Standard Costs

Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how standards are set. State the formulas for determining direct materials and

direct labor variances. State the formulas for determining manufacturing overhead

variances. Discuss the reporting of variances.

Our Focus

The Need for Standards

Standards• Are common in business• Are often imposed by government agencies (and

called regulations)

Standard costs• Are predetermined unit costs• Used as measures of performance

Distinguishing Between Standards and Budgets

Standards and budgets are both• Pre-determined costs

• Part of management planning and control

A standard is a unit amount whereas a budget is a total amount

• Standard costs may be incorporated into a cost accounting system

Advantages of Standard Costs

Setting Standard Costs

Setting standard costs• Requires input from all persons who have responsibility for

costs and quantities• Standards costs need to be current and should be under

continuous review

There are two levels of standard costs• Ideal standards represent optimum levels of performance

under perfect operating conditions • Normal standards represent efficient levels of performance

attainable under expected operating conditions (rigorous but attainable)

Direct Materials Price Standard

Direct materials price standard• Cost per unit which should be incurred

• Based on the purchasing department’s best estimate of the cost of raw materials

• Includes related costs such as receiving, storing, and handling

Direct Materials Quantity Standard

Direct materials quantity standard• Quantity of direct materials used per unit of finished goods

• Based on physical measure such as pounds, barrels, etc.• Considers both the quantity and quality of materials required

• Includes allowances for unavoidable waste and normal storage

Total Direct Materials Cost/Unit

STANDARD DIRECT

MATERIALSPRICE

x =

STANDARDDIRECT

MATERIALSQUANTITY

STANDARDDIRECT

MATERIALS COSTPER UNIT

The standard direct materials cost per unit is calculated as follows

Direct Labor Price Standard

Direct labor price standard • Rate per hour incurred for direct labor• Based on current wage rates adjusted for anticipated

changes, such as cost of living adjustments• Includes employer payroll taxes,and fringe benefits

Direct Labor Quantity Standard

Direct labor quantity standard• Time required to make one unit of the product

• Critical in labor-intensive companies

• Allowances should be made for rest periods, cleanup, machine setup and machine downtime

Direct Labor

The standard direct labor cost per unit is calculated as follows

STANDARD DIRECT

LABOR RATEx =

STANDARDDIRECT

LABOR HOURS

STANDARDDIRECT

LABOR COSTPER UNIT

Manufacturing Overhead Standard

For manufacturing overhead, a standard predetermined overhead rate is used

• The predetermined rate is computed by dividing budgeted overhead costs by an expected standard activity index

• The standard manufacturing overhead rate per unit is the predetermined overhead rate times the activity index quantity standard (for example, direct labor hours)

Standard Cost Per Unit

Standard cost per unit• Sum of the standard costs for direct materials, direct labor, and

manufacturing overhead

• Is determined for each product and often recorded on a standard cost card which provides the basis for determining variances from standards

materialslabour Manufacturing

Overheads

Variances from StandardsVariances from Standards Variances from standards• Differences between total actual costs and total

standard costs• Unfavorable variances occur when too much is paid

for materials and labor or when there are inefficiencies in using materials and labor

• Favorable variances occur when there are efficiencies in incurring costs and in using materials and labor– A variance is not favorable if quality control standards are

sacrificed

Analyzing variances Variances must be analyzed to

determine their significance• First, determine the cost elements that comprise the

variance• For each manufacturing cost element, a total dollar

variance is computed. Then this variance is analyzed into a price variance and a quantity variance

Variance Relationships

Formula for Total Materials Variance

Actual Quantityx Actual Price

(AQ) x (AP)

Standard Quantityx Standard Price

(SQ) x (SP)

Total MaterialsVariance

(TMV)=_

The total materials variance is computed from the following formula:

Formula for Materials Price Variance

Actual Quantityx Actual Price

(AQ) x (AP)

Actual Quantityx Standard Price

(SQ) x (SP)

Materials PriceVariance

(MPV)=_

The materials price variance is computed from the following formula:

Formula for Materials Quantity Variance

Actual Quantityx Standard Price

(AQ) x (SP)

Standard Quantityx Standard Price

(SQ) x (SP)

MaterialsQuantityVariance

(MQV)

=_

The materials quantity variance is determined from the following formula:

Matrix for Direct Materials Variance

AQ X AP4200 X 3.10=13020

AQ XSP4200 X 3.00 =12,600

SQ XSP4000 X3= 12,000

1 - 2Price Variance13,020-12,600=Rs 420 UF

2 - 3Quantity Discount

12,600- 12,000=Rs 600 uf

1-3Total Variance13,020-12,000=Rs 1020 UF

1 2 3

Causes of Materials Variances

Materials variances may be caused by a variety of factors, including both internal and external factors

• Investigating materials price variances begins in the purchasing department, but the variance may be beyond the control of purchasing (for ex., prices rise faster than expected)

• Investigating materials quantity variance begins in the production department, but the variance may be beyond the control of production (for ex., faulty machinery)

Formula for Total Labor Variance

Actual Hoursx Actual Rate(AH) x (AR)

Standard Hoursx Standard Rate

(SH) x (SR)

Total LaborVariance

(TLV)=

_

The total labor variance is obtained from the following formula:

Formula for Labor Price Variance

Actual Hoursx Actual Rate(AH) x (AR)

Actual HoursX Standard Rate

(AH) x (SR)

Labor PriceVariance

(LPV)=

_

The formula for the labor price variance is as follows:

Formula for Labor Quantity Variance

Actual Hoursx Standard Rate

(AH) x (SR)

Standard Hoursx Standard Rate

(SH) x (SR)

LaborQuantityVariance

(LQV)

=_

The labor quantity variance is derived from the following formula:

Matrix for Direct Materials Variance

AH X AR2100 X 9.80=20580

AH XSR2100 X 10 =21,000

SH XSR2000 X10= 20,000

1 - 2Price Variance20,580-21,000

=Rs 420 F

2 - 3Quantity Variance

21,000- 20,000=Rs 1000 uf

1-3Total Variance20,580-20,000

=Rs 580UF

1 2 3

Causes of Labor Variances

Labor variances may be caused by a variety of factors

• Labor price variances usually result from either paying workers higher wages than expected or misallocating workers (for ex., using skilled workers in place of unskilled workers)

• Labor quantity variances relate to the efficiency of workers and are usually related to the production department

Actual Overhead Costs

The total overhead variance is the difference between actual overhead costs and overhead costs applied to work done.

Formula for Total Overhead Variance

Actual Overhead

OverheadApplied basedon Standard

Hours Allowed

Total OverheadVariance

=_

With standard costs, manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done. Standard hours allowed are the hours that should have been worked for the units produced. The formula for the total overhead variance is:

Formula for OverheadControllable Variance

Actual Overhead

OverheadBudgeted based

on Standard Hours Allowed

OverheadControllable

Variance=_

The formula for the Overhead Controllable Variance is shown below:

Formula forOverhead Volume Variance

FixedOverhead

Rate

Normal CapacityHours - Standard

Hours Allowed

Overhead Volume

Variance=X

The Overhead Volume Variance indicates whether fixed costs were efficiently used during the period. The formula for computing the volume variance is as follows:

Alternative Formula for OverheadVolume Variance

OverheadBudgeted based

on StandardHours Allowed

Overhead Applied basedon Standard

Hours Allowed

Overhead Volume

Variance=

_

An alternative formula for computing the volume variance is shown below:

Causes of Manufacturing Overhead Variances

Manufacturing overhead variances may be caused by a variety of factors

• The controllable variance relates to variable manufacturing costs and usually is the responsibility of the production department• May result from either higher than expected use of indirect materials,

indirect labor or supplies or increases in indirect manufacturing costs such as fuel

• The volume variance may be the responsibility of the production department (inefficient use of direct labor hours) or may come from outside the production department (lack of sales orders)

Reporting Variances

Reporting variances• All variances should be reported to appropriate levels of

management as soon as possible so that corrective action can be taken

• The form, content, and frequency of variance reports vary considerably among companies

• Variance reports facilitate the principle of “management by exception”

• In using variance reports, top management normally looks for significant variances

Let’s ReviewLet’s Review

The setting of standards is:The setting of standards is:

a. A managerial accounting decisiona. A managerial accounting decision..

d.d. Preferably set at the ideal level of Preferably set at the ideal level of performance.performance.

c.c. A worker decisionA worker decision.

b.b. A management decisionA management decision

Let’s ReviewLet’s Review

The setting of standards is:The setting of standards is:

a. A managerial accounting decisiona. A managerial accounting decision..

d.d. Preferably set at the ideal level of Preferably set at the ideal level of performance.performance.

c.c. A worker decision.

b.b. A management decisionA management decision