Cornerstones of Managerial

Accounting 2e

Chapter Nine
Standard Costing: A Managerial
Control Tool
Mowen/Hansen

Copyright 2008 Thomson South-Western, a part of the Thomson Corporation.

Thomson, the Star logo, and South-Western are trademarks used herein under
license.

Objective # 1

Explain how units standards are

set and why standard cost
systems are adopted.

Unit Standards
Developing standards enhances control.
Need to determine the unit standard cost for a
particular input
Two decisions:
Quantity
decision

Pricing
decision
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Quantity Decision

The amount of input that should be used

per unit of output

Called Quantity Standard

Price Decision

The amount that should be paid for the

quantity of input to be used.

Called Price Standard

Quantity Standard x Price Standard
= Unit Standard
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Unit Standard

Used to enhance cost control

Are budgeted unit costs

Unlike budgets which contain aggregate

amounts of total revenue and total costs

Development of Standards
Quantity Standards are developed by:
Historical experience
Engineering studies
Input from operating personnel

Development of Standards
Price Standards are the joint responsibility of:
Operations

Personnel

Purchasing

Accounting

Types of Standards
Ideal standards

---

Currently attainable
standards

--- can be achieved under

efficient operating
conditions

demand maximum
efficiency and can be
achieved only if
everything operates
perfectly

Why Standard Cost Systems Are

Adopted
Two reasons:
To improve planning and control
To facilitate product costing

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Planning and Control

Standards:
Enhance planning and control
Improve performance management
Fundamental requirement for a
flexible budgeting system
Actual costs are compared to
budgeted costs and variances are
computed
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Product Costing
Costs are assigned to products using standards
for:
Direct materials quantity

Direct labor quantity

Direct materials price

Direct labor price

Overhead quantity
Overhead price

12

Standard Costing
Advantages:
Greater capacity for control
Provides readily available unit cost
information
Simplifies cost assignments in both
process and job costing systems

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Objective # 2

Explain the purpose of a

standard cost sheet.

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Example
Corn allowed:

SQ

Unit
Quantity
Standard

Actual
Output

Standard quantity of
materials allowed
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Example

SQ =
SQ

Unit
Quantity
Standard
18

x
x

Actual
Output
100,000

SQ = 1,800,000 ounces
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Example
Operator hours allowed:

SH =

Unit
Quantity
Standard

Actual
Output

Standard hours
allowed
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Example
Operator hours allowed:

SH =
SH

=
SH

Unit
Quantity
Standard
0.01

x
x

Actual
Output
100,000

= 1,000 direct labor hours

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Objective # 3

Describe the basic concepts

underlying variance analysis,
and explain when variances
should be investigated.

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Variance Analysis Components

SP = Standard unit price of an input
SQ = Standard quantity of input for the
actual output
AP = Actual price per unit of the input
AQ = Actual quantity of the input used

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Total Budget Variance

Total
=
Variance

Actual
Cost

Planned
Cost

(AP x AQ)

(SP x SQ)

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Price (Rate) Variance

Actual
Price

Standard
Price

Number
of
x
inputs used

Favorable variance = Actual price is

less than standard price
Unfavorable variance = Actual price
is greater than standard price

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Usage (Efficiency) Variance

Actual
Quantity

Standard
Quantity

Standard
Unit Price

Favorable variance = Actual quantity

is less than standard quantity
Unfavorable variance = Actual
quantity is greater than standard
quantity

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The Decision to Investigate

Performance rarely meets established
standards exactly
Random variations around the standard are
expected
Management should determine an acceptable
range of performance

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Cornerstone 9-2
HOW TO Use Control Limits to
Trigger a Variance Investigation

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Example
Information: Standard cost: $100,000; allowable
deviation: $10,000; actual costs for six months:
June

$97,500

September $102,500

July

105,000

October

107,500

November

112,500

August

95,000

Required: Plot the actual costs over time against

the upper and lower control limits. Determine
when a variance should be investigated.
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Example
$120,000
110,000

100,000

Standard

Acceptable
Range
(Dont
Investigate)

90,000

June July August September October November

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Example
$120,000

Investigate

110,000

100,000

90,000

June July August September October November

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Objective # 4

Compute the materials

variances, and explain how they
are used for control.

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Direct Material Variances

Materials Price Variance
Measures the difference between what
should have been paid for raw materials
and what was actually paid

MPV

(AP

SP) x AQ

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Direct Material Variances

Materials Usage Variance
Measures the difference between the direct
materials actually used and the direct materials
that should have been used for the actual output

MUV

(AQ

SQ) SP

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Responsibility for the Materials

Price Variance
Belongs to the purchasing agent
Price can be influenced by:
Quality
Quantity discounts
Distance of the source from the plant

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Responsibility for the Materials

Usage Variance
Belongs to the production manager
Variance can be influenced by minimizing:
Scrap
Waste
Rework

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Analysis of the Variances

First step:
Decide whether the variance is
significant
Second step:
Find out why it occurred

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Accounting and Disposition of

Materials Variances
Materials variances are ADDED to
cost of goods sold if they are
UNFAVORABLE.
Materials variances are
SUBTRACTED from cost of goods
sold if FAVORABLE

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Direct Labor Variances

Labor Rate Variance
Computes the difference between what
was paid to direct laborers and what
should have been paid

LRV

(AR - SR) AH

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Direct Labor Variances

Labor Efficiency Variance
Measures the difference between the labor
hours that were actually used and the labor
hours that should have been used

LEV =

(AH SH) SR

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Objective # 5

Compute the labor variances

and explain how they are used
for control.

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Causes of Labor Rate Variance

Labor rates are largely determined by such
external forces as labor markets and union
contracts.
Labor rates can vary when:
More skilled and more highly paid
laborers are used for less skilled tasks
Unexpected overtime occurs
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Responsibility for the Labor

Efficiency Variance
Generally speaking, production managers
are responsible for the use of direct labor
But once the cause is discovered,
responsibility may be assigned elsewhere.

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