CHAPTER 13: STANDARD COSTING

STANDARD COSTS are “what a unit cost of products should be”.

Standard Costs
Represent the "planned" costs
of a production and are Expected to be achieved in
generally established well aparticular process under
before production begins; normal conditions. Standard
establishment of standards costing is concerned with cost
thus provide ,management with per unit and serves basically the
goals to attain and bases for same purpose as a budget.
comparison with actual results.
The purpose is to control costs
and promote eficiency. It is
used with either job order
costing or process costing to
manufacture a product and the
subsequent comparison of the
actuial costs wiuth the
established stnadard.

Figure 13.1 Defining Standrd Cost

Planned
Costs

Specification Standard Predicted

Costs
Cost Costs

Scheduled
Costs
 Figure 13.2 Other Terms for Standard Cost

Standard costs are usually determined for a period of one year and are revised annually or as
needed.

USE OF STANDARD COSTS

 COST CONTROL – identifying cost with its related benefits and making sure that the cost is
justified given the benefits derived. The standard cost is then used to determine the cost of
manufacturing any number of units by simply multiplying the total units produced by the
standard unit cost. Standard cost is per unit based, thus standard unit cost. Unnecessary high
costs could go unnoticed or undetected without standard costs.
 PRICING DECISIONS – prices are established by any entity to cover the cost of a product and at
the same time provide for profit. Standard costs provide a measure of consistency by
eliminating fluctuations in actual costs. Standard costs provide this timely information.
 PERFORMANCE APPRAISAL – standards provide measurements that can be applied uniformly to
all personnel being evaluated. Standards provide one of the few objectives means of
performance evaluation. The employee should also know how the standards are used in
employee evaluation and reward system.
 COST AWARENESS – the primary concern of management is usually increasing production,
improving product quality, and reducing absenteeism. Standard costs performance reports
inform managers of the cost implications of these actions and as a result make them take steps
to effectively control costs.
 MANAGEMENT BY OBJECTIVES (MBO) – means that specific objectives are established for each
business activity and the manager responsible for that activity works to achieve the objectives.
A standard cost facilitates MBO because it provides a quick reference for identifying and
reporting differences between standard and actual performance.

ESTABLISHMENT OF STANDARDS

An integral part of any standard cost system is the setting of standard for direct materials, direct
labor, and factory overhead.

 DIRECT MATERIALS STANDARDS

 1. Direct materials price standards – price standards are the unit price at which direct
materials should be purchased. The sales forecast is of utmost importance because it
will first determine the total units of finished goods that will have to be purchased
during the total quantity of direct materials that will have to be purchased during the
next period. Once the quantity to be purchased has been determined, the net purchase
price can be established by the supplier. The standard setting process is very time
consuming especially for large manufacturing companies that must set standards for
hundreds of different materials. Each material needs to have a determined standard
cost.
2. Direct materials usage (efficiency) standards – efficiency (quantity or usage) standards
predetermined specifications of the quantity of direct materials that should go into the
production of one finished unit. Individual standard must be computed for each direct
material.

 DIRECT LABOR STANDARDS

1. Direct labor price standards – price (rate) standards are predetermined rates for a
period. The standard rate of pay that an individual will receive is usually based on the of
job being performed and the experience that the person has had on the job. The wage
rate of most manufacturing companies is usually set forth in the union contract or if
nonunion, wage rate is determined by management in consultation with human
resources department. Vacation pay and sick pay are not usually included in standard
cost as they are normally accounted as part of factory overhead.
2. Direct labor efficiency standards – efficiency standards are predetermined performance
standards for the amount of direct labor hours that should go into the production of one
finished unit. Time and motion studies are helpful in developing direct labor efficiency
standards. The effect of the learning prices on workers may be visually shown in what
nis technically called the learning curve. The learning curved is based on statistical
findings indicating that as the cumulative number of units produced doubles, the
average direct labor time required per unit will decease at a constant percentage
(normally from 10% to 40%). These percentages are normally called cost reduction
percentages. The period in which the output per hour stabilizes is kwon at the constant
period. Many companies routinely shift workers to different job assignment as a simple
and effective means of preventing boredom from developing. Failure to take the
learning process into consideration may result in erroneous efficiency standards that
could have adverse effects on managerial decision making. Time and motion engineers
are usually given the responsibility for setting direct labor efficiency standards.
 FACTORY OVERHEAD STANDARDS
The individual costs that make up total factory overhead are affected differently by
increases or decreases in plant activity. The total fixed overhead cost will remain
constant cost over different activity levels within relevant range, while fixed overhead
cost per unit will decrease as production increases and increase as production
decreases. Due to this cost behavior characteristic, the application of a standard fixed
 factory overhead cost to each product becomes a problem when production levels vary.
Budgets are commonly used in controlling factory overhead costs. They are either static
or flexible. Flexible budget show anticipated costs at different activity levels. Static
budgets show anticipated costs at one level of activity only.

VARIANCE ANALYSIS

Standards enable management to make periodic comparisons of actual results with standard (or
planned) results. Differences that arise between actual results and planned results are called
variances. Variance analysis is a technique that can be use by management to measure
performance, correct inefficiencies, and deal with the “accountability function”.

COMPUTING DIFFERENT TYPES OF VARIANCES

I. MATERIAL VARIANCES – a price variance and usage variance are isolated for materials
and because purchasing agent maybe responsible for the price variance and a
production manager for the usage variance.
A. Material Price Variance – difference between actual price per unit of direct
materials purchased and standard price per unit of direct materials purchased
results in the direct materials price variance per unit when multiplied by the actual
quantity purchased, the outcome is the total direct material price variance. This is
caused by paying a higher or lower price than the standard price for materials.

Formulas: (AP= actual price; AQ= actual quantity; SP= standard price; SQ= standard
quantity)
1. Material price variance = Actual quantity x (actual price – standard price)

2. Actual quantity x Actual price xx

Actual quantity x Standard price xx
Material price variance xx

3. Actual price xx
Less: Standard price xx
Difference in price xx
x Actual quantity xx

AQ x AP – AQ x SP = Price variance

AQ x SP – SQ x SP = Efficiency variance
B. Materials Usage Variance – caused by using more or less than the standard
amount of materials to produce a product.

Formulas: (AP= actual price; AQ= actual quantity; SP= standard price; SQ= standard quantity)
1. Material usage variance = Standard price x (actual quantity – standard
quantity)

2. AQ x SP xx
SQ x SP xx
Material usage variance xx

3. AQ xx
Less: SQ xx
Difference in quantity xx
x SP xx
Materials usage variance xx

Possible Possible
causes of causes of
material material
price Fluctuations in quantuity Loss of materials
variances market prices of variance due to poor
materials handling

Purchasing from
distant suppliers Use of defective or
resulting in substandards
additional materials
transportation costs

Failure to avail cash Lack of proper tools

discounts or machines

Purchasing Spoilage or waste

materials of inferior due to use of
quality inferior quality
materials
II. LABOR VARIANCES – labor rate and efficiency variances relate to the same period
because, unlike materials, labor services cannot be purchased in one period, stored, and
then used in the next year.
A. Labor Rate Variances – caused by paying a higher or lower rate of pay than
standard cost to produce a product or complete a process.

Formulas: (AH= actual hours; AR= actual rate; SH= standard hours; SR= standard rate)

1. Labor rate variance = Actual hours x (actual rate – standard rate)

2. AH x AR xx
AH x SR xx
Labor rate variance xx

3. Actual rate xx
Less: Standard rate xx
Difference in rate xx
x Actual hours xx
Labor rate variance xx

B. Labor Efficiency Variance – caused by using more or less than the standards amount
of labor hours to produce or complete a process.
 Formulas: (AH= actual hours; AR= actual rate; SH= standard hours; SR= standard rate)

1. Labor efficiency variance = Standard rate x (actual hours – standard hours)

2. AH x SR xx
SH x SR xx
Labor eficiency variance xx

3. Actual hours xx
Less: Standard hours xx
Difference in hours xx
x Standard rate xx
Labor efficiency variance xx

Possible
Possible
causes of
causes of
labor
labor rate
efficiency
variances Hiring inexperinced Lack of trtaining for
variance
workers workers

Poor scheduling of
Change in labor rate
work

Hiring of workers
with pay higher
than that assumed Lack of supervision
when the standard
for a job was set

FAulty equipment

III. OVERHEAD VARIANCES

A. One-Factor Method
Formula: (FOH= factory overhead; SH= standard hours; SFOHR= standard factory overhead rate)
Actual FOH xx
Less: SH x SFOHR xx
Total FOH variance xx

COMBINED MANUFACTURING OH (VARIABLE AND FIXED) VARIANCES

 If the company is using a flexible budget, the total OH variance may be analyzed using (a) two-
variance method, (b) three-variance method, and (c) four-variance method.

A. Two-Variance Method
Formulas:
1. Controllable (Budget) Variance
Actual FOH xx
Less: Budget allow. based on SH
Fixed OH xx
Variable (SH x Variable rate) xx xx
Controllable Variance xx
2. Volume (Capacity or Production) Variance
Budget allow. based in SH xx
Less: SH x S OH Rate xx
Volume Variance xx

Controllable Variance – manager or supervisor has some control over this combined
spending and efficiency variance
Volume Variance – sometimes called denominator variance because the variance is the
result of production art an activity level different from thar used in the denominator to
calculate fixed FOH application rate.

Denominator direct labor hours (used in computing fixed OH rate) xx

Less: Standard direct labor hours allowed xx

Difference in number of hours xx

x Standard fixed FOH application rate xx

Production volume (volume variance) xx

B. Three-Variance Method
Formulas:
1. Spending Variance
Actual FOH xx
Less: Budget allow. based on actual hrs.
Fixed OH xx
Variable (actuals hrs. x variable rate) xx xx
Spending Variance xx
2. Variable Efficiency Variance
Budget allow. based on actual hrs. xx
Less: Budget allow. based on Std. hrs. xx
Variable Efficiency Variance xx

3. Volume Variance
 Budget allow. based on std. hrs. xx
Less: std. hrs. x FOH rate xx
Volume Variance xx
C. Four-Variance Method
a. Variable OH Variance
Formulas:
1. Actual variable FOH xx
Less: actual hrs. x variable OH rate xx
variable Spending Variance xx
2. Actual hrs. x variable OH rate xx
Less: Std. hrs. x variable OH rate xx
Variable Efficiency Variance xx
b. Fixed OF Variance
Formulas:
1. Actual fixed OH xx
Less: budgeted fixed OH at normal capacity xx
Fixed Spending Variance xx
2. Budgeted fixed OH at normal capacity xx
Less: Std. hrs. x fixed OH rate xx
Volume Variance xx

Possible causes of volume variance:

 Poor production scheduling

 Unusual machine breakdowns
 Shortage of skilled workers
 Decrease in demand from customers
 Unused plant capacity