Cost Accounting: Standard Costing

Chapter 7:
Standard Costing and

Variance Analysis
Cost Accounting:
Foundations & Evolutions, 9e
Kinney and Raiborn
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Learning Objectives
◼ Why are standard cost systems used?
◼ How are material, labor, and overhead standards set?
◼ How are material, labor, and overhead variances
calculated and recorded?
◼ 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?
Why Use Standard Cost Systems
A standard cost system tracks both standard and
actual costs. This dual recording provides an
essential element to cost control: having norms
against which actual operations can be compared.
◼ Motivating
◼ Planning
◼ Controlling - variance analysis
◼ Clerical efficiency
◼ Decision making
◼ Performance evaluation
Setting Standards
◼ Appropriateness
◼ Attainability
❑ Expected standards
❑ Practical standards
❑ Ideal standards
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
Material Standards
◼ Materials used
❑ Types
❑ Quality
❑ Quantity
❑ Price
◼ From
❑ Product specifications, observation, inquiry
❑ Bill of materials
◼ Balance cost, quality, and projected sales price
Labor Standards
◼ Labor used
❑ Types
◼ Production, setup, cleanup, and rework
❑ Quantity
❑ Cost
◼ Include wages, payroll taxes, and fringe benefits
◼ From
❑ Industrial engineering studies including methods-
time measurement (MTM), time and motion studies,

and historical data
❑ Operations flow document
Overhead Standards
◼ Variable and fixed manufacturing
overhead
◼ Estimated level of activity
◼ Estimated costs
◼ Predetermined factory overhead
application rates
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
Material Price Variance (MPV)
AP x AQ SP x AQ SP x SQ
MPV
Total Variance
What
was What should
(AP - SP) x AQ* have been
paid
paid
*Favorable or unfavorable
Material Price Variance
◼ Calculate Material Price Variance at

❑ point of purchase, or
❑ when materials used
Material Quantity Variance (MQV)
MQV
Total Variance
What
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
was (AP - SP) x AQ* have been
paid
paid
Labor Efficiency Variance (LEV)
LEV
Total Variance
What
was What should
used (AQ - SQ) x SP* have been
used for
level of output
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
hours
What should 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 Variance
◼ Calculate variance for each component
◼ Caused by price differences
◼ May reflect mismanagement of
resources
FOH Volume Variance
◼ Calculate variance for each component

◼ Measures capacity utilization
◼ Caused by producing at a level that differs
from the capacity level used to compute
the predetermined overhead rate
◼ Also called the noncontrollable variance
Questions
◼ Why are standard cost systems used?

◼ How are standards set for material, labor,
and overhead?
◼ How are material, labor and overhead
variances calculated and recorded?
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

Cost Accounting: Standard Costing

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Cost Accounting: Standard Costing

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Chapter 7:

Standard Costing and

Kinney and Raiborn

◼ Balance cost, quality, and projected sales price

time measurement (MTM), time and motion studies,

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

◼ Calculate Material Price Variance at

❑ when materials used

◼ Caused by price differences

◼ Calculate variance for each component

◼ Why are standard cost systems used?

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