Chapter 10

Standard Costs
4/26/04

Standard Costs
Predetermined.

Standard Costs are

Used for planning labor, material and overhead requirements. Benchmarks for measuring performance.

Used to simplify the accounting system.
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Standard Costs

Managers focus on quantities and costs that differ from standards by a significant amount, a practice known as management by exception.

Amount

Standard
Direct Material

Direct Labor

Manufacturing Overhead

Type of Product Cost
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Setting Standard Costs
Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations.

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Setting Standard Costs
Should we use practical standards or ideal standards?

Engineer
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Managerial Accountant

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Setting Standard Costs
Practical standards should be set at levels that are currently attainable with reasonable and efficient effort.

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Production manager

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Setting Standard Costs
I agree. Ideal standards, based on perfection, are unattainable and discourage most employees.

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Note
The argument that ideal standards are discouraging has been persuasive for many years. So “normal” defects and waste were built into the standards. In recent years, TQM and other initiatives have sought to eliminate all defects and waste.

Ideal standards, that allow for no waste, have become more popular. The emphasis is on improvement over time, not attaining the ideal standards right now.
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Setting Direct Material Standards (example p. 428)
Price Standards

Quantity Standards

Final, delivered cost of materials, net of discounts.

Material required per spec plus allowance for waste, etc.

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Setting Direct Labor Standards (example p. 429)
Rate Standards Time Standards

Use wage surveys and labor contracts, include fringes.

Time required to complete a unit of product, use time and motion study

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Setting Variable Overhead Standards (example p. 430)
Rate Standards Activity Standards

The rate is the variable portion of the predetermined overhead rate.

The activity is the base used to apply overhead to units of product

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Standard Cost Card – Variable Production Cost
A standard cost card for one unit of product might look like this:
A
Standard Quantity or Hours
3.0 lbs. 2.5 hours 2.5 hours

B
Standard Price or Rate

AxB
Standard Cost per Unit
12.00 35.00 7.50 54.50

Inputs
Direct materials Direct labor Variable mfg. overhead Total standard unit cost
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$ 4.00 per lb. $ 14.00 per hour 3.00 per hour $

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Standard Cost Variances
A standard cost variance is the amount by which an actual cost differs from the standard cost.

Standard
Cost

This variance is unfavorable because the actual cost exceeds the standard cost.

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Standard Cost Variances
Mr.D: “I see that there is an unfavorable variance. But why are variances important to me?”
First, they point to causes of problems and directions for improvement. Second, they trigger investigations in departments having responsibility for incurring the costs.

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Standard Cost Variances
Standard Cost Variances

Price Variance

Quantity Variance

The difference between the actual price and the standard price
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The difference between the actual quantity and the standard quantity
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A General Model for Variance Analysis (Exhibit 10-3)
Actual Quantity × Actual Price Actual Quantity × Standard Price Standard Quantity × Standard Price

Price Variance

Quantity Variance

Standard price is the amount that should have been paid for the resources acquired.

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A General Model for Variance Analysis
Actual Quantity × Actual Price Actual Quantity × Standard Price Standard Quantity × Standard Price

Price Variance

Quantity Variance

Standard quantity is the quantity allowed for the actual good produced.
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A General Model for Variance Analysis
Actual Quantity × Actual Price Actual Quantity × Standard Price Standard Quantity × Standard Price

Price Variance
AQ(AP - SP)
AQ = Actual Quantity AP = Actual Price
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Quantity Variance
SP(AQ - SQ)
SP = Standard Price SQ = Standard Quantity
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Favorable/Unfavorable Variances
If AQ(AP-SP) = positive = unfavorable (actual is greater than standard) If AQ(AP-SP) = negative = favorable (actual is less than standard) If SP(AQ-SQ) = positive = unfavorable If SP(AQ-SQ) = negative = favorable

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Standard Costs
Let’s use the general model to calculate all standard cost variances, starting with direct material.

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Material Variances Example

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.

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Quick Check 
What is the actual price per pound paid for the material? a. $4.00 per pound. b. $4.10 per pound. c. $3.90 per pound. d. $6.63 per pound.

Zippy

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Quick Check 

Zippy

What is the actual price per pound paid for the material? a. $4.00 per pound. b. $4.10 per pound. AP = $6,630 ÷ 1,700 lbs. c. $3.90 per pound. AP = $3.90 per lb. d. $6.63 per pound.
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Quick Check 

Zippy

Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable.
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Quick Check 

Zippy

Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($3.90 - 4.00) d. $800 favorable.
MPV = $170 Favorable
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Quick Check 

Zippy

The standard quantity of material that should have been used to produce 1,000 Zippies is: a. 1,700 pounds. b. 1,500 pounds. c. 2,550 pounds. d. 2,000 pounds.
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Quick Check 

Zippy

The standard quantity of material that should have been used to produce 1,000 Zippies is: a. 1,700 pounds. b. 1,500 pounds. c. 2,550 pounds. SQ = 1,000 units × 1.5 lbs per unit d. 2,000 pounds.
SQ = 1,500 lbs
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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.

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Material Variances Summary
Actual Quantity × Actual Price
1,700 lbs. × $3.90 per lb. = $6,630

Zippy

Actual Quantity × Standard Price
1,700 lbs. × $4.00 per lb. = $ 6,800

Standard Quantity × Standard Price
1,500 lbs. × $4.00 per lb. = $6,000

Price variance $170 favorable
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Quantity variance $800 unfavorable
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Material Variances

Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used?
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The price variance is computed on the entire quantity purchased.

The quantity variance is computed only on the quantity used.
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Material Variances Continued
Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound

Zippy

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.
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Material Variances Continued
Actual Quantity Purchased × Actual Price 2,800 lbs. × $3.90 per lb. = $10,920 Actual Quantity Purchased × Standard Price 2,800 lbs. × $4.00 per lb. = $11,200

Zippy

Price variance $280 favorable
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Price variance increases because quantity purchased increases.
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Material Variances Continued
Actual Quantity Used × Standard Price 1,700 lbs. × $4.00 per lb. = $6,800 Quantity variance is unchanged because actual and standard quantities are unchanged.
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Zippy

Standard Quantity × Standard Price 1,500 lbs. × $4.00 per lb. = $6,000

Quantity variance $800 unfavorable
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Responsibility for Material Variances You used too much material
because of poorly trained workers and poorly maintained equipment.
I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances.

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Material Price Variance Causes
Odd lot sizes Price discounts Rush orders Lower quality materials Special pricing Transportation method

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Material Quantity Variance Causes
Faulty/poorly maintained machinery Poor quality material Untrained workers New workers Poor supervision

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Standard Costs – Direct Labor
Now let’s calculate standard cost variances for direct labor.

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Note
Materials variances:

Material price variance  MPV = AQ (AP - SP) Material quantity variance  MQV = SP (AQ - SQ)
Labor rate variance  LRV = AH (AR - SR) Labor efficiency variance  LEV = SR (AH - SH)

Actual hours

Actual rate
Standard rate Standard hours allowed for the actual good output
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Labor variances:

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Labor Variances Example

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.
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Quick Check 
What was Hanson’s actual rate (AR) for labor for the week? a. $12.20 per hour. b. $12.00 per hour. c. $11.80 per hour. d. $11.60 per hour.

Zippy

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Quick Check 

Zippy

What was Hanson’s actual rate (AR) for labor for the week? AR = $18,910 ÷ 1,550 hours a. $12.20 per hour. AR = $12.20 per hour b. $12.00 per hour. c. $11.80 per hour. d. $11.60 per hour.

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Quick Check 
Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable.

Zippy

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Quick Check 

Zippy

Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. LRV = AH(AR - SR) c. $300 unfavorable. LRV = 1,550 hrs($12.20 - $12.00) d. $300 favorable. LRV = $310 unfavorable

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Quick Check 
The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. 1,550 hours. b. 1,500 hours. c. 1,700 hours. d. 1,800 hours.
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Zippy

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Quick Check 

Zippy

The standard hours (SH) of labor that should have been worked to produce 1,000 Zippies is: a. 1,550 hours. b. 1,500 hours. c. 1,700 hours. SH = 1,000 units × 1.5 hours per unit d. 1,800 hours. SH = 1,500 hours
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Quick Check 
Hanson’s labor efficiency variance (LEV) for the week was: a. $590 unfavorable. b. $590 favorable. c. $600 unfavorable. d. $600 favorable.

Zippy

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

Zippy

LEV = SR(AH - SH) LEV = $12.00(1,550 hrs - 1,500 hrs) LEV = $600 unfavorable
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Labor Variances Summary
Actual Hours × Actual Rate
1,550 hours × $12.20 per hour = $18,910

Zippy

Actual Hours × Standard Rate
1,550 hours × $12.00 per hour = $18,600

Standard Hours × Standard Rate
1,500 hours × $12.00 per hour = $18,000

Rate variance $310 unfavorable
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Efficiency variance $600 unfavorable
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Labor Rate Variance – A Closer Look
Using highly paid skilled workers to perform unskilled tasks results in an unfavorable rate variance.

Overtime Premium

Turnover of Employees

Wage increase

Production managers who make work assignments are generally responsible for rate variances.
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Labor Efficiency Variance – A Closer Look
Poorly trained workers Insufficient demand for product Poor quality materials

Unfavorable Efficiency Variance
Poor supervision of workers
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Poorly maintained equipment
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Responsibility for Labor Variances
Production Manager Poorly trained/motivated workers Poorly maintained equipment Poor supervision of workers Inaccurate standards Purchasing Manager Poor quality of materials
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Standard Costs – Variable Manufacturing Overhead
Now let’s calculate standard cost variances for the last of the variable production costs – variable manufacturing overhead.

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Note
Labor variances:

Labor rate variance  LRV = AH (AR - SR) Labor efficiency variance  LEV = SR (AH - SH)

Actual hours of the allocation base Actual variable overhead rate Standard variable overhead rate

Variable overhead variances:

Variable overhead spending variance  VOSV = AH (AR - SR) Variable overhead efficiency variance  VOEV = SR (AH –SH) Standard hours allowed for the actual good output

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Variable Manufacturing Overhead Example
Hanson Inc. has the following variable manufacturing overhead standard: 1.5 standard hours per Zippy at a POHR of $3.00 per direct labor hour Last week, 1,550 direct labor hours were worked to make 1,000 Zippies, and a total cost of $5,115 was incurred for variable manufacturing overhead. OH cost per hour is $5,115/1,550 = $3.30
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Quick Check 
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.

Zippy

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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. SV = AH(AR - SR) c. $335 unfavorable. SV = 1,550 hrs($3.30 - $3.00) d. $300 favorable. SV = $465 unfavorable

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Quick Check 
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.

Zippy

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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. 1,000 units × 1.5 hrs per unit c. $150 unfavorable. d. $150 favorable. EV = SR(AH - SH)
EV = $3.00(1,550 hrs - 1,500 hrs) EV = $150 unfavorable
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Variable Manufacturing Overhead Variances
Actual Hours × Actual Rate
1,550 hours × $3.30 per hour = $5,115

Zippy

Actual Hours × Standard Rate
1,550 hours × $3.00 per hour = $4,650

Standard Hours × Standard Rate
1,500 hours × $3.00 per hour = $4,500

Spending variance $465 unfavorable
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Efficiency variance $150 unfavorable
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Variable Manufacturing Overhead Variances – Causes
Timing of overhead spending Changes in costs of overhead items Difference between actual and standard allocation base activity Spent more than what was budgeted

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Variance Analysis and Management by Exception

How do I know which variances to investigate?

Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
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Advantages of Standard Costs
Possible reductions in production costs Management by exception

Responsibility Accounting

Simplify Bookkeeping

Advantages
Better Information for planning and decision making
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Improved cost control and performance evaluation
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Disadvantages of Standard Costs
Emphasis on negative may impact morale.

Potential Problems

Favorable variances may be misinterpreted. Continuous improvement may be more important than meeting standards. Emphasizing standards may exclude other important objectives.
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Standard cost reports may not be timely. Incentives to build Inventories, to absorb excess overhead McGraw-Hill/Irwin

Delivery Performance Measures
Delivery time cycle – time from when an order is received from a customer to when it is shipped Manufacturing cycle time (throughput time) – time required to turn raw materials into completed products Objective is to reduce/eliminate non-value added activities such as waiting, inspection, move, rework, test and queue time
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Delivery Performance Measures
Order Received Production Started Goods Shipped

Wait Time

Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time

What time is the only value-added time?
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Delivery Performance Measures
Order Received Production Started Goods Shipped

Wait Time

Process Time + Inspection Time + Move Time + Queue Time Throughput Time Delivery Cycle Time

Manufacturing Cycle = Efficiency
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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 3.0 days Inspection 0.4 days Process 0.2 days

Move 0.5 days Queue 9.3 days

What is the throughput time? a. 10.4 days b. 0.2 days c. 4.1 days d. 13.4 days
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Quick Check 
A TQM team at Narton Corp has recorded the following average times for production:

Wait 3.0 days Inspection 0.4 days Process 0.2 days

Move 0.5 days Queue 9.3 days

What is the throughput time? a. 10.4 days b. 0.2 days Throughput time = Process + Inspection + Move + Queue c. 4.1 days = 0.2 days + 0.4 days + 0.5 days + 9.3 days = 10.4 days d. 13.4 days
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Quick Check 
A TQM team at Narton Corp has recorded the following average times for production:

Wait 3.0 days Inspection 0.4 days Process 0.2 days

Move 0.5 days Queue 9.3 days

What is the Manufacturing Cycle Efficiency? a. 50.0% b. 1.9% c. 52.0% d. 5.1%
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Quick Check 
A TQM team at Narton Corp has recorded the following average times for production:

Wait 3.0 days Inspection 0.4 days Process 0.2 days

Move 0.5 days Queue 9.3 days

What is the MCE? a. 50.0% MCE = Value-added time ÷ Throughput time b. 1.9% = Process time ÷ Throughput time c. 52.0% = 0.2 days ÷ 10.4 days d. 5.1% = 1.9%
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End of Chapter 10

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