11-1

11
Control and
Evaluation of
Cost Centers
Prepared by
Douglas Cloud
Pepperdine University
 11-2

Objectives
 Develop standard variable costs for a product.
After
 Calculate direct reading this
labor, variable overhead, and
chapter, you should
materials variances.
be ableand
 Discuss the advantages to: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.
 11-3

Cost control is important

for companies following a
cost leadership strategy
where total demand for the
product is not growing.
 11-4

A standard cost is the

per-unit cost a company
should incur to make a
unit of product.
 11-5

A standard cost has two

components: a standard
price, or rate, and a
standard quantity.
 11-6

Standard Variable Costs

Cost Factor Std. Quantity Std. PriceStd. Cost
Materials 10.00$0.80 $8.00
Direct labor 0.5016.00 8.00
Variable overhead 0.506.00 3.00
Total standard variable cost $19.00
Actual results:
Production 1,000 units
Materials purchased, 11,000 at $0.78. $8,580
Materials used 10,200
gallons
Direct labor, 480 hours at $16.20 $7,776
Variable overhead incurred $3,100
 11-7

Labor Variances
Total
Actual Standard standard
production x direct labor = direct labor
(units) cost per unit cost
1,000 x $8.00 = $8,000
 11-8

Labor Variances

Actual
Actual Actual rate
cost of
input x for input =
input
quantity factor
factor

480 hours x $16.20 = $7,776

 11-9

Labor Variances
Budget
Actual Standard rate allowance for
input x for input = actual
quantity factor quantity of
input factor
480 hours x $16 = $7,680
 11-10

Labor Variances
Budget
Standar Standard rate allowance for
d input x for input = actual
quantity factor quantity of
output
1,000 units x
½ hour per
unit = 500
x $16 = $8,000
hours
 11-11

Labor Variances

Labor rate variance $ 96 unfavorable

Labor efficiency variance 320 favorable
Total labor variance $224 favorable
 11-12

Labor Variances
Flexible Budget for
Actual Quantity Flexible Budget Standard Quantity
at Actual Rates For Actual at Standard Rate
(Total Actual Quantity at (Total Standard
Costs) Standard Rate Cost)

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

480 x $16.20 480 x $16.00 1,000 x 1/2 x $16.00
$96 U $320 F
Rate variance Efficiency variance

$224 F
Total Variance
 11-13

Variable Overhead Variances

Actual Quantity Flexible Budget Flexible Budget for
at Actual Rate for Actual Standard Quantity at
(Total Actual Quantity at Standard Rate (Total
Cost) Standard Rate Standard Cost)

480 x $6 1,000 x 0.50 x $6

$3,100 $2,880 $3,000
$220 U $120 F
Budget variance Efficiency variance

$100 U

Total Variance
 11-14

Variable Overhead Variances

The variable overhead
efficiency variance
reflects the efficient or
inefficient use of the item
used as the cost driver.
 11-15

Materials Variances

Actual
Quantity Actual Quantity
Purchased at Purchased at
Standard Price
Actual Price
11,000 x $0.78 11,000 x $0.80
$8,580 $8,800

$220 F
Material Price Variance
 11-16

Materials Variances

Material Actual
price = quantity x Standard – Actual
variance purchased price price

$220 F = 11,000 x ($0.80 – $0.78)

 11-17

Materials Variances

Flexible Budget Flexible Budget for

for Actual Standard Quantity at
Quantity Used at Standard Price (Total
Standard Price Standard Cost)
10,200 x $0.80 1,000 x 10 x $0.80
$8,160 $8,000

$160 U
Material Use Variance
 11-18

Materials Variances

Material Standard
Standard
use = price x quantity for – Actual
variance actual quantity
output
$160 U = $0.80 x (10,000 – 10,200)
 11-19

Materials Variances
Material use variance Material price variance—differs
—is calculated the same from its counterparts in labor and
as the labor and overhead variable overhead because
efficiency variances 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.
 11-20

Standard Costs and Activity-

Based Costing Example
• 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.
Continued
 11-21

Standard Costs and Activity-

Based Costing Example
• 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.
 11-22

Standard Costs and Activity-

Based Costing Example
Actual Budget for Standard
Cost Actual Cost
Use
14,000 x $6.00 10 x 1,500 x $6.00
$85,000 $84,000 $90,000
$1,000 U $6,000 F
Budget variance Efficiency variance

$5,000 F Machine-driven
variable
Total Variance
overhead
 11-23

Standard Costs and Activity-

Based Costing Example
Actual Budget for Standard
Cost Actual Cost
Use
210 x $140 10 x 20 x $140
$27,500 $29,400 $28,000
$1,900 F $1,400 U
Budget variance Efficiency variance

$500 F Setup-driven
variable
Total Variance
overhead
 11-24

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.
 11-25

Setting Standards—Behavioral
Problems

Engineering methods
Managerial estimates
Benchmarking and best
practices
 11-26

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.
 11-27

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.
 11-28

Setting Standards—Behavioral
Problems

Benchmarking

Benchmarking is a relatively recent

development that companies use to determine
whether their operations and costs compare
favorably to those of world-class companies.
 11-29

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.
 11-30

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.
 11-31

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.
 11-32

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.
 11-33

Chapter 11

The End
11-34