Chapter 8

Standard Costs

9-2

Standard Costs
Standards are benchmarks or norms for
measuring performance. In managerial accounting,
two types of standards are commonly used.
Quantity standards
specify how much of an
input should be used to
make a product or
provide a service.

Price standards
specify how much
should be paid for
each unit of the
input.

Examples: Firestone, Sears, McDonalds, hospitals,

construction, and manufacturing companies.

9-3

Standard Costs

Amount

Deviations from standards deemed significant

are brought to the attention of management, a
practice known as management by exception.
Standard

Direct
Labor

Direct
Material

Manufacturing
Overhead

Type of Product Cost

9-4

Variance Analysis Cycle

Identify
questions

Receive
explanations

Take
corrective
actions

Conduct next
periods
operations

Analyze
variances
Prepare standard
cost performance
report

Begin

9-5

Setting Standard Costs

Accountants, engineers, purchasing
agents, and production managers
combine efforts to set standards that encourage
efficient future operations.

9-6

Setting Standard Costs

Should we use
ideal standards that
require employees to
work at 100 percent
peak efficiency?

Engineer

I recommend using practical

standards that are currently
attainable with reasonable
and efficient effort.

Managerial Accountant

9-7

Learning Objective 1
Explain how direct
materials standards and
direct labor
standards are set.

9-8

Setting Direct Material Standards

Standard Price
Per Unit

Standard
Quantity Per Unit

Final, delivered
cost of materials,
net of discounts.

Summarized in
a Bill of Materials.

9-9

Setting Standards
Six Sigma advocates have sought to
eliminate all defects and waste, rather than
continually build them into standards.
As a result allowances for waste and
spoilage that are built into standards
should be reduced over time.

9-10

Setting Direct Labor Standards

Standard Rate
Per Hour

Often a single
rate is used that reflects
the mix of wages earned.

Standard Hours
Per Unit

Use time and

motion studies for
each labor operation.

9-11

Setting Variable Manufacturing

Overhead Standards
Price
Standard

Quantity
Standard

The rate is the

variable portion of the
predetermined overhead
rate.

The quantity is
the activity in the
allocation base for
predetermined overhead.

9-12

Standard Cost Card

A standard cost card for one unit
of product might look like this:

9-13

Price and Quantity Standards

Price and quantity standards are
determined separately for two reasons:
The purchasing manager is responsible for raw
material purchase prices and the production manager
is responsible for the quantity of raw material used.

The buying and using activities occur at different times.

Raw material purchases may be held in inventory for a
period of time before being used in production.

9-14

Price and Quantity Variances

Variance Analysis

Price Variance

Quantity Variance

Difference between
actual price and
standard price

Difference between
actual quantity and
standard quantity

9-15

Price and Quantity Variances

Variance Analysis

Price Variance

Quantity Variance

Materials price variance

Labor rate variance
VOH rate variance

Materials quantity variance

Labor efficiency variance
VOH efficiency variance

9-16

Price and Quantity Variances

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

9-17

Price and Quantity Variances

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Actual quantity is the amount of direct

materials, direct labor, and variable
manufacturing overhead actually used.

9-18

Price and Quantity Variances

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard quantity is the standard quantity

allowed for the actual output of the period.

9-19

Price and Quantity Variances

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Actual price is the amount actually

paid for the input used.

9-20

Price and Quantity Variances

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 input used.

9-21

Price and Quantity Variances

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance
(AQ AP) (AQ SP)
AQ = Actual Quantity
AP = Actual Price

Standard Quantity

Standard Price

Quantity Variance
(AQ SP) (SQ SP)
SP = Standard Price
SQ = Standard Quantity

9-22

Learning Objective 2
Compute the direct
materials price and
quantity variances and
explain their significance.

9-23

Glacier Peak Outfitters An Example

Glacier Peak Outfitters has the following direct material
standard for the fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased and used to
make 2,000 parkas. The material cost a total of $1,029.
Lets calculate the material price and quantity variances.

9-24

Material Variances Summary

Actual Quantity

Actual Price
210 kgs.

Actual Quantity

Standard Price

Standard Quantity

Standard Price

210 kgs.

200 kgs.

9-25

Material Variances Summary

Actual Quantity

Actual Price
210 kgs.

Actual Quantity

Standard Price

Standard Quantity

Standard Price

210 kgs.

200 kgs.

9-26

Material Variances Summary

Actual Quantity

Actual Price

Actual Quantity

Standard Price

210 kgs.

$4.90 per kg.

210 kgs.

$5.00 per kg.

Standard Quantity

Standard Price
200 kgs.

$5.00 per kg.

9-27

Material Variances:
Using the Factored Equations
Materials price variance

MPV = AQ (AP - SP)

= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F

Materials quantity variance

MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U

9-28

Direct Materials Variances Points

of Clarification
I need the price variance
sooner so that I can better
identify purchasing problems.
You accountants just dont
understand the problems that
purchasing managers have.

Ill start computing

the price variance
when material is
purchased rather
than when its used.

9-29

Direct Materials Variances Points

of Clarification

Glacier purchased and

used 210 kilograms.
How are the variances
computed if the amount
purchased differs from
the amount used?

The price variance is

computed on the entire
quantity purchased.
The quantity variance
is computed only on
the quantity used.

9-30

Direct Materials Variances Points

of Clarification
Materials Quantity Variance

Production Manager

Materials Price Variance

Purchasing Manager

The standard price is used to compute the quantity variance

so that the production manager is not held responsible for
the purchasing managers performance.

9-31

Direct Materials Variances Points

of Clarification
I am not responsible for
this unfavorable material
quantity variance.
You purchased cheap
material, so my people
had to use more of it.

Your poor scheduling

sometimes requires me to
rush order material at a
higher price, causing
unfavorable price variances.

9-32

Quick Check

Zippy

Hanson Inc. has the following direct material

standard to manufacture one 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.

9-33

Quick Check
Hansons
Hansonsmaterial
materialprice
pricevariance
variance(MPV)
(MPV)
for
forthe
theweek
weekwas:
was:
a.
a. $170
$170unfavorable.
unfavorable.
b.
b. $170
$170favorable.
favorable.
c.
c. $800
$800unfavorable.
unfavorable.
d.
d. $800
$800favorable.
favorable.

Zippy

9-34

Quick Check
Hansons
Hansonsmaterial
materialquantity
quantityvariance
variance(MQV)
(MQV)
for
forthe
theweek
weekwas:
was:
a.
a. $170
$170unfavorable.
unfavorable.
b.
b. $170
$170favorable.
favorable.
c.
c. $800
$800unfavorable.
unfavorable.
d.
d. $800
$800favorable.
favorable.

Zippy

9-35

Quick Check
Actual Quantity

Actual Price

Zippy

Actual Quantity

Standard Price

Standard Quantity

Standard Price

1,700 lbs.

$3.90 per lb.

1,700 lbs.

$4.00 per lb.

1,500 lbs.

$4.00 per lb.

= $6,630

= $ 6,800

= $6,000

Price variance
$170 favorable

Quantity variance
$800 unfavorable

9-36

Quick Check Continued

Zippy

Hanson Inc. has the following material standard to

manufacture one 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.

9-37

Quick Check Continued

Actual Quantity
Purchased

Zippy

Actual Quantity
Purchased

2,800Price
lbs.
Actual

$3.90 per lb.

2,800 lbs.
Standard
Price

$4.00 per lb.

= $10,920

= $11,200

Price variance
$280 favorable

Price variance increases

because quantity
purchased increases.

9-38

Quick Check Continued

Quantity

Actual Quantity
Used

Standard Price
1,700 lbs.

$4.00 per lb.

= $6,800

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

Zippy

Standard

Standard Price
1,500 lbs.

$4.00 per lb.

= $6,000

Quantity variance
$800 unfavorable

9-39

Learning Objective 3
Compute the direct labor
rate and efficiency
variances and explain
their significance.

9-40

Glacier Peak Outfitters - An Example

Glacier Peak Outfitters has the following direct labor
standard for its mountain parka.
1.2 standard hours per parka at
$10.00 per hour
Last month, employees actually worked 2,500 hours at
a total labor cost of $26,250 to make 2,000 parkas.
Lets calculate the labor rate and efficiency variances?

9-41

Labor Variances Summary

Actual Hours

Actual Rate

Actual Hours

Standard Rate

2,500 hours

$10.50 per hour

2,500 hours

$10.00 per hour.

= $26,250

= $25,000

Rate variance
$1,250 unfavorable

Standard Hours

Standard Rate
2,400 hours

$10.00 per hour

= $24,000

Efficiency variance
$1,000 unfavorable

9-42

Labor Variances Summary

Actual Hours

Actual Rate

Actual Hours

Standard Rate

2,500 hours

2,500 hours

Standard Hours

Standard Rate
2,400 hours

9-43

Labor Variances Summary

Actual Hours

Actual Rate

Actual Hours

Standard Rate

2,500 hours

2,500 hours

Standard Hours

Standard Rate
2,400 hours

9-44

Labor Variances:
Using the Factored Equations
Labor rate variance
LRV = AH (AR - SR)
= 2,500 hours ($10.50 per hour $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable

Labor efficiency variance

LEV = SR (AH - SH)
= $10.00 per hour (2,500 hours 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable

9-45

Direct Labor Variances Points of

Clarification
Production managers are
usually held accountable
for labor variances
because they can
influence the:

Mix of skill levels

assigned to work tasks.
Level of employee
motivation.
Quality of production
supervision.

Production Manager

Quality of training
provided to employees.

9-46

Direct Labor Variances Points of

Clarification
I am not responsible for
the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.

I think it took more time

to process the
materials because the
Maintenance
Department has poorly
maintained your
equipment.

9-47

Quick Check

Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at
$12.00 per direct labor hour
Last week, 1,550 direct labor hours were worked at a
total labor cost of $18,910 to make 1,000 Zippies.

9-48

Quick Check
Hansons
Hansons labor
labor rate
rate variance
variance (LRV)
(LRV) for
for the
the
week
week was:
was:
a.
a. $310
$310 unfavorable.
unfavorable.
b.
b. $310
$310 favorable.
favorable.
c.
c. $300
$300 unfavorable.
unfavorable.
d.
d. $300
$300 favorable.
favorable.

Zippy

9-49

Quick Check

Zippy

Hansons
Hansons labor
labor rate
rate variance
variance (LRV)
(LRV) for
for the
the
week
week was:
was:
a.
a. $310
$310 unfavorable.
unfavorable.
b.
b. $310
$310 favorable.
favorable.
LRV = AH(AR - SR)
c.
c. $300
$300 unfavorable.
unfavorable.
LRV = 1,550 hrs($12.20 - $12.00)
d.
d. $300
$300 favorable.
favorable.
LRV = $310 unfavorable

9-50

Quick Check
Hansons
Hansons labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was:
was:
a.
a. $590
$590 unfavorable.
unfavorable.
b.
b. $590
$590 favorable.
favorable.
c.
c. $600
$600 unfavorable.
unfavorable.
d.
d. $600
$600 favorable.
favorable.

Zippy

9-51

Quick Check

Zippy

Actual Hours

Actual Rate

Actual Hours

Standard Rate

Standard Hours

Standard Rate

1,550 hours

1,550 hours

1,500 hours

9-52

Learning Objective 4
Compute the variable
manufacturing overhead
rate and efficiency
variances.

9-53

Glacier Peak Outfitters An Example

Glacier Peak Outfitters has the following direct
variable manufacturing overhead labor standard for
its mountain parka.
1.2 standard hours per parka
at $4.00 per hour
Last month, employees actually worked 2,500 hours
to make 2,000 parkas. Actual variable
manufacturing overhead for the month was $10,500.

9-54

Variable Manufacturing Overhead

Variances Summary
Actual Hours

Actual Rate

Actual Hours

Standard Rate

Standard Hours

Standard Rate

2,500 hours

$4.20 per hour

2,500 hours

$4.00 per hour

2,400 hours

$4.00 per hour

= $10,500

= $10,000

= $9,600

Rate variance
$500 unfavorable

Efficiency variance
$400 unfavorable

9-55

Variable Manufacturing Overhead

Variances Summary
Actual Hours

Actual Rate

Actual Hours

Standard Rate

2,500 hours

2,500 hours

Standard Hours

Standard Rate
2,400 hours

9-56

Variable Manufacturing Overhead

Variances Summary
Actual Hours

Actual Rate

Actual Hours

Standard Rate

2,500 hours

2,500 hours

Standard Hours

Standard Rate
2,400 hours

9-57

Variable Manufacturing Overhead

Variances: Using Factored Equations
Variable manufacturing overhead rate variance
VMRV = AH (AR - SR)
= 2,500 hours ($4.20 per hour $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable

Variable manufacturing overhead efficiency variance

VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable

9-58

Quick Check

Zippy

Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Zippy:
1.5 standard hours per Zippy at
$3.00 per direct labor hour
Last week, 1,550 hours were worked to make
1,000 Zippies, and $5,115 was spent for
variable manufacturing overhead.

9-59

Quick Check
Hansons
Hansons rate
rate variance
variance (VMRV)
(VMRV) for
for variable
variable
manufacturing
manufacturing overhead
overhead for
for the
the week
week was:
was:
a.
a. $465
$465 unfavorable.
unfavorable.
b.
b. $400
$400 favorable.
favorable.
c.
c. $335
$335 unfavorable.
unfavorable.
d.
d. $300
$300 favorable.
favorable.

Zippy

9-60

Quick Check

Zippy

Hansons
Hansons efficiency
efficiency variance
variance (VMEV)
(VMEV) for
for
variable
variable manufacturing
manufacturing overhead
overhead for
for the
the week
week
was:
was:
a.
a. $435
$435 unfavorable.
unfavorable.
b.
b. $435
$435 favorable.
favorable.
c.
c. $150
$150 unfavorable.
unfavorable.
d.
d. $150
$150 favorable.
favorable.

9-61

Quick Check

Zippy

Actual Hours

Actual Rate

Actual Hours

Standard Rate

Standard Hours

Standard Rate

1,550 hours

$3.30 per hour

1,550 hours

$3.00 per hour

1,500 hours

$3.00 per hour

= $5,115

= $4,650

= $4,500

9-62

Variance Analysis and Management

by Exception

How do I know
which variances to
investigate?

Larger variances, in
dollar amount or as
a percentage of the
standard, are
investigated first.

9-63

A Statistical Control Chart

Warning signals for investigation
Favorable Limit

Desired Value

Unfavorable Limit

Variance Measurements

9-64

Advantages of Standard Costs

Management by
exception

Promotes economy
and efficiency

Advantages
Simplified
bookkeeping

Enhances
responsibility
accounting

9-65

Potential Problems with Standard Costs

Emphasizing standards
may exclude other
important objectives.

Standard cost
reports may
not be timely.
Invalid assumptions
about the relationship
between labor
cost and output.

Potential
Problems

Favorable
variances may
be misinterpreted.

Emphasis on
negative may
impact morale.
Continuous
improvement may
be more important
than meeting standards.