Chapter 17

Process costing

Cost per unit

The total cost is deducted by normal loss scrap value and then it is
divided by the input units minus the normal loss units.

Treatment in accounts
Normal loss : The cost of normal loss is absorbed by units
produced.
When normal loss has a scrap value, the same is credited in
the process account.
Abnormal gain

Abnormal gain does not affect cost of normal production.

The process account is debited with full cost of abnormal gain.
The abnormal gain account is debited and normal process loss
account is credited.
The balance is transferred to costing Profit and Loss account as
abnormal gain.

From the following particulars of two processes Process X and Process Y prepare
process accounts of X and Y
Process X
Process Y
Input (units)
5000
4600
Normal Loss
10%
?
Cost incurred (Rs.)
Materials
8000
1500
Direct Labours
3000
4000
Overheads
2750
3010
Scrap value
0.50
2
Output of Process Y was 4300 units and cost is Rs.5 and there is no WIP, closing or
opening stocks.

Dr
-------------------------------------------------Units Cost/unit
Amount
To Mat 5000
8000
To Lab
3000
To OH
2750
-----------------------5000
13750
To
Abnormal
Gain
100
3.00
300
--------------------5100
14050

Process X Account

Cost per unit = (Total process cost scrap value of normal

loss)/ (Inputs normal loss)
= 13750 250 / 5000 500
= 3.00

Cr.
-------------------------------------------------------Units Cost/unit Amount
By Normal loss 500 0.50
250
(scrap value)
By process
Y A/c
4600 3.00 13800
-----------------------5100
14050

 Abnormal loss

Abnormal loss is charged to the respective cost of production.

The process account is credited by abnormal loss account with cost of
materials, labours and overheads equivalent to good units.
Abnormal loss units rank equal with normal units.
Abnormal loss account is credited by realizable scrap value and the
balance is written off to costing Profit and Loss Account as abnormal
loss.
Dr
-------------------------------------------------Units Cost/unit Amount
To Process X
A/c.
4600 3.00
13800
To Mat
1500
To Lab
4000
To OH
3010
-----------------------4600
22310

Process Y Account

Cost per unit = (Total process cost scrap value

of normal loss)/ (Inputs normal loss)
5 = 22310 2x / 4600 x
x = 230 units

Cr.
-------------------------------------------------------Units Cost/unit Amount
By Normal loss 230 2.00
460
(scrap value)
By Abnormal
Loss
70
5.00
350
By Finished
goods A/c
4300 5.00 21500
-----------------------4600
22310

Inter process profit Example

Following details are available for two processes X and Y
in Rupees
Process X
Process Y
Materials
15000
-Labour
10000
15000
Overheads
10000
15000
Closing stock (at cost)
5000
7500
The output from process X is transferred to process Y at cost plus 25% mark-up
basis and also the output from Y is also charged at 25% mark-up basis. Finished
stock sold at Rs.90000 and stocks worth of Rs.15000 remained unsold. No
opening, closing work-in-progress.
Show process Accounts and profits.

Chapter 7 & 8
Standard costing

Managing Costs

Standard
cost

A managerial accountants
budgetary-control system has three
parts.
First, a predetermined or standard cost is
set. In essence, a standard cost is a
budget for the production of one unit of
product or service. It serves as the
benchmark in the budgetary-control
system. When the firm produces more
than one unit, the managerial accountant
uses the standard unit cost to determine
the budgeted cost of production or the
total standard cost.

Actual
cost

Comparison between
standard and actual
performance
level

Cost
variance

Second, the managerial accountant measures the actual cost incurred in the
production process.
Third, the managerial accountant compares the actual cost with the budgeted or
standard cost.
Any difference between the two is called a cost variance. Cost variances then are used
in controlling costs
10-7

Management by Exception
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.

Amount

Standard

Direct
Labor

Direct
Material

Type of Product Cost

10-8

 Managers do not have time to investigate every

variance between actual and standard costs.
They focus their attention on the causes of significant
cost variances.
This is called management by exception.
When operations are going along as planned, actual
costs and profit will typically be close to the budgeted
amounts.
However, if there are significant departures from
planned operations, such effects will show up as
significant cost variances.
Managers investigate these variances to determine
their causes, if possible, and take corrective action
when indicated.

 Management by Exception (MBE) is a practice where only

significant deviations from a budget or plan are brought to the
attention of management.
The idea behind it is that management's attention will be focused
only on those areas in need of action.

When they are notified of a variance, they can hone in on that

specific issue and let staff handle everything else.
If nothing is brought up, then management can assume everything
is going according to plan.
This model is similar to the vital signs monitoring systems in
hospital critical care units.
When one of the patient's vital signs goes outside the range
programmed into the machine, an alarm sounds and staff runs to the
rescue.
If the machine is quiet, it's assumed that the patient is stable, and
they will receive only regular staff attention.

 MBE can bring forward business errors and oversights,

ineffective strategies that need to be improved, changes in
competition and business opportunities.
MBE is intended to reduce the managerial load and enable
managers to spend their time more effectively in areas where
it will have the most impact.

Setting Standards
Cost
Standards

Analysis of
Historical Data

Task
Analysis
10-12

 Two methods are typically used for setting cost

standards: analysis of historical data and task analysis.
One indicator of future costs is historical cost data. In a
mature production process, where the firm has a lot of
production experience, historical costs can provide a
good basis for predicting future costs.
In using task analysis, the emphasis shifts from what
the product did cost in the past to what it should cost
in the future.
The managerial accountant typically works with
engineers to conduct studies in an effort to determine
exactly how much direct material should be required,
how machinery should be used in the production
process, and many direct labor hours are required.

Participation in Setting Standards

Accountants, engineers, personnel administrators,
and production managers combine efforts to set
standards based on experience and expectations.

Standards should not be determined by the managerial accountant alone. People generally
will be more committed to meeting standards if they are allowed to participate in setting
them.
For example, production supervisors should have a role in setting production cost
standards, and sales managers should be involved in setting targets for sales prices and
volume.
In addition, knowledgeable staff personnel should participate in the standard-setting
process.
10-14

Perfection versus Practical Standards: A

Behavioral Issue

Should we use
practical standards
or perfection
standards?

Practical standards
should be set at levels
that are currently
attainable with
reasonable and
efficient effort.

10-15

 Standards that are as tight as practical, but

still are expected to be attained, are called
practical (or attainable) standards.
Such standards assume a production process
that is as efficient as practical under normal
operating conditions.
Practical standards allow for such occurrences
as occasional machine breakdowns and
normal amounts of raw-material waste.

Perfection versus Practical Standards: A

Behavioral Issue
Some managers believe that perfection
standards motivate employees to achieve
the lowest cost possible.
They claim that since the standard is
theoretically attainable, employees will
have an incentive to come as close as
possible to achieving it.
Other managers and many behavioral
scientists disagree.
They feel that perfection standards
discourage employees, since they are so
unlikely to be attained.
Moreover, setting unrealistically difficult
standards may encourage employees to
sacrifice product quality to achieve lower
costs.

I agree. Perfection
standards are
unattainable and therefore
discouraging to most
employees.

10-17

Use of Standards by Service Organizations

Many service industry firms, nonprofit
organizations, and governmental units
make use of standards.
Fast food restaurants set a standard for the
amount of ingredients in a menu item.
Airlines set standards for fuel and
maintenance costs.
Insurance companies set standards for the
amount of time to process an insurance
application.
Even a district motor vehicle office may
have a standard for the number of days
required to process and return an
application for vehicle registration.
These and similar organizations use
standards in budgeting and cost control in
much the same way that manufacturers
use standards.

Standard cost analysis

may be used in any
organization with
repetitive tasks.
A relationship between
tasks and output
measures must be
established.

10-18

Cost Variance Analysis

Standard Cost Variances

Price Variance

The difference between

the actual price and the
standard price

Quantity Variance

The difference between

the actual quantity and
the standard quantity
10-19

 There are two types of standard cost

variances: price variance and quantity
variance.
A price variance arises when there is a
difference between the actual price and the
standard price.
A quantity variance occurs when there is a
difference between the actual quantity used
and the standard quantity to be used.

A General Model for Variance Analysis

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance
Materials
price
variance
AQ(AP
- SP)
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP =spending
Actual Price
variance

Standard Quantity

Standard Price

Quantity Variance
Materials
SP(AQ quantity
- SQ) variance
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQefficiency
= Standard
Quantity
variance
10-21

 The general model for variance analysis calculates

the price variance and the quantity variance.
The (actual quantity times the actual price) less
(the actual quantity times the standard price) is
the formula for calculating the price variance.
This formula can be restated as the actual price
minus the standard price, then multiplied by the
actual quantity.
The (actual quantity times the standard price)
less (the standard quantity times the standard
price) is the formula for calculating the quantity
variance.
This formula can be restated as the actual
quantity minus the standard quantity, then
multiplied by the standard price.

A General Model for Variance Analysis

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard price is the amount that should have

been paid for the resources acquired.
In this model, the standard price is the amount that should have been paid for the
resources acquired.

10-23

A General Model for Variance Analysis

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard quantity is the quantity that should have

been used.
The standard quantity is the quantity of that resource that should have been used.
10-24

Standard Costs

Lets use the concepts of

the general model to
calculate standard cost
variances, starting with

direct material.
Lets use the concepts of the general model to calculate standard cost variances for
Hanson, Inc. We will start with direct materials.
10-25

Material Variances
Hanson Inc. has the following direct material
standard to manufacture one Zippy:

Zippy

1.5 pounds per Zippy at $4.00 per pound

Last week 1,700 pounds of material were
purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.

Hanson Inc. manufactures a product called a zippy. The direct material standard for one
zippy is 1.5 pounds of material at a cost of $4.00 per pound. Last week, 1,700 pounds of
materials were purchased and used to make 1,000 Zippies. The actual cost of the
materials was $6,630

10-26

Material Variances

Zippy

What is the actual price per pound

paid for the material?
a.
b.
c.
d.

$4.00 per pound.

$4.10 per pound.
$3.90 per pound.
$6.63 per pound.

To calculate the direct-material price variance, we must first determine the actual price
per pound of material

10-27

Material Variances
The actual price per pound can be calculated by taking the total actual cost
of $6,630 and dividing it by the actual number of pounds which was 1,700.
Therefore, the actual cost per pound was $3.90.

Zippy

What is the actual price per pound

paid for the material?
a.
b.
c.
d.

$4.00 per pound.

$4.10 per pound.
$3.90 per pound.
$6.63 per pound.

AP = $6,630 1,700 lbs.

AP = $3.90 per lb.

10-28

Material Variances

Zippy

Hansons direct-material price variance (MPV)

for the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.

Now that we know the actual price per pound, the standard price per pound and the actual
10-29
number of pounds used, we can calculate the material price variance

Material Variances

Hansons direct-material price variance (MPV)

for the week was:
a.
b.
c.
d.

Zippy

$170 unfavorable.
$170 favorable.
$800 unfavorable. MPV = AQ(AP - SP)
MPV = 1,700 lbs. ($3.90 - 4.00)
$800 favorable.
MPV = $170 Favorable

The standard price of $4.00 is subtracted from the actual price of $3.90.
This difference is multiplied by the actual quantity of 1,700 pounds.
The resulting variance is a negative $170.
The variance is favorable because the actual price per pound was less than the standard
price per pound.
10-30

Material Variances

The standard quantity of material that

should have been used to produce
1,000 Zippies is:
a.
b.
c.
d.

Zippy

1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.

To calculate the direct-material quantity variance, we must first determine the standard
quantity of materials that should have been used to produce 1,000 Zippies.

10-31

Material Variances

The standard quantity of material that

should have been used to produce
1,000 Zippies is:

a.
b.
c.
d.

1,700 pounds.
1,500 pounds.
2,550 pounds.
2,000 pounds.

Zippy

SQ = 1,000 units 1.5 lbs per unit

SQ = 1,500 lbs

The standard quantity of material for one Zippy is 1.5 pounds.

Since 1,000 Zippies were produced, we must multiply 1.5 pounds times 1,000 units to get
1,500 pounds of material for the standard quantity
10-32

Material Variances

Hansons direct-material quantity variance (MQV) for

the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.

Zippy

Now that we know the actual quantity used, the standard quantity that should have been
used and the standard price per pound, we can calculate the material quantity variance.

10-33

Material Variances

Hansons direct-material quantity variance (MQV) for

the week was:
a.
b.
c.
d.

$170 unfavorable.
$170 favorable.
$800 unfavorable.
$800 favorable.

MQV = SP(AQ - SQ)

MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
Zippy

The standard quantity of 1,500 pounds is subtracted from the actual quantity of 1,700
pounds.
This difference is multiplied by the standard price of $4.00 per pound.
The resulting variance is a positive $800.
The variance is unfavorable because the actual quantity used was greater than the
standard quantity that should have been used to make the 1,000 Zippies.
10-34

Material Variances Summary

Actual Quantity

Actual Price
1,700 lbs.

$3.90 per lb.

$6,630

Actual Quantity

Standard Price
1,700 lbs.

$4.00 per lb.

$ 6,800

Price variance
$170 favorable

Standard Quantity

Standard Price
1,500 lbs.

$4.00 per lb.

$6,000

Quantity variance
$800 unfavorable
10-35

 To summarize, the direct-material price variance

is the difference between the actual quantity at
the actual price and the actual quantity at the
standard price.
The result is a $170 favorable price variance.
The direct-material quantity variance is the
difference between the actual quantity at the
standard price and the standard quantity at the
standard price.
The result is a $800 unfavorable quantity
variance.

Material Variances
When the amount of direct-materials purchased is different from the amount
used, the direct-material price variance is based on the quantity purchased.
The difference between the purchase price and the standard price are
highlighted by the price variance, which relates to the purchasing function.
In contrast, the direct-material quantity variance is based on the amount of
material used in production.
The quantity variance highlights differences between the quantity of material
actually used and the standard quantity allowed.

Hanson purchased and used

1,700 pounds. How are the
variances computed if the
amount purchased differs from
the amount used?

Zippy

The price variance is computed on

the entire quantity purchased.

The quantity variance is computed

only on the quantity used.

10-37

Material Variances

Hanson Inc. has the following material

standard to manufacture one Zippy:

Zippy

1.5 pounds per Zippy at $4.00 per pound

Last week 2,800 pounds of material were

purchased at a total cost of $10,920, and
1,700 pounds were used to make 1,000
Zippies.
Lets try an example where the amount of materials purchased is different than the amount
of materials used in production.
The direct material standard for one zippy is still 1.5 pounds of material at a cost of $4.00 per
pound.
Last week, 2,800 pounds of materials were purchased at a total cost of $10,920.
1,700 pounds of material were used to make 1,000 Zippies.
10-38

Material Variances
Actual Quantity
Purchased

Actual Price

Actual Quantity
Purchased

Standard Price

2,800 lbs.

$3.90 per lb.

2,800 lbs.

$4.00 per lb.

$10,920

Zippy

MPV = AQ(AP - SP)

MPV = 2,800 lbs.
($3.90 - 4.00)
MPV = $280
Favorable

$11,200

Price variance
$280 favorable

Price variance increases

because quantity purchased
increases.
10-39

 The standard price of $4.00 is subtracted from

the actual price of $3.90.
This difference is multiplied by the amount of
materials purchases, which is 2,800 pounds.
The resulting direct-material price variance is a
negative $280.
The variance is favorable because the actual price
per pound was less than the standard price per
pound.
But the variance is larger when a greater quantity
of materials were purchased.

MQV = SP(AQ - SQ)

MQV = $4.00(1,700 lbs
- 1,500 lbs)
MQV = $800unfavor.

Material Variances
Actual Quantity
Used
Standard Quantity

Standard Price Standard Price

1,700 lbs.

$4.00 per lb.

$6,800

Quantity variance is
unchanged because actual
and standard quantities are
unchanged.

1,500 lbs.

$4.00 per lb.

Zippy

$6,000

Quantity variance
$800 unfavorable
10-41

 To calculate the material quantity variance, the

standard quantity of 1,500 pounds is subtracted from
the actual quantity of 1,700 pounds.
This difference is multiplied by the standard price of
$4.00 per pound.
The resulting direct-material quantity variance is a
positive $800.
The variance is unfavorable because the actual quantity
used was greater than the standard quantity that
should have been used to make the 1,000 Zippies.
Notice that the amount of material purchased did not
effect this variance.

Isolation of Material Variances

I need the variances as soon
as possible so that I can
better identify problems
and control costs.

You accountants just dont

understand the problems
we production managers have.

A significant price variance should be

investigated as soon as possible after the
material is purchased.
The directmaterial quantity variance should be
calculated at the time the material is
used in production

Okay. Ill start computing

the price variance when
material is purchased and
the quantity variance as
soon as material is used.

10-43