COST CONTROL THROUGH

STANDARD COSTS

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 THE USE OF STANDARD

• Manufacturing
• Service
• Not-for-Profit

• Record standard and actual costs in the accounting

records
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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Standard Costs

• Standard costs are budgeted costs to

• Manufacture a single unit of product or
• Perform a single service
• To develop standards, identify
• Material and labor types, quantities, and prices
• Overhead types and behavior

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Advantages of Standards

• Cost Control
production of desired quality at the
lowest possible costs under existing
conditions

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Advantages of Standards

• Cost Management
using all resources in such a
manner that maximizes business
profits
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 Advantages of Standards

• Decision Making
helps managers by giving
appropriate basis in making
decisions

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Advantages of Standards

• Recordkeeping Costs
reduce clerical labour and expense
by avoiding the detailed record-
keeping

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Advantages of Standards

• Inventory Valuation
A standard cost system provides
easier inventory valuation than an
actual cost system
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 Standard Cost Sheet

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whole or in part, except for use as permitted in a license distributed with a certain product or
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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Material Standards
• Materials used • From
• Types
• Product specifications,
• Quantity observation, inquiry
• Quality • Bill of materials
• Price

 Balance cost, quality, and projected sales price

Standard
Material = Unit Purchase Price * quantity
Cost
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whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
Material Price Variance (MPV)

AP x AQ SP x AQ SP x SQ

MPV
Total Variance
What What should
was (AP – SP) x AQ* have been
paid paid
*Favorable or unfavorable
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whole or in part, except for use as permitted in a license distributed with a certain product or
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Material Quantity Variance (MQV)

AP x AQ SP x AQ SP x SQ

MQV
What Total Variance
was
What should
used (AQ – SQ) x SP* have been
used for
*Favorable or unfavorable
level of output
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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Labor Standards
• Labor used • From
• Types
• Industrial engineering
• Production, setup, studies including
cleanup, and rework methods-time
• Quantity measurement (MTM),
time and motion studies,
• Cost historical data
• Include wages, payroll • Operations flow document
taxes, and fringe
benefits

Standard
Labor = Hours * Wage Rate
Cost
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whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in
whole or in part, except for use as permitted in a license distributed with a certain product or
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 Labor Rate Variance (LRV)

AP x AQ SP x AQ SP x SQ

LRV
Total Variance
What
What should
was (AP – SP) x AQ* have been
paid
paid
*Favorable or unfavorable
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whole or in part, except for use as permitted in a license distributed with a certain product or
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Labor Efficiency Variance (LEV)

AP x AQ SP x AQ SP x SQ

LEV
What Total Variance
was
used What should
(AQ – SQ) x SP* have been
used for
*Favorable or unfavorable
level of output
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whole or in part, except for use as permitted in a license distributed with a certain product or
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Causes of Labor Variances

Labor Price Variance

• Amount of overtime paid.

• Shift premiums.
• Excess staff wages, both from
over-staffing and idle hours.
• Production downtime

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Causes of Labor Variances

Labor Efficiency Variance

• Hiring of more higher skilled labor

(this may adversely impact labor
rate variance)
• Training of work force in improved
production techniques and
methodologies
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Overhead Standards
 Variable and fixed manufacturing
overhead
 Estimated level of activity
 Estimated costs
 Predetermined factory overhead
application rates

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Overhead Variances
Variable Overhead
Fixed Overhead

Actual variable overhead is

total of various ledger Actual fixed overhead is
accounts total of various ledger
accounts

SP = Predetermined
variable overhead rate SP = Predetermined fixed
overhead rate

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whole or in part, except for use as permitted in a license distributed with a certain product or
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Variable Overhead Variances
Actual Budgeted Applied
VOH VOH VOH
Actual SP x AQ SP x SQ
VOH VOH
Spending Efficiency
For Variance Variance
actual Total VOH Variance What should
hours have been
used used for level
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of output
whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
 VOH Spending Variance

• Caused by price differences

• Managers have little control over prices
• Caused by shrinkage or waste
• Managers should be held accountable

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whole or in part, except for use as permitted in a license distributed with a certain product or
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Fixed Overhead Variances
Actual Budgeted Applied
FOH FOH FOH
SP x SQ
FOH FOH
Spending Volume
Constant Variance Variance
Amount Total FOH Variance What should
have been
used for level
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of output
whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
 FOH Spending and Volume Variance
• FOH Volume Variance
• Measures capacity
• FOH Spending Variance •
utilization
Caused by producing at a
• Calculate variance for each level that differs from the
component capacity level used to
• Caused by price compute the
predetermined overhead
differences
rate
• May reflect
• Also called the
mismanagement of
resources noncontrollable variance

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whole or in part, except for use as permitted in a license distributed with a certain product or
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Alternative Overhead Variance Approaches

• One variance
• Two variance
• Three variance
• Four variance

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whole or in part, except for use as permitted in a license distributed with a certain product or
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One Variance Approach

Actual Standard
OH Cost of
OH
SP x SQ

Total OH Variance
Applied
Overhead
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whole or in part, except for use as permitted in a license distributed with a certain product or
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Two Variance Approach

Actual Budgeted OH Standard

OH based on SQ Cost of
OH
SP x SQ
Budget Volume
Variance Variance
Total OH Variance Applied
Overhead
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whole or in part, except for use as permitted in a license distributed with a certain product or
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Three Variance Approach
Budgeted OH
Actual Standard
based on based on
OH Actual Inputs Actual Output OH
SP x SQ
OH OH
Spending Efficiency Volume
Variance Variance Variance
Total OH Variance Applied
Overhead
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Year-End Treatment for VOH
VOH VOH
Efficiency Spending
Variance Variance VOH
Actual Applied
---------------

Debit—Unfavorable Enter a debit or

credit to bring
Credit—Favorable
balance to zero

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whole or in part, except for use as permitted in a license distributed with a certain product or
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Year-End Treatment for FOH
FOH
Spending Volume
Variance Variance FOH
Actual Applied
-------------

Debit—Unfavorable Enter a debit or

credit to bring
Credit—Favorable
balance to zero

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Year-End Treatment of Variances
Immaterial—Adjust Cost of Goods Sold
Material—Prorate variances to:
• Material Price Variances
• Raw Materials
• All other variances
• WIP
• WIP

• Finished Goods
• Finished Goods

• Cost of Goods Sold

• Cost of Goods Sold

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 Standard Costs in Service
Organization

• Variance analysis factors in product companies consist of direct

materials, direct labor, variable manufacturing overhead and fixed
manufacturing overhead. In the case of a service company, direct
materials are the computers, office equipment and office supplies
necessary to complete the service. Direct labor is the salary of the
professional providing the service. For example, a lawyer's salary is
considered direct labor in a law firm, while the general secretary's
salary is considered an overhead cost.

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 Standard Costs in JIT Environment

• In a JIT environment, measuring standard costing variances for

perform. The primary purpose of the JIT production system is to
increase profits by decreasing costs. It does this by eliminating
excessive inventory and/or work-force? Items will be produced only at
the time they are needed and in the precise amounts in which they are
needed -- thus removing the necessity for inventories. ance evaluation
may encourage dysfunctional behaviour

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whole or in part, except for use as permitted in a license distributed with a certain product or
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 Potential Ethical Issues
• Setting high standards to create favorable variances
• Ignoring effects of one production area on another
• Setting overhead rates too low based on high production
levels to distort inventory cost and operating income
• Producing inventory only to create a favorable volume
variance
• Not updating standards so that favorable variances are
created
• Using low quality materials or labor to create favorable
variances and low quality products
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whole or in part, except for use as permitted in a license distributed with a certain product or
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