Kinney 8e - CH 07

CHAPTER
STANDARD COSTING AND VARIANCE

7 ANALYSIS
Learning Objectives
After reading and studying Chapter 7, you should be able to answer the following questions:
1. How are material, labor, and overhead standards set?
2. How are material, labor, and overhead variances calculated and recorded?
3. Why are standard cost systems used?
4. How have the setting and use of standards changed over time?
5. How does the use of a single conversion element (rather than the traditional labor and overhead
elements) affect standard costing?
6. (Appendix) How are variances affected by multiple material and labor categories?
©2011 Cengage Learning. All Rights Reserved. SM Cost Accounting 8th Edition by Raiborn and Kinney.
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Chapter 07: Standard Costing and Variance Analysis IM 2
Terminology
Bill of materials: a document that contains specifications for materials, including quality and quantity
Budget variance: the difference between total actual overhead and budgeted overhead based on
standard hours allowed for the production achieved during the period
Controllable variance: the budget variance of the two-variance approach to analyzing overhead
variances; it is so named because managers are able to exert influence on this amount during the short
run
Expected standard: expected cost or result; expected standards anticipate and allow for future waste
and inefficiencies and therefore are not of significant value for motivation, control, or performance
evaluation
Fixed overhead spending variance: the difference between the total actual fixed overhead and
budgeted fixed overhead; this amount normally represents the price variance for multiple fixed overhead
components
Ideal standards: standards that provide for no inefficiencies of any type (e.g., normal operating delays
and human limitations such as fatigue, boredom, or misunderstanding); ideal standards are impossible to
attain on a continuous basis and should not be used in motivating workers or determining their
performance levels
Labor efficiency variance: in terms of hours, the difference between actual hours worked for the period
and the standard hours allowed for the actual output achieved; in terms of costs, (actual hours worked for
the period - standard hours allowed for the actual output) x the standard labor rate
Labor mix variance: the financial effect associated with changing the proportionate amount of higher or
lower paid workers in production; it can also be computed as (standard mix x actual hours x standard
rate) minus (actual mix x actual hours x standard rate)
Labor rate variance: the difference between the actual wages paid for total hours worked and the
standard wages for hours worked; it can also be computed as (actual labor rate - standard labor rate) x
total actual hours worked during the period
Labor yield variance: the monetary impact of using a higher or lower number of hours than the standard
allowed; it can be computed as (standard mix x standard hours x standard rate) minus (standard mix x
actual hours x standard rate)
Management by exception: a practice whereby managers investigate only those processes, costs,
variances, or other items of interest that deviate from expectation
Material mix variance: the effect of substituting a nonstandard mix of materials during the production
process; it can also be computed as (standard mix × actual quantity × standard price) minus (actual mix ×
actual quantity × standard price)
Material price variance: the difference between the amount actually paid for material and the standard
price of the material; it can also be computed as (actual purchase price per unit of material - standard
purchase price per unit of material) x the actual number of units purchased
Material quantity variance: in terms of units of material, the difference between the actual quantity of
material used and the standard quantity allowed for the actual output achieved; in terms of cost, (actual
quantity of materials used - standard quantity allowed) x standard price of material
Material yield variance: the difference between the actual total quantity of input and the standard total
quantity allowed based on output; this difference reflects standard mix and standard prices; it can be
computed as (standard mix × standard quantity × standard price) minus (standard mix × actual quantity ×
standard price)
Methods-time measurement: an industrial engineering process that analyzes work tasks to determine
the time a trained worker requires to perform a given operation at a rate that can be sustained for an
eight-hour workday
Mix: any possible combination of material or labor inputs
Noncontrollable variance: the fixed overhead variance due to capacity utilization (i.e., volume); it can
also be computed as applied fixed overhead minus budgeted fixed overhead
Operations flow document: a document listing all operations necessary to produce one unit of product
(or perform a specific service) and the corresponding time allowed for each operation
Overhead efficiency variance: a variance consisting solely of variable overhead, it is the difference
between total budgeted overhead at the actual activity level and total budgeted overhead at the standard
activity level under the three variance approach; it can also be computed as budgeted overhead based on
standard input quantity allowed minus budgeted overhead based on actual input quantity used
Overhead spending variance: the difference between the actual overhead and total budgeted overhead
at the actual activity level under the three-variance approach; it is the sum of the variable and fixed
overhead spending variances of the four-variance approach
Practical standard: a standard that can be reached or slightly exceeded with reasonable effort by
workers; it allows for normal, unavoidable time problems or delays such as machine downtime and worker
breaks; it is often believed to be most effective in motivating workers and determining performance levels
Standard: the expected costs and quantities needed to manufacture a single unit of product or perform a
single service
Standard cost card: a document that summarizes the standard quantities and costs for direct material,
direct labor, and overhead needed to complete one unit of product
Standard quantity: the standard input quantity that should have been needed to achieve a given output
Total cost of ownership: the direct purchase price of an input plus freight/duty/tax charges, payment
and discount terms, inventory storage costs, scrap rates, rebates or special incentives, warranties, and
disposal costs
Total overhead variance: the difference between total actual overhead and total applied overhead; it is
the amount of underapplied or overapplied overhead
Total variance: the difference between total actual cost incurred and total standard cost applied to the
output of the period
Variable overhead efficiency variance: the difference between budgeted variable overhead for actual
hours and standard variable overhead; this variance quantifies the effect of using more or less overhead-
based inputs (e.g., labor hours, machine hours) than the standard allowed for the production achieved; it
can also be computed as (standard hours – actual hours) x hourly variable overhead rate
Variable overhead spending variance: the difference between total actual variable overhead and the
budgeted variable overhead based on actual hours; it can also be computed as budgeted variable
overhead for actual hours – actual variable overhead for the period
Variance analysis: the process of categorizing the nature (favorable or unfavorable) of the differences
between standard and actual costs and determining the reasons for those differences
Volume variance: a fixed overhead variance that represents the difference between budgeted fixed
overhead and fixed overhead applied to production; it is also referred to as the noncontrollable variance;
this variance is caused solely by producing at a level that differs from that used to compute the
predetermined overhead rate which incorrectly treats fixed overhead as a variable cost; it can also be
computed under three-variance analysis as applied fixed overhead minus budgeted fixed overhead
Yield (or process yield): the output quantity that results from a specified input
Lecture Outline
LO.1: How are material, labor, and overhead standards set?
A. Introduction
1. General
a. Organizations develop and use standards for almost all tasks.
b. Because of the variety of organizational activities and information objectives, no single

standard costing system is appropriate for all situations.
c. This chapter discusses a traditional standard cost system that provides price and quantity
standards for each manufacturing cost component and explains how standards are
developed and illustrates the information that can be gained from performing a detailed
variance analysis.
B. Development of a Standard Cost System
1. General
a. A standard is a performance benchmark or norm used for planning and control purposes.
Standards specify the expected costs and quantities needed to manufacture a single unit of
product or perform a single service.
b. A standard cost system is a product costing system that determines product cost by using
standards or norms for quantities and/or prices of component elements; it allows actual costs
to be compared against norms for cost control purposes.
i. Developing a standard cost involves judgment and practicality in identifying material and
labor types, quantities, and prices as well as an understanding of the types of
organizational overhead costs and how they behave.
ii. A primary objective in manufacturing a product is to minimize unit cost while achieving
certain quality specifications.
iii. After management has determined the input resources needed to achieve desired output
quality at reasonable cost, it can develop quantity and price standards.
c. Standards should be developed by a group, composed of representatives from the following

areas: cost accounting, industrial engineering, human resources, data processing,
purchasing, and management.
d. To ensure credibility of the standards and to motivate people to operate as close to the
standards as possible, standard-setting involvement of managers and workers whose
performance will be compared to standards is vital.
2. Material standards
a. The first step in developing material standards is to identify and list the specific direct material
components used to manufacture the product. Four things must be known about the
materials inputs:
i. type of material needed;
ii. quality (grade) of material needed;
iii. quantity of material needed; and
iv. price per unit of material (must be based on level of quality specified).
b. In making quality decisions, managers should remember that as the material grade rises, so
generally does price; decisions about material inputs usually seek to balance the
relationships of price, quality, and projected selling prices with company objectives.
c. The bill of materials is a document that contains specifications for materials, including
quality and quantity (See text Exhibit 7-1).
i. Companies often make allowances for normal waste of components.
ii. Purchasing agents should be aware of company purchasing habits and of alternative
suppliers and such information should be incorporated into price standards.
d. Rather than considering only the direct purchase price of an input, purchasing agents now try
to estimate and minimize the total cost of ownership, which includes price, freight/duty/tax
charges, payment and discounts terms, inventory storage costs, scrap rates, rebates or
special incentives, warranties, and disposal costs.
e. When all quantity and price information is available, component quantities are multiplied by
unit prices to obtain the total cost of each component. These totals are summed to determine
the total standard material cost of one unit of product.
3. Labor Standards
a. The development of labor standards requires the same basic procedures as those used for
materials.
b. Each production operation performed by workers or by machinery should be identified.
i. All unnecessary movements of workers and of material should be disregarded when time
standards are set.
c. To develop effective standards, a company must obtain quantitative information for each
production operation. Methods-time measurement is an industrial engineering process that
analyzes work tasks to determine the time a trained worker takes to perform a given
operation at a rate that can be sustained for an eight-hour workday.
d. After an analysis of labor tasks is completed, an operations flow document can be

prepared which lists all operations necessary to make one unit of product (or perform a
specific service) and the corresponding time allowed for each operation. (See text Exhibit 7-
2.)
e. Labor rate standards should reflect the wages paid to employees who perform the various
production tasks as well as the related employer costs such as fringe benefits, FICA, and
unemployment taxes.
i. A weighted average rate, computed as the total wage cost per hour divided by the
number of workers, should be used if employees are paid different wage rates.
f. When time and rate information are available, job task times are multiplied by wage rates to
generate the total cost of each operation. Theses totals are summed to obtain the total
standard labor cost for one unit of product.
4. Overhead standards
a. Overhead should be assigned to separate cost pools based on the cost drivers, and
allocations to products are made using various activity drivers in order to provide the most
appropriate costing information.
b. The development of the bill of materials, operations flow document, and predetermined
overhead rates is followed by the preparation of a standard cost card, which summarizes all
standard quantities and costs needed to complete one unit of product. (See text Exhibit 7-3.)
c. Both actual and standard costs are recorded in a standard cost system. But standard costs,
rather than actual costs, are charged to the Raw (Direct) Material, Work in Process, and
Finished Goods Inventory accounts with any differences between actual and standard costs
reported as variances.
LO.2: How are material, labor, and overhead variances calculated and recorded?
C. General Variance Analysis Model
1. General
a. A total variance is the difference between total actual cost for the production inputs and the
total standard cost applied to the production output:
Actual cost of actual input – Standard cost of actual output
b. Total variances indicate differences between actual and expected production costs, but they
do not provide useful information for determining why such differences occurred. Thus, total
variances are subdivided into price and usage variances in order to help managers
accomplish their control objectives:
i. A price (or rate) variance reflects the difference between the actual price (AP) paid for
inputs and the standard input price (SP) for the actual quantity (AQ) of inputs used during
the period:
 Price (or Rate) Variance = (AP – SP)(AQ)
ii. A usage (quantity or efficiency) variance shows the difference between the actual
quantity (AQ) of inputs used and the standard quantity (SQ) of inputs allowed for the
actual output achieved during the period. Usage variances focus on the efficiency of
results—the relationship of inputs to outputs:
 Quantity (or Efficiency) Variance = (AQ – SQ) (SP)
c. The standard quantity (SQ) is the quantity of input that should have been used to achieve
the actual output.
d. Variances occur when the actual price or quantity amounts differ from standard.
i. Variances are labeled ―unfavorable‖ if the actual price or quantity amounts are higher
than the standard price or quantity amounts; variances are labeled ―favorable‖ when the
actual price or quantity amounts are lower than the standard amounts.
ii. The terms favorable and unfavorable do not necessarily equate to good and bad
performance, respectively.
iii. A total variance can be computed for each production cost element (DM, DL, OH).
D. Material and Labor Variance Computations
1. Material Variances
a. Text Exhibit 7-4 presents the standard cost card for a mountain bike made by Sanjay
Corporation as well as actual costs and quantities used. This information is used in the text
narrative to illustrate variance analysis.
b. The total material variance can be subdivided into the material price variance and the
material quantity variance:
AP × AQ SP × AQ SP × SQ
Material Material
Price Variance Quantity Variance
Total Material Variance
c. The material price variance (MPV) indicates whether the amount paid for material was less
than or more than standard price.
i. This variance is usually the responsibility of the purchasing manager.
d. The material quantity variance (MQV) indicates whether the actual quantity used was less
than or more than the standard quantity for the actual output achieved.
i. This variance is usually the responsibility of the production manager.
e. The total material variance (TMV) is the summation of the individual variances or can also
be calculated by subtracting the total standard cost from the total actual cost.
f. Price and quantity variance computations must be made for each direct material component
and these component variances are summed to obtain the total price and quantity variances
(although such a sum does not provide useful information for cost control).
2. Point of Purchase Material Variance Model
a. When the quantity of material purchased is not the same as the quantity of material placed
into production, the general variance model can be easily modified to isolate material price
variances as early as possible to provide more rapid information for management control
purposes.
i. Because the material price variance relates to the purchasing (rather than the production)
function, the point of purchase model calculates the material price variance using the
quantity of materials purchased (Qp) rather than the quantity of materials used (Q u).
b. The total material variance can be subdivided into the material purchase price variance and
the material price usage variance:
AP × AQP SP × AQP
Material Price Variance
SP × AQU SP × SQ
Material Quantity Variance
c. The material purchase price variance is the materials price variance when computed based
on the quantity of materials purchased during the period rather than the quantity of materials
used.
d. The material quantity variance is the material usage variance when computed based on the
quantity of materials used during the period.
e. Note that because the price and quantity variances have been computed using different
bases, they should not be summed to determine a total material variance under this method.
3. Labor Variances
a. The total labor variance can be subdivided into the labor rate variance and the labor
efficiency variance.
Labor Labor
Rate Variance Efficiency Variance
Total Labor Variance
b. The labor rate variance (LRV) is the difference between the actual wages paid to labor for
the period and the standard cost of actual hours worked.
c. The labor efficiency variance (LEV) indicates whether the amount of time worked was less
than or more than the standard quantity for the actual output.
d. The total labor variance is the summation of the individual variances or can also be
calculated by subtracting the total standard cost from the total actual cost.
e. Note that because the rate and efficiency variances have been computed using the same
base (actual hours), they may be summed to determine a total labor variance.
E. Overhead Variances
1. Overhead Variances
a. Because total variable overhead changes in direct relationship with changes in activity and
fixed overhead per unit changes inversely with changes in activity, a specific capacity level
must be selected to compute budgeted overhead costs and to develop a predetermined
overhead (OH) rate.
i. Capacity refers to any measure of activity. The most common capacity measures are
theoretical capacity, practical capacity, normal capacity, and expected capacity.
b. If the company uses separate variable and fixed overhead application rates, separate price
and usage components are calculated for each type of overhead. This four-variance
approach provides managers the greatest detail and, thus, the greatest flexibility for control
and performance evaluation.
2. Variable Overhead
a. The total variable overhead variance is the difference between actual variable overhead costs
incurred for the period and standard variable overhead cost applied to the period’s actual
production or service output.
Actual VOH Budgeted VOH Applied VOH

(for actual activity) (for standard quantity allowed)
VOH VOH
Spending Variance Efficiency Variance
Total VOH Variance

(Underapplied or Overapplied VOH)
b. The variable overhead spending variance is the difference between total actual variable
overhead and the budgeted amount of variable overhead based on actual hours; it is caused
by both component price and volume differences.
i. Variable overhead spending variances associated with price differences can occur
because, over time, changes in VOH prices have not been included in the standard rate.
ii. Variable overhead spending variances associated with quantity differences can be
caused by waste or shrinkage of production inputs (such as indirect material).
c. The variable overhead efficiency variance is the difference between budgeted variable
overhead based on actual hours and variable overhead applied based on standard hours
allowed for the production achieved.
i. This variance quantifies the effect of using more or less of the activity or resource which
is the base for variable overhead application. When actual input exceeds standard input
allowed, production operations are considered to be inefficient. Excess input also
indicates that an increased VOH budget is needed to support the additional activity base
being used.
3. Fixed Overhead
a. The total fixed overhead variance is the difference between actual fixed overhead costs
incurred and standard fixed overhead cost applied to the period’s actual production.
Actual FOH Budgeted FOH Applied FOH

(for standard quantity allowed)
SP × SQ
FOH
Spending Variance Volume Variance
Total FOH Variance

(Underapplied or Overapplied FOH)
b. The left column is simply the total actual fixed overhead incurred. The middle column,
budgeted FOH, is a constant amount throughout the relevant range of activity and was the
amount used to developed the predetermined FOH rate; thus, this amount is a constant
figure regardless of the actual quantity of input or the standard quantity of input allowed. The
right column is the amount of fixed overhead applied to production based on the standard
fixed overhead rate and standard quantity allowed.
c. The fixed overhead spending variance is the difference between the total actual fixed
overhead and budgeted fixed overhead.
i. This variance amount normally represents the differences between budgeted and actual
costs for the numerous FOH components, although it can also reflect resource
mismanagement.
d. The fixed overhead volume variance is the difference between budgeted and applied fixed
overhead.
i. Although capacity utilization is controllable to some degree, the volume variance is the
one over which managers have the least influence and control, especially in the short run
and for that reason the volume variance is also called the noncontrollable variance.
ii. The volume variance merely translates under-or-over-utilization into a dollar amount. An
unfavorable volume variance indicates less-than-expected utilization of capacity. If
available capacity is commonly being used at a level higher (or lower) than that which
was anticipated or is available, managers should investigate and initiate appropriate
action.
4. Alternative Overhead Variance Approaches
a. A four-variance approach can be used only if the accounting system distinguishes between
variable and fixed costs.
b. The total overhead variance is the difference between total actual overhead and total
applied overhead, and is the only variance computed under the one-variance approach:
Actual Overhead Applied Overhead

(Variable OH + Fixed OH) (SP × SQ)
Total Overhead Variance
c. A middle column representing budgeted overhead based on standard quantity is inserted

between total actual overhead and total applied overhead under the two-variance approach:
Actual Overhead Budgeted OH

(Variable OH (for standard Applied OH
+ Fixed OH) quantity) SP × SQ
Budget Variance Volume Variance

(or Controllable (or Noncontrollable
Variance) Variance)
i. The budget variance is the difference between total actual overhead and budgeted
overhead based on standard hours allowed for the production achieved; it is computed as
part of the two-variance analysis; it is also referred to as the controllable variance.
ii. The volume variance can be computed under the four-variance, three-variance, or two-
variance analysis.
d. A column representing budgeted overhead based on actual hours is inserted immediately to

the right of total actual overhead under the three-variance approach:
Budgeted Budgeted
Actual Overhead Overhead Applied
Overhead (for actual (for actual Overhead
(VOH + FOH) input used) output) (SP × SQ)
Overhead Overhead Overhead

Spending Efficiency Volume
Variance Variance Variance
i. The overhead spending variance is the difference between total actual overhead and
total budgeted overhead at actual input activity; thus, a flexible budget is required. It is
computed as part of the three-variance analysis; it is equal to the sum of the variable and
fixed overhead spending variances.
ii. The overhead efficiency variance is the difference between total budgeted overhead at
actual input activity and total budgeted overhead at standard input allowed (output
activity); it is computed as part of the three-variance analysis; it is the same as variable
overhead efficiency variance.
e. Text Exhibit 7-5 shows the interrelationships of overhead variances.
F. Standard Cost System Journal Entries
1. Standard cost system journal entries are presented in text Exhibit 7-6.
2. Note that unfavorable variances have debit balances while favorable variances have credit
balances.
3. Although standard costs are useful for internal reporting, they can be used in financial statements
only if the amounts are substantially equivalent to those that would have resulted from using an
actual cost system.
4. At year-end, adjusting entries are made to eliminate standard cost variances. The entries depend
on whether the variances are, in total, insignificant or significant.
a. If insignificant, unfavorable variances are closed as debits to Cost of Goods Sold; favorable
variances are credited to Cost of Goods Sold.
b. If significant, variances are prorated at year-end among ending inventories and Cost of
Goods Sold so that the balances in those accounts approximate actual costs.
i. Proration is based on the relative size of the account balances as illustrated in the
example provided in the text narrative.
LO.3: Why are standard cost systems used?
G. Why Standard Cost Systems are Used
1. Clerical efficiency—a company that uses standard costs to trace the flow of costs through its
accounting system usually discovers that less clerical time and effort are required than in an
actual cost system.
2. Motivation—standards represent a technique of communicating management’s expectations of

efficiency to workers.
3. Planning—managers can use currently available standard costs to estimate future quantities and
costs.
4. Controlling—the control process begins with the establishment of standards which provide a
basis against which actual costs can be measured so variances may be computed.
a. Variance analysis is the process of categorizing the nature (favorable or unfavorable) of the
differences between standard and actual costs and determining the reasons for those
differences.
b. The setting of upper and lower tolerance limits for deviations allows managers to implement
the management by exception concept. (See text Exhibit 7-7.)
5. Decision making—standard cost information availability facilitates many decisions.
6. Performance evaluation—summary variance reports focus attention on the operating

performance of subordinate managers, allowing top managers to determine when costs were and
were not controlled by which managers. Top management can then provide vital feedback to the
subordinate managers.
H. Considerations in Establishing Standards
1. Appropriateness
a. Appropriateness and attainability need to be considered when standards are established.
i. Appropriateness, in relation to a standard, refers to the basis on which the standards are
developed and how long they are expected to last.
b. Standards are developed from past and current information, and they should reflect technical
and environmental factors expected during the period in which the standards are to be
applied.
c. Factors such as the materials quality, normal ordering quantities of materials, expected
employee wage rates, degree of plant automation, facility layout, and mix of employee skills
should be considered.
d. Standards must evolve over the organization’s life to reflect its changing methods and
processes.
2. Attainability
a. Attainability refers to management’s belief about the degree of difficulty or rigor that should
be incurred in achieving the standard. Standards can be classified by their degree of rigor
and, thus, their motivational value from easy to difficult as follows: expected, practical, and
ideal.
b. Expected standards are standards set at a level that reflects what is actually expected to
occur in the future period; these standards anticipate future wastes and inefficiencies and
allow for them; they are not of significant value for control and performance evaluation
purposes.
c. Practical standards are standards that can be reached or slightly exceeded approximately
60 to 70 percent of the time with reasonable effort by workers; they allow for normal,
unavoidable time problems or delays and for worker breaks; they are believed to be most
effective in inducing the best performance from workers, since such standards represent an
attainable challenge.
d. Ideal standards are standards that provide for no inefficiencies of any type, are impossible to
attain, and are sometimes called theoretical standards.
LO. 4: How have the setting and use of standards changed over time?
I. Changes in Standards Usage
1. Use of Ideal Standards and Theoretical Capacity
a. Many accountants and business people believe that incorrect measurements are sometimes
employed in utilizing variances for control and performance evaluation purposes.
b. The Japanese philosophy is a notable exception to the practice of not using ideal or
theoretical standards for performance evaluation.
i. The just-in-time (JIT) production system and total quality management (TQM) concepts
both have goals of zero defects, zero inefficiency, and zero downtime.
c. Ideal standards become expected standards under such a system, and there is no (or only
minimal) level of acceptable deviation from standard.
d. Implementing ideal standards requires that employees communicate and work together to
improve performance:
i. Current problems must be identified and their causes must be pinpointed.
ii. Management must be willing to invest in those plant and equipment items, equipment
rearrangements, worker training and/or pay increases, vendor changes, and so on that
will make it possible to achieve ideal standards.
iii. Training is essential if workers are to perform at high levels of efficiency.
e. Setting standards at the ideal level in part assigns the responsibility for quality to workers.
i. Thus, management must empower workers with the authority to react effectively to
problems since management has delegated the responsibility for quality to the workers.
ii. Management must provide rewards for achievement since people are required to work at
their maximum potential.
f. The process of implementing ideal standards is illustrated in text Exhibit 7-8.
g. World-class companies can also use theoretical capacity to set fixed overhead rates.
i. Such a capacity measure would provide the lowest and most appropriate predetermined
OH rate.
ii. Any underapplied OH resulting from a difference between theoretical and actual capacity
would indicate capacity that should be either used or eliminated or it could indicate
human capabilities that have not been fully developed.
iii. Any end-of-period underapplied OH would be viewed as a period cost and closed to a
loss account to attract managerial attention to the inefficient and ineffective use of
resources.
h. Standards are slowly moving away from the practical and closer to the ideal in order for
American companies to compete in global markets.
2. Adjusting Standards
a. Standards were traditionally set and retained for at least one year.
b. The current business environment changes so swiftly that a standard might not be useful for
management control purposes during the entire year.
c. Management can either decide to ignore such changes or to incorporate the changes in the
standard. Changing the standards to reflect the changes in prices or quantities would make
some aspects of management control and performance evaluation more effective and others
more difficult.
d. Management may also consider the original standards to be ―frozen‖ for budget purposes and
prepare a revised budget using the new current standards.
i. A combined ―frozen‖ and revised budget system is depicted in text Exhibit 7-9.
3. Material Price Variance Based on Purchases Rather than Usage
a. The material price variance calculation has usually been based on purchases rather than on
usage.
b. The variance is computed as quickly as possible relative to the incurrence of cost.
c. Such variance calculation at the point of purchase does allow the manager to measure the
impact of buying decisions more rapidly, but may not be relevant in a JIT environment.
d. A material price variance computation based on purchases may lessen the probability of
recognizing a relationship between a favorable material price variance and an unfavorable
material quantity variance.
4. Decline in Direct Labor
a. The necessity for direct labor variance calculations will be minimized as the percentage of
total product cost represented by direct labor cost declines.
b. Direct labor cost may become a small part of a conversion cost category.
c. An increase in automation often relegates labor to an indirect category since workers become
machine overseers rather than product producers.
LO.5: How does the use of a single conversion element (rather than the traditional labor and
overhead elements) affect standard costing?
J. Conversion Cost as an Element in Standard Costing
1. Direct labor cost usually represents an extremely small part of total product cost in highly
automated factories.
a. One worker may oversee a large number of machines and deal mainly with trouble-shooting
machinery malfunctions.
b. The worker’s wages may be more closely related to indirect labor rather than to direct labor.
2. Many companies have responded to overhead costs being so much larger than direct labor costs
by adapting their standard cost systems to provide for only two elements of product cost: direct
material and conversion.
a. Conversion costs are likely to be separated into their variable and fixed components.
b. Conversion costs are also likely to be separated into direct and indirect categories based on
their ability to be traced to a machine rather than to a product.
3. Variance analysis for conversion cost in automated plants usually focuses on:
a. Spending variances for overhead costs;
b. Efficiency variances for machinery and production costs rather than labor costs; and
c. Volume variance for production.
4. In automated systems, managers are better able to control not only the spending and efficiency
variances but also the volume variance.
5. The analysis is similar to the traditional three-variance overhead approach.
a. See text Exhibit 7-10 for an illustration of variance analysis under a conversion cost
approach.
LO.6: (Appendix) How are variances affected by multiple material and labor categories?
K. Mix and Yield Variances
1. Mix and Yield Variances
a. A mix is any possible combination of materials or labor inputs.
b. A yield is the quantity of output that results from a specified input.
c. Text Exhibit 7-11 provides standard and actual information for an example discussed in the
text narrative.
2. Material Price, Mix, and Yield Variances
a. A material price variance shows the dollar effect of paying prices that differ from the raw
material standard.
b. The material mix variance measures the monetary effect of substituting a nonstandard mix
of materials; (actual mix × actual quantity × standard price) minus (standard mix × actual
quantity × standard price).
c. The material yield variance is the difference between the actual total quantity of input and
the standard total quantity allowed based on output and uses standard mix and standard
prices to determine variance; (standard mix × actual quantity × standard price) minus
(standard mix × standard quantity × standard price).
d. Text Exhibit 7-12 presents the computations for the material variances.
3. Labor Rate, Mix, And Yield Variances
a. The labor mix variance presents the financial effect associated with changing the
proportionate amount of higher or lower paid workers in production; (actual mix × actual
hours × standard rate) minus (standard mix × actual hours × standard rate).
b. The labor yield variance shows the monetary impact of using more or fewer total hours than
the standard allowed; (standard mix × actual hours × standard rate) minus (standard mix ×
standard hours × standard rate).
c. Text Exhibit 7-13 presents the computations for the labor variances.
4. Because there are trade-offs in mix and yield when component qualities and quantities are
changed, management should observe the integrated nature of price, mix, and yield.
a. The effects of changes of one element on the other two need to be considered for managing
cost efficiency and output quality.
b. If mix and yield can be increased by substituting less expensive resources while maintaining
quality, then the standards and proportions of components should be changed.
c. If costs are reduced but quality is maintained, selling prices may be reduced to gain a larger
market share.
Multiple Choice Questions
1. (LO.1) Select the correct statement regarding standards.

a. A standard is a benchmark or norm used for planning and control.
b. The difference between standard cost and actual cost is referred to as a variance.
c. Standards are developed for materials, labor, and overhead.
d. All of the above
2. (LO.1) The document that summarizes the expected quantities and costs needed to produce a
unit is called a
a. bill of materials.
b. total cost of ownership document.
c. operations flow document.
d. standard cost card.
3. (LO.2) This month R Company planned to produce 3,000 units of its product. The standard cost
card calls for six pounds of material at $.30 per pound. Actual production for the month was 3,100
units, resulting in a favorable price variance of $380 and an unfavorable quantity variance of
$120. Based on these variances, one could conclude that:
a. more materials were purchased than were used.
b. the actual cost of material was less than the standard cost.
c. the actual usage of material was less than the standard allowed.
d. the actual cost and usage of material were both less than standard.
4. (LO.2) An unfavorable direct labor efficiency variance could be caused by a (n):

a. unfavorable variable overhead spending variance.
b. unfavorable fixed overhead volume variance.
c. unfavorable material usage variance.
d. favorable fixed overhead volume variance.
5. (LO.2) The flexible budget for the month of August was for 9,000 units with direct material at $15
per unit. Direct labor was budgeted at 45 minutes per unit for a total of $81,000. Actual output for
the month was 8,500 units with $127,500 in direct material and $77,775 in direct labor expense.
Direct labor hours of 6,375 were actually worked during the month. Variance analysis would
show:
a. a favorable direct labor efficiency variance of $1,275.
b. an unfavorable direct labor efficiency variance of $1,275.
c. an unfavorable direct labor rate variance of $1,275.
d. none of the above.
6. (LO.2) The total fixed overhead variance is the:

a. measure of the lost profits from the lack of sales volume.
b. amount of the underapplied or overapplied fixed overhead costs.
c. potential cost reduction that can be achieved from better cost control.
d. measure of production inefficiency.
7. (LO.2) Variable overhead is applied on the basis of standard direct labor hours. If the direct labor
efficiency variance is favorable, the variable overhead efficiency variance will be:
a. unfavorable.
b. favorable.
c. zero.
d. the same amount as the labor efficiency variance.
8. (LO.2) Y Company’s product has a labor standard of 2 hours per unit. For 2011, it estimates its
production will be 200,000 units (400,000 DLHs). It budgets total overhead at $900,000, which
results in a fixed overhead rate of $1.50 per hour. Actual data for the year include: Actual
production, 198,000 units (440,000 DLHs), Actual variable overhead, $352,000, Actual fixed
overhead, $575,000 The variable overhead efficiency variance for the year is:
a. $66,000 unfavorable.
b. $35,520 favorable.
c. $33,000 favorable.
d. $33,000 unfavorable.
9. (LO.3) Standard cost systems should be used for all of the following reasons except:
a. motivation.
b. decision-making.
c. establishing blame.
d. clerical efficiency.
10. (LO.3) Select the correct statement from the following.

a. An extremely favorable variance is not necessarily a good variance.
b. There is a movement in practice toward reporting variances less often than in the past.
c. Only unfavorable variances need to be investigated.
d. For proper performance evaluation to be made, responsibility for variances should not be
traced to specific managers.
11. (LO.4) The best basis upon which cost standards should be set to measure controllable
production inefficiencies is:
a. engineering standards based on attainable performance.
b. normal capacity.
c. engineering standards.
d. ideal capacity.
12. (LO.5) Variance analysis for conversion cost in automated plants normally focuses on:
a. spending variances for overhead costs.
b. efficiency variances for machinery and production costs rather than labor costs.
c. volume variance for production.
d. all of the above.
13. (LO.6) (Appendix) A possible combination of materials or labor is called

a. materials-time measurement.
b. yield.
c. mix.
d. conversion.
14. (LO.6) (Appendix) A measure of the difference between the actual total quantity of input and the
standard total quantity allowed based on output is called the
a. mix variance.
b. yield variance.
c. volume variance.
d. none of the above.
15. (LO.6) (Appendix) Select the correct equation for the labor mix variance.
a. (Actual mix x Actual hours x Actual rate) – (Actual mix x Actual hours x Standard rate)
b. (Actual mix x Actual hours x Standard rate) – (Actual mix x Actual hours x Standard rate)
c. (Actual mix x Actual hours x Standard rate) – (Standard mix x Actual hours x Standard rate)
d. (Standard mix x Actual hours x Standard rate) – (Standard mix x Standard hours x Standard
rate)
Multiple Choice Solutions
1. d
2. d
3. b
4. c
5. c
$12.20 × 6,375 $12.00 × 6,375 $12.00 × 6,375
$77,775 $76,500 $76,500
$1,275 U $-0-
Labor Rate Variance Labor Efficiency Variance

$1,275 U
Total Labor Variance
6. b
7. b
8. d
Flexible Budget
Based on Input (Output Measure)
(SP × AQ) (SP × SQ)
($0.75 × 440,000 LHs) ($0.75 × 396,000 LHs)
$330,000 $297,000
$33,000 U
VOH
9. c
10. a
11. a
12. d
13. c
14. b
15. c

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CHAPTER

STANDARD COSTING AND VARIANCE

1. How are material, labor, and overhead standards set?

3. Why are standard cost systems used?

Mix: any possible combination of material or labor inputs

LO.1: How are material, labor, and overhead standards set?

a. Organizations develop and use standards for almost all tasks.

b. Because of the variety of organizational activities and information objectives, no single

B. Development of a Standard Cost System

c. Standards should be developed by a group, composed of representatives from the following

i. type of material needed;

ii. quality (grade) of material needed;

iii. quantity of material needed; and

i. Companies often make allowances for normal waste of components.

b. Each production operation performed by workers or by machinery should be identified.

d. After an analysis of labor tasks is completed, an operations flow document can be

C. General Variance Analysis Model

Actual cost of actual input – Standard cost of actual output

 Price (or Rate) Variance = (AP – SP)(AQ)

 Quantity (or Efficiency) Variance = (AQ – SQ) (SP)

D. Material and Labor Variance Computations

Total Material Variance

i. This variance is usually the responsibility of the purchasing manager.

i. This variance is usually the responsibility of the production manager.

2. Point of Purchase Material Variance Model

Material Price Variance

Material Quantity Variance

Total Labor Variance

Actual VOH Budgeted VOH Applied VOH

Total VOH Variance

Actual FOH Budgeted FOH Applied FOH

Total FOH Variance

4. Alternative Overhead Variance Approaches

Actual Overhead Applied Overhead

Total Overhead Variance

c. A middle column representing budgeted overhead based on standard quantity is inserted

Actual Overhead Budgeted OH

Budget Variance Volume Variance

Total Overhead Variance

d. A column representing budgeted overhead based on actual hours is inserted immediately to

Overhead Overhead Overhead

Total Overhead Variance

e. Text Exhibit 7-5 shows the interrelationships of overhead variances.

F. Standard Cost System Journal Entries

LO.3: Why are standard cost systems used?

G. Why Standard Cost Systems are Used

2. Motivation—standards represent a technique of communicating management’s expectations of

5. Decision making—standard cost information availability facilitates many decisions.

6. Performance evaluation—summary variance reports focus attention on the operating

H. Considerations in Establishing Standards

a. Appropriateness and attainability need to be considered when standards are established.

I. Changes in Standards Usage

1. Use of Ideal Standards and Theoretical Capacity

i. Current problems must be identified and their causes must be pinpointed.

iii. Training is essential if workers are to perform at high levels of efficiency.

f. The process of implementing ideal standards is illustrated in text Exhibit 7-8.

3. Material Price Variance Based on Purchases Rather than Usage

b. The variance is computed as quickly as possible relative to the incurrence of cost.

4. Decline in Direct Labor