16
Standard Costing,
Variance Analysis
and Kaizen Costing
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
16-2
Learning Objective 1
16-3
Using Standard-Costing Systems for
Control
based on carefully
predetermined amounts.
Standard
costs are
used for planning labor
and material requirements.
the expected level
of performance.
benchmarks for
measuring performance.
16-4
Using Standard-Costing Systems for
Control
STANDARD COST
a budget for the
production of one
unit of product or
service
ACTUAL COST
incurred and
recorded in the
production of the
product or service
COST VARIANCE
the difference
between the
actual cost and
the standard cost
16-5
Using Standard-Costing Systems for
Control
This variance is unfavorable
because the actual cost
exceeds the standard cost.
Product cost
Standard
A standard cost variance
is the amount by which
an actual cost differs from
the standard cost.
16-6
Management by Exception
Amount
Managers focus on quantities and costs
that deviate significantly from standards
(a practice known as management by exception).
Standard
Direct
labor
Direct
materials
Type of Product Cost
16-7
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 production
process
Depends on
the type of the
organization
16-8
Variance Analysis Cycle
Identify
questions
Receive
explanations
Conduct next
period’s
operations
Analyze
variances
Begin
Take
corrective
actions
Prepare standard
cost performance
report
16-9
Setting Standards
Analysis of
historical
data
What DID
the product
cost?
Used in a mature
production process
Task
analysis
What
SHOULD the
product
cost?
Analyze the process
of manufacturing
the product
Combined
approach
Analyze the process for the step that
has changed, but use historical data
for the steps that have not changed
16-10
Participation in Setting Standards
Accountants, engineers, personnel
administrators, and production managers
combine efforts to set standards based on
experience and expectations.
16-11
Learning Objective 2
16-12
Perfection versus Practical
Standards: A Behavioral Issue
PERFECTION
STANDARDS
PRACTICAL OR
ATTAINABLE
STANDARDS
Can only be attained
under near perfect
conditions
Tight as practical,
but still 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
16-13
Perfection versus Practical
Standards: A Behavioral Issue
Should we use
practical standards
or perfection
standards?
Practical standards
should be set at levels
that are currently
attainable with
reasonable and
efficient effort.
16-14
Perfection versus Practical
Standards: A Behavioral Issue
I agree. Perfection
standards are
unattainable and
therefore discouraging
to most employees.
16-15
Setting Standards – Direct Materials
Price
Standards
Quantity
Standards
Use competitive
bids for the quality
and quantity desired.
Use product
design specifications.
16-16
Setting Standards – Direct Materials
The standard materials cost for one unit of product is:
Standard price for
one unit of material
×
Standard quantity
of material
required for one
unit of product
16-17
Setting Standards – Direct Labor
Rate
standards
Efficiency
standards
Use wage
surveys and
labor contracts.
Use time and
motion studies for
each labor operation.
16-18
Setting Standards – Direct Labor
The standard labor cost for one unit of product is:
Standard wage rate
for one hour
×
Standard number
of labor hours
for one unit
of product
16-19
Standard Cost in Service Industries

Jobs with repetitive
tasks lend themselves
to efficiency
measures.

Computing nonmanufacturing
efficiency variances
requires some
assumed relationship
between input and
output activity.
Examples
Examples
16-20
Standard Cost in Service Industries
Department
Input
Output
Mailing
Labor hours
Number of pieces mailed
Personnel
Labor hours
Number of personnel changes processed
Food service
Labor hours
Number of meals served
Consulting
Billable hours
Customer revenues
Nursing
Labor hours
Number of patients and/or procedures
Check processing
Computer hours
Number of checks processed
16-21
Costs and Benefits of
Standard-Costing Systems
Costs
Benefits
IMPROVED
DECISION
MAKING, BUT:
Implementing and maintaining cost standards can
be time-consuming, labor-intensive, and expensive.
16-22
Cost Variance Analysis
Standard cost variances
Price variance
Quantity variance
The difference between
the actual price and the
standard price
The difference between
the actual quantity and
the standard quantity
16-23
A General Model for
Variance Analysis
Actual quantity
×
Actual price
Actual quantity
×
Standard price
Price / Rate
variance
Standard quantity
×
Standard price
Quantity / Efficiency
variance
16-24
A General Model for
Variance Analysis
Actual quantity
×
Actual price
Actual quantity
×
Standard price
Price / Rate
variance
Standard quantity
×
Standard price
Quantity / Efficiency
variance
Standard price is the amount that should
have been paid for the resources acquired.
16-25
A General Model for
Variance Analysis
Actual quantity
×
Actual price
Actual quantity
×
Standard price
Price / Rate
variance
Standard quantity
×
Standard price
Quantity / Efficiency
variance
Standard quantity is the quantity
allowed for the actual good output.
16-26
A General Model for
Variance Analysis
Actual quantity
×
Actual price
Actual quantity
×
Standard price
Price / Rate
variance
Materials price variance
AQ(AP - SP)
Labor rate variance
overhead
AQVariable
= Actual
Quantity
APspending
= Actualvariance
Price
Standard quantity
×
Standard price
Quantity / Efficiency
variance
Materials quantity variance
SP(AQ - SQ)
Labor efficiency variance
overhead
SP Variable
= Standard
Price
variance
SQ efficiency
= Standard
Quantity
16-27
Standard Costs
Let’s use the
concepts of the
general model to
calculate standard
cost variances,
starting with
direct materials.
16-28
Learning Objective 3
16-29
Materials Variances
Koala Camp Gear Company in Melbourne
Australia has the following direct material
standard to manufacture one Tree Line tent:
12 square meters per tent at
$8.00 per square meter (sq m)
Last month Koala purchased 40,000 square
meters at $8.15 per square meter and used
36,400 square meters to make 3,000 tents.
16-30
Materials Variances
Actual quantity
purchased
×
Actual price
Actual quantity
purchased
×
Standard price
40,000 sq m
×
$8.15 per sq m
40,000 sq m
×
$8.00 per sq m
$326,000
$320,000
Price variance
$6,000 Unfavorable
We should compute
the price variance
using the actual
quantity purchased.
16-31
Materials Variances
SQ = 3,000 tents × 12 sq m per tent
SQ = 36,000 sq m
Actual quantity
used
×
We should compute Standard price
the quantity variance
36,400 sq m
using the actual
×
quantity used.
$8.00 per sq m
$291,200
Standard quantity
×
Standard price
36,000 sq m
×
$8.00 per sq m
$288,000
Quantity variance
$3,200 Unfavorable
16-32
Materials Variances
We may also calculate materials
variances using formulas:
MPV = AQp(AP – SP)
MPV = 40,000 sq m × ($8.15 – $8.00)
MPV = $6,000 Unfavorable
MQV = SP(AQu – SQ)
MQV = $8.00(36,400 sq m – 36,000 sq m)
MQV = $3,200 Unfavorable
16-33
Reporting Materials Variances
I need the variances as soon
as possible so that I can
better identify problems
and control costs.
You accountants just don’t
understand the problems we
production managers have.
Okay. I’ll compute
the price variance when
materials are purchased,
and the usage variance as
soon as material is used.
16-34
Responsibility for Materials Variances
I am not responsible
for this unfavorable
materials usage
variance.
You bought poor quality
materials, so my people
had to use more of it.
Your poorly trained workers and
poorly maintained equipment
caused the problems.
Also, your poor scheduling
requires rush orders of
materials at higher prices,
causing unfavorable price
variances.
16-35
Standard Costs
Now let’s calculate
standard cost
variances for
direct labor.
16-36
Labor Variances
Koala has the following direct labor
standard to manufacture one Tree Line tent:
2 standard hours per tent at
$18.00 per direct labor hour
Last month 5,900 direct labor hours were
worked at $19.00 per hour to make 3,000 tents.
16-37
Labor Variances
SH = 3,000 tents × 2 hours per tent
SH = 6,000 hours
Actual hours
×
Actual rate
Actual hours
×
Standard rate
Standard hours
×
Standard rate
5,900 hours
×
$19.00 per hour
5,900 hours
×
$18.00 per hour
6,000 hours
×
$18.00 per hour
$112,100
$106,200
Rate variance
$5,900 Unfavorable
$108,000
Efficiency variance
$1,800 Favorable
16-38
Labor Variances
We may also calculate labor
variances using formulas:
LRV = AH(AR - SR)
LRV = 5,900 hrs($19.00 - $18.00)
LRV = $5,900 Unfavorable
LEV = SR(AH - SH)
LEV = $18.00(5,900 hrs - 6,000 hrs)
LEV = $1,800 Favorable
16-39
Labor Rate Variance –
A Closer Look
Using highly paid skilled workers to
perform unskilled tasks results in an
unfavorable price variance.
High skill,
high rate
Low skill,
low rate
Production managers who make work assignments
are generally responsible for price variances.
16-40
Labor Efficiency Variance –
A Closer Look
Poorly
trained
workers
Poor
quality
materials
Unfavorable
Efficiency
Variance
Poor
supervision
of workers
Poorly
maintained
equipment
16-41
Responsibility for Labor Variances
I am not responsible for
the unfavorable labor
efficiency variance!
You bought poor quality
materials, so my people took
more time to process them.
You used too much
time because of poorly
trained workers and
poor supervision.
16-42
Responsibility for Labor Variances
Maybe I can attribute the labor
and materials variances to personnel
for hiring the wrong people
and training them poorly.
16-43
Allowance for Defects or Spoilage
In some manufacturing processes, a certain amount
of defective production or spoilage is normal.
Example: 1,000 liters of chemicals are normally required in a
chemical process in order to obtain 800 liters of good output.
If total good output in February is 5,000 liters, what is the
standard allowed quantity of input?
Good output quantity
= 80% X Input quantity
Good output quantity ÷ 80%
= Input quantity allowed
5,000 liters of good
output ÷ 80%
= 6,250 liters of
input allowed
16-44
Learning Objective 4
16-45
Significance of Cost Variances:
When to Follow Up
How does a manager know when to follow up
on a cost variance and when to ignore it?
Size of variance
Absolute amount
?
Relative amount
16-46
Significance of Cost Variances

Size of variance






What clues help me
to determine the
variances that I should
investigate?

Dollar amount
Percentage of standard
Recurring variances
Trends
Controllability
Favorable variances
Costs and benefits of
investigation
16-47
Significance of Cost Variances:
When to Follow Up
How do I know which
variances to
investigate?
Larger variances, in
dollar amount or as a
percentage of the
standard, are
investigated first.
We could use a rule of thumb such as:
investigate all variances that are over $10,000
or over 10 percent of the standard cost.
16-48
Significance of Cost Variances:
When to Follow Up
What about recurring variances?
Month
September
October
November
December
Variance
$6,000 F
6,400 F
3,200 F
6,200 F
Percentage of
standard cost
6.0%
6.4%
3.2%
6.2%
None of the variances are greater than $10,000 or
10% for any one month, but they should be investigated
because of they have continued for several months.
16-49
Significance of Cost Variances:
When to Follow Up
What about trends?
Month
September
October
November
December
Variance
$
250 U
840 U
4,000 U
9,300 U
Percentage of
standard cost
0.25%
0.84%
4.0%
9.3%
None of the variances are greater than $10,000 or
10% for any one month, but they should be
investigated because of the unfavorable trend.
16-50
Significance of Cost Variances:
When to Follow Up
Controllability
Favorable variances
A manager is more likely
to investigate a variance
that is controllable by
someone in the
organization than one
that is not.
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
16-51
Statistical Analysis
Control
charts
Display variations in a
process and help to
analyze the variations
over time.
Distinguish between
random variations
and variations that
should be investigated.
Provide a warning signal when variations
are beyond a specified level.
16-52
Statistical Analysis
Warning signals for investigation
Favorable limit
•
Desired value
•
•
•
•
•
•
Unfavorable limit
1
2
3
4
5
6
7
Variance measurements
•
8
•
9
16-53
Learning Objective 5
16-54
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
16-55
Which Managers Influence Cost
Variances?
Direct-materials price variance
Purchasing manager
Get the best prices available for purchased goods and
services through skillful purchasing practices
Direct-materials quantity variance
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
Production supervisor
Generally results from using a different mix of employees
than that anticipated when the standard were set
Direct-labor efficiency variance
Production supervisor
Motivating employees toward production goals and
effective work schedules improves efficiency
Exh.
16-5
16-56
Interaction among Variances
Interaction among variances often occurs, making it difficult to
determine the responsibility for a particular variance.
Variances in one part of the value chain can be
due to root causes in another part of the chain.
Value chain
Physical
resources
Research
and
development
Design
perspective
Supply
Human
resources
ProducDistriMarketing
tion
bution
Customer
service
16-57
Learning Objective 6
Exh.
16-6
16-58
Using Standard Costs for
Product Costing
Work-in-process inventory
Direct-materials cost
Direct-labor cost
Manufacturing
overhead
Finished-goods inventory
Product cost transferred
when product is finished
Product cost transferred when product is sold
Cost of goods sold
Income summary
Expense closed into
Income summary at end
of accounting period
16-59
Standard Cost Journal Entries


Inventories are recorded at standard cost.
Variances are recorded as follows:



Favorable variances are credits, representing savings
in production costs.
Unfavorable variances are debits, representing excess
production costs.
Standard cost variances are usually closed to
cost of goods sold.


Favorable variances decrease cost of goods sold.
Unfavorable variances increase cost of goods sold.
16-60
Impact of Information Technology
on Standard Costing
CAD designers can access
the data base for instant
design cost estimates.
Labor time and rate
are recorded at standard,
using bar codes
and employee IDs.
Standard cost
data base
Materials purchases
and uses are recorded
at standard,
using bar codes.
16-61
Learning Objective 7
16-62
Standard Costing: Its Traditional
Advantages
Sensible cost
comparisons
Performance
evaluation
Management
by exception
Advantages
More stable
product costs
Employee
motivation
Less expensive than
actual- or normalcosting systems
16-63
Learning Objective 8
16-64
Criticisms of Standard Costing in
Today’s Manufacturing Environment




There is too much focus on the
cost and efficiency of direct
labor.

Standard costing may not be
applicable in flexible
manufacturing operations
with short life-cycle products.
Automation reduces labor
costs and the significance of
labor variances.

There is too much focus on
cost minimization rather than
increasing product quality or
customer service.
Automated manufacturing
processes tend to be more
consistent in meeting
production specifications.

Variance reports are often
provided too late to be useful
to managers.
Variances are often too
aggregated. They are not tied
to specific product lines,
production batches, or to the
flexible management system.
16-65
Adaptation of Standard-Costing
Systems
Applications of standard costing have adapted to
changes in the manufacturing environment and the
resulting criticisms leveled at standard costing.
Reduced
importance of
labor
standards.
Automation means
more overhead,
less labor.
Less use of labor
as a cost driver.
More emphasis
on material and
overhead
costs.
16-66
Adaptation of Standard-Costing
Systems
Applications of standard costing have adapted to
changes in the manufacturing environment and the
resulting criticisms leveled at standard costing.
Automation
Reduces labor
efficiency variance
Reduces material
quantity variance
Reduces variation in quality
and increases quality
16-67
Adaptation of Standard-Costing
Systems
Applications of standard costing have adapted to
changes in the manufacturing environment and the
resulting criticisms leveled at standard costing.
Shorter
product life
cycles
Non-financial
measures such a
delivery times are
more important
More frequent
benchmarking
More frequent
revisions of
standard costs
Elimination
of non-valueadded costs
Real-time
information systems
provide more timely
variance reports
16-68
Learning Objective 9
16-69
Comparing Standard Costing and
Kaizen Costing

Standard costing – the use of carefully
predetermined product costs for budgeting
and performance evaluation.


Standard costs are typically used in established
production processes.
Kaizen costing – the emphasis is on
continuous reduction of production costs.

Rather than standards or targets, the goal is current
costs that are less than previous costs.
Exh.
16-7
16-70
Kaizen Costing
Cost per product unit
Current year
cost base
Kaizen goal:
cost reduction
rate
Kaizen goal:
cost reduction
amount
Actual cost
reduction
achieved
Actual cost
performance
of the
current year
Cost base
for next
year
Time
12/31/x0
12/31/x1
16-71
Learning Objective 10
16-72
Production Mix and Yield Variances



Nearly all production processes require
multiple materials and labor inputs.
A summary quantity variance for materials
and labor would hide the individual effects
of these inputs.
The quantity variances can be analyzed
into two further variances:



Mix (the difference between actual and
standard input proportions)
Yield (the difference between actual and
standard input used)
The analysis assumes, of course, that the
inputs can be substituted for each other.
16-73
End of Chapter 16