CHAPTER 10: Standard Costs and Overhead Analysis
Management by Exception – A system in which standards are set for operating activities
which are periodically compared to actual results.
Standard Cost Card – A detailed listing of the standard amounts of materials, labour, and
overhead that should go into a unit of product, multiplied by the standard price for each.
Setting Standard Costs:
Ideal Standards – those that can be attained only under the Best circumstances. Few firms use
these, because large variances can be normal and it discourages workers.
Practical Standards – tight but attainable, which allow for machine downtime and employee
rest. It can also be used to forecast cash flows and plan inventory.
Standard Price per Unit – the price for a single unit of materials that includes
allowances for quality, quantitiy, shipping, and net of any other discounts.
Standard Qty per unit – the amount of material going into each unit of finished product,
accounting for unavoidable waste, spoilage, an dohter inefficiencies.
For example, 3 kg per unit x $4/unit = $12 per unit of finished goods
Same for standard rate per hour and labour hours – includes everything!
Variable Manufacturing Overhead
The major distinction between standards and budgets is that standard is a unit amount, while a
budget is a total amount.
The reason for separating standards into price and qty is that different managers are
responsible for buying and using inputs. E.g. purchasing and production manager. A
variance is the difference between standard prices and quantities and actual prices and
Materials Price Variance = (AQ x AP) – (AQ x SP) = AQ(AP – SP)
Materials Qty Variance = SP(AQ – SQ)
Variable Overhead Spending Variance = AH(AR – SR) in terms of rates
Useful when the cost driver is the number of labour or machine hours.
Variable Overhead Efficiency Variance = SR(AH-SH) in terms of hours
Overhead Rates and Fixed OH Analysis
Predetermined OH rate = OH from the flexible budget at the denominator level of
activity/denominator level of activity.
Budget Variance – the difference between actual fixed OH costs and budgeted fixed OH costs
in the flexible budget.
Volume Variance – a measure of utilization of plant facilities. Fixed portion of predetermined OH
rate x (denominator hours – standard hours allowed)
Advantages of Standard Costs
Key element in management by exception; managers are alerted whenever costs fall
significantly outside standards, and helps them focus on important issues
Standards that are viewed as reasonable by employees can promote economy and
efficiency, as well as benchmarks It can simplify bookkeeping because they don’t have to record actual costs
It fits naturally with an integrated system of responsibility accounting. It establishes what
costs should be, who is responsible, and whether actual costs are under control
Problems with Standard Costs
Since standard cost variance reports are released days or weeks after the end of the
month, the information may be outdated
If managers use variance reports to lay blame, morale might suffer. Workers may cover
up unfavourable variances by rushing work and omitting quality
Output in many companies is not labour-paced, and direct labour may not be variable.
Since these assumptions are made in the labour qty and efficiency variances, there can
IN some cases, favourable variances, such as less material used, is worse than
unfavourable. For example at Harvey’s, less meat may mean a dissatisfied customer
There can be a tendency to emphasize meeting the standards instead of improving
quality and satisfaction. This can be reduced by using performance measures that focus
on other objectives
CHAPTER 11: Reporting for Control
Decentralized Organization – decision making is spread throughout the org, rather than being
confined to a few top executives. It requires segment reporting to permit an alysis and
evaluation of segment managers’ decisions.
Responsibility Centre – part of an org whose manager has control over and is accountable for
cost, profit, or investments.
Cost Centre – a segment whose manager has control over costs, but not revenue or
investment. Accounting and finance depts. Are cost centres, as well as manufacturing
Profit Centre – manager has control over both cost and revenue, for example, a manager of a
resort. He is evaluated by comparing actual profits to budgeted profit.
Investment Centre – manager has control over cost, revenue, and investments, such as the
CEO of GM or the president of an operations division.
This is the price charged when one division or segment provides goods or services to another
segment. Although one department stands to gain over another, the overall profit of the
company stays the same. Three common approaches to set transfer prices are:
1. Allow the managers involved in the transfer to negotiate
2. Set transfer prices at cost using either variable or full absorption cost
3. Set transfer prices at the market price
The FUNDAMENTAL OBJECTIVE in setting transfer prices is to motivate managers to act in
the best interests of the OVERALL COMPANY. Suboptimization occurs when they do not.
1. Negotiated Transfer Prices – advantageous because it preserves the autonomy of the
divisions and consistent with decentralization. The managers of divisions are likely to
have much better info about the potential costs and benefits of the transfer. It will fall in
the range of acceptable transfer prices set by the lowest they will sell and highest they
will pay. Both divisions must be profitable. Transfer Price = Variable Cost per Unit + Total CM on lost sales/number of units
2. Transfers to the Selling Division at Cost – Although it’s easy to apply, there are
disadvantages. It can lead to suboptimization because there could be cheaper suppliers
elsewhere if the full cost was charged. Also, the selling division would never profit for
any internal transfer. They do not provide incentives to control costs, if the costs of one
division is simply passed on to the next.
3. Transfers at Market Price – This approach is designed for situations in which there is
an intermediate market for the transferred product or service. If this is set, the manager
would not lose anything on the transfer, because there is no greater opportunity cost of
selling it elsewhere. Difficulties arise when there is idle capacity. When the purchaser
buys the ingredient at a higher market price, it can lead to inc orrect pricing decisions.
Divisional Autonomy and Suboptimization – basically top management should decentralize
and permit more decision making power to sub-managers, since they know more details
anyway. However, some managers might suboptimize and act in their departments best