Chapter 16 Standard Costing Variance Analysis and Kaizen

Chapter 16 Standard Costing, Variance Analysis, and Kaizen Costing

Using Standard-Costing Systems for Control STANDARD COST a budget for the production of one unit of product or service ACTUAL COST used in the production of the product or service COST VARIANCE the difference between the actual cost and the standard cost

Management by Exception Take the time to investigate only significant cost variances What is significant? Depends on the Size of the Organization Depends on the Type of the Organization Depends on the Production Process

Perfection Vs. Practical Standards PERFECTION STANDARDS PRACTICAL OR ATTAINABLE STANDARDS Can only be attained under near perfect conditions Tight as practical, but still are expected to be attained • Peak efficiency • Lowest possible input prices • best-quality material • no disruption in production • Occasional machine breakdowns • Normal amounts of raw material waste

Use Of Standards can be used by service firms, nonprofit organizations, and governmental units COST BENEFITS Implementing and maintaining cost standards can be time-consuming, labor-intensive, and expensive.

Cost Variance Analysis DIRECT MATERIAL STANDARDS The total amount of material normally required to produce a finished product including allowances for normal waste or efficiency Koala Camp Gear Company The total delivered cost, after subtracting any purchase discounts

Cost Variance Analysis DIRECT LABOR STANDARDS Koala Camp Gear Company

Standard Costs Given Actual Output The standard cost for the direct-material and direct-labor inputs is based upon Koala’s actual output of 3, 000 tents They should incur a cost of $396, 000 ($288, 000 + $108, 000) to make 3, 000 tents Koala Camp Gear Company

Analysis Of Material Variances Actual quantity 40, 000 sq. meters x purchased Actual price x $8. 15 per sq. meter $326, 000 Actual quantity Standard price x Standard x quantity price 40, 000 sq. $8. 00 per meters x sq. meter purchased 36, 000 $8. 00 per sq. meters x sq. meter allowed $320, 000 $288, 000 $6, 000 U Direct-material price variance 36, 400 sq. meters used $8. 00 per sq. meter $291, 200 $3, 200 U Directmaterial quantity variance

Direct-Material Variances What caused Koala to spend more than the anticipated amount on direct material? First, the company purchased fabric at a higher price ($8. 15 per square meter) than the standard price ($8. 00 per square meter). Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased AP = Actual price SP = Standard price Koala’s direct- material price variance for June is computed as follows: Direct-material price variance = PQ(AP - SP) = 40, 000 ($8. 15 - $8. 00) = $6, 000 unfavorable

Direct-Material Variances What caused Koala to spend more than the anticipated amount on direct material? Second, the company used more fabric than the standard price. (36, 400 sq. meters actually used, instead of the standard amount of 36, 000 sq. meters) Direct-material quantity variance = (AQ X SP) - (SQ X SP) = SQ(AQ - SQ) where: AQ = Actual quantity used SQ = Standard quantity allowed Koala’s direct- material quantity variance for June is computed as follows: Direct-material quantity variance = SP(AQ - SQ) = $8. 00(36, 400 - 36, 000) =$3, 200 unfavorable

Analysis of Direct-Labor Variances Actual Labor Cost Actual X hours rate 5, 900 hours used X $19 per hour Actual hours 5, 900 hours used $112, 100 Standard price X X $18 per hour $106, 200 $5, 900 Unfavorable Direct-labor rate variance Standard Labor Cost Standard X rate 6, 000 hours allowed X $18 per hour $108, 000 $1, 800 Favorable Direct-labor efficiency variance $4, 100 Unfavorable Direct-labor variance

Direct-Labor Variances What caused Koala to spend more than the anticipated amount on direct labor? First, the company incurred a cost of $19 per hour for direct labor instead of the standard amount of $18 per hour Direct-labor rate variance = (AH X AR) - (AH X SR) = AH(AR - SR) where: AH = Actual hours used AR = Actual rate per hour SR = Standard rate per hour Koala’s direct-labor rate variance for June is computed as follows: Direct-labor rate variance = AH(AR - SR) = 5, 900 ($19 - $18) =$5, 900 unfavorable

Direct-Labor Variances What caused Koala to spend more than the anticipated amount on direct labor? Koala used only 5, 900 hours of direct labor, which is < standard quantity of 6, 000 hours, given actual output of 3, 000 tents. The increased efficiency does not fully offset the unexpectedly high wage rate. Direct-labor efficiency variance = (AH X SR) - (SH X SR) = SR(AH - SH) where: AH = Actual hours used SH = Standard hours allowed Koala’s direct - labor efficiency variance for June is computed as follows: Direct - labor efficiency variance = SR(AH - SH) = $18 (5, 900 - 6, 000) = $1, 800 favorable

Multiple Types Of Direct Material Or Direct Labor When there are several types of direct material or direct labor, price and quantity variances are computed for each type, and then added to obtain a total price variance and a total quality variance

Additional Issues Controllability A manager is more likely to investigate a variance that is controllable by someone in the organization than one that is not Favorable Variances It is as important to investigate significant favorable variances as well as significant unfavorable variances Cost and Benefits of Investigation The decision whether to investigate a variance is a cost benefit decision

Behavioral Effects Of Standard Costing Standard costs, budgets, and variances are used to evaluate the performance of individuals and departments They can profoundly influence behavior when they are used to determine salary increases, bonuses, and promotions

Which Managers Generally Influence Cost Variances? Direct-material price variance The purchasing manager Get the best prices available for purchased goods and services through skillful purchasing practices Direct-material quantity variance The production supervisor Skillful supervision and motivation of production employees, coupled with the careful use and handling of materials, contribute to minimal waste Direct-labor rate variance The production supervisor Generally results from using a different mix of employees than that anticipated when the standard were set Direct- labor efficiency variance The production supervisor Motivating employees toward production goals and effective work schedules improves efficiency

Disposition Of Variances Cost of Goods Sold Variances are temporary accounts, like revenue and expense accounts, and they are closed out at the end of the accounting period. Unfavorable variances represent costs of operating inefficiently, relative to the standards, and thus cause the Cost of Goods Sold to be higher Favorable variances represent costs of operating efficiently, relative to the standards, and thus cause the Cost of Goods Sold to be lower

Kaizen Costing KAIZEN COSTING is the process of cost reduction during the manufacturing phase of a product. Improvement is the goal and responsibility of each worker. Cost per product unit Current year cost base Kaizen goal: cost reduction rate Actual cost performance of the current year 12/31/x 0 Actual cost reduction achieved Cost base for next Time year 12/31/x 1

Chapter 17 Flexible Budgets, Overhead Cost Management, and Activity-Based Budgeting

What Are Flexible Overhead Budgets? A flexible budget is valid for a range of activity This range of activity is the relevant range A flexible overhead budget is defined as a detailed plan for controlling overhead cost valid in the firm’s relevant range of activity A static budget is based on a particular planned level of activity

Static Budget Versus Flexible Budget Based on planned Based on only ONE anticipated activity level June production of 4, 000 tents, at 1. 5 machine hours per tent. We cannot tell from this budget what it would cost to make 3, 000 tents. Includes several possible activity levels

Advantages Of Flexible Budgets Actual Electricity Cost $1, 050 Budgeted Electricity Cost (static budget) Cost Variance $1, 200 $150 Favorable The manager is comparing the electricity cost incurred at the ACTUAL activity level (3, 000 tents) with the budgeted electricity cost at the PLANNED activity level (4, 000 tents). These activity levels are different, therefore we would expect the electricity cost to be different

Advantages Of Flexible Budgets Actual Electricity Cost $1, 050 Budgeted Electricity Cost (flexible budget) Cost Variance $900 $150 Unfavorable The manager is comparing the electricity cost incurred at the ACTUAL activity level, 3, 000 tents with the budgeted electricity cost at the ACTUAL activity level, (3, 000 tents x 1. 5 machine hours) = 4, 500 machine hours Electrical cost was greater than it should have been, given the actual level of output

Formula Flexible Budget. EXAMPLE Assume that the company needs flexible budget numbers for three activity levels: 4, 500 hours, 6, 000 hours, and 7, 500 hours. Also, assume that the Predetermined Budgeted Variable-Overhead Cost per Activity Unit is $6 per hour. Budgeted Fixed-Overhead Cost for the month is $30, 000. If you recall, this is similar to the Predetermined Cost -Driver Rate discussed in Chapter 4. Flexible Budget?

Formula Flexible Budget The flexed total budgeted monthly overhead for each activity level can now be used effectively in planning and variance analysis.

Overhead Cost Variances Koala manufactured 3, 000 tree line tents X 1. 5 machine hours per tent = standard allowed 4, 500 machine hours For standard allowed 4, 500 machine hours the budget overhead (from Exhibit 17 -3) for June = Variable overhead $27, 000 Fixed overhead $30, 000 From the cost accounting records, the actual overhead for June = Variable overhead $30, 480 Fixed overhead $32, 500 $62, 980 Actual machine hours for June = 4, 800 The total variable overhead variance for June = Actual variable overhead $30, 480 Budget variable overhead $27, 000 $ 3, 480 U

Variable Overhead Variances The VARIABLE-OVERHEAD SPENDING VARIANCE is the difference between the actual variable overhead cost and the product of the standard variable -overhead rate and the actual hours of an activity base (or cost driver) Actual variable overhead Actual machine hours × the standard rate Actual machine hours (AH) Actual rate (AVR) Actual machine hours (AH) Standard rate (SVR) 4, 800 machine ? hours $6. 35 per ? machine hour 4, 800 machine ? hours $6. 00 per ? machine hour $30, 480 $28, 800 $1, 680 Unfavorable Variable-overhead spending variance

Variable Overhead Variances The VARIABLE-OVERHEAD EFFICIENCY VARIANCE is the difference between the actual and the standard hours of an activity base (or cost driver) multiplied by the standard variable overhead rate Actual machine hours times the standard rate Flexible budget: variable overhead Actual machine hours (AH) Standard rate (SVR) Standard allowed machine hours (SH) Standard rate (SVR) 4, 800 machine ? hours $6. 00 per ? machine hour 4, 500 machine ? hours $6. 00 per ? machine hour $27, 000 $28, 800 $1, 800 Unfavorable Variable-overhead efficiency variance

Variable Overhead Variances The flexible budget amount for variable overhead $27, 000 is the amount that will be applied to Work-in-Process for product-costing purposes Flexible budget: variable overhead Variable overhead applied to work in process Standard allowed machine hours (SH) Standard rate (SVR) 4, 500 machine ? hours $6. 00 per ? machine hour $27, 000 No difference

How To Interpret The Variable Overhead Variances Efficiency variance The unfavorable variance resulting from using more machine hours than the standard quantity, given actual output The variable overhead efficiency variance has nothing to do with efficient or inefficient use of variable overhead items Spending variance The actual labor rate per hour differs from the standard rate ? An unfavorable variance means that the total actual cost of variable overhead is > expected, after adjusting for the actual quantity of machine hours used The spending variance is the real control variance for variable overhead

VOH Efficiency Variance • VOH efficiency variance has nothing to do with efficient or inefficient usage of electricity, indirect material, and other VOH items. This variance simply reflects an adjustment in the cost-management analyst’s expectation about total VOH cost because the company used more than the standard quantity of machine hours.

Fixed Overhead Budget Variance The FIXED-OVERHEAD BUDGET VARIANCE is the difference between actual fixed overhead and budgeted fixed overhead Fixed-overhead budget variance = Actual Fixed overhead - Budgeted fixed overhead Fixed-overhead budget variance = Actual Fixed overhead = $32, 500 - Budgeted fixed overhead = $30, 000 Unfavorable variance of $2, 500, because we spent more than budgeted

Fixed Overhead Volume Variance The FIXED-OVERHEAD VOLUME VARIANCE is the difference between budgeted fixed overhead and applied fixed overhead. Assume that the predetermined fixed overhead per machine hour = $5 and that it is based on 4, 500 machine hours. Fixed-overhead volume variance = Budgeted fixed overhead - Applied fixed overhead = Budgeted fixed overhead = $30, 000 - Applied fixed overhead = $22, 500 Variance = $7, 500 U, because we produced less than budgeted.

Managerial Interpretation Of Fixed-Overhead Variances Budget Variance Volume Variance The real control variance for fixed overhead because it compares actual expenditures with budgeted fixed overhead costs Reconciles the two different purposes of the cost accounting system 係因『實際生產水準』與 『擬定預算固定費用率之 基準產能水準』不同 For cost-management purposes, the costaccounting system recognizes that fixed overhead does not change as production activity varies For product-costing purposes, budgeted fixed overhead is divided by planned activity to obtain a predetermined or standard fixedoverhead rate

Fixed Overhead Budget And Volume Variances (1) Actual fixed O/H $32, 500 (3) Fixed overhead applied to work in process (2) Budgeted fixed O/H Standard allowed machine hours X Standard fixed overhead rate 4, 500 machine hrs X $5. 00 per machine hr $30, 000 Fixed-overhead budget variance = $2, 500 U $22, 500 Fixed-overhead volume variance = $7, 500 U

Budgeted Versus Applied Fixed Overhead Fixed overhead $30, 000 Applied fixed overhead ($5. 00 per standard allowed machine hour) Volume variance $7, 500 Budgeted fixed overhead $22, 500 Applied fixed overhead in June 0 4, 500 Standard 6, 000 allowed hours, Planned given actual monthly output activity Machine hours

4 -, 3 -, & 2 -way Variance Analysis Four-way analysis Variableoverhead spending variance Fixedoverhead budget variance Variableoverhead efficiency variance Fixedoverhead volume variance $1, 680 U $2, 500 U $1, 800 U $7, 500 U Combined spending variance Three-way analysis $4, 180 U $1, 800 U $7, 500 U Combined budget variance Two-way analysis $62, 980 actual overhead - overhead applied to WIP, 49, 500 = $13, 480 $5, 980 U $7, 500 U Underapplied overhead

Using Standard Costs In Product Costing Manufacturing Overhead Actual $62, 980 Debit: Cost of goods sold Debit: $13, 480 Work-in-process inventory Applied overhead: $11. 00 (predetermined overhead rate) X 4, 500 (standard allowed hours $49, 500 Applied $13, 480 Credit: Indirect-material inventory Wages payable Utilities payable Accumulated depreciation Prepaid insurance and property taxes Engineering salaries payable 19, 350 32, 610 2, 170 1, 300 1, 050 6, 500

Activity-Based Flexible Budget An activity-based flexible budget may provide more useful cost management information than a conventional flexible budget The traditional budget Activity-based flexible budget Costs are categorized as variable based on volume measures Costs are categorized as variable based on several cost drivers Machine hours Direct labor hours Cost that may seem fixed with respect to a single volume-based cost driver may be variable with respect to other non-volume related cost drivers

Homework • Backflush costing • Exhibit 17 -20