Accounting Principles, 7th Edition Weygandt • Kieso • Kimmel Chapter 26 Performance Evaluation Through Standard Costs Prepared by Naomi Karolinski Monroe Community College and Marianne Bradford Bryant College CHAPTER 26 Performance Evaluation Through Standard Costs After studying this chapter, you should be able to: Distinguish between a standard and a budget Identify the advantages of standard costs Describe how standards are set State the formulas for determining direct materials and direct labor variances State the formulas for determining manufacturing overhead variances Discuss the reporting of variances Enumerate the features of a standard cost accounting system The Need for Standards • Standards – common in business – those imposed by government agencies are often called regulations (such as Fair Labor Standards Act) • Standard costs – predetermined unit costs used as measures of performance Standards and Budgets STUDY OBJECTIVE • Both are pre-determined costs and both contribute to management planning and control • Standard – unit amount • Budget – total amount • Standard costs may be incorporated into a cost accounting system Why Standard Costs? STUDY OBJECTIVE The advantages of standard costs include all of the following except: a management by exception may be used b management planning is facilitated c they may simplify the costing of inventories d management must use a static budget The advantages of standard costs include all of the following except: a management by exception may be used b management planning is facilitated c they may simplify the costing of inventories d management must use a static budget Setting Standard Costs STUDY OBJECTIVE • Input from all persons who have responsibility for costs and quantities • Two levels – Ideal standards • optimum levels of performance under perfect operating conditions – Normal standards • efficient levels of performance attainable under expected operating conditions A Case Study • To establish the standard cost of producing a product, it is necessary to establish standards for each manufacturing cost element - direct materials, direct labor, and manufacturing overhead • The standard for each element is derived from the standard price to be paid and the standard quantity to be used • To illustrate, assume that Xonic, Inc., wishes to use standard costs to measure performance in filling an order for 1,000 gallons of Weed-O, a liquid weed killer WEED-O Direct Materials Standard • Cost per unit which should be incurred – purchasing department’s best estimate of the cost of raw materials – include amount for related costs • receiving, storing, and handling Standard Cost Accounting System STUDY OBJECTIVE • Double-entry system of accounting – – • standard costs in making entries and variances recognized in the accounts A standard cost, job order cost accounting system includes two important assumptions: 1) Variances from standards are recognized at the earliest opportunity 2) Work in Process account is maintained exclusively on the basis of standard costs Standard Cost System Jour n al Entr y #1 Purchased raw materials on account for $13,020 when the standard cost is $12,600 12,600 420 13,020 The inventory account is debited for actual quantities at standard cost This enables the perpetual materials records to show actual quantities The price variance, which is unfavorable, is debited to Materials Price Variance Standard Cost System Jour n al Entr y #2 Incur direct labor costs of $20,580 when the standard labor cost is $21,000 21,000 420 20,580 Like the raw materials inventory account, Factory Labor is debited for the actual hours worked at the standard hourly rate of pay In this case, the labor variance is favorable Thus, Labor Price Variance is credited Standard Cost System Jour n al Entr y #3 Incur actual manufacturing overhead costs of $10,900 10,900 10,900 The controllable overhead variance is not recorded at this time It depends on standard hours applied to work in process.This amount is not known at the time overhead is incurred Standard Cost System Jour n al Entr y #4 Issue raw materials for production at a cost of $12,600 when the standard cost is $12,000 12,000 600 12,600 Work in Process Inventory is debited for standard materials quantities used at standard prices The variance account is debited because the variance is unfavorable Raw Materials Inventory is credited for actual quantities at standard prices Standard Cost System Jour n al Entr y #5 Assign factory labor to production at a cost of $21,000 when standard cost is $20,000 20,000 1,000 21,000 Work in Process Inventory is debited for standard hours at standard rates,and the unfavorable variance is debited to Labor Quantity Variance The credit to Factory Labor produces a zero balance in this account Standard Cost System Jour n al Entr y #6 Applying manufacturing overhead to production, $10,000 10,000 10,000 Work in Process Inventory is debited for standard hours allowed multiplied by the standard overhead rate Standard Cost System Jour n al Entr y #7 Transfer completed work to finished goods, $42,000 42,000 42,000 Both inventory accounts are at standard cost Standard Cost System Jour n al Entr y #8 The 1,000 gallons of Weed-O are sold for $60,000 60,000 42,000 60,000 42,000 Cost of Goods Sold is debited at standard cost Gross profit, in turn, is the difference between sales and the standard cost of goods sold Standard Cost System Jour n al Entr y #9 Recognize unfavorable overhead variances: controllable, $500; volume, $400 500 400 900 Prior to this entry, a debit balance of $900 existed in Manufacturing Overhead This entry therefore produces a zero balance in the Manufacturing Overhead account Statement Presentation of Variances • Income statements prepared for management – cost of goods sold is stated at standard cost and the variances are separately disclosed • Financial statements prepared for stockholders and other external users – standard costs may be used when there are no significant differences between actual costs and standard costs Variances in Income Statement for Management Variances Materials price quantity Notice that variances from standard costs in this $ 420 Materials example 600 Labor Price reduced net (420) Labor quantity income by Overhead controllable $2,500 1,000 500 Overhead volume Total variance unfavorable 400 2,500 The setting of standards is: a a managerial accounting decision b a management decision c a worker decision d preferably set at the ideal level of performance The setting of standards is: a a managerial accounting decision b a management decision c a worker decision d preferably set at the ideal level of performance COPYRIGHT Copyright © 2005 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein .. .CHAPTER 26 Performance Evaluation Through Standard Costs After studying this chapter, you should be able to: Distinguish between a standard... overhead variances Discuss the reporting of variances Enumerate the features of a standard cost accounting system The Need for Standards • Standards – common in business – those imposed by government... Standard – unit amount • Budget – total amount • Standard costs may be incorporated into a cost accounting system Why Standard Costs? STUDY OBJECTIVE The advantages of standard costs include