CHAPTER 9
STANDARD COSTING: A FUNCTIONAL-BASED CONTROL APPROACH
The responsibilities of management include planning, controlling, and decision making. Chapter 8
discussed static and flexible budgeting, which have a significant impact on the functions of planning and
controlling. Flexible budget variances provide significant information for control. Chapter 9 continues the
explanation of the control function by looking at standard costing.
LEARNING OBJECTIVES
After studying Chapter 9, students should be able to:
1. Describe how unit input standards are developed, and explain why standard costing systems are
adopted.
2. Explain the purpose of a standard cost sheet.
3. Compute and journalize the direct materials and direct labor variances, and explain how they are used
for control.
4. Compute overhead variances three different ways, and explain overhead accounting.
5. Calculate mix and yield variances for direct materials and direct labor.
KEY TOPICS
The following major topics are covered in this chapter (related learning objectives are listed for each
topic):
1. Developing Unit Input Standards (LO 1)
2. Standard Cost Sheets (LO 2)
3. Variance Analysis and Accounting: Direct Materials and Direct Labor (LO 3)
4. Variance Analysis: Overhead Costs (LO 4)
5. Mix and Yield Variances: Materials and Labor (LO 5)
I. DEVELOPING UNIT INPUT STANDARDS
1. Developing standards for input prices and input quantities allows a more detailed understanding of
the sources of flexible budget variances and improves the overall control function. Quantity standards
specify
how much of an input should be used per unit of output. Price standards specify how much should be
paid for the quantity of the input to be used. The unit standard cost is defined as the product of these two
standards: Standard price (SP) Standard quantity (SQ).
Standards can be classified as either ideal or currently attainable. Ideal standards demand maximum
efficiency and can be achieved only if everything operates perfectly. Currently attainable standards are
achievable under efficient operating conditions. Conventional wisdom favors currently attainable
standards because ideal standards are too demanding and can prove to be frustrating to workers and
managers.
In developing quantitative standards, there are three potential sources of input that can be used: (1)
historical experience, (2) engineering studies, and (3) input from operating personnel. In setting price
standards for materials, factors that must be considered include market forces, discounts, freight, and
quality. For labor, we must consider such factors as market forces, trade unions, payroll taxes, and
qualifications.
Another type of standard, a kaizen standard, is also possible. Kaizen standards are continuous
improvement standards. A kaizen standard is considered to be a currently attainable standard and focuses
on planned improvement and cost reduction. Because of the emphasis on continuous improvement, the
standards are constantly changing. Kaizen standards are discussed more thoroughly in Chapter 12.
Several reasons for adopting a standard costing system include: managing costs, improving planning and
control, facilitating decision making, and facilitating product costing.
Exhibit 9.1 (p. 448) summarizes the actual, normal, and standard cost assignment approaches.
Teaching hint: Point out that the use of variances at the operational level is generally discouraged for the
advanced manufacturing environment. Using variances at the operational level may actually impede the
effectiveness of a JIT system. It is also useful to indicate that standard cost systems are widely used and
that many firms using standard costing do calculate and report variances at the operational level.
Although many academics are questioning the value of detailed variances at the operational level, their
continued use suggests some utility or at least the belief in their utility.
II. STANDARD COST SHEETS
The standard cost sheet provides the unit quantity and price standards and the standard cost per unit.
Exhibit 9.2 (p. 449) illustrates a standard cost sheet. Cornerstone 9.1 (p. 450) shows the computation of
standard amounts for actual production. Another example of a standard cost sheet is on the following
page:
Description
Standard
Price
Standard
Usage
Standard
Cost
Direct materials
$ 1.50
×
10 lbs.
=
$15.00
Direct labor
6.00
×
2 hrs.
=
12.00
Variable overhead
10.00
×
2 hrs.
=
20.00
Fixed overhead
8.00*
×
2 hrs.
=
16.00
Total standard unit cost
$63.00
*Fixed overhead rate = $310,000/38,750 hrs.
Actual Operating Data for Period:
Units produced: 20,000 units
Materials: 210,000 pounds purchased @ $1.55 per pound; 205,000 lbs. used
Direct labor costs: $39,000 hours @ $6.10 per hour
Variable overhead: $410,000
Fixed overhead: $300,000
Teaching hint: At this point, it is probably a good idea to reinforce the ideas underlying the development
of standards. Referring to the standard cost sheet above, ask how the standard of 10 pounds of materials
per unit was developed. Then, ask the same question about the price of $1.50. Next, using information
from this sheet, compute the standard quantity of materials (SQ) allowed and the standard hours allowed
(SH) for the actual output. Often students have difficulty distinguishing between unit standards and the
inputs allowed, which are based on unit standards and actual output. Make sure that students understand
the difference.
III. VARIANCE ANALYSIS AND ACCOUNTING: DIRECT MATERIALS AND DIRECT
LABOR
Teaching hint: Start by describing the total budget variance and how it can be broken down into price and
usage variances. The three-pronged representation of this decomposition is presented below.
Price (rate) variance is the difference between the actual and standard unit prices of an input multiplied
by the actual quantity of inputs. Usage (efficiency) variance is the difference between the actual and
standard quantity of inputs multiplied by the standard unit price of the input. A favorable (F) variance
occurs whenever actual prices or usage of inputs are less than the standard prices or usage. An
unfavorable (U) variance occurs whenever actual prices or usage of inputs are greater than the standard
prices or usage.
The direct materials price variance (MPV) can be calculated at one of two points: (1) when the direct
materials are purchased or (2) when they are issued into production. Computing the MPV at the point of
purchase is preferable. The direct materials usage variance (MUV) will be calculated when materials are
used in the production of products. Cornerstone 9.2 (p. 452) is a good example of calculating the direct
materials price and usage variances.
The direct labor (rate) variance (LRV) computes the difference between what was paid to direct laborers
and what should have been paid. The direct labor efficiency variance (LEV) measures the difference
between the direct labor hours that were actually used and the direct labor hours that should have been
used. Cornerstone 9.3 (p. 456) illustrates how to compute the direct labor rate and efficiency variances.
Materiality will determine whether variances are large enough to be investigated. If a variance is
significant, an investigation is required to find out why a variance occurred and who is responsible for the
variance. Investigating, however, is costly and should be undertaken only if the benefits from corrective
action exceed the costs of investigating and taking corrective action. Because it is difficult to estimate the
costs and benefits of investigation, managers may investigate only if the variance is outside some
predetermined acceptable range. The top and bottom measures of the allowable range are referred to as
upper and lower control limits. These limits are determined by taking the standard and adding or
subtracting the allowable deviation.
Immaterial variances are generally charged to Cost of Goods Sold. Significant variances can be either
closed or prorated among Work in Process, Cost of Goods Sold, and Finished Goods.
Exercise 9.20 is a good problem for illustrating the calculation of direct materials and direct labor
variances and the preparation of the journal entries in a standard costing system.
Teaching hint: Discuss the issue of responsibility as the computation of each variance is described.
Explain why the normal assignment of responsibility can change as the variance is analyzed. Also, ask
when a manager might decide to change the standard after an investigation has been completed.
Remember, one reason for a variance can be that the standard is too tight or too loose.
IV. VARIANCE ANALYSIS: OVERHEAD COSTS
The total overhead variance is the difference between the actual overhead and the applied overhead. As
with the direct materials and direct labor variances, this total variance is also broken down into
component variances. First, overhead is divided into variable and fixed overhead categories, and then two
variances are computed for each category. Cornerstone 9.6 (p. 464) shows the calculation of the total
variable overhead variance.
The variable overhead variances are the variable overhead spending variance and the variable overhead
efficiency variance. The variable overhead spending variance measures the aggregate effect of
differences in the actual variable rate (AVOR) and the standard variable overhead rate (SVOR). The
variable overhead efficiency variance measures the change in variable overhead consumption that occurs
because of efficient (or inefficient) use of direct labor. These variances are calculated in a similar manner
to the way in which direct materials and direct labor variances are computed. Cornerstone 9.7 (p. 466) is a
good illustration here.
The fixed overhead variances are the fixed overhead spending variance and the fixed overhead volume
variance. The fixed overhead spending variance is defined as the difference between the actual fixed
overhead and the budgeted fixed overhead. The fixed overhead volume variance is the difference between
budgeted fixed overhead and applied fixed overhead. Since these costs are not variable in nature, the
calculations of the variances are not the same as the direct materials, direct labor, and variable overhead
variances. Cornerstone 9.8 (p. 471) shows how to calculate the fixed overhead spending and volume
variances.
At the end of the year, the applied variable and fixed overhead costs and the actual fixed overhead costs
are closed out and the variances isolated. Any resulting variance is disposed of by closing it to Cost of
Goods Sold if immaterial or by prorating it among Work in Process, Finished Goods, and Cost of Goods
Sold if material.
Exercise 9.22 is a good problem for illustrating the calculation of the variable and fixed overhead
variances, as well as the preparation of the journal entries for assigning overhead to production, recording
actual overhead, recognizing overhead variances, and closing out overhead variances.
Teaching hint: As the variances are discussed, point out that the two variances will always add up to the
total under- or overapplied overhead variance. By breaking the variances down into two pieces, a
manager gains more knowledge about why the total variance occurred. This knowledge will facilitate the
planning and control process for managers.
V. MIX AND YIELD VARIANCES: MATERIALS AND LABOR
For some production processes, it may be possible to substitute one direct material input for another or
one direct labor input for another. A mix variance is created whenever the actual mix of inputs differs
from the standard mix. A yield variance occurs whenever the actual output differs from the standard
output. Cornerstones 9.9 (p. 477) and 9.10 (p. 478) illustrate these concepts, respectively.
For direct materials, the sum of the mix and yield variance equals the direct materials usage variance. For
direct labor, the sum of the mix and yield variance equals the direct labor efficiency variance.
Exercise 9.17 is a good problem for illustrating direct materials mix and yield variances, while Exercise
9.19 is a good problem for illustrating direct labor mix and yield variances.
VI. INFORMATION ABOUT EXERCISES, PROBLEMS, AND CASES
Exercises and problems are described on the following two pages according to coverage of content,
learning objective(s), and level of difficulty. The time required to solve the problems is roughly
proportional to the level of difficulty.
In general, basic exercises/problems are fairly simple and straightforward. The text material is relatively
brief; only one or two concepts are covered. Basic exercises and problems should take about 15 to 20
minutes each.
Moderate exercises/problems may take longer and involve more concepts. These problems may have a
“twist” and require more thought. Moderate exercises and problems may take 20 to 40 minutes each.
Challenging problems are more comprehensive and may cover more concepts. The text material is
relatively longer and may include some ambiguity. Challenging problems may take 60 to 90 minutes
each.
Cornerstone
Exercise (CS)/
Exercise/
Problem/Case
Topic
Learning
Objective
Degree of
Difficulty
CS 9.1
Calculating Standard Quantities for Actual Production
LO 1
Basic
CS 9.2
Calculating the Direct Materials Price Variance and the
Direct Materials Usage Variance
LO 3
Basic
CS 9.3
Calculating the Direct Labor Rate Variance and the
Direct Labor Efficiency Variance
LO 3
Basic
CS 9.4
Using Control Limits to Determine When to Investigate
a Variance
LO 3
Basic
CS 9.5
Closing the Balances in the Variance Accounts at the
End of the Year
LO 3
Basic
CS 9.6
Calculating the Total Overhead Variance
LO 4
Basic
CS 9.7
Calculating the Variable Overhead Spending and
Efficiency Variances
LO 1
Basic
CS 9.8
Calculating the Fixed Overhead Spending and Volume
Variances
LO 4
Basic
CS 9.9
Calculating the Direct Materials Mix Variance
LO 5
Basic
CS 9.10
Calculating the Direct Labor Mix Variance
LO 5
Basic
CS 9.11
Calculating the Yield Variance
LO 5
Basic
9.12
Setting Standards, Ethical Behavior
LO 1, 2
Moderate
9.13
Computation of Inputs Allowed, Direct Materials and
Direct Labor
LO 2
Basic
9.14
Direct Materials and Direct Labor Variances
LO 3
Basic
9.15
Overhead Variances, Four-Variance Analysis
LO 4
Basic
9.16
Overhead Variances, Two- and Three-Variance
Analyses
LO 4
Basic
9.17
Direct Materials Mix and Yield Variances
LO 5
Basic
9.18
Direct Materials Variances, Journal Entries
LO 3, 5
Basic
9.19
Direct Labor Mix and Yield Variances
LO 5
Basic
9.20
Direct Labor and Direct Materials Variances, Journal
Entries
LO 3
Moderate
9.21
Investigation of Variances
LO 3
Moderate
9.22
Overhead Variances, Four-Variance Analysis, Journal
Entries
LO 4
Moderate
9.23
CPA-Type Exercise
LO1
Basic
9.24
CPA-Type Exercise
LO4
Basic
9.25
CPA-Type Exercise
LO4
Basic
9.26
CPA-Type Exercise
LO3
Basic
9.27
CPA-Type Exercise
LO1
Basic
9.28
Standard Costs, Decomposition of Budget Variances,
Direct Materials and Direct Labor
LO 2, 3
Moderate
9.29
Overhead Application, Overhead Variances, Journal
Entries
LO 4
Moderate
9.30
Direct Materials, Direct Labor, and Overhead
Variances, Journal Entries
LO 3, 4
Moderate
Cornerstone
Exercise (CS)/
Exercise/
Problem/Case
Topic
Learning
Objective
Degree of
Difficulty
9.31
Solving for Unknowns
LO 2, 3, 4
Moderate
9.32
Basic Variance Analysis, Revision of Standards,
Journal Entries
LO 1, 2, 3, 4
Moderate
9.33
Unit Costs, Multiple Products, Variance Analysis,
Journal Entries
LO 1, 2, 3, 4
Moderate
9.34
Direct Materials Usage Variance, Direct Materials Mix
and Yield Variances
LO 3, 5
Challenging
9.35
Direct Labor Efficiency Variance, Direct Labor Mix
and Yield Variances
LO 3, 5
Challenging
9.36
Direct Materials Usage Variances, Direct Materials
Mix and Yield Variances
LO 3, 5
Challenging
9.37
Solving for Unknowns, Overhead Analysis
LO 3, 4
Moderate
9.38
Flexible Budget, Standard Cost Variances, T-Accounts
LO 1, 3, 4
Moderate
9.39
Standard Costing: Planned Variances
LO 2, 3
Challenging
9.40
Variance Analysis in a Process-Costing Setting
(Chapter 6 Required), Service Firm
LO 2, 3
Challenging
9.41
Setting Standards, Calculating and Using Variances
LO 1, 3
Challenging
9.42
Cyber Research Case
LO 1, 3
Moderate
LIST OF ILLUSTRATIONS
Illustration
Topic
Exhibit 9.1
Cost Assignment Approaches
Exhibit 9.2
Standard Cost Sheet for Deluxe Strawberry Frozen Yogurt
Exhibit 9.3
Standard Bill of Materials
Exhibit 9.4
Variable Overhead Spending Variance by Item
Exhibit 9.5
Variable Overhead Spending and Efficiency Variances by Item
Exhibit 9.6
Fixed Overhead Spending Variance by Item
Exhibit 9.7
Two-Variance Analysis: Helado Company
Exhibit 9.8
Three-Variance Analysis: Helado Company