CHAPTER 18
DISCUSSION QUESTIONS
Q18-1. Standard costs are the predetermined costs (c) The elements of cost, such as direct
of manufacturing products during a specific materials, direct labor, and factory over-
period under current or anticipated operating head, must be defined clearly at the unit
conditions. Standards aid in planning and level of activity.
controlling operations. Q18-6. Normal or currently attainable standards are
Q18-2. A few uses of standard costs are: preferable to theoretical or ideal standards
(a) establishing budgets for (a) performance evaluation and/or
(b) controlling costs by motivating employees employee motivation, and (b) budgeting and
and measuring efficiencies planning. Theoretical or ideal standards are
(c) simplifying costing procedures and expe- not realistically attainable. As a conse-
diting cost reports quence of using such standards, employees
(d) assigning costs to materials, work in may become discouraged rather than moti-
process, and finished goods inventories vated, and budgets or plans are likely to be
(e) forming the basis for establishing contract distorted and unreliable.
bids and for setting sales prices Q18-7. Behavioral issues that need to be considered
Q18-3. To set sales prices, executives need cost when selecting the level of performance to be
information furnished by the accounting incorporated into standards include the fol-
department. Since standard costs represent lowing:
the cost that should be attained in a well- (a) The standards must be legitimate. The
managed plant operated at normal capacity, standards need not reflect the actual cost
they are ideally suited for furnishing informa- of a single item or cycle. However, they
tion that will enable the sales department to ideally will represent the cost that should
price products. be incurred in the production of a given
Budgets are used for planning and coordi- product or the performance of a given
nating future activities and for controlling cur- operation.
rent activities. When budget figures are based (b) The standards must be attainable. When
on standard costs, the accuracy of the result- the standards are set too high, the
ing budget is strongly influenced by the relia- repeated failure to achieve them will tend
bility of the standard costs. With standards to reduce the motivation for attainment.
available, production figures can be translated The converse is also true. Standards that
into the manufacturing costs. are too loose represent an invitation to
Q18-4. Standards are an integral part of job order relax.
and process cost accumulation, but do not (c) The participant should have a voice or
comprise a system that could be utilized in influence in the establishment of stan-
lieu of one of the accumulation methods. dards and resulting performance meas-
Costs may be accumulated with or without the ures. Involvement in the formulation of
use of standards. standards gives the participant a greater
Q18-5. Criteria to be used when selecting the opera- sense of understanding and commitment.
tional activities for which standards are to be Q18-8. (a) The role of the accounting department in
set include the following: the establishment of standards is to
(a) The activity should be repetitive in nature, determine their ability to be quantified
with the repetition occurring in relatively and to provide dollar values for specific
short cycles. unit standards.
(b) The input and output (product or service) (b) In the establishment of standards, the
of the activity should be measurable and role of the department in which the per-
uniform. formance is being measured is to provide
18-1
,18-2 Chapter 18
information for realistic standards, and to (c) take corrective action and recognize and
allow for subsequent performance evalu- reward desirable performance, where
ation for the purpose of detecting prob- appropriate
lems and improving performance. (d) revise standards if needed
(c) The role of the industrial engineering Q18-13. (a) Features of tolerance limits include:
department in the establishment of stan- (1) A standard cost control system is
dards is to provide reliable measures of established, specifying expected perform-
physical activities related to the standards ance levels.
of performance, and to verify the consis- (2) An information system is designed to
tency of the performance between highlight the areas most in need of inves-
departments. tigation and possible corrective action.
Q18-9. The factory overhead variable efficiency vari- (3) Variance ranges for areas and items
ance is a measure of the efficient or inefficient are computed. Management does not
use of the “base” that was used in allocating spend time on parts of the operations that
factory overhead to production. To the extent produce satisfactory performance levels
that the activity used as an allocation base within these ranges.
drives variable factory overhead, the variable (4) Management’s attention and efforts
efficiency variance is a measure of the cost are concentrated on significant variances
savings or cost incurrence that is attributable from expected results, which signal the
to the efficient or inefficient use of that activity. presence of unplanned conditions need-
Q18-10. The factory overhead spending variance is a ing investigation.
measure of the efficient or inefficient use of (b) Tolerance limits have potential benefits
the various items of factory overhead. It is because they may result in more effective
caused by differences in the prices paid for use of management time. The manager’s
the items of overhead actually used (i.e., the time is not wasted on the process of iden-
differences between the actual quantity at the tifying important problems or in working
actual price and the actual quantity at the on unimportant ones. The manager
standard price for all items of factory over- should be able to concentrate efforts on
head) and the differences in the quantities of important problems, because the tech-
the various items of factory overhead actually nique highlights them.
used (i.e., the differences between the stan- (c) It may be difficult to determine which vari-
dard quantity allowed for the actual level of ances are significant. Also, by focusing on
the activity base at the standard price and the variances above a certain level, other
actual quantity used at the standard price for useful information, such as trends, may
all items of factory overhead). not be noticed at an early stage.
Q18-11. The factory overhead volume variance is a If the evaluation system is in any way
measure of the under- or over-utilization of directly tied to the variances, subordinates
plant facilities. It is the difference between the may be tempted to cover up negative
total budgeted fixed factory overhead and the exceptions or not report them at all. In
amount charged to (or chargeable to) actual addition, subordinates may not receive
production based on the standard quantity reinforcement for the reduction and main-
allowed for the activity base used to allocate tenance of cost levels, but only reprimands
overhead. The volume variance may be thought for those items which exceed the range.
of as the amount of under- or overapplied bud- Subordinate morale may suffer because of
geted fixed factory overhead. the lack of positive reinforcement for work
Q18-12. After variances have been determined, man- well done. Using tolerance limits may also
agement should: affect supervisory employees in an unsat-
(a) decide whether each variance is suffi- isfactory manner. Supervisors may feel
ciently significant to require investigation that they are not getting a complete
and explanation review of operations because they are
(b) investigate and obtain, from the responsi- always keying on problems. In addition,
ble department head, explanations of sig- supervisors may think that they are
nificant variances excessively critical of their subordinates.
,Chapter 18 18-3
A negative impact on supervisory morale and reduce the amount of inefficiency result-
may result. ing from the learning required to change pro-
Q18-14. Overemphasis on price variances can result duction from one product to another. Large
in a large number of low cost vendors, high work in process inventories result from long
levels of inventory, and poor quality materials production runs, and large inventories are
and parts. Since the emphasis is on price likely to be viewed by department managers
rather than quality or reliability, purchasing will as buffers that can be used to absorb
likely have a large number of low cost vendors machine breakdowns, employee absen-
available, who can be played one against the teeism, and slack demand for the product.
other to get the lowest possible prices. In Although carrying large inventories is costly,
addition, purchasing will likely purchase the carrying costs do not affect the efficiency
inventory in large quantities to take advantage variance, which in turn encourages depart-
of purchase discounts and to reduce the need mental managers to overproduce. Since effi-
to place rush orders that result in premium ciency variances measure the use of inputs in
prices. Inventory tends to become unneces- relation to output volume, efforts to control
sarily large, resulting in excessive carrying quality tend to be oriented to inspection
costs, and material quality tends to decline, alone. Stopping the process to experiment
resulting in poor product quality and/or exces- with alternative production methods to perma-
sive spoilage, scrap, and rework. nently correct a problem or improve quality
Overemphasis on efficiency variances can can result in an unfavorable labor efficiency
result in long production runs, large work in variance. In contrast, increasing the volume of
process inventories, and attempts to control production and reworking or discarding
quality through inspection alone. Long pro- defects has a smaller impact on the efficiency
duction runs require fewer machine set ups variance.
, 18-4 Chapter 18
EXERCISES
E18-1
Quantity × Unit Cost = Amount
Actual materials purchased
at actual cost ......................... 4,500 lbs. $13.40 actual $ 60,300
Actual materials purchased
at standard cost .................... 4,500 13.50 standard 60,750
Materials purchase price
variance.................................. 4,500 $ (.10) $ (450) fav.
Quantity × Unit Cost = Amount
Actual materials used at
actual cost ............................. 4,000 lbs. $13.41 actual $ 53,640
Actual materials used at
standard cost ........................ 4,000 13.50 standard 54,000
Materials price usage
variance.................................. 4,000 $ (.09) $ (360) fav.
Quantity × Unit Cost = Amount
Actual materials used at
standard cost ........................ 4,000 lbs. $13.50 standard $ 54,000
Standard quantity allowed
at standard cost .................... 3,800 13.50 standard 51,300
Materials quantity variance ....... 200 lbs. 13.50 standard $ 2,700 unfav.
E18-2
Quantity × Unit Cost = Amount
Actual materials purchased
at actual cost ......................... 5,000 $22.00 actual $110,000
Actual materials purchased
at standard cost .................... 5,000 22.50 standard 112,500
Materials purchase price
variance.................................. 5,000 $ (.50) $ (2,500) fav.
Quantity × Unit Cost = Amount
Actual materials purchased
at standard cost .................... 5,000 $22.50 standard $112,500
Actual materials issued at
standard cost ........................ 4,400 22.50 standard 99,000
Materials inventory variance ..... 600 22.50 standard $ 13,500 unfav.
DISCUSSION QUESTIONS
Q18-1. Standard costs are the predetermined costs (c) The elements of cost, such as direct
of manufacturing products during a specific materials, direct labor, and factory over-
period under current or anticipated operating head, must be defined clearly at the unit
conditions. Standards aid in planning and level of activity.
controlling operations. Q18-6. Normal or currently attainable standards are
Q18-2. A few uses of standard costs are: preferable to theoretical or ideal standards
(a) establishing budgets for (a) performance evaluation and/or
(b) controlling costs by motivating employees employee motivation, and (b) budgeting and
and measuring efficiencies planning. Theoretical or ideal standards are
(c) simplifying costing procedures and expe- not realistically attainable. As a conse-
diting cost reports quence of using such standards, employees
(d) assigning costs to materials, work in may become discouraged rather than moti-
process, and finished goods inventories vated, and budgets or plans are likely to be
(e) forming the basis for establishing contract distorted and unreliable.
bids and for setting sales prices Q18-7. Behavioral issues that need to be considered
Q18-3. To set sales prices, executives need cost when selecting the level of performance to be
information furnished by the accounting incorporated into standards include the fol-
department. Since standard costs represent lowing:
the cost that should be attained in a well- (a) The standards must be legitimate. The
managed plant operated at normal capacity, standards need not reflect the actual cost
they are ideally suited for furnishing informa- of a single item or cycle. However, they
tion that will enable the sales department to ideally will represent the cost that should
price products. be incurred in the production of a given
Budgets are used for planning and coordi- product or the performance of a given
nating future activities and for controlling cur- operation.
rent activities. When budget figures are based (b) The standards must be attainable. When
on standard costs, the accuracy of the result- the standards are set too high, the
ing budget is strongly influenced by the relia- repeated failure to achieve them will tend
bility of the standard costs. With standards to reduce the motivation for attainment.
available, production figures can be translated The converse is also true. Standards that
into the manufacturing costs. are too loose represent an invitation to
Q18-4. Standards are an integral part of job order relax.
and process cost accumulation, but do not (c) The participant should have a voice or
comprise a system that could be utilized in influence in the establishment of stan-
lieu of one of the accumulation methods. dards and resulting performance meas-
Costs may be accumulated with or without the ures. Involvement in the formulation of
use of standards. standards gives the participant a greater
Q18-5. Criteria to be used when selecting the opera- sense of understanding and commitment.
tional activities for which standards are to be Q18-8. (a) The role of the accounting department in
set include the following: the establishment of standards is to
(a) The activity should be repetitive in nature, determine their ability to be quantified
with the repetition occurring in relatively and to provide dollar values for specific
short cycles. unit standards.
(b) The input and output (product or service) (b) In the establishment of standards, the
of the activity should be measurable and role of the department in which the per-
uniform. formance is being measured is to provide
18-1
,18-2 Chapter 18
information for realistic standards, and to (c) take corrective action and recognize and
allow for subsequent performance evalu- reward desirable performance, where
ation for the purpose of detecting prob- appropriate
lems and improving performance. (d) revise standards if needed
(c) The role of the industrial engineering Q18-13. (a) Features of tolerance limits include:
department in the establishment of stan- (1) A standard cost control system is
dards is to provide reliable measures of established, specifying expected perform-
physical activities related to the standards ance levels.
of performance, and to verify the consis- (2) An information system is designed to
tency of the performance between highlight the areas most in need of inves-
departments. tigation and possible corrective action.
Q18-9. The factory overhead variable efficiency vari- (3) Variance ranges for areas and items
ance is a measure of the efficient or inefficient are computed. Management does not
use of the “base” that was used in allocating spend time on parts of the operations that
factory overhead to production. To the extent produce satisfactory performance levels
that the activity used as an allocation base within these ranges.
drives variable factory overhead, the variable (4) Management’s attention and efforts
efficiency variance is a measure of the cost are concentrated on significant variances
savings or cost incurrence that is attributable from expected results, which signal the
to the efficient or inefficient use of that activity. presence of unplanned conditions need-
Q18-10. The factory overhead spending variance is a ing investigation.
measure of the efficient or inefficient use of (b) Tolerance limits have potential benefits
the various items of factory overhead. It is because they may result in more effective
caused by differences in the prices paid for use of management time. The manager’s
the items of overhead actually used (i.e., the time is not wasted on the process of iden-
differences between the actual quantity at the tifying important problems or in working
actual price and the actual quantity at the on unimportant ones. The manager
standard price for all items of factory over- should be able to concentrate efforts on
head) and the differences in the quantities of important problems, because the tech-
the various items of factory overhead actually nique highlights them.
used (i.e., the differences between the stan- (c) It may be difficult to determine which vari-
dard quantity allowed for the actual level of ances are significant. Also, by focusing on
the activity base at the standard price and the variances above a certain level, other
actual quantity used at the standard price for useful information, such as trends, may
all items of factory overhead). not be noticed at an early stage.
Q18-11. The factory overhead volume variance is a If the evaluation system is in any way
measure of the under- or over-utilization of directly tied to the variances, subordinates
plant facilities. It is the difference between the may be tempted to cover up negative
total budgeted fixed factory overhead and the exceptions or not report them at all. In
amount charged to (or chargeable to) actual addition, subordinates may not receive
production based on the standard quantity reinforcement for the reduction and main-
allowed for the activity base used to allocate tenance of cost levels, but only reprimands
overhead. The volume variance may be thought for those items which exceed the range.
of as the amount of under- or overapplied bud- Subordinate morale may suffer because of
geted fixed factory overhead. the lack of positive reinforcement for work
Q18-12. After variances have been determined, man- well done. Using tolerance limits may also
agement should: affect supervisory employees in an unsat-
(a) decide whether each variance is suffi- isfactory manner. Supervisors may feel
ciently significant to require investigation that they are not getting a complete
and explanation review of operations because they are
(b) investigate and obtain, from the responsi- always keying on problems. In addition,
ble department head, explanations of sig- supervisors may think that they are
nificant variances excessively critical of their subordinates.
,Chapter 18 18-3
A negative impact on supervisory morale and reduce the amount of inefficiency result-
may result. ing from the learning required to change pro-
Q18-14. Overemphasis on price variances can result duction from one product to another. Large
in a large number of low cost vendors, high work in process inventories result from long
levels of inventory, and poor quality materials production runs, and large inventories are
and parts. Since the emphasis is on price likely to be viewed by department managers
rather than quality or reliability, purchasing will as buffers that can be used to absorb
likely have a large number of low cost vendors machine breakdowns, employee absen-
available, who can be played one against the teeism, and slack demand for the product.
other to get the lowest possible prices. In Although carrying large inventories is costly,
addition, purchasing will likely purchase the carrying costs do not affect the efficiency
inventory in large quantities to take advantage variance, which in turn encourages depart-
of purchase discounts and to reduce the need mental managers to overproduce. Since effi-
to place rush orders that result in premium ciency variances measure the use of inputs in
prices. Inventory tends to become unneces- relation to output volume, efforts to control
sarily large, resulting in excessive carrying quality tend to be oriented to inspection
costs, and material quality tends to decline, alone. Stopping the process to experiment
resulting in poor product quality and/or exces- with alternative production methods to perma-
sive spoilage, scrap, and rework. nently correct a problem or improve quality
Overemphasis on efficiency variances can can result in an unfavorable labor efficiency
result in long production runs, large work in variance. In contrast, increasing the volume of
process inventories, and attempts to control production and reworking or discarding
quality through inspection alone. Long pro- defects has a smaller impact on the efficiency
duction runs require fewer machine set ups variance.
, 18-4 Chapter 18
EXERCISES
E18-1
Quantity × Unit Cost = Amount
Actual materials purchased
at actual cost ......................... 4,500 lbs. $13.40 actual $ 60,300
Actual materials purchased
at standard cost .................... 4,500 13.50 standard 60,750
Materials purchase price
variance.................................. 4,500 $ (.10) $ (450) fav.
Quantity × Unit Cost = Amount
Actual materials used at
actual cost ............................. 4,000 lbs. $13.41 actual $ 53,640
Actual materials used at
standard cost ........................ 4,000 13.50 standard 54,000
Materials price usage
variance.................................. 4,000 $ (.09) $ (360) fav.
Quantity × Unit Cost = Amount
Actual materials used at
standard cost ........................ 4,000 lbs. $13.50 standard $ 54,000
Standard quantity allowed
at standard cost .................... 3,800 13.50 standard 51,300
Materials quantity variance ....... 200 lbs. 13.50 standard $ 2,700 unfav.
E18-2
Quantity × Unit Cost = Amount
Actual materials purchased
at actual cost ......................... 5,000 $22.00 actual $110,000
Actual materials purchased
at standard cost .................... 5,000 22.50 standard 112,500
Materials purchase price
variance.................................. 5,000 $ (.50) $ (2,500) fav.
Quantity × Unit Cost = Amount
Actual materials purchased
at standard cost .................... 5,000 $22.50 standard $112,500
Actual materials issued at
standard cost ........................ 4,400 22.50 standard 99,000
Materials inventory variance ..... 600 22.50 standard $ 13,500 unfav.
