Chapter 6:

STANDARD COSTS AND

VARIANCES

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 CONTENTS
Learning Objectives

10.
Standard Costs- Setting the Stage
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10.2 A general Model for Cost Variance Analysis
10.3 Using Standard Costs- Direct Materials Variances

10.4 Using Standard Costs- Direct Labor Variances

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 CONTENTS (cont)

5.5 Using Standard Costs- Variable Manufacturing

Overhead Variances

An Important Subtlety in the Materials

5.6 Variances

5.7 Variance Analysis & Management by

Exception

International Uses of Standard Costs

5 .8
Evaluation of Controls Based on Standard
5 .9 Costs 3
 OBJECTIVES

- Compute the direct materials quantity and price

variances and explain their significance.

- Compute the direct labor efficiency and rate

variances and explain their significance.

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 OBJECTIVES (cont)

- Compute the variable manufacturing overhead

efficiency and rate variances and explain their
significance.

- Compute and interpret the fixed overhead volume

and budget variances.

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10.1. STANDARD COSTS- SETTING THE STAGE
Standards are benchmarks or “norms” for
measuring performance. In this chapter,
two types of standards are commonly used.

Quantity standards Price standards

specify how much of an specify how much
input should be used to should be paid for
make a product or each unit of the
provide a service. input.

Examples: Firestone, Sears, McDonald’s, hospitals,

construction, and manufacturing companies.
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10.1. STANDARD COSTS- SETTING THE STAGE

Deviations from standards deemed significant

are brought to the attention of management, a
practice known as management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

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Variance Analysis Cycle

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10.1.1. Who Uses Standard Costs?

• Manufacturing,
• Service,
• Food,
• Not-for-profit organizations

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10.1.2. Setting Standard Costs
Should we use I recommend using practical
ideal standards that standards that are currently
require employees to attainable with reasonable and
work at 100 percent efficient effort.
peak efficiency?

Engineer Managerial Accountant 10

10.1.3. Setting Direct Materials Standards
Standard Price Standard Quantity
per Unit per Unit

Final, delivered Summarized in

cost of materials, a Bill of Materials.
net of discounts.

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10.1.4. Setting Direct Labor Standards

Standard Rate Standard Hours

per Hour per Unit

Often a single Use time and

rate is used that reflects motion studies for
the mix of wages earned. each labor operation.

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10.1.5. Setting Variable
Manufacturing Overhead Standards
Price Quantity
Standard Standard

The rate is the The quantity is

variable portion of the the activity in the allocation
predetermined overhead base for predetermined
rate. overhead.

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The Craft Company’s only product is an art
and craft wooden-bookend. The bookend is
made largely by hand, using traditional
metalworking tools.

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 Exhibit 5.1: Standard cost card- Variable
Manufacturing Cost
Input Standard Standard Standard Cost
quantity or price or (1)X(2)
hour (1) rate (2)

Direct materials 0.01 m3 $1,000 $10.00

Direct labor 1 22.00 $22.00
Variable manufacturing 1 6.0 $6.00
Overhead

Total standard Cost per $38.00

unit

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10.1.6. Using Standards in Flexible Budgets

Standard costs per unit for direct materials, direct

labor, and variable manufacturing overhead can be
used to compute activity and spending variances.

Spending variances become more

useful by breaking them down into
quantity and price variances.
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Exhibit 5.2: Flexible budget Performance Report for manufacturing
costs
Craft Company

Planning Activity Flexible Spending Actual

budget variance budget variance results

Bookends 21,000 20,000 20,000

produced (q)

Direct materials $210,000 $10,000 F $200,000 $16,000 U $216,000

(10q)

Direct labor $462,000 $22,000 F $440,000 $40,000 U $480,000

(22q)
Variable $126,000 $18,000 U $144,000 $12,000 U $156,000
Manufacturing
overhead
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10.2. A GENERAL MODEL FOR
STANDARD COST VARIANCE ANALYSIS

Variance Analysis

Quantity Variance Price Variance

Materials quantity variance Materials price variance

Labor efficiency variance Labor rate variance
VOH efficiency variance VOH rate variance
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Exhibit 10.3: A General Model for Standard Cost Variance
analysis- Variable manufacturing Costs

(1) (2)
Actual Quantity (3)
Standard Quantity Actual Quantity
Allowed for Actual of Input,
at Standard Price of Input,
Output, at Actual Price
at Standard Price (AQ × SP)
(AQ × AP)
(SQ × SP)

Quantity Variance Price Variance

(2) – (1) (3) – (2)

Spending Variance
(3) – (1)
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10.2. A GENERAL MODEL FOR STANDARD COST
VARIANCE ANALYSIS
Actual quantity is the amount of direct materials, direct labor,
and variable manufacturing overhead actually used.

(1) (2) (3)

Standard Quantity Actual Quantity Actual Quantity
Allowed for Actual of Input, of Input,
Output, at Standard Price at Actual Price
at Standard Price (AQ × SP) (AQ × AP)
(SQ × SP)
Quantity Variance Price Variance
(2) – (1) (3) – (2)

Spending Variance
(3) – (1)
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 10.2. A GENERAL MODEL FOR STANDARD
COST VARIANCE ANALYSIS
Standard quantity is the standard quantity allowed for the
actual output of the period.

(1) (2) (3)

Standard Quantity Actual Quantity Actual Quantity
Allowed for Actual Output, of Input, of Input,
at Standard Price at Standard Price at Actual Price
(SQ × SP) (AQ × SP) (AQ × AP)

Quantity Variance Price Variance

(2) – (1) (3) – (2)

Spending Variance
(3) – (1)
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10.2. A GENERAL MODEL FOR STANDARD
COST VARIANCE ANALYSIS
Actual price is the amount actually
paid for the input used.

(1) (2) (3)

Standard Quantity Actual Quantity Actual Quantity
Allowed for Actual of Input, of Input,
Output, at Standard at Actual Price
at Standard Price Price (AQ × AP)
(SQ × SP) (AQ × SP)
Quantity Variance Price Variance
(2) – (1) (3) – (2)

Spending Variance
(3) – (1)
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10.2. A GENERAL MODEL FOR STANDARD COST
VARIANCE ANALYSIS
Standard price is the amount that should
have been paid for the input used.

(1) (2) (3)

Standard Quantity Actual Quantity Actual Quantity
Allowed for Actual Output, of Input, of Input,
at Standard Price at Standard Price at Actual Price
(SQ × SP) (AQ × SP) (AQ × AP)

Quantity Variance Price Variance

(2) – (1) (3) – (2)

Spending Variance
(3) – (1)
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10.3. USING STANDARD COSTS- DIRECT
MATERIALS VARIANCES:( +5.6)

Craft company:
0.01 m3 per unit x$ 1,000 per m3 = $10.00 per unit.
240m3 of ironwood were purchased at a cost of $900.00
per m3, for a total cost of $216,000. All of the
materials purchased was used during June to
manufacture 20,000 units of bookends.

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 Materials Variances Summary

Standard Quantity Actual Quantity Actual Quantity

× × ×
Standard Price Standard Price Actual Price
200 m3 240m3 240 m3.
× × ×
$1,000 $1,000. $900
= $200,000 = $240,000 = $216,000

Quantity variance Price variance

$40,000 U $24,000 F
Spending Variance
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 Materials Variances:
Using the Factored Equations
Materials quantity variance
MQV = (AQ × SP) – (SQ × SP)
= SP(AQ – SQ)
= $1,000 (240m3– (0.01m3 20,000 units))
= $1,000 (240 – 200)
= $40,000 U
Materials price variance
MPV = (AQ × AP) – (AQ × SP)
= AQ(AP – SP)
= 240m3($900/m3 – $1,000m3)
= $24,000 F

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 Responsibility for Materials
Variances
Materials Quantity Variance Materials Price Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity variance

so that the production manager is not held responsible for
the purchasing manager’s performance.
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 Responsibility for Materials
Variances
Your poor scheduling
I am not responsible for sometimes requires me to
this unfavorable materials rush order materials at a
quantity variance. higher price, causing
You purchased cheap unfavorable price
material, so my people variances.
had to use more of it.

Production Manager Purchasing Manager 31

10.4. USING STANDARD COSTS- DIRECT
LABOR VARIANCES

Example: Craft Company has the following direct

labor standard for its mountain parka.
1.0 hour per unit at $22.00 per hour
During June, employees actually worked 24,000
hours at a total labor cost of $480,000 to make
20,000 units.

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 Labor Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
21,000 hours 24,000 hours 24,000 hours
× × ×
$22.00 per hour $22.00 per hour $20.00 per hour
= $462,000 = $528,000 = $480,000

Efficiency variance Rate variance

$66,000 U $48,000 F

Spending variance
$18,000 U 33
Labor Variances: Using the Factored
Equations
Labor efficiency variance
LEV = (AH × SR) – (SH × SR)
= SR (AH – SH)
= $22.00 per hour (24,000 hours – 21,000 hours)
= $66,000 U
Labor rate variance
LRV = (AH × AR) – (AH × SR)
= AH (AR – SR)
= 24,000 hours ($20.00 per hour – $22.00 per hour)
= $48,000 F

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 Responsibility for Labor
Variances
Production managers are Mix of skill levels
usually held accountable assigned to work tasks.
for labor variances
because they can
Level of employee
influence the:
motivation.

Quality of production
supervision.

Quality of training
provided to employees.
Production Manager
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 Responsibility for Labor
Variances I think it took more time
to process the materials
I am not responsible for because the Maintenance
the unfavorable labor Department has poorly
efficiency variance! maintained your
equipment.
You purchased cheap
material, so it took more
time to process it.

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10.5. USING STANDARD COSTS- VARIABLE
MANUFACTURING OVERHEAD VARIANCES

Craft Company has the following direct variable

manufacturing overhead labor standard for its.
1.0 standard hours per unit at $6.00 per hour
During June, employees actually worked 24,000
hours to make 20,000 units. Actual variable
manufacturing overhead for the month was
$156,000.

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 Variable Manufacturing Overhead
Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
21,000 hours 24,000 hours 24,000 hours
× × ×
$6.00 per hour $6.00 per hour $6.50 per hour
= $126,000 = $144,000 = $156,000

Efficiency variance Rate variance

$18,000 U $12,000 U

Spending variance
$30,000 U 38
 Variable Manufacturing Overhead
Variances: Using Factored Equations
Variable manufacturing overhead efficiency variance
VMEV = (AH × SR) – (SH – SR)
= SR (AH – SH)
= $6.00 per hour (24,000 hours – 21,000 hours)
= $18,00 U
Variable manufacturing overhead rate variance
VMRV = (AH × AR) – (AH – SR)
= AH (AR – SR)
= 24,000 hours ($6.50 per hour – $6.00 per hour)
= $12.00 U

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10.7. VARIANCE ANALYSIS AND
MANAGEMENT BY EXCEPTION

Larger variances, in
How do I know dollar amount or as a
which variances to percentage of the
investigate? standard, are
investigated first.
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10.9. EVALUATION OF CONTROLS BASED ON
STANDARD COSTS
5.9.1.Advantages of Standard Costs
Management by Promotes economy
exception and efficiency

Advantages
Enhances
Simplified responsibility
bookkeeping accounting
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10.9.2. Potential Problems with
Standard Costs
Emphasizing standards Favorable
may exclude other variances may
important objectives. be misinterpreted.
Potential
Problems
Standard cost Emphasis on
reports may negative may
not be timely. impact morale.

Invalid assumptions Continuous

about the relationship improvement may
between labor be more important
cost and output. than meeting standards.
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SUMMARY

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