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Control and Control and Evaluation of Evaluation of Cost CentersCost Centers

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

1111

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Develop standard variable costs for a product. Calculate direct labor, variable overhead, and

materials variances. Discuss the advantages and disadvantages of

approaches to setting standards. Describe new approaches to cost control and

management, as described by proponents of JIT and other continuous improvement approaches.

ObjectivesObjectivesObjectivesObjectives

After reading this After reading this chapter, you should chapter, you should

be able to:be able to:

After reading this After reading this chapter, you should chapter, you should

be able to:be able to:

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Cost control is important for companies following a

cost leadership strategy where total demand for the

product is not growing.

Cost control is important for companies following a

cost leadership strategy where total demand for the

product is not growing.

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A standard cost is the per-unit cost a company should incur to make a

unit of product.

A standard cost is the per-unit cost a company should incur to make a

unit of product.

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A standard cost has two components: a standard

price, or rate, and a standard quantity.

A standard cost has two components: a standard

price, or rate, and a standard quantity.

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Standard Variable CostsStandard Variable CostsStandard Variable CostsStandard Variable Costs

Cost Factor Std. Quantity Std. Price Std. CostMaterials 10.00 $0.80 $8.00Direct labor 0.50 16.00 8.00Variable overhead 0.50 6.00 3.00 Total standard variable cost $19.00

Actual results:Production 1,000 unitsMaterials purchased, 11,000 at $0.78. $8,580Materials used 10,200gallonsDirect labor, 480 hours at $16.20 $7,776Variable overhead incurred $3,100

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Labor VariancesLabor VariancesLabor VariancesLabor Variances

Actual production

(units)

Standard direct labor cost per unit

Total standard

direct labor cost

x =

1,000 x $8.00 = $8,000

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Labor VariancesLabor VariancesLabor VariancesLabor Variances

Actual input

quantity

Actual rate for input

factor

Actual cost of input factor

x =

480 hours x $16.20 = $7,776

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Labor VariancesLabor VariancesLabor VariancesLabor Variances

Actual input

quantity

Standard rate for input

factor

Budget allowance for

actual quantity of input factor

x =

480 hours x $16 = $7,680

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Labor VariancesLabor VariancesLabor VariancesLabor Variances

Standard input quantity

Standard rate for input

factor

Budget allowance for

actual quantity of

output

x =

1,000 units x ½ hour per unit = 500

hours x $16 = $8,000

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Labor VariancesLabor VariancesLabor VariancesLabor Variances

Labor rate variance $ 96 unfavorable

Labor efficiency variance 320 favorable

Total labor variance $224 favorable

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Actual Quantityat Actual Rates(Total Actual

Costs)

Flexible Budget For Actual Quantity at

Standard Rate

Flexible Budget forStandard Quantity at Standard Rate(Total Standard

Cost)

Rate variance Efficiency variance

$96 U

$320 F

$224 F

Total Variance

Labor VariancesLabor VariancesLabor VariancesLabor Variances

480 x $16.20 480 x $16.00 1,000 x 1/2 x $16.00

$7,776 $7,680 $8,000

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Variable Overhead VariancesVariable Overhead VariancesVariable Overhead VariancesVariable Overhead Variances

Actual Quantity at Actual Rate (Total Actual

Cost)

Flexible Budget for Actual

Quantity at Standard Rate

Flexible Budget for Standard Quantity at Standard Rate (Total

Standard Cost)

$220 U

Budget variance Efficiency variance

$120 F

$100 U

Total Variance

480 x $6 1,000 x 0.50 x $6$2,880 $3,000$3,100

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Variable Overhead VariancesVariable Overhead VariancesVariable Overhead VariancesVariable Overhead Variances

The variable overhead efficiency variance

reflects the efficient or inefficient use of the item

used as the cost driver.

The variable overhead efficiency variance

reflects the efficient or inefficient use of the item

used as the cost driver.

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Actual Quantity Purchased at

Standard Price

Actual Quantity

Purchased at Actual Price

Materials VariancesMaterials VariancesMaterials VariancesMaterials Variances

$8,580 $8,800

11,000 x $0.78 11,000 x $0.80

$220 FMaterial Price Variance

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Materials VariancesMaterials VariancesMaterials VariancesMaterials Variances

Material price

variance

Actual quantity

purchased

Standard price

Actual price

–= x

$220 F = 11,000 x ($0.80 – $0.78)

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Materials VariancesMaterials VariancesMaterials VariancesMaterials Variances

Flexible Budget for Standard Quantity at Standard Price (Total

Standard Cost)

Flexible Budget for Actual

Quantity Used at Standard Price

$8,160 $8,000

10,200 x $0.80 1,000 x 10 x $0.80

$160 UMaterial Use Variance

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Materials VariancesMaterials VariancesMaterials VariancesMaterials Variances

Material use

variance

Standard price

Standard quantity for

actual output

Actual quantity

–= x

$160 U = $0.80 x (10,000 – 10,200)

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Material use variance—is calculated the same as the labor and overhead efficiency variances

Material price variance—differs from its counterparts in labor and variable overhead because materials,unlike labor, can be stored. Purchases made in one period are not necessarily used in that period, but the economic effect of paying more or less than standard prices for materials occurs at the time of purchase. So the material price variance is based on the quantity of materials purchased, not the quantity used.

Materials VariancesMaterials VariancesMaterials VariancesMaterials Variances

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• There are two principle variable overhead cost pools.

• One is driven by machine time, while the other is driven by the number of machine setups.

• The two rates are $6.00 per machine hour and $140 per setup.

ContinuedContinued

Standard Costs and Activity-Based Costing Example

Standard Costs and Activity-Based Costing Example

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• The standard machine hours and number of setups for 1 batch (1,000 units) is 1,500 hours and 20 setups, respectively.

• Actual machine hours and number of setups for 10 batches (10,000 units) are 14,000 hours and 210 setups, respectively.

• The actual overhead costs driven by machine hours and number of setups are $85,000 and $27,500, respectively.

Standard Costs and Activity-Based Costing Example

Standard Costs and Activity-Based Costing Example

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Actual Cost

Budget for Actual

Use

Standard Cost

Standard Costs and Activity-Based Costing Example

Standard Costs and Activity-Based Costing Example

$1,000 U

Budget variance Efficiency variance

$6,000 F

$5,000 F

Total Variance

14,000 x $6.00 10 x 1,500 x $6.00$84,000 $90,000$85,000

Machine-driven variable overhead

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Actual Cost

Budget for Actual

Use

Standard Cost

Standard Costs and Activity-Based Costing Example

Standard Costs and Activity-Based Costing Example

$1,900 F

Budget variance Efficiency variance

$1,400 U

$500 F

Total Variance

210 x $140 10 x 20 x $140$29,400 $28,000$27,500

Setup-driven variable overhead

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Variances and Performance Evaluation

Variances and Performance Evaluation

• Variances signal nonstandard performance only if they are based on up-to-date standards that reflect current production methods and current prices of input factors.

• Many variances are interdependent.

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Setting Standards—Behavioral Problems

Setting Standards—Behavioral Problems

Engineering methods

Managerial estimates

Benchmarking and best practices

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Setting Standards—Behavioral Problems

Setting Standards—Behavioral Problems

Engineering Methods

Some companies develop standard quantities for materials and labor by

carefully examining production methods and determining how much of an input

factor is necessary to obtain a finished unit.

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Setting Standards—Behavioral Problems

Setting Standards—Behavioral Problems

Managerial Estimates

Some companies rely on the judgment of managers closest to the task to determine quantities of input needed to produce a

unit of product. Managers who participate in setting standards are more

likely to commit to meeting them.

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Benchmarking is a relatively recent development that companies use to determine whether their operations and costs compare

favorably to those of world-class companies.

Setting Standards—Behavioral Problems

Setting Standards—Behavioral Problems

Benchmarking

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What Standard?What Standard?

An ideal standard can be attained only under perfect conditions.

Setting a currently attainable standard recognizes expectations about efficiency under normal working conditions.

An historical standard is based on experience.

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Kaizen Costing and Target Costing

Kaizen Costing and Target Costing

Kaizen costing stresses continuous improvement in the production process. Under kaizen, performance standards are

continually raised (standard costs lowered), so the objective is to meet targeted reductions,

not standard costs.

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Kaizen Costing and Target Costing

Kaizen Costing and Target Costing

Value engineering refers to design and re-design that focuses on customer value. Value

engineering is redesigning products so that they will cost less. Value engineering is an optimizing

technique where people seek exactly what features the product needs, how to make it, what

materials to use, and so on.

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Kaizen Costing and Target Costing

Kaizen Costing and Target Costing

Target costing is price-driven; market prices

determine cost instead of vice versa. Companies reduce cost through systemic analyses of

the features and functions deemed most important to customers. Much of target costing takes place during

product design.

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The EndThe End

Chapter 11Chapter 11

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