Standard Costs and Variances

Chapter 10
 10-2

Standard Costs
Standards are benchmarks or “norms” for
measuring performance. In managerial accounting,
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.
 10-3

Standard Costs
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

 10-4

Variance Analysis Cycle

 10-5

Setting Standard Costs

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

Engineer Managerial Accountant

 10-6

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.
 10-7

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.
 10-8

Setting Variable Manufacturing

Overhead Standards
Price Quantity
Standard Standard

The rate is the The quantity is

variable portion of the the activity in the
predetermined overhead allocation base for
rate. predetermined overhead.
 10-9

The Standard Cost Card

A standard cost card for one unit
of product might look like this:
A B AxB
Standard Standard Standard
Quantity Price Cost
Inputs or Hours or Rate per Unit
Direct materials 3.0 lbs. $ 4.00 per lb. $ 12.00
Direct labor 2.5 hours 14.00 per hour 35.00
Variable mfg. overhead 2.5 hours 3.00 per hour 7.50
Total standard unit cost $ 54.50
 10-10

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.
 10-11

A General Model for Variance

Analysis
Variance Analysis

Quantity Variance Price Variance

Difference between Difference between

actual quantity and actual price and
standard quantity standard price
 10-12

Quantity and Price Standards

Quantity and price standards are
determined separately for two reasons:

 The purchasing manager is responsible for raw

material purchase prices and the production manager
is responsible for the quantity of raw material used.

 The buying and using activities occur at different times.

Raw material purchases may be held in inventory for a
period of time before being used in production.
 10-13

A General Model for 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
 10-14

A General Model for Variance

Analysis

(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)
 10-15

A General Model for 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 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)
 10-16

A General Model for 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)
 10-17

A General Model for 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 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)
 10-18

A General Model for 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)
 10-19

Learning Objective 1

Compute the direct

materials quantity
and price variances
and explain their
significance.
 10-20

Materials Variances – An
Example
Glacier Peak Outfitters has the following direct
materials standard for the fiberfill in its mountain
parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased and
used to make 2,000 parkas. The materials cost a
total of $1,029.
 10-21

Materials Variances Summary

Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
× × ×
$5.00 per kg. $5.00 per kg. $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance Price variance

$50 unfavorable $21 favorable
 10-22

Materials Variances Summary

Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
0.1 kg per parka  2,000
× × ×
parkas = 200 kgs
$5.00 per kg. $5.00 per kg. $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance Price variance

$50 unfavorable $21 favorable
 10-23

Materials Variances Summary

Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
× ×  210 kgs
$1,029 ×
$5.00 per kg. $5.00 per kg.
= $4.90 per kg $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance Price variance

$50 unfavorable $21 favorable
 10-24

Materials Variances:
Using the Factored Equations
Materials quantity variance
MQV = (AQ × SP) – (SQ × SP)
= SP(AQ – SQ)
= $5.00/kg (210 kgs – (0.1 kg/parka  2,000 parkas))
= $5.00/kg (210 kgs – 200 kgs)
= $5.00/kg (10 kgs) = $50 U

Materials price variance

MPV = (AQ × AP) – (AQ × SP)
= AQ(AP – SP)
= 210 kgs ($4.90/kg – $5.00/kg)
= 210 kgs (– $0.10/kg) = $21 F
 10-25

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.
 10-26

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 variances.
material, so my people
had to use more of it.

Production Manager Purchasing Manager

 10-27

Quick Check  Zippy

Hanson Inc. has the following direct materials

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week, 1,700 pounds of materials were
purchased and used to make 1,000 Zippies. The
materials cost a total of $6,630.
 10-28

Quick Check  Zippy

How many pounds of materials should

Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
d. 1,000 pounds.
 10-29

Quick Check  Zippy

How many pounds of materials should

Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
The standard quantity is:
d. 1,000 pounds.
1,000 × 1.5 pounds per Zippy.
 10-30

Quick Check  Zippy

Hanson’s materials quantity variance (MQV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 10-31

Quick Check  Zippy

Hanson’s materials quantity variance (MQV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
 10-32

Quick Check  Zippy

Hanson’s materials price variance (MPV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 10-33

Quick Check  Zippy

Hanson’s materials price variance (MPV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MPV = AQ(AP - SP)
MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable
 10-34

Quick Check  Zippy

Standard Quantity Actual Quantity Actual Quantity

× × ×
Standard Price Standard Price Actual Price

1,500 lbs. 1,700 lbs. 1,700 lbs.

× × ×
$4.00 per lb. $4.00 per lb. $3.90 per lb.
= $6,000 = $ 6,800 = $6,630

Quantity variance Price variance

$800 unfavorable $170 favorable
 10-35

Quick Check  Zippy

Recall that the standard quantity for 1,000 Zippies
is 1,000 × 1.5 pounds per Zippy = 1,500 pounds.
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price

1,500 lbs. 1,700 lbs. 1,700 lbs.

× × ×
$4.00 per lb. $4.00 per lb. $3.90 per lb.
= $6,000 = $ 6,800 = $6,630

Quantity variance Price variance

$800 unfavorable $170 favorable
 10-36

Learning Objective 2

Compute the direct labor

efficiency and rate
variances and explain
their significance.
 10-37

Labor Variances – An Example

Glacier Peak Outfitters has the following direct

labor standard for its mountain parka.
1.2 standard hours per parka at $10.00 per hour
Last month, employees actually worked 2,500
hours at a total labor cost of $26,250 to make
2,000 parkas.
 10-38

Labor Variances Summary

Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × ×
$10.00 per hour $10.00 per hour $10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance Rate variance

$1,000 unfavorable $1,250 unfavorable
 10-39

Labor Variances Summary

Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× per parka  2,000
1.2 hours × ×
$10.00 per hour parkasper
$10.00 = 2,400
hour hours$10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance Rate variance

$1,000 unfavorable $1,250 unfavorable
 10-40

Labor Variances Summary

Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × hours
$26,250  2,500 ×
$10.00 per hour = $10.50
$10.00per
perhour
hour $10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance Rate variance

$1,000 unfavorable $1,250 unfavorable
 10-41

Labor Variances: Using the

Factored Equations
Labor efficiency variance
LEV = (AH × SR) – (SH × SR)
= SR (AH – SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable
Labor rate variance
LRV = (AH × AR) – (AH × SR)
= AH (AR – SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable
 10-42

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
 10-43

Responsibility for Labor

Variances
I think it took more time
to process the
I am not responsible for materials because the
the unfavorable labor Maintenance
efficiency variance! Department has poorly
maintained your
You purchased cheap
equipment.
material, so it took more
time to process it.
 10-44

Quick Check  Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at
$12.00 per direct labor hour
Last week, 1,550 direct labor hours were
worked at a total labor cost of $18,910
to make 1,000 Zippies.
 10-45

Quick Check  Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
 10-46

Quick Check  Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
LEV = SR(AH - SH)
LEV = $12.00(1,550 hrs - 1,500 hrs)
LEV = $600 unfavorable
 10-47

Quick Check  Zippy

Hanson’s labor rate variance (LRV) for the

week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
 10-48

Quick Check  Zippy

Hanson’s labor rate variance (LRV) for the

week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
LRV = AH(AR - SR)
d. $300 favorable.LRV = 1,550 hrs($12.20 - $12.00)
LRV = $310 unfavorable
 10-49

Quick Check  Zippy

Standard Hours Actual Hours Actual Hours

× × ×
Standard Rate Standard Rate Actual Rate
1,500 hours 1,550 hours 1,550 hours
× × ×
$12.00 per hour $12.00 per hour $12.20 per hour
= $18,000 = $18,600 = $18,910

Efficiency variance Rate variance

$600 unfavorable $310 unfavorable
 10-50

Learning Objective 3

Compute the variable

manufacturing overhead
efficiency and rate
variances and explain
their significance.
 10-51

Variable Manufacturing
Overhead Variances – An
Example
Glacier Peak Outfitters has the following direct
variable manufacturing overhead labor standard
for its mountain parka.
1.2 standard hours per parka at $4.00 per hour
Last month, employees actually worked 2,500
hours to make 2,000 parkas. Actual variable
manufacturing overhead for the month was
$10,500.
 10-52

Variable Manufacturing
Overhead Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × ×
$4.00 per hour $4.00 per hour $4.20 per hour
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable
 10-53

Variable Manufacturing
Overhead Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× 1.2 hours ×
per parka  2,000 ×
$4.00 per hour $4.00 per
parkas hour hours $4.20 per hour
= 2,400
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable
 10-54

Variable Manufacturing
Overhead Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× ×
$10,500  2,500 hours ×
$4.00 per hour $4.00 per
= $4.20 per hour
hour $4.20 per hour
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable
 10-55

Variable Manufacturing Overhead

Variances: Using Factored Equations
Variable manufacturing overhead efficiency variance
VMEV = (AH × SR) – (SH – SR)
= SR (AH – SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
Variable manufacturing overhead rate variance
VMRV = (AH × AR) – (AH – SR)
= AH (AR – SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
 10-56

Quick Check  Zippy

Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Zippy:
1.5 standard hours per Zippy at
$3.00 per direct labor hour
Last week, 1,550 hours were worked to make
1,000 Zippies, and $5,115 was spent for
variable manufacturing overhead.
 10-57

Quick Check  Zippy

Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.
 10-58

Quick Check  Zippy

Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
a. $435 unfavorable.
b. $435 favorable.
1,000 units × 1.5 hrs per unit
c. $150 unfavorable.
d. $150 favorable.
VMEV = SR(AH - SH)
VMEV = $3.00(1,550 hrs - 1,500 hrs)
VMEV = $150 unfavorable
 10-59

Quick Check  Zippy

Hanson’s rate variance (VMRV) for variable

manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.
 10-60

Quick Check  Zippy

Hanson’s rate variance (VMRV) for variable

manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. VMRV = AH(AR - SR)
$335 unfavorable.
VMRV = 1,550 hrs($3.30 - $3.00)
d. $300 favorable.VMRV = $465 unfavorable
 10-61

Quick Check  Zippy

Standard Hours Actual Hours Actual Hours

× × ×
Standard Rate Standard Rate Actual Rate
1,500 hours 1,550 hours 1,550 hours
× × ×
$3.00 per hour $3.00 per hour $3.30 per hour
= $4,500 = $4,650 = $5,115

Efficiency variance Rate variance

$150 unfavorable $465 unfavorable
 10-62

Materials Variances―An Important

Subtlety

The quantity variance

is computed only on
the quantity used.
The price variance is
computed on the entire
quantity purchased.
 10-63

Materials Variances―An Important

Subtlety
Glacier Peak Outfitters has the following direct
materials standard for the fiberfill in its mountain
parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased at a
cost of $1,029. Glacier used 200 kgs. to make
2,000 parkas.
 10-64

Materials Variances―An Important

Subtlety
Standard Quantity Actual Quantity
× ×
Standard Price Standard Price
200 kgs. 200 kgs.
× ×
$5.00 per kg. $5.00 per kg.
= $1,000 = $1,000

Quantity variance
$0
 10-65

Materials Variances―An Important

Subtlety
Actual Quantity Actual Quantity
× ×
Standard Price Actual Price
210 kgs. 210 kgs.
× ×
$5.00 per kg. $4.90 per kg.
= $1,050 = $1,029

Price variance
$21 favorable
 10-66

Variance Analysis and

Management by Exception

Larger variances, in
How do I know dollar amount or as
which variances to a percentage of the
investigate? standard, are
investigated first.
 10-67

A Statistical Control Chart

Warning signals for investigation

Favorable Limit
• •
• • •
Desired Value
• •
Unfavorable Limit •
•
1 2 3 4 5 6 7 8 9
Variance Measurements
 10-68

Advantages of Standard Costs

Management by Promotes economy

exception and efficiency

Advantages
Enhances
Simplified responsibility
bookkeeping accounting
 10-69

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.
Journal Ledger
General EntriesEntries
to Record
to
Variances
Record Variances
Appendix 10A
 10-71

Learning Objective 5

(Appendix 10A)
Prepare journal entries
to record standard
costs and variances.
 10-72

Glacier Peak Outfitters ―

Revisited
We will use information from the Glacier Peak Outfitters
example presented earlier in the chapter to illustrate journal
entries for standard cost variances. Recall the following:

Material Labor
AQ × AP = $1,029 AH × AR = $26,250
AQ × SP = $1,050 AH × SR = $25,000
SQ × SP = $1,000 SH × SR = $24,000
MPV = $21 F LRV = $1,250 U
MQV = $50 U LEV = $1,000 U

Now, let’s prepare the entries to record

the labor and material variances.
 10-73

Recording Materials Variances

GENERAL JOURNAL Page 4
Post.
Date Description Ref. Debit Credit
Raw Materials 1,050
Materials Price Variance 21
Accounts Payable 1,029
To record the purchase of material

Work in Process 1,000

Materials Quantity Variance 50
Raw Materials 1,050
To record the use of material
 10-74

Recording Labor Variances

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process 24,000
Labor Rate Variance 1,250
Labor Efficiency Variance 1,000
Wages Payable 26,250
To record direct labor
 10-75

Cost Flows in a Standard Cost System

Inventories are recorded at standard cost.

Variances are recorded as follows:
 Favorable variances are credits, representing
savings in production costs.
 Unfavorable variances are debits, representing
excess production costs.
Standard cost variances are usually closed out
to cost of goods sold.
 Unfavorable variances increase cost of goods sold.
 Favorable variances decrease cost of goods sold.
 10-76

End of Chapter 10