25-1

CHAPTER25
Standard Costs
and Balanced
Scorecard

25-2
 PreviewofCHAPTER25

25-3
 The Need for Standards

Distinguishing between Standards and Budgets

Both standards and budgets are predetermined costs,
and both contribute to management planning and
control.

There is a difference:

A standard is a unit amount.

A budget is a total amount.

25-4 SO 1 Distinguish between a standard and a budget.

 The Need for Standards
Illustration 25-1
Why Standard Costs? Advantages of standard costs

Facilitate management Promote greater economy Useful in setting selling

planning by making employees prices
more “cost-conscious”

Contribute to management Useful in highlighting Simplify costing of

control by providing basis variances in management inventories and reduce
for evaluation of cost by exception clerical costs
control

25-5 SO 2 Identify the advantages of standard costs.

 Setting Standard Costs—a Difficult Task

Setting standard costs requires input from all persons

who have responsibility for costs and quantities.

Standards should change whenever managers

determine that the existing standard is not a good
measure of performance.

25-6 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Ideal versus Normal Standards

Companies set standards at one of two levels:
 Ideal standards represent optimum levels of performance
under perfect operating conditions.
 Normal standards represent efficient levels of
performance that are attainable under expected operating
conditions.

Properly set, normal standards should be rigorous but

attainable.

25-7 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Question
Most companies that use standards set them at a(n):

a. optimum level.

b. ideal level.

c. normal level.

d. practical level.

25-8 SO 3 Describe how companies set standards.

25-9
 Setting Standard Costs—a Difficult Task

A Case Study
To establish the standard cost of producing a product, it is
necessary to establish standards for each manufacturing cost
element—
 direct materials,
 direct labor, and
 manufacturing overhead.

The standard for each element is derived from the standard

price to be paid and the standard quantity to be used.

25-10 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Direct Materials
Direct materials price standard is the cost per unit of direct
materials that should be incurred.
Illustration 25-2
Setting direct materials
price standard

25-11 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Direct Materials
Direct materials quantity standard is the quantity of direct
materials that should be used per unit of finished goods.
Illustration 25-3
Setting direct materials quantity standard

The standard direct materials cost is $12.00 ($3.00 x 4.0 pounds).

25-12 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Question
The direct materials price standard should include an
amount for all of the following except:

a. receiving costs.

b. storing costs.

c. handling costs.

d. normal spoilage costs.

25-13 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Direct Labor
Direct labor price standard is the rate per hour that should be
incurred for direct labor.
Illustration 25-4
Setting direct labor
price standard

25-14 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Direct Labor
Direct labor quantity standard is the time that should be
required to make one unit of the product.
Illustration 25-5
Setting direct labor
quantity standard

The standard direct labor cost is $20 ($10.00 x 2.0 hours).

25-15 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Manufacturing Overhead
For manufacturing overhead, companies use a standard
predetermined overhead rate in setting the standard.

This overhead rate is determined by dividing budgeted overhead

costs by an expected standard activity index, such as standard
direct labor hours or standard machine hours.

25-16 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Manufacturing Overhead
The company expects to produce 13,200 gallons during the year
at normal capacity. It takes 2 direct labor hours for each gallon.
Illustration 25-6
Computing predetermined overhead rates

Standard manufacturing overhead rate per gallon is $10 ($5 x 2 hours).

25-17 SO 3 Describe how companies set standards.

 Setting Standard Costs—a Difficult Task

Total Standard Cost Per Unit

The total standard cost per unit is the sum of the standard costs of
direct materials, direct labor, and manufacturing overhead.
Illustration 25-7
Standard cost per
gallon of Weed-O

The total standard cost per gallon is $42.

25-18 SO 3 Describe how companies set standards.

25-19
 Setting Standard Costs—a Difficult Task

Ridette Inc. accumulated the following standard cost

data concerning product Cty31.
► Materials per unit: 1.5 pounds at $4 per pound.
► Labor per unit: 0.25 hours at $13 per hour.
► Manufacturing overhead: Predetermined rate is 120% of direct labor
cost.
Compute the standard cost of one unit of product Cty31.

25-20
SO 3
 Analyzing and Reporting Variances From
Standards

One of the major management uses of standard costs is to

identify variances from standards.

Variances are the differences between total actual costs

and total standard costs.

25-21 SO 3 Describe how companies set standards.

 Analyzing and Reporting Variances

Question
A variance is favorable if actual costs are:

a. less than budgeted costs.

b. less than standard costs.

c. greater than budgeted costs.

d. greater than standard costs.

25-22 SO 3 Describe how companies set standards.

 Analyzing and Reporting Variances

When actual costs exceed standard costs, the variance is

unfavorable.

When actual costs are less than standard costs, the variance
is favorable.

To interpret properly the significance of a variance, you must

analyze it to determine the underlying factors. Analyzing
variances begins by determining the cost elements that
comprise the variance.

25-23 SO 3 Describe how companies set standards.

 Analyzing and Reporting Variances

Illustration: Assume that in producing 1,000 gallons of Weed-O

in the month of June, Xonic, Inc. incurred the following costs.

Illustration 25-8
Actual production
costs

Illustration 25-9
Computation of total
variance

Total standard cost of

Weed-O is $42,000
(1,000 gallons x $42).

25-24
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Materials Variances

In completing the order for 1,000 gallons of Weed-O, Xonic used
4,200 pounds of direct materials. These were purchased at a cost
of $3.10 per unit. Standard price is $3.

Actual Quantity x Standard Quantity x Total Materials

Actual Price (AQ) - Standard Price = Variance
x (AP) (SQ) x (SP) (TMV)

$13,020 - $12,000 = $1,020 U

(4,200 x $3.10) (4,000 x $3.00)

Illustration 25-10
Formula for total materials
variance SO 4 State the formulas for determining direct
25-25
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Materials Variances

Next, the company analyzes the total variance to determine the
amount attributable to price (costs) and to quantity (use). The
materials price variance is computed as follows.

Actual Quantity x Actual Quantity x Materials Price

Actual Price (AQ) - Standard Price = Variance
x (AP) (AQ) x (SP) (MPV)

$13,020 - $12,600 = $420 U

(4,200 x $3.10) (4,200 X $3.00)

Illustration 25-11
Formula for materials price
variance SO 4 State the formulas for determining direct
25-26
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Materials Variances

The materials quantity variance is determined from the following
formula.

Actual Quantity x Standard Quantity x Materials

Standard Price - Standard Price = Quantity
(AQ) x (SP) (SQ) x (SP) Variance (MQV)

$12,600 - $12,000 = $600 U

(4,200 X $3.00) (4,000 x $3.00)

Companies sometimes use a matrix to analyze a variance.

Illustration 25-12
Formula for materials
quantity variance SO 4 State the formulas for determining direct
25-27
materials and direct labor variances.
 Matrix for Direct Materials Variances
1 2 3

Actual Quantity Actual Quantity Standard Quantity

× Actual Price × Standard Price × Standard Price
(AQ) × (AP) (AQ) × (SP) (SQ) × (SP)
4,200 x $3.10 = $13,020 4,200 x $3.00 = $12,600 4,000 x $3.00 = $12,000

Price Variance Quantity Variance

1 - 2 2 - 3

$13,020 – $12,600 = $420 U $12,600 – $12,000 = $600 U

Total Variance
1 - 3

Illustration 25-14 $13,020 – $12,000 = $1,020 U

25-28 SO 4
 Analyzing and Reporting Variances

Causes of Material Variances

Materials price variance – factors that affect the price paid for raw materials
include the availability of quantity and cash discounts, the quality of the
materials requested, and the delivery method used. To the extent that these
factors are considered in setting the price standard, the purchasing
department is responsible.

Materials quantity variance – if the variance is due to inexperienced workers,

faulty machinery, or carelessness, the production department is responsible.

25-29
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

The standard cost of Product XX includes two

units of direct materials at $8.00 per unit.
During July, the company buys 22,000 units of direct materials at
$7.50 and uses those materials to produce 10,000 units. Compute
the total, price, and quantity variances for materials.

25-30
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Labor Variances

In completing the Weed-O order, Xonic, Inc. incurred 2,100
direct labor hours at an average hourly rate of $9.80. The
standard hours allowed for the units produced were 2,000
hours (1,000 gallons x 2 hours). The standard labor rate was
$10 per hour. The total labor variance is computed as follows.

(2,100 x $9.80) - (2,000 x $10.00) = $580 U

Illustration 25-15
Formula for total labor
25-31 variance
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Labor Variances

Next, the company analyzes the total variance to determine the
amount attributable to price (costs) and to quantity (use). The
labor price variance is computed from the following formula.

(2,100 x $9.80) - (2,100 x $10.00) = $420 F

Illustration 25-16
Formula for labor price
variance

25-32
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

Direct Labor Variances

The labor quantity variance is determined from the following
formula.

(2,100 x $10.00) - (2,000 x $10.00) = $1,000 U

Illustration 25-17
Formula for labor quantity
variance

25-33
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Matrix for Direct Labor Variances
1 2 3

Actual Hours Actual Hours Standard Hours

× Actual Rate × Standard Rate × Standard Rate
(AH) × (AR) (AH) × (SR) (SH) × (SR)
2,100 x $9.80 = $20,580 2,100 x $10.00 = $21,000 2,000 x $10.00 = $20,000

Price Variance Quantity Variance

1 - 2 2 - 3

$20,580 – $21,000 = $420 F $21,000 – $20,000 = $1,000 U

Total Variance
1 - 3

Illustration 25-19 $20,580 – $20,000 = $580 U

25-34 SO 4
 Analyzing and Reporting Variances

Causes of Labor Variances

Labor price variance – usually results from two factors: (1) paying
workers different wages than expected, and (2) misallocation of workers.
The manager who authorized the wage increase is responsible for the
higher wages. The production department generally is responsible for
labor price variances resulting from misallocation of the workforce.

Labor quantity variances - relates to the efficiency of workers. The

cause of a quantity variance generally can be traced to the production
department.

25-35
SO 4 State the formulas for determining direct
materials and direct labor variances.
 Analyzing and Reporting Variances

Manufacturing Overhead Variances

Manufacturing overhead variances involve total overhead
variance, overhead controllable variance, and overhead
volume variance.

Manufacturing overhead costs are applied to work in

process on the basis of the standard hours allowed for the
work done.

25-36
SO 5 State the formula for determining the total
manufacturing overhead variance.
 Analyzing and Reporting Variances

Manufacturing Overhead Variances

Total overhead variance is the difference between actual
overhead costs and overhead costs applied to work done. The
computation of the actual overhead is comprised of a variable
and a fixed component.
Illustration 25-20

The predetermined rate for Weed-O is $5, comprised of a variable

overhead rate of $3 and a fixed rate of $2.
25-37
SO 5 State the formula for determining the total
manufacturing overhead variance.
 Analyzing and Reporting Variances

Manufacturing Overhead Variances

The formula for the total overhead variance and the calculation
for Xonic, Inc. for the month of June.

Illustration 25-21
Formula for total overhead
variance

25-38
SO 5 State the formula for determining the total
manufacturing overhead variance.
 Analyzing and Reporting Variances

Manufacturing Overhead Variances

Overhead variance is generally analyzed through a price
variance and a quantity variance.

Overhead controllable variance (price variance) shows whether

overhead costs are effectively controlled.

Overhead volume variance (quantity variance) relates to

whether fixed costs were under- or over-applied during the year.

25-39
SO 5 State the formula for determining the total
manufacturing overhead variance.
 Analyzing and Reporting Variances

Causes of Manufacturing Overhead Variances

 One reason for an overhead variance relates to over-
or underspending on overhead items.

 The overhead variance can also result from the

inefficient use of overhead.

25-40
SO 5 State the formula for determining the total
manufacturing overhead variance.
 Analyzing and Reporting Variances
The standard cost of Product YY includes 3 hours of
direct labor at $12.00 per hour. The
predetermined overhead rate is $20.00 per direct labor hour. During
July, the company incurred 3,500 hours of direct labor at an average
rate of $12.40 per hour and $71,300 of manufacturing overhead
costs. It produced 1,200 units. (a) Compute the total, price, and
quantity variances for labor. (b) Compute the total overhead variance.

25-41
SO 5
 Analyzing and Reporting Variances

Reporting Variances
 All variances should be reported to appropriate levels of
management as soon as possible.

 The form, content, and frequency of variance reports vary

considerably among companies.

 Facilitate the principle of “management by exception.”

 Top management normally looks for significant variances.

25-42 SO 6 Discuss the reporting of variances.

 Analyzing and Reporting Variances

Reporting Variances
Materials price variance report for Xonic, Inc., with the
materials for the Weed-O order listed first. Illustration 25-22
Materials price variance report

25-43 SO 6 Discuss the reporting of variances.

 Analyzing and Reporting Variances
Illustration 25-23
Statement Variances in income statement
for management
Presentation
of Variances
In income statements
prepared for
management under a
standard cost
accounting system,
cost of goods sold is
stated at standard
cost and the
variances are
disclosed separately.

25-44
SO 7 Prepare an income statement for management
under a standard costing system.
 Analyzing and Reporting Variances

Question
Which of the following is incorrect about variance reports?

a. They facilitate “management by exception”.

b. They should only be sent to the top level of

management.

c. They should be prepared as soon as possible.

d. They may vary in form, content, and frequency among

companies.

25-45
SO 7 Prepare an income statement for management
under a standard costing system.
 Balanced Scorecard

Balanced scorecard incorporates financial and nonfinancial

measures in an integrated system that links performance
measurement and a company’s strategic goals. Illustration 25-25
Objectives within the four
perspectives of balanced scorecard

25-46 SO 8 Describe the balanced scorecard approach to performance evaluation.

 Balanced Scorecard

Question
Which of the following would not be an objective used in
the customer perspective of the balanced scorecard
approach?

a. Percentage of customers who would recommend a

product to a friend.

b. Customer retention.

c. Brand recognition.

d. Earning per share.

25-47 SO 8 Describe the balanced scorecard approach to performance evaluation.

 Balanced Scorecard

In summary, the balanced scorecard does the following:

1. Employs both financial and nonfinancial measures.

2. Creates linkages so that high-level corporate goals can be

communicated all the way down to the shop floor.

3. Provides measurable objectives for such nonfinancial

measures as product quality, rather than vague statements
such as “We would like to improve quality.”

4. Integrates all of the company’s goals into a single performance

measurement system, so that an inappropriate amount of
weight will not be placed on any single goal.

25-48 SO 8 Describe the balanced scorecard approach to performance evaluation.

 Balanced Scorecard
Indicate which of the four perspectives in the
balanced scorecard is most likely associated with
with the objectives that follow.

1. Percentage of repeat customers.

Financial perspective
2. Number of suggestions for
improvement from employees.
Customer perspective
3. Contribution margin.

4. Market share. Internal process

5. Number of cross-trained perspective
employees.
Learning and growth
6. Amount of setup time. perspective

25-49 SO 8 Describe the balanced scorecard approach to performance evaluation.

25-50
 APPENDIX25A Standard Cost
Accounting System

A standard cost accounting system is a double-entry system

of accounting. Companies may use a standard cost system with
either
 job order or
 process costing.

The system is based on two important assumptions:

1. Variances from standards are recognized at the earliest
opportunity.
2. The Work in Process account is maintained exclusively on
the basis of standard costs.

25-51 SO 9 Identify the features of a standard cost accounting system.

 Standard Cost Accounting System

Illustration: 1. Purchase raw materials on account for

$13,020 when the standard cost is $12,600.
Raw materials inventory 12,600
Materials price variance 420
Accounts payable 13,020

2. Incur direct labor costs of $20,580 when the standard labor

cost is $21,000.
Factory labor 21,000
Labor price variance 420
Factory Wages payable 20,580

25-52 SO 9 Identify the features of a standard cost accounting system.

 Standard Cost Accounting System

3. Incur actual manufacturing overhead costs of $10,900.

Manufacturing overhead 10,900
Accounts payable/Cash/Accum. Depreciation10,900

4. Issue raw materials for production at a cost of $12,600 when

the standard cost is $12,000.
Work in process inventory 12,000
Materials quantity variance 600
Raw materials inventory 12,600

25-53 SO 9 Identify the features of a standard cost accounting system.

 Standard Cost Accounting System

5. Assign factory labor to production at a cost of $21,000 when

standard cost is $20,000.
Work in process inventory 20,000
Labor quantity variance 1,000
Factory labor 21,000

6. Applying manufacturing overhead to production $10,000.

Work in process inventory 10,000

Manufacturing overhead 10,000

25-54 SO 9 Identify the features of a standard cost accounting system.

 Standard Cost Accounting System

7. Transfer completed work to finished goods $42,000.

Finished goods inventory 42,000

Work in process inventory 42,000

8. The 1,000 gallons of Weed-O are sold for $60,000.

Accounts receivable 60,000

Cost of goods sold 42,000
Sales 60,000
Finished goods inventory 42,000

25-55 SO 9 Identify the features of a standard cost accounting system.

 Standard Cost Accounting System

9. Recognize unfavorable total overhead variance:

Overhead variance 900

Manufacturing overhead 900

25-56 SO 9 Identify the features of a standard cost accounting system.

 Appendi
Ledger x 25A
Accounts

Illustration 25A-1
Cost accounts with
variances

Standard Cost
Accounting System

25-57
SO 9
 APPENDIX25B A Closer Look at
Overhead Variances
Total Overhead Variance

Overhead variance is generally analyzed through a price

variance and a quantity variance.

Overhead controllable variance (price variance) shows

whether overhead costs are effectively controlled.

Overhead volume variance (quantity variance) relates to

whether fixed costs were under- or over-applied during the
year.

25-58 SO 10 Compute overhead controllable and volume variance.

 A Closer Look at Overhead Variances

Overhead Controllable Variance

The overhead controllable variance shows whether overhead
costs are effectively controlled. To compute this variance, the
company compares actual overhead costs incurred with
budgeted costs for the standard hours allowed. The budgeted
costs are determined from a flexible manufacturing overhead
budget.

25-59 SO 10 Compute overhead controllable and volume variance.

 A Closer Look at Overhead Variances

Overhead Controllable Variance

For Xonic the budget formula for manufacturing overhead is
variable manufacturing overhead cost of $3 per hour of labor plus
fixed manufacturing overhead costs of $4,400.
Illustration 25B-1

25-60 SO 10
 A Closer Look at Overhead Variances

Overhead Controllable Variance

Illustration 25B-2 shows the formula for the overhead controllable
variance and the calculation for Xonic, Inc.
Illustration 25B-2

25-61 SO 10 Compute overhead controllable and volume variance.

 A Closer Look at Overhead Variances

Overhead Volume Variance

Difference between normal capacity hours and standard hours
allowed times the fixed overhead rate.
Illustration 25B-3

25-62 SO 10 Compute overhead controllable and volume variance.

 A Closer Look at Overhead Variances

Illustration: Xonic Inc. budgeted fixed overhead cost for the year of
$52,800. At normal capacity, 26,400 standard direct labor hours are
required. Xonic produced 1,000 units of Weed-O in June. The
standard hours allowed for the 1,000 gallons produced in June is
2,000 (1,000 gallons x 2 hours). For Xonic, standard direct labor
hours for June at normal capacity is 2,200 (26,400 annual hours / 12
months). The computation of the overhead volume variance in this
case is as follows.
Illustration 25B-4

25-63 SO 10 Compute overhead controllable and volume variance.

 A Closer Look at Overhead Variances

In computing the overhead variances, it is important to

remember the following.

1. Standard hours allowed are used in each of the variances.

2. Budgeted costs for the controllable variance are derived

from the flexible budget.

3. The controllable variance generally pertains to variable

costs.

4. The volume variance pertains solely to fixed costs.

25-64 SO 10 Compute overhead controllable and volume variance.

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25-65