Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith Chapter 10 Standard costs for control: Direct material and direct labour

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 2 Controlling costs  Businesses are in control when operations proceed to plan and objectives are achieved  Necessary requirements for control ÙA predetermined or standard performance level ÙA measure of actual performance; and ÙA comparison between standard performance and actual performance

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 3 Control systems: a thermostat

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 4 Controlling costs  Standard costing is a part of the budgetary control system  A predetermined or standard cost is developed ÙA standard cost is a budget for the production of one unit of a product, either goods or services  The actual cost incurred is measured continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 5 Controlling costs  The actual cost is compared to the budgeted or standard cost, to form a standard cost variance ÙStandard cost variances are used to evaluate actual performance and control costs ÙStandard costs can be developed for direct material, direct labour and overheads

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 6 Setting standards  A variety of methods may be used to set cost standards  Analysis of historical data ÙCan provide a good basis for predicting future costs ÙMay need to be adjusted to reflect expected movements in price levels or technological changes into the product process ÙMust be used with care as changes can make those costs irrelevant, and can include inefficiencies of the past continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 7 Setting standards  Engineering methods ÙRather than what did it cost in the past, the focus is on what should it cost in the future? ÙNeed to determine how much material should be required and how much direct labour should be used in the production process ÙTime and motion studies may be conducted to ascertain how long it should take for workers to perform each step  In practice both historical cost analysis and engineering methods may be used in combination continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 8 Setting standards  Participation in setting standards ÙStandards should not be set by accountants alone ÙPeople will usually be more committed to meeting standards and have greater confidence in their accuracy if they are allowed to participate in setting them ÙAny manager who plays an integral part in an operation or process should participate in setting standards for that area continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 9 Setting standards  Perfection standards reflect minimum attainable costs under nearly perfect operation conditions ÙAssumes peak efficiency, the lowest material and labour prices, the use of the best quality materials, and no production disruptions due to power failures or machine breakdowns continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 10 Setting standards  Perfection standards ÙMay motivate people to achieve the lowest cost possible, as the standard is theoretically attainable ÙMay discourage employees from workings hard as the standards are unlikely to be achieved ÙMay encourage employees to sacrifice quality to achieve low costs continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 11 Setting standards  Practical standards are the minimum attainable costs under normal operating conditions, with allowances made for downtime and wastage ÙFactors in occasional machine breakdowns and normal amounts of raw material wastage ÙMay encourage more positive and productive attitudes among employees compared to perfection standards ÙSome companies include allowances for idle time, material wastage or normal spoilage, which may encourage inefficiency and waste ÙOther companies build continuous improvements into standards to make them more demanding continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 12 Setting standards  Benchmarking of costs may involve ÙIdentifying companies that have the best cost performance, ÙAssessing their level of costs, and ÙIdentifying the cost performance gap that needs to be closed  Cost standards may be formulated to achieve external performance standards over the medium to long term

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 13 Direct material standards  Standard material quantity is the total amount of direct material required to produce one unit of product  Standard material price is the total delivered cost of that material, less quantity discounts  Based on ordering a certain quality of material in specific order quantities from a specified supplier

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 14 Direct labour standards  Standard direct labour is the number of labour hours normally needed to manufacture one unit of products  Standard about rate is the total hourly cost of wages, including on-costs ÙOn-costs are extra salary-related costs that all Australian companies have to pay, and usually treated as part of the cost of labour

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 15 Standard costs given actual output

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 16 Calculating standard cost variances

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 17 Direct material variances  Direct material price variances ÙThe effect on cost of purchasing at a price that is different from standard = PQ (AP – SP) Where PQ= quantity purchased AP= actual price SP= standard price continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 18 Direct material variances  Sometimes the direct material price variance is calculated using the quantity of materials used in production (AQ) rather than the quantity of material purchased (PQ) continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 19 Direct material variances  Direct material quantity variance ÙThe effect on cost of using a different quantity of material in production, compared with the standard quantity that should have been used for the actual production output = SP (AQ - SQ) Where SP= standard price AQ= actual quantity used SQ = standard quantity used, given actual output

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 20 Direct labour variances  Direct labour rate variance ÙEffect on cost of paying a different labour rate, compared with standard = AH (AR - SR) Where AH= actual hours used AR= actual rate per hour SR= standard rate per hour continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 21 Direct labour variances  Direct labour efficiency variance ÙEffect on cost of using a different number of direct labour hours, compared with the standard hours that should have been used for the actual production output = SR (AH-SH) Where AH= actual hours used SH= standard hours allowed given actual output SR= standard rate per hour

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 22 Investigating significant variances  Management by exception ÙOnly reporting significant cost variances  Significant variances ÙSize of variance ÙRecurring variances ÙTrends ÙControllability continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 23 Investigating significant variances  Favourable variances warrant similar investigation to unfavourable variances  Investigating variances may include ÙTalking with managers and employees familiar with the operations to find causes ÙWritten reports to explain significant variances and possible corrective actions

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 24 A statistical approach to variance investigation  Variances may be caused by random fluctuations which may not require correction  Statistical control charts plot standard cost variances across time and compares them with a statistically determined critical value to highlight the variances which should be investigated

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 25 Costs and benefits of investigation  Costs include ÙTime spent investigating the problem ÙDisruption to the production process as the investigation is conducted ÙCorrective actions  Benefits include ÙReduced costs if cause of variance is eliminated ÙCauses of favourable variances may improve work practices

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 26 Behavioural impact of standard costing  Standard costing can be used to evaluate the performance of employees and departments  Comparing individuals’ performance with standards or budgets is used to determine salary increases, bonuses and promotions. These can profoundly influence behaviour

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 27 Cost control through assigning responsibility  Cost control is accomplished through the efforts of individual managers and employees  It is important that managers held responsible for achieving certain cost standards ÙCan control these outcomes ÙAre involved in setting the standards continued

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 28 Cost control through assigning responsibility  Interactions between variances may make it difficult to assign responsibility for particular variances ÙNot all favourable variances are desirable ÙUnfavourable variances do not always indicate a problem ÙSource of the variance may lie in a different area of the firm than where the variance is being reported

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 29 Standard costs for product costing  Standard costing system ÙAll inventories are recorded at standard cost  Variances are closed off at the end of accounting period ÙTo cost of goods sold expense, or ÙProrate between WIP, FG and COGS

Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 30