Standard Costing

Accounting 2020-Chapter 10
Prof. Richard McDermott
What is a Standard?
• A goal
• A yardstick
• A requirement
• A criterion
• Merriam-Webster says
– A definite rule, principle, or measure
established by authority.
In Cost Accounting . . .
• A standard is a budgeted cost per
unit of product.
• We have standard costs for:
– Direct labor
– Direct materials
– Factory overhead
Taxonomy
• A way of classifying things.
• How could you classify the marbles
in a large jar?
– By size
– By color
– By material
– Etc.
One Accounting Taxonomy
• Actual costing system
• Normal costing system
• Standard costing system
Actual Costing System
• Debit work-in-process for
– Actual direct labor
– Actual direct materials
– Actual factory overhead
• Actual costing systems are rarely
used because
– One cannot establish product
overhead costs until the period is over
– Fluctuations in monthly fixed overhead
or monthly production distorts product
costs
Normal Costing System
• Debit work-in-process for
– Direct labor
– Direct materials
– Overhead applied using an overhead
rate
• This is basically what you have
been taught up to this point.
Standard Costing System
• Debit work-in-process for:
– Standard direct labor
– Standard direct materials
– Standard factory overhead
• Standard variable overhead
• Standard fixed overhead
• Calculate variances and debit or
credit them to
– Cost of goods sold if not material
– WIP, Finished Goods & COGs if
material
Standard Costing Reports:
• Standard Costs—what a product
should cost.
• Actual Costs—what the actual
actually cost
• Cost Variances—the difference
between a standard cost and the
actual cost.
Example
• The standard direct labor cost for a
widget is $12.00.
• During January 2008 the actual
cost to manufacture one widget
was $11.50
• There was a favorable cost
variance of $0.50.
Types of Standards
• Ideal Standards—represent
optimum levels of performance
under perfect operating conditions.
• Normal Standards—represent
efficient levels of performance that
are attainable under expected
operating conditions.
Why Standard Costing?
• Facilitation of • Provides basis for
management evaluating
planning. management
• Make employees performance.
more cost • Allows
conscious. management by
• Helpful in setting exception.
prices. • Simplifies clerical
costs and
inventory costing.
What is best?
• Most managers believe it is best to
use rigorous but attainable
standards.
• We classify these as normal
standards.
• In the remainder of this chapter we
assume standard costs are set at a
normal level.
Direct Materials Standard
• What the cost of direct materials
should be to manufacture one unit.
• Standard direct material cost can
include:
• Purchase price of materials
• Freight
• Receiving and handling
Direct Materials Standard
• Is broken into two sub-standards
• Quantity Standard—how much
(ounces, pounds and so on) of the
material one unit of the product
should contain
• Price Standard—what the price per
unit of material (ounce, pound, and
so on) should be.
Direct Materials Variances
• Price Variance—the cost difference
attributable to the difference between
the standard price of one unit of material
and the actual price of one unit of
material.
• Quantity Variance—the cost difference
attributable to the difference between
the standard amount and the actual
amount in one unit of the product during
the period.
Calculation of Variances

AQ X AP = X1 Where:

AQ = actual quantity
AQ x SP = X2 AP = actual price
SQ = standard
quantity
SQ x SP = X3 SP = standard price
Calculation of Variances

AQ X AP = X1
Price Variance
AQ x SP = X2
Quantity
Variance
SQ x SP = X3
Example
• The standard material for one ingot
is 2 pounds of copper at $2.00 per
pound.
• During the period the company
made 1,000 ingots.
• The company actually used 1,950
pounds of copper costing $1.75 per
pound.
• What are the direct
material variances?
Example
AQ X AP = X1
1950 x $1.75 = $3,412.50
$487.50
AQ x SP = X2 Favorable
1950 x $2.00 = $3,900.00 Price
Example
AQ X AP = X1
1950 x $1.75 = $3,412.50
$487.50
AQ x SP = X2 Favorable
1950 x $2.00 = $3,900.00 Price

$100 Favorable
SQ x SP = X3
Quantity
2000 x $2 = $4,000.00
Direct Labor Variances
• The standard is based on current
wage rates, adjusted for
anticipated changes such as cost of
living adjustments.
• The rate standard also generally
includes employer payroll taxes,
and fringe benefits such as paid
holidays and vacations.
Direct Labor Variance

AH X AR = X1 Where:

AH = actual hours
AR = actual rate
AH x SR = X2 SH = standard
hours
SR = standard rate
SH x SR = X3
Note: This is essentially the same formula as for materials, except
we substitute hours for quantity, and rate for price.
Example
• The standard hours for one ingot is
1 hour at $10 per hour.
• During the period the company
made 1,000 ingots.
• The company actually used 1,050
hours at a total labor cost of
$10,237.50
• What are the direct
labor variances?
Example
AH X AR = X1
1050 x $9.75 = $10,237.50
$262.50
AH x SR = X2 Favorable
1050 x $10.00 = $10,500.00 Rate
Example
AH X AR = X1
1050 x $9.75 = $10,237.50
$262.50
AH x SR = X2 Favorable
1050 x $10.00 = $10,500.00 Rate

$500
SH x SR = X3 Unfavorable
1000 x $10.00 = $10.000.00 Efficiency
Manufacturing Overhead
• Similar to manufacturing overhead
rate we learned about earlier.
• Applied using a base such as direct
labor hours or dollars.
• Usually there are separate
standards for fixed and variable
overhead.
• Formula: Actual overhead –
overhead applied = total overhead
variance
Overhead Variance
• The total overhead variance can be
broken into a controllable variance
and a overhead volume variance.
• The formula is:
• Actual OH – Budgeted OH =
Controllable variance
• Fixed OH rate x (Normal capacity
hours – standard hours allowed) =
overhead volume variance
Three Kinds of Overhead
• Budgeted overhead—number we
came up with at the beginning of
the year.
– Use for one thing—to calculate rate for
the year (actually we use it for
calculating variance)
• Actual overhead—this is what we
actually spent, this number comes
from the general ledger).
• Overhead applied—budgeted
overhead rate x base.
Overhead Variance
• The controllable variance tells
whether spending on individual
overhead items was controlled or
not.
• The volume variance relates to
whether overhead was over or
under applied due to differences in
budgeted base and actual base.
– i.e. did we us too many overhead
hours (if it is the base) or fewer than
we estimated?
Overhead Variance
• There was not a problem assigned
in the homework for overhead
variances.
• You may be tested on the concept
in Appendix 11B, however.
• We will work some example
questions in class before taking the
test.
Who is Responsible?
• Materials price variance—usually
the purchasing agent
• Materials quantity variance—
usually the production supervisor
• Labor rate variance—usually the
personnel director
• Labor efficiency variance—usually
the production supervisor
Who is Responsible?
• Overhead variances
– Over or under spending on specific
overhead items
– Use of more or less of the base than
anticipated. For example if the base is
direct labor hours, then additional
hours used incur additional fringe
benefit costs, one component of the
overhead pool.
Reporting Variances
• Report variances to appropriate
levels of management as soon as
possible.
• The form, content, and frequency
of variance reports varies
considerably among companies.
• In income statements prepared for
management, cost of goods sold is
stated at standard costs and the
variances are disclosed separately.
Book Example
Sales $60,000
COGS (at standard) 42,000
Gross profit (at standard) $18,000
Variances
Materials price $420
Materials quantity 600
Labor rate (420)
Labor quantity 1,000
Overhead 900
Total variances unfavorable 2,500
Gross profit (actual) 15,500
Selling and Administrative 3,000
Net Income $12,500
Balanced Scorecard
• Based on the concept that
accountants should report on more
than just financial matters.
• The balanced scorecard should
report on the key factors necessary
to implement the company’s
strategy.
Four Most Common Perspectives

• Financial Perspective—financial
measures of performance used by
most firms.
• Customer perspective—evaluates
how well the company is
performing from the viewpoint of
the customer.
Four Most Common Perspectives

• Internal Growth Perspectiv2—

evaluates the internal growth
processes critical to success such
as product development,
production, delivery and after sales
service.
• Learning and Growth Perspective—
evaluates how well the company
develops and retains its
employees.
Brief Exercise 11-2
• Asaki Company accumulates the
following data concerning raw
materials in making one gallon of
finished product:
– Price—net purchase price $2.20,
freight-in $0.20, and receiving and
handling $0.10.
– Quantity—required materials 2.6
pounds, allowance for waste and
spoilage 0.4 pounds.
• Compute required variances.
Brief Exercise 11-2
• Standard direct materials price
per gallon = $2.20 purchase price
+ $0.20 freight-in + $0.10
receiving and handling = $2.50.
• Standard direct materials
quantity per gallon = 2.6
poundsquantity needed +
allowance for spoilage 0.4 = 3.00
pounds.
Brief Exercise 11-2
• Standard direct materials cost
per gallon = $2.50 x 3.00 pounds
= $7.50.
Exercise 11-2
• Tony Rondeli manufactures and
sells homemade wine, and he
wants to develop a standard cost
per gallon.
Exercise 11-2
• The following costs are required for
a production of a 50 gallon batch.
– 3,000 ounces of grape concentrate at
$0.40 per ounce
– 54 pounds of granulated sugar at
$0.35 per pound
– 60 lemons at $0.60 each
– 50 yeast nutrient tablets at $0.25 each
– 50 nutrient tablets at $0.20 each
– 2,500 ounces of water at $.004 per
ounce
Exercise 11-2
• Tony estimates that 4% of the
grape concentrate is wasted, 10%
of the sugar is lost, and 20% of the
lemons cannot be used.
• Compute the standard cost of the
ingredients for one gallon wine
(carry computations to two decimal
places).
Exercise 11-2
• Let’s start by figuring how much we
have to buy of the ingredients to
have the wastage and still have
enough to make 50 gallons.
• Let’s start with the 4% waste of
grape concentrate.
• This is not 4% of the concentrate
that goes into the juice, but 4% of
the purchased concentrate.
Exercise 11-2
• Grape Concentrate:
• Let X = amount that must be
purchased before waste
• For one gallon we need 60 0z
• X - .04X = 60 (amount needed for 1
gallon_
• .96 x = 60
• X = 62.50 standard amount
purchased
Exercise 11-2
• Sugar:
• Let X = amount that must be
purchased before waste
• For one gallon we need 54/50 =
1.08 pounds of input
• X - .10X = 1.08 pounds
• .9X = 1.08 pounds
• X = 1.2 pounds
Exercise 11-2
• Lemons:
• We need 60/50 lemons for 1 gallon
= 1.20 lemons
• X - .20X = 1.20
• .8X = 1.20
• X = 1.50 lemons

Now we are ready to calculate the

total standard cost of materials.
Standard Materials
Amount Standard
Ingredient Per Standard Standard Standard Cost Per
Gallon Waste Usage Price Gallon

Grape concentrate 60* oz.  4%   62.5 oz.       $.04    $2.50

Sugar (54 ÷ 50) 1.08 lb. 10% 1.2 lb.  .35      .42
Lemons (60 ÷ 50) 1.2 20% 1.5  .60       .90
Yeast 1 tablet  0% 1 tablet  .25      .25
Nutrient 1 tablet  0% 1 tablet  .20      .20
Water (2,500 ÷ 50) 50 oz.  0% 50 oz. .004   .20
$4.47

Standar
Amoun Amount d
t used Purchased Cost
Exercise 11-3 (to be cont)
• Muhsin Co. has gathered the
information shown on page 502
about its product.
• Direct materials: Each unit of
product contains 4.5 pounds of
materials.