Standard Costing: A Managerial Tool

Exercise 1: Garrison Company has a contract with a major computer manufacturer to do warranty
repairs for computers with a given set of failure diagnostics. During the year, Garrison Company
repaired 1,700 units. Garrison’s materials and labor standards for performing the repairs are:
Direct materials (4 components @ $14.00) $56
Direct labor (1.5 hr. @ $16) 24

Required
1. Compute the standard hours allowed for the repair of 1,700 units.
2. Compute the standard number of components allowed for the repair of 1,700 units.
3.
Exercise 2: Seasonal Confections, Inc., a manufacturer of candies for various seasons of the year, wants
to set up a standard costing system. The controller decided to set up a standard cost card for one
product line. He chose the chocolate bunny line, which operates from February through April of each
year. The chocolate bunnies are 8" tall dark chocolate molded rabbits. They are very popular each Easter
season. Last year, Seasonal Confections produced 40,000 dark chocolate bunnies with the following
total costs:
Direct materials (340,000 oz. @ $0.30) $102,000
Direct labor (10,000 DLH @ $9) 90,000

Required
1. Compute the direct materials allowed per bunny in ounces.
2. Compute the direct labor hours allowed per bunny in hours.
3. Set up a standard cost card for the prime cost of one chocolate bunny.

Exercise 3: Suppose that Seasonal Confections expects to produce 47,000 dark chocolate bunnies this
spring.

Required
1. Compute the standard quantity of direct materials allowed for the production of 47,000
bunnies. 2. Compute the standard hours allowed for the production of 47,000 bunnies. 3.
Compute the total standard prime cost for the production of 47,000 bunnies.

Exercise 4: Ellerbee Cable Company uses a standard costing system to control the labor costs associated
with cable installation and repair. Ellerbee uses the following rule to determine whether the labor
efficiency variance should be investigated: a labor efficiency variance will be investigated when the
amount exceeds the lesser of $2,100 or 5% of standard cost. The company collected reports for the past
four months to provide the following information:
Required
1. Using the rule provided, identify the cases that will be investigated.
2. Suppose investigation reveals that the cause of an unfavorable labor efficiency variance is the
hiring of a number of new workers who worked more slowly while they were being trained.
Who is responsible? What corrective action would likely be taken?

Exercise 5: Juice Company produces fruit juices, sold in gallons. Recently, the company adopted the
following standards for one gallon of its cranberry juice:

During the first week of operation, the company experienced the following actual results:
a. Gallon units produced: 52,000
b. Ounces of materials purchased: 6,420,000 ounces at $0.047
c. No beginning or ending inventories of raw materials
d. Direct labor: 2,000 hours at $12.50

Required
1. Compute price and usage variances for direct materials.
2. Compute the rate variance and the efficiency variance for direct labor.
Exercise 6:Guerin Corporation produces leather purses. The company uses a standard costing system
and has set the following standards for materials and labor:

During the year, Guerin produced 34,000 leather purses. Actual leather purchased was 173,500 strips at
$6.82 per strip. There were no beginning or ending inventories of leather. Actual direct labor was 50,900
hours at $13.50 per hour.

Required
1. Compute the costs of leather and direct labor that should have been incurred for the production
of 34,000 leather purses.
2. Compute the total budget variances for materials and labor.
3. Break down the total variance for materials into a price variance and a usage variance.
4. Break down the total variance for labor into a rate variance and an efficiency variance.

Problem 1: Jasper Company manufactures large plastic bins for industrial usage. One of Jasper’s larger
customers uses model T-367. Jasper located a plant dedicated to the manufacture of model T-367 across
the street from the customer’s plant. To help ensure cost efficiency, a standard costing system was
installed in the plant. The following standards have been established for the product’s variable inputs:
During the first week in January, the company had the following actual results:

Other information includes the following. The purchasing agent located a new source of slightly higher-
quality plastic, and this material was used during the first week in January. Also, a new manufacturing
process was implemented on a trial basis. The new process required a slightly higher level of skilled
labor. The higher quality material has no effect on labor utilization. However, the new manufacturing
process was expected to reduce materials usage by 0.25 pound per can.

Required
1. Compute the materials price and usage variances. Assume that the 0.25 pound reduction of
materials occurred as expected and that the remaining effects are all attributable to the higher-
quality material. Would you recommend that the purchasing agent continue to buy this quality?
Or should the usual quality be purchased? Assume that the quality of the end product is not
affected significantly.
2. Compute the labor rate and efficiency variances. Assuming that the labor variances are
attributable to the new manufacturing process, should it be continued or discontinued? In
answering, consider the new process’s materials reduction effect as well. Explain.
3. Refer to Requirement 2. Suppose that the industrial engineer argued that the new process
should not be evaluated after only one week. His reasoning was that it would take at least a
week for the workers to become efficient with the new approach. Suppose that the production
is the same the second week and that the actual labor hours were 2,200 and the labor cost was
$22,400. Should the new process be adopted? Assume the variances are attributable to the
new process. Assuming production of 4,000 units per week, what would be the projected
annual savings? (Include the materials reduction effect.)

Problem 2: Mantenga Company provides routine maintenance services for heavy moving and
transportation vehicles. Although the vehicles vary, the maintenance services provided follow a fairly
standard pattern. Recently, a potential new customer has approached the company and requested a
new maintenance service for a radically different type of vehicle. New servicing equipment and some
new labor skills will be needed to provide the maintenance service. The customer is placing an initial
order to service 150 vehicles and has indicated that if the service is satisfactory, several additional
orders of the same size will be placed every three months over the next three to five years.
Mantenga uses a standard costing system and wants to develop a set of standards for the new
service. The usage standards for direct materials such as oil, lubricants, and transmission fluids were
easily established. The usage standard is 25 quarts per servicing with a standard cost of $4.00 per quart.
Management has also decided on standard rates for labor and overhead: the standard labor rate is $15
per hour, the standard variable overhead rate is $8 per hour, and the standard fixed overhead rate is
$12 per hour. The only remaining decision is the standard for labor usage. To assist in developing this
standard, the engineering department has estimated the following relationship between units serviced
and average direct labor hours used:

As the workers learn more about servicing the new vehicles, they become more efficient, and
the average time needed to service one unit declines. Engineering estimates that all of the learning
effects will be achieved by the time 320 units are produced. No further improvement will be realized
past this level.

Required
1. Assuming no further improvement in labor time per unit is possible past 320 units, explain why
the cumulative average time per unit at 640 is lower than the time at 320 units.
2. What standard would you set for the per-unit usage of direct labor? Explain.
3. Using the labor standard from Requirement 2, prepare a standard cost sheet that details the
standard service cost per unit.
4. Given the standard you set in Requirement 2, would you expect favorable or unfavorable labor
and variable overhead efficiency variances for servicing the first 320 units? Explain.

Problem 3: The Minot plant of Rao’s Small Motor Division produces a major subassembly for
motorcycles. The plant uses a standard costing system for production costing and control. The standard
cost

During the year, the Minot plant had the following actual production activity:
a. Production of subassemblies totaled 70,000 units.
b. A total of 465,000 pounds of materials was purchased at $5.80 per pound.
c. There were 26,400 pounds of materials in beginning inventory (carried at $6 per pound). There
was no ending inventory.
d. The company used 150,000 direct labor hours at a total cost of $1,950,000.
e. Actual fixed overhead totaled $913,000.
f. Actual variable overhead totaled $1,470,000.
The Minot plant’s practical activity is 75,000 units per year. Standard overhead rates are computed
based on practical activity measured in standard direct labor hourssheet for the subassembly follows:
Required
1. Compute the materials price and usage variances. Of the two materials variances, which is
viewed as the most controllable? To whom would you assign responsibility for the usage
variance in this case? Explain.
 2. Compute the labor rate and efficiency variances. Who is usually responsible for the labor
efficiency variance? What are some possible causes for this variance?
3. Compute the variable overhead spending and efficiency variances.
4. Compute the fixed overhead spending and volume variances. Interpret the volume variance.
What can be done to reduce this variance?
5. Assume that the purchasing agent for the small motors plant purchased a lowerquality
material from a new supplier. Would you recommend that the plant continue to use this
cheaper material? If so, what standards would likely need revision to reflect this decision?
Assume that the end product’s quality is not significantly affected.
6. Prepare all possible journal entries.

Problem 4: Norris Company produces telephones. To help control costs, Norris employs a standard
costing system and uses a flexible budget to predict overhead costs at various levels of activity. For the
most recent year, Norris used a standard overhead rate of $18 per direct labor hour. The rate was
computed using practical activity. Budgeted overhead costs are $792,000 for 36,000 direct labor hours
and $1,080,000 for 60,000 direct labor hours. During the past year, Norris generated the following data:
a. Actual production: 100,000 units
b. Fixed overhead volume variance: $36,000 U
c. Variable overhead efficiency variance: $24,000 F
d. Actual fixed overhead costs: $380,000 e. Actual variable overhead costs: $620,000
Required
1. Calculate the fixed overhead rate.
2. Determine the fixed overhead spending variance.
3. Determine the variable overhead spending variance.
4. Determine the standard hours allowed per unit of product.
5. Assuming the standard labor rate is $13 per hour, compute the labor efficiency variance.

Case 1: Sabroso Chips was established in 1938 by Paul and Nancy Golding (Nancy sold her piano to help
raise capital to start the business). Paul assumed responsibility for buying potatoes and selling chips to
local grocers; Nancy assumed responsibility for production. Since Nancy was already known for her
delicious, thin potato chips, the business prospered.

Over the past 70 years, the company has established distribution channels in 11 western states, with
production facilities in Utah, New Mexico, and Colorado. In 1980, Paul and Nancy Golding both died, and
their son, Edward, took control of the business. By 2018, the company was facing stiff competition from
national snack-food companies. Edward was advised that the company’s plants needed to gain better
control over production costs. To assist in achieving this objective, he hired a consultant to install a
standard costing system. To help the consultant in establishing the necessary standards, Edward sent
her the following memo:

To: Diana Craig, CMA

From: Edward Golding, President, Sabroso Chips
Subject: Description and Data Relating to the Production of Our Plain Potato Chips
Date: September 28, 2018

The manufacturing process for potato chips begins when the potatoes are placed into a large vat
in which they are automatically washed. After washing, the potatoes flow directly to an automatic
peeler. The peeled potatoes then pass by inspectors who manually cut out deep eyes or other
blemishes. After inspection, the potatoes are automatically sliced and dropped into the cooking oil. The
frying process is closely monitored by an employee. After they are cooked, the chips pass under a salting
device and then pass by more inspectors, who sort out the unacceptable finished chips (those that are
discolored or too small). The chips then continue on the conveyor belt to a bagging machine that bags
them in one-pound bags. After bagging, the bags are placed in a box and shipped. Each box holds 15
bags.
The raw potato pieces (eyes and blemishes), peelings, and rejected finished chips are sold to
animal-feed producers for $0.16 per pound. The company uses this revenue to reduce the cost of
potatoes; we would like this reflected in the price standard relating to potatoes.
Sabroso Chips purchases high-quality potatoes at a cost of $0.245 per pound. Each potato
averages 4.25 ounces. Under efficient operating conditions, it takes four potatoes to produce one 16-
ounce bag of plain chips. Although we label bags as containing 16 ounces, we actually place 16.3 ounces
in each bag. We plan to continue this policy to ensure customer satisfaction. In addition to potatoes,
other materials include the cooking oil, salt, bags, and boxes. Cooking oil costs $0.04 per ounce, and we
use 3.3 ounces of oil per bag of chips. The cost of salt is so small that we add it to overhead. Bags cost
$0.11 each and boxes $0.52.
Our plant produces 8.8 million bags of chips per year. A recent engineering study revealed that
we would need the following direct labor hours to produce this quantity if our plant operates at peak
efficiency:

Raw potato inspection 3,200

Finished chip inspection 12,000
Frying monitor 6,300
Boxing 16,600
Machine operators 6,300

I’m not sure that we can achieve the level of efficiency advocated by the study. In my opinion,
the plant is operating efficiently for the level of output indicated if the hours allowed are about 10
percent higher.
The hourly labor rates agreed upon with the union are:

Raw potato inspectors $15.20

Finished chip inspectors 10.30
Frying monitor 14.00
Boxing 11.00
Machine operators 13.00
 Overhead is applied on the basis of direct labor dollars. We have found that variable overhead
averages about 116 percent of our direct labor cost. Our fixed overhead is budgeted at $1,135,216 for
the coming year

Required
1. Discuss the benefits of a standard costing system for Sabroso Chips.
2. Discuss the president’s concern about using the results of the engineering study to set the labor
standards. What standard would you recommend?
3. Develop a standard cost sheet for Sabroso Chips’ plain potato chips.
4. Suppose that the level of production was 8.8 million bags of potato chips for the year as
planned. If 9.5 million pounds of potatoes were used, compute the materials usage variance for
potatoes.

Case 2: Pat James, the purchasing agent for a local plant of the Oakden Electronics Division, was
considering the possible purchase of a component from a new supplier. The component’s purchase
price, $0.90, compared favorably with the standard price of $1.10. Given the quantity that would be
purchased, Pat knew that the favorable price variance would help offset an unfavorable variance for
another component. By offsetting the unfavorable variance, his overall performance report would be
impressive and good enough to help him qualify for the annual bonus. More importantly, a good
performance rating this year would help him secure a position at division headquarters at a significant
salary increase.
Purchase of the part, however, presented Pat with a dilemma. He had made inquiries regarding
the reliability of the new supplier and the part’s quality, and reports were basically negative. The
supplier had a reputation for making the first two or three deliveries on schedule, but being unreliable
from then on. Worse, the part itself was of questionable quality. The number of defective units was only
slightly higher than that for other suppliers, but the life of the component was 25 percent less than what
other sources provided.
If the part were purchased, no problems with deliveries would surface for several months. The
problem of shorter life would cause eventual customer dissatisfaction and perhaps some loss of sales,
but the part would last at least 18 months after the final product began to be used. If all went well, Pat
expected to be at headquarters within six months. He saw very little personal risk associated with a
decision to purchase the part from the new supplier. By the time any problems surfaced, they would
belong to his successor. With this rationalization, Pat decided to purchase the component from the new
supplier.

Required
1. Do you agree with Pat’s decision? Why or why not? How important do you think Pat’s
assessment of his personal risk was in the decision? Should it be a factor?
2. Do you think that the use of standards and the practice of holding individuals accountable
for their achievement played major roles in Pat’s decision?
3. Review the ethical standards for management accountants in Chapter 1. Even though Pat is
not a management accountant, identify the standards that might apply to his situation.
Should every company adopt a set of ethical standards that apply to their employees,
regardless of their specialty?