Management

Advisory Services

Ferdinand E. Ventura, CPA, MBA

Teacher
Standard Costing

Ferdinand E. Ventura, CPA, MBA

Teacher
Learning Objectives:
1. Explain how standard costs are
2.
developed.
Calculate and interpret
variances for direct material.
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret
variances for manufacturing
overhead.
5. Discuss how the management
by exception approach is
applied to investigation of
standard cost variances.
Standard Costs
The term standard cost refers
to the cost that management
believes should be incurred
to produce a good or service
under anticipated conditions.
The primary benefit of a
standard cost system is that
it allows for comparison of
standard versus actual costs.
Differences are referred to as
standard cost variances and
should be investigated if
significant.
Related Learning Objectives:
1. Explain how standard costs are
developed.
Standard Costs
2. Calculate and interpret variances
for direct material. & Budgets
3. Calculate and interpret variances
for direct labor. At the outset, it is important
4. Calculate and interpret variances to understand the subtle
for manufacturing overhead.
differences in definitions of
5. Discuss how the management by
exception approach is applied to
standard cost and budgeted
investigation of standard cost cost.
variances.

Standard cost: the standard

cost of a single unit.

Budgeted cost: the cost, at

standard, of the total number
of budgeted units.
Related Learning Objectives:
1. Explain how standard Development of
costs are developed.
2. Calculate and interpret variances Standard Costs
for direct material.
3. Calculate and interpret variances Standard costs are
for direct labor. developed in a variety of
4. Calculate and interpret variances ways. They are
for manufacturing overhead.
5. Discuss how the management by 1. specified in engineering
exception approach is applied to plans.
investigation of standard cost
variances.
Related Learning Objectives:
1. Explain how standard
costs are developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of
Standard Costs
Standard costs are
developed in a variety of
ways. They are
1. specified in engineering
plans.
2. developed from price lists
provided by suppliers.
Related Learning Objectives:
1. Explain how standard
costs are developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of
Standard Costs
Standard costs are
developed in a variety of
ways. They are
1. specified in engineering
plans.
2. developed from price lists
provided by suppliers.
3. determined time and
motion studies
conducted by industrial
engineers.
Related Learning Objectives:
1. Explain how standard Development of
costs are developed.
2. Calculate and interpret variances Standard Costs
for direct material.
3. Calculate and interpret variances Standard costs are
for direct labor. developed in a variety of
4. Calculate and interpret variances ways. They are
for manufacturing overhead.
5. Discuss how the management by 1. specified in engineering
exception approach is applied to plans.
investigation of standard cost 2. developed from price lists
variances.
provided by suppliers.
3. determined time and
motion studies
conducted by industrial
engineers.
4. developed from analyses
of past data.
Related Learning Objectives:
1. Explain how standard
costs are developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Ideal vs Attainable
Standards
In developing standard costs,
there are two schools of thought.
Ideal standards: developed under
the assumption that no obstacles
to the production process will be
encountered. They are
sometimes referred to as
perfection standards.
Attainable Standards: developed
under the assumption that there
will be occasional problems in
the production process such as
equipment failure, labor turnover,
and materials defects.
Related Learning Objectives:
1. Explain how standard costs are
developed.
General Approach to
2. Calculate and interpret
variances for direct
material.
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret
variances for manufacturing
overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Variance Analysis
An analysis of the difference
between a standard cost and
actual cost is called variance
analysis. The process
decomposes the difference in two
components.
For direct material: materials price
and materials quantity variance.
For direct labor: labor rate (price)
and labor efficiency (quantity)
variance.
For overhead: overhead volume
variance and controllable
overhead variance.
Related Learning Objectives:
1. Explain how standard costs are
developed.
Materials Price
2. Calculate and interpret
variances for direct material.
Variance
3. Calculate and interpret variances
The material price variance is
for direct labor.
expressed as (AP – SP)AQp where:
4. Calculate and interpret variances
for manufacturing overhead. (AP) = actual price per unit of
5. Discuss how the management by material.
exception approach is applied to (SP) = standard price per unit of
investigation of standard cost
variances.
direct material.
(AQp) = actual quantity of material
purchased.
If actual price > standard price,
then the variance is unfavorable.
If actual price < standard price,
then the variance is favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret
variances for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Materials Quantity
Variance
The material quantity variance is
expressed as (AQu – SQ)SP
where:
(AQu) = actual quantity of
material used.
(SQ) = standard quantity of
material allowed.
(SP) = standard price of material.
If actual quantity > standard
quantity, then the variance is
unfavorable.
If actual quantity < standard
quantity, then the variance is
favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Labor Rate
Variance
The labor rate (price) variance is
expressed as (AR – SR)AH
where:
(AR) = actual wage rate (price).
(SR) = standard wage rate (price).
(AH) = actual number(quantity) of
labor hours.
If actual rate > standard rate, then
the variance is unfavorable.
If actual rate < standard rate, then
the variance is favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Labor Rate
Variance
The labor rate (price) variance is
expressed as (AR – SR)AH
where:
(AR) = actual wage rate (price).
(SR) = standard wage rate (price).
(AH) = actual number(quantity) of
labor hours.
If actual rate > standard rate, then
the variance is unfavorable.
If actual rate < standard rate, then
the variance is favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Labor Efficiency
Variance
The labor efficiency (quantity)
variance is expressed as (AH –
SH)SR where:
(AH) = actual number of hours
worked.
(SH) = standard number of hours
worked.
(SR) = standard labor wage rate.
If actual hours > standard hours,
then the variance is unfavorable.
If actual hours < standard hours,
then the variance is favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret
variances for manufacturing
overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Controllable
Overhead Variance
The controllable overhead
variance is expressed as (actual
overhead - flexible budget level
of overhead) for actual level of
production. It is referred to as
controllable because managers
are expected to control costs so
they are not substantially
different from budget.
If actual > budget, then the
variance is unfavorable.
If actual < budget, then the
variance is favorable.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret
variances for manufacturing
overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Overhead Volume
Variance
The overhead volume variance is
expressed as (flexible budget
level of overhead for actual level
of production - overhead applied
to production using standard
overhead rate).
This variance is solely the
product of more or less units
being produced than planned in
the static budget.
Its usefulness is limited.
Related Learning Objectives:
1. Explain how standard costs are
developed. Investigation of
2. Calculate and interpret
variances for direct material. Standard Cost
Variances
3. Calculate and interpret
variances for direct labor.
4. Calculate and interpret
variances for manufacturing
overhead.
It is important to note that
5. Discuss how the management by standard cost variances are not a
exception approach is applied to definitive sign of good or bad
investigation of standard cost performance.
variances.
These variances are merely
indicators of potential problems
which must be investigated.
And there are many plausible
explanations for them.
Related Learning Objectives:
1. Explain how standard costs are
developed.
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management
by exception approach is
applied to investigation of
standard cost variances.
Management by
Exception
Because investigation of
standard cost variances is itself a
costly activity, management must
decide which variances to
investigate.
Most managers practice
management by exception.
What is “exceptional?”
Usually an absolute dollar
amount or a percentage dollar
amount.
Related Learning Objectives:
1. Explain how standard costs are
developed.
“Favorable” Variances
2. Calculate and interpret variances
for direct material.
3. Calculate and interpret variances
for direct labor.
4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management
by exception approach is
applied to investigation of
standard cost variances.
May Be Unfavorable
The fact that a variance is
“favorable” does not mean that it
should not be investigated. Raw
materials are good examples of
this phenomenon, especially
considering the competitive
pricing environment for most
commodities. Suppose inferior,
low-priced materials are ordered.
On one hand, a favorable price
variance will arise. On the other
hand, most likely there will be
substantially more scrap and
rework, and thus a higher quantity
variance.
Related Learning Objectives:
1. Explain how standard costs are
developed.
Responsibility
2. Calculate and interpret
variances for direct material.
Accounting &
3. Calculate and interpret
variances for direct labor.
Variances
4. Calculate and interpret
variances for manufacturing As noted previously, managers
overhead. should be held responsible only
5. Discuss how the management for costs they can control. This is
by exception approach is
applied to investigation of
true in the area of variance
standard cost variances. analysis. For example, a
purchasing agent may be held
responsible for direct material
price variances, but certainly not
direct material quantity (usage)
variances.
Related Learning Objectives:
1. Record standard costs in the
account of a manufacturing
Recording of
firm.
Standard Costs in
Accounts
In a standard costing system, the
costs added to the Raw Materials
Inventory, Work in Process
Inventory, Finished Goods
Inventory, and Cost of Goods
Sold accounts are all recorded at
standard rather than actual cost.
Variances are also calculated and
recorded for management’s use
in performance evaluation.
Recording of Material Costs
Purchase of raw materials inventory:
Account dr. cr.
Raw Material Inventory (std.) x
Material Price Variance x
Accounts Payable (actual) x
(This is an unfavorable price variance)
Usage of raw materials inventory:
Account dr. cr.
Work in Process Inventory x
Material Quantity Variance x
Raw Material Inventory x
(This is an unfavorable quantity variance)
 Recording of Labor Costs
Account dr. cr.
Work in Process Inventory (std.) x
Labor Rate Variance x
Labor Efficiency Variance x
Salaries Payable (actual) x
(Note: both the labor rate variance and efficiency
variance are unfavorable)
Recording of Manufacturing Overhead
Account dr. cr.
Recording manufacturing overhead in a standard
costing system is a three-step process:

1. Actual overhead is recorded in the

manufacturing overhead account.
2. Overhead is applied to Work in Process
Inventory at the standard cost.
3. The difference between actual overhead and
overhead applied at standard is closed and
overhead variances are identified.
Recording of Manufacturing Overhead
(Step 1)
To record actual overhead cost:

Account dr. cr.

Manufacturing Overhead x
*Various Accounts x

*Various accounts include indirect wages payable,

utilities payable and accumulated depreciation.
Recording of Manufacturing Overhead
(Step 2)
To apply overhead cost to work in process inventory
at cost:

Account dr. cr.

Work in Process Inventory x
Manufacturing Overhead x
Recording of Manufacturing Overhead
(Step 3)
To close out manufacturing overhead cost to work in
process inventory at cost:

Account dr. cr.

Manufacturing Overhead x
Overhead Volume
Variance x
Controllable Overhead
Variance x
Recording of Cost of Goods Sold
To apply overhead cost to work in process inventory
at cost:

Account dr. cr.

Cost of Goods Sold x
Finished Goods
Inventory x
x
Work in Process
Inventory x
Closing Variance Accounts
At the end of the accounting period, the temporary
variance accounts must be closed. As a practical
matter this is usually accomplished by debiting or
crediting the variances to cost of goods sold.
Account dr. cr.
Cost of Goods Sold x
Overhead Volume Variance x
Controllable Overhead Variance x
Material Price Variance x
Material Quantity Variance x
Labor Rate Variance x
Labor Efficiency Variance x