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11th Edition Chapter 10

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**Standard Costs and the Balanced Scorecard**

Chapter Ten This chapter begins our study of management control and performance measures. It explains how standard costs are used by managers to control costs. It also introduces the balanced scorecard as a method for top management to translate its strategy into performance measures that employees can understand and influence.

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Standard Costs Standards are benchmarks or “norms” for measuring performance. Two types of standards are commonly used. Quantity standards specify how much of an input should be used to make a product or provide a service. Cost (price) standards specify how much should be paid for each unit of the input. A standard is a benchmark or “norm” for measuring performance. In managerial accounting, two types of standards are commonly used by manufacturing, service, food and not-for-profit organizations: Quantity standards specify how much of an input should be used to make a product or provide a service. For example: a. Auto service centers like Firestone and Sears set labor time standards for the completion of work tasks. b. Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat used in a sandwich. Cost (price) standards specify how much should be paid for each unit of the input. For example: a. Hospitals have standard costs for food, laundry, and other items b. Home construction companies have standard labor costs that they apply to sub-contractors such as framers, roofers, and electricians.

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**Manufacturing Overhead**

Standard Costs Deviations from standard deemed significant are brought to the attention of management, a practice known as management by exception. Standard Amount Direct Material Management by exception is a 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.” In this chapter, we will apply the management by exception principle to quantity and cost (price) standards with an emphasis on manufacturing applications. Direct Labor Manufacturing Overhead Type of Product Cost

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**Variance Analysis Cycle**

Exh. 10-1 Variance Analysis Cycle Identify questions Receive explanations Take corrective actions Conduct next period’s operations Analyze variances The variance analysis cycle is a continuous five-step process: The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight variances that are differences between actual results and what should have occurred according to standards. Variances raise questions such as: a. Why did this variance occur? b. Why is this variance larger than it was last period? Significant variances are investigated to discover their root causes. Corrective actions are taken and the next period’s operations are carried out. Our objective is to correct problems that caused unfavorable variances and to possibly adopt and reward the practices that resulted in favorable variances. Prepare standard cost performance report Begin

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**Setting Standard Costs**

Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production. Setting price and quantity standards requires the combined expertise of everyone who has responsibility for purchasing and using inputs. In a manufacturing setting, this might include managerial accountants, engineers, purchasing managers, production managers, line managers, and production workers. Standards should be designed to encourage efficient future operations, not just a repetition of past inefficient operations.

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**Setting Standard Costs**

Should we use ideal standards that require employees to work at 100 percent peak efficiency? I recommend using practical standards that are currently attainable with reasonable and efficient effort. Ideal standards can only be attained under the best of circumstances. They allow for no work interruptions, and they require employees to continually work at one hundred percent peak efficiency. Practical standards are tight but attainable. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Practical standards can also be used for forecasting cash flows and in planning inventory. Engineer Managerial Accountant

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**Setting Direct Material Standards**

Price Standards Quantity Standards Summarized in a Bill of Materials. Final, delivered cost of materials, net of discounts. The standard price per unit for direct materials should reflect the final, delivered cost of the materials, net of applicable discounts. Standard quantities are amounts needed to meet the production designs. The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies. A bill of materials is a list that shows the quantity of each type of material in a unit of finished product.

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Setting Standards In recent years, TQM advocates have sought to eliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste and spoilage that are built into standards should be reduced over time. TQM advocates argue that waste and spoilage should not be tolerated. If allowances for waste and spoilage are built into the standard quantity, the level of those allowances should be reduced over time.

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**Setting Direct Labor Standards**

Rate Standards Often a single rate is used that reflects the mix of wages earned. Time Standards Use time and motion studies for each labor operation. Instead of the terms price and quantity used for material, we use rate and time when we apply standard cost concepts to direct labor. Labor rates can be determined by wage surveys of rates paid in comparable companies or by labor contracts. The standard rate per hour for direct labor includes not only wages earned but also fringe benefits and other labor costs. Many companies prepare a single rate for all employees within a department that reflects the “mix” of wage rates earned. The standard hours per unit reflects the labor hours required to complete one unit of product. Standard times 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.

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**Setting Variable Overhead Standards**

Rate Standards The rate is the variable portion of the predetermined overhead rate. Activity Standards The activity is the base used to calculate the predetermined overhead. For variable manufacturing overhead, we use a rate standard which is the variable portion of the predetermined overhead rate. The activity standard is the units of activity in the base used to apply our predetermined overhead. Examples of the activity base might be direct labor hours or machine hours, depending on which is used as the allocation base in the predetermined overhead rate.

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**Standard Cost Card – Variable Production Cost**

A standard cost card for one unit of product might look like this: The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.

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**Standards vs. Budgets A standard is a per unit cost.**

Standards are often used when preparing budgets. Are standards the same as budgets? A budget is set for total costs. As we’ve seen, a budget deals with total costs. Standards are calculated on a per unit basis and can be viewed as the budgeted cost for one unit of product. Standards are often used in the preparation of budgets.

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**Price and Quantity Standards**

Price and and quantity standards are determined separately for two reasons: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. Price and and quantity standards are determined separately for two reasons Different managers are usually responsible for buying and for using inputs For example: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. The buying and using activities occur at different points in time. For example: Raw material purchases may be held in inventory for a period of time before being used in production. The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

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**A General Model for Variance Analysis**

Price Variance Difference between actual price and standard price Quantity Variance Difference between actual quantity and standard quantity Price variances result when we pay an actual price for a resource that differs from the standard price that should have been paid. Quantity variances are caused by using an actual amount of a resource that differs from the standard amount that should have been used. The act of computing and interpreting variances is called variance analysis.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Price and quantity variances can be computed for all three variable cost elements – direct materials, direct labor, and variable manufacturing overhead – even though the variances have different names as shown. Materials price variance Labor rate variance VOH spending variance Materials quantity variance Labor efficiency variance VOH efficiency variance

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Here’s a general model for computing standard cost variances. We multiply the actual quantity times the actual price and compare that to the actual quantity times the standard price. The difference is the price variance. Then we compare the actual quantity times the standard price to the standard quantity at the standard price. The difference is the quantity variance. Although price and quantity variances are known by different names, they are computed exactly the same way (as shown on your screen) for direct materials, direct labor, and variable manufacturing overhead.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used. The actual quantity represents the actual amount of direct materials, direct labor, and variable manufacturing overhead used.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Standard quantity is the standard quantity allowed for the actual output for the period. The standard quantity represents the standard quantity allowed for the actual output of the period.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price The actual price represents the actual amount paid for the input used. Actual price is the amount actually paid for the for the input used.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price The standard price represents the amount that should have been paid for the input used. Standard price is the amount that should have been paid for the input used.

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**A General Model for Variance Analysis**

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price We can reduce these relationships to mathematical equations as shown on your screen. For example, we can determine the price variance by subtracting the actual quantity times the standard price from the actual quantity times the actual price, and we can determine the quantity variance by subtracting the standard quantity times the standard price from the actual quantity times the standard price. (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

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**Material Variances Example**

Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka. 0.1 kg. of fiberfill per parka at $5.00 per kg. Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029. Here’s an example that will give us an opportunity to compute material price and quantity variances.

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**Material Variances Summary**

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 Price variance $21 favorable The materials price variance, the difference between what is actually paid for a quantity of materials and what should have been paid according to the standard, is twenty-one dollars favorable. The materials price variance is favorable because the actual price was less than the standard price by ten cents per kilogram. The materials quantity variance, the difference between the standard cost of materials actually used in production and the standard cost of the quantity that should have been used, is fifty dollars unfavorable. The materials quantity variance is unfavorable because the actual quantity exceeds the standard quantity allowed by ten kilograms. Quantity variance $50 unfavorable

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**Material Variances Summary**

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 $1,029 210 kgs = $4.90 per kg The actual price is four dollars and ninety cents per kilogram, computed by dividing the actual cost of the material by the actual number of kilograms purchased. Price variance $21 favorable Quantity variance $50 unfavorable

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**Material Variances Summary**

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 0.1 kg per parka 2,000 parkas = 200 kgs The standard quantity of material is two hundred kilograms, computed by multiplying the standard quantity per parka times the number of parkas made. Price variance $21 favorable Quantity variance $50 unfavorable

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**Material Variances: Using the Factored Equations**

Materials price variance MPV = AQ (AP - SP) = 210 kgs ($4.90/kg - $5.00/kg) = 210 kgs (-$0.10/kg) = $21 F Materials quantity variance MQV = SP (AQ - SQ) = $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas)) = $5.00/kg (210 kgs kgs) = $5.00/kg (10 kgs) = $50 U Part I The equations that we have been using thus far can be factored and used to compute material price and quantity variances. Part II We can determine the material price variance by multiplying the actual quantity times the difference between the actual price and the standard price. Part III We can determine the material quantity variance by multiplying the standard price times the difference between the actual quantity and the standard quantity.

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**Isolation of Material Variances**

I’ll start computing the price variance when material is purchased rather than when it’s used. I need the price variance sooner so that I can better identify purchasing problems. You accountants just don’t understand the problems that purchasing managers have. Most companies compute the materials price variance when materials are purchased. They calculate the materials quantity variance after materials are used in production.

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Material Variances The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used. Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used? The materials price variance is computed using the entire amount of material purchased during the period. The materials quantity variance is computed using only the portion of materials that was used in production during the period.

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**Responsibility for Material Variances**

Materials Quantity Variance Materials Price Variance Purchasing Manager Production Manager The purchasing manager and production manager are usually held responsible for the materials price variance, and materials quantity variance, respectively. 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. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance.

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**Responsibility for Material Variances**

Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances. I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. The materials variances are not always entirely controllable by one person or department. For example: The production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager. In this example, since his performance evaluation is negatively impacted by the unfavorable material quantity variance, the production manager is trying to find reasons for the unfavorable variance other than his own production operation.

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**1.5 pounds per Zippy at $4.00 per pound**

Quick Check Zippy Hanson Inc. has the following direct material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630. In this example the company produces a Zippy. The direct materials standard calls for one point five pounds per Zippy at four dollars per per pound. Last week, Hanson purchased and used one thousand seven hundred pounds of material to produce one thousand Zippies. The one thousand seven hundred pounds of material cost a total of six thousand six hundred thirty dollars. Now, we will see several questions based on the information on this screen. You may wish to take some notes to use as you answer the questions. Try to answer each question before advancing to the solution.

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**Quick Check Hanson’s material price variance (MPV) for the week was:**

Zippy Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. Here’s your first question.

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**Quick Check Hanson’s material price variance (MPV) for the week was:**

Zippy Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($ ) MPV = $170 Favorable We find the material price variance by multiplying the actual quantity of material purchased times the difference between the actual price per pound and the standard price per pound. We find the actual price per pound by dividing the six thousand six hundred thirty dollars total actual price paid for the material by the one thousand seven hundred pounds purchased. The one hundred seventy dollars favorable material price variance results because Hanson paid ten cents per pound less than standard for one thousand seven hundred pounds of material.

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Quick Check Zippy Hanson’s material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. Here’s your second question.

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Quick Check Zippy Hanson’s material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. The standard quantity is the amount of material that Hanson should have used to make one thousand Zippies. We find the standard quantity by multiplying the one point five pounds per unit standard for one Zippy times the one thousand Zippies. Now that we know the standard quantity, let’s calculate the material quantity variance We find the material quantity variance by multiplying the standard price for one pound of material times the difference between the actual quantity of material and the standard quantity of material. The eight hundred dollars unfavorable material quantity variance results because Hanson used two hundred pounds more than standard to make the one thousand Zippies, and each pound of material has a standard price of four dollars. MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable

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Quick Check Zippy Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,700 lbs ,700 lbs ,500 lbs × × × $3.90 per lb $4.00 per lb $4.00 per lb. = $6, = $ 6, = $6,000 Here we see a summary of the material price and quantity variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Price variance $170 favorable Quantity variance $800 unfavorable

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**Quick Check Continued**

Zippy Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies. Let’s extend the Hanson example by increasing the quantity of material purchased to two thousand eight hundred pounds at a total costs of ten thousand nine hundred twenty dollars. All other information is the same as before.

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**Quick Check Continued**

Zippy Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs ,800 lbs × × $3.90 per lb $4.00 per lb. = $10, = $11,200 Hanson actually paid ten thousand nine hundred twenty dollars for the two thousand eight hundred pounds of material. Multiplying the standard price of four dollars per pound times the two thousand eight hundred pounds of material purchased, we find that Hanson should have paid eleven thousand two hundred dollars. The price variance is now two hundred eighty dollars favorable. The price variance increases in this example because the quantity purchased increased. The two hundred eighty dollars favorable material price variance results because Hanson paid ten cents per pound less than standard for two thousand eight hundred pounds of material. Price variance $280 favorable Price variance increases because quantity purchased increases.

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**Quick Check Continued**

Zippy Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs ,500 lbs × × $4.00 per lb $4.00 per lb. = $6, = $6,000 The material quantity variance is the same as before because Hanson again used the same amount of material as before to make the same number of Zippies. Quantity variance is unchanged because actual and standard quantities are unchanged. Quantity variance $800 unfavorable

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**Labor Variances Example**

Glacier Peak Outfitters has the following direct labor standard for its mountain parka. 1.2 standard hours per parka at $10.00 per hour Last month employees actually worked 2,500 hours at a total labor cost of $26,250 to make 2,000 parkas. Now let’s turn our attention back to Glacier Peak Outfitters to illustrate the computation of labor rate and efficiency variances.

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**Labor Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 Rate variance $1,250 unfavorable The labor rate variance, the difference between the actual total cost for labor and the total amount that should have been paid for the actual hours worked, is one thousand two hundred fifty dollars unfavorable. The labor rate variance is unfavorable because the actual average wage rate is fifty cents per hour more than the standard wage rate. The labor efficiency variance, the difference between the standard cost of the actual hours of labor used in production and the standard cost of the hours that should have been used, is one thousand dollars unfavorable. The efficiency variance is unfavorable because the actual quantity of hours is one hundred hours more than the standard quantity of hours allowed. Efficiency variance $1,000 unfavorable

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**Labor Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 $26,250 2,500 hours = $10.50 per hour Rate variance $1,250 unfavorable The actual wage rate is ten dollars and fifty cents per hour, computed by dividing the actual total cost for labor by the actual number of hours worked. Efficiency variance $1,000 unfavorable

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**Labor Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 1.2 hours per parka 2,000 parkas = 2,400 hours Rate variance $1,250 unfavorable The standard quantity of labor hours is two thousand four hundred hours, computed by multiplying the standard hours for one parka times the number of parkas made. Efficiency variance $1,000 unfavorable

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**Labor Variances: Using the Factored Equations**

Labor rate variance LRV = AH (AR - SR) = 2,500 hours ($10.50 per hour – $10.00 per hour) = 2,500 hours ($0.50 per hour) = $1,250 unfavorable Labor efficiency variance LEV = SR (AH - SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavorable Part I The equations that we have been using thus far can be factored and used to compute labor rate and efficiency variances. Part II We can determine the labor rate variance by multiplying the actual hours times the difference between the actual rate and the standard rate. Part III We can determine the labor efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.

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**Responsibility for Labor Variances**

Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of training provided to employees. Quality of production supervision. Production Manager Labor variances are partially controllable by employees within the production department. For example, production managers/supervisors can influence the: Deployment of highly skilled workers and less skilled workers on tasks consistent with their skill levels. Level of employee motivation within the department. Quality of production supervision. Quality of the training provided to the employees.

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**Responsibility for Labor Variances**

I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. I am not responsible for the unfavorable labor efficiency variance! You purchased cheap material, so it took more time to process it. Labor variances are not entirely controllable by one person or department. For example: 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. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable labor efficiency variance for the production manager.

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**1.5 standard hours per Zippy at $12.00 per direct labor hour**

Quick Check Zippy Hanson Inc. has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $12.00 per direct labor hour Last week 1,550 direct labor hours were worked at a total labor cost of $18,910 to make 1,000 Zippies. Let’s return to the Hanson Company and compute labor variances. The direct labor standard to produce each Zippy is one point five hours at twelve dollars per hour. Last week, it took one thousand five hundred fifty direct labor hours to produce one thousand Zippies, and the total labor cost was eighteen thousand nine hundred ten dollars. Now, we will see several questions based on the information on this screen. Again, you may wish to take some notes to use as you answer the questions. Also, just as you did with the material variance questions, try to answer each question before advancing to the solution.

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**Quick Check Hanson’s labor rate variance (LRV) for the week was:**

Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable. Here’s your first labor variance question.

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**Quick Check Hanson’s labor rate variance (LRV) for the week was:**

Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable. LRV = AH(AR - SR) LRV = 1,550 hrs($ $12.00) LRV = $310 unfavorable We find the actual labor rate by dividing the eighteen thousand nine hundred ten dollars total labor cost by one thousand five hundred fifty direct labor hours actually worked. Now that we know the actual labor rate, let’s calculate the labor rate variance. We find the labor rate variance by multiplying the actual labor hours worked times the difference between the actual rate per labor hour and the standard rate per labor hour. The three hundred ten dollars unfavorable labor rate variance results because Hanson paid twenty cents per labor hour more than standard for one thousand five hundred fifty labor hours actually worked.

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Quick Check Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $590 unfavorable. b. $590 favorable. c. $600 unfavorable. d. $600 favorable. Here’s your second labor variance question.

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Quick Check Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $590 unfavorable. b. $590 favorable. c. $600 unfavorable. d. $600 favorable. The total standard hours for labor is the amount of time Hanson’s employees should have worked to make one thousand Zippies. We find the total standard hours by multiplying the one point five standard hours for one Zippy times the one thousand Zippies made. Now that we know the total standard hours, let’s calculate the labor efficiency variance. We find the labor efficiency variance by multiplying the standard rate for one hour of labor times the difference between the actual hours of labor and the standard hours of labor. The six hundred dollars unfavorable labor efficiency variance results because Hanson’s employees worked fifty hours more than standard to make one thousand Zippies, and each hour of labor has a standard rate of twelve dollars. LEV = SR(AH - SH) LEV = $12.00(1,550 hrs - 1,500 hrs) LEV = $600 unfavorable

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Quick Check Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours ,550 hours ,500 hours × × × $12.20 per hour $12.00 per hour $12.00 per hour = $18, = $18, = $18,000 Here we see a summary of the labor rate and efficiency variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Rate variance $310 unfavorable Efficiency variance $600 unfavorable

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**Variable Manufacturing Overhead Variances Example**

Glacier Peak Outfitters has the following direct variable manufacturing overhead labor standard for its mountain parka. 1.2 standard hours per parka at $4.00 per hour Last month employees actually worked 2,500 hours to make 2,000 parkas. Actual variable manufacturing overhead for the month was $10,500. Now that we have studied material and labor variances, let’s take a look a variable manufacturing overhead variances. We will return to Glacier Peak Outfitters to illustrate the computation of variable manufacturing spending and efficiency variances.

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**Variable Manufacturing Overhead Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 Spending variance $500 unfavorable The variable manufacturing overhead spending variance, the difference between the actual total cost for variable manufacturing overhead and the total amount that should have been paid for the actual hours worked, is five hundred dollars unfavorable. The variable manufacturing overhead spending variance is unfavorable because the actual variable manufacturing overhead rate is twenty cents per hour more than the standard variable manufacturing overhead rate. The variable manufacturing overhead efficiency variance, the difference between the standard cost of the actual hours used in production and the standard cost of the hours that should have been used, is four hundred dollars unfavorable. The efficiency variance is unfavorable because the actual quantity of hours is one hundred hours more than the standard quantity of hours allowed. Efficiency variance $400 unfavorable

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**Variable Manufacturing Overhead Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 $10,500 2,500 hours = $4.20 per hour Spending variance $500 unfavorable The actual variable manufacturing overhead rate is four dollars and twenty cents per hour, computed by dividing the actual total cost for variable manufacturing overhead by the actual number of hours worked. Efficiency variance $400 unfavorable

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**Variable Manufacturing Overhead Variances Summary**

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 1.2 hours per parka 2,000 parkas = 2,400 hours Spending variance $500 unfavorable The standard quantity for labor hours is two thousand four hundred hours, computed by multiplying the standard hours for one parka times the number of parkas made. Efficiency variance $400 unfavorable

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**Variable Manufacturing Overhead Variances: Using Factored Equations**

Variable manufacturing overhead spending variance VMSV = AH (AR - SR) = 2,500 hours ($4.20 per hour – $4.00 per hour) = 2,500 hours ($0.20 per hour) = $500 unfavorable Variable manufacturing overhead efficiency variance VMEV = SR (AH - SH) = $4.00 per hour (2,500 hours – 2,400 hours) = $4.00 per hour (100 hours) = $400 unfavorable Part I The equations that we have been using thus far can be factored and used to compute the variable manufacturing overhead variances. Part II We can determine the variable manufacturing overhead spending variance by multiplying the actual hours times the difference between the actual rate and the standard rate. Part III We can determine the variable manufacturing overhead efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.

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**1.5 standard hours per Zippy at $3.00 per direct labor hour**

Quick Check Zippy Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy: 1.5 standard hours per Zippy at $3.00 per direct labor hour Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead. Now let’s return to the Hanson company and compute the variable manufacturing overhead variances. The variable manufacturing overhead standard to produce each Zippy is one point five hours at three dollars per hour. Last week, it took one thousand five hundred fifty hours to produce one thousand Zippies, and the total variable manufacturing overhead cost was five thousand one hundred fifteen dollars. Now, we will see several questions based on the information on this screen. Again, you may wish to take some notes to use as you answer the questions. Also, just as you did with the material and labor variance questions, try to answer each question before advancing to the solution.

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Quick Check Zippy Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. Here’s your first variable manufacturing overhead variance question.

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Quick Check Zippy Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. VOSV = AH(AR - SR) VOSV = 1,550 hrs($ $3.00) VOSV = $465 unfavorable We find the actual variable manufacturing overhead rate by dividing the five thousand one hundred fifteen dollars total variable manufacturing overhead cost by one thousand five hundred fifty direct labor hours actually worked. Now that we know the actual variable manufacturing overhead rate, let’s calculate the variable manufacturing overhead spending variance. We find the variable manufacturing overhead spending variance by multiplying the actual hours worked times the difference between the actual variable manufacturing overhead rate per hour and the standard variable manufacturing overhead rate per hour. The four hundred sixty-five dollars unfavorable variable manufacturing overhead rate variance results because Hanson’s actual variable manufacturing overhead rate per labor hour is thirty cents per hour more than the standard variable manufacturing overhead rate per hour for the one thousand five hundred fifty labor hours actually worked.

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Quick Check Zippy Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. Here’s your second variable manufacturing overhead variance question.

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Quick Check Zippy Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. 1,000 units × 1.5 hrs per unit The total standard hours is the amount of time Hanson’s employees should have worked to make one thousand Zippies. We find the total standard hours by multiplying the one point five standard hours for one Zippy times the one thousand Zippies made. Now that we know the total standard hours, let’s calculate the variable manufacturing overhead efficiency variance. We find the variable manufacturing overhead efficiency variance by multiplying the standard rate for variable manufacturing overhead times the difference between the actual hours of labor and standard hours of labor. The one hundred fifty dollars unfavorable variable manufacturing overhead efficiency variance results because Hanson’s employees worked fifty hours more than standard to make one thousand Zippies at a standard variable manufacturing overhead rate of three dollars per hour. VOEV = SR(AH - SH) VOEV = $3.00(1,550 hrs - 1,500 hrs) VOEV = $150 unfavorable

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Quick Check Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours ,550 hours ,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour = $5, = $4, = $4,500 Just as we did with labor and material variances, we can summarize the variable manufacturing overhead variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Spending variance $465 unfavorable Efficiency variance $150 unfavorable

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**Variance Analysis and Management by Exception**

Larger variances, in dollar amount or as a percentage of the standard, are investigated first. All variances are not worth investigating. Methods for highlighting a subset of variances as exceptions include: Looking at the size of the variance. Looking at the size of the variance relative to the amount of spending. How do I know which variances to investigate?

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**A Statistical Control Chart**

Exh. 10-9 A Statistical Control Chart Warning signals for investigation • • Favorable Limit • • • • Desired Value • • Unfavorable Limit • Plotting variance analysis data on a statistical control chart is helpful in variance investigation decisions. Variances are investigated if: They are unusual relative to the normal level of random fluctuation. An unusual pattern emerges in the data. 1 2 3 4 5 6 7 8 9 Variance Measurements

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**Advantages of Standard Costs**

Management by exception Promotes economy and efficiency Advantages Standard cost systems offer many advantages including: Standard costs are a key element of the management by exception approach that helps managers focus their attention on the most important issues. Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency. Standard costs can greatly simplify bookkeeping. Standard costs fit naturally into a responsibility accounting system. Enhances responsibility accounting Simplified bookkeeping

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**Potential Problems with Standard Costs**

Emphasizing standards may exclude other important objectives. Favorable variances may be misinterpreted. Potential Problems Standard cost reports may not be timely. Emphasis on negative may impact morale. The use of standard costs can also present a number of problems. For example: 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. If variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions. 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. In some cases, a favorable variance can be as bad or worse than an unfavorable variance. Excessive emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. Just meeting standards may not be sufficient; continual improvement may be necessary to survive in a competitive environment. Continuous improvement may be more important than meeting standards. Invalid assumptions about the relationship between labor cost and output.

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**The Balanced Scorecard**

Management translates its strategy into performance measures that employees understand and accept. Customers Financial Performance measures A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s strategy. Importantly, the measures included in a company’s balanced scorecard are unique to its specific strategy. The balanced scorecard enables top management to translate its strategy into four groups of performance measures – financial, customer, internal business process, and learning and growth – that employees can understand and influence. Learning and growth Internal business processes

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**The Balanced Scorecard: From Strategy to Performance Measures**

Exh. 10-11 The Balanced Scorecard: From Strategy to Performance Measures Performance Measures Financial Has our financial performance improved? What are our financial goals? What customers do we want to serve and how are we going to win and retain them? Vision and Strategy Customer Do customers recognize that we are delivering more value? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? What internal busi- ness processes are critical to providing value to customers? The premise of these four groups of measures is that learning is necessary to improve internal business processes, which in turn improves the level of customer satisfaction, which in turn improves financial results. Note the emphasis on improvement, not just attaining some specific objective. Learning and Growth Are we maintaining our ability to change and improve?

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**The Balanced Scorecard: Non-financial Measures**

The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. Top managers are ordinarily responsible for financial performance measures – not lower level managers Non-financial measures are more likely to be understood and controlled by lower level managers. The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.

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**The Balanced Scorecard for Individuals**

The entire organization should have an overall balanced scorecard. Each individual should have a personal balanced scorecard. While the entire organization has an overall balanced scorecard, each responsible individual should have his or her own personal scorecard as well. A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard. A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard.

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**The Balanced Scorecard**

A balanced scorecard should have measures that are linked together on a cause-and-effect basis. If we improve one performance measure . . . Another desired performance measure will improve. Then A balanced scorecard, whether for an individual or the company as a whole, should have measures that are linked together on a cause-and-effect basis. Each link can be read as a hypothesis in the form “If we improve this performance measure, then this other performance measure should also improve.” In essence, the balanced scorecard lays out a theory of how a company can take concrete actions to attain desired outcomes. If the theory proves false or the company alters its strategy, the measures within the scorecard are subject to change. The balanced scorecard lays out concrete actions to attain desired outcomes.

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**The Balanced Scorecard and Compensation**

Incentive compensation should be linked to balanced scorecard performance measures. Incentive compensation for employees probably should be linked to balanced scorecard performance measures. However, this should only be done after the organization has been successfully managed with the scorecard for some time – perhaps a year or more. Managers must be confident that the measures are reliable, not easily manipulated, and understandable by those being evaluated with them.

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**The Balanced Scorecard Jaguar Example**

Exh. 10-13 The Balanced Scorecard Jaguar Example Profit Financial Contribution per car Number of cars sold Customer Customer satisfaction with options Assume that Jaguar pursues a strategy as shown on your screen. Internal Business Processes Number of options available Time to install option Learning and Growth Employee skills in installing options

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**The Balanced Scorecard Jaguar Example**

Profit Contribution per car Number of cars sold Results Customer satisfaction with options Satisfaction Increases If “employee skills in installing options” increases, then the “number of options available” should increase and the “time to install an option” should decrease. If the “number of options available” increases and the “time to install an option” decreases, then “customer satisfaction with options” should increase. Strategies Increase Options Number of options available Time to install option Time Decreases Increase Skills Employee skills in installing options

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**The Balanced Scorecard Jaguar Example**

Profit Contribution per car Results Cars sold Increase Number of cars sold Customer satisfaction with options Satisfaction Increases If the “customer satisfaction with options” increases, then the “number of cars sold” should increase. Strategies Increase Options Number of options available Time to install option Employee skills in installing options

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**The Balanced Scorecard Jaguar Example**

Results Profit Contribution per car Contribution Increases Number of cars sold Customer satisfaction with options If the “time to install an option” decreases and the “customer satisfaction with options” increases, then the “contribution per car” should increase. Number of options available Time to install option Time Decreases Strategies Increase Skills Employee skills in installing options

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**The Balanced Scorecard Jaguar Example**

Results Profit Profits Increase If number of cars sold and contribution per car increase, profits increase. Contribution per car Contribution Increases Number of cars sold Customer satisfaction with options Satisfaction Increases If the “number of cars sold” and the “contribution per car” increase, then the “profit” should increase. Strategies Increase Options Number of options available Time to install option Time Decreases Increase Skills Employee skills in installing options

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**Advantages of Graphic Feedback**

When interpreting its performance, Jaguar will be looking for a trend of continual improvement. These trends are better identified with graphic feedback. For example: Assume that Jaguar’s “time to install an option” performance over ten weeks is as shown on your screen It is much easier to spot trends or unusual performance if this data is presented graphically as shown. When interpreting its performance, Jaguar will look for continual improvement. It is easier to spot trends or unusual performance if this data is presented graphically.

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**Delivery Performance Measures**

Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Delivery cycle time is the elapsed time from when a customer order is received to when the completed order is shipped. Throughput (manufacturing cycle) time is the amount of time required to turn raw materials into completed products. This includes process time, inspection time, move time, and queue time. Process time is the only value-added activity of the four times mentioned. Delivery Cycle Time Process time is the only value-added time.

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**Delivery Performance Measures**

Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Manufacturing cycle efficiency (MCE) is computed by dividing value-added time by manufacturing cycle (throughput) time. A manufacturing cycle efficiency less than one indicates that non-value-added time is present in the production process. Next we will look at a series of questions dealing with delivery performance measures. Delivery Cycle Time Manufacturing Cycle Efficiency Value-added time Manufacturing cycle time =

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Quick Check A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the throughput time? a days b days c days d days Here’s your first question on delivery performance measures asking for a computation of throughput time.

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Quick Check A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the throughput time? a days b days c days d days Throughput time is the sum of process time, inspection time, move time, and queue time. The total for these four times is ten point four days. Throughput time = Process + Inspection + Move + Queue = 0.2 days days days days = 10.4 days

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Quick Check A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the MCE? a. 50.0% b % c. 52.0% d % Here’s your second question on delivery performance measures asking for a computation of manufacturing cycle efficiency.

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Quick Check A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the MCE? a. 50.0% b % c. 52.0% d % Manufacturing cycle efficiency is found by dividing value-added time by throughput time. Process time is the only value-added time. Process time of zero point two days divided by throughput time of ten point four days results in a manufacturing cycle efficiency of one point nine percent. MCE = Value-added time ÷ Throughput time = Process time ÷ Throughput time = 0.2 days ÷ 10.4 days = 1.9%

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Quick Check A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the delivery cycle time? a days b days c days d days Here’s your third question on delivery performance measures asking for a computation of delivery cycle time.

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Quick Check Delivery cycle time = Wait time + Throughput time = 3.0 days days = 13.4 days A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the delivery cycle time? a days b days c days d days Delivery cycle time is the sum of wait time plus throughput time. The total for these two times is thirteen point four days.

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**Appendix 10A Journal Entries to Record Variances**

We will use information form the Glacier Peak Outfitters example earlier in the chapter to illustrate journal entries for standard cost variances. Recall the following: Material AQ × AP = $1,029 AQ × SP = $1,050 SQ × SP = $1,000 MPV = $21 F MQV = $50 U Labor AH × AR = $26,250 AH × SR = $25,000 SH × SR = $24,000 LRV = $1,250 U LEV = $1,000 U Standard costs and variance analysis can be used without formal journal entries. However, recording inventories and cost of goods sold using standard costs simplifies bookkeeping since it eliminates the need to keep track of the actual costs of each unit. We will use the information from the Glacier Peak Outfitters example earlier in the chapter to illustrate journal entries for labor and material variances. A summary of the standard cost variance computations for Glacier Peak Outfitters’ labor and material variances is shown on your screen. Now let’s prepare the entries to record the labor and material variances.

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**Appendix 10A Journal Entries to Record Variances**

The first entry is to to record the purchase of materials. A favorable materials price variance is recorded with a credit. The second entry is to record the use of material. The use of material involves a transfer of material from the asset account raw materials inventory to the asset account work-in-process inventory. An unfavorable materials quantity variance is record with a debit. Note that the price variance is recorded at purchase, and the quantity variance is recorded sometime later as materials are used.

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**Appendix 10A Journal Entries to Record Variances**

Here we see the entry for the incurrence of direct labor. Both labor variances are unfavorable and are recorded with debits. Variable manufacturing overhead variances are usually not recorded in the accounts separately, but rather are determined as part of the general analysis of overhead that is covered in the next chapter. Variable manufacturing overhead variances are usually not recorded in the accounts separately, but are determined as part of the general analysis of overhead that is covered in the next chapter.

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**Cost Flows in a Standard Cost System**

Inventories are recorded at standard cost. Variances are recorded as follows: Favorable variances are credits, representing savings in production costs. Unfavorable variances are debits, representing excess production costs. Standard cost variances are usually closed to cost of goods sold. Favorable variances decrease cost of goods sold. Unfavorable variances increase cost of goods sold. Entries into the various accounts are made at standard cost – not actual cost. Differences between actual and standard costs are entered into special accounts that accumulate the various standard cost variances. Standard cost variance accounts are usually closed out to Cost of Goods Sold at the end of the period. Unfavorable variances increase Cost of Goods Sold, and favorable variances decrease Cost of Goods Sold.

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End of Chapter 10 Standards are used for both the cost and quantity of resources used in manufacturing goods or providing services. Comparing standards to actual performance results in either favorable or unfavorable variances. Variance analysis leads to better cost control and performance evaluation. A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s strategy. The balanced scorecard enables top management to translate its strategy into four groups of performance measures – financial, customer, internal business process, and learning and growth – that employees can understand and influence.

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