Standard Costing and Analysis

of Direct Costs
Week 2

13-1
Learning
Objectives
1. Describe the elements of a cost control system
2. Describe two ways to set cost standards and distinguish between perfection
and practical standards
3. Compute and interpret the direct-material price and quantity variances and
the direct-labor rate and efficient variances
4. Explain several methods for determining the significance of cost variances
5. Describe some behavioral effects of standard costing
6. Explain how standard costs are used in product costing
7. Summarize some advantages of standard costing
8. Explain several common criticisms of standard costing
9. Prepare journal entries to record and close out cost variances
 Managing
Costs
Standard (budgeted) Actual
cost cost

manager compare actual & budget cost Comparison between

diff: cost variance standard and actual
performance
level

Cost [Results control]

variance

10-3
 Favorable and Unfavorable Variances

Favorable variances arise when actual

results exceed budgeted.

Unfavorable variances arise when

actual results fall below budgeted.

Favorable (F) versus Unfavorable (U) Variances

Profits Revenue Costs

Actual > Expected F F U
Actual < Expected U U F

Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 8-

4
 Static-budget variance

- Static-budget variance  difference between the actual result & the

corresponding budgeted amount in the static budget.
- FAVOURABLE VARIANCE
- When considered in isolation, of increasing operating income relative to the budgeted amount.
- For revenue items: F means actual revenues exceed budgeted revenues.
- For cost items: F means actual costs are less than budgeted costs.
- UNFAVOURABLE VARIANCE
- When viewed in isolation, of decreasing operating income relative to the budgeted amount.
 only those impt/sig variances shld be investigated

Management by
Exception
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception..

Standard
Amount

Direct
Material
Direct

Labor

Type of Product Cost

11-6
Setting Standards

Cost
Standards

Analysis of Task
Historical Data Analysis

11-7
Participation in Setting
Standards
Accountants, engineers, personnel administrators, and
production managers combine efforts to set standards
based on experience and expectations.

11-8
 Perfection versus Practical Standards:
A Behavioral Issue
Perfection stnd: nvr make any mistake (no idle min, nvr make defect pdts)
Practical standards
should be set at levels
that are currently
attainable with
Should we use reasonable and
practical standards efficient effort.
or perfection
standards?

11-9
Perfection versus Practical Standards:
A Behavioral Issue
I agree. Perfection
standards are
unattainable and
therefore discouraging
to most employees.

11-10
 Static Budgets vs Flexible
Budgets
Static budgets are Hmm!
prepared for a single, Comparing static
planned level of activity. budgets with actual
Performance evaluation is costs is like
difficult when actual comparing
activity differs from the apples and oranges.
planned level of activity.

Static: done in advance

If cost of item is $20, based on static budget, $20,000

If produce 1,500 items, cost at $21 per item, $21 * 1, 500 = $31,500

Not related to cost control [cost cntrl is based on assumption of amt of raw materials]
doing good cost cntrl on material price?
Unless thr is no diff in the actual & budgeted production [then its cost cntrl problem]

11-11
 Static Budgets vs Flexible
Budget
• Example: the budgeted quantity for apple pie in May is
planned in April at the level of 100, standard cost per
apple pie is $5, the actual apple made and sold in May is
80, at actual cost of $6. Evaluate the cost control .
• The relevant question is . . .
“How much of the favorable cost variance is due to
lower activity, and how much is due to good cost
control?” Static budget: $500
Diff btwn static & budget: $20
Actual = $6 * 80 = $480 Actual < Budgeted cost [consequence on income: actual > budget]
Budget = $5 * 100 = $500 $5 * 80 = $400 Favourable variance

Flexible budget: stnd cost per apple v actual apple made

Cost variance: $80
Unfavourable variance (actual cost of apple pie more
ex) 11-11
 Static Budget v.s. Flexible
• ABudget
static budget is a type of budget that incorporates anticipated values
about inputs and outputs that are conceived before the period in question
begins. (A static budget is prepared for only one expected level of activity.)
• When compared to the actual results that are received after the fact, the
numbers from static budgets are often quite different from the actual
results.
• Static Budget Variance: The difference between the actual results and the
static budget
• A flexible budget is a budget that adjusts to different levels of activity
• Flexible budget variance: The difference between the actual results and
the flexible budget
• Example: the budgeted quantity for apple pie in May is planned in April at the
level of 100, standard cost per apple pie is $5, the actual apple pies made and
sold in May are 80, at actual cost of $6 per apple pie. Evaluate the cost control
.
Actual < Budgeted = Favourable
• Actual costs: $6 * 80 = $480
• Static Budgeted costs = $5 * 100 = $ 500
• Flexible budgeted costs = $5 * 80 = $400
• Static budget variance =?

• What caused the variance?

Not doing a good cost cntrl

From now
on…..
• we must adjust the budget to the actual level of activity.
• Use Flexible budget based on actual level !!
 Inputs v.s. Outputs
• Inputs Outputs
Flour/Milk Cake
Apples Apple Pie $320/400 = $0.8 [actual per apple cost]
buying cheaper materials for production [doing good job]

Example:
• Standards quantity of making 1 apple pie is 3 apples, the
standard cost per apple is $1. 100 apple pies are
produced and sold, 400 apples is actually used, the actual
total cost is
$320
• Question: what is the standard cost per apple pie? What is
the flexible budget? Why actual cost is different from flexible
budget?
flexible budget: 100*3=300*$1=$300
Cost Variance
Analysis
Standard Cost
Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price. the standard quantity.

10-17
 Cost Variance
Analysis
Standard Cost
Variances

Price Variance Quantity Variance

INPUT!!! The difference between The difference between INPUT!!!

the actual price and the the actual quantity and
standard price. the standard quantity.

10-18
A General Model for Variance
Analysis
Total cost variance = Total actual cost - Total stnd cost = Actual cost - Stnd cost = (AP * AQ) - (SP * SQ)
= (AP * AQ) - (SP * AQ) + (SP *AQ) - (SP * SQ)

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

AQ(AP
Materials price-variance
SP) SP(AQ
Materials - SQ)
quantity variance

AQ =Variable
Actualoverhead SP Variable
= Standard Price
overhead
Quantity APvariance
spending = SQ efficiency
= Standard Quantity
variance
Actual Price
10-19
A General Model for Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
INPUT!!!

Price Variance Quantity Variance

Standard price is the amount that should

have been paid for the resources acquired.

10-20
A General Model for Variance
Analysis INPUT!!!
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard quantity is the quantity that should

have been used.

10-21
 Exampl
 Dcdesserts.com, produces fresh cakes and frozen desserts
e
 Direct-Material Standards:
Standard quantity per multilayer fancy cake 5 pounds
Standard price per pound $1.40

 Direct-Labor Standards:
Standard quantity: Direct labor required per multilayer fancy 0.5 hour
cake Standard rate: total hourly compensation (wage + fringe $20
benefits)
 Forecasted Output: 2,200 cakes ; Actual Output: 2,000
cakes
 Actual costs: Static
AQ AP

Direct material used: 10,250 pounds @ $1.42 per pound $14,555

Direct labor: 980 hours @ $21 per hour $20,580
AH AP
 Analysis of cost
 variances
Question 1: What is the standard direct-material cost per cake?

 Question 2: What is standard direct –labor cost per cake? 17024351

2021-05-17 10:18:49
--------------------------------------------
qn1: $1.4 * 5 = $7
qn2: $20 * 0.5 = $10

 Question 3: What is the total standard direct-material cost? qn3: $7 * 2,000 = $14,000
qn4: $10 * 2,000 = $20,000
qn5: $14,555 - $14,000 = $555 (U)
qn6: $20,580 - $20,000 = $580 (U)
qn7:
 Question 4: What is the total standard direct-labor cost?

 Question 5: What is the direct-material variance?

 Question 6: What is the direct-labor variance?

 Question 7: Why were we off?

Isolation of Material
Variances
I need the variances as soon
as possible so that I can
better identify problems Okay. I’ll start computing
and control costs. the price variance when
You accountants just don’t material is purchased and
understand the problems the quantity variance as
we production managers have. soon as material is used.

10-23
 Direct-Material

Variances
Direct Material Quantity Variance:
The difference in spending on direct material that is explained by a difference in the
quantity of material used in production of actual output, and the amount of
material expected to use for the actual output (standard quantity allowed)

Direct-material quantity variance = (AQ * SP) – (SQ* SP) = SP (AQ – SQ)

where
SQ = Standard quantity allowed SQ = 2,000 * 5

 Question 8: What is the direct –material quantity variance?

$1.4 * (10,250 - 2,000 * 5) = $350 (U)
 Direct-Material

Variances
Direct Material (input) Price Variance:
The deviation between the actual and projected material costs caused by

a difference in the price of material.

Direct-material price variance = (AQ * AP) – (AQ* SP) = AQ (AP – SP)

where
AQ = Actual quantity used
AP = Actual price
SP = Standard price

 Question 9: What is the direct –

material price variance?
$10,250 * (1.42 - 1.40) = 205 (U)
Direct-Material Price and Quantity
Variances
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
10,250 pounds 10,250 pounds 10,000 pounds
× × ×
$1.42 per pound $1.40 per pound $1.40 per pound
$14,555 $ 14,350 $14,000

Total = $14,555 - $14,000 = $555 (U)

OR
Price variance Quantity variance $205 + $350 = $555 (U)
$205 Unfavorable $350 Unfavorable

10-27
Standard
Costs

Now let’s calculate

standard cost
variances for
direct labor.

10-28
 Direct-Labor

Variances
Direct Labor Efficiency Variance:
Measure the difference in spending that is caused by the change of amount of direct
labor used.
The deviation between the projected direct-labor cost and standard labor cost

Direct-labor efficiency variance = (AH * SR) – (SH* SR) = SR (AH – SH)

where
SH = Standard hours allowed SH = 2,000 * 0.5

 Question 10: What is the direct –labor efficiency variance?

$20 * (980 - 2,000*0.5) = 400 (F)
 Direct-Labor

Variances
Direct Labor Rate Variance:
Measure the difference in spending that is caused by the change of direct labor rate.
The deviation between the actual labor cost and projected direct-labor cost.

Direct-labor rate variance = (AH * AR) – (AH* SR) = AH (AR – SR)

where
AH = Actual hours used
AR = Actual rate per hour
SR = Standard rate per
hour

 Question 11: What is the direct

–labor rate variance?
980 * (21 - 20) = 980 (U)
Labor Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
980 hours 980 hours 1,000 hours
× × ×
$21 per hour $20 per hour $20 per hour
$20,580 $19,600 $20,000
Total = $20,580 - $20,000 = $580 ( U)
OR

Rate variance Efficiency variance $980 - $400 = $580 (U)

$980 unfavorable $400 favorable

10-31
Significance of Cost
Variances Eg of recurring variances
1. Size of variance
1. Dollar amount 17024351
2021-05-17 10:34:03
--------------------------------------------
2. Percentage of standard
price variance: $20,000 total
stnd cost: $100,000 labour

1. Recurring variances variance: $50,000 total stnd

cost: $2,500,000

2. Trends
4. Controllability Eg of trends

5. Favorable variances
What clues help me 6. Costs and benefits of
to determine the investigation
variances that I should
investigate?
10-32
 Statistical Control
Chart
Eg of Controllability

Warning signals for investigation

Favorable Limit
• •
Desired
• •
• •
•
Va lue
Unfavorable Limit •
•
1 2 3 4 5 6 7 8 9
Variance Measurements

10-33
Behavioral Impact of Standard
Costing
If I buy cheaper materials, my direct-
materials expenses will be lower than what is
budgeted. Then I’ll get my bonus.
But we may lose customers because of
lower quality.

10-34
 Controllability of
Variances
Direct-Material Direct-Material
Price Quantity Variance
Variance
Who
is
resp
onsi
ble? Direct-Labor Direct-Labor
Rate Variance Efficiency Variance
10-35
Interaction among Variances

I am not responsible for

the unfavorable labor You used too much time
efficiency variance! because of poorly
trained workers and
You purchased cheap poor supervision.
material, so it took more
time to process it.

10-36
Interaction among Variances
• Purchase of off-standard material
 Direct-material price variance (F) $(8,500)
Direct-material quantity variance (U) 1,000
Direct-labor rate variance (U) 2,000
Direct-labor efficiency variance (U) 1,500
$(4,000)
$4,000 favourable

overall to the firm: beneficial [only looking at economic amt for this period]

implications for long-term: other factors to consider as well

Standard Costs and Product
Costing
Standard material and labor costs
are entered into Work-in-Process
inventory instead of actual
costs.

Standard cost variances

are closed directly to
Cost of Goods Sold.
10-38
 Use of Standard
Costs for Product
Costing
Raw-material Inventory Accounts Payable

Actual quantity at Actual quantity at

standard cost actual cost

The company purchased 10,250 pounds of direct

material for $14,555 (actual unit price $1.42 per
pounds), standard price per pound is $1.40
17024351
2021-05-17 10:55:19
Direct-Material Price Variance --------------------------------------------
RM inventory:
Unfavorable Favorable 1.4 * 10,250 = $14,350
DM price variance:
variance variance (1.42 - 1.4) * 10,250 = $205
AP:
To isolate the direct material price variance: 1.42 * 10,250 = $14,555

Dr: Raw-Material Inventory (SP*AQ) ?

Direct-Material Purchase Price Variance(AP-SP)*AQ ?
Cr: Accounts Payable (AP*AQ) ?

10-39
 Use of Standard
Costs for Product
Costing
Raw-material Inventory Work-in-Process Inventory

Actual quantity at Standard quantity

standard cost at standard price

17024351
2021-05-17 10:59:05
--------------------------------------------
WIP inventory:
1.4 * 5 * 2,000 = $14,000
DM quantity variance:
$350
RM inventory:
Direct-Material Quantity Variance 1.4 * 10,250 = $14,350

Unfavorable Favorable
variance variance To isolate the direct material quantity variance:
10,250 pounds were actually used, SQ=10,000 pounds)

Dr: Work-in-Process Inventory (SP*SQ) ?

Direct-Material Quantity Variance (AQ-
SQ)*SP ? ?
Cr: Raw-Material Inventory (SP*AQ)
10-40
 Use of Standard
Costs for Product Wages Payable
Costing
Work-in-Process Inventory

Standard quantity Actual quantity at

at standard price actual cost

Direct-Labor Efficiency Variance

Direct-Labor Rate Variance 17024351
2021-05-17 11:01:34
Unfavorable Favorable --------------------------------------------
Unfavorable Favorable variance variance WIP inventory: 20,000
variance variance DL rate variance: 980
DL efficiency variance: 400 Wages
& benefits payable: 20,580

To record the usage of direct labor and the direct labor variances:

Dr: WIP l Inventory (SR*SH) ?

Direct-Labor Rate Variance (AR-SR)*AH ?
Cr: Direct Labor Efficiency Variance SR(AH-SH) ?
Wages and benefits payable(AR*AH) 10-40 ?
Cost flow under standard costing
• If all 2,000 cakes were sold: 17024351
2021-05-17 11:06:13
--------------------------------------------

• Dr: Finished Goods Inventory FG Inventory:

?
14,000 + 20,000 = $34,000
(7+10) * 2,000 = 14,000

Cr: WIP inventory

Dr: COGS ?
Cr: Finished Goods Inventory

?
Use of Standard
Costs for Product
Costing
Cost of Goods Sold

Unfavorable Favorable
variance variance
To
c
lDr: COGS ?
o Direct-Labor Efficiency Variance ?
s
Cr: Direct Labor Rate ?
e
Variance ?
v Directmaterial
Direct materialprice
quantity variance ?
a variance
r
i
a
n
10-42
c
Close variances to
COGS
Advantages of Standard
Costing
Sensible Cost Management by
Exception
Comparisons

Performance Employee
Evaluation
Advantages Motivation

Stable Product
Costs

10-45
Criticisms of Standard
Costing
Too aggregate, Not specific
too late

Too much focus Disadvantages Stable production

on direct-labor required

Shorter life
cycles

Focus on cost
minimization
10-46