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Controlling Manufacturing

Costs: Standard Costs

Controlling Manufacturing

Costs: Standard Costs

Section 1: Cost Behavior

and the BudgetSection Objectives

1. Explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes.

2. Use the high-low point method to determine the fixed and variable components of a semivariable cost.

3. Prepare a fixed budget for manufacturing costs.

4. Develop a flexible budget for manufacturing costs.

Chapter

29

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Why do managers need information on the variability of costs?

QUESTION:

Understanding the variability of costs—how costs change as the volume of output changes—helps managers to control costs and make effective decisions.

ANSWER:

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Variable

Fixed

Semivariable

Classifications of Manufacturing Costs

Explain how fixed, variable, and semivariable costs change as the level of manufacturing activity changes

Objective 1

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Variable Costs

Variable costs vary in total in direct proportion to the changes in the level of activity.

Direct materials and direct labor are examples of variable costs.

Direct Materials

1 unit = $ 4

1,000 units = $ 4,000

5,000 units = $20,000

The total variable cost change, but the cost per unit does not change.

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Fixed Costs

Fixed costs do not change in total as the total level of activity changes.

Although fixed costs do not change in total as the level of activity changes, the cost per unit does change.

Factory Supervisory Salaries Units Produced Cost Per Unit

$8,000/month 2,000 $4.00

$8,000/month 2,500 $3.20

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Semivariable Costs

Semivariable costs vary with, but not in direct proportion to, the volume of activity.

Utilities are an example of a semivariable cost:

Fixed portion

Usage will vary in proportion to level of production.

Variable portion

Needed no matter how many units produced.

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Use the high-low point method to determine the fixed and variable components of a semivariable cost.

Objective 2

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Step 1. Determine the production and cost data for the months of highest and lowest production during the past year.

Step 2. Compute the difference in direct labor hours, and the difference in utilities costs, in the months of highest and lowest production.

Step 3. Compute the variable cost per direct labor hour.

Semivariable expense: utilities

Difference in utilities costs ÷ Difference in direct labor hours

Step 4. Compute the fixed cost for a month.

Total cost – (direct labor hours x cost per direct labor hour)

High-Low Point Method

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Step 1: Determine the production and cost data for the months of highest and lowest production during the past year.

High-Low Point Method

January 1,700 $1,900

June 3,200 3,400

Month Direct Labor Hours Utilities Cost

February 2,160 2,360March 2,580 2,780April 2,800 3,000May 2,950 3,050

July 2,200 2,400August 2,040 2,240September 2,120 2,320October 2,200 2,400November 2,060 2,260December 1,800 2,000

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High-Low Point Method

Step 2: Compute the difference in direct labor hours, and the difference in utilities costs, in the months of highest and lowest production.

January 1,700 1,900

June 3,200 $3,400

Month Direct Labor Hours Utilities Cost

1,500 $1,500

Step 1: Highest production: June 3,200 DL hours $3,400 Lowest production: January 1,700 DL hours 1,900

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High-Low Point Method

Step 3: Compute the variable cost per direct labor hour.

Difference in utilities costs ÷ Difference in DL hours

= $1,500 ÷ 1,500 DL hours = $1 per DL hour

Step 1: Highest production: June 3,200 DL hours $3,400 Lowest production: January 1,700 DL hours 1,900

Step 2: Difference: 1,500 DL hours $1,500

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High-Low Point Method

Step 4: Compute the fixed cost for a month.

June:

Total cost $3,400

Variable cost (3,200 DL hours x $1) 3,200

Fixed costs $ 200

Step 1: Highest production: June 3,200 DL hours $3,400 Lowest production: January 1,700 DL hours 1,900

Step 2: Difference: 1,500 DL hours $1,500 Step 3: Variable cost per DL hour:

= $1,500 ÷ 1,500 DL hours = $1 per DL hour

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Ohio Manufacturing Company Budget of Manufacturing Costs Month Ended January 29, 2010

Direct materials 25,000.00 Direct labor 15,000.00Manufacturing overhead Supervision and clerical wages 5,000.00 Other indirect labor (1,000 X $2) 2,000.00 Payroll taxes and fringe benefits [$500 + (1,000 X $2.50)] 3,000.00 Manufacturing supplies [$100 + (1,000 X $0.20)] 300.00 Depreciation 1,500.00 Repairs and maintenance [$400 + (1,000 X $0.50)] 900.00 Insurance and taxes 500.00 Total manufacturing overhead 13,200.00Total manufacturing cost 53,200.00

Fixed Budget of Manufacturing Costs

Shows one level of activity – 1,000 direct labor hours

Prepare a fixed budget for manufacturing costs

Objective 3

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Ohio Manufacturing CompanyBudget of Manufacturing Costs

Month of January 2010

(Over) Budget Actual Under

Direct materials 25,000 24,100 900 Direct labor 15,000 14,800 200Manufacturing overhead Supervision and clerical wages 5,000 4,900 100 Other indirect labor 2,000 2,150 (150) Payroll taxes and fringe benefits 3,000 2,270 730 Manufacturing supplies 300 290 (10) Depreciation 1,500 1,600 ( 100) Repairs and maintenance 900 550 350 Insurance and taxes 500 525 (25) Total manufacturing overhead 13,200 12,305 895Total manufacturing cost 53,200 51,205 1,995

Highlights differences between budgeted and actual amounts

Budget Performance Report

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Ohio Manufacturing Company Budget of Manufacturing Costs

Month of January 2010

Activity LevelNumber of direct labor hours 950 1,000 1,050Percent of expected activity 95 100 105

Variable Costs Other indirect labor 1,900 2,000 2,100 Payroll taxes and fringe benefits 2,375 2,500 2,520 Manufacturing supplies 190 200 210 Repairs and maintenance 475 500 525 Total variable costs 4,940 5,200 5,355

Fixed Costs Supervision and clerical wages 5,000 5,000 4,000 Payroll taxes and fringe benefits 500 500 400 Manufacturing supplies 100 100 100 Depreciation 1,500 1,500 2,500 Repairs and maintenance 400 400 500 Insurance and taxes 500 500 400 Total fixed costs 8,000 8,000 7,900Total manufacturing overhead 12,940 13,200 13,255

Flexible Budget of Manufacturing Costs

Develop a flexible budge for manufacturing costs

Objective 4

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Used when the level of activity fluctuates from month to month.

Shows fixed and variable costs separately.

Flexible Budget

The different levels of activity are called the relevant range of activity.

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Budget Performance Report

(80)2,0001,920Other indirect labor (960 x $2)

0 5,0005,000Supervision and clerical wages

(Over)Under

ActualBudget for 960 hours

Ohio Manufacturing CompanyManufacturing Overhead Budget Performance Report

Month Ended February 28, 2010

50 2,8502,900Payroll taxes and fringe benefits [$500 + (960 x $2.50)]

(33)325292Manufacturing supplies [$100 + (960 x $0.20)]

01,5001,500Depreciation

180700880Repairs and maintenance [$400 + (960 x $0.50)]

25375400Insurance and taxes

14212,75012,892 Total manufacturing overhead

Compares overhead expenses at an actual activity level of 960 hours

ControllingManufacturing

Costs: Standard Costs

ControllingManufacturing

Costs: Standard Costs

Section 2: Standard Costs

As a Control Tool

Chapter

29

Section Objectives5. Develop standard costs per unit of product.6. Compute the standard costs of products

manufactured during the period and determine cost variances between actual costs and standard costs.

7. Compute the amounts and analyze the nature of variances from standard for raw materials, labor, and manufacturing overhead.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Reflect what costs should be per unit under normal, efficient operating conditions.

Used to measure the effectiveness of operations.

Should be set at an achievable level.

Standard Costs

Develop standard costs per unit of product

Objective 5

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Raw Materials Standards

Direct Labor Standards

Manufacturing Overhead Standards

Developing Standard Costs

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Standard Quantity: Number of units of each type of raw material required to manufacture one unit of finished product.

Standard Cost: Cost of each unit of raw material required to make the product.

Raw Materials Standard

Raw Materials Standard = Standard Quantity x Standard Cost

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Standard Quantity: Number of hours of each type of labor needed to manufacture one unit of finished product.

Standard Cost: Cost of each type of labor used to make the product.

Direct Labor Standard

Direct Labor Standard = Standard Quantity x Standard Cost

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The standard overhead cost per unit of product is usually based on the overhead application rate used to assign overhead costs to products.

Overhead application rate can be based on: Direct labor cost, Direct labor hours, or Some other measure.

Standard Overhead Cost

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Compute the standard costs of products manufactured during the period and determine cost variances between actual costs and standard costs.

Objective 6

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Shows the per-unit standard costs for one product

Preparing a Standard Cost Card STANDARD COST CARD

Item: Toy Car—Product DC 24

Materials Base material: 1 pound @ $1.60/lb. $1.60 Finishing material: 3 ounces @ $0.05/ounce .15 Total Materials $1.75

Labor 1/10 hour @ $15/hour $1.50

Manufacturing Overhead 1/10 hour @ $10 per hour $1.00

Total Standard Cost per Unit $4.25

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Compute actual costs.

Compare actual costs to standard costs.

Analyze the cost variance.

Comparing Actual and Standard Costs

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Comparing Actual and Standard Costs

Manufacturing costs charged to job 6,411.70

Standard cost of 1,500 units: 1,500 units X $4.25 per unit $6,375.00Compute the variance:

Unfavorable Variance $ (36.70)

Job Order Cost Sheet:

Manufacturing costs: Materials: Base material: 1,475 pounds @ $1.62/lb. $2,389.50

Job X2–16Product: Toy Car—Product DC 24Number of units manufactured: 1,500

Total manufacturing costs $6,411.70

Finishing material: 4,600 ounces @ $.045/ounce 207.00 Total materials $2,596.50 Direct labor: 152 hours @ $15.10 per hour 2,295.20 Manufacturing overhead: 152 hours @ $10.00 per hour 1,520.00

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Compute the amounts and analyze the nature of variances from standard for raw materials, labor, and manufacturing overhead.

Objective 7

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Materials Variance

Labor Variance

Manufacturing Overhead Variance

Variances Between Standard and Actual Costs

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Materials VarianceMaterials Variance

Materials Quantity Variance: Results from a difference between the actual quantity of

materials consumed and the standard quantity allowed for the job.

Formula:

Materials Price Variance: Results from a difference between the actual cost and

the standard cost allowed. Formula:

(Actual Quantity – Standard Quantity) x Standard Cost

(Actual Cost – Standard Cost) x Actual Quantity

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QUESTION:

How is the materials quantity variance calculated?

Base Material

Actual quantity 1,475 pounds

Standard quantity(1,500 units x 1lb./unit) 1,500 pounds

(Actual Quantity – Standard Quantity) x Standard Cost

Base material under standard 25 pounds

Times standard price per pound $ 1.60

Favorable quantity variance $40.00

Determining Materials Quantity Variance

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QUESTION:

How is the materials price variance calculated?

Base Material

Actual priceper pound $ 1.62

Standard price per pound $ 1.60

(Actual Cost – Standard Cost) x Actual Quantity

Excess of actual over standard price $ 0.02

Times actual numberof pounds consumed 1,475

Unfavorable materials price variance $29.50

Determining Materials Price Variance

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Base Material

Quantity variance $ 40.00

Favorable or (Unfavorable)

Variance

Price variance (29.50) $10.50

Summary of Materials Variances

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Labor Variance

Labor Time Variance: Results from a difference between the actual hours

worked and the standard labor hours allowed for the job.

Formula:

Labor Rate Variance: Results from a difference between the actual labor

rate per hour and the standard labor rate per hour. Formula:

(Actual Hours – Standard Hours) x Standard Rate

(Actual Rate – Standard Rate) x Actual Hours

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Actual hours worked 152

Determining Labor Time Variance

Because more hours were worked than the number of hours allowed by the standard, the variance is unfavorable.

Standard hours allowed(1,500 units x 1/10 hour per unit) 150Excess of standard over actual hours 2Times standard rate per hour $ 15.00Unfavorable labor time variance $ 30.00

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Actual rate per hour $ 15.10

Determining Labor Rate Variance

Human resources is responsible for labor rate variance, though labor market conditions and operating decisions may also affect the rate at which employees can be hired.

Standard rate per hour 15.00Excess of actual over standard rate $ 0.10Times actual number of hours worked 152Unfavorable labor rate variance $(15.20)

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Applied overhead and standard overhead are analyzed to determine the variance.

Because it is difficult to determine actual overhead for individual jobs, the overhead variance analysis is usually based on the total actual overhead and total standard overhead for the products manufactured.

Manufacturing Overhead Variances

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College Accounting, 12th Edition

Price • Haddock • Farina