Standard Costing, Variance Analysis, and
Kaizen Costing
Standards
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Predetermined amount for what should happen
Quantity standard
Quantity of the resource that should be consumed
Cost standard
Cost per unit that should be paid for the resource
Provides a context for evaluating actual amounts
Advantages
Provides a context for evaluating actual amounts
Standard costs do not fluctuate
Simplified accounting
Less expensive than actual costing
Management by Exception
Take the time to investigate only significant cost variances
Depends on the Size of the organization
Depends on the Type of the Organization
Depends on the Production Process
Setting Standards
Analysis of historical data
Used in a mature production Process
Task analysis
Analyze the process of manufacturing the product
A Combined approach
Analyze the process for the step that has changed, but use
historical data for the steps that have not changed
Perfection versus practical standards: A
behavioral issue
Perfection standards
• Can only be attained under near perfect conditions
• Peak efficiency
• Lowest possible input prices
• Best-quality material
• No disruption in production
Practical or attainable standards
• Tight as practical, but still are expected to be attained
• Occasional machine breakdowns
• Normal amounts of raw material waste
Cost and benefits of standard-costing
systems
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Provide information that can help managers control costs
Time consuming
Costly
Labor- intensive
Expensive process
Must be updated periodically to reflect changes in the cost
structure of production process
The benefit of information, in terms of improved production
cost control and decision making, must be weighed against
the cost of generation the information
Standard direct material quantity:
Total amount of material normally required to a finished product,
including allowances for normal waste or inefficiency any purchase
discount.
Standard direct-material price:
Is the total delivered cost after subtracting any purchase discounts.
Standard direct-labor quantity:
Is the number of labor hours normally needed to manufacture one unit of
product.
Standard direct-labor:
Is the total hourly cost of compensation, including fringe benefits.
Analysis of Cost Variances
Cost management analyst uses the following deviations to control the excess costs:
1- Direct-Material Variances
2- Direct-Labor Variances
1- Direct-Material Variance
Imagine the company manufactures tents.
Standard amount of material in square meters=36,000
Direct material purchases in square meters =40,000
Direct material used in square meters = 36,400
Standard cost per square meter= $ 8.00
Actual Cost per square meter= $8.15
- The Budgeted or Standard costs for direct materials are as follows:
Total standard direct-material cost=36,000* $8= $288,000
-The Actual costs for the direct-materials are as follows:
-Direct material purchases=40,000*$8.15=$326,000
-Direct material used=36,400*$8.15=$296,660
1-1-Direct-Material Price Variance = (Quantity purchased)*(Actual price-Standard price)
Direct-Material Price Variance = 40,000($8.15-$8)=$6,000 Unfavorable
 The variance is unfavorable, because the actual purchase price exceeded the standard price.
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2-1-Direct-Material Quantity Variance = (Standard Price)*(Actual Quantity Used-Standard Quantity Allowed)
=$8(36,400-36000)=$3,200 Unfavorable
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The variance is unfavorable, because the actual quantity of direct material exceeded the standard quantity allowed.
NOTICE: Standard quantity of material must be based on the actual production output to
provide helpful information for management.
2- Direct-Labor Variance
1-2- Direct-Labor rate Variance=Actual Hours Used(Actual Rate per Hour-Standard Rate per Hour) = 5,900($19-$18)= $5,900 Unfavorable
 This variance is unfavorable because the actual rate exceeded the standard rate.
2-2- Direct-Labor Efficiency Variance=
Standard Rate per Hour (Actual Hour used-Standard Hours Allowed)=$18(5,900-6,000)=$1.80
 This variance is favorable because the actual number of direct labor hours were less than the number of standard hours allowed.
NOTICE: The number of standard hours of direct labor allowed is based on the actual production
output .
Multiple Types of Direct Material and Direct Labor
Manufacturing processes usually involve types of direct material. In such cases, direct materials
price and quantity variances are computed for each type of material. Then these variances are
added to obtain a total price variance and a total quantity variance:
Direct Material X…………………….$1,500 F
Direct Material Y…………………….$2,400 U
Direct Material Z…………………….$900 U
Total Variance………………………..$1,800 U
Allowance for Defects or Spoilage
In some manufacturing processes, a certain amount of defective production or spoilage is normal.
Forexample when 1000 units of inputs are required to obtain 800 outputs and the total output
in a certain period is going to be 5000 units, the standard allowed quantity of input will be
calculated as below:
Good output quantity=80% * Input quantity
Input allowed= 5000/ 80%= 6250 units of input allowed
Significance of Cost Variances:
Managers are busy people. They don’t have time to investigate the causes of every cost variance.
A manager applies judgement and experience in making guesses, following his guesses and
relying on intution to determine when to investigate a variance.Nevertheless, these are
guidelines and rules of thumb that managers often apply.
Size of variance
How does a manager know when to
follow up on a cost variance and when
to ignore it?
Absolute size
Managers are more likely to follow up
on large variances than on small size
Relative size
Standard direct- material cost: 200,000 $
Material quantity variance: 40,000 $(20%)
Standard direct –labor cost:3,000,000
Labor efficiency variance: 60,000$(2%)
The Rule of Thumb:
Investigate variances that are either more than 10,000 $ or more
than 10% of standard cost
Recurring variances
MONTH
VARIANCE % OF STANDARD COST
September $6,000 F
6.0%
October
6,400 F
6.4%
November
3,200 F
3.2%
December
6,200 F
6.2%
None of the variances are greater than $10,000 or
10%, but this variance should be investigated
because it has occurred at a reasonably
high amount for four months
Trends
MONTH
VARIANCE % OF STANDARD COST
September
$250 U
0.25%
October
840 U
0.84%
November
4,000 U
4.0%
December
9,300 U
9.3%
None of the variances are greater than $10,000 or
10%, but this variance should be investigated
because it has an unfavorable trend.
Controllability
A manager is more likely to
investigate a variance that is
controllable by someone in
the organization than one that
is not
Favorable Variances
It is as important to
investigate significant
favorable variances as well
as significant unfavorable
variances
Cost and Benefits of
Investigation
The decision whether to
investigate a variance is a
cost - benefit decision
Statistical Analysis
A STATISTICAL CONTROL CHART plots cost variances
across time and compares them with a statistically
determined critical value that triggers an investigation
Favorable
variances
Investigate
1 standard
deviation
Critical
value
1 standard
deviation
Unfavorable
variances
Behavioral
Effects Of
Standard
Costing
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Time
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X
Jan.
Feb.
March
Standard costs,
budgets, and variances
are used to
evaluate the
performance of
individuals and
departments
April
May
June
They can profoundly
influence behavior when
they are used to
determine salary
increases, bonuses, and
promotions
Which Managers Generally Influence Cost Variances?
Direct-material price variance
The purchasing manager
Get the best prices available for purchased goods and services through
skillful purchasing practices
Direct-material quantity variance
The production supervisor
Skillful supervision and motivation of production employees, coupled with
the careful use and handling of materials, contribute to minimal waste
Direct-labor rate variance
The production supervisor
Generally results from using a different mix of employees than that anticipated
when the standard were set
Direct- labor efficiency variance
The production supervisor
Motivating employees toward production goals and effective work schedules
improves efficiency
Interaction among variances
• Interaction among variances often occur making it difficult to
determine the responsibility for a particular variance.
• Variances in one part of the value chain can be due to root
causes in another part of the chain
• Value chain perspective
Research and
development
Design
Supply
Production
Marketing
Distribution
Customer
service
Use of standard cost for product costing
• Standard costing has long been used in manufacturing and
some distribution environment as a control for measuring
variation for expected results.
Standard costing system
Direct material
Direct labor
Disposition of variances
Impact of information technology on standard
costing
Use of bar codes
Computer-aided design
Standard costing: its traditional advantage
 Enables managers to employ management by exception.
 Standard costs provide a basis for sensible cost comparison.
 Variances provide a means of performance evaluation and
rewards for employees.
 They provide motivation for employees to adhere standards.
 Use of standard costs in product costing results in more stable
product costs.
 A standard-costing system is usually less expensive.
Criticisms of Standard Costing in Today’s
Manufacturing Environment
Variances can be too aggregated
Work best in stable, mass production environment
Focus on cost minimization, not qualitative issues
Greater automation reduces variances
Standards are often relevant for only a short time
Adaption of Standard-Costing Systems
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Reduced importance of labor standards and variances
Emphasis on material and overhead costs
Cost drivers
Shifting cost structure
High quality and no defects
Non-value-added costs
New measures and standards
Kaizen costing
• most consistent with the saying "slow and steady wins the
race."
• Kaizen costing is the process of cost reduction during the
manufacturing phase of a product
Flexible-Overhead Budgets,
• budget that adjusts or flexes for changes in the volume of
activity
• Flexible budget is not based on only one level of activity
• Measuring the activity
– input or output
– When different type of product
• Flexible-Overhead budget illustration
- Columnar flexible budget
- Formula flexible budget
• Overhead application
– Normal costing: Actual figures
– Standard costing: Standard figures allowed
What is difference and similarities?
• Choice of Activity Measure:
Technology
Money!
Impact of Information Technology
• Many business are adopting integrated business software
package that handle abroad range of computing need such as
customer and supplier databases, personnel and pay roll
function, production scheduling and management
Overhead Cost Variance
• At the end of each accounting period, the cost –management
analyst uses the flexible- overhead budget to determine the
level of overhead cost that should have been incurred, given
the actual level of activity.
Variable- Overhead Efficiency Variance
• It is difference between the actual and standard quantity of an
activity base multiplied by the standard variable-overhead rate
Fixed-Overhead Budget Variance
• The variance that managers use to control fixed overhead is
called the fixed-overhead budget variance. The fixed-overhead
budget variance is the difference between actual fixed
overhead and budgeted fixed overhead given actual output
Capacity Utilization :
Positive volume variance :
It measures the cost of underutilizing
productive capacity .
The fault of this view:
It ignores the real cost of underutilization
productive capacity and the real cost results not
produced when capacity is underutilized.
What do four –way , three-way , two-way
variance analyses tell the cost manager ?
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Variable overhead spending variance
Variable overhead efficiency variance
Fixed overhead budgeted variance
Fixed overhead volume variance
Journal entries under standard costing
Manufacturing overhead……………………… 62,980
Indirect-material inventory.……………….
19,350
Wages payable…………………………………..
32,610
Utilities payable ………….……………………
2,170
Accumulated depreciation ……………….
1,300
Prepaid insurance &property taxes ....
1,050
Engineering salaries payable ………….…
6,500
Work-in-process Inventory ……………… …………… 49,500
manufacturing overhead…………………………..
Manufacturing Overhead
Actual
62,980 49,500
Applied
49,500
Disposition of Variances
Cost of good sold……………………………. 13,480
Manufacturing overhead……….......
13,480
How Does ABC Affect Performance
Reporting?
Conventional and activity based flexible budgets use different cost drivers for overhead costs. The
differences are important for performance reporting.
The conventional budget:
• Treats quality assurance, setup, materials-handling and engineering costs as fixed.
The activity-based flexible budget :
 Provides a more accurate prediction (And benchmark) of overhead costs.
 A more accurate benchmark against which to compare actual costs.
 Shows that quality assurance, setup, materials-handling and engineering costs are all
with respect to the appropriate cost driver.
variable
Standard Costing in a Just-in-Time Environment
Just-in-Time manufacturing
setting with demand-pull of
products
Manufacturing
process
Minimizing inventories
As a result, some companies have simplified their accounting system by charging all
manufacturing costs directly to Costs of Goods Sold.
This method of accounting is known as Backflush costing.
Sales variance analysis with cost variance
Sales performance is equally important in affecting a company’s bottom-line.
Sales Volume of
Each Product
Revenue
Contribution Margin
Profit
Sales Price
Sales variance analysis:
A technique used to help management understand and manage the effects
of the company’s sales performance on its profitability.
Case Study