Standard Costs

Our Focus
 Distinguish between a standard and a budget.
 Identify the advantages of standard costs.
 Describe how standards are set.
 State the formulas for determining direct materials and
direct labor variances.
 State the formulas for determining manufacturing overhead
variances.
 Discuss the reporting of variances.
 The Need for Standards
 Standards
• Are common in business
• Are often imposed by government agencies (and
called regulations)
 Standard costs
• Are predetermined unit costs
• Used as measures of performance
Distinguishing Between Standards and
Budgets

 Standards and budgets are both

• Pre-determined costs
• Part of management planning and control
 A standard is a unit amount whereas a
budget is a total amount
• Standard costs may be incorporated into a cost accounting
system
Advantages of Standard Costs
 Setting Standard Costs

 Setting standard costs

• Requires input from all persons who have responsibility for
costs and quantities
• Standards costs need to be current and should be under
continuous review
 There are two levels of standard costs
• Ideal standards represent optimum levels of performance
under perfect operating conditions
• Normal standards represent efficient levels of performance
attainable under expected operating conditions (rigorous but
attainable)
 Direct Materials Price Standard

 Direct materials price standard

• Cost per unit which should be incurred
• Based on the purchasing department’s best estimate of the cost
of raw materials
• Includes related costs such as receiving, storing, and handling
 Direct Materials Quantity
Standard
 Direct materials quantity standard
• Quantity of direct materials used per unit of finished goods
• Based on physical measure such as pounds, barrels, etc.
• Considers both the quantity and quality of materials required
• Includes allowances for unavoidable waste and normal storage
 Total Direct Materials
Cost/Unit
 The standard direct materials cost per
unit is calculated as follows

STANDARD STANDARD STANDARD

DIRECT DIRECT DIRECT
MATERIALS x MATERIALS = MATERIALS COST
PRICE QUANTITY PER UNIT
 Direct Labor Price Standard

 Direct labor price standard

• Rate per hour incurred for direct labor
• Based on current wage rates adjusted for anticipated
changes, such as cost of living adjustments
• Includes employer payroll taxes,and fringe benefits
 Direct Labor Quantity Standard
 Direct labor quantity standard
• Time required to make one unit of the product
• Critical in labor-intensive companies
• Allowances should be made for rest periods, cleanup,
machine setup and machine downtime
 Direct Labor
 The standard direct labor cost per unit is
calculated as follows

STANDARD
STANDARD STANDARD DIRECT
DIRECT x DIRECT = LABOR COST
LABOR RATE LABOR HOURS PER UNIT
Manufacturing Overhead Standard

 For manufacturing overhead, a standard

predetermined overhead rate is used
• The predetermined rate is computed by dividing budgeted
overhead costs by an expected standard activity index
• The standard manufacturing overhead rate per unit is the
predetermined overhead rate times the activity index quantity
standard (for example, direct labor hours)
 Standard Cost Per Unit

 Standard cost per unit

• Sum of the standard costs for direct materials, direct labor, and
manufacturing overhead
• Is determined for each product and often recorded on a standard cost
card which provides the basis for determining variances from standards

labour Manufacturing
materials Overheads
 Variances from Standards
 Variances from standards
• Differences between total actual costs and total
standard costs
• Unfavorable variances occur when too much is paid
for materials and labor or when there are inefficiencies
in using materials and labor
• Favorable variances occur when there are efficiencies
in incurring costs and in using materials and labor
– A variance is not favorable if quality control standards are
sacrificed
 Analyzing variances
 Variances must be analyzed to
determine their significance
• First, determine the cost elements that comprise the
variance
• For each manufacturing cost element, a total dollar
variance is computed. Then this variance is analyzed
into a price variance and a quantity variance
Variance Relationships
 Formula for Total
Materials Variance

The total materials variance is computed

from the following formula:

Actual Quantity Standard Quantity Total Materials

x Actual Price _ x Standard Price = Variance
(AQ) x (AP) (SQ) x (SP) (TMV)
 Formula for Materials
Price Variance

The materials price variance is

computed from the following formula:

Actual Quantity Actual Quantity Materials Price

x Actual Price _ x Standard Price = Variance
(AQ) x (AP) (SQ) x (SP) (MPV)
 Formula for Materials
Quantity Variance
The materials quantity variance is
determined from the following formula:

Actual Quantity Standard Quantity Materials

x Standard Price _ x Standard Price = Quantity
(AQ) x (SP) (SQ) x (SP) Variance
(MQV)
 Matrix for Direct
Materials Variance
1 2 3

AQ X AP AQ XSP SQ XSP
4200 X 3.10=13020 4200 X 3.00 =12,600 4000 X3= 12,000

1 - 2 1 - 3
Price Variance Quantity Discount
13,020-12,600 12,600- 12,000
=Rs 420 UF =Rs 600 uf

1-3
Total Variance
13,020-12,000
=Rs 1020 UF
 Causes of Materials Variances
 Materials variances may be caused by a
variety of factors, including both
internal and external factors
• Investigating materials price variances begins in the
purchasing department, but the variance may be beyond
the control of purchasing (for ex., prices rise faster than
expected)
• Investigating materials quantity variance begins in the
production department, but the variance may be beyond
the control of production (for ex., faulty machinery)
 Formula for Total
Labor Variance

The total labor variance is obtained

from the following formula:

Actual Hours Standard Hours Total Labor

x Actual Rate _
x Standard Rate = Variance
(AH) x (AR) (SH) x (SR) (TLV)
Formula for Labor Price Variance

The formula for the labor price variance

is as follows:

Actual Hours Actual Hours Labor Price

x Actual Rate _
X Standard Rate = Variance
(AH) x (AR) (AH) x (SR) (LPV)
 Formula for
Labor Quantity Variance

The labor quantity variance is derived

from the following formula:

Actual Hours Standard Hours Labor

x Standard Rate _ x Standard Rate = Quantity
(AH) x (SR) (SH) x (SR) Variance
(LQV)
 Matrix for Direct
Materials Variance
1 2 3

AH X AR AH XSR SH XSR
2100 X 9.80=20580 2100 X 10 =21,000 2000 X10= 20,000

1 - 2 1 - 3
Price Variance Quantity Variance
20,580-21,000 21,000- 20,000
=Rs 420 F =Rs 1000 uf

1-3
Total Variance
20,580-20,000
=Rs 580UF
 Causes of Labor Variances
 Labor variances may be caused by a
variety of factors
• Labor price variances usually result from either paying
workers higher wages than expected or misallocating
workers (for ex., using skilled workers in place of
unskilled workers)
• Labor quantity variances relate to the efficiency of
workers and are usually related to the production
department
 Actual Overhead Costs

The total overhead variance is the

difference between actual overhead costs
and overhead costs applied to work done.
 Formula for Total
Overhead Variance
With standard costs, manufacturing
overhead costs are applied to work in
process on the basis of the standard hours
allowed for the work done. Standard hours
allowed are the hours that should have been
worked for the units produced. The formula
for the total overhead variance is:

Overhead Total
Actual _ Applied based = Overhead
Overhead on Standard Variance
Hours Allowed
 Formula for Overhead
Controllable Variance

The formula for the Overhead

Controllable Variance is shown below:

Overhead
Actual _ Budgeted based =
Overhead
Controllable
Overhead on Standard
Variance
Hours Allowed
 Formula for
Overhead Volume Variance
The Overhead Volume Variance indicates whether
fixed costs were efficiently used during the period.
The formula for computing the volume variance is
as follows:

Fixed Normal Capacity Overhead

Overhead X Hours - Standard = Volume
Rate Hours Allowed Variance
Alternative Formula for Overhead
Volume Variance

An alternative formula for computing

the volume variance is shown below:

Overhead Overhead Overhead

Budgeted based _ Applied based Volume
on Standard on Standard
=
Variance
Hours Allowed Hours Allowed
Causes of Manufacturing Overhead
Variances
 Manufacturing overhead variances may be
caused by a variety of factors
• The controllable variance relates to variable
manufacturing costs and usually is the responsibility of
the production department
• May result from either higher than expected use of indirect materials,
indirect labor or supplies or increases in indirect manufacturing costs such as
fuel
• The volume variance may be the responsibility of the
production department (inefficient use of direct labor
hours) or may come from outside the production
department (lack of sales orders)
 Reporting Variances

 Reporting variances
• All variances should be reported to appropriate levels of
management as soon as possible so that corrective
action can be taken
• The form, content, and frequency of variance reports
vary considerably among companies
• Variance reports facilitate the principle of “management
by exception”
• In using variance reports, top management normally
looks for significant variances
 Let’s Review

The setting of standards is:

a. A managerial accounting decision.

b. A management decision

c. A worker decision.
decision
d. Preferably set at the ideal level of
performance.
 Let’s Review

The setting of standards is:

a. A managerial accounting decision.

b. A management decision

c. A worker decision.
d. Preferably set at the ideal level of
performance.