Chapter 12:

Standard Costing and Operating Performance

Measures
 Benefit of Performance Measures
• 1. Performance feedback can help improve the
“production process” through better
understanding of what works and what
doesn’t.
• 2. feedback on performance can sustain
motivation and effort, because it is
encouraging and /or because it suggests that
more effort is inquired to meet the goal.
 Variances
• Provide direct feedback concerning how well an
organisation performed in attaining its financial goals.
• For example: Unfavorable spending variance for supplies
could be due to: (1) using too many supplies, and or (2)
paying too much for the supplies.
• It would be useful to separate those two different effects,
especially if two different people are responsible for using
the supplies and for purchasing them
• This chapter will decomposing spending variance into 2:
(1) measures how well resources were used, and (2) how
well acquisition prices of those resources were controlled
•  The answer for this control: Standard Cost
 Standard Costs
• A Standard: a benchmark or “norm” for measuring
performance.
• In management accounting, standard relate to the
quantity and cost (or 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.
• Actual quantities and actual costs of inputs are
compared to the standards.
• If these actual depart significantly from the
standards, managers investigate the
discrepancy and find the cause of the problem
and eliminate it  the process: management
by exception
 Variance Analysis Cycle
• The approach to identify and solve problems:
highlighting problems, finding their root
causes, then taking corrective action.

• Standard Cost Card: the standard quantities

and costs of the input required to produce a
unit of specific product or service
 Ideal VS Practical Standards
• Ideal standards: can be attained only under the best
circumstances no machine breakdowns, no work
interruptions
• Few organisations use it
•  Most managers feel that this standard tend to
discourage even the most diligent workers.
• Variance from this standards are difficult to interpret
• Large variance from this standard are normal, and is
therefore difficult to “manage by exception”.
 Practical Standards
• Standards that are tight but attainable.
•  Allow normal machine downtime and
employee rest periods
•  Can be attained through reasonable, highly
efficient efforts by the average worker
• Variances from this standard: signal a need for
management attention because they represent
deviations from normal operating conditions.
• The remainder chapter use this standard
 Setting Direct Materials Standards
• Standard quantity per unit for direct materials:
amount of material required for each unit of finished
product as well as allowance for unavoidable waste
• Standard price per unit for direct materials: the
final, delivered cost of materials, net of any discount
taken
• Standard cost of materials per unit of finished
product: standard quantity per unit x standard price
per unit
 Setting Direct Labor Standards
• Standard rate per hour include: wages,
employment taxes, and fringe benefit
• Standard hours per unit: total time required
to complete the task
• Standard direct labor cost: standard rate per
hour x standard hours per unit
 Setting Variable Manufacturing Overhead
Standards
• The hours relate to the activity base that is
used to apply overhead to units of product
• Usually machine-hours or direct labor-hours
 Price Variance
• The difference between the actual price of an
input and its standard price, multiplied by the
actual amount of the input purchased
• Can be computed for each of variable cost
elements: DM, DL and Variable OH.
 Quantity Variance
• The difference between how much of an input
was actually used and how much should have
been used (standard quantity allowed for
actual output: the amount of an input that
should have been used to produce the actual
output of the period), is stated in dollar terms
using the standard price of the input
• Can be computed for the three variable cost:
DM, DL and Variable OH.
 Direct Materials Variances
• Price Variance: Actual Quantity (actual Price-
Standard Price)
• Quantity Variance: Standard Price (Actual
Quantity used in production – Standard
Quantity)
 Direct Labor Variances
• Labor Rate Variance: Actual hours (Actual
Rate – Standard Rate)
• Labor Efficiency Variance: Standard Rate
(Actual hours – Standard hours)
 Variable Overhead Variance
• Variable Overhead Rate Variance: Actual hours
(Actual rate – Standard rate)
• Variable overhead Efficiency Variance:
Standard Rate (Actual hours – Standard
hours)
Fixed Overhead Variance
(Appendix 12 A)