1. Copyright © by Houghton Miffin Company. All rights reserved.1 Financial & Managerial Accounting 2002e Belverd E. Needles, Jr. Marian Powers Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College

2. Copyright © by Houghton Miffin Company. All rights reserved.2 Chapter 22 Performance Measurement Using Standard Costing

3. Copyright © by Houghton Miffin Company. All rights reserved.3 1.Define standard costs and describe how managers use standard costs in the management cycle. 2.Identify the six elements of, and compute, a standard unit cost. 3.Describe how to control costs through variance analysis. LEARNING OBJECTIVES

4. Copyright © by Houghton Miffin Company. All rights reserved.4 4.Compute and analyze direct materials variances. 5.Compute and analyze direct labor variances. 6.Define and prepare a flexible budget. 7.Compute and analyze manufacturing overhead variances. 8.Explain how variances are used to evaluate managers’ performance. LEARNING OBJECTIVES

5. Copyright © by Houghton Miffin Company. All rights reserved.5 Standard Costs in Today’s Business Environment OBJECTIVE 1 Define standard costs and describe how managers use standard costs in the management cycle.

6. Copyright © by Houghton Miffin Company. All rights reserved.6 Standard Costing u A budgeting control technique with 3 components: 1. A standard, predetermined performance level. 2. A measure of actual performance. 3. A measure of the variance, the difference, between the standard and the actual.

7. Copyright © by Houghton Miffin Company. All rights reserved.7 Standard Costs u Standard costs are predetermined costs that are developed from analyses of both: 4 Past operating costs, quantities, and times..  Future costs and operating conditions.

8. Copyright © by Houghton Miffin Company. All rights reserved.8 Standard Cost Flow u In a standard costing system, standard costs for direct materials, direct labor, and manufacturing overhead flow through the inventory accounts and eventually into the Cost of Goods Sold account. u The difference from normal costing systems is that under standard costing systems, standard costs instead of actual costs are used to record all of these flows.

9. Copyright © by Houghton Miffin Company. All rights reserved.9 The Management Cycle u Managers use standard costs throughout the management cycle. 4 In the planning stage of the management cycle, standard costs aid in the development of budgets and as yardsticks for evaluating capital expenditures. 4 During the executing stage, standard costs, quantities, and times are applied to work performed.

10. Copyright © by Houghton Miffin Company. All rights reserved.10 The Management Cycle u During the reviewing stage, actual costs are compared with standard costs to compute variances, and managers analyze the causes of those variances to improve operations. Both favorable and unfavorable variances should be investigated. u During the reporting stage, a variance report provides information on operations and managerial performance.

11. Copyright © by Houghton Miffin Company. All rights reserved.11 Standard Costing, Variance Analysis, and the Management Cycle

12. Copyright © by Houghton Miffin Company. All rights reserved.12 Standard Costing Systems u The primary difference between a standard costing system in service versus manufacturing organizations is that there are no direct materials variances in service organizations. u The importance of labor-related standards and variances has been reduced because direct labor costs as a proportion of product costs has decreased over time.

13. Copyright © by Houghton Miffin Company. All rights reserved.13 The Management Cycle u In today’s globally competitive environment, new standards or measurements are necessary to help managers: 4 Reduce processing time. 4 Improve quality. 4 Improve customer satisfaction. 4 Improve on-time deliveries.

14. Copyright © by Houghton Miffin Company. All rights reserved.14 A. A. The primary difference between a standard costing system in service versus manufacturing organizations is that there are no direct materials variances in service organizations.Discussion Q. Q.What is the difference between a standard costing system in service versus manufacturing organizations?

15. Copyright © by Houghton Miffin Company. All rights reserved.15 The Development of Standard Costs OBJECTIVE 2 Identify the six elements of, and compute, a standard cost.

16. Copyright © by Houghton Miffin Company. All rights reserved.16 A Standard Costing System u Standard costs replace actual costs in all accounts. u Materials Inventory, Work in Process, Finished Goods and Cost of Goods Sold balances are based on standard costs. u Separate records are kept of actual costs for comparison.

17. Copyright © by Houghton Miffin Company. All rights reserved.17 Standard Cost per Unit u There are six standards used to determine the standard cost per unit: 1.Direct materials price standard. 2.Direct materials quantity standard. 3.Direct labor time standard. 4.Direct labor rate standard. 5.Standard variable manufacturing overhead rate. 6.Standard fixed manufacturing overhead rate.

18. Copyright © by Houghton Miffin Company. All rights reserved.18 Direct Materials Price Standard u The direct materials price standard is calculated by carefully considering: 4 Expected price changes. 4 Changes in available quantities. 4 Possible new sources of supply.

19. Copyright © by Houghton Miffin Company. All rights reserved.19 Direct Materials Quantity Standard u The direct materials quantity standard is affected by: 4 Product engineering specifications. 4 Quality of direct materials. 4 Age and productivity of machines. 4 Quality and experience of the work force.

20. Copyright © by Houghton Miffin Company. All rights reserved.20 Direct Labor Time Standard u The direct labor time standard is based on: 4 Current time and motion studies of workers and machines. 4 Past performance.

21. Copyright © by Houghton Miffin Company. All rights reserved.21 Direct Labor Rate Standard u The direct labor rate standards are affected by: 4 Labor union contracts. 4 Company personnel policies.

22. Copyright © by Houghton Miffin Company. All rights reserved.22 Standard Direct Materials and Standard Direct Labor Costs Standard direct materials cost = Direct materials price standard x Direct materials quantity standard Standard direct labor cost = Direct labor time standard x Direct labor rate standard

23. Copyright © by Houghton Miffin Company. All rights reserved.23 Standard Manufacturing Overhead Costs Standard manufacturing overhead cost = (Standard variable overhead rate x Variable overhead application basis) + (Standard fixed overhead rate x Fixed overhead application basis)

24. Copyright © by Houghton Miffin Company. All rights reserved.24 Standard Rates Standard variable manufacturing overhead rate = Total budgeted variable manufacturing overhead costs ÷ Expected number of standard machine hours Standard fixed manufacturing overhead rate = Total budgeted fixed manufacturing overhead costs ÷ Normal capacity in terms of standard machine hours

25. Copyright © by Houghton Miffin Company. All rights reserved.25 Standard Unit Cost u A product’s standard unit cost is determined by adding: 4 Standard direct materials cost. 4 Standard direct labor cost. 4 Standard manufacturing overhead cost.

26. Copyright © by Houghton Miffin Company. All rights reserved.26 A. A. 1.Direct materials price standard. 2.Direct materials quantity standard. 3.Direct labor time standard. 4.Direct labor rate standard. 5.Standard variable manufacturing overhead rate. 6.Standard fixed manufacturing overhead rate.Discussion Q. Q.What are the six standards used in determining the standard cost per unit?

27. Copyright © by Houghton Miffin Company. All rights reserved.27 Using Variance Analysis to Control Operations OBJECTIVE 3 Describe how to control costs through variance analysis.

28. Copyright © by Houghton Miffin Company. All rights reserved.28 Standard Costing Systems u A standard costing system has traditionally been associated with: 4 Cost control activities. 4 Evaluation of operating performance.

29. Copyright © by Houghton Miffin Company. All rights reserved.29 Manufacturing Operations u Managers of manufacturing operations, as well as those responsible for selling and service functions, constantly compare the costs of what was expected to happen with the costs of what did happen.

30. Copyright © by Houghton Miffin Company. All rights reserved.30 Variance Analysis u Variance analysis is a four-step approach. 1.Compute the variance. If the variance is insignificant, actual operating results are close to or equal to anticipated operating conditions, no corrective action is needed. 2.Determine the cause of any significant variance.

31. Copyright © by Houghton Miffin Company. All rights reserved.31 Variance Analysis 3.Identify and analyze the performance measures that track those activities. 4.Take action to correct the problem or continue to improve operations.

32. Copyright © by Houghton Miffin Company. All rights reserved.32 Using Variance Analysis to Control Costs

33. Copyright © by Houghton Miffin Company. All rights reserved.33 A. 1.Compute the variance. 2.Determine the cause. 3.Identify the performance measures. 4.Take action to correct or continue.Discussion Q. Q.What are the four steps of variance analysis?

34. Copyright © by Houghton Miffin Company. All rights reserved.34 Direct Materials Variances OBJECTIVE 4 Compute and analyze direct materials variances.

35. Copyright © by Houghton Miffin Company. All rights reserved.35 u Variance analysis need not be limited to the following 6 variances. u Companies may use dozens of variances for many different types of activities.

36. Copyright © by Houghton Miffin Company. All rights reserved.36 Direct Materials Cost Variance u Direct materials cost variance is the sum of: 1.Direct materials price variance. =(Standard Price - Actual Price) x Actual Quantity. 2.Direct materials quantity variance. =(Standard Quantity - Actual Quantity) x Standard Price.

37. Copyright © by Houghton Miffin Company. All rights reserved.37 Direct Materials Price Variance u Possible causes of a direct materials price variance are: 1.Changes in vendor prices. 2.Inaccurate or outdated direct materials price standards. 3.Differences between the quality of direct materials purchased and the quality desired.

38. Copyright © by Houghton Miffin Company. All rights reserved.38 Direct Materials Price Variance 4.Differences between quantity discounts received and those anticipated. 5.The purchase of substitute direct materials that differ from product specifications.

39. Copyright © by Houghton Miffin Company. All rights reserved.39 Direct Materials Quantity Variance u Possible causes of a direct materials quantity variance are: 1. Inaccurate or outdated direct materials quantity standards. 2. Poor workmanship or excellent workmanship.

40. Copyright © by Houghton Miffin Company. All rights reserved.40 Direct Materials Quantity Variance 3.Faulty equipment. 4.Inferior or superior quality of direct materials. 5.Poor materials handling.

41. Copyright © by Houghton Miffin Company. All rights reserved.41 Direct Materials Variance Analysis

42. Copyright © by Houghton Miffin Company. All rights reserved.42 A. A. 1.Inaccurate or outdated direct materials quantity standards. 2.Poor/excellent workmanship. 3.Faulty equipment. 4.Inferior/superior direct material quality. 5.Poor materials handling. Discussion Q. Q.What are some possible causes of a direct materials quantity variance?

43. Copyright © by Houghton Miffin Company. All rights reserved.43 Direct Labor Variances OBJECTIVE 5 Compute and analyze direct labor variances.

44. Copyright © by Houghton Miffin Company. All rights reserved.44 Direct Labor Cost Variance u Direct labor cost variance is the sum of: 1. Direct labor rate variance. = (Standard Rate – Actual Rate) x Actual Quantity (hours) 2. Direct labor efficiency variance. = Standard Rate x (Standard Hours Allowed – Actual Hours)

45. Copyright © by Houghton Miffin Company. All rights reserved.45 Direct Labor Rate Variance u A direct labor rate variance can occur because: 1. A worker is hired at a pay rate that is higher or lower than expected. 2. An employee performed the duties of a higher- or lower-paid position.

46. Copyright © by Houghton Miffin Company. All rights reserved.46 Direct Labor Rate Variance 3.Overall wage rates changed due to: New labor agreements. Labor strikes that cause the temporary hiring of unskilled help. Large layoffs that result in unusual usage of remaining workers.

47. Copyright © by Houghton Miffin Company. All rights reserved.47 Favorable Direct Labor Efficiency Variance u A favorable direct labor efficiency variance can be caused by: 1. Improved training of employees. 2. New machinery. 3. Higher quality of materials.

48. Copyright © by Houghton Miffin Company. All rights reserved.48 Unfavorable Direct Labor Efficiency Variance u An unfavorable direct labor efficiency variance can be caused by: 1. Machine breakdowns. 2. Inferior direct materials. 3. Poor supervision. 4. Slow materials handling. 5. Poor employee performance.

49. Copyright © by Houghton Miffin Company. All rights reserved.49 Direct Labor Variance Analysis

50. Copyright © by Houghton Miffin Company. All rights reserved.50 A. 1.Improved training of employees. 2.New machinery. 3.Higher quality of materials.Discussion Q. Q.What are the causes of favorable direct labor efficiency variance?

51. Copyright © by Houghton Miffin Company. All rights reserved.51 Manufacturing Overhead Variances OBJECTIVE 6 Define and prepare a flexible budget.

52. Copyright © by Houghton Miffin Company. All rights reserved.52 Flexible Budget u The budgets discussed earlier were static or fixed budgets, which forecast revenues and expenses for one level of sales and production. u A flexible budget is a summary of anticipated costs for a range of activity levels, geared to changes in productive output.

53. Copyright © by Houghton Miffin Company. All rights reserved.53 Flexible Budget Formula u The flexible budget formula: 1. Includes a budgeted variable cost per unit, which is the same for all levels of output within the range chosen. 2. Includes a budgeted total fixed cost, which stays constant for the range.

54. Copyright © by Houghton Miffin Company. All rights reserved.54 Flexible Budget Formula Total budget costs = (Variable cost per unit x Number of units produced) + Budgeted fixed costs

55. Copyright © by Houghton Miffin Company. All rights reserved.55 A. A. Total budget costs = (Variable cost per unit x Number of units produced) + Budgeted fixed costs.Discussion Q. Q.What is the format of the flexible budget formula?

56. Copyright © by Houghton Miffin Company. All rights reserved.56 Analyzing Manufacturing Overhead Variances OBJECTIVE 7 Compute and analyze manufacturing overhead variances.

57. Copyright © by Houghton Miffin Company. All rights reserved.57 Manufacturing Overhead Variance u The total manufacturing overhead variance is equal to the difference between: 4 The actual manufacturing overhead costs incurred and 4 The standard manufacturing overhead costs applied to production.

58. Copyright © by Houghton Miffin Company. All rights reserved.58 Total Manufacturing Overhead Variance Total Manufacturing Overhead Variance u The total manufacturing overhead variance is then divided into two parts: 4 Controllable manufacturing overhead variance. 4 Manufacturing overhead volume variance.

59. Copyright © by Houghton Miffin Company. All rights reserved.59 Controllable Manufacturing Overhead Variance Controllable Manufacturing Overhead Variance u Is the difference between the actual manufacturing overhead costs incurred and the manufacturing overhead costs budgeted for the level of production achieved. u Can occur because too much or too little is spent on manufacturing overhead items such as indirect materials, indirect labor, supervision, or machine maintenance.

60. Copyright © by Houghton Miffin Company. All rights reserved.60 Manufacturing Overhead Variance Analysis

61. Copyright © by Houghton Miffin Company. All rights reserved.61 Manufacturing Overhead Volume Variance u Is the difference between the manufacturing overhead budgeted for the level of production achieved and the total manufacturing overhead costs applied to production using the standard variable and fixed manufacturing overhead rates. u Will occur if more or less capacity than normal is used.

62. Copyright © by Houghton Miffin Company. All rights reserved.62DiscussionA. 1. Unfavorable 2. Unfavorable Q. 1. If machine operators were inefficient and took longer to perform their work than expected, what would be the resulting controllable variance? 2. If less fixed manufacturing overhead was applied than expected, what would be the resulting volume variance?

63. Copyright © by Houghton Miffin Company. All rights reserved.63 Using Variances in Performance Evaluation OBJECTIVE 8 Explain how variances are used to evaluate managers’ performance.

64. Copyright © by Houghton Miffin Company. All rights reserved.64 Management Evaluation u The effective evaluation of managers’ performance depends on both human factors and company policies. u To ensure effectiveness and fairness when establishing a performance evaluation process, management should develop appropriate policies and seek input from managers and employees.

65. Copyright © by Houghton Miffin Company. All rights reserved.65 Policies and Procedures u Policies and procedures should address: 1. Preparing operational plans. 2. Assigning responsibility for performance. 3. Communicating operational plans to key personnel. 4. Evaluating each area of responsibility. 5. Identifying causes of significant variances. 6. Taking corrective action to eliminate problems.

66. Copyright © by Houghton Miffin Company. All rights reserved.66 Performance Reports u The keys to preparing a performance report are to: 4 Identify the personnel responsible for each variance. 4 Determine the causes for each significant variance. 4 Develop a reporting format suited to the task.

67. Copyright © by Houghton Miffin Company. All rights reserved.67 Performance Reports u The management accountant should tailor performance to each manager’s responsibilities so that each report contains those cost items controllable by that manager. u Managers should be held accountable for only those cost areas under their control.

68. Copyright © by Houghton Miffin Company. All rights reserved.68 A. 1.Human factors. 2.Company policies.Discussion Q. Q.The effective evaluation of managers’ performance depends on what two things?

69. Copyright © by Houghton Miffin Company. All rights reserved.69 OK, LET’S REVIEW... 1.Define standard costs and describe how managers use standard costs in the management cycle. 2.State the purposes for using standard costs. 3.Identify the six elements of, and compute, a standard unit cost. 4.Describe how to control costs through variance analysis.

70. Copyright © by Houghton Miffin Company. All rights reserved.70 AND FINALLY... AND FINALLY... 5.Compute and analyze direct materials variances. 6.Compute and analyze direct labor variances. 7.Define and prepare a flexible budget. 8.Compute and analyze manufacturing overhead variances. 9.Explain how variances are used to evaluate managers’ performance.