. • |_________________________________| • Total Var. OH Variance

13. Responsibility for Variances • Materials price - Purchasing • Materials Quantity - Production, Purchasing • Labor rate - Personnel, Production • Labor efficiency - Production, Purchasing • Variable spending – Production, Administration • Variable efficiency – depends on cost driver • BUT: • Must investigate the variance to see who is actually responsible

14. International Uses of Standard Costs • Standard costs are usually all over the world • Used mainly for: • Cost management • Budgetary planning • Pricing

15. Standard Cost SystemsBenefits • Easier bookkeeping • Motivation • Planning • Control costs • Decision making • Performance evaluation

16. Potential Problems with Standard Costs • Standard costs should be used for planning and improvement • Standard costs should not be used to punish workers • Variances should be investigated to determine their causes, not to assign blame • Variances should not be used to manipulate the financial statements • Favorable variances are not always good; unfavorable variances are not always bad

17. Operating Performance Measures Delivery cycle time – Throughput time + wait time before production began Throughput time - time to manufacture Inspection time Process time Queue time Move time Manufacturing Cycle Efficiency = Process time/Throughput time (Goal = 100%)