1. Chapter 9 Introduction to a Standard Cost System

2. 1. Why are standard cost systems used? 2. How are standards for material and labor set? 3. How are material, labor, and overhead variances calculated? C9 Learning Objectives

3. 4. How can variances be used for control and performance evaluation purposes? 5. How do organizational evolution and desired level of attainability affect standard setting? C9 Continuing... Learning Objectives

4. 6. How are standard setting and standard usage changing in modern business? 7. What journal entries are needed in a standard cost system? (Appendix) C9 Continuing... Learning Objectives

5. Standards and Standard Costs The estimated cost to manufacture a single unit of product or to perform a single service is the standard cost.

6. Material Standards In developing material standards, the specific direct material components used to manufacture the product or to perform the service must be identified and listed. Three things must be known about the materials: –What inputs are needed? –What must be the quality of those inputs? –What quantities of inputs of the specified quality are needed?

7. Bill of Materials Product: PC Jeans: Waist 70 cm.; Length 82.5 cm. Revision Date: 8/1/98 Product Number: Stock Keeping Unit (SKU) #262 Standard Contract Size: 400 COMPONENT ID# QUANTITY REQUIRED DESCRIPTION OF COMPONENT COMMENTS F-15 Z-7 S-2 2 square meters 1 Black denim fabric 18.5 centimeter zipper 1.9 centimeter snap Highest quality Brass Brass; imprinted with PC jeans logo

8. Labor Standards Identify each worker operation Setup Disregard all unnecessary movements Convert each operation to time –Time and motion studies –Industrial engineering studies –Historical data Operations flow document Labor rates –Wages and fringe benefits

9. Operations Flow Document Product: PC Jeans: Waist 70 cm.; Length 82.5 cm. Revision Date: 8/1/98 Product Number: Stock Keeping Unit (SKU) #262 Standard Contract Size: 400 OPERATION ID#DEPARTMENT STANDARD LABOR MINUTES PER PAIR DESCRIPTION OF TASK 27 29 Cutting 3.50 2.50 1.50 Align fabric for cutting (actual machine time, 6 min.) Cut fabric (actual machine time, 4 min.) Move to Sewing Dept.

10. Overhead Standards Predetermined overhead rate –From flexible budget –Plantwide rate –Department rate

11. Standard Cost Card One per product Summarizes standard quantities and costs needed to complete one unit –Direct material –Direct labor –Overhead

12. Total Variance Actual cost incurred (AP x AQ) Standard cost allowed for output (SP x SQ) Total Variance * * Favorable or unfavorable For each production cost element

13. Price Variance AP x AQSP x SQ SP x AQ Price Variance AQ (AP - SP)* *Favorable or unfavorable

14. Quantity Variance AP x AQSP x SQ SP x AQ Quantity Variance SP (AQ - SQ)* *Favorable or unfavorable

15. Standard Cost Card

16. Material Variances AP x AQSP x AQSP x SQ $18,860 $.80 x 23,000 $.80 x 1,000 x 20 $460 U Material Price Variance Material Quantity Variance $2,860 U Total Material Variance $2,400 U

17. Labor Variances AP x AQSP x AQSP x SQ $10.10 x 480 $10.00 x 480 $10.00 x 1,000 x 1/2 $48 U Labor Rate Variance Labor Efficiency Variance $152 F Total Labor Variance $200 F

18. Variable Overhead Variances AP x AQSP x AQSP x SQ $980 $2.00 x 480 $2.00 x 1,000 x 1/2 $20 U VOH Spending Variance VOH Efficiency Variance $20 F Total VOH Variance $40 F

19. Fixed Overhead Variances Actual Fixed Overhead Costs Budgeted Fixed Overhead Costs Fixed Overhead Applied SP x SQ $2,500 $2,400 $6.00 x 1,000 x 1/2 $100 U FOH Spending Variance FOH Volume Variance $500 F Total FOH Variance $600 F

20. Variance Analysis Focuses on the variances Variance analysis is the process of categorizing the nature of the differences between standard and actual costs and seeking the reasons for those differences

21. Control Over Material Price PURCHASING AGENT

22. Control Over Material Quantity and Labor Costs SCHEDULE PRODUCTION SUPERVISOR

23. Control Over Variable Overhead Control by keeping actual costs in line with planned costs and getting planned output yield from overhead resources placed into production Variable overhead spending variances –Caused by price differences –Who has control over price? Variable overhead efficiency –Analyze variance from standard for each VOH component

24. Control Over Fixed Overhead Managers may have limited ability to control in short run –Control occurs at time of commitment rather than time of activity Fixed overhead spending variance –Control takes place on a transaction-by-transaction basis –Need to review individual cost variances Fixed overhead volume variance –Direct function of capacity level chosen for the computation of standard FOH rate –Managers have least control

25. Establishing Standards Appropriateness –Basis on which standards are developed –How long standards are expected to last Attainability –Expected standards –Practical standards –Theoretical standards

26. Changes in the Use of Standards Use of theoretical standards for quality improvement –Just-in-time –Total quality management MPV at point-of-purchase vs. usage Long-term vs. short-term standards

27. Standard Cost System Journal Entries Each variance is recorded in an account Favorable variance –Credited –Represents cost reductions Unfavorable variance –Debited –Represents excess costs Inventories show standard costs

28. Purchase of Material Raw Material s Accounts Payable Material Price Variance SP x AQ Purchased AP x AQ Purchased Dr. if Unfavorable Cr. if Favorable Point-of-Purchase Method

29. Exhibit 9-8: Purchase of Material Raw Material Inventory 10,500 Material Price Variance 1,950 Accounts Payable12,450 To record the purchase of 3,000 square yards of cotton fabric at $4.15 per square yard; standard cost is $3.50 per square yard.

30. Material Used Material Quantity Variance SP x SQ Allowed SP x AQ Used Dr. if Unfavorable Cr. if Favorable Raw Material s WIP

31. Material Used WIP Inventory 9,240 Material Quantity Variance 315 Raw Material Inventory9,555 To record the issuance and usage of 2,730 square yards of cotton fabric for 2,200 shirts; standard usage is 4.20 yards.

32. Labor Incurrence Labor Rate Variance SP x SQ Allowed AP x AQ Used Dr. if Unfavorable Cr. if Favorable Wages Payable WIP Labor Efficiency Variance

33. Labor Incurrence WIP Inventory 5,280 Labor Rate Variance 200 Labor Efficiency Variance 480 Wages Payable 5,000 To record the usage of 500 direct labor hours at a wage rate of $10 per DLH.

34. Overhead Incurred During Period VOH FOH Actual cost Actual cost Various Accounts Actual Cost Actual Cost Various Accounts

35. Overhead Incurred During Period VOH--Cutting Dept. 3,360 Various accounts3,360 To record actual variable overhead costs. FOH--Cutting Dept. 2,875 Various accounts2,875 To record actual fixed overhead costs.

36. Overhead Applied During Period SP x SQ Allowed SP x AQ Allowed VOH WIP SP x AQ Allowed FOH

37. Overhead Applied During Period WIP Inventory 6,050 VOH--Cutting Department3,850 FOH--Cutting Department2,200 To apply variable overhead at $7 per DLH and fixed overhead at $6 per MH for actual production of 2,200 shirts.

38. Variable Overhead at Year-End For each variance: Dr. if Unfavorable Cr. if Favorable VOH Efficiency Variance VOH Spending Variance VOH Dr. or Cr. to bring balance to zero

39. Variable Overhead at Year-End VOH--Cutting Department 490 VOH Spending Variance--Cutting Dept. 140 VOH Efficiency Variance--Cutting Dept. 350 To close the variable overhead account.

40. Fixed Overhead at Year-End For each variance: Dr. if Unfavorable Cr. if Favorable Volume Variance FOH Spending Variance FOH Dr. or Cr. to bring balance to zero

41. Fixed Overhead at Year-End FOH Spending Variance--Cutting Dept.379 FOH Volume Variance--Cutting Dept.296 Fixed Overhead--Cutting Dept. 675 To close the fixed overhead account.

42. Variable and Fixed Overhead at Year-End If immaterial – close to Cost of Goods Sold If material – allocate among: –Work in Process Inventory –Finished Goods Inventory –Cost of Goods Sold