Chapter 10
Standard Costing:
A Managerial Control Tool
COPYRIGHT © 2012 Nelson Education Ltd.
Learning Objectives
1. Explain how units standards are set and why standard cost
systems are adopted
2. Explain the purpose of a standard cost sheet
3. Describe the basic concepts underlying variance analysis,
and explain when variances should be investigated
4. Compute the materials variances and explain how they are
used for control
5. Compute the labour variances, and explain how they are
used for control
6. (Appendix) Prepare journal entries for materials and labour
variances
10-2
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 1
Explain how unit
standards are set and
why standard cost
systems are adopted
Unit Standards
Developing standards enhances control
Need to determine the unit standard cost for
a particular input
Two decisions:
Quantity
decision
Pricing
decision
10-4
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Quantity & Price Decision
The amount of input that should be
used per unit of output
Quantity Standard
The amount that should be paid for
the quantity of input to be used
Price Standard
Quantity Standard × Price Standard = Unit Standard
10-5
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Unit Standard &
Development of Standards
Unit Standard:
• Used to enhance cost control
• Budgeted ‘unit’ costs
– Unlike budgets which contain aggregate
amounts of total revenue and total costs
Quantity Standards are developed by:
• Historical experience
• Engineering studies
• Input from operating personnel
10-6
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Development of Standards
Price Standards are the joint responsibility of:
• Operations
• Personnel
• Purchasing
• Accounting
10-7
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Types of Standards
Ideal standards
---
Currently attainable --standards
demand maximum
efficiency and can be
achieved only if
everything operates
perfectly
can be achieved under
efficiency operating
conditions
10-8
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Why Standard Cost
Systems Are Adopted
Two reasons:
• To improve planning and control
• To facilitate product costing
10-9
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Planning and Control
Standards:
• Enhance planning and control
• Improve performance management
• Fundamental requirement for a
flexible budgeting system
Actual costs are compared to budgeted costs
and variances are computed
10-10
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Product Costing
Costs are assigned to products using
standards for:
• Direct materials quantity
• Direct labour quantity
• Direct materials price
• Direct labour price
• Overhead quantity
• Overhead price
10-11
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Standard Costing
Advantages:
• Greater capacity for control
• Provides readily available unit cost
information
• Simplifies cost assignments in both
process and job costing systems
10-12
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OBJECTIVE 2
Explain the purpose of a
standard cost sheet
Example: Cornerstone 10-1
HOW TO Compute Standard Quantities Allowed (SQ and SH)
Information:
• Assume that 100,000 packages of corn chips are produced
during the first week of March
• Unit quantity standard is 18 grams of yellow corn per
package
• Unit quantity standard for machine operators is 0.01 hour
per package produced
Required:
• For the actual output of 100,000 packages:
– How much yellow corn should have been used?
– How many operator hours should have been used?
10-14
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Corn allowed:
Standard
quantity of
materials
allowed
SQ
=
Unit
Quantity
Standard
SQ
=
18
SQ
=
x
Actual
Output
x
100,000
1,800,000 grams
10-15
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Operator hours allowed:
Standard
hours
allowed
SH
=
Unit
Quantity
Standard
SH
=
0.01
SH
=
x
Actual
Output
x 100,000
1,000 direct labour hours
10-16
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OBJECTIVE 3
Describe the basic concepts
underlying variance analysis,
and explain when variances
should be investigated
Variance Analysis
Components
SP = Standard unit price of an input
SQ = Standard quantity of input for the
actual output
AP = Actual price per unit of the input
AQ = Actual quantity of the input used
10-18
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Total Budget Variance
Total =
Variance
Actual
Cost
–
Planned
Cost
(AP x AQ) – (SP x SQ)
10-19
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Price (Rate) Variance
Actual
Price
-
Standard
Price
Number of
x
inputs used
Favourable variance = Actual price is less
than standard price
Unfavourable variance = Actual price is
greater than standard price
10-20
COPYRIGHT © 2012 Nelson Education Ltd.
Usage (Efficiency) Variance
Actual
Quantity
-
Standard
Quantity
Standard
x
Unit Price
Favourable variance = Actual quantity is less
than standard quantity
Unfavourable variance = Actual quantity is
greater than standard quantity
10-21
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The Decision to Investigate
• Performance rarely meets established
standards exactly
• Random variations around the standard
are expected
• Management should determine an
acceptable range of performance
10-22
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Example: Cornerstone 10-2
HOW TO Control Limits to Trigger a Variance Investigation
Information:
Standard cost: $100,000; allowable deviation: $10,000;
actual costs for six months:
June
July
August
$97,500
105,000
95,000
September
October
November
$102,500
107,500
112,500
Required:
Plot the actual costs over time against the upper and lower
control limits. Determine when a variance should be investigated
10-23
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Example
$120,000
110,000
Standard
100,000
Acceptable
Range
(Don’t
Investigate)
90,000
June July August September October November
COPYRIGHT © 2012 Nelson Education Ltd.
Example
$120,000
Investigate
110,000
100,000
90,000
June July August September October November
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 4
Compute the materials
variances, and explain how
they are used for control
Example: Cornerstone 10-3
HOW TO Calculate the Total Variance for Materials
Information:
Unit standards:
Standard price: $0.01 per gram
Standard usage: 18 grams
Actual results for the first week in March:
Actual production: 48,500 bags of corn chips
Actual cost of corn: 780,000 grams at $0.015
Required:
Calculates the total variance for corn for the first week in March
10-27
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Total variance for corn:
Actual
Costs
– Budgeted
Costs
Total
=
Variance
AQ x AP
780,000 grams x $0.015
Corn
$11,700
10-28
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Total variance for corn:
Actual
Costs
– Budgeted
Costs
Total
=
Variance
SQ x SP
(18 grams x 48,500 bags)
Corn
x
$0.01
$11,700 – $8,730
10-29
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Total variance for corn:
Actual
Costs
Corn
– Budgeted
Costs
$11,700 -
Total
=
Variance
$8,730 = $2,970 U
10-30
COPYRIGHT © 2012 Nelson Education Ltd.
Direct Materials Variances
Materials Price Variance
Measures the difference between what
should have been paid for raw materials
and what was actually paid
MPV
=
(AP –
SP) x AQ
10-31
COPYRIGHT © 2012 Nelson Education Ltd.
Direct Materials Variances
Materials Usage Variance
Measures the difference between the
direct materials actually used and the
direct materials that should have been
used for the actual output
MUV
=
(AQ – SQ) SP
10-32
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 10-4
HOW TO Calculate Materials Variances:
Formula and Columnar Approaches
Information:
Unit standards:
Standard price: $0.01 per gram
Standard usage: 18 grams
Actual results for the first week in March:
Actual production: 48,500 bags of corn chips
Actual cost of corn: 780,000 grams at $0.015
Required:
Calculates the materials price and usage variance using the
3-pronged (columnar) and formula approaches
10-33
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
Materials Price Variance
MPV
=
(AP –
MPV
=
($0.015 –
MPV
=
$3,900 U
SP) AQ
$0.01) 780,000
10-34
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
Materials Usage Variance
MUV
= (AQ –
MUV
= [780,000 – (18 x 48,500)] ($0.01)
MUV
= $930 F
SQ) SP
10-35
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AQ x AP
$11,700
780,000 x $0.015
2. AQ x SP
$7,800
780,000 x $0.01
3. SQ x SP
$8,730
(18 x 48,500) x $0.01
10-36
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AQ x AP
$11,700
2. AQ x SP
$7,800
Price Variance
(1 – 2)
$3,900 U
3. SQ x SP
$8,730
Usage Variance
(2 – 3)
$930 F
10-37
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AQ x AP
$11,700
2. AQ x SP
$7,800
Price Variance
(1 – 2)
$3,900 U
3. SQ x SP
$8,730
Usage Variance
(2 – 3)
$930 F
Total Variance
(1 – 3)
$2,970 U
10-38
COPYRIGHT © 2012 Nelson Education Ltd.
Responsibility for the
Materials Price Variance
• Belongs to the purchasing agent
• Price can be influenced by:
• Quality
• Quantity discounts
• Distance of the source from the plant
10-39
COPYRIGHT © 2012 Nelson Education Ltd.
Responsibility for the
Materials Usage Variance
• Belongs to the production manager
• Variance can be influenced by minimizing:
• Scrap
• Waste
• Rework
10-40
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Analysis of the Variances
First step:
Decide whether the variance is
significant
Second step:
Find out why it occurred
10-41
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Accounting and Disposition
of Materials Variances
Materials variances are ADDED to cost
of goods sold if they are
UNFAVOURABLE
Materials variances are
SUBTRACTED from cost of goods
sold if FAVOURABLE
10-42
COPYRIGHT © 2012 Nelson Education Ltd.
Direct Labour Variances
Labour Rate Variance
Computes the difference between what
was paid to direct labourers and what
should have been paid
LRV
=
(AR –
SR) x AH
10-43
COPYRIGHT © 2012 Nelson Education Ltd.
Direct Labour Variances
Labour Efficiency Variance
Measures the difference between the labour
hours that were actually used and the
labour hours that should have been used.
LEV
=
(AH –
SH) SR
10-44
COPYRIGHT © 2012 Nelson Education Ltd.
OBJECTIVE 5
Compute the labour
variances and explain how
they are used for control
Example: Cornerstone 10-5
HOW TO Calculate the Total Variance for Labour
Information:
Unit standards:
Standard price: $8.00 per hour
Standard usage: 0.01 hours
Actual results for the first week in March:
Actual production: 48,500 bags of corn chips
Actual cost of corn: 360 hours @ $8.35
Required:
Calculate the total variance for inspection labour for
the first week in March
10-46
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Total variance for inspection labour:
Actual
Costs
AQ x AP
Inspection
labour
Budgeted
Costs
Total
= Variance
SQ x SP
$3,006 - $3,880 = $874F
10-47
COPYRIGHT © 2012 Nelson Education Ltd.
Example: Cornerstone 10-6
How to Calculate Labour Variances:
Formula and Columnar Approaches
Information:
Unit standards:
Standard price: $8.00 per hour
Standard usage: 0.01 hours
Actual results for the first week in March:
Actual production: 48,500 bags of corn chips
Actual cost of corn: 360 hours @ $8.35
Required:
Calculate the labour rate and efficiency variances using the 3-pronged
(columnar) and formula approaches
10-48
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
Labour Rate Variance
LRV
=
(AR –
LRV
=
($8.35 – $8.00) 360
LRV
=
$126 U
SR) AH
10-49
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Formula Approach
Labour Efficiency Variance
LEV
=
(AH –
LEV
=
(360
–
SH) SR
485) $8.00
0.01 x 48,500
LEV
=
$1,000 F
10-50
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AH x AR
$3,006
360 x $8.35
2. AH x SR
$2,880
360 x $8.00
3. SH x SR
$3,880
(0.01 x 48,500) x $8.00
10-51
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AH x AR
$3,006
2. AH x SR
$2,880
Price Variance
(1 – 2)
$126 U
3. SH x SR
$3,880
Usage Variance
(2 – 3)
$1,000 F
10-52
COPYRIGHT © 2012 Nelson Education Ltd.
Example
Columnar Approach
1. AH x AR
$3,006
2. AH x SR
$2,880
Price Variance
(1 – 2)
$126 U
3. SH x SR
$3,880
Usage Variance
(2 – 3)
$1,000 F
Total Variance
(1 – 3)
$874 F
10-53
COPYRIGHT © 2012 Nelson Education Ltd.
Causes of Labour Rate
Variance
• Labour rates are determined by
external forces as labour markets and
union contracts
• Labour rates can vary when:
– more skilled and more highly paid
labourers are used for less skilled tasks
– unexpected overtime occurs
10-54
COPYRIGHT © 2012 Nelson Education Ltd.
Responsibility for the
Labour Efficiency Variance
• Production managers are responsible
for the use of direct labour
• But once the cause is discovered,
responsibility may be assigned
elsewhere
10-55
COPYRIGHT © 2012 Nelson Education Ltd.