Chapter 10 – Lecture Notes
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Chapter 10
Lecture Notes
Chapter theme: This chapter extends our study of
management control by explaining how standard costs
are used by managers to control costs. It demonstrates how
to compute direct materials, direct labor, and variable
overhead variances.
I. Standard costs – setting the stage
A. Basic definitions/concepts
i. A standard is a benchmark for measuring
performance. In managerial accounting, two types
of standards are commonly used by
manufacturing, service, food, and not-for-profit
organizations:
1. Quantity standards specify how much of
an input should be used to make a product or
provide a service. For example:
a. Auto service centers like Firestone
and Sears set labor time standards for
the completion of work tasks.
b. Fast-food outlets such as
McDonald’s have exacting standards
for the quantity of meat going into a
sandwich.
2. Price standards specify how much should
be paid for each unit of the input. For
example:
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a. Hospitals have standard costs for
food, laundry, and other items.
b. Home construction companies have
standard labor costs that they apply to
sub-contractors such as framers,
roofers, and electricians.
c. Manufacturing companies often
have highly developed standard
costing systems that establish
quantity and price standards for each
separate product’s material, labor,
and overhead inputs.
II. Setting standard costs
A. Setting direct materials standards
i. The standard price per unit for direct materials
should reflect the final, delivered cost of the
materials.
ii. The standard quantity per unit for direct
materials should reflect the amount of material
required for each unit of finished product, as well
as an allowance for unavoidable waste, spoilage,
and other normal inefficiencies.
B. Setting direct labor standards
i. The standard rate per hour for direct labor
includes not only wages earned but also fringe
benefits and other labor costs.
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1. Many companies prepare a single rate for
all employees within a department that
reflects the “mix” of wage rates earned.
ii. The standard hours per unit reflects the labor
hours required to complete one unit of product.
1. Standards can be determined by using
available references that estimate the time
needed to perform a given task, or by
relying on time and motion studies.
C. Setting variable manufacturing overhead standards
i. The price standard for variable manufacturing
overhead comes from the variable portion of the
predetermined overhead rate.
ii. The quantity standard for variable manufacturing
overhead is expressed in either direct labor hours or
machine hours depending on which is used as the
allocation base in the predetermined overhead rate.
D. The standard cost card
i. The standard cost card is a detailed listing of the
standard amounts of direct materials, direct
labor, and variable overhead inputs that should
go into a unit of product, multiplied by the standard
price or rate that has been set for each input.
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III. Using standards in flexible budgets
A. Activity and spending variances
i. Standard costs per unit for direct materials, direct
labor, and variable manufacturing overhead can be
used to compute activity and spending variances
as described in the previous chapter.
B. Price and quantity variances
ii. Spending variances become more useful by
breaking them down into price and quantity
variances. This is our focus in this chapter.
IV. A general model for standard cost variance analysis
A. Price and quantity variances
i. A price variance is the difference between the
actual price of an input and its standard price,
multiplied by the actual amount of the input
purchased.
ii. A quantity variance is the difference between how
much of an input was actually used and how much
should have been used and is stated in dollar terms
using the standard price of the input.
B. Price and quantity standards
i. Price and quantity standards are determined
separately because price and quantity variances
usually have different causes. In addition:
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1. Different managers are usually
responsible for buying and for using
inputs. For example:
a. The purchasing manager is
responsible for raw material purchase
prices and the production manager is
responsible for the quantity of raw
material used.
2. The buying and using activities occur at
different points in time. For example:
a. Raw material purchases may be held
in inventory for a period of time
before being used in production.
C. The general model—an overview
i. Price and quantity variances can be computed for
all three variable cost elements – direct materials,
direct labor, and variable manufacturing
overhead – even though the variances have
different names as shown.
ii. Although price and quantity variances are known
by different names, they are computed exactly the
same way (as shown on this slide) for direct
materials, direct labor, and variable manufacturing
overhead.
1. The actual quantity represents the actual
amount of direct materials, direct labor, and
variable manufacturing overhead used.
Helpful Hint: Emphasize that the quantities in this
model pertain to inputs not outputs. So, in the case of
direct materials, the quantities will be stated in terms
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such as pounds, ounces, etc., not the number of units of
finished goods produced.
2. The standard quantity represents the
standard quantity allowed for the actual
output of the period.
Helpful Hint: Mention that the “SQ” portion of the
model is the most common stumbling block for students
when it comes to variance analysis. Emphasize that
“SQ” refers to the standard quantity of inputs allowed
for the actual level of output achieved. For example, if
5,000 drapes were produced and each requires 2 yards
of fabric, the standard quantity allowed would be
10,000 yards. Any other amount of fabric used would
result in a variance.
3. The actual price represents the actual
amount paid for the input used.
4. The standard price represents the amount
that should have been paid for the input
used.
V. Using standard costs—direct materials variances
Learning Objective 1: Compute the direct materials
price and quantity variances and explain their
significance.
A. Glacier Peak Outfitters – an example
i. The materials price variance, defined as the
difference between what is paid for a quantity of
materials and what should have been paid
according to the standard, is $21 favorable.
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1. The price variance is labeled favorable
because the actual price was less than the
standard price by $0.10 per kilogram.
ii. The materials quantity variance, defined as the
difference between the quantity of materials used in
production and the quantity that should have been
used according to the standard, is $50 unfavorable.
1. The quantity variance is labeled
unfavorable because the actual quantity
exceeds the standard quantity allowed by 10
kilograms.
Helpful Hint: Remind students that a favorable price
variance might not always be a good thing. If it arose
from receiving inferior or obsolete goods at a reduced
price, the total costs of making the company’s products
might be higher.
iii. Supporting/additional computations
1. The standard quantity of 200 kilograms was
computed as shown.
2. The actual price of $4.90 per kilogram was
computed as shown.
3. The equations that we have been using thus
far can be factored as shown and used to
compute price and quantity variances.
B. Direct materials variances—points of clarification:
i. The purchasing manager and production
manager are usually held responsible for the
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