STANDARD COSTING

Standard Costing: A Managerial Control Tool

A. Introduction
Cost control. The opening scenario illustrates that many prosperous companies tend to ignore the need for cost
control. As conditions become more competitive and profits are being squeezed, it suddenly becomes more
important to be cost conscious. In reality, even prosperous firms should be cost conscious. By exerting control over
costs in prosperous times, the ability to weather more demanding times is improved. Comparing actual amounts with
budgeted amounts is one approach to control.
A standard cost is the expected or budgeted cost of materials, labor, and manufacturing overhead required to
produce one unit of product.
The unit standard cost is calculated as follows:
Quantity standard × Price standard
A price standard is the price that should be paid per unit of input (such as pound of material).
A quantity standard is the quantity of input allowed per unit of output (for example, pounds of material allowed
per one unit of product).
A standard cost sheet calculates the total standard cost for one unit of product. It lists the standard costs for one
unit of product for the following:
 Materials (Price standard × Quantity standard)
 Labor (Price standard × Quantity standard)
 Variable manufacturing overhead (Price standard × Quantity standard)
 Fixed manufacturing overhead (Price standard × Quantity standard)

B. Why Standard Cost Systems Are Adopted

Two reasons for adopting a standard cost system are:
 To improve planning and control. A standard cost system compares actual amounts with standard
amounts to determine variances from the standard. The use of a standard cost system for operational
control in an advanced manufacturing environment can produce dysfunctional behavior. However,
standards in the advanced manufacturing environment are still useful for planning, such as developing
bids.
 To facilitate product costing. Standard costing uses standard costs for direct materials, direct labor, and
overhead. Standard cost systems provide readily available unit cost information that can be used for pricing
decisions.
Costs under the three product cost assignment approaches are summarized below:

PRODUCT COSTING SYSTEM MANUFACTURING COSTS

Direct Materials Direct Labor Overhead
Actual costing system Actual Actual Actual
Normal costing system Actual Actual Budgeted
Standard costing system Standard Standard Standard

2. STANDARD PRODUCT COSTS

The standard cost sheet for one unit of product might appear as follows:
 STANDARD COST SHEET
Production Costs for One Unit of Product
Direct materials
(Standard price for materials × Standard quantity of materials)
Direct labor
(Standard direct labor rate × Standard direct labor hours)
Variable manufacturing overhead
(Standard variable overhead rate × Standard direct labor hours)
Fixed manufacturing overhead
(Standard fixed overhead rate × Standard direct labor hours)
Total standard cost per unit of product

The standard cost for direct materials is calculated as follows:

Standard cost for direct materials =
Standard quantity of materials × Standard price for the materials
Standard quantity of materials allowed (SQ) is calculated:
SQ = Unit quantity standard × Actual output
The standard direct labor cost for a unit of product would be calculated as follows:
Standard direct labor cost =
Standard quantity of direct labor × Standard rate per direct labor hour
Standard hours allowed (SH) is calculated:
SH = Unit labor standard × Actual output

3. VARIANCE ANALYSIS: GENERAL DESCRIPTION

A. Price and Efficiency Variances

The total budget variance is the difference between actual cost of inputs and the standard (or planned) cost of
inputs.
There are two variances for variable production costs:
1. price or rate variances— the difference between actual costs of inputs and what the inputs should have cost
(standard prices).
2. usage or efficiency variances— the difference between the actual quantity used and the standard quantity
allowed for units produced.
The general model for calculating variable cost variances appears below:

Actual quantity of Actual quantity of Standard quantity of

input at actual price input at standard price input at standard price
(AP × AQ) (SP × AQ ) (SP × SQ)
(AP – SP)AQ (AQ – SQ )SP
Price variance Usage or efficiency variance
Total variance = (AP × AQ) – (SP × SQ )

If the actual price or quantity is less than the standard, the variance is considered favorable.
If the actual price or quantity exceeds the standard, the variance is considered unfavorable.
B. The Decision to Investigate
Variances indicate that actual performance is not going according to plan.
Variances do not indicate the cause of the variance or responsibility.
Usually the cause of a variance can be determined only by an investigation. For example, an unfavorable materials
quantity variance may not be the fault of the production supervisor. Instead, it may be the result of the
purchasing agent buying inferior-quality material.
Most firms adopt the general guideline of investigating variances only if they fall outside an acceptable range.

For example, management may investigate any variance that exceeds $1,000 or 5% of the standard amount to
which the variance relates.

4. VARIANCE ANALYSIS:  MATERIALS

A. Direct Materials Variances

Direct Materials Price Variance
The materials price variance (MPV ) for materials is calculated as follows:
Actual quantity purchased Actual quantity purchased
at actual price at standard price
(AP × AQ) (SP × AQ )
(AP – SP)AQ
Direct materials price variance
The materials price variance can be computed at one of two points:
1. When the raw materials are issued for use in production.
2. When the raw materials are purchased.
Variances should be calculated at the earliest point possible so management can take any necessary cor rective
action. Thus, the price variance for materials should be calculated at the time of purchase.
Responsibility for the materials price variance is usually assigned to the purchasing agent.
Variance analysis involves the following process:
 Decide whether the variance is significant.
 If insignificant, no further investigation is needed.
 If significant, investigate the cause of the variance and take corrective action if necessary.
B. Direct Materials Usage Variance
The materials usage variance (MUV ) is calculated as follows:

Actual quantity used Standard quantity allowed

at standard price at standard price
(SP × AQ ) (SP × SQ)
(AQ – SQ )SP
Direct materials usage variance

The production manager is usually responsible for materials usage because the production manager can minimize
scrap, waste, and rework in order to meet the standard.
The materials usage variance is calculated at the time materials are issued or used in the manufacturing process.
5. VARIANCE ANALYSIS: DIRECT LABOR

A. Direct Labor Variances

The labor rate variance (LRV ) is calculated as follows:

Actual labor hours Actual labor hours

at actual rate at standard rate
(AR × AH) (SR × AH)
(AR – SR)AH
Direct labor rate variance

When labor rate variances occur, it is usually due to:

 using the average wage rate as the standard rate, or
 using more skilled and higher paid laborers for less skilled tasks.
Responsibility for the labor rate variance is often assigned to the individual, such as the production manager, who
decides how labor will be used.

B. Labor Efficiency Variance

The labor efficiency variance (LEV ) is calculated as follows:

Actual labor hours Standard labor hours

at standard rate allowed at standard rate
(AH × SR) (SH × SR)
(AH – SH)SR
Direct labor efficiency variance

Usually production managers are responsible for the direct labor efficiency variance; however, once the cause of the
variance is discovered, responsibility may be assigned elsewhere.
The total variance for direct labor would be the sum of the rate variance and the efficiency variance. The total
variance can also be calculated as follows:
Total direct labor variance =
(Actual quantity × Actual price) – (Standard quantity × Standard price)

6. KAISEN COSTING AND TARGET COSTING

A. Kaizen Costing
Kaizen costing is concerned with reducing costs of existing products and processes by reducing nonvalue-added
costs. A kaizen standard reflects the planned improvement for the upcoming period and is a currently attainable
standard.

B. Target Costing
A target cost is the difference between the sales price needed to capture a predetermined market share and the
desired per-unit profit. When the target cost is less than what is currently achievable, management typically uses
three cost reduction methods to move the actual cost toward the target cost.
Target costing is often referred to as a profit planning technique.
Target costing is more of a long-term approach to cost reduction whereas kaizen costing is a more continuous, short-
term approach to cost reduction.

SUMMARY
The following summarizes direct materials and direct labor variances:

Variances
Actual cost Standard cost
Direct AP × AQ SP × AQ SP × SQ
materials
Variance* Direct materials price variance Direct materials efficiency variance

Direct AR × AH SR × AH SH × SR
labor
variance Direct labor rate variance Direct labor efficiency variance

Ex. 1
Deines, Inc. manufactures one product called tybos. The company uses a standard cost system and sells each tybo
for $8. At the start of monthly production, Deines estimated 8,000 tybos would be produced in March. Deines has
established the following material and labor standards to produce one tybo:
Standard Quantity Standard Price
Direct materials 2.5 pounds $3 per pound
Direct labor 0.6 hours $10 per hour
During March 2009, the following activity was recorded by the company relating to the production of tybos:
1. The company produced 7,500 units during the month.
2. A total of 20,000 pounds of materials were purchased at a cost of $55,000.
3. A total of 20,000 pounds of materials were used in production.
4. 4,000 hours of labor were incurred during the month at a total wage cost of $44,000.
Instructions
Calculate the following variances for March for Deines, Inc.
(a) Materials price variance
(b) Materials quantity variance
(c) Labor price variance
(d) Labor quantity variance

Ex. 2
Chee See Company estimated it would produce 6,200 buckets, though actual production was 6,000 during August.
The standard labor cost is 2 buckets per hour at $24.00 per hour. Actual cost per hour was $24.50 with a total labor
cost of $71,050.
Instructions
Determine the amounts of the labor price and the labor quantity variances for August.
Ex. 3
Hite Company has developed the following standard costs for its product for 2009:
HITE COMPANY
Standard Cost Card
Product A
Cost Element Standard Quantity × Standard Price = Standard Cost
Direct materials 4 pounds $3 $12
Direct labor 3 hours 8 24
Manufacturing overhead 3 hours 4 12
$48
The company expected to produce 25,000 units of Product A in 2009 and work 75,000 direct labor hours.
Actual results for 2009 are as follows:
 26,000 units of Product A were produced.
 Actual direct labor costs were $630,800 for 76,000 direct labor hours worked.
 Actual direct materials purchased and used during the year cost $283,500 for 105,000 pounds.
 Actual variable overhead incurred was $130,000 and actual fixed overhead incurred was $170,000.
Instructions
Compute the following variances showing all computations to support your answers. Indicate whether the variances
are favorable or unfavorable.
(a) Materials quantity variance.
(b) Total direct labor variance.
(c) Direct labor quantity variance.
(d) Direct materials price variance.
(e) Total overhead variance.

Ex. 4
Feeney Company developed the following standard costs for its product for 2009:
FEENEY COMPANY
Standard Cost Card

Cost Elements Standard Quantity × Standard Price = Standard Cost

Direct materials 4 pounds $ 5 $20
Direct labor 2 hours 10 20
Variable overhead 2 hours 4 8
Fixed overhead 2 hours 2 4
$52
The company expected to work at the 60,000 direct labor hours level of activity and produce 30,000 units of
product.
Actual results for 2009 were as follows:
 28,400 units of product were actually produced.
 Direct labor costs were $546,000 for 56,000 direct labor hours actually worked.
 Actual direct materials purchased and used during the year cost $554,400 for 115,500 pounds.
 Total actual manufacturing overhead costs were $340,000.
Instructions
Compute the following variances for Feeney Company for 2009 and indicate whether the variance is favorable or
unfavorable.
1. Direct materials price variance.
2. Direct materials quantity variance.
3. Direct labor price variance.
4. Direct labor quantity variance.
a
5. Overhead controllable variance.
a
6. Overhead volume variance.

Ex. 5
Thomas, Inc. manufactures widgets for distribution. The standard costs for the manufacture of widgets follow:
Standard Costs Actual Costs
Direct materials 3 lbs. per widget at 15,500 lbs. at $34
$35 per pound per pound

Direct labor 2.5 hours per widget 11,250 hours at

at $11 per hour $11.80 per hour

Factory overhead Variable cost, $24/widget $120,750 variable cost

Fixed cost, $40/widget $190,625 fixed cost

Budgeted factory overhead was $320,000. Overhead applied is based on widgets produced. The company estimated
that 5,000 widgets would be produced; however, only 4,800 were produced.
Instructions
Calculate the following amounts.
1. Rate at which total factory overhead is applied
2. Materials price variance
3. Total materials variance
a
4. Overhead volume variance
a
5. Overhead controllable variance

Ex. 6
American Sporting Goods Company manufactures aluminum baseball bats that it sells to university athletic
departments. It has developed the following per unit standard costs for 2009 for each baseball bat:
Manufacturing
Direct Materials Direct Labor Overhead
Standard Quantity 2 Pounds (Aluminum) 1/2 hour 1/2 hour
Standard Price $4.00 $10.00 $6.00
Unit Standard Cost $8.00 $5.00 $3.00
In 2009, the company planned to produce 80,000 baseball bats at a level of 40,000 hours of direct labor.
Actual results for 2009 are presented below:
1. Direct materials purchases were 164,000 pounds of aluminum which cost $688,800.
2. Direct materials used were 145,000 pounds of aluminum.
3. Direct labor costs were $379,270 for 39,100 direct labor hours actually worked.
4. Total manufacturing overhead was $235,000.
5. Actual production was 76,000 baseball bats.
Instructions
(a) Compute the following variances:
1. Direct materials price.
2. Direct materials quantity.
3. Direct labor price.
4. Direct labor quantity.
5. Total overhead variance.
a
(b) Prepare the journal entries to record the transactions and events in 2009.

Ex. 7
Reagan Company planned to produce 20,000 units of product and work 100,000 direct labor hours in 2009.
Manufacturing overhead at the 100,000 direct labor hours level of activity was estimated to be:
Variable manufacturing overhead $ 700,000
Fixed manufacturing overhead 300,000
Total manufacturing overhead $1,000,000
At the end of 2009, 21,000 units of product were actually produced and 108,000 actual direct labor hours were
worked. Total actual overhead costs for 2009 were $1,025,000.
Instructions
(a) Compute the total overhead variance.
a
(b) Compute the overhead controllable variance.
a
(c) Compute the overhead volume variance.