Learning Objectives
1. Why are standard cost systems used?
5. How does the use of a single conversion element (rather than the traditional labor and overhead
elements) affect standard costing?
6. (Appendix) How are variances affected by multiple material and labor categories?
STANDARD COSTING AND VARIANCE
ANALYSIS
CHAPTER
7
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Terminology
Bill of materials: a document that contains specifications for materials, including quality and quantity
Budget variance: the difference between total actual overhead and budgeted overhead based on
Controllable variance: the budget variance of the two–variance approach to analyzing overhead
Expected standard: expected cost or result; expected standards anticipate and allow for future waste
Fixed overhead spending variance: the difference between the total actual fixed overhead and
Ideal standards: standards that provide for no inefficiencies of any type (e.g., normal operating delays
Labor efficiency variance (LEV): in terms of hours, the difference between actual hours worked for the
Labor mix variance: the financial effect associated with changing the proportionate amount of higher or
Labor rate variance (LRV): the difference between the actual wages paid for total hours worked and the
Labor yield variance: the monetary impact of using a higher or lower number of hours than the standard
Management by exception: a practice whereby managers investigate only those processes, costs,
Material mix variance: the effect of substituting a nonstandard mix of materials during the production
Material price variance (MPV): the difference between the amount actually paid for material and the
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Material quantity variance (MQV): in terms of units of material, the difference between the actual
Material yield variance: the difference between the actual total quantity of input and the standard total
Methods-time measurement (MTM): an industrial engineering process that analyzes work tasks to
Mix: any possible combination of material or labor inputs
Noncontrollable variance: the fixed overhead variance due to capacity utilization (i.e., volume); it can
Operations flow document: a document listing all operations necessary to produce one unit of product
Overhead efficiency variance: a variance consisting solely of variable overhead, it is the difference
between total budgeted overhead at the actual activity level and total budgeted overhead at the standard
Overhead spending variance: the difference between the actual overhead and total budgeted overhead
Practical standard: a standard that can be reached or slightly exceeded with reasonable effort by
Standard: the expected costs and quantities needed to manufacture a single unit of product or perform a
single service
Standard cost card: a document that summarizes the standard quantities and costs for direct material,
Total cost of ownership (TCO): the direct purchase price of an input plus freight/duty/tax charges,
Total overhead variance: the difference between total actual overhead and total applied overhead; it is
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Variable overhead efficiency variance: the difference between budgeted variable overhead for actual
hours and standard variable overhead; this variance quantifies the effect of using more or less overhead–
Variable overhead spending variance: the difference between total actual variable overhead and the
Variance: the difference between total actual cost incurred and total standard cost applied to the output
of the period
Variance analysis: the process of categorizing the nature (favorable or unfavorable) of the differences
Volume variance: a fixed overhead variance that represents the difference between budgeted fixed
overhead and fixed overhead applied to production; it is also referred to as the noncontrollable variance;
Yield (or process yield): the output quantity that results from a specified input
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Lecture Outline
LO.1: Why are standard cost systems used?
A. Why Standard Cost Systems are Used
1. Clerical efficiency—a company that uses standard costs to trace the flow of costs through its
actual cost system.
efficiency to workers.
costs.
4. Controlling—the control process begins with the establishment of standards which provide a
differences.
5. Decision making—standard cost information availability facilitates many decisions.
6. Performance evaluation—summary variance reports focus attention on the operating
subordinate managers.
B. Considerations in Establishing Standards
1. Appropriateness
a. Appropriateness and attainability need to be considered when standards are established.
applied.
c. Factors such as the materials quality, normal ordering quantities of materials, expected
should be considered.
d. Standards must evolve over the organization’s life to reflect its changing methods and
processes.
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2. Attainability
a. Attainability refers to management’s belief about the degree of difficulty or rigor that should
ideal.
b. Expected standards are standards set at a level that reflects what is actually expected to
occur in the future period; these standards anticipate future wastes and inefficiencies and
c. Practical standards are standards that can be reached or slightly exceeded approximately
60 to 70 percent of the time with reasonable effort by workers; they allow for normal,
attainable challenge.
d. Ideal standards are standards that provide for no inefficiencies of any type, are impossible to
attain, and are sometimes called theoretical standards.
C. Introduction
1. General
a. Organizations develop and use standards for almost all tasks.
b. Because of the variety of organizational activities and information objectives, no single
standard costing system is appropriate for all situations.
variance analysis.
D. Development of a Standard Cost System
1. General
a. A standard is a performance benchmark or norm used for planning and control purposes.
b. A standard cost system is a product costing system that determines product cost by using
i. Developing a standard cost involves judgment and practicality in identifying material and
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ii. A primary objective in manufacturing a product is to minimize unit cost while achieving
certain quality specifications.
purchasing, and management.
d. To ensure credibility of the standards and to motivate people to operate as close to the
2. Material standards
a. The first step in developing material standards is to identify and list the specific direct material
materials inputs:
i. type of material needed;
ii. quality (grade) of material needed;
iii. quantity of material needed; and
c. The bill of materials is a document that contains specifications for materials, including
quality and quantity (See text Exhibit 7.2 p. 249).
to estimate and minimize the total cost of ownership, which includes price, freight/duty/tax
3. Labor Standards
a. The development of labor standards requires the same basic procedures as those used for
materials.
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b. Each production operation performed by workers or by machinery should be identified.
i. All unnecessary movements of workers and of material should be disregarded when time
standards are set.
c. To develop effective standards, a company must obtain quantitative information for each
prepared which lists all operations necessary to make one unit of product (or perform a
specific service) and the corresponding time allowed for each operation. (See text Exhibit 7.3
p. 250.)
unemployment taxes.
i. A weighted average rate, computed as the total wage cost per hour divided by the
number of workers, should be used if employees are paid different wage rates.
4. Overhead standards
a. Overhead should be assigned to separate cost pools based on the cost drivers, and
b. The development of the bill of materials, operations flow document, and predetermined
c. Both actual and standard costs are recorded in a standard cost system. But standard costs,
LO.3: How are material, labor, and overhead variances calculated and recorded?
E. General Variance Analysis Model
1. General
a. A total variance is the difference between total actual cost for the production inputs and the
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accomplish their control objectives:
i. A price (or rate) variance reflects the difference between the actual price (AP) paid for
inputs and the standard input price (SP) for the actual quantity (AQ) of inputs used during
the period:
the actual output.
d. Variances occur when the actual price or quantity amounts differ from standard.
i. Variances are labeled “unfavorable” if the actual price or quantity amounts are higher
than the standard price or quantity amounts; variances are labeled “favorable” when the
performance, respectively.
iii. A total variance can be computed for each production cost element (DM, DL, OH).
F. Material and Labor Variance Computations
1. Material Variances
a. Text Exhibit 7.5 (p. 253) presents the standard cost card for a mountain bike made by
material quantity variance:
AP × AQ SP × AQ SP × SQ
Material Material
Price Variance Quantity Variance
Total Material Variance
than or more than standard price.
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i. This variance is usually the responsibility of the purchasing manager.
and these component variances are summed to obtain the total price and quantity variances
(although such a sum does not provide useful information for cost control).
2. Point of Purchase Material Variance Model
purposes.
i. Because the material price variance relates to the purchasing (rather than the production)
b. The total material variance can be subdivided into the material purchase price variance and
the material price usage variance:
AP × AQP SP × AQP
Material Price Variance
SP × AQU SP × SQ
Material Quantity Variance
used.
d. The material quantity variance is the material usage variance when computed based on the
e. Note that because the price and quantity variances have been computed using different
3. Labor Variances
efficiency variance.