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LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe how unit input standards are developed, and explain why standard costing systems
are adopted.
2. Explain the purpose of a standard cost sheet.
3. Compute and journalize the direct materials and direct labor variances, and explain how they
are used for control.
5. Compute overhead variances three different ways, and explain overhead accounting.
6. Calculate mix and yield variances for direct materials and direct labor.
CHAPTER SUMMARY
This chapter examines the functional-based standard costing systems in managing costs, improv-
ing planning and control, and facilitating decision making and product costing. It provides detailed
discussion of cost variance analyses for all product cost elements and considers their behavioral
implications. Mix and yield variance analyses are also presented when it is possible to make input
substitutions.
CHAPTER REVIEW
I. Developing Unit Input Standards Learning Objective #1
A. Decisions to Be Made
1. Price standards specify how much should be paid for the quantity of the input to
be used.
2. Quantity standards specify how much of the input should be used per unit of out-
put.
3. The unit standard cost for a particular input = Standard price × Standard quantity.
B. Establishing Standards
1. Potential sources of quantitative standards include historical experience, engineer-
ing studies, and input from operating personnel.
187
188 Chapter 9
Review textbook Exhibit 9-1, which summarizes and compares the cost assignment
approaches of actual costing, normal costing, and standard costing systems.
A. Standard costing systems can be used in both manufacturing and service organiza-
tions. For example, consider the standard costing in a hospital,
1. A relative value unit (RVU) is used to measure the relative amount of time re-
quired to perform a procedure.
2. A standard cost per RVU is computed by dividing the variable direct labor costs of
a hospital department by the number of RVUs performed by that department.
190 Chapter 9
3. A standard direct labor cost for a given procedure can be computed by multiplying
the RVUs of the procedure by the standard cost per RVU.
B. The standard cost sheet provides the standard costs and standard quantities of ma-
terials, labor, and overhead that should be applied to a single product or service, in-
cluding:
1. A standard cost per unit is the per-unit cost that should be achieved given mate-
rials, labor, and overhead standards. It can be computed as follows:
Standard cost per unit = Standard price × Standard usage
2. The quantity of each input that should be used to produce one unit of output is
shown.
a. Standard quantity of materials allowed (SQ) is computed as follows:
SQ = Unit quantity standard × Actual output
b. Standard hours allowed (SH) is computed as follows:
SH = Unit quantity standard × Actual output
Review textbook Exhibit 9-2, which provides an example of a standard cost sheet.
3. If the variances are material, they are prorated to Work in Process, Finished
Goods, and Cost of Goods Sold.
a. GAAP requires that inventories be reported at actual costs.
b. But it is hard to justify carrying costs of inefficiency as an asset.
A. The total overhead variance is the difference between the actual and the applied
overhead. The four-variance method breaks down the total overhead variance into
1. Variable overhead variances including
a. the variable overhead spending variance, and
b. the variable overhead efficiency variance.
2. Fixed overhead variances including
a. the fixed overhead spending variance, and
b. the fixed overhead volume variance.
B. Analyzing Variable Overhead Variances
1. The total variable overhead variance is the difference between the actual and the
applied variable overhead.
Can be split into a spending and efficiency variance.
2. The variable overhead spending variance (VOSV) measures the aggregate effect
of differences in the actual variable overhead rate and the standard variable over-
head rate.
VOSV = (AVOR × AH ) – (SVOR × AH)
or
VOSV = (AVOR – SVOR ) × AH
a. Variable overhead is not a homogeneous input and, thus, the standard variable
overhead rate represents a weighted average for all of the variable overhead
items.
b. A spending variance is affected by price changes and by how efficiently over-
head is used.
Waste or inefficient use of variable overhead causes an unfavorable varia-
ble overhead spending variance.
c. To the extent that the consumption of variable overhead can be traced, respon-
sibility can be assigned.
Controllability is a prerequisite for assigning responsibility.
3. The variable overhead efficiency variance (VOEV) measures the change in vari-
able overhead consumption that occurs because of efficient (or inefficient) usage of
the activity.
VOEV = (AH – SH ) × SVOR
a. The variable overhead efficiency variance is directly related to the direct labor
efficiency variance if the variable overhead cost driver is direct labor hours.
Standard Costing: A Functional-Based Control Approach 195
b. The causes of variable overhead efficiency variance are generally the same as
those for the direct labor usage variance.
3. The three-variance analysis computes the spending variance, the efficiency variance,
and the volume variance.
a. The spending variance is the sum of the variable and fixed overhead spending
variances.
b. The efficiency variance is the same as the variable overhead efficiency vari-
ance of the four-variance method.
c. The volume variance is the same as the fixed overhead volume variance of the
four-variance method.
Standard mix quantity (SM) is the quantity of each input that should have been
used given the total actual input quantity.
Thus, the materials mix variance for all input materials = (AQi – SMi) × Spi
2. The direct materials yield variance is the difference between the standard cost of
the actual yield of output units and the standard cost of the yield of output that
should have been produced. Steps to compute the yield variance are as follows:
a. Identify the total standard input units and the expected standard yield units. Use
the standard input-output relationship to compute the standard yield ratio.
Standard yield units
Standard yield ratio =
Standard input units
b. Compute the standard cost of yield per unit (SPy ).
Total input standard cost
SPy =
Standard yield units
1. The difference between actual fixed overhead and budgeted fixed overhead is the
___________________________________________________.
2. The difference between what was paid and what should have been paid for actual inputs is
called the ______________________ or the ______________________.
3. The difference between the direct materials actually used and the direct materials allowed for
actual output multiplied by the standard price is the ________________________________.
5. The ____________________________ is the price that should have been paid per unit of
input; the quantity of input allowed per unit of output is the _____________________________.
6. The difference between the actual payroll and what should have been paid for the actual hours
worked is the _______________________________________.
8. The difference between the actual labor hours worked and the standard hours allowed multiplied
by the variable overhead rate is the _____________________________________________
______________; the difference between what was spent and what should have been spent
for variable overhead at actual hours is the ____________________________
_______________________________.
9. The per-unit cost that should be achieved given materials, labor, and overhead standards is
the _____________________________________ or_______________________________.
Standard Costing: A Functional-Based Control Approach 199
10. A listing of the standard costs and standard quantities of materials, labor, and overhead that
should apply to a single product is the ________________________________.
11. The maximum allowable deviation from a standard is called the _____________________.
13. The difference between the actual cost of an input and its planned cost is the _________
_________________________.
14. The difference between standard quantities and actual quantities multiplied by the standard
price is the _____________________________.
15. The difference between the standard material cost of the standard yield and the standard
material cost of the actual yield is the _______________________.
16. The difference between the standard cost of the mix of actual material inputs and the
standard cost of the material input mix that should have been used is the
______________________.
18. A(n) ______________________________ is produced whenever the actual dollars spent are
less than the standard allowances.
19. A detailed listing of the type and quantity of materials allowed for a given level of output is
called the ________________________________.
20. The difference between what was paid for materials purchased and what should have been
paid is the _____________________________________.
21. The direct labor hours that should have been used to produce the actual output is the
_____________________________________; the quantity of materials that should have
been used to produce the actual output is the _________________________________
____________________________.
22. The difference between the actual direct labor hours used and the standard labor hours
allowed multiplied by the standard hourly wage rate is the _______________________
______________.
23. Hospital standard costing systems often use a homogeneous work unit called a ________
_________________ to measure the relative amount of time required to perform a proce-
dure.
200 Chapter 9
MULTIPLE-CHOICE QUIZ
Complete each of the following statements by circling the letter of the best answer.
1. If more direct materials were used for production than were allowed for the output, then the:
a. direct labor efficiency variance will be unfavorable.
b. direct labor rate variance will be favorable.
c. direct materials price variance will be favorable.
d. direct materials usage variance will be unfavorable.
e. overhead budget variance will be unfavorable.
3. Which of the following variances would be least likely if the materials used were of much poorer
quality than the standard?
a. unfavorable direct materials price variance
b. unfavorable direct materials efficiency variance
c. unfavorable direct labor efficiency variance
d. unfavorable variable overhead efficiency variance
e. All of the above would be equally likely to occur.
4. If the direct labor force is poorly trained, which of the following variances is most likely to occur?
a. unfavorable direct labor efficiency variance
b. unfavorable direct labor rate variance
c. favorable direct materials efficiency variance
d. favorable fixed overhead spending variance
e. unfavorable variable overhead spending variance
5. Which of the following circumstances is least likely to cause a direct materials usage variance?
a. inexperienced workers
b. lack of regular maintenance of automated production machinery
c. materials of poorer than expected quality
d. price increases by suppliers
e. unanticipated changes in the design of the product
6. Which of the following would accompany an unfavorable direct labor efficiency variance?
a. favorable direct materials usage variance
b. unfavorable direct materials price variance
c. unfavorable direct labor rate variance
d. unfavorable variable overhead efficiency variance
e. unfavorable fixed overhead spending variance
Standard Costing: A Functional-Based Control Approach 201
9. The direct materials standard for XYZ Company is 10 pounds of input at $4.00 per pound. XYZ
purchased 25,000 pounds of material for $97,600. The company used 22,000 pounds of mate-
rial to produce 2,250 units of output. The direct materials price variance is:
a. $2,000 unfavorable.
b. $2,400 favorable.
c. $7,600 unfavorable.
d. $9,600 unfavorable.
e. none of the above.
10. Assume the same information as in Question 9 above. The direct materials usage variance
is:
a. $2,000 unfavorable.
b. $2,400 favorable.
c. $7,600 unfavorable.
d. $9,600 unfavorable.
e. none of the above.
11. The direct labor standard for XYZ Company is 2 hours per unit of output at a standard rate of
$15 per hour. During August, 2,250 units were produced using 4,760 hours. Direct labor payroll
totaled $73,675. The direct labor rate variance is:
a. $2,275 favorable.
b. $2,275 unfavorable.
c. $3,900 favorable.
d. $6,175 unfavorable.
e. none of the above.
12. Assume the same information as in Question 11 above. The direct labor efficiency variance
is:
a. $2,275 favorable.
b. $2,275 unfavorable.
c. $3,900 favorable.
d. $6,175 unfavorable.
e. none of the above.
202 Chapter 9
PRACTICE TEST
EXERCISE 1
ABC Company produced 25,000 units of Product XP-1 during 2000. Each product required
6 pounds of material at $11 per pound and 2 hours of direct labor at $15 per hour. During 2003,
160,000 pounds of material were purchased and used for $1,750,000; payroll totaled $743,900 for
49,000 hours.
Required:
Calculate the direct materials price and usage variances and the direct labor rate and efficiency
variances.
EXERCISE 2
Acme Corp. applies overhead to production using a rate of $75 per machine hour ($35 variable,
$40 fixed). Acme produced 15,000 units and incurred overhead of $3,710,000 (of which $1,495,000
was variable overhead) while using 43,500 machine hours. The overhead standards assumed
each product would use 3 machine hours. The practical capacity of 18,000 units was used as the
denominator activity.
Required:
Calculate the overhead variances using a four-variance analysis.
Standard Costing: A Functional-Based Control Approach 203
EXERCISE 3
XYZ Company produces a compound by mixing 3 gallons of AB-5 (costing $2.25 per gallon) and
4 gallons of CR-3 (costing $7.50 per gallon). The output is 5 gallons of the compound. During
August, 21,000 gallons of AB-5, costing $46,500, were purchased and used; 26,000 gallons of
CR-3, costing $198,000, were purchased and used. A total of 37,000 gallons of output were ob-
tained.
Required:
1. Calculate the direct materials price and usage variances.
EXERCISE 4
Scooter Company has the following standard cost sheet using an expected capacity of 120,000
units:
Direct materials ..................... 25 pounds @ $ 1.20 $ 30.00
Direct labor ........................... 2 hours @ 12.50 25.00
Overhead:
Variable............................. 3 machine hours @ 8.00 24.00
Fixed ................................. 3 machine hours @ 12.00 36.00
Total...................................... $115.00
During the year, 125,000 units were produced. Actual costs included the following:
Direct materials ..................... 3,200,000 pounds purchased for $3,725,000.
3,110,000 pounds were used in production.
Direct labor ........................... 260,000 hours worked; payroll totaled $3,320,000.
Overhead .............................. Variable: $3,025,000
Fixed: $4,275,000
Machine hours. ..................... 378,000 actually used
Required:
Calculate as many variances as possible.
Standard Costing: A Functional-Based Control Approach 205
ANSWERS
MULTIPLE-CHOICE QUIZ
1. d 7. c
2. d 8. e
3. a 9. b $97,600 – (25,000 × $4) = $97,600 – $100,000 = –$2,400 Favorable
4. a 10. e [22,000 – (2,250 × 10)] × $4 = (22,000 – 22,500) × $4 = –500 × $4 = –$2,000 Favorable
5. d 11. b $73,675 – (4,760 × $15) = $73,675 – $71,400 = $2,275 Unfavorable
6. d 12. e [4,760 – (2,250 × 2)] × $15 = (4,760 – 4,500) × $15 = 260 × $15 = $3,900 Unfavorable
206 Chapter 9
PRACTICE TEST
EXERCISE 1 (ABC Company)
MPV: $1,750,000 – (160,000 × $11) = $1,750,000 – $1,760,000 = –$10,000 Favorable
MUV: (160,000 × $11) – (25,000 × 6 × $11) = $1,760,000 – $1,650,000 = $110,000 Unfavorable
LRV: $743,900 – (49,000 × $15) = $743,900 – $735,000 = $8,900 Unfavorable
LEV: (49,000 × $15) – (25,000 × 2 × $15) = $735,000 – $750,000 = –$15,000 Favorable