Standard Costs and Variances

 We learn how to use standard costs to decompose spending variances into two parts—a part
that measures how well the acquisition prices of resources were controlled and a part that
measures how efficiently those resources were used.

Standard Costs—Setting the Stage

 Standards are also widely used in managerial accounting where they relate to the quantity and
acquisition price of inputs used in manufacturing goods or providing services.
 Quantity standards specify how much of an input should be used to make a product or provide a
service.
 Price standards specify how much should be paid for each unit of the input.

Setting Direct Materials Standards

 The standard quantity per unit defines the amount of direct materials that should be used
for each unit of finished product, including an allowance for normal inefficiencies, such as
scrap and spoilage.
 The standard price per unit defines the price that should be paid for each unit of direct
materials and it should reflect the final, delivered cost of those materials.
 Once the quantity and price standards are established, the standard direct materials cost
per unit is computed by multiplying the standard quantity and the standard price per unit.

Setting Direct Labor Standards

 Direct labor quantity and price standards are usually expressed in terms of labor-hours
or a labor rate.
 The standard hours per unit defines the amount of direct labor-hours that should be
used to produce one unit of finished goods. One approach used to determine this
standard is for an industrial engineer to do a time and motion study, actually clocking
the time required for each task.
 The standard rate per hour defines the company’s expected direct labor wage rate per
hour, including employment taxes and fringe benefits. The standard rate may reflect the
expected “mix” of workers, even though the actual hourly wage rates may vary
somewhat from individual to individual due to differing skills or seniority.
 Once the time and rate standards are established, the standard direct materials cost per
unit is computed by multiplying the standard hours and the standard rate per unit.

Setting Variable Manufacturing Overhead Standards

 As with direct labor, the quantity and price standards for variable manufacturing
overhead are usually expressed in terms of hours and a rate.
 The standard hours per unit for variable overhead measures the amount of the
allocation base from a company’s predetermined overhead rate that is required to
produce one unit of finished goods.
  If company uses direct labor-hours as the allocation base in its predetermined overhead
rate, the standard hours per unit for variable overhead is exactly the same as the
standard hours per unit for direct labor.
 The standard rate per unit that a company expects to pay for variable overhead equals
the variable portion of the predetermined overhead rate.
 Once the time and rate standards are established, the standard variable manufacturing
overhead cost per unit is computed by multiplying the standard hours and the standard
rate per unit.
 This standard for variable manufacturing overhead appears along with direct materials
and direct labor on the standard cost card. A standard cost card shows the standard
quantity (or hours) and standard price (or rate) of the inputs required to produce a unit
of a specific product.
 The standard cost per unit for all three variable manufacturing costs is computed the
same way. The standard quantity (or hours) per unit is multiplied by the standard price
(or rate) per unit to obtain the standard cost per unit.

Using Standards in Flexible Budgets

 Once the standard cost card is created, information is used to calculate direct materials,
direct labor, and variable manufacturing overhead variances.
 The actual results and flexible budget columns are each based on the actual output. The
planning budget column is based on the planned output.
 The standard costs per unit for materials, direct labor, and variable manufacturing
overhead are each multiplied by the actual output to compute the amounts in the
flexible budget.
 Similarly, the three standard variable cost figures are multiplied by planned output to
compute the amounts in the planning budget.
 The spending variances are computed by taking the amounts in the actual results
column and subtracting the amounts in the flexible budget.
 The activity variances are computed by taking the amounts in the flexible budget
column and subtracting the amounts in the planning budget column.

A General Model for Standard Cost Variance Analysis

 Standard cost variance analysis decomposes spending variances from the flexible budget into
two elements—one due to the price paid for the input and the other due to the amount of the
input that is used.
 A price variance is the difference between the actual amount paid for an input and the standard
amount that should have been paid, multiplied by the actual amount of the input purchased.
 A quantity variance is the difference between how much of an input was actually used and how
much should have been used and is stated in dollar terms using the standard price of the input.
 Why are standards separated into two categories—price and quantity? Price variances and
quantity variances usually have different causes. In addition, different managers are usually
responsible for buying (purchasing manager) and using inputs (production manager).

 Three things should be noted
1. It can be used to compute a price variance and a quantity variance for each of the three
variable cost elements—direct materials, direct labor, and variable manufacturing overhead
—even though the variances have different names. A price variance is called a materials
price variance in the case of direct materials, a labor rate variance in the case of direct labor,
and a variable overhead rate variance in the case of variable manufacturing overhead. A
quantity variance is called a materials quantity variance in the case of direct materials, a
labor efficiency variance in the case of direct labor, and a variable overhead efficiency
variance in the case of variable manufacturing overhead.
2. All three columns in the exhibit are based on the actual amount of output produced during
the period.
o The key to understanding the flexible budget column is to grasp the meaning of the
term standard quantity allowed (SQ).
o The standard quantity allowed (when computing direct materials variances) or standard
hours allowed (when computing direct labor and variable manufacturing overhead
variances) refers to the amount of an input that should have been used to manufacture
the actual output of finished goods produced during the period. It is computed by
multiplying the actual output by the standard quantity (or hours) per unit. The standard
quantity (or hours) allowed is then multiplied by the standard price (or rate) per unit of
the input to obtain the total cost according to the flexible budget
3. The spending, price, and quantity variances—regardless of what they are called—are
computed exactly the same way regardless of whether one is dealing with direct materials,
direct labor, or variable manufacturing overhead
o In all of these variance calculations, a positive number should be labelled as an
unfavorable (U) variance and a negative number should be labelled as a favorable
(F) variance.
Using Standard Costs—Direct Materials Vaances