Cost Accounting

Foundations and Evolutions

Kinney and Raiborn
Seventh Edition

Chapter 7
Standard Costing and Variance Analysis

COPYRIGHT 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein
under license

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1

Learning Objectives (1 of 2)
Describe how standards are set for material,
labor, and overhead
List the documents that are associated with
standard cost systems and describe the
information that those documents provide
Calculate and record material, labor, and
overhead variances
2

Learning Objectives (2 of 2)
Explain why standard cost systems are used
Identify changes in the use of standards
Contrast the traditional labor and overhead
elements to a single conversion element
(Appendix) Explain how multiple material
and labor categories affect variances

Standard Cost Systems

Manufacturing
Service
Not-for-Profit
Record standard and actual costs
in the accounting records
4

Standards
Standard costs are budgeted costs to
manufacture a single unit of product, or
perform a single service

To develop standards identify

material and labor types, quantities, and prices
overhead types and behavior

Manufacturing Objective
Minimize unit cost while achieving
certain quality specifications
Input
Resources

Output
Quality

Material Standards
Materials used
Types
Quantity
Quality
Price
From
Product specifications, observation, inquiry
Bill of materials
Balance cost, quality, and projected sales price
7

Material Standards
Standard
Material =
Cost

Unit Purchase Price x quantity

 Labor used

Labor Standards

Types
Production, setup, cleanup, and rework
Quantity
Cost
Include wages, payroll taxes, and fringe benefits

From
Industrial engineering studies including methods-time
measurement (MTM), time and motion studies,
historical data
Operations flow document
10

11

Labor Standards
Standard
Labor
=
Cost

Hours x Wage Rate

12

Overhead Standards

Variable and fixed manufacturing overhead

Estimated level of activity
Estimated costs
Predetermined factory overhead application
rates

13

Standard Cost Card

For one unit of output (a bike)
Standard Direct Material Components
Standard Direct Labor Components
Manufacturing Overhead
Variable Overhead
Fixed Overhead
14

15

Variance
Variance is the
difference between
an actual cost and
a standard cost

16

Total Variance
Total actual cost incurred minus
total standard cost applied to output produced

Actual price of
actual
production input

Standard cost of
actual
production
output

Total Variance*
Favorable or unfavorable

17

Total Variance
AP x AQ
Inputs

SP x SQ
Total Variance

Outputs

AP = actual cost/price per unit of materials or hours of

labor
AQ = actual quantity of materials or hours of labor
SP = standard cost/price per unit of materials or
hours of labor
SQ = standard quantity of materials or hours of labor
18

Price Variance
AP x AQ

SP x AQ

SP x SQ

Price/Rate

Variance
Total Variance
What
was
paid
*

(AP - SP) x AQ

Favorable or unfavorable

What should
have been
paid
19

Usage Variance
AP x AQ

What
was
used
*

SP x AQ
SP x SQ
Usage
Variance
Total Variance

(AQ - SQ) x SP

Favorable or unfavorable

What should
have been
used for the
level of output
20

Material Price Variance (MPV)

AP x AQ

SP x AQ

SP x SQ

MPV
Total Variance
What
was
paid
*

(AP - SP) x AQ

Favorable or unfavorable

What should
have been
paid
21

Material Price Variance

Calculate Material Price Variance at
point of purchase, or
when materials used

22

Material Quantity Variance (MQV)

AP x AQ

SP x AQ

SP x SQ

MQV
What
was
used
*

Total Variance
(AQ - SQ) x SP

Favorable or unfavorable

What should
have been
used for
level of output
23

24

Labor Rate Variance (LRV)

AP x AQ

SP x AQ

SP x SQ

LRV
Total Variance
What
was
paid
*

(AP - SP) x AQ

Favorable or unfavorable

What should
have been
paid
25

Labor Efficiency Variance (LEV)

AP x AQ

SP x AQ

SP x SQ

LEV
What
was
used
*

Total Variance
(AQ - SQ) x SP

Favorable or unfavorable

What should
have been
used for
level of output
26

Overhead Variances
Variable Overhead
Actual variable overhead
is total of various
ledger accounts
SP = Predetermined
variable overhead rate

Fixed Overhead
Actual fixed overhead is
total of various ledger
accounts
SP = Predetermined
fixed overhead rate

27

Variable Overhead Variances

Actual
VOH
Actual

For
actual
hours
used

Budgeted
VOH

Applied
VOH

SP x AQ

SP x SQ

VOH
Spending
Variance

VOH
Efficiency
Variance

Total VOH Variance

What should have been
used for level of output
28

VOH Spending Variance

Caused by price differences
managers have little control over
prices
Caused by shrinkage or waste
managers should be held accountable

29

Fixed Overhead Variances

Actual
FOH

Budgeted
FOH

Applied
FOH
SP x SQ

Constant
Amount

FOH
Spending
Variance

FOH
Volume
Variance

Total FOH Variance

What should have been
used for level of output
30

FOH Spending Variance

Calculate variance for each component
Caused by price differences
May reflect mismanagement of
resources

31

FOH Volume Variance

Measures capacity utilization
Caused by producing at a level that
differs from the capacity level used to
compute the predetermined overhead rate
Also called the noncontrollable variance

32

Alternative Overhead Variance

Approaches

One variance
Two variance
Three variance
Four variance

33

One Variance Approach

Standard
Cost of
OH
SP x SQ

Actual
OH

Total OH Variance

Applied
Overhead
34

Two Variance Approach

Actual Budgeted OH Standard
OH
based on
Cost of
Standard
OH
Quantity
SP x SQ
Budget
Variance

Volume
Variance

Total OH Variance

Applied
Overhead
35

Three Variance Approach

Actual
OH

Budgeted OH
based on
based on
Actual Inputs actual output

Standard
OH
SP x SQ

OH
Spending
Variance

OH
Efficiency
Variance

Volume
Variance

Total OH Variance
Applied
Overhead
36

Standard Cost Journal Entries

Variances recorded in accounting system
Favorable variances
Credits
Represent savings in production costs

Unfavorable variances
Debits
Represent excess production costs

Inventories are recorded at standard cost

during the period

37

Purchase of Materials
(Point of Purchase Method)
At
Standard
Cost
Materials
SP x AQ
purchased

Materials
Price
Variance
U

Accts Pay

AP x AQ
purchased

Debit - Unfavorable
Credit - Favorable
38

Use of Materials
At
Standard
Cost
WIP
SP x SQ
allowed

Materials
Quantity
Variance
U

Materials

Debit - Unfavorable
Credit - Favorable

SP x AQ
used

39

Record Labor
At
Standard
Cost

Labor Rate
Variance
WIP

Labor
Efficiency
Variance
U

Wages Pay
AP x AQ

SP x SQ
allowed
Debit - Unfavorable
Credit - Favorable

40

Apply Overhead
Throughout the Year
WIP
SP x SQ
Allowed

VOH
SP x SQ
Allowed

FOH
SP x SQ
Allowed

41

Year-End Treatment for VOH

VOH
Efficiency
Variance

VOH
Spending
Variance

VOH
Actual Applied
---------------

Debit - Unfavorable
Credit - Favorable

Enter a debit
or credit to
bring balance
to zero42

Year-End Treatment for FOH

FOH
Spending
Variance

Volume
Variance

FOH
Actual Applied
-------------

Debit - Unfavorable
Credit - Favorable

Enter a debit
or credit to
bring balance
to zero43

Year-End Treatment of Variances

Immaterial - Adjust Cost of Goods Sold
Material - Prorate variances to
Material Price Variance

Raw Materials
WIP
Finished Goods
Cost of Goods Sold

All other variances

WIP
Finished Goods
Cost of Goods Sold
44

Why Use Standard Cost Systems

Clerical efficiency
Motivation
Planning
Controlling - variance analysis
Decision making
Performance evaluation
45

Setting Standards
Appropriateness
Attainability
Expected standards
Practical standards
Ideal standards
46

Trends in Standards

Ideal Standards and Theoretical Capacity

Adjusting standards
Price variance on purchase versus usage
Decline in direct labor content

47

Conversion Costs
Combine direct labor and manufacturing
overhead
Variances
Spending variance for overhead
Efficiency variances for machinery and
production costs
Volume variances for production
48

Material Mix and Yield Variances

AM x
AQ x
AP

Material
Price
Variance
AM - Actual Mix
SM - Standard Mix

AM x
AQ x
SP

SM x
AQ x
SP

Material
Mix
Variance

SM x
SQ x
SP

Material
Yield
Variance

What should have been

used for level of output
49

Labor Mix and Yield Variances

AM x
AH x
AR

Labor
Rate
Variance
M - Mix
H - Hours
R - Rate

AM x
AH x
SR

SM x
SH x
SR

SM x
AH x
SR

Labor
Mix
Variance

Labor
Yield
Variance

What should have been

used for level of output
50

Questions
How are standards set for material, labor,
and overhead?
How is variance analysis used for control
and performance evaluation?
Why are labor and overhead elements
sometimes combined into a single
conversion element?
51

Potential Ethical Issues

Setting high standards to create favorable
variances
Ignoring effects of one production area on
another
Setting overhead rates too low based on
high production levels to distort inventory
cost and operating income
52

Potential Ethical Issues

Producing inventory only to create a
favorable volume variance
Not updating standards so that favorable
variances are created
Using low quality materials or labor to
create favorable variances and low quality
products
53