Standard Costing: Setting

Standards and Analyzing

Variances: Materials and
Labor
Using Standard-Costing Systems for
Control
Based on carefully
predetermined amounts.

Used for planning labor

Standard and material requirements.
Costs are
The expected level
of performance.

Benchmarks for
measuring performance.
Using Standard-Costing Systems for
Control
STANDARDCOST
STANDARD COST
ACTUALCOST
ACTUAL COST
aabudget
budgetforforthe
the
used in
inthe
the
productionofof one
one used
production production ofof the
the
unit of
of product
product oror production
unit product or
or service
service
service product
service

COSTVARIANCE
COST VARIANCE
thedifference
the difference
betweenthe
between the
actualcost
actual costand
and
thestandard
the standard cost
cost
 Using Standard-Costing Systems for
Control
This variance is unfavorable
because the actual cost
exceeds the standard cost.

Standard
Product Cost

A standard cost variance

is the amount by which
an actual cost differs from
the standard cost.
 Management by Exception

Managers focus on quantities and costs

that exceed standards, a practice known as
management by exception.

Standard
Amount

Direct
Material
Direct
Labor

Type of Product Cost

 Management by Exception

Takethe
Take thetime
timeto
toinvestigate
investigateonly
only significant
significant cost
cost variances.
variances.

Whatis
What issignificant?
significant?

Dependson
Depends on
Dependson
Depends on
the
the
theSize
the Sizeof
ofthe
the
Production
Production
Organization
Organization
Dependson
Depends on Process
Process
theType
the Typeof
of
the
the
Organization
Organization
Variance Analysis Cycle

Take
Identify Receive
corrective
questions explanations
actions

Conduct next
Analyze
periods
variances
operations

Begin Prepare standard

cost performance
report
 Setting Standards

Analysis of What
WhatDID
DID
the
theproduct
product
Historical Used
cost?
cost? Usedin
inaamature
mature
Data production
productionProcess
Process

What
What Analyze
Analyzethe
theprocess
process
Task SHOULD
SHOULDthe the of
ofmanufacturing
manufacturing
Analysis product
product the
theproduct
product
cost?
cost?

A Analyze
Analyzethetheprocess
processfor
forthe
thestep
stepthat
that
has
haschanged,
changed,but
butuse
usehistorical
historicaldata
data
Combined
for
forthe
thesteps
steps that
thathave
havenot
notchanged
changed
Approach
Participation in Setting Standards

Accountants, engineers, personnel

administrators, and production managers
combine efforts to set standards based on
experience and expectations.
 Perfection Versus Practical
Standards: A Behavioral Issue
PERFECTION
PERFECTIONOR
OR PRACTICAL
PRACTICALOR
OR
IDEAL
IDEAL ATTAINABLE
ATTAINABLE
STANDARDS
STANDARDS STANDARDS
STANDARDS
Can
Canonly
onlybe
beattained
attained Tight,
Tight,but
butare
arestill
still
under
undernear
nearperfect
perfect expected
expectedtotobe
be
conditions
conditions attained
attained

Peak
Peakefficiency
efficiency Occasional
Occasionalmachine
machine
Lowest
Lowestpossible
possible breakdowns
breakdowns
input
inputprices
prices Normal
Normalamounts
amounts
best-quality
best-qualitymaterial
material of
ofraw
rawmaterial
material
no
nodisruption
disruptionin
in waste
waste
production
production
Perfection Versus Practical
Standards: A Behavioral Issue
Practical standards
should be set at levels
that are currently
attainable with
Should we use reasonable and
practical standards efficient effort.
or perfection
standards?
Perfection Versus Practical
Standards: A Behavioral Issue
I agree. Perfection
standards are
unattainable and
therefore discouraging
to most employees.
 Selection of a Standard

Activity
Activity analysis
analysis
Historical
Historical data
data
Benchmarking
Benchmarking
Market
Market
expectation
expectation
Strategic
Strategic
decisions
decisions
Nonfinancial Measures

Friendly
Friendly service
service
On-time
On-time delivery
delivery
Quality
Quality
Cleanliness
Cleanliness
Value
Value
Setting Standards Direct Materials

Price Quantity
Standards Standards

Use competitive Use product

bids for the quality design specifications;
and quantity desired; summarized in a
final, delivered cost Bill of Materials.
of materials,
net of discounts.
Setting Standards Direct Materials

The standard material cost for one unit of product is:

standard quantity
standard price for of material
one unit of material required for one
unit of product
Setting Standards Direct Labor

Rate Efficiency
Standards Standards

Use wage
surveys and
labor contracts
Often a single
Use time and
rate is used that reflects motion studies for
the mix of wages earned.
each labor operation.
Setting Standards Direct Labor

The standard labor cost for one unit of product is:

standard number
standard wage rate of labor hours
for one hour for one unit
of product
 Setting Standards - Variable
Overhead
Rate Activity
Standards Standards

The rate is the The activity is the

variable portion of the base used to calculate
predetermined overhead the predetermined
rate. overhead.
Standards vs. Budgets

Are standards the A standard is a per

same as budgets? unit cost.
A budget is set for Standards are often
total costs. used when
preparing budgets.
 Cost Variance Analysis

Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity
 A General Model for
Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price

Price or Rate Quantity or Efficiency

Variance Variance
 A General Model for
Variance Analysis
Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price

Price or Rate Quantity or Efficiency

Variance Variance
Standard price is the amount that should
have been paid for the resources acquired.
 A General Model for
Variance Analysis
Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price

Price or Rate Quantity or Efficiency

Variance Variance
Standard quantity is the quantity
allowed for the actual good output.
 A General Model for
Variance Analysis
Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price

Price or Rate Quantity or Efficiency

Variance Variance
AQ(AP
Materials price- SP)
variance SP(AQ
Materials - SQ)
quantity variance
Labor rate variance Labor efficiency variance
AQ =Variable
Actual overhead
Quantity SP = Standard
Variable Price
overhead
AP = spending
Actual Price
variance SQ = Standard
efficiency Quantity
variance
Standard Costs

Lets use the

concepts of the
general model to
calculate standard
cost variances,
starting with
direct material.
Material Variances

Koala Camp Gear Company in Melbourne

Australia has the following direct material
standard to manufacture one Tree Line tent:
12 square meters per tent at
$8.00 per square meter
Last month Koala purchased 40,000 square
meters at $8.15 per square meter and used
36,400 square meters to make 3,000 tents.
 Material Variances

Actual Quantity Actual Quantity

Purchased Purchased

Actual Price Standard Price We should compute
40,000 sqm. 40,000 sqm. the price variance
using the actual
$8.15 per sqm. $8.00 per sqm. quantity purchased.
$326,000 $320,000

Price variance
$6,000 Unfavorable
 Material Variances
SQ = 3,000 tents 12 sqm. per tent
SQ = 36,000 sqm.
Actual Quantity
Used Standard Quantity
We should compute
the quantity variance Standard Price
36,400 sqm.
Standard Price
36,000 sqm.
using the actual
quantity used. $8.00 per sqm. $8.00 per sqm.
$291,200 $288,000

Quantity variance
$3,200 Unfavorable
Material Variances
We
We may
may also
also calculate
calculate material
material
variances
variances using
using formulas:
formulas:

MPV = AQp(AP SP)

MPV = 40,000 sqm. ($8.15 $8.00)
MPV = $6,000 Unfavorable

MQV = SP(AQu SQ)

MQV = $8.00(36,400 sqm. 36,000 sqm.)
MQV = $3,200 Unfavorable
 Reporting Material Variances

I need the variances as soon

as possible so that I can
Okay. Ill compute
better identify problems
the price variance when
and control costs.
material is purchased and
You accountants just dont the usage variance as
understand the problems we soon as material is used.
production managers have.
Responsibility for
Material Variances
Your poorly trained workers and
I am not responsible poorly maintained equipment
for this unfavorable caused the problems.
material usage
variance. Also, your poor scheduling
requires rush orders of material
You bought poor quality at higher prices, causing
material, so my people unfavorable price variances.
had to use more of it.
 Price and Quantity Standards
Price and and quantity standards are
determined separately for two reasons:

The
The purchasing
purchasing manager
manager is is responsible
responsible for
for raw
raw
material
material purchase
purchase prices
prices and
and the
the production
production manager
manager
is
is responsible
responsible for
for the
the quantity
quantity ofof raw
raw material
material used.
used.

The
The buying
buying and
and using
using activities
activities occur
occur atat different
different times.
times.
Raw
Raw material
material purchases
purchases may
may be be held
held inin inventory
inventory forfor aa
period
period of
of time
time before
before being
being used
used inin production.
production.
Allowance for Defects or Spoilage

In
Insome
somemanufacturing
manufacturing processes,
processes, aacertain
certainamount
amount
of
of defective
defective production
productionor
or spoilage
spoilageis
is normal.
normal.

Example:
Example:1,0001,000liters
litersof
ofchemicals
chemicalsare
arenormally
normallyrequired
requiredin
inaa
chemical
chemicalprocess
processin inorder
orderto
toobtain
obtain800
800liters
litersofofgood
goodoutput.
output.
IfIftotal
totalgood
goodoutput
outputininFebruary
Februaryis
is5,000
5,000liters,
liters,what
whatis
isthe
the
standard
standardallowed
allowedquantity
quantityof
ofinput?
input?

Good
Goodoutput
outputquantity
quantity ==80%
80%XXInput
Inputquantity
quantity

Good
Goodoutput
outputquantity
quantity80%
80% ==Input
Inputquantity
quantityallowed
allowed

5,000
5,000liters
litersof
ofgood
good ==6,250
6,250liters
litersof
of
output
output80%
80% input
inputallowed
allowed
Standard Costs

Now lets calculate

standard cost
variances for
direct labor.
Labor Variances

Koala has the following direct labor

standard to manufacture one Tree Line tent:
2 standard hours per tent at
$18.00 per direct labor hour
Last month 5,900 direct labor hours were
worked at $19.00 per hour to make 3,000 tents.
 Labor Variances
SH = 3,000 tents 2 hours per tent
SH = 6,000 hours

Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate
5,900 hours 5,900 hours 6,000 hours

$19.00 per hour $18.00 per hour $18.00 per hour
$112,100 $106,200 $108,000

Rate variance Efficiency variance

$5,900 Unfavorable $1,800 Favorable
Labor Variances

We
We may
may also
also calculate
calculate labor
labor
variances
variances using
using formulas:
formulas:

LRV = AH(AR - SR)

LRV = 5,900 hrs($19.00 - $18.00)
LRV = $5,900 Unfavorable

LEV = SR(AH - SH)

LEV = $18.00(5,900 hrs - 6,000 hrs)
LEV = $1,800 Favorable
 Labor Rate Variance
A Closer Look
Using highly paid skilled workers to
perform unskilled tasks results in an
unfavorable price variance.

High skill, Low skill,

high rate low rate

Production managers who make work assignments

are generally responsible for price variances.
 Labor Efficiency Variance
A Closer Look
Poorly Poor
trained quality
workers materials

Unfavorable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
 Responsibility for Labor Variances

I am not responsible for

the unfavorable labor You used too much
efficiency variance! time because of poorly
You bought poor quality trained workers and
material, so my people used poor supervision.
more time to process it.
Responsibility for Labor Variances

Maybe I can attribute the labor

and material variances to personnel
for hiring the wrong people
and training them poorly.
Mix and Yield Variances

Mix or Blend Variance results from the

mixing or combining or the basic
materials in a ratio different from
standard material specifications.
May also apply to a mix in the use of labor
with different pay rates
Mix and Yield Variances

Yield Variance is the result of obtaining

a yield different from what would be
expected from actual input.

Yield is the amount of product

manufactured from a given amount of
materials.
 Material Mix and Yield Variances
Actual Mix Actual Mix Standard Mix Standard Mix
x x x x
Actual Quantity Actual Quantity Actual Quantity Standard Quantity
x x x x
Actual Price Standard Price Standard Price Standard Price

Material Material Material

Price Mix Yield
Variance Variance Variance

What should have been

used for level of output
 Labor Mix and Yield Variances
Actual Mix Actual Mix Standard Mix Standard Mix
x x x x
Actual Hours Actual Hours Actual Hours Standard Hours
x x x x
Actual Rate Standard Rate Standard Rate Standard Rate

Labor Labor Labor

Rate Mix Yield
Variance Variance Variance

What should have been

used for level of output
Significance of Cost Variances:
When to follow Up
How
Howdoes
doesaamanager
managerknow
knowwhen
whento
tofollow
followup
up
on
onaacost
costvariance
varianceand
andwhen
whento
toignore
ignoreit?
it?

What clues help me

to determine the
variances that I should
investigate?
Significance of Cost Variances
Size of variance
Amount
Percentage of standard
Recurring variances
Trends
Controllability
How do I know which
Favorable variances
variances to
Costs and benefits of investigate?
investigation
Significance of Cost Variances:
When to follow Up

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

We
We could
could use
use aa rule
rule of
of thumb
thumb such
such as:
as:
investigate
investigate all
all variances
variances that
that are
are over
over $10,000
$10,000
or
or over
over 10
10 percent
percent of
of the
the standard
standard cost.
cost.
Significance of Cost Variances:
When to follow Up
What about recurring variances?

Percentage
Percentage of
of
MONTH
MONTH VARIANCE
VARIANCE Standard
Standard Cost
Cost
September
September $6,000
$6,000 FF 6.0%
6.0%
October
October 6,400
6,400 FF 6.4%
6.4%
November
November 3,200
3,200 FF 3.2%
3.2%
December
December 6,200
6,200 FF 6.2%
6.2%

None
Noneofofthe
thevariances
variancesare
aregreater
greaterthan
than$10,000
$10,000or
or
10%
10%for
forany
anyone
onemonth,
month,but
butthey
theyshould
shouldbebeinvestigated
investigated
because
becauseofofthey
theyhave
havecontinued
continuedfor
forseveral
severalmonths.
months.
Significance of Cost Variances:
When to follow Up
What about trends?
Percentage
Percentage ofof
MONTH
MONTH VARIANCE
VARIANCE Standard
Standard Cost
Cost
September
September $$ 250
250UU 0.25%
0.25%
October
October 840
840UU 0.84%
0.84%
November
November 4,000
4,000UU 4.0%
4.0%
December
December 9,300
9,300UU 9.3%
9.3%

None
Noneof ofthe
thevariances
variancesare
aregreater
greaterthan
than$10,000
$10,000or
or
10%
10%for
forany
anyone
onemonth,
month,but
butthey
theyshould
shouldbebe
investigated
investigated because
becauseofofthe
theunfavorable
unfavorabletrend.
trend.
 Significance of Cost Variances:
When to follow Up
Controllability
Controllability Favorable
FavorableVariances
Variances
AAmanager
manageris ismore
morelikely
likely ItItis
isas
asimportant
importanttotoinvestigate
investigate
to
toinvestigate
investigateaavariance
variance significant
significantfavorable
favorablevariances
variancesas
as
that
thatis
iscontrollable
controllablebyby well
wellas assignificant
significantunfavorable
unfavorable
someone
someonein inthe
the variances.
variances.
organization
organizationthan
thanone
one
that
thatis
isnot.
not.

Cost
Cost and
andBenefits
Benefitsof
of
Investigation
Investigation
The
Thedecision
decisionwhether
whethertoto
investigate
investigateaavariance
variance is
isaacost
cost--
benefit
benefitdecision
decision
Costs and Benefits of
Standard-Costing Systems

Costs Benefits

COST
COST
BENEFITS
BENEFITS

Implementing
Implementingand
andmaintaining
maintainingcost
coststandards
standardscan
can
be
betime-consuming,
time-consuming,labor-intensive,
labor-intensive,and
andexpensive.
expensive.
 Behavioral Effects Of Standard
Costing
Standard
Standard costs,
costs,budgets,
budgets,and
andvariances
variancesare
areused
usedto
to
evaluate
evaluatethe
theperformance
performanceofofindividuals
individualsand
anddepartments
departments

They
Theycan
canprofoundly
profoundlyinfluence
influencebehavior
behaviorwhen
whenthey
theyare
areused
usedto
to
determine
determinesalary
salaryincreases,
increases,bonuses,
bonuses,and
andpromotions
promotions
Behavioral Impact of Standard
Costing
If I buy cheaper materials, my direct-
materials expenses will be lower than
what is budgeted. Then Ill get my bonus.
But we may lose customers because of
lower quality.
 Which Managers Influence Cost
Variances?
Direct-material price variance The purchasing manager
Get the best prices available for purchased goods and
services through skillful purchasing practices

Direct-material quantity variance The production supervisor

Skillful supervision and motivation of production employees, coupled with
the careful use and handling of materials, contribute to minimal waste

Direct-labor rate variance The production supervisor

Generally results from using a different mix of employees
than that anticipated when the standard were set

Direct-labor efficiency variance The production supervisor

Motivating employees toward production goals and
effective work schedules improves efficiency
Advantages of Standard Costing
Sensible Cost Management by
Comparisons Exception

Performance Employee
Evaluation Motivation
Advantages

Stable Product
Costs
Lets set the
standard a
little higher.