Managerial Accounting - Ch 10 - Standard Costing and Analysis of Direct Costs

Methods for Setting Standards

1. Analysis of Historical Data. 2. Task Analysis: Setting standards by analyzing the production process.

Advantages of Standard Costing

1. Provide a basis for sensible cost comparisons. 2. Computation of standard costs and cost variances enables managers to employ management by exception. 3. Variances provide a means of performance evaluation and rewards for employees. 4. Provide motivation for employees to adhere to standards. 5. Use of standard costs in product costing results in more stable product costs than if actual production costs are used. Actual costs often fluctuate erratically, whereas standard costs are changed only periodically.

Significance of Cost Variances

1. Size of Variances 2. Recurring Variances 3. Trends 4. Controllability 5. Favorable Variances 6. Costs and Benefits of Investigation

Criticisms of Standard Costing in Today's Manufacturing Environment

1. The variances calculated under standard costing are at too aggregate a level and come too late to be useful. 2. Traditional cost variances are also too aggregate in the sense that they are not tied to specific product lines or production batches. The aggregate nature of the variances makes it difficult for managers to determine their cause. 3. Traditional standard-costing systems focus too much on the cost and efficiency of direct labor, which is rapidly becoming a relatively unimportant factor of production in manufacturing. 4. One of the most important conditions for the successful use of standard costing is a stable production process. Yet the introduction of flexible manufacturing systems has reduced this stability, with frequent switching among a variety of products on the same production line. 5. Shorter product life cycles. New products are introduced, new standards must be developed. 6. Traditional standard costs are not defined broadly enough to capture various important aspects of performance. 7. Traditional standard-costing systems tend to focus too much on cost minimization, rather than increasing product quality or customer service.

Favorable Variance

Abbreviated as F, when spending is lower than expected, the amount by which spending is less than planned.

Unfavorable Variance

Abbreviated as U, when spending is higher than expected, the excess spending is called this.

Standard Cost

Is the company's best estimate of the average cost to produce a single unit of product or service.

Standard Direct-Labor Quantity

Is the number of direct labor hours normally needed to manufacture one unit of product.

Product Costing

Is the process of accumulating the costs of a production process and assigning them to the completed products.

Cost Variance Analysis

Is the process of systematically comparing expected costs (standards) against actual costs, analyzing the differences, and explaining significant deviations.

Standard Direct-Material Quantity

Is the total amount of direct material normally required to produce one unit of finished product, including allowances for normal waste or inefficiency.

Standard Direct-Material Price

Is the total delivered cost, after subtracting any purchase discounts, of one direct-material unit.

Standard Direct-Labor Rate

Is the total hourly cost of compensation, including fringe benefits.

Statistical Control Chart

Plots cost variances across time and compares them with a statistically determined critical value that triggers an investigation. The critical value is usually determined by assuming that cost variances have a normal probability distribution with a mean of zero.

Task Analysis

Setting standards by analyzing the production process.

Practical (Attainable) Standards

The cost expected under normal operating conditions. Such standards assume a production process that is as efficient as practical under normal operating conditions. Allow for such occurrences as occasional machine breakdowns and normal amounts of raw-material waste. (Most behavioral theorists believe this standard encourage a more positive and productive employee attitudes than do perfection standards.)

Perfection (Ideal) Standard

The cost expected under perfect or ideal operating conditions. Such standards assume peak efficiency, the lowest possible input prices, the best-quality materials obtainable, and no disruption in production due to such causes as machine breakdowns or power failures. (Behavioral scientists believe that this standard discourage employees, since they are so unlikely to be attained.)

Cost Variance

The difference between actual and standard (budgeted) cost.

Direct-Labor Rate Variance

The difference between actual and standard hourly labor rate multiplied by the actual hours of direct labor used. = AH(AR - SR) AH = Actual hours used AR = Actual rate per hour SR = Standard Rate per hour

Direct-Labor Efficiency Variance

The difference between actual and standard hours of direct labor multiplied by the standard hourly labor rate. = SR(AH - SH) SH = Standard Hours Allowed

Direct-Material Price Variance

The difference between actual and standard price of direct material used in production, multiplied by the actual quantity of material used. = AQ(AP - SP) AQ = Actual Quantity Used AP = Actual Price SP = Standard Price

Direct-Material Quantity Variance

The difference between actual and standard quantity of materials allowed, given actual output, multiplied by standard price. = SP(AQ - SQ) SQ = Standard Quantity

Direct-Material Purchase Price Variance

The difference between the standard price and the actual price paid for direct material purchased, multiplied by the actual quantity of material purchased. = PQ(AP - SP) PQ = Quantity purchased

Controllability

The extent to which managers are able to control or influence a cost or cost variance.

Management by Exception

The process of following up on only significant cost variances.

Standard-Costing System

The standard costs of direct material and direct labor are entered into WIP Inventory.

Control System

Thermostat Example: 1. Predetermined or standard performance. - The thermostat is set to a standard temp. 2. Measure of actual performance. - The thermometer measures the actual room temp. 3. Comparison of actual and standard performance. - The thermostat compares the present or standard temp with actual temp.