Chapter 11

Practical Standards

Tight, but attainable. Allow for normal machine down time and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Can also be used for forecasting cash flows and in planning inventory. Variances typically signal a need for management attention because they represent deviations that fall outside of normal operating conditions. Most organizations use these standards

Actual

To calculate a quantity variance, multiply the _______ quantity x the standard price and compare it to the standard quantity allowed x the standard price

Variance Analysis Cycle

a continuous process used to identify and solve problems: 1. The cycle begins with the preparation of standard cost performance reports in the accounting department. 2. These reports highlight variances that are differences between actual results and what should have occurred according to standards. 3. The variances raise questions such as: Why did this variance occur? Why is this variance larger than it was last period? 4. The significant variances are investigated to discover their root causes. 5. Corrective actions are taken. 6. Next period's operations are carried out and the process is repeated.

The DM spending Variance

1. Needs to be decomposed for analysis 2. Can be broken down into the quantity variance and the price variance 3. Explains what was spent on materials and what should have been spent on materials

Standard

A benchmark or "norm" for measuring performance, found everywhere

Variance Analysis

Act of computing and interpreting variances

Variance Analysis and Management by Exception

All variances are not worth investigating. Methods for highlighting a subset of variances as exceptions include looking at the size of the variance and looking at the size of the variance relative to the amount of spending

Used to calculate the standard quantity per unit of DM

Allowance for waste and spoilage, DM required per unit of finished product

Unfavorable

An _________ MQV occurs when the actual amount of material used is greater than the standard amount of material allowed for the actual output of the period

When using a standard cost system

An undue emphasis on labor efficiency variances can create pressure to build excess inventory and the information in the variance reports may be too old to be useful

DM Standards

Are based on standard price and standard quantity, should be based on input from both the production and purchasing managers

Labor Efficiency Variance

Attempts to measure the productivity of DL. No variance is more closely watched because it is widely believed that increasing DL productivity is vital to decrease costs. = (AH x SR) - (SH x SR) =SR (AH - SH)

The standard price per unit for DM

Based on the quantity of materials to be purchased, can change as a result of a change in the delivery method

Fixed OH Volume Variances

Budgeted fixed OH - the fixed OH applied to work in progress OR Can be computed by multiplying the fixed portion of the predetermined OH rate x the difference between denominator hours and standard hours = FPOHR x (DH - SH)

Ideal Standards

Can only be attained under the best of circumstances. They allow for no work interruptions and they require employees to work at 100% peak efficiency all of the time. Variances are difficult to interpret.

Price standard for Variable Manufacturing OH

Comes from the variable portion of the predetermined OH rate

Standard cost per unit for Variable Manufacturing OH

Computed the same way as for DM or DL. The standard quantity allowed per unit of the output in multiplied by the standard price

Quantity Variance

Difference between how much of an input was actually used and how much should have been used. Stated in dollar terms using the standard price of the input

Variances

Difference between standard prices and actual prices and standard quantities and actual quantities

Price Variance

Difference between the actual price of an input and its standard price, multiplied by the actual amount of the input purchased

Quantity standard for Variable Manufacturing OH

Expressed in either DL hours or machine hours depending on which is used as the allocation base in the predetermined OH rate

OH variances

Graphic analysis of fixed OH offers insight into ________

Price

How much should be paid for each unit of an input is specified by a _________ standard

Standard, Actual

In a standard cost system, OH is applied on the basis of the _________ hours allowed for the _________ output of the period

Standard rate per hour of DL

Includes not only wages earned but also fringe benefits, employee taxes, and other labor costs. Many firms prepare a single rate for all employee within a dept that reflects the "mix" of wage rates earned.

The Fixed OH Volume Variance

Is the error that occurs when the level of activity is incorrectly estimated, occurs because the costing system assumes fixed costs behave as if they were variable

Bill of Materials

List that shows the quantities of each type of material in a unit of finished product

Purchasing Manager

MQV due to inferior materials are the responsibility of the _____________

Significant Deviations

Management by Exception is a system in which standards are set and ________ from the standards are flagged for investigation

Practical

Management by exception works well with _______ standards

Standard

Material requirements + an allowance for normal inefficiencies are added together to determine the ______ quantity of a material input per unit of output

Materials Quantity Variance

Measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard = (AQ x SP) - (SQ x SP) = SP (AQ - SQ)

Materials Price Variance

Measures the difference between what is paid for a given quantity of materials and what should have been paid according to the standard. A negative variance is always labeled as favorable. A positive variance is always unfavorable = (AQ x AP) - (AQ x SP) =AQ (AP - SP)

Unfavorable Materials Variances

More input was used to produce the actual output than the standard allows

The Input

the actual quantity of DM or DL purchased

Setting standard Costs

Should be designed to encourage efficient future operations, not just a repetition of past operations that may or may not have been efficient

Standard Quantity per unit of DM

Should reflect the amount of material required for each unit of finished products as well as an allowance for uncontrollable waste, spoilage, and other normal inefficiencies

Standard price per unit of DM

Should reflect the final, delivered cost of the materials

Standard Cost Card

Shows the standard quantity and costs of the inputs required to produce a unit of a specific product. The Standard amounts of DL, DM, and variable OH inputs x the standard price or rate set for each input

Quantity Standards

Specify how much of an input should be used to make a product. EX: Auto service centers like firestone and sears set labor time standards for the completion of work tasks

Price Standards

Specify how much should be paid for each unit of the input. EX: Manufacturing firms often have highly developed standard costing systems that establish quantity and price standards for each separate product material, labor and OH inputs.

Both Flexible budget activity and spending variances

Standard costs can be used to compute ____________

Using Standards in Flexible Budgets

Standard costs per unit for DM, DL, and variable Man OH can be used to compute activity and spending variances. Spending variances become more useful by breaking them down into quantity and price variances.

Management by Exception

System of management in which standards are set for various operating activities with actual results compared to these standards. Any deviations that are deemed significant are brought to the attention of management as exceptions

Purchased, Used

The MPV is computed when materials are _______ and the materials quantity variance is computed when the materials are ___________

Price, Quantity

The Purchasing manager is generally responsible for the material ________ variance and the production manager is generally responsible for the materials ______ variance

MPV

The _______ is calculated using the actual quantity of the input purchased

Variable

The ________ part of Manufacturing OH is analyzed using the same basic formulas used for material and labor

Production Manager

The _________ may be held responsible for the materials price variance due to rush orders placed to satisfy customer orders and is most often respsonible for the MQV

Favorable Materials Variances

The actual quantity is less than the standard quantity

Standard Quantity or Hours allowed

The amount of an input that should have been used to produce the actual output of the period. Computed by multiplying the actual output in units by the standard input allowed per unit of output

Variable OH Efficiency Variances

The difference between the actual activity of a period and the standard activity allowed, multiplied by the variable part of the predetermined OH rate = (AH x SR) - (SH x SR) = SR (AH - SH)

Fixed OH Budget Variances

The difference between the actual fixed man OH and the budgeted fixed man OH for the period

Variable OH Rate Variances

The difference between the actual variable OH costs incurred during the period and the standard cost that should have been incurred based on the actual activity of the period = (AH x SR) - (AH x SR) = AH (AR - SR)

Denominator activity

The estimated amount of the allocation base used in the formula for the predetermined OH rate is called the ___________

The Output

The good production of the period, expressed in terms of the standard quantity or hours allowed for the actual output

Production

The labor efficiency variance is generally the responsibility of the ____________ manager

Allocation Base

The predetermined OH application rate is calculated by dividing the estimated total manufacturing OH cost by the estimated total amount of the __________

both Fixed and Variable OH

The predetermined OH rate includes ___________

Labor Rate Variance

The price variance for DL. Measures any deviation from standard in the average hourly rate paid to direct labor workers = (AH x AR) - (AH x SR) = AH (AR - SR)

Responsibility for Materials Variance

The purchasing manager and the production manager are usually held responsible for the materials price variance and the materials quantity variance. Are not always controllable by 1 person or 1 department. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the performance of the purchasing manager

MQV

The standard price of the material is used in the calculation of the ______ because using actual prices would hold the production manager responsible for the inefficiencies of the purchasing manager

Efficiency of DL

The variable OH efficiency variance may depend on the __________

DL Rates

The variable OH rate variance uses the same basic formula as the labor rate variance except that the variable OH rates are used instead of the ________

Quantity and Price standards are determined separately for 2 reasons

1. Different managers are usually responsible for buying and or using inputs. EX: The purchasing Manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used 2. The buying and using activities occur at different points in time. EX: Raw material purchases my be held in inventory for a period of time before being used in production

The use of standard costs can also present a number of problems

1. Standard cost variance reports are usually prepared on a monthly basis and are often released days or weeks after the end of the month; hence, the information can be outdated. 2. If variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions. 3. Labor variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. Second, the computations assume that labor is a variable cost. These assumptions are often invalid in today's automated manufacturing environment where employees are essentially a fixed cost. 4. In some cases, a "favorable" variance can be as bad or worse than an unfavorable variance. 5. Excessive emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. 6. Just meeting standards may not be sufficient; continual improvement using techniques such as Six Sigma may be necessary to survive in a competitive environment.

When Variances should be investigated

1. When the size of the variance relative to the amount of spending is large 2. When variances are unusual relative to the normal level of random fluctuation

Responsibility for Labor Variances

Partially controllable by employees within the production department. The Production manager/supervisor can influence: 1. The deployment of highly skilled workers and less skilled workers on tasks consistent with their skill levels. 2. The level of employee motivation within the department. 3. The quality of production supervision. 4. The quality of the training provided to the employees However, they are not entirely controllable by 1 person or department. EX: The Maintenance Department may do a poor job of maintaining production equipment. This may increase the processing time required per unit, thereby causing an unfavorable labor efficiency variance.

A Statistical Control Chart

Plotting variance analysis data on a ___________ is helpful in variance investigation decisions. Variances are investigated if they are unusual relative to the normal level of random fluctuation or an unusual pattern emerges in the data

Unfavorable Labor Efficiency Variance Causes

Poorly trained or motivated workers and poor quality materials require more labor time, faulty equipment causing breakdowns and work interruptions, poor worker supervision, and inaccurate standards. May also be caused by insufficient demand for the product

At the time the materials are purchased

Reasons why the materials price variance is calculated _____________ : 1. The practice simplifies bookkeeping 2. Management can generate more timely variance reports 3. Allows materials to be carried in the inventory accounts at standard costs

Standard hours per unit of DL

Reflects the labor hours required to complete one unit of product. Can be determined by using available references that estimate the time needed to perform a given task, or by relying on time and motion studies. Most difficult standard to determine. The standard time should include allowances for breaks, personal needs of employees, cleanup, and machine downtime

Actual Price

Represents the actual amount paid for the input used

Actual Quantity

Represents the actual quantity of DM, DL, and variable man OH used

Standard Price

Represents the amount that should have been paid for the input used

Standard Quantity

Represents the standard quantity allowed for the actual output of the period

Advantages of Standard Costs

Research has shown that a substantial portion of companies in the United Kingdom, Canada, Japan, and the United States use standard cost systems. This is because standard cost systems offer many advantages including: 1. Standard costs are a key element of the management by exception approach which helps managers focus their attention on the most important issues. 2. Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency. 3. Standard costs can greatly simplify bookkeeping. 4. Standard costs fit naturally into a responsibility accounting system. The standards establish what costs should be

Labor Efficiency Variances

What attempts to measure the productivity of DL?

DL Standards

When setting ______________, the production manager should be consulted, time and motion studies may be used, it is best to use "tight but attainable" standards

ASAP

When should variances be isolated and brought to managements attention?

Materials Variances

When the quantity of materials purchased differs from the quantity used in production, the quantity variance is based on the quantity used in production and the price variance is based on the quantity purchased