Chapter

8
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Standard Costs
Predetermined.

Standard Costs are

Used for planning labour, material and overhead requirements. Benchmarks for measuring performance. Used to simplify the accounting system.
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Standard Costs
Managers focus on quantities and costs that exceed standards, a practice known as management by exception.

Amount

Standard
Direct Material

Direct Labour

Manufacturing Overhead

Type of Product Cost
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Setting Standard Costs
Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations.

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Setting Standard Costs
Should we use practical standards or ideal standards?

Engineer

Managerial Accountant

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

Production manager
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Setting Standard Costs
I agree. Ideal standards, which are based on perfection, are unattainable and discourage most employees.

Human Resources Manager
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Note
• The argument that ideal standards are discouraging has been persuasive for many years. So “normal” defects and waste were built into the standards. • In recent years, TQM and other initiatives have sought to eliminate all defects and waste.
– Ideal standards, that allow for no waste, have become more popular. – The emphasis is on improvement over time, not attaining the ideal standards right now.
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Setting Direct Material Standards
Price Standards Quantity Standards

Final, delivered cost of materials, net of discounts.

Use product design specifications.

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Setting Direct Labour Standards
Rate Standards Time Standards

Use wage surveys and labour contracts.

Use time and motion studies for each labour operation.

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Setting Variable Overhead Standards
Rate Standards Activity Standards

The rate is the variable portion of the predetermined overhead rate.

The activity is the base used to calculate the predetermined overhead.

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Standard Cost Card: Variable Production Cost
A standard cost card for one unit of product might look like this:
A
Standard Quantity or Hours
3.0 kgs. 2.5 hours 2.5 hours

B
Standard Price or Rate

AxB
Standard Cost per Unit
12.00 35.00 7.50 54.50

Inputs
Direct materials Direct labour Variable mfg. overhead Total standard unit cost

$ 4.00 per kg. $ 14.00 per hour 3.00 per hour $

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Standards vs. Budgets

Are standards the same as budgets? A budget is set for total costs.

A standard is a per unit cost. Standards are often used when putting together a budget.

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Standard Cost Variances
A standard cost variance is the amount by which an actual cost differs from the standard cost.

Standard Cost

This variance is unfavourable because the actual cost exceeds the standard cost.

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Standard Cost Variances
I see that there is an unfavorable variance.
But why are variances important to me? First, they point to causes of problems and directions for improvement.

Second, they trigger investigations in departments having responsibility for incurring the costs.

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Variance Analysis Cycle
Identify questions Receive explanations
Take corrective actions

Analyze variances

Conduct next period’s operations Prepare standard cost performance report
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Begin

Standard Cost Variances
Standard Cost Variances

Price Variance

Quantity Variance

The difference between the actual price and the standard price

The difference between the actual quantity and the standard quantity

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

Price Variance

Quantity Variance

Standard price is the amount that should have been paid for the resources acquired.

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

Price Variance Quantity Variance Standard quantity is the quantity allowed for the actual good output.

standard input per unit of output X amount of good output.
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A General Model for Variance Analysis
Actual Quantity × Actual Price Actual Quantity × Standard Price Standard Quantity × Standard Price

Price Variance
AQ(AP - SP)

Quantity Variance
SP(AQ - SQ)

AQ = Actual Quantity AP = Actual Price

SP = Standard Price SQ = Standard Quantity

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Standard Costs

Let’s use the general model to calculate standard cost variances, starting with direct material.
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Material Variances Example
Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka.
0.1kg of fiberfill per parka at $5.00 per kg.

Last month 210kg of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029.

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Material Variances Summary
Actual Quantity × Actual Price 210kg × $4.90 per kg Actual Quantity × Standard Price 210kg × $5.00 per kg Standard Quantity × Standard Price 200kg × $5.00 per kg

= $1,029

= $1,050

= $1,000

Price variance $21 favourable

Quantity variance $50 unfavourable

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Material Variances Summary
Actual Quantity × Actual Price 210kg × $4.90 per kg Actual Quantity × Standard Price 210kg $1,029 ×210kg $5.00 per kg = $4.90 per kg = $1,050 Standard Quantity × Standard Price 200kg × $5.00 per kg

= $1,029

= $1,000

Price variance $21 favourable

Quantity variance $50 unfavourable

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Material Variances Summary
Actual Quantity × Actual Price Actual Quantity × Standard Price Standard Quantity × Standard Price

210kg 210kg 200kg × × 0.1kg per parka× 2,000 parkas $4.90 per kg $5.00 per kg $5.00 per kg = 200kg

= $1,029

= $1,050

= $1,000

Price variance $21 favourable

Quantity variance $50 unfavourable

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Note: Using the formulas
• 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 [210kg - (0.1kg/parka 2,000 parkas)] = $5.00/kg (210kg - 200kg) = $5.00/kg (10kg) = $50 U
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Quick Check 
Suppose only 190kg of fiberfill were used to make 2,000 parkas. What is the materials quantity variance? Remember that the standards call for 0.1kg of fiberfill per parka at a cost of $5 per kg of fiberfill. a. $50 F b. $50 U c. $100 F d. $100 U

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Quick Check 
If the material standard specifies exactly how much material should be in the final product without any wastage, is a favourable (F) materials quantity variance a good thing? a. Yes b. No

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Material Variances Example

Zippy

Hanson Inc. has the following direct material standard to manufacture one Zippy:
1.5kg per Zippy at $4.00 per kg

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

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Quick Check 
What is the actual price per kg paid for the material? a. $4.00 per kg b. $4.10 per kg c. $3.90 per kg d. $6.63 per kg

Zippy

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Quick Check 

Zippy

Hanson’s material price variance (MPV) for the week was: a. $170 unfavourable. b. $170 favourable. c. $800 unfavourable. d. $800 favourable.

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Quick Check 
The standard quantity of material that should have been used to produce 1,000 Zippies is: a. 1,700kg b. 1,500kg c. 2,550kg d. 2,000kg
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Zippy

Quick Check 

Zippy

Hanson’s material quantity variance (MQV) for the week was: a. $170 unfavourable. b. $170 favourable. c. $800 unfavourable. d. $800 favourable.

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Material Variances Summary
Actual Quantity × Actual Price
1,700kg × $3.90 per kg = $6,630

Zippy

Actual Quantity × Standard Price
1,700kg × $4.00 per kg = $ 6,800

Standard Quantity × Standard Price
1,500kg × $4.00 per kg = $6,000

Price variance $170 favourable

Quantity variance $800 unfavourable

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Material Variances

Hanson purchased and used 1,700kg. 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.

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Material Variances Continued

Zippy

Hanson Inc. has the following material standard to manufacture one Zippy:
1.5kg per Zippy at $4.00 per kg

Last week 2,800kg of material were purchased at a total cost of $10,920, and 1,700kg were used to make 1,000 Zippies.

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Material Variances Continued
Actual Quantity Purchased × Actual Price 2,800kg × $3.90 per kg = $10,920 Actual Quantity Purchased × Standard Price 2,800kg × $4.00 per kg = $11,200

Zippy

Price variance $280 favourable

Price variance increases because quantity purchased increases.

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Material Variances Continued
Actual Quantity Used × Standard Price 1,700kg × $4.00 per kg = $6,800 Quantity variance is unchanged because actual and standard quantities are unchanged.

Zippy

Standard Quantity × Standard Price 1,500kg × $4.00 per kg = $6,000

Quantity variance $800 unfavourable

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Isolation of Material Variances
I need the price variance sooner so that I can better identify purchasing problems. You accountants just don’t understand the problems that purchasing managers have. I’ll start computing the price variance when material is purchased rather than when it’s used.

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Responsibility for Material You used too much material Variances of poorly trained because
I am not responsible for this unfavourable material quantity variance. workers and poorly maintained equipment. Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavourable price variances.

You purchased cheap material, so my people had to use more of it.

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Standard Costs

Now let’s calculate standard cost variances for direct labour.

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Note
• Materials variances:
– Material price variance • MPV = AQ (AP - SP) – Material quantity variance • MQV = SP (AQ - SQ) Actual hours

• Labour variances:
– Labour rate variance • LRV = AH (AR - SR) • LEV = SR (AH - SH)

Actual rate
Standard rate

Standard hours allowed – Labour efficiency variance

for the actual good output

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Labour Variances Example

Zippy

Hanson Inc. has the following direct labour standard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 per direct labour hour

Last week 1,550 direct labour hours were worked at a total labour cost of $9,610 to make 1,000 Zippies.
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Quick Check 
What was Hanson’s actual rate (AR) for labour for the week? a. $6.20 per hour. b. $6.00 per hour. c. $5.80 per hour. d. $5.60 per hour.

Zippy

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Quick Check 

Zippy

Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable.

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Quick Check 

Zippy

The standard hours (SH) of labour that should have been worked to produce 1,000 Zippies is: a. 1,550 hours. b. 1,500 hours. c. 1,700 hours. d. 1,800 hours.
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Quick Check 

Zippy

Hanson’s labour efficiency variance (LEV) for the week was: a. $290 unfavourable. b. $290 favourable. c. $300 unfavourable. d. $300 favourable.

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Labour Variances Summary
Actual Hours × Actual Rate
1,550 hours × $6.20 per hour = $9,610

Zippy

Actual Hours × Standard Rate
1,550 hours × $6.00 per hour = $9,300

Standard Hours × Standard Rate
1,500 hours × $6.00 per hour = $9,000

Rate variance $310 unfavourable

Efficiency variance $300 unfavourable

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Labour Rate Variance: A Closer Look
Using highly paid skilled workers to perform unskilled tasks results in an unfavourable rate variance.

High skill, high rate

Low skill, low rate

Production managers who make work assignments are generally responsible for rate variances.
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Labour Efficiency Variance: A Closer Look
Poorly trained workers Poor quality materials

Unfavourable Efficiency Variance
Poor supervision of workers
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Insufficient Demand or Bottlenecks

Responsibility for Labour Variances
I am not responsible for the unfavorable labour efficiency variance! You used too much time because of poorly trained workers and poor supervision.

You purchased cheap material, so it took more time to process it.

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Responsibility for Labour Variances
Maybe I can attribute the labour and material variances to personnel for hiring the wrong people and training them poorly.

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Standard Costs

Now let’s calculate standard cost variances for the last of the variable production costs – variable manufacturing overhead.
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• Labour variances:

NoteActual hours of the allocation base Actual variable overhead rate Standard variable overhead rate

– Labour rate variance • LRV = AH (AR - SR) • LEV = SR (AH - SH)

– Labour efficiency variance • Variable overhead variances:

– Variable overhead spending variance • VOSV = AH (AR - SR)

– Variable overhead efficiency variance
• VOEV = SR (AH - SH) Standard hours allowed • for the actual good output
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Variable Manufacturing Overhead Variances Example

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 labour hour

Last week 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead.
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Quick Check 

Zippy

What was Hanson’s actual rate (AR) for variable manufacturing overhead rate for the week? a. $3.00 per hour. b. $3.19 per hour. c. $3.30 per hour. d. $4.50 per hour.
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Quick Check 

Zippy

Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a. $465 unfavourable. b. $400 favourable. c. $335 unfavourable. d. $300 favourable.
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Quick Check 

Zippy

Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavourable. b. $435 favourable. c. $150 unfavourable. d. $150 favourable.
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Variable Manufacturing Overhead Variances
Actual Hours × Actual Rate
1,550 hours × $3.30 per hour = $5,115

Zippy

Actual Hours × Standard Rate
1,550 hours × $3.00 per hour = $4,650

Standard Hours × Standard Rate
1,500 hours × $3.00 per hour = $4,500

Spending variance $465 unfavourable

Efficiency variance $150 unfavourable

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Variable Manufacturing Overhead Variances: A Closer Look
If variable overhead is applied on the basis of direct labour hours, the labour efficiency and variable overhead efficiency variances will move in tandem.

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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.

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Advantages of Standard Costs
Possible reductions in production costs Management by exception

Advantages
Improved cost control and performance evaluation Better Information for planning and decision making

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Emphasis on negative may impact morale.

Favorable variances may be misinterpreted.

Standard cost reports may not be timely.

Potential Problems

Continuous improvement may be more important than meeting standards.

Labour quantity standards and efficiency variances may not be appropriate.

Emphasizing standards may exclude other important objectives.

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