Chapter 7:
Standard Costing and
Variance Analysis
Cost Accounting:
Foundations and Evolutions, 8e
Kinney ● Raiborn
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Learning Objectives
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How are material, labor, and overhead standards
set?
How are material, labor, and overhead variances
calculated and recorded?
Why are standard cost systems used?
How have the setting and use of standards changed
over time?
How does the use of a single conversion element
(rather than the traditional labor and overhead
elements) affect standard costing?
(Appendix) How are variances affected by multiple
material and labor categories?
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Standard Cost Systems
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Manufacturing
Service
Not-for-Profit
Record standard and actual costs in the
accounting records
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Standards

Standard costs are budgeted costs to



Manufacture a single unit of product or
Perform a single service
To develop standards, identify


Material and labor types, quantities, and prices
Overhead types and behavior
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Manufacturing Objective
Minimize unit cost while achieving certain
quality specifications.
Input
Resources
Output
Quality
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Material Standards

Materials used




Types
Quantity
Quality
Price

From


Product specifications,
observation, inquiry
Bill of materials
 Balance cost, quality, and projected sales price
Standard
Material =
Cost
Unit Purchase Price * quantity
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Labor Standards

Labor used

Types




From

Production, setup,
cleanup, and rework
Quantity
Cost

Include wages, payroll
taxes, and fringe
benefits
Standard
Labor
=
Cost

Industrial engineering
studies including
methods-time
measurement (MTM),
time and motion studies,
historical data
Operations flow
document
Hours * Wage Rate
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Overhead Standards
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

Variable and fixed manufacturing
overhead
Estimated level of activity
Estimated costs
Predetermined factory overhead
application rates
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Standard Cost Card
For one unit of output (a bike)
Standard Direct Material Components
Standard Direct Labor Components
Manufacturing Overhead
Variable Overhead
Fixed Overhead
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Variance
 Variance is the difference between
an actual cost and a standard cost.
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Total Variance
Total actual cost incurred minus total standard cost
applied to output produced
Actual price of
actual
production input
Standard cost of
actual
production
output
Total Variance*
*Favorable
or unfavorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Total Variance
AP x AQ
SP x SQ
Total Variance
Inputs
Outputs
AP = actual cost/price per unit of materials or hours of
labor
AQ = actual quantity of materials or hours of labor
SP = standard cost/price per unit of materials or
hours of labor
SQ = standard quantity of materials or hours of labor
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Price Variance
AP x AQ
SP x AQ
SP x SQ
Price/Rate
Variance
Total Variance
What
was
paid
(AP – SP) x AQ*
What should
have been
paid
*Favorable or unfavorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Usage Variance
AP x AQ
What
was
used
SP x AQ
SP x SQ
Usage
Variance
Total Variance
(AQ – SQ) x
*Favorable or unfavorable
SP*
What should
have been
used for the
level of output
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Material Price Variance (MPV)
AP x AQ
SP x AQ
SP x SQ
MPV
Total Variance
What
was
paid
(AP – SP) x
AQ*
What should
have been
paid
*Favorable or unfavorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
MPV Calculations

Calculate MPV at
 Point of purchase or
 When materials used
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Material Quantity Variance (MQV)
AP x AQ
SP x AQ
SP x SQ
MQV
What
was
used
Total Variance
(AQ – SQ) x
*Favorable or unfavorable
SP*
What should
have been
used for
level of output
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Labor Rate Variance (LRV)
AP x AQ
SP x AQ
SP x SQ
LRV
Total Variance
What
was
paid
(AP – SP) x
AQ*
What should
have been
paid
*Favorable or unfavorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Labor Efficiency Variance (LEV)
AP x AQ
SP x AQ
SP x SQ
LEV
What
was
used
Total Variance
(AQ – SQ) x
*Favorable or unfavorable
SP*
What should
have been
used for
level of output
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Overhead Variances
Variable Overhead
Fixed Overhead
Actual variable overhead
is total of various ledger
accounts
Actual fixed overhead is
total of various ledger
accounts
SP = Predetermined
variable overhead rate
SP = Predetermined
fixed overhead rate
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Variable Overhead Variances
Actual
VOH
Actual
For
actual
hours
used
Budgeted
VOH
Applied
VOH
SP x AQ
SP x SQ
VOH
Spending
Variance
VOH
Efficiency
Variance
Total VOH Variance
What should
have been
used for level
of output
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
VOH Spending Variance
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Caused by price differences
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
Managers have little control over prices
Caused by shrinkage or waste

Managers should be held accountable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Fixed Overhead Variances
Actual
FOH
Budgeted
FOH
Applied
FOH
SP x SQ
Constant
Amount
FOH
Spending
Variance
FOH
Volume
Variance
Total FOH Variance
What should
have been
used for level
of output
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
FOH Spending and Volume Variance

FOH Spending
Variance



Calculate variance for
each component
Caused by price
differences
May reflect
mismanagement of
resources

FOH Volume Variance



Measures capacity
utilization
Caused by producing at
a level that differs from
the capacity level used to
compute the
predetermined overhead
rate
Also called the
noncontrollable variance
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Alternative Overhead Variance
Approaches
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One variance
Two variance
Three variance
Four variance
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
One Variance Approach
Standard
Cost of
OH
SP x SQ
Actual
OH
Total OH Variance
Applied
Overhead
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Two Variance Approach
Actual Budgeted OH Standard
OH
based on SQ Cost of
OH
SP x SQ
Budget
Variance
Volume
Variance
Total OH Variance
Applied
Overhead
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Three Variance Approach
Actual
OH
Budgeted OH
based on
based on
Actual Inputs Actual Output
Standard
OH
SP x SQ
OH
Spending
Variance
OH
Efficiency
Variance
Total OH Variance
Volume
Variance
Applied
Overhead
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Standard Cost Journal Entries
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
Variances recorded in accounting system
Favorable variances



Unfavorable variances



Credits
Represent savings in production costs
Debits
Represent excess production costs
Inventories are recorded at standard cost
during the period
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Purchase of Materials
(Point of Purchase Method)
At
Standard
Cost
Materials
SP x AQ
purchased
Materials
Price
Variance
U
Accts Pay
F
AP x AQ
purchased
Debit—Unfavorable
Credit—Favorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Use of Materials
At
Standard
Cost
WIP
SP x SQ
allowed
Materials
Quantity
Variance
U
Materials
F
SP x AQ
used
Debit—Unfavorable
Credit—Favorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Record Labor
LRV
At
Standard
Cost
U
F
LEV
U
F
WIP
Wages Pay
AP x AQ
SP x SQ
allowed
Debit—Unfavorable
Credit—Favorable
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Apply Overhead
WIP
SP x SQ
Allowed
VOH
SP x SQ
Allowed
FOH
SP x SQ
Allowed
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Year-End Treatment for VOH
VOH
Efficiency
Variance
VOH
Spending
Variance
VOH
Actual Applied
---------------
Debit—Unfavorable
Credit—Favorable
Enter a debit or
credit to bring
balance to zero
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Year-End Treatment for FOH
FOH
Spending
Variance
Volume
Variance
FOH
Actual Applied
-------------
Debit—Unfavorable
Credit—Favorable
Enter a debit or
credit to bring
balance to zero
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Year-End Treatment of Variances
Immaterial—Adjust Cost of Goods Sold
Material—Prorate variances to:

Material Price
Variances




Raw Materials
WIP
Finished Goods
Cost of Goods Sold

All other variances



WIP
Finished Goods
Cost of Goods Sold
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Why Use Standard Cost Systems
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
Motivation
Planning
Controlling—variance analysis
Decision making
Performance evaluation
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Setting Standards and Trends

Setting Standards


Appropriateness
Attainability



Expected standards
Practical standards
Ideal standards

Trends in Standards
 Ideal Standards and
Theoretical Capacity
 Adjusting standards
 Price variance on
purchase versus
usage
 Decline in direct labor
content
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Conversion Costs


Combine direct labor and manufacturing
overhead
Variances



Spending variance for overhead
Efficiency variances for machinery and production
costs
Volume variances for production
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Material Price, Mix, and Yield Variances
AM x
AQ x
AP
Material
Price
Variance
AM—Actual Mix
SM—Standard Mix
AM x
AQ x
SP
SM x
AQ x
SP
Material
Mix
Variance
SM x
SQ x
SP
Material
Yield
Variance
What should
have been
used for level
of output?
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Labor Rate, Mix, and Yield Variances
AM x
AH x
AR
Labor
Rate
Variance
M—Mix
H—Hours
R—Rate
AM x
AH x
SR
SM x
SH x
SR
SM x
AH x
SR
Labor
Mix
Variance
Labor
Yield
Variance
What should
have been
used for level
of output?
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Questions



How are standards set for material, labor,
and overhead?
How is variance analysis used for control
and performance evaluation?
Why are labor and overhead elements
sometimes combined into a single
conversion element?
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential Ethical Issues
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




Setting high standards to create favorable variances
Ignoring effects of one production area on another
Setting overhead rates too low based on high
production levels to distort inventory cost and
operating income
Producing inventory only to create a favorable volume
variance
Not updating standards so that favorable variances
are created
Using low quality materials or labor to create favorable
variances and low quality products
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.