Standard Costs and Operating Performance Measures

Standard Costs and
Operating Performance
Measures
10-2
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Explain how direct materials standards and
direct labour standards are set.
2. Compute the direct materials price and quantity
variances and explain their significance.
3. Compute mix and yield variances for materials
and explain their significance.
4. Compute the direct labour rate and
efficiency variances and explain their
significance.
5. Compute the variable manufacturing
overhead spending and efficiency© McGraw-Hill
variances.
Ryerson Limited., 2001
10-3
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
6. Understand the advantages of and the potential
problems with using standard costs.
7. Understand how a balanced
scorecard fits together and how it
supports a company’s strategy.
8. Compute the delivery cycle time, the throughput
time and the manufacturing cycle efficiency
(MCE).
9. (Appendix 10A) Prepare journal entries to record
standard costs and variances.
10. (Appendix 10B) Explain the value of
learning curves.
© McGraw-Hill Ryerson Limited., 2001
10-4
Standard Costs
based on carefully
predetermined amounts.
used for planning labour, material

Standard and overhead requirements.
Costs are:
the expected level
of performance.
benchmarks for
measuring performance.

10-5
Standard Costs
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.
Standard
Amount
Direct
Materia
Direct Manufacturin
l
Labour g Overhead
Type of Product Cost

10-6
Setting Standard Costs
Accountants, engineers, personnel

administrators, and production managers
combine efforts to set standards based on
experience and expectations.

10-7
Should we use
practical standards
or ideal
standards?
Engineer Managerial
Accountan
t © McGraw-Hill Ryerson Limited., 2001
10-8

Practical standards
should be set at
levels
that are
currently
attainable with
reasonable and
efficient effort.
Productio
n Managerial
manager Accountan
t © McGraw-Hill Ryerson Limited., 2001
10-9

I agree. Ideal
standards, that are
based on
perfection, are
unattainable and
discourage
most
employees.
Human
Resources Managerial
Manager Accountant
10-10
Setting Direct Material Standards
Price Quantity
Standard Standard
s s
Final, delivered Use product

cost of materials, design specifications.
net of discounts.

10-11
Setting Direct Labour Standards
Rate Time
Standard Standard
s s
Use wage Use time and

surveys and motion studies for
labour each labour
contracts. operation.

10-12
Setting Variable Overhead

Standards
Rate Activity
Standard Standard
s s
The rate is the The activity is the

variable portion of the base used to calculate
predetermined overhead the predetermined
rate. overhead.

10-13
Standard Cost Card – Variable

Production Cost
A standard cost card for one unit of
product might look like this:
A B AxB
Standar Standar Standar
d d d
Inputs Quantity Price Cost
or or Rate per Unit
Hours
Direct materials 3.0 kg. $ 4.00 per kg. $ 12.00
Direct labour 2.5 hours 14.00 per 35.00
Variable mfg. overhead 2.5 hours hour 7.50
Total standard unit cost 3.00 © McGraw-Hill
per Ryerson
$ Limited.,
54.502001
hour
10-14
Standards vs. Budgets
A standard is the
expected cost for one
Are standards the unit.
same as A budget is the
budgets? expected cost for all
units.

10-15
Standard Cost Variances

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

because the actual cost
exceeds the standard cost.

10-16

First, they point to causes of
I see that problems and directions
there is an for improvement.
unfavourable
variance. Second, they trigger
investigations in departments
But why are having responsibility
variances for incurring the costs.
important to me?

10-17
Variance Analysis Cycle
Take
Identify Receive
correctiv
question explanation
e actions
s s
Conduct next
Analyze
period’s
variance
operations
s
Begin Prepare standard

cost performance
report

10-18
Price Variance Quantity Variance
The difference between The difference between

the actual price and the actual quantity and
the standard price the standard quantity

10-19
A General Model for Variance

Analysis
Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price
Standard price is the amount that should

have been paid for the resources acquired.

10-20

Analysis

× × ×
Standard quantity is the quantity allowed for

the actual good output.

10-21

Analysis

× × ×
AQ(AP - SP) SP(AQ - SQ)

AQ = Actual SP = Standard Price
Quantity AP = SQ = Standard Quantity
Actual Price
10-22
Standard Costs
Let’s use the

general model to
calculate standard
cost variances,
starting with
direct material.

10-23
Material Variances Example Zippy
Hanson Inc. has the following direct material

standard to manufacture one Zippy:
1.5 kilograms per Zippy at $4.00 per kilogram
Last week 1,700 kilograms of material were

purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.

10-24
Material Variances Zippy
What
What isis the
the actual
actual price
price per
per kilogram
kilogram
paid for the material?
a.
a. $4.00
$4.00 perper kilogram.
kilogram.
b.
b. $4.10
kilogram.
c.
c. $3.90
kilogram.
d.
d. $6.63
kilogram.

10-25
What
What isis the
the actual
actual price
price per
per kilogram
kilogram
paid for the material?
a.
a. $4.00
kilogram.
b.
b. $4.10
kilogram.
c. $3.90
c. $6.63 per
$3.90 per kilogram.
per kilogram.
kilogram.
d.
d. $6.63 per kilogram. AP = $6,630 ÷ 1,700 k g.
AP = $3.90 per kg.

10-26
Hanson’s
Hanson’s material
material price
price variance
variance (MPV)
(MPV)
for the week was:
a.
a. $170
$170 unfavourable.
unfavourable.
b.
b. $170
$170 favourable.
favourable.
c.
c. $800
$800 unfavourable.
unfavourable.
d.
d. $800
$800 favourable.
favourable.

10-27
Hanson’s
Hanson’s material
material price
price variance
variance (MPV)
(MPV)
for the week was:
a.
a. $170
$170 unfavourable.
unfavourable.
b.
b. $170
$170 favourable.
favourable.
c.
c. $800
$800 unfavourable
unfavourable.
MPV = AQ(AP - SP)
d. $800 favoura . MPV = 1,700 kg. × ($3.90 - 4.00)
d. $800 favourable.
MPV = $170 Favourable
ble.

10-28
The
The standard
standard quantity
quantity of
of material
material that
that
should have been used to produce
1,000
1,000Zippies
Zippiesis:is:
a.
a. 1,700
1,700kilograms.
kilograms.
b.
b. 1,500
1,500kilograms.
kilograms.
c.
c. 2,550
2,550kilograms.
kilograms.
d.
d. 2,000
2,000kilograms.
kilograms.

10-29
The
The standard
standard quantity
quantity ofof material
material that
that
should have been used to produce
1,000
1,000Zippies
Zippiesis:is:
a.
a. 1,700
1,700kilograms.
kilograms.
b.
b. 1,500
1,500kilograms.
kilograms.
c.
c. 2,550
2,550kilograms.
kilograms.
d. 2,000 kilog SQ = 1,000 units × 1.5 kg
rams
d. 2,000 kilograms.
per unit .
SQ = 1,500 kg
10-30
Hanson’s
Hanson’s material
material quantity
quantity variance
variance (MQV)
(MQV)
for the
for the week
week was:
was:
a.
a. $170
$170unfavourable.
unfavourable.
b.
b. $170
$170favourable.
favourable.
c.
c. $800
$800unfavourable.
unfavourable.
d.
d. $800
$800favourable.
favourable.

10-31
Hanson’s
Hanson’s material
material quantity
quantity variance
variance (MQV)
(MQV)
for the
for the week
week was:
was:
a.
a. $170
$170unfavourable.
unfavourable.
b.
b. $170
$170favourable.
favourable.
c.
c. $800
$800unfavourable.
unfavourable.
d.
d. $800
$800favourable.
favourable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 kg - 1,500
kg)
MQV = $800 unfavourable
10-32
Material Variances Summary Zippy

× × ×
1,700 kg. 1,700 kg. 1,500 kg.
× × ×
$3.90 per kg. $4.00 per kg. $4.00 per kg.
= $6,630 = $ 6,800 = $6,000
Price variance Quantity variance

$170 favourable $800 unfavourable
10-33
Material Variances
The price variance is

Hanson purchased and
computed on the entire
used 1,700 kilograms.
quantity purchased.
How are the variances
computed if the amount The quantity variance is
purchased differs from computed only on the
the amount used? quantity used.
10-34
Material Variances Continued Zippy
Hanson Inc. has the following material

1.5 kilograms per Zippy at $4.00 per
kilogram
Last week 2,800 kilograms of material were

purchased at a total cost of $10,920, and
1,700 kilograms were used to make 1,000
Zippies.

10-35
Actual Quantity Actual Quantity

Purchased Purchased
× ×
Actual Price Standard Price
2,800 kg.
2,800 kg. ×
× $4.00 per kg.
$3.90 per kg.
= $11,200
= $10,920
Price variance increases
Price variance because quantity
$280 favourable purchased increases.
10-36
Actual Quantity
Used Standard Quantity
× ×
Standard Price Standard Price
1,700 kg. 1,500 kg.
× ×
$4.00 per kg. $4.00 per kg.
= $6,800 = $6,000
Quantity variance is
unchanged because
actual and standard Quantity variance
quantities are unchanged. $800 unfavourable
10-37
Isolation of Material Variances

I’ll start computing
I need the price variance the price variance
sooner so that I can better when material is
identify purchasing problems.
purchased rather than
You accountants just don’t when it’s used.
understand the problems that
purchasing managers have.

10-38
Responsibility for Material

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

10-39
Standard Costs
Now let’s calculate

standard cost
variances for
direct
labour.

10-40
Labour Variances Example Zippy
Hanson Inc. has the following direct labour

1.5 standard hours per Zippy at $6.00 per
direct labour hour
Last week 1,550 direct labour hours were

worked at a total labour cost of $9,610 to
make 1,000 Zippies.

10-41
Labour Variances Zippy
What
What waswas Hanson’s
Hanson’s actual
actual rate
rate (AR)
(AR)
for labour
for labour for
for the
the week?
week?
a.
a. $6.20
$6.20per
perhour.
hour.
b.
b. $6.00
$6.00per
perhour.
hour.
c.
c. $5.80
$5.80per
perhour.
hour.
d.
d. $5.60
$5.60per
perhour.
hour.

10-42
What
Hanson’s actual
actual rate
rate (AR)
(AR)
for labour
for labour for
for the
the week?
week?
a. $6.20 per hour. AR = $9,610 ÷ 1,550 hours
a. $6.20 per hour. AR = $6.20 per hour
b.
b. $6.00
$6.00per
perhour.
hour.
c.
c. $5.80
$5.80per
perhour.
hour.
d.
d. $5.60
$5.60per
perhour.
hour.

10-43
Hanson’s
Hanson’s labour
labour rate
rate variance
variance (LRV)
(LRV) for
for
the week
the week was:
was:
a.
a. $310
$310unfavourable.
unfavourable.
b.
b. $310
$310favourable.
favourable.
c.
c. $300
$300unfavourable.
unfavourable.
d.
d. $300
$300favourable.
favourable.

10-44
Hanson’s
Hanson’s labour
labour rate
rate variance
variance (LRV)
(LRV) for
for
the week
the week was:
was:
a.
a. $310
$310unfavourable.
unfavourable.
b.
b. $310
$310favourable.
favourable.
c.
c. $300
$300unfavou rable
unfavourable.
LRV = AH(AR - SR)
. LRV = 1,550 hrs($6.20 - $6.00)
d.
d. $300
$300 favoura
favourable.
LRV = $310 unfavourable
ble.

10-45
The
The standard
standard hours
hours (SH)
(SH) of
of labour
labour that
that
should have been worked to produce
1,000
1,000Zippies
Zippiesis:
is:
a.
a. 1,550
1,550hours.
hours.
b.
b. 1,500
1,500hours.
hours.
c.
c. 1,700
1,700hours.
hours.
d.
d. 1,800
1,800hours.
hours.

10-46
The
The standard
standard hours
hours (SH)
(SH) ofof labour
labour that
that
should have been worked to produce
1,000
1,000Zippies
Zippiesis:
is:
a.
a. 1,550
1,550hours.
hours.
b.
b. 1,500
1,500hours.
hours.
c.
c. 1,700
1,700hours.
hours.
d.
d. 1,800
1,800 hours
hours.
SH = 1,000 units × 1.5 hours per unit
. SH = 1,500 hours
10-47
Hanson’s
Hanson’s labour
labour efficiency
efficiency variance
variance (LEV)
(LEV)
for the
for the week
week was:
was:
a.
a. $290
$290unfavourable.
unfavourable.
b.
b. $290
$290favourable.
favourable.
c.
c. $300
$300unfavourable.
unfavourable.
d.
d. $300
$300favourable.
favourable.

10-48
Hanson’s
Hanson’s labour
labour efficiency
efficiency variance
variance (LEV)
(LEV)
for the
for the week
week was:
was:
a.
a. $290
$290unfavourable.
unfavourable.
b.
b. $290
$290favourable.
favourable.
c.
c. $300
$300unfavourable.
unfavourable.
d.
d. $300
$300favourable.
favourable.
LEV = SR(AH - SH)
LEV = $6.00(1,550 hrs - 1,500
hrs)
LEV = $300 unfavourable
10-49
Labour Variances Summary Zippy
Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$6.20 per hour $6.00 per hour $6.00 per hour
= $9,610 = $9,300 = $9,000
Rate variance Efficiency variance

$310 unfavourable $300 unfavourable
10-50
Labour Rate Variance –

A Closer Look
Using highly paid
skilled workers to perform unskilled
tasks results in an
unfavourable rate variance.
High skill, Low skill,

high low rate
rate
Production
Production managers
managers who
who make
make work
work assignments
assignments
are generally
are generally responsible
responsible for
for rate
rate variances.
variances.

10-51
Labour Efficiency Variance –

A Closer Look
Poorly Poor
trained quality
worker materials
s
Unfavourabl
e Efficiency
Variance
Poor Poorly
supervisio maintaine
n of d
workers equipment
10-52
Responsibility for Labour

Variances
I am not responsible for

the unfavourable You used too much
labour efficiency time because of poorly
variance! trained workers and
poor supervision.
You purchased cheap
material, so it took
more time to process
it.

10-53
Responsibility for Labour

Variances
Maybe I can attribute the labour

and material variances to personnel
for hiring the wrong people
and training them poorly.

10-54
Standard Costs
Now let’s calculate

standard cost
variances for the
last of the variable
production costs
– variable
manufacturing
overhead.
10-55
Variable Manufacturing
Overhead Variances Example Zippy
Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Zippy:
1.5 standard hours per Zippy at $3.00 per
direct labour hour
Last week 1,550 hours were worked to make

1,000 Zippies, and $5,115 was spent for
variable manufacturing overhead.

10-56
Overhead Variances Zippy
What
Hanson’s actual
actual rate
rate (AR)
(AR) for
for
variable manufacturing overhead rate
for
forthe
theweek?
week?
a.
a. $3.00
$3.00per
perhour.
hour.
b.
b. $3.19
$3.19per
perhour.
hour.
c.
c. $3.30
$3.30per
perhour.
hour.
d.
d. $4.50
$4.50per
perhour.
hour.

10-57
What
Hanson’s actual
actual rate
rate (AR)
(AR) for
for
variable manufacturing
variable manufacturing overhead
overhead raterate
for
forthe
theweek?
week?
a.
a. $3.00
$3.00 per
per hour.
hour.
b.
b. $3.19
$3.19per
perhour.
hour.
AR = $5,115 ÷ 1,550 hours
c. $3.30 per hour.
c. $3.30 per hour. AR = $3.30 per hour
d.
d. $4.50
$4.50 per
per hour.
hour.

10-58
Hanson’s
Hanson’s spending
spending variance
variance (SV)
(SV) for
for
manufacturing overhead for
for
the
the week
week was:
was:
a.
a. $465
$465unfavourable.
unfavourable.
b.
b. $400
$400favourable.
favourable.
c.
c. $335
$335unfavourable.
unfavourable.
d.
d. $300
$300favourable.
favourable.

10-59
Hanson’s
Hanson’s spending
spending variance
variance (SV)
(SV) for
for
variable manufacturing overhead
overhead forfor
the
the week
week was:
was:
a.
a. $465
$465unfavourable.
unfavourable.
b.
b. $400
$400favourable.
favourable.
SV = AH(AR - SR)
ble
c. $335
c. $335 unfavoura
unfavourable.
SV = 1,550 hrs($3.30 - $3.00)
.
d. $300
d. $300favourabl
favourable.SV = $465 unfavourable
e.

10-60
Hanson’s
Hanson’s efficiency
efficiency variance
variance (EV)
(EV) for
for
variable
manufacturing overhead
overhead for
for the
the
week
week was:
was:
a.
a. $435
$435unfavourable.
unfavourable.
b.
b. $435
$435favourable.
favourable.
c.
c. $150
$150unfavourable.
unfavourable.
d.
d. $150
$150favourable.
favourable.

10-61
Hanson’s
Hanson’s efficiency
efficiency variance
variance (EV)
(EV) for
for
variable
manufacturing overhead
overhead for for the
the
week
week was:
was:
a.
a. $435
$435unfavourable.
unfavourable.
b.
b. $435
$435favourable.
favourable.
1,000 units × 1.5 hrs per
c. unit
$150 unfavourable.
c.
d. $150 ble
$150unfavourable.
favourable.
.
d. $150 favoura EV = SR(AH - SH)
EV = $3.00(1,550 ©hrs -
McGraw-Hill Ryerson Limited., 2001
1,500 hrs)
10-62
Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$3.30 per hour $3.00 per hour $3.00 per hour
= $5,115 = $4,650 = $4,500
Spending variance Efficiency variance

$465 unfavourable $150 unfavourable
10-63
Variable Manufacturing Overhead

Variances – A Closer Look
IfIfvariable
variableoverhead
overheadisisapplied
appliedononthe
thebasis
basis
of
of direct
direct labour
labour hours,
hours, the
the labour
labour efficiency
efficiency
and
and variable
variable overhead
overhead efficiency
efficiency variances
variances
will
will move
move in
in tandem.
tandem.

10-64
Variance Analysis and

Management by Exception
Larger variances, in
How do I know dollar amount or
which as a percentage of
variances to the standard, are
investigate? investigated first.
10-65
Advantages of Standard Costs
Possible reductions Management by

in production costs exception
Advantages
Improved cost control Better Information

and performance for planning and
evaluation decision making

10-66
Emphasis on negative Favourable variances

may impact morale. may be misinterpreted.
Potential Continuous
Standard cost improvement
reports may Problems may be more
not be timely. important than
meeting
standards.
Labour quantity standards Emphasizing standards

and efficiency variances may exclude other
may not be important objectives.
appropriate.
10-67
The Balanced Scorecard

Management
Management translates
translates its
its strategy
strategy into
into
performance
performance measures
measures that
that employees
employees
understand
understandand
andaccept.
accept.
Financial Customers
Performanc
e
Internal measures Learning
business and growth
processes
10-68

How do we look
to the owners?
In which internal How can we

business processes continually learn,
must we excel? grow, and
improve?
How do we look
to customers?

10-69

Learning improves
business processes.
Improved business
processes improve
customer satisfaction.
Improving customer
satisfaction improves
financial results.
10-70
Delivery Performance Measures

Order Productio Goods
Received n Shippe
Started d
Process Time + Inspection Time

Wait Time + Move Time + Queue Time
Throughput Time
Delivery Cycle Time
Process time is the only value-added time.

10-71
Delivery Performance Measures

Order Productio Goods
Received n Shippe
Started d
Process Time + Inspection Time

Wait Time + Move Time + Queue Time
Throughput Time
Delivery Cycle Time
Manufacturin
Value-added time
g Cycle =
Efficiency Throughput time
Appendix
10A
General Ledger Entries to
Record Variances
10-73
Journal Entries - Material Variances

✒ Price variance
Dr Raw Materials
Dr Materials Price Variance (U)
Cr Materials Price
Variance (F) Cr Accounts
Payable
✒ Quantity variance
Dr Work in Process
Dr Materials
Quantity Variance
(U)
Cr Materials Quantity
10-74
Journal Entries - Labour Variances

✒ Rate variance
Dr Work in Process
Dr Labour Rate Variance (U)
Cr Labour
Rate Variance (F) Cr Wages
Payable
✒ Efficiency variance
Dr Work in Process
Dr Labour Efficiency
Variance (U)
Cr Labour
Efficiency Variance (F) Cr Wages

Appendix
10B
The Learning Curve
10-76
The Learning Curve
 Productivity in hours per unit will

decrease as an employee produces more
units.
 Used to set and revise standard labour
hours in a repetitive task environment.
 Used for labour intensive
manufacturing.

10-77
End of discussion

Standard Costs and Operating Performance Measures

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Standard Costs and Operating Performance Measures

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Standard Costs and

used for planning labour, material

© McGraw-Hill Ryerson Limited., 2001

Type of Product Cost

Setting Standard Costs

Accountants, engineers, personnel

© McGraw-Hill Ryerson Limited., 2001

Setting Standard Costs

Setting Standard Costs

Setting Standard Costs

Setting Direct Material Standards

Final, delivered Use product

© McGraw-Hill Ryerson Limited., 2001

Setting Direct Labour Standards

Use wage Use time and

© McGraw-Hill Ryerson Limited., 2001

Setting Variable Overhead

The rate is the The activity is the

© McGraw-Hill Ryerson Limited., 2001

Standard Cost Card – Variable

Standards vs. Budgets

© McGraw-Hill Ryerson Limited., 2001

Standard Cost Variances

This variance is unfavourable

© McGraw-Hill Ryerson Limited., 2001

Standard Cost Variances

© McGraw-Hill Ryerson Limited., 2001

Variance Analysis Cycle

Begin Prepare standard

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Standard Cost Variances

Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

© McGraw-Hill Ryerson Limited., 2001

A General Model for Variance

Actual Quantity Actual Quantity Standard Quantity

Price Variance Quantity Variance

Standard price is the amount that should

© McGraw-Hill Ryerson Limited., 2001

A General Model for Variance

Actual Quantity Actual Quantity Standard Quantity

Price Variance Quantity Variance

Standard quantity is the quantity allowed for

© McGraw-Hill Ryerson Limited., 2001

A General Model for Variance

Actual Quantity Actual Quantity Standard Quantity

Price Variance Quantity Variance

AQ(AP - SP) SP(AQ - SQ)

Let’s use the

© McGraw-Hill Ryerson Limited., 2001

Material Variances Example Zippy

Hanson Inc. has the following direct material

Last week 1,700 kilograms of material were

© McGraw-Hill Ryerson Limited., 2001

Material Variances Zippy

© McGraw-Hill Ryerson Limited., 2001

Material Variances Zippy

© McGraw-Hill Ryerson Limited., 2001

Material Variances Zippy

© McGraw-Hill Ryerson Limited., 2001

Material Variances Zippy

© McGraw-Hill Ryerson Limited., 2001

Material Variances Zippy