Standard Costing: A Functional-Based Control Approach

Price and Quantity Standards and unit standard Cost

• Price standards: Specify how much should be paid for the quantity of the input to be used
• Quantity standards: Specify how much of the input should be used per unit of output
• Unit standard cost: Product of standard price (SP) and standard quantity (SQ)
Standards
• Sources of quantitative standards
– Historical experience
– Engineering studies
– Input from operating personnel
• Price standards are the joint responsibility of operations, purchasing, personnel, and accounting
– Choices are limited by market forces, trade unions, and other external forces
Classification of Standards
• Ideal standards
– Demand maximum efficiency
– Achieved only if everything operates perfectly
• Currently attainable standards
– Can be achieved under efficient operating conditions
– Allowance is made for normal breakdowns, interruptions, and less than perfect skill
Kaizen Standards
• Continuous improvement standards
• Reflect planned improvement and are a type of currently attainable standard
• Focus on cost reduction
Standards and activity-based costing
• Activity cost is determined by the amount of resources consumed by each activity
– Standard consumption patterns are identified based on historical experience
– Use standards for control
– Activities are classified as either value-added or non-value-added
• Purpose of standards
– To facilitate cost assignments
Reasons for Adopting Standard Costing Systems
• Cost management
• Planning and control
 • Decision making and product costing
EXHIBIT 9.1 - Cost Assignment Approaches

Manufacturing Costs: Manufacturing Costs: Manufacturing Costs:

Direct Materials Direct Labor Overhead

Actual costing system Actual Actual Actual

Normal costing system Actual Actual Budgeted

Standard costing system Standard Standard Standard

EXHIBIT 9.2 - Standard Cost Sheet for Deluxe Strawberry Frozen Yogurt

Description Standard Price Standard Usage Standard Cost Subtotal

Direct materials:

Yogurt $ 0.04 × 25 oz. = $1.00

Strawberries 0.02 × 10 oz. = 0.20

Milk 0.03 × 8 oz. = 0.24

Cream 0.05 × 4 oz. = 0.20

Gelatin 0.02 × 1 oz. = 0.02

Container 0.06 × 1 = 0.06

Total direct materials $1.72

Direct labor:

Machine operators 16.00 × 0.01 hr. = $0.16

Total direct labor 0.16

Overhead:

Variable overhead 12.00 × 0.01 hr. = $0.12

Fixed overhead 40.00 × 0.01 hr. = 0.40

Total overhead 0.52

 Total standard unit $2.40
cost

Standard Costing systems

• Standard costs are developed for direct materials, direct labor, and overhead used in producing a
product or service
• Total of standard costs yields the standard cost per unit
– Standard cost sheet: Provides the detail underlying the standard unit cost
Purpose of a Standard Cost Sheet
• Reveals the quantity of each input that should be used to produce one unit of output
– Unit quantity standards can be used to compute the total amount of inputs allowed for the actual
output
 Helps in the computation of standard quantity of materials allowed (SQ) and the
standard hours allowed (SH) for the actual output
Total Budget Variance
• Difference between the actual cost of the input and its standard cost
– Total budget variance = (AP × AQ) – (SP × SQ)
 AP = Actual price per unit
 AQ = Actual quantity of direct material used in production
 SP = Standard price per unit
• Components of total Budget VariancePrice (rate) variance
– Difference between the actual and standard unit prices of an input multiplied by the actual
quantity of input
• Usage (efficiency) variance
– Difference between the actual and standard quantity of input multiplied by the standard unit
price of the input
Favorable and Unfavorable Variance
• Favorable (F) variance: Occurs whenever actual prices or usage of inputs are lesser than standard
prices or usage
• Unfavorable (U) variance: Occurs whenever actual prices or usage of inputs are greater than standard
prices or usage
Direct materials price variance (MPV)
• MPV = (AP × AQ) – (SP × AQ) or
• MPV = (AP – SP) AQ
– MPV is unfavorable if the actual price is greater than the standard price
– MPV is favorable if the actual price is less than the standard
 • Computed at one of two points:
– When the direct materials are issued for use in production
– When they are purchased
Direct Materials Usage Variance (MUV)
• MUV = (SP × AQ) – (SP × SQ) or
• MUV = (AQ – SQ)SP
– If the actual quantity is greater than the standard quantity, the MUV is unfavorable
– If the actual quantity is less than the standard, the MUV is favorable
• Should be computed as direct materials are issued for production
Companies use standard bill of materials, color-coded excessive usage forms, and color-coded returned-
materials forms to facilitate the process
Direct Materials Price and Materials Usage Variances – Example (1 of 5)
• Helado Company provided the following information for the production of deluxe strawberry frozen
yogurt during the month of April:
– Actual production: 30,000 quarts
– Actual yogurt usage: 745,000 ounces (no beginning or ending yogurt inventory)
– Actual price paid per ounce of yogurt: $0.05
 Unit quantity standard: 25 ounces of yogurt per quart
 Standard price of yogurt: $0.04 per ounce
 Direct labor standard: 0.01 direct labor hour per quart
Direct Materials Price and Materials Usage Variances – Example (2 of 5)
• Calculate the ounces of yogurt that should have been used (SQ) for the actual production of frozen
yogurt for the month of April
• Calculate MPV and MUV for April using the formula approach and the graphical approach
• Calculate the total direct materials variance for yogurt for April
Direct Materials Price and Materials Usage Variances – Example (3 of 5)
• Solution
– SQ = Unit quantity standard × Actual output
= 25 × 30,000 = 750,000 ounces
– Materials price variance (MPV)
= (AP − SP) AQ = ($0.05 − $0.04) 745,000
= $0.01 × 745,000 = $7,450 U
– Materials usage variance (MUV)
= (AQ − SQ) SP = (745,000 − 750,000) $0.04
= (5,000 × $0.04) = $200 F
Direct Materials Price and Materials Usage Variances – Example (4 of 5)

Direct Materials Price and Materials Usage Variances – Example (5 of 5)

 Total direct materials variance

= (AP × AQ) − (SP × SQ) = MPV + MUV
= ($0.05 × 745,000) − ($0.04 × 750,000)
= $37,250 − $30,000
= $7,250 U
Standard Bill of Materials
• Identifies the quantity of direct materials that should be used to produce a predetermined quantity of
output
• Acts as a materials requisition form
• Product: Quarts of Deluxe Strawberry Frozen Yogurt
• Output: 30,000 Quarts

Direct Material Unit Standard Total Requirements

Yogurt 25 oz. 750,000 oz.

Strawberries 10 oz. 300,000 oz.

Milk 8 oz. 240,000 oz.

Cream 4 oz. 120,000 oz.

Gelatin 1 oz. 30,000 oz.

 Container 1 container 30,000 containers

Accounting for Direct Materials Price and Usage Variances (1 of 3)

• All inventories are carried at standard
– Direct materials price variance is computed at the point of purchase
• Rules for recording variances
– Unfavorable variances are always debits
– Favorable variances are always credits
Accounting for Direct Materials Price and Usage Variances (2 of 3)
• Journal entry associated with the purchase of direct materials
– Assumptions
 Unfavorable MPV
 AQ is defined as direct materials purchased

Debit Credit

Materials (SP × AQ)

Direct Materials Price Variance (AP – SP)AQ

Accounts Payable (AP × AQ)

Accounting for Direct Materials Price and Usage Variances (3 of 3)

• Journal entry to record the issuance and usage of direct materials
– Assumption - Unfavorable MUV

Debit Credit

Work in Process (SP × SQ)

Direct Materials Usage Variance (AQ – SQ)SP

Materials (SP × AQ)

Direct labor rate variance (LRV) and Direct Labor Efficiency Variance (LEV)
• LRV = (AR × AH) – (SR × AH) or (AR – SR) AH
– AR = Actual hourly wage rate
– SR = Standard hourly wage rate
 – AH = Actual direct labor hours used
• LEV = (AH × SR) – (SH × SR) or (AH – SH) SR
– AH = Actual direct labor hours used
– SH = Standard direct labor hours that should have been used
– SR = Standard hourly wage rate
Direct Labor Rate and Efficiency Variances – Example (1 of 4)
• Helado Company provided the following information for the production of deluxe strawberry frozen
yogurt during the month of April:
– Actual production: 30,000 quarts
– Actual direct labor hours worked: 325 hours
– Actual rate paid per hour to direct labor: $15.90
• Calculate the direct labor hours that should have been worked (SH) for the actual production of frozen
yogurt for the month of April
Direct Labor Rate and Efficiency Variances – Example (2 of 4)
• Calculate LRV and LEV for April using the formula and graphical approaches
• Calculate the total direct labor variance for yogurt for April
• Solution
– SH = Unit quantity standard × Actual output
= 0.01 × 30,000
= 300 hours
Direct Labor Rate and Efficiency Variances – Example (3 of 4)
– Labor rate variance (LRV) = (AR − SR) AH
= ($15.90 − $16.00)325
= $0.10 × 325 = $32.50 F
– Labor efficiency variance (LEV) = (AH – SH) SR
= (325 − 300) $16.00
= (25 × $16.00) = $400 U
– Total direct labor variance = (AR × AH) – (SR×SH) = LRV + LEV
= ($15.90 × 325) – ($16.00 × 300)
= $5,167.50 − $4,800 = $367.50 U
Direct Labor Rate and Efficiency Variances – Example (4 of 4)
Accounting for Direct Labor Rate and Efficiency Variances
• Assumptions
– Favorable direct labor rate variance
– Unfavorable direct labor efficiency variance

Debit Credit

Work in Process (SH × SR)

Direct Labor Efficiency Variance (AH – SH)SR

Direct Labor Rate Variance (AR − SR)AH

Wages Payable AH × AR

Establishing Acceptable Range of Performance

• Acceptable range is the standard set by the management, plus or minus one allowable deviation
• Control limits: Top and bottom measures of the allowable range
– Upper control limit - Standard plus the allowable deviation
– Lower control limit - Standard minus the allowable deviation
– Set based on past experience, intuition, and judgment
Responsibility for the Direct Materials Variances (1 of 2)
• Price variance can be influenced by quality, quantity discounts, and distance of the source from the
plant
– Factors are under the control of the purchasing agent
• Production manager is responsible for direct materials usage
– Standard can be met by minimizing scrap, waste, and rework
Responsibility for the Direct Materials Variances (2 of 2)
• Limitations in using price variance to evaluate performance of purchasing
– Emphasis on meeting or beating the standard can produce undesirable outcomes
– Applying the usage variance to evaluate performance can lead to undesirable behavior
Responsibility for the Direct Labor Variances
• Direct labor rate variances occur when:
– An average wage rate is used for the rate standard
– More skilled and more highly paid laborers are used for less skilled tasks
• Use of direct labor is controllable by the production manager
Disposition of Direct Materials and Direct Labor Variances
• Immaterial variances are assigned to Cost of Goods Sold
– Cost of Goods Sold must be increased at the end of the year to reflect the higher actual cost for
unfavorable variances
• Materials variances are prorated among Work in Process, Finished Goods, and Cost of Goods Sold
– Direct materials and direct labor variances can be assigned in proportion to the total prime costs
in each of the inventory accounts
Four-Variance Method for Calculating Overhead Variances
• Calculates two variances for variable overhead and two variances for fixed overhead
• Total variable overhead variance is divided into:
– Variable overhead spending variance
– Variable overhead efficiency variance
• Total fixed overhead variance is divided into:
– Fixed overhead spending variance
– Fixed overhead volume variance
Variable Overhead Spending Variance and Variable Overhead Efficiency Variance
• Variable overhead spending variance
= (AVOR × AH) – (SVOR × AH)
= (AVOR – SVOR) AH
– Variable overhead changes in proportion to changes in the direct labor hours used
– AVOR = Actual variable overhead rate
– SVOR = Standard variable overhead rate
• Variable overhead efficiency variance
= (SVOR × AH) – (SVOR × SH)
= (AH – SH) SVOR
Variable Overhead Spending and efficiency Variances – Example (1 of 4)
• Helado Company provided the following information for the month of May:

Variable overhead rate (standard) $12.00 per direct labor houra

Actual variable overhead costs $16,120

Actual hours worked 1,300

Quarts of deluxe strawberry frozen yogurt produced 120,000

Hours allowed for actual production 1,200b

Applied variable overhead $14,400c

Variable Overhead Spending and efficiency Variances – Example (2 of 4)

• Calculate the variable overhead spending variance using the formula approach
• Calculate the variable overhead efficiency variance using the formula approach
• Calculate the variable overhead spending variance and variable overhead efficiency variance using the
three-pronged graphical approach
Variable Overhead Spending and efficiency Variances – Example (3 of 4)
• Solution:
– Variable overhead spending variance = (AVOR – SVOR) AH
= [($16,120/1,300) – $12] 1,300
= ($12.40 − $12) ×1,300 = $520 U
– Variable overhead efficiency variance = (AH – SH) SVOR
= (1,300 – 1,200) $12 = $1,200 U
Variable Overhead Spending and efficiency Variances – Example (4 of 4)
Interpreting Variable Overhead Variances
• Variable overhead spending variance
– Affected by price changes and how efficiently an overhead is used
– Variable overhead items are affected by several responsibility centers
 Assigning the cost to a specific area of responsibility requires that cost be traced to the
area
• Variable overhead efficiency variance
– If variable overhead is driven by direct labor hours, the variance is caused by efficient or
inefficient use of direct labor
Exhibit 9.4 - Variable Overhead Spending Variance by Item
Helado Company Performance Report for the Month Ended May 31, 2013

Cost Formulaa Actual Costs Budgetb Spending

Variance

Natural gas $ 7.60 $ 9,640 $ 9,880 $240 F

Electricity 4.00 5,850 5,200 650 U

Water 0.40 630 520 110 U

Total $12.00 $16,120 $15,600 $520 U

a
Per direct labor hour.
b
The budget allowance is computed using the cost formula and 1,300 actual direct labor hours.
Exhibit 9.5 - Variable Overhead Spending and Efficiency Variances by Item
Helado Company Performance Report For the Month Ended May 31, 2013

Cost Actual Budgetb Spending Budget for Efficiency

Formulaa Costs Variance Standard Variance
Hoursc

Natural gas $ 7.60 $ 9,640 $ 9,880 $240 F $ 9,120 $ 760 U

Electricity 4.00 5,850 5,200 650 U 4,800 400 U

Water 0.40 630 520 110 U 480 40 U

Total $12.00 $16,120 $15,600 $520 U $14,400 $1,200 U

a
Per direct labor hour.
b
The budget allowance is computed using the cost formula and 1,300 actual direct labor hours.
c
Standard hours for actual production equal 1,200 (0.01 hours × 120,000 quarts).
Fixed Overhead Spending Variance (FOSV)
• FOSV = AFOH − BFOH
– AFOH = Actual fixed overhead
– BFOH = Budgeted fixed overhead
• If less is spent on fixed overhead items than was budgeted, the spending variance is favorable and vice
versa
Fixed Overhead Volume Variance
• Volume variance = Budgeted fixed overhead – Applied fixed overhead
• If actual production is less than budgeted production, the volume variance will be unfavorable and vice
versa
Fixed Overhead spending and Volume Variances – Example (1 of 4)
• Helado Company provided the following information for the month of May:

Budgeted/planned items for May:

Budgeted fixed overhead $40,000

Expected production in quarts of frozen yogurt 100,000

Expected activity in direct labor hours (0.01 × 100,000) 1,000 direct labor hours

Standard fixed overhead rate ($40,000/1,000) $40 per direct labor hour

Actual results for May:

 Actual production of yogurt in quarts 120,000

Actual fixed overhead cost $40,500

Standard hours allowed for actual production (0.01 × 120,000) 1,200 direct labor hours

Fixed Overhead spending and Volume Variances – Example (2 of 4)

• Calculate the fixed overhead spending variance using the formula approach
• Calculate the volume variance using the formula approach
• Calculate the fixed overhead spending variance and volume variance using the three-pronged graphical
approach
Fixed Overhead spending and Volume Variances – Example (3 of 4)
• Solution:
– Fixed overhead spending variance
= Actual fixed overhead − Budgeted fixed overhead = $40,500 − $40,000 = $500 U
– Volume variance
= Budgeted fixed overhead − Applied fixed overhead
= Budgeted fixed overhead – (Fixed overhead rate × SH) = $40,000 – ($40 × 1,200) = $8,000 F
Fixed Overhead spending and Volume Variances – Example (4 of 4)

Interpreting Fixed Overhead Variances

• Fixed overhead spending variance
– Budget variance is usually small
 Many fixed overhead costs are affected primarily by long-run decisions and not by
changes in production levels
 • Fixed overhead volume variance
– Measure of planned utilization of capacity if the budgeted volume is the amount that
management believed could be produced and sold
 Volume variance is a direct measure of capacity utilization if practical capacity is used as
the budgeted volume
Exhibit 9.6 - Fixed Overhead Spending Variance by Item
Helado Company Performance Report For the Month Ended May 31, 2013

Actual Costs Budgeted Cost Spending Variance

Depreciation $10,000 $10,000 $0

Salaries 26,300 25,800 500 U

Taxes 2,200 1,200 1,000 U

Insurance 2,000 3,000 1,000 F

Total $40,500 $40,000 $ 500 U

Accounting for Overhead Variances (1 of 3)

• Applying overhead to production
– Work in Process is accumulated on the debit side
– Variance and fixed overhead control accounts are accumulated on the credit side
• Recognizing the incurrence of actual overhead
– Variable and fixed overhead control accounts are debited
– Value of various accounts is credited
Accounting for Overhead Variances (2 of 3)
• Recognizing variances
– Fixed overhead control account, fixed overhead spending variance account, and variable
overhead spending and efficiency variance accounts are debited
– Variable overhead control account and fixed overhead volume variance account are credited
Accounting for Overhead Variances (3 of 3)
• Overhead variance reports are prepared periodically
• Closing the variances to cost of goods sold
– Fixed overhead volume variance account is debited and cost of goods sold is credited
– Another entry is made to debit cost of goods sold and credit variable overhead spending and
efficiency variance accounts and fixed overhead spending variance account
Exhibit 9.7 - Two-Variance Analysis: Helado Company

Exhibit 9.8 - Three-Variance Analysis: Helado Company

Mix and Yield Variances: Materials and Labor

• Mix variance: Created whenever the actual mix of inputs differs from the standard mix
• Yield variance: Occurs whenever the actual yield (output) differs from the standard yield
Direct Materials Mix Variance
• SM - Quantity of each input that should have been used given the total actual input quantity
– SM = Standard mix proportion × Total actual input quantity
• If relatively more of a more expensive input is used, the mix variance will be unfavorable and vice versa

Mix variance = ∑ ( AQi−SMi ) SPi

Direct Materials Yield Variance
• Yield variance = (Standard yield – Actual yield) SPy
 – Standard yield = Yield ratio × Total actual inputs
– Yield ratio = Total output ÷ Total input
– SPy = Standard cost of the yield (equal to total cost of a standard batch divided by the amount
of the yield)
Direct Labor Mix and Yield Variances (1 of 2)

Direct Labor Type Mix Mix Proportion SP Standard Cost

Shelling 3 hrs. 0.60 $ 8.00 $24

Mixing 2 0.40 15.00 30

Total 5 hrs. $54

Yield 120 lbs.

• Yield ratio: 24 = (120/5), or 2,400%

• Standard cost of the yield (SPy): $0.45 per pound ($54/120 pounds of yield)
• Suppose that Malcom processes 1,600 pounds of nuts and produces the following actual results:

Direct Labor Type Actual Mix Percentages*

Shelling 20 hrs. 40.0%

Mixing 30 60.0

Total 50 hrs. 100.0%

Yield 1,300 lbs. 2,600.0%

Direct Labor Mix and Yield Variances (2 of 2)

• Direct labor mix variance
– SM (shelling) = 0.60 × 50 = 30 hours
– SM (mixing labor) = 0.40 × 50 = 20 hours

Direct Labor Type AH SM AH-SM SP (AH-SM)SP

Shelling 20 30 (10) $8.00 $(80)

Mixing 30 20 10 15.00 150

Direct labor mix variance $(70) U

• Direct labor yield variance
= (Standard yield − Actual yield) SPy
= [(24 × 50) − 1,300] $0.45 = (1,200 − 1,300) $0.45
=$45 F