1. Chapter 12 – Standard Costs: Direct Labor and Materials
Accounting 6310
Chapter 12 – Standard Costs: Direct Labor and Materials

2. Standard Costs
Actual costs detail materials, labor, overhead, and expense costs that actually happened.
Standard cost systems detail what costs SHOULD BE as determined by designated teams of employees.
Standard costs are benchmarks.

3. Standard Cost Systems Can be used for planning or control purposes
Comparable to a budget broken down to a unit figure
Like predetermined OH rates
Developed for DM, DL, and OH or any cost you want 2

4. Variances
Difference between actual and standard cost is called a VARIANCE.
For costs:
Variances are FAVORABLE if Actual < Standard
Variances are UNFAVORABLE if Actual > Standard
For revenues, the opposite holds true.
FAVORABLE: Actual > Standard
UNFAVORABLE: Actual < Standard 7

5. Standard Cost Systems Benefits
Used for decision management
Planning
Product pricing
Contract bidding
Outsourcing decisions
Used for decision control
Easier bookkeeping
Motivation
Control costs
Performance Evaluation
Transfer pricing 3

6. Standard Cost Systems Who develops standard costs? Types of standards
Engineers
Cost accountants
Managers
Workers
Types of standards
Expected standards
Practical standards
Ideal standards 4

7. Traditional Cost-Plus Costing versus Target Costing
Traditional Costing: DM
+DL
+OH
=Total Cost
+Profit Markup
=Price charged
Target Costing
Price charged
less profit markup
=Target Cost
(DM, DL, + OH must not be more than the target cost

8. Direct Labor Variances
Price (Wage) Variance - difference in rates actually paid and standard wage rates per hour
Quantity (Efficiency) Variance - difference in actual hours worked and standard hours that should have been worked.
Causes 11

9. Direct Labor Variances
AR x AH SR x AH SR x SH
|__________________| |_____________|
Wage Variance Efficiency Variance
|_________________________________|
Total Labor Variance 12

10. Standard Quantity Allowed
Standard Quantity per unit
X units produced
= Standard Quantity Allowed
Example:
4 hours per sleeping bag
X 100 bags produced
= 400 hours allowed for production 10

11. Direct Material Variances
Price Variance
Purchase price variance (when purchased)
Usage price variance (when used)
Quantity (Efficiency) Variance
Causes 8

12. Direct Material Variances
AP x AQ SP x AQ pur.
|__________________|
Price Variance
SP x AQ used SP x SQ
|______________|
Quantity Variance 9

13. Incentive Effects of DL and DM Variances
Control costs
Purchasing manager
If purchasing manager is only evaluated on DM price variance, they will buy in bulk, unnecessarily building costly inventories
Should charge cost of inventory holding costs to purchasing department

14. Incentive Effects of DL and DM Variances
Poor quality materials often affect production causing more wasted materials and more direct labor hours
Have quality specifications and do not allow deviations
Tie purchasing manager’s evaluation to amount of rework

15. Incentive Effects of DL and DM Variances
Rush orders are more costly for purchasing
Have production (sales) bear the cost of rush orders
Engineering change orders cause wasted materials and more labor hours
Make sure changes are needed
Note these changes in production variances

16. Incentive Effects of DL and DM Variances
Mutual Monitoring
Production and Purchasing work together for the overall company good
Satisficing
Rewarding workers for achieving a standard may cause them to slack once goal is met
Encourage workers to continuously improve

17. Disposition of Variances
At end of the period, variances are usually closed into cost of goods sold
They can be allocated among WIP and FG inventories and COGS.
If there are lots of unfavorable (favorable) variances, this will increase (decrease) expenses
This can be manipulated.

18. Responsibility for Variances
Materials price - Purchasing
Materials Quantity - Production, Purchasing
Labor rate - Personnel, Production
Labor efficiency - Production, Purchasing
BUT:
Must investigate the variance to see who is actually responsible 13

19. Three Conditions Necessary to Use Standard Costs
There must be a way to measure outputs.
A predetermined standard of performance must exist.
There must be an ability to use variance information as feedback to make corrections and improvements.

20. Variance Analysis Cycle

21. Uses of Variance Analysis
Calculation of variances do not explain causes
Variances should be investigated
Often reasons for variances are explained beside the calculated variance
Favorable variances are not always good
Unfavorable variances are not always bad
It is not good to net variances
Netting of variances may cancel out large favorable variances against large unfavorable variances

22. Uses of Variance Analysis
Management by exception – allows managers to focus only on those variances which are truly out of the ordinary
Management by exception allows managers to focus on certain areas
Maximizes return on management
Variance analysis should be performed often in order to make corrections as early as possible – at least every month if possible

23. Limitations on Standards
Make sure you determine the cause of the variances; do not just mindlessly calculate them.
Any variance is only as good as the standards or planned activity to which actual is compared!!!!!!
Changing conditions may warrant changing the standards.
Variances should always be used for feedback and continuous improvement.

24. Homework P12-3 – Alexander Products P12-4 – Oaks Auto Supply
P12-10 – Marian Health Care System
DUE WEDNESDAY, MARCH 18