STANDARD COST

Standard cost is the amount the firm thinks a product or the operation of the
process for a period of time should cost, based upon certain assumed conditions of
efficiency, economic conditions and other factors. (Backer and Jacobsen)
Setting Standards
Normally, setting up standards is based on the past experience. The total standard
cost includes direct materials, direct labor and overheads. Normally, all these are
fixed to some extent. The standards should be set up in a systematic way so that
they
are
used
as
a
tool
for
cost
control.
Various Elements which Influence the Setting of Standards
Setting Standards for Direct Materials -There are several basic principles which
ought to be appreciated in setting standards for direct materials. Generally, when
you want to purchase some material what are the factors you consider. If material is
used for a product, it is known as direct material. On the other hand, if the material
cost cannot be assigned to the manufacturing of the product, it will be called
indirect material. Therefore, it involves two things:
Quality of material
Price of the material
When you want to purchase material, the quality and size should be determined.
The standard quality to be maintained should be decided. The quantity is
determined by the production department. This department makes use of historical
records, and an allowance for changing conditions will also be given for setting
standards. A number of test runs may be undertaken on different days and under
different situations, and an average of these results should be used for setting
material
quantity
standards.
The second step in determining direct material cost will be a decision about the
standard price. Materials cost will be decided in consultation with the purchase
department. The cost of purchasing and store keeping of materials should also be
taken into consideration. The procedure for purchase of materials, minimum and
maximum levels for various materials, discount policy and means of transport are
the other factors which have bearing on the materials cost price. It includes the
following:
Cost of materials
Ordering cost
Carrying cost
The purpose should be to increase efficiency in procuring and store keeping of
materials. The type of standard used-- ideal standard or expected standard-- also
affects
the
choice
of
standard
price.
Objective relationship between specified inputs and expected outputs. Therefore,
standard costs are generally related to carefully analyzed phenomena both in the
laboratory and in the workplace. For example, in the factory of a company that
produces high-quality cotton shirts for men, standard costs are used for materials

and labor. To establish the standard usage of fabric for a single shirt, the cutting
possibilities are analyzed in the laboratory, where attention can be given to how
much fabric must be used if the shirt is cut as specified. At this point, the focus is
not on how many minutes are needed by an experienced cutter to meticulously cut
the fabric so as to minimize usage. Rather, there is experimentation in the ways of
cutting and the time required for each way considered. Experimentation continues
until the most economical combination of fabric usage and cutting time is
established. That combination is likely to be modified to take account of less than
perfect
conditions
in
the
workplace.
The goal of the personnel responsible for setting standard costs is to provide
realistic standards. Workers are to be motivated to achieve output with specified
standards. If standards are unreasonableeither too tight or too loosethe level of
discipline expected is seriously undermined. If standards cannot be achieved with
reasonable effort, workers may become discouraged and become so indifferent that
their work quality deteriorates significantly. If standards are too easy to achieve,
there
may
be
an
unnecessary
waste
of
resources.
Standard costing has applications to any type of business activity. The process
described briefly above can be applied, for example, for processing documents in an
insurance company or in a financial services business.

Variances
It is the differences between standard prices and actual prices and between
standard quantities and actual quantities.
Variance Analysis- the act of computing and interpreting variances.
Actual Quantity of
Inputs, at Actual Price
( AQ AP

Actual Quantity of
Inputs at Standard
Price

Price Variance (1)(2)

Materials price
variance Labor rate
variance
Variable Overhead
spending variance

( AQ SP)

Standard Quantity
Allowed for Output, at
Standard Price

(SQ SP)
Quantity Variance
(2)-(3)
Materials quantity
variance
Labor Efficiency
variance
Variable Overhead

Total Variance
DIRECT MATERIALS VARIANCES
Colonial Pewters purchasing records for June showed that 6,500 pounds of pewter
were purchased at a cost of $3.80 per pound. This cost included freight and
handling and was net of the quantity discount. All of the material purchased was
used during June to manufacture 2,000 pairs of pewter bookends.
Actual Quantity of
Inputs at Actual Price
( AQ AP

6,500 pounds

per pound

= $ 24,700

$3.80

Price Variance = $
1,300 F

Total Variance = $ 700 U

* 2000 units

= $ 26,000
3.0 pounds

6,000 pounds*

per unit = 6,000 pounds

F- Favorable U- Unfavorable

( AQ SP)

Quantity Variance = $
per pound
2,000 U
=$ 24,000

Actual Quantity of
Inputs at Standard
Price

6,500 pounds

(SQ SP)
$4.00

Standard Quantity
Allowed for Output, at
Standard Price

$4.00

per pound

A price / quantity variance is labeled unfavorable (U) if the actual price/quantity

exceeds the standard price/quantity and is labeled favorable (F) if the actual
quantity in less than the standard quantity.
Assume that during June the company purchased 6,500 pounds of materials, as
before but that it used only 5,000 pounds of material during the month and
produced only 1,600 units. In this case, the price variance and quantity variance
would be as shown in Exhibit 8-5.
Actual Quantity

Actual Quantity

of Inputs,
at Actual Price
(AQ x AP)
6,500 pounds x
$3.80
per pound
= $24,700

of Inputs,
at Standard Price
(AQ x SP)
6,500 pounds x
$4.00
per pound
= $26,000

Standard Quantity
Allowed for
Output,
at Standard Price
(SQ x SP)
4,800 pounds*x
$4.00
per pound
= $19,200

Price variance, $1,300 F

5,000 pounds x $4.00 per pound

= $20,000

Quantity variance, $800 U

A total variance cant be computed in this situation, since the amount of materials purchased (6,500
pounds ) differs from the amount used in production (5,000 pounds).
*1,600 units x 3.0 pounds per unit = 4,800 pounds

Materials Price Variance

A materials price variance measures the difference between what is paid for a
given quantity of materials and what should have been paid according to the
standard that has been set. This difference can be expressed by the following
AQ- Actual Quantity
formula:
APQuantity
Actual Price
SPAP- Standard
Actual Price
Price
SP- Standard Price

Materials price variance = ( AQ AP ( AQ SP)

Simplified Form:
Materials price variance =

AQ ( APSP )

=6,500 pounds ($3.80 per pound - $4.00 per pound) = $1,300 F *

*Also note that using this formula approach, a negative variance is always labeled favorable (F) and a
positive variance is always labeled as unfavorable (U).

Variance reports are often issued in a tabular format. An example of such a report
follows, along with an explanation for the materials price variance that has been
provided.

Pewter..

COLONIAL PEWTER COMPANY

Performance Report - Purchasing Department
1
2
3
4
5
Actua
Quantity
l
Standard Difference Total Price
Purchased
Price
Price
in Price
Variance
(2)-(3)
(1)x(4)
6,500 pounds $3.80
$4.00
$0.20
$1,300 F

F = Favorable,

U = unfavorable.

item
Purchased

Explanation
Bargained for
an especially
good price

Materials Quantity Variance

The materials quantity variance measures the difference between the quantity
of materials used in production and the quantity that should have been used
according to the standard that has been set. The formula for the materials quantity
AQ- Actual Quantity
variance is as follows:
SQ- Standard
Quantity
Materials quantity variance = ( AQ SP (SQ SP) SP- Standard Price
Simplified Form:
Materials quantity variance =

SP ( AQSQ )

=$4.00 per pound (6,500 pounds 6,000 pounds*) = $2,000 U

*2,000 units x 3.0 pounds per unit = 6,000 pounds.

Type of
Materials

COLONIAL PEWTER COMPANY

Performance Report - Purchasing Department
1
2
3
4
5
Total
Standard
Actual Standard Difference
Quantity
Quanti
Price
ty
Quantity
in Price
Variance
Allowed
(2)-(3)
(1)x(4)

Pewter..

$4.00

F = Favorable,

U = unfavorable.

6,500
pound
s

6,000
pounds

500
pounds

$2,000 U

Explanation
Low-quality
materials
unsuitable for
production

Direct Labor Variances

Problem: During June, the company paid its direct labor workers $74, 250, including
employment taxes and fringe for 5,400 hours of work. This was an average of $
13.75 per hour.

Labor Rate Variance a measure of the difference between the actual hourly
labor rate and the standard rate multiplied by the number of hours worked during
the period.
-Commonly permed used in the price variance for direct labor.
-Measure any deviation from direct labor workers.
Formula:
AH- Actual Hour
Labor Rate Variance = ( AH AR ( AH SR) AR- Actual Rate
SR- Standard
Rate
Simplified form:
Labor Rate Variance AH ( ARSR )
= 5,400 hours ($ 13.75 per hour - $ 14.00 per hour) = $ 1,350 F
Labor Efficiency Variance the measure between the difference of actual hours
taken to complete a task and the standard hours allowed, multiplied by the
standard hourly labor rate.
-Commonly called to the quantity variance for direct labor
-No variance is more closely watched by management agreement, since it is
widely believed that increasing the productivity of direct labor time is vital to
reducing costs.
Formula:
AH- Actual Hour
SR)
Labor Efficiency Variance = ( AH SR (SH SHStandard
Hour
SR- Standard
Simplified Form:
Rate
Labor Efficiency Variance S R ( AH SH )
= 14.00 per hour(5,400 hours 5,000 hours) = $ 5,600 U
Actual Hours of Inputs at F- Favorable U- Unfavorable
Standard Hours Allowed for
Actual hours of Inputs at
Actual Rate
Output, at Standard Rate
Labor
Rate
Variance if Labeled
Standard Rate
AH

AR

(SH SR)
(
F (Favorable)- the actual rate
less than the standard rate
( AHwas
SR)
U(Unfavorable)- the actual rate exceeds the standard rate
5,400 hours $13.75
5,000 hours* $ 14.00

5,400 hours
$14.00
per
hourEfficiency Variance if Labeled
per hour
Labor
per was
hourless than the standard
= $F74,
250
=$ 70,
000
(Favorable)the actual hour
hour
= hour
$ 75,600
U(Unfavorable)- the actual
exceeds the standard hour
Rate Variance = $ 1,
350 F
Efficiency Variance = $ 5,
600
U 250 U
Total Variance =
$ 4,
* 2000 units

unit= 5,000 hours

2.5 hours per

Manufacturing Overhead Variance

- Difference between the actual manufacturing overhead costs incurred and the
standard manufacturing overhead costs applied to production using the standard
variable and fixed manufacturing overhead rates.
Problem: The Colonial Pewters cost records showed that the total actual variable
manufacturing overhead cost for June was $ 15, 390 with a 5,400 hours of direct
labor were recorded during the month and that the company produced 2,000 pairs
of bookends.
Formula:
AH- Actual Hour
AR- Actual Rate
SR)
Variable overhead spending variance = ( AH AR ( AH
SR-Standard
Rate
(variable
Simplified form:
Manufacturing
Variable overhead spending Variance AH ( ARSR )
overhead)
= 5,400 hours ($ 2.85 per hour - $ 3.00 per hour) = $ 810 F
Labor Efficiency Variance the measure between the difference of actual hours
taken to complete a task and the standard hours allowed, multiplied by the
standard hourly labor rate.
Commonly called to the quantity variance for direct labor
No variance is more closely watched by management agreement, since it is widely
believed that increasing the productivity of direct labor time is vital to reducing
costs.
Formula:
AH- Actual Hour
SHSR)Standard Hour
Variable overhead efficiency variance= ( AH SR ( SH
SR- Standard Rate
(variable
Simplified form:
Manufacturing
Variable overhead efficiency Variance SR ( AH SH )
= $ 3.00 per hour(5,400 hours -5,000 hours) = $ 1,200 U
Actual Hours of Inputs at
Actual Rate

** Actual Manufacturing
overhead/Direct Labor Hours
F- Favorable U- Unfavorable

Actual hours of Inputs at

( AH AR
Manufacturing overheadStandard
spendingRate
Variance if Labeled
$ 5,400 F$(Favorable)2.85 per hourthe
** actual rate
( AHwas
SR)
less than the
standard
rate Allowed for
Standard
Hours
U(Unfavorable)the
actual
rate
exceeds
the
standard
rate
Output,
at
Standard Rate
= 15, 390
5,400 hours

* 2000 units

$3.00 per

(SH SR)

Manufacturing overhead Efficiency Variance if Labeled

hour
$ 3.00 per
F Spending
(Favorable)the actual
was less than the
standard
Variance
= $ hour
5,000
hours*hour
= $ 16,200
U(Unfavorable)the actual hour exceeds the standard hour
810 F
hour
Total Variance = $ 390 U
=$ 15,000
Efficiency Variance = $ 1,
2.5 hours per
200 U

unit= 5,000 hours

Jennielyn
Santos
Justine Dawn
Santos
Submitted by:
Group 7
Kim Marie
Roque
Mary Jane
Roxas
Margely
Santiago
Fairy Ann
Santos

Submitted to:
Mrs. Felicitas
Mirabuenos