MA 6e PPT Ch10 IE NEW

CORNERSTONES
of Managerial Accounting, 6e
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CHAPTER 10:
STANDARD COSTING: A
MANAGERIAL CONTROL TOOL
Cornerstones of Managerial
Accounting, 6e
Learning Objectives
1. Explain how unit standards are set and why standard

cost systems are adopted.
2. Explain the purpose of a standard cost sheet.
3. Describe the basic concepts underlying variance
analysis, and explain when variances should be
investigated.
4. Compute the materials variances, and explain how they
are used for control.
5. Compute the labor variances, and explain how they are
used for control.
6. (Appendix 10A) Prepare journal entries for materials
and labor variances.
Unit Standards
 Budgets set standards that are used to control
and evaluate managerial performance.
 To determine the unit standard cost for a
particular input, two decisions must be made:
 The quantity decision: The amount of input that should
be used per unit of output
 The pricing decision: The amount that should be paid
for the quantity of the input to be used
LO-1
Quantity and Price Standards
 The quantity decision produces quantity
standards.
 The pricing decision produces price standards.
 The unit standard cost can be computed by
multiplying these two standards:
Standard cost per unit = Quantity standard x

Price standard
LO-1
How Standards Are Developed
 Three potential sources of quantitative standards
are as follows:
 Historical experience: Provides an initial guideline for
setting standards, but should be used with caution
because they can perpetuate existing inefficiencies.
 Engineering studies: Identifies efficient approaches
rigorous guidelines, but engineered standards often are
too rigorous.
 Input from operating personnel: Since operating
personnel are accountable for meeting standards, they
should have significant input in setting standards.
LO-1
Types of Standards
 Standards are generally classified as either ideal or
currently attainable.
 Ideal standards demand maximum efficiency and can be
achieved only if everything operates perfectly.
 Currently attainable standards can be achieved under
efficient operating conditions. Allowance is made for
normal breakdowns, interruptions, and less than perfect
skill.
LO-1
Types of Standards (cont.)
 Of the two types, currently attainable standards offer the
most behavioral benefits.
LO-1
Why Standard Cost Systems
Are Adopted
 Two reasons for adopting a standard cost system
are frequently mentioned:
 To improve planning and control
 Comparing actual costs with budgeted costs identifies
variances, the difference between the actual and planned
costs for the actual level of activity.
 Overall variances can be further broken down into a price
variance or a usage or efficiency variance if unit price or
quantity standards have been developed.
LO-1
Why Standard Cost Systems
Are Adopted (cont.)
 To facilitate product costing
 Costs are assigned to products using quantity and price
standards for all three manufacturing costs: direct materials,
direct labor, and overhead.
 Standard costing and variance analysis for
controlling cost and evaluating performance can
have strong ethical implications.
LO-1
Cost Assignment Approaches
LO-1
Advantages of
Standard Product Costing
 Standard product costing has several advantages
over normal costing and actual costing.
 Greater capacity for control
 Provides readily available unit cost information that can
be used for pricing decisions at any time throughout the
period because actual costs do not need to be known
 No unit cost calculations for each equivalent unit
category in process costing
 No need to distinguish between FIFO and weighted
average methods of accounting for beginning inventory
costs
LO-1
Standard Product Costs
 In manufacturing firms, standard costs are
developed for direct materials, direct labor, and
overhead.
 Using these costs, the standard cost per unit is
computed.
 The standard cost sheet provides the
production data needed to calculate the standard
unit cost.
LO-2
The Standard Cost Sheet
 The standard cost sheet also shows the quantity
of each input that should be used to produce one
unit of output.
 A manager should be able to compute the
standard quantity of materials allowed (SQ)
and the standard hours allowed (SH) for the
actual output, where:
and
LO-2
The Standard Cost Sheet (cont.)
LO-2
Computing Standard Quantities Allowed
(SQ & SH)
LO-2
Variance Analysis:
General Description
 Actual input cost can be calculated as:

Actual cost = AP x AQ
where
AP = Actual price per unit
AQ = Actual quantity of input used
LO-3
Variance Analysis:
General Description
 It is also possible to calculate the costs that

should have been incurred for the actual level of
activity.
Planned cost = SP x SQ
where
SP = Standard price per unit
SQ = Standard quantity of input allowed
for the actual output
LO-3
Total Budget Variance
 The total budget variance is the difference
between the actual cost of the input and its
planned cost:
LO-3
Total Budget Variance (cont.)
 Because responsibility for deviations from
planned prices tends to be located in the
purchasing or personnel department and
responsibility for deviations from planned usage
of inputs tends to be located in the production
department, it is important to separate the total
variance into price and usage (quantity)
variances.
LO-3
Price and Usage Variances
 For labor, the price variance is usually called a rate

variance.
 Price (rate) variance is the difference between the
actual and standard unit price of an input multiplied
by the number of inputs used:
Price variance = (AP - SP) x AQ
 The usage (quantity) variance is called an
efficiency variance.
LO-3
Price and Usage Variances (cont.)
 Usage (efficiency) variance is the difference
between the actual and standard quantity of
inputs multiplied by the standard unit price of the
input:
Usage variance = (AQ - SQ) x SP
LO-3
Variance Analysis:
General Description
LO-3
Unfavorable and
Favorable Variances
 Unfavorable (U) variances occur whenever
actual prices or actual usage of inputs are greater
than standard prices or standard usage.
 When the opposite occurs, favorable (F)
variances are obtained.
 Favorable and unfavorable variances are not
equivalent to good and bad variances. The terms
merely indicate the relationship of the actual prices
(or quantities) to the standard prices (or
quantities).
LO-3
The Decision to Investigate
 As a general principle, an investigation should

be undertaken only if the expected benefits are
greater than the expected costs.
 Managers determine whether variances are
significant based on an acceptable range that
has top and bottom measures called control
limits.
LO-3
Using Control Limits to Trigger A Variance
Investigation
LO-3
Cornerstone 10.2
Using Control Limits to Trigger A Variance
Investigation (cont.)
LO-3
Variance Analysis: Materials
 The total variance for materials measures the
difference between the actual costs of materials
and their budgeted costs for the actual level of
activity:
Total Variance = Actual cost - Planned cost

= (AP x AQ) - (SP x SQ)
LO-4
Cornerstone 10.3
Calculating the Total Variance
for Materials
LO-4
Direct Materials Variances
 To help control the cost of materials, price and
usage variances are calculated.
 The materials price variance is computed by
using the actual quantity of materials purchased,
and the materials usage variance is computed
by using the actual quantity of materials used,
calculated as:
LO-4
Cornerstone 10.4
Calculating Materials Variances: Formula and
Columnar Approaches
LO-4
Cornerstone 10.4
Calculating Materials Variances: Formula and
Columnar Approaches
LO-4
Materials Price Variance
 The materials price variance (MPV) measures
the difference between what should have been
paid for raw materials and what was actually paid
and is calculated as:
MPV = (AP - SP) x AQ
 Where AP = Actual price per unit
SP = Standard price per unit
AQ = Actual quantity of material purchased
LO-4
Materials Usage Variance
 The materials usage variance (MUV) measures
the difference between the direct materials actually
used and the direct materials that should have
been used for the actual output.
 The formula is:
MUV = (AQ - SQ) x SP
 AQ = Actual quantity of materials used
 SQ = Standard quantity of materials allowed for the actual
output
 SP = Standard price per unit
LO-4
Using Materials Variance
Information
 Calculating materials variances is only the first
step.
 Using the variance information to exercise control
is fundamental to a standard cost system.
 Responsibility must be assigned, variance
significance must be assessed, and the variances
must be accounted for and disposed of at the end
of the year.
LO-4
Responsibility for
 The responsibility for controlling the materials
price variance usually belongs to the purchasing
agent.
 Admittedly, the price of materials is largely
beyond the agent’s control and can have
undesirable outcomes from an evaluation
perspective.
 Pressure to produce favorable variances may
result in the purchase of materials of lower quality
than desired or excessive inventory purchases in
order to get quantity discounts.
LO-4
The Analysis of
 The first step in variance analysis is to decide
whether the variance is significant.
 If so, what is its cause?
 Once the reason is known, corrective action can be
taken if necessary—and if possible.
 For example, if high quality materials were purchased
due to a supply shortage of usual materials, no action
is needed. A firm has no control over the supply
shortage; it will simply have to wait until market
conditions improve.
 If the variance is judged insignificant, no further steps
are needed.
LO-4
Responsibility for
 The responsibility for controlling the materials usage

usually belongs to the production manager.
 Minimizing scrap, waste, and rework are all ways in which
the manager can ensure that the standard is met.
 At times, the cause of the variance is attributable to others
outside the production area.
 Pressure to produce favorable variances may allow
defective units to be transferred to finished goods and
ultimately cause customer relations problems.
LO-4
The Analysis of
 If variance is significant, investigation is needed to
find out the causes for the deviation.
 It is important to note that standards are not static.
 As improvements in production take place and
conditions change, standards may need to be
revised to reflect the new operating environment.
 The importance of evaluating current business
conditions and updating standards to reflect any
changes in these conditions cannot be
overlooked.
LO-4
Accounting and Disposition of
Materials Variances
 Recognizing the price variance for materials at
the point of purchase also means that the raw
materials inventory is carried at standard cost.
 In general, materials variances are not
inventoried.
 Typically, materials variances are added to cost of
goods sold if unfavorable and are subtracted from
cost of goods sold if favorable.
LO-4
YOUDECIDE
Relationship between MPV and MUV
LO-4
Relationship between MPV and MUV (cont.)
LO-4
Variance Analysis:
Direct Labor
 The total labor variance measures the difference
between the actual costs of labor and their
budgeted costs for the actual level of activity:
LO-5
Calculating the Total Variance
for Labor
LO-5
Direct Labor Variances
 Labor hours cannot be purchased and stored for future
use as can be done with materials (i.e., there can be no
difference between the amount of labor purchased and
the amount of labor used).
 The labor rate and labor efficiency variances always
will add up to the total labor variance.
 The rate (price) and efficiency (usage) variances for
labor can be calculated by using either the columnar
approach or the associated formulas.
Total labor variance = Labor rate variance + Labor
efficiency variance
LO-5
Labor Rate Variance
 The labor rate variance (LRV) computes the
difference between what was paid to direct
laborers and what should have been paid:
LRV = (AR - SR) x AH
 AR = Actual hourly wage rate
 SR = Standard hourly wage rate
 AH = Actual direct labor hours used
LO-5
Labor Efficiency Variance
 The labor efficiency variance (LEV) measures
the difference between the labor hours that were
actually used and the labor hours that should
have been used:
LEV = (AH - SH) x SR
 AH = Actual direct labor hours used
 SH = Standard direct labor hours that should have been
used
 SR = Standard hourly wage rate
LO-5
Cornerstone 10.6
Calculating Labor Variances: Formula and
Columnar Approaches
LO-5
Calculating Labor Variances: Formula and
Columnar Approaches
LO-5
Using Labor Variance
Information
 Calculating labor variances initiates the feedback
process.
 Using the labor variance information to exercise
control is fundamental.
 Responsibility must be assigned, variance
significance must be assessed, and the variances
must be accounted for and disposed of at the end
of the year.
LO-5
Responsibility for
the Labor Rate Variance
 Labor rates are determined by such external
forces as labor markets and union contracts.
 Departures of actual rates from standard rates
are rare and variances are usually due to
unexpected overtime or the use of higher paid
employees for less skilled tasks.
 The use of labor is controllable by the production
manager, so responsibility for the labor rate
variance generally is assigned to the individuals
who decide how labor will be used.
LO-5
Responsibility for
the Labor Efficiency Variance
 Production managers are responsible for the productive
use of direct labor.
 As is true of all variances, once the cause is discovered,
responsibility may be assigned elsewhere.
 Production managers may be tempted to engage in
dysfunctional behavior if too much emphasis is placed on
the labor efficiency variance.
 For example, to avoid losing hours or using additional
hours because of possible rework, a production manager
could deliberately transfer defective units to finished
goods.
LO-5
Analysis of the
Labor Efficiency Variance
 If variance is significant, investigation is needed
to find out the causes for such variance.
 Based on the findings, corrective actions may be
taken, if necessary.
LO-5
Additional Cost Management
Practices
 In addition to standard costing, some companies
choose to employ other cost management
practices, such as kaizen costing and target
costing.
 Kaizen costing focuses on the continuous reduction of
the manufacturing costs of existing products and
processes.
LO-5
Additional Cost Management
Practices (cont.)
 Target costing focuses on the reduction of the design

costs of existing and future products and processes.
 A target cost is the difference between the sales price
needed to capture a predetermined market share and the
desired per-unit profit:
Target cost per unit = Expected sales price per unit

- Desired profit per unit
LO-5
Appendix 10A:
Accounting for Variances
 The accounts containing the variances between
applied standard costs and actual costs are
closed, which allows the amount of actual costs
to ultimately impact the final cost of goods sold
number that appears in the financial statements.
 In recording variances, unfavorable variances
always are debits, and favorable variances
always are credits.
Entries for Direct Materials
Variances: Materials Price Variance
 The entry to record the purchase of materials
follows (assuming an unfavorable MPV and that
AQ is materials purchased):
Materials SP x AQ
Materials Price Variance (AP - SP) x AQ
Accounts Payable AP x AQ
Entries for Direct Materials
Variances: Materials Usage Variance
 The general form for the entry to record the
issuance and usage of materials, assuming a
favorable MUV, is as follows:
Work in Process SP x SQ
Materials Usage Variance (AQ - SQ) x SP
Materials SP x AQ
Entries for Direct Labor Variances
 Unlike the materials variances, the entry to record
both types of labor variances is made
simultaneously.
 If we assume an unfavorable labor rate variance
and an unfavorable labor efficiency variance, the
following entry will be made:
Work in Process SR x SH
Labor Efficiency Variance (AH - SH) x SR
Labor Rate Variance (AR - SR) x AH
Accrued Payroll AR x AH
LO-6
Entries for Direct Labor
Variances (cont.)
 Keep in mind that only standard hours and
standard rates are used to assign costs to Work
in Process.
 Actual prices or quantities are not used.
LO-6
Disposition of
Materials and Labor Variances
 At the end of the year, the variances for materials
and labor usually are closed to Cost of Goods
Sold.
 If the variances are material, they must be
prorated among various accounts.
 Materials variances are prorated on the basis of
the materials balances in each of these accounts
and the labor variances on the basis of the labor
balances in the accounts.
LO-6

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CORNERSTONES

1. Explain how unit standards are set and why standard

Standard cost per unit = Quantity standard x

 Actual input cost can be calculated as:

 It is also possible to calculate the costs that

 For labor, the price variance is usually called a rate

 As a general principle, an investigation should

Total Variance = Actual cost - Planned cost

 The responsibility for controlling the materials usage

 Target costing focuses on the reduction of the design

Target cost per unit = Expected sales price per unit

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