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Chapter 10

Chapter 10 - ACTG 2020.docx

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York University
ACTG 2020
Sylvia Hsingwen Hsu

Chapter10–StandardCostsandOverheadAnalysis STANDARD COSTS–MANAGEMENT BY EXCEPTION - Standard  a benchmark or a “norm” for measuring performance - Standards are widely use in managerial accounting where they relate to quantity and cost of inputs used in manufacturing goods or producing services - Quantity and cost standards are set for major input (raw materials, labour time) Quantity Standards specify how much of an input should be used to make unit of a product or provide a unit of service Cost (Price) Standards specify how much should be paid for each unit of the input - Management by Exception  a system of management `in which standards are set for various operating activities that are then periodically compared to actual results; any differences that are deemed significant are brought to the attention of management as “exceptions” – we operate in this mode in our daily lives (i.e. when you turn the key in the ignition you expect the car to start) - Variances occur when there are discrepancies – things don’t meet standards - Variance Analysis Cycle  basic approach to identify and solve problems (see cycle below) o The cycle puts emphasis on highlighting problems, finding their root cause, and taking corrective action o Goal is to improve operations – not to assign blame - Setting Standard Costs - Standards should be designed to encourage efficient future operations, not a repetition of past operations that may or may not have been efficient. Who Uses Standard Costs? - Manufacturing, service, food, and NFP organizations - Standard Cost Record  a detailed listing of the standard amounts of materials, labour, and overhead that should go into a unit of a product; multiplied by the standard price or rate that has been set for each cost element; the cost is calculated by multiplying the standard quantity of each input requires to produce one unit by the price/rate for the unit. Ideal vs. Practice Standards - Ideal Standards  standards that allow for no machines breakdowns or other work interruptions that require peak efficiency at all times; best and most optimistic circumstances o Ideal standards cannot be used in normal budgets or plans; they do not allow for normal inefficiencies, and therefore they result in unrealistic planning and forecasting figures - Practical Standards  standards that allow for normal machine downtime and other work interruptions and can be attained through reasonable, although highly efficient, efforts by the average employee; “tight but attainable” standards – our focus for the chapter th Example: HEIRLOOM PEWTER COMPANY – producer of an 18 century pewter bookend; controlled by George Hanlon. Hanlon has been asked to develop a system that would allow the company to periodically evaluate the productivity of its employees, the efficiency of raw material usage, and the prices paid for labour and materials. 1 Setting Direct Materials Standards - Hanlon was asked to prepare price and quantity standards for the company’s only significant raw material, pewter ingots. - Standard Price Per Unit  the price that should be paid for a single unit of materials, including shipping, receiving, and other such costs, net of any discounts allowed Purchase price, top-grade pewter 3.66 Freight, by truck from the supplier’s warehouse 0.44 Receiving and handling 0.05 Less purchase discount (0.09) Standard price per kilogram 4.00 - Standard Quantity Per Unit  the amount of materials that should be required to complete a single unit of product, including allowances for normal waste, spoilage, and other inefficiencies Materials requirements for a pair of bookends 2.7 kilograms Allowance for waste and spoilage 0.2 kilograms Allowance for rejects 0.1 kilograms Standard quantity per pair of bookends 3.0 kilograms - Allowance for waste, spoilage and rejects is often criticized because it contradicts improvement program like Six Sigma ∴ such allowance should be monitored and reduced over time - “Waste and spoilage” refers to materials that are wasted as a normal part of the production process or that spoil before they are used. - “Rejects” refers to the direct materials contained in units that are defective and must be scrapped. - Once the price and quantity standards are set, the cost of materials per unit of finished product can be computed and will appear as one item on the standard cost record of the product: 3.0 kilograms per unit × $4 per kilogram = $12 per unit Setting Direct Labour Standards - Usually expressed in terms of labour rate and labour-hours - Standard Rate Per Hour  the labour rate that should be incurred per hour of labour time including employment insurance, employee benefits, and other labour costs Basic average wage rate per hour 15.00 Employment taxes at 10% of the basic rate 1.50 Employee benefits at 30% of the basic rate 4.50 Standard rate per direct labour-hour 21.00 - Many companies prepare a single standard rate for all employees in the department, even though some rates may vary among individuals - Standard Hours Per Unit  the amount of labour time that should be required to complete a single unit of product, including allowances for breaks, machine downtime, clean-up rejects, and other normal inefficiencies Basic labour time per unit 1.9 hours Allowance for breaks and personal needs 0.1 hours Allowance for clean-up and machine downtime 0.3 hours Allowance for rejects 0.2 hours Standard labour-hours per unit of product 2.5 hours - Once the rate and time standards have been set, the standard labour cost per unit of product can be computed as follows: 2.5 hours × $21 per hour = $52.50 per unit - Standard labour hours have declined for some organizations – more machines are being used - Standards help to inform workers and managers what is expected and how labour should be used; standards may even motivate workers and managers + influence workers in setting their own goals Setting Variable Manufacturing Overhead Standards - Generally expressed in rate and hours - The rate represents the variable portion of the predetermined overhead rate; it requires and estimate of both unit cost of the variable overhead items used in production and the quantity required - Can be based on prior year amounts or existing contractual agreements with suppliers that lock in prices - Quantities can be estimated using amounts from prior periods - The hours relate to whatever activity base is used to apply overhead to units - At Heirloom Pewter, the variable portion of the predetermined overhead rate = $3 per direct labour-hours; ∴ the standard variable manufacturing overhead cost per unit is: 2.5 hours per unit × $3 per hour = $7.50 per unit 2 - Standard Cost Per Unit  shown in the standard cost card; computed by multiplying the standard quantity or hours by the standard price for each cost element Inputs Standard Quantity of Standard Price Standard Cost Hours Direct Materials 3.0 kilograms $4.00 $12.00 Direct Labour 2.5 hours $21.00 $52.50 Variable Manufacturing 2.5 hours $3.00 $7.50 Overhead Total Standard Cost/Unit $72.00 - A standard can be viewed as the budgeted cost for one unit of product. A General Model for Variance Analysis - Standards are separated into two categories – price and quantity – because different managers are usually responsible for buying and for using inputs and these two activities occur at different points in time o Purchasing manager is in charge of raw materials - PRICE o Production manager is responsible for the amount of raw materials used = QUANTITY - It is important to separate discrepancies from deviations in price standards from those due to deviations in quantity standards - Variances  differences between actual prices and standard prices and the differences between actual quantities and standard quantities (1) (2) (3) Actual Quantity of Inputs Actual Quantity of Inputs, at Standard Quantity Allowed at Actual Price Standard Price for Actual Output and Standard Price AQ × AP AQ × SP SQ × SP Price Quantity Variance Variance (1) – (2) (2) – (3) Total Flexible Budget Variance - There are four important things to remember about the general model for variance analysis 1. A price variance and a quantity variance can be computed for all three variable cost elements – direct materials, direct labour and variable manufacturing overhead 2. Although price variance may be called different names, it is computed in the exact same way regardless of whether one is dealing with direct materials, direct labour, or variable manufacturing overhead 3. The inputs represent the actual quantity of direct materials, direct labour and variable manufacturing overheard used; the output represents the good production of the actual output Standard Quantity Allowed  the amount of materials that should have been used to complete the periods output, as computed by multiplying the actual number of units products by the standard quantity per unit Standard Hours Allowed  the time that should have been taken to complete the period’s output, as computed by multiplying the actual number of units products by the standard hours per unit 4. The amount in column (3) represents the flexible budget for the period USING STANDARD COSTS –DIRECT MATERIALSVARIANCES - Hanlon’s next step is to compute the company’s variances for June, the most recent month 3 - Variances are computed by comparing actual costs to standard costs - Recall, standard cost of direct materials per unit = $12 per unit - Purchasing records for June showed that 6,500 kilograms of pewter were purchased at $3.80/kilogram to manufacture 2,000 pairs of bookends Price 6,500 × 3.80 = $24,700 (actual total cost during June) 6,500 × 4.00 = $26,000 (actual quantity would have cost if purchased at $4) 26,000 – 24,700 = $1,300 (price variance; the pewters were purchased for $0.20 less) F Quantity 6,500 × 4.00 = $26,000 (actual quantity would have cost if purchased at $4) 6,000 × 4.00 = $24,000 (actual cost would have occurred if allotted quantity was purchased) 26,000 – 24,000 = $2,000 (quantity variance; 500 more pewters were purchased) U ∴ total flexible budget variance: 2,000 – 1,300 = $700; U - Note: this is a lot easier if computed with the general model above ^ of the formulas below v - Companies compute the materials price variance when materials are purchased rather than when they are used in production because: o Delaying the computation of the price variance until the materials are used would results in less-timely variance reports if here is a time gap between the purchase of materials and their use in production o By computing the price variance at the time of the purchase, materials can be carried in the inventory accounts for their standard cost, which simplifies bookkeeping - However, this is not likely to occur with JIT - Important to remember that the price variance is computed on the entire amount of material purchased (6,500 kilograms), as before, whereas the quantity variance is computed only on the portion of this material used in production during the month (5,000 kilograms) Materials Price Variance – A Closer Look - Materials Price Variance  the measure of the difference between the actual unit price paid for an item and the standard price, multiplied by the quantity purchased Materials Price Variance = AQ × (AP – SP) - Isolation of Variances. Variances should be isolated and brought to the attention of management. Significant variances should be viewed as “red flags.” - Responsibility for the Variance. Generally, the purchasing manager is responsible for any price variances, but a production manager may have scheduled production in such a way that the many materials were requested. It is important to remember that there should be no blame placed on anyone; variance analysis is a control function. The emphasis should be positive, not negative. Materials Quantity Variance – A Closer Look - Materials Quantity Variance  a measure of the difference between the actual quantity of materials used in production and the standard quantity allowed, multiplied by the standard price per unit Materials Quantity Variance = SP × (AQ – SQ) - The materials quantity variance is best isolated at the time that materials are placed into production - Excessive usage in materials can result from many factors: faulty machines, inferior quality of materials, untrained workers, poor supervision…etc. - It is generally the responsibility of the production department to make sure materials usage is kept in line with standards; however, just like before, the purchasing department may take fault as well USING STANDARD COSTS –DIRECT LABOUR VARIANCES - Now Hanlon had to determine direct labour variances for June - Recall, the standard direct labour cost per unit = $52.50 - During June, employees received $108,000 for 5,400 hours of work. This was an average of $20 per hour Labour Rate Variance – A Closer Look - Labour Rate Variance  a measure of the difference between that actual hourly labour rate and the standard rate, multiplied by the number of hours worked during the period Labour Rate Variance = AH × (AR – SR)
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