Meeting 8 - Standard Costing and Variance

Meeting 8:
Standard Costing and Variance
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Learning Objectives
 How are material, labor, and overhead standards
set?
 How are material, labor, and overhead variances
calculated and recorded?
 Why are standard cost systems used?
 How have the setting and use of standards changed
over time?
 How does the use of a single conversion element
(rather than the traditional labor and overhead
elements) affect standard costing?
 (Appendix) How are variances affected by multiple
material and labor categories?
Standard Cost Systems
 Manufacturing
 Service
 Not-for-Profit
 Record standard and actual costs in the

accounting records
Standards
 Standard costs are budgeted costs to

 Manufacture a single unit of product or
 Perform a single service
 To develop standards, identify
 Material and labor types, quantities, and prices
 Overhead types and behavior
Manufacturing Objective
Minimize unit cost while achieving certain

quality specifications.
Input Output
Resources Quality
Material Standards
 Materials used  From

 Types  Product specifications,
 Quantity observation, inquiry
 Quality  Bill of materials
 Price
 Balance cost, quality, and projected sales price
Standard
Material = Unit Purchase Price * quantity
Cost
Labor Standards
 Labor used  From

 Types  Industrial engineering
 Production, setup, studies including
cleanup, and rework methods-time
 Quantity measurement (MTM),
 Cost time and motion studies,
historical data
 Include wages, payroll
taxes, and fringe  Operations flow
benefits document
Standard
Labor = Hours * Wage Rate
Cost
Overhead Standards
 Variable and fixed manufacturing
overhead
 Estimated level of activity
 Estimated costs
 Predetermined factory overhead
application rates
Standard Cost Card
For one unit of output (a bike)
Standard Direct Material Components
Standard Direct Labor Components
Manufacturing Overhead
Variable Overhead
Fixed Overhead
Variance
 Variance is the difference between

an actual cost and a standard cost.
Total Variance
Total actual cost incurred minus total standard cost
applied to output produced
Actual price of Standard cost of

actual actual
production input production
output
Total Variance*
*Favorable or unfavorable
Total Variance
AP x AQ SP x SQ
Total Variance
Inputs Outputs
AP = actual cost/price per unit of materials or hours of

labor
AQ = actual quantity of materials or hours of labor
SP = standard cost/price per unit of materials or
hours of labor
SQ = standard quantity of materials or hours of labor
Price Variance
AP x AQ SP x AQ SP x SQ
Price/Rate
Variance
Total Variance
What What should
was (AP – SP) x AQ* have been
paid paid
Usage Variance
Usage
Variance
Total Variance
What
was
What should
used (AQ – SQ) x SP* have been
used for the
level of output
Material Price Variance (MPV)
MPV
Total Variance
What What should
paid paid
MPV Calculations
 Calculate MPV at
 Point of purchase or
 When materials used
Material Quantity Variance (MQV)
MQV
What Total Variance
was
What should
used (AQ – SQ) x SP* have been
used for
level of output
Labor Rate Variance (LRV)
LRV
Total Variance
What
What should
paid
paid
Labor Efficiency Variance (LEV)
LEV
What Total Variance
was
used What should
(AQ – SQ) x SP* have been
used for
level of output
Overhead Variances
Variable Overhead Fixed Overhead
Actual variable overhead Actual fixed overhead is

is total of various ledger total of various ledger
accounts accounts
SP = Predetermined SP = Predetermined
variable overhead rate fixed overhead rate
Variable Overhead Variances
Actual Budgeted Applied
VOH VOH VOH
Actual SP x AQ SP x SQ
VOH VOH
Spending Efficiency
For Variance Variance
actual Total VOH Variance What should
hours have been
used used for level
of output
VOH Spending Variance
 Caused by price differences
 Managers have little control over prices
 Caused by shrinkage or waste
 Managers should be held accountable
Fixed Overhead Variances
Actual Budgeted Applied
FOH FOH FOH
SP x SQ
FOH FOH
Spending Volume
Constant Variance Variance
Amount Total FOH Variance What should
have been
used for level
of output
FOH Spending and Volume Variance
 FOH Spending  FOH Volume Variance

Variance  Measures capacity
 Calculate variance for utilization
each component  Caused by producing at
 Caused by price a level that differs from
differences the capacity level used to
 May reflect compute the
mismanagement of predetermined overhead
resources rate
 Also called the
noncontrollable variance
Alternative Overhead Variance
Approaches
 One variance
 Two variance
 Three variance
 Four variance
One Variance Approach
Actual Standard
OH Cost of
OH
SP x SQ
Total OH Variance
Applied
Overhead
Two Variance Approach
Actual Budgeted OH Standard

OH based on SQ Cost of
OH
SP x SQ
Budget Volume
Variance Variance
Total OH Variance Applied
Overhead
Three Variance Approach
Budgeted OH
Actual Standard
based on based on
OH Actual Inputs Actual Output OH
SP x SQ
OH OH
h1
Spending Efficiency Volume
Variance Variance Variance
Total OH Variance Applied
Overhead
Slide 31
h1 AU: Please check if "Volume Variance" should be "OH Volume Variance."

hhenjum; 04/02/2010
Standard Cost Journal Entries
 Variances recorded in accounting system
 Favorable variances
 Credits
 Represent savings in production costs
 Unfavorable variances
 Debits
 Represent excess production costs
 Inventories are recorded at standard cost
during the period
Purchase of Materials
(Point of Purchase Method)
At
Standard
Materials
Cost
Price
Materials Variance Accts Pay
SP x AQ U F AP x AQ
purchased purchased
Debit—Unfavorable
Credit—Favorable
Use of Materials
At
Standard Materials
Cost Quantity
WIP Variance Materials
SP x SQ U F SP x AQ
allowed used
Debit—Unfavorable
Credit—Favorable
Record Labor
LEV
At LRV
Standard
Cost
U F U F
WIP Wages Pay
SP x SQ AP x AQ
allowed
Debit—Unfavorable
Credit—Favorable
Apply Overhead
WIP VOH FOH

SP x SQ SP x SQ SP x SQ
Allowed Allowed Allowed
Year-End Treatment for VOH
VOH VOH
Efficiency Spending
Variance Variance VOH
Actual Applied
---------------
Debit—Unfavorable Enter a debit or

credit to bring
Credit—Favorable
balance to zero
Year-End Treatment for FOH
FOH
Spending Volume
Variance Variance FOH
Actual Applied
-------------
Debit—Unfavorable Enter a debit or

credit to bring
Credit—Favorable
balance to zero
Year-End Treatment of Variances
Immaterial—Adjust Cost of Goods Sold
Material—Prorate variances to:
 Material Price  All other variances
Variances  WIP
 Raw Materials  Finished Goods
 WIP  Cost of Goods Sold
 Finished Goods
 Cost of Goods Sold
Why Use Standard Cost Systems
 Motivation
 Planning
 Controlling—variance analysis
 Decision making
 Performance evaluation
Setting Standards and Trends
 Setting Standards  Trends in Standards

 Appropriateness  Ideal Standards and
 Attainability Theoretical Capacity

 Expected standards  Adjusting standards
 Practical standards  Price variance on

 Ideal standards purchase versus
usage
 Decline in direct labor
content
Conversion Costs
 Combine direct labor and manufacturing

overhead
 Variances
 Spending variance for overhead
 Efficiency variances for machinery and production
costs
 Volume variances for production
Material Price, Mix, and Yield Variances
AM x AM x SM x SM x
AQ x AQ x AQ x SQ x
AP SP SP SP
Material Material Material

Price Mix Yield
What should
AM—Actual Mix
have been
SM—Standard Mix used for level
of output?
Labor Rate, Mix, and Yield Variances
AM x AM x SM x SM x
AH x AH x AH x SH x
AR SR SR SR
Labor Labor Labor

Rate Mix Yield
What should
M—Mix have been
H—Hours used for level
R—Rate of output?
Questions
 How are standards set for material, labor,

and overhead?
 How is variance analysis used for control
and performance evaluation?
 Why are labor and overhead elements
sometimes combined into a single
conversion element?
Potential Ethical Issues
 Setting high standards to create favorable variances
 Ignoring effects of one production area on another
 Setting overhead rates too low based on high
production levels to distort inventory cost and
operating income
 Producing inventory only to create a favorable volume
variance
 Not updating standards so that favorable variances
are created
 Using low quality materials or labor to create favorable
variances and low quality products

Meeting 8 - Standard Costing and Variance

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Meeting 8:

Standard Costing and Variance

 Record standard and actual costs in the

 Standard costs are budgeted costs to

Minimize unit cost while achieving certain

 Materials used  From

 Balance cost, quality, and projected sales price

 Labor used  From

 Variance is the difference between

Actual price of Standard cost of

AP = actual cost/price per unit of materials or hours of

 When materials used

Actual variable overhead Actual fixed overhead is

 FOH Spending  FOH Volume Variance

Actual Budgeted OH Standard

h1 AU: Please check if "Volume Variance" should be "OH Volume Variance."

WIP VOH FOH

Debit—Unfavorable Enter a debit or

Debit—Unfavorable Enter a debit or

 Setting Standards  Trends in Standards

 Attainability Theoretical Capacity

 Practical standards  Price variance on

 Combine direct labor and manufacturing

Material Material Material

Labor Labor Labor

 How are standards set for material, labor,

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