Chapter 10 – Standard Costing and Analysis of Direct Costs
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CHAPTER 10
STANDARD COSTING AND ANALYSIS OF DIRECT COSTS
Learning Objectives
1. Describe the elements of a cost control system.
2. Describe two ways to set cost standards and distinguish between perfection and
practical standards.
4. Explain several methods for determining the significance of cost variances.
5. Describe some behavioral effects of standard costing.
6. Explain how standard costs are used in product costing.
8. Explain several common criticisms of standard costing.
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Chapter Overview
I. Managing Costs
A. System components
B. Management by exception
II. Setting Standards
A. Analysis of historical data
B. Task analysis
C. A combined approach
III. Cost Variance Analysis
A. Direct-material and direct-labor standards
B. Standard costs given actual output
C. Analysis of cost variances
D. Direct-material and direct-labor variances
E. Multiple Types of direct material or direct labor
F. Allowing for production loss
IV. Significance of Cost Variances
A. Size of variances
B. Recurring variances
C. Trends
D. Controllability
V. Behavioral Impact of Standard Costing
VI. Controllability of Variances
A. Interaction among variances
VII. Standard Costs and Product Costing
VIII. Evaluation of Standard Costing Systems
A. Advantages of standard costs
B. Criticisms of standard-costing systems in today’s manufacturing
environment
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IX. Appendix: Use of Standard Costs for Product Costing
Key Lecture Concepts
I. Managing Costs
• Standard-cost systems are used to help managers control the cost of
• A standard cost for each product cost category (materials, labor, and
overhead) is calculated on a per-unit basis.
➢ This calculation considers the planned quantity of each input factor
allowed (pounds, hours, etc.) and the planned price for each input
factor (price per pound, rate per hour, etc.). The total planned cost
is a mini, per-unit budgeted amount.
• After the actual costs are known, a report is generated that shows actual
costs, planned costs, and related variances. A manager can examine the
variance column quickly to ascertain which exceptions require attention.
II. Setting Standards
• Managers set standards by analyzing historical data. However, past data
must be adjusted for expected changes in technology, the production
process, inflation, and other similar factors.
➢ Managers also use task analysis to focus on how much a product
should cost. These are when accountants typically work with
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• Two types of standards may be used: perfection standards and practical
standards.
➢ Perfection (ideal) standards assume that production takes place in
the ideal world: employees always work at peak performance,
materials are never defective, and machines never break down.
▪ Although some managers feel that ideal standards give
➢ Practical (attainable) standards are set high enough to encourage
efficient and effective operations but not so high as to seem
impossible.
▪ Behavioral scientists feel that practical standards have a
more positive effect on the productivity of employees.
▪ Unlike variances computed with perfection standards,
variances calculated when practical standards are employed
• Service firms also use standards. For example, McDonald’s restaurants
are noted for using standards, not only for quantities of material (amount
of beef per burger) but also for the time allowed to serve customers at the
drive-in window or counter.
III. Cost Variance Analysis
• Variance analysis involves calculating the actual amount of input used
and comparing it to the budgeted amount of input that should have been
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• Standards are established for:
➢ The amount of material required to produce a finished product (the
standard material quantity).
• The following model can be used to calculate variances for direct
materials (DM) and direct labor (DL):
DM Price = (AQ Purchased x AP) – (AQ Purchased x SP)
Notice that the price and rate variances use a similar approach, and the
quantity and efficiency variances use a similar approach, with efficiency
being another way to say “quantity of hours” allowed.
IV. Significance of Cost Variances
• A manager does not have time to examine each variance; therefore, he or
she must consider selected factors in deciding when an investigation
should take place. The factors include one or more of the following:
➢ Size of the variance (in absolute and/or relative terms, such as
$5,000 or 10% of standard cost)
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➢ Frequency of occurrence
➢ Trends may call for investigations.
➢ Controllability (there is little point to investigate items over which
managers have no control).
➢ Favorable variances
➢ Costs and benefits of investigations (the decision to investigate
involves a cost-benefit analysis, as a number of investigative costs
are incurred).
• Some companies use a statistical approach to variance investigation by
preparing a statistical control chart.
V. Behavioral Impact of Standard Costing
• Variances may be used to evaluate personnel, often with regard to salary
increases, bonuses, and promotions.
➢ Such incentives can have positive and negative effects, as a bonus
plan may prompt a manager to pursue actions that are not in the
best interests of the organization.
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VI. Controllability of Variances
• It is rare that one person controls any event; however, it is often possible
to identify the manager who is most able to influence a particular
variance. These managers are often the following:
➢ Direct-material price variance—Purchasing manager
• Variances often interact, making investigation and controllability difficult.
For example, a labor efficiency variance may be caused by problems not
only with labor but by problems with machinery and/or material.
VII. Standard Costs and Product Costing
• In a standard-cost system, costs flow through the same accounts in the
VIII. Evaluation of Standard Costing Systems
• A standard-cost system has several advantages, as follows:
➢ Managers have a sensible comparison method at their disposal, one
that looks at budgeted costs vs. actual costs at the actual level of
output.
➢ Managers can practice management by exception.
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➢ Variances provide a benchmark for performance evaluation and
employee rewards.
• Criticisms of standard costing in advanced manufacturing settings
include:
➢ Variances are too aggregated and arrive too late to be useful.
Variances should focus on activities, specific product lines, or
production batches.
➢ Variances focus too much on the cost and efficiency of labor, which
is becoming a relatively unimportant factor of production.
IX. Appendix: Use of Standard costs for Product Costing
• Under most systems, Work-in-Process Inventory is generally carried at
standard quantities and standard prices.
• The differences between standard costs and the actual costs incurred are
Teaching Overview
There is a danger when teaching this chapter to go overboard in the calculation of
variances and to avoid a number of the other key issues. I normally handle the topics
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by first presenting a series of qualitative topics with regard to standards and variances,
anything from how standards are set (parties involved and level) to whether variances
should be investigated. I then move into variance calculation, concluding the
presentation with some role playing on variance controllability (i.e., trying to hold an
individual responsible for a variance that he or she cannot control).
Students are very adept (and creative) at visualizing what problems may be behind the
numerous variances in a given situation, and a discussion usually ensues with little
prompting. It is often necessary to remind students that variance analysis is a tool used
to spot problems and gather intelligent questions, not to get immediate answers.
Someone within the organization usually has to assume the role of a detective to track
down the cause of any variances that arise.
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Links to the Text
Homework Grid – CHAPTER 10
Item No.
Learning
Objectives
Completion
Time (min.)
Exercises:
10-22
1, 3
15
10-23
3
30
10-24
2
10
10-25
1, 3
15
10-26
3
30
10-27
2
30
10-28
2
5
10-29
1, 3
30
10-30
4
25
10-31
6, 9
15
10-32
6, 9
15
Problems:
10-33
1, 3
25
10-34
1, 3
25
10-35
2
15
10-36
1, 3
45
10-37
3, 4
35
10-38
1, 3
35
10-39
1, 3
30
10-40
1, 3
30
10-41
2
30
10-42
1, 2
40
10-43
4
40
10-44
2, 5
35
10-45
1, 3, 9
25
10-46
3, 6, 9
50
10-47
1, 3
60
10-48
6, 9
45
Cases:
10-49
1, 3, 6,9
60
10-50
1, 3, 9
75