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Standard Costing: A Managerial Control Tool
LEARNING OBJECTIVES
After studying Chapter 9, students should be able to:
1. Explain how unit standards are set and why standard cost systems are adopted.
2. Explain the purpose of a standard cost sheet.
3. Describe the basic concepts underlying variance analysis and explain when variances should be investigated.
4. Compute the materials variances and explain how they are used for control.
5. Compute the labor variances and explain how they are used for control.
1. UNIT STANDARDS
A. Introduction
Cost control. The opening scenario illustrates that many prosperous companies tend to ignore the need for cost control. As conditions become more competitive and profits are being squeezed, it suddenly becomes more important to be cost conscious. In reality, even prosperous firms should be cost conscious. By exerting control over costs in prosperous times, the ability to weather more demanding times is improved. Comparing actual amounts with budgeted amounts is one approach to control.
A standard cost is the expected or budgeted cost of materials, labor, and manufacturing overhead required to produce one unit of product.
The unit standard cost is calculated as follows:
Price standard × Quantity standard
A price standard is the price that should be paid per unit of input (such as pound of material).
A quantity standard is the quantity of input allowed per unit of output (for example, pounds of material allowed per one unit of product).
A standard cost sheet calculates the total standard cost for one unit of product. It lists the standard costs for one unit of product for the following:
- Materials (Price standard × Quantity standard)
- Labor (Price standard × Quantity standard)
- Variable manufacturing overhead (Price standard × Quantity standard)
- Fixed manufacturing overhead (Price standard × Quantity standard)
B. Why Standard Cost Systems Are Adopted
Two reasons for adopting a standard cost system are:
- To improve planning and control. A standard cost system compares actual amounts with standard amounts to determine variances from the standard. The use of a standard cost system for operational control in an advanced manufacturing environment can produce dys functional behavior. However, standards in the advanced manufacturing environment are still useful for planning, such as developing bids.
- To facilitate product costing. Standard costing uses standard costs for direct materials, direct labor, and overhead. Standard cost systems provide readily available unit cost information that can be used for pricing decisions.
Costs under the three product cost assignment approaches are summarized below:
PRODUCT COSTING SYSTEM
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MANUFACTURING COSTS |
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Direct Materials |
Direct Labor |
Overhead |
Actual costing system
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Actual |
Actual |
Actual |
Normal costing system
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Actual |
Actual |
Budgeted |
Standard costing system
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Standard |
Standard |
Standard |
2. STANDARD PRODUCT COSTS
The standard cost sheet for one unit of product might appear as follows:
STANDARD COST SHEET
Production Costs for One Unit of Product
Direct materials
(Standard quantity of materials × Standard price for materials)
Direct labor
(Standard direct labor hours × Standard direct labor rate)
Variable manufacturing overhead
(Standard direct labor hours × Standard variable overhead rate)
Fixed manufacturing overhead
(Standard direct labor hours × Standard fixed overhead rate)
Total standard cost per unit of product
The standard cost for direct materials is calculated as follows:
Standard cost for direct materials =
Standard quantity of materials × Standard price for the materials
Standard quantity of materials allowed (SQ) is calculated:
SQ = Unit quantity standard × Actual output
The standard direct labor cost for a unit of product would be calculated as follows:
Standard direct labor cost =
Standard quantity of direct labor × Standard rate per direct labor hour
Standard hours allowed (SH) is calculated:
SH = Unit labor standard × Actual output
Cornerstone 9-1: How to Compute Standard Quantities Allowed (SQ and SH)
- See Mowen and Hansen text for demo problems.
3. VARIANCE ANALYSIS: GENERAL DESCRIPTION
A. Price and Efficiency Variances
The total budget variance is the difference between actual cost of inputs and the standard (or planned) cost of inputs.
There are two variances for variable production costs:
1. price or rate variances— the difference between actual costs of inputs and what the inputs should have cost (standard prices).
2. usage or efficiency variance s— the difference between the actual quantity used and the standard quantity allowed for units produced.
The general model for calculating variable cost variances appears below:
Actual quantity of
input at actual price
(AP × A Q)
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Actual quantity of
input at standard price
.(SP × A Q) |
Standard quantity of
input at standard price
.(SP × S Q) |
............................. (AP – SP)AQ ...............................(AQ – S Q)SP |
......................Price variance ...............Usage or efficiency variance |
..Total variance = (AP × A Q) – (SP × S Q)
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If the actual price or quantity is less than the standard, the variance is considered favorable.
If the actual price or quantity exceeds the standard, the variance is considered unfavorable.
B. The Decision to Investigate
- Variances indicate that actual performance is not going according to plan.
- Variances do not indicate the cause of the variance or responsibility.
- Usually the cause of a variance can be determined only by an investigation. For example, an unfavorable materials quantity variance may not be the fault of the production supervisor. Instead, it may be the result of the purchasing agent buying inferior-quality material.
- Most firms adopt the general guideline of investigating variances only if they fall outside an acceptable range.
- For example, management may investigate any variance that exceeds $1,000 or 5% of the standard amount to which the variance relates.
Cornerstone 9-2: How to Use Control Limits to Trigger a Variance Investigation
- See Mowen and Hansen text for demo problems.
4. VARIANCE ANALYSIS:MATERIALS
A. Direct Materials Variances
Direct Materials Price Variance
The materials price variance (MP V) for materials is calculated as follows:
Actual quantity purchased
at actual price
(AP × A Q) |
Actual quantity purchased
at standard price
(SP × A Q) |
(AP – SP)AQ |
Direct materials price variance |
The materials price variance can be computed at one of two points:
1. When the raw materials are issued for use in production.
2. When the raw materials are purchased.
Variances should be calculated at the earliest point possible so management can take any necessary corrective action. Thus, the price variance for materials should be calculated at the time of purchase.
Responsibility for the materials price variance is usually assigned to the purchasing agent.
Variance analysis involves the following process:
Decide whether the variance is significant.
If insignificant, no further investigation is needed.
If significant, investigate the cause of the variance and take corrective action if necessary.
B. Direct Materials Usage Variance
The materials usage variance (MU V) is calculated as follows:
Actual quantity used
at standard price
(SP × A Q) |
Standard quantity allowed
at standard price
(SP × S Q) |
(AQ – S Q)SP |
Direct materials usage variance |
The production manager is usually responsible for materials usage because the production manager can minimize scrap, waste, and rework in order to meet the standard.
The materials usage variance is calculated at the time materials are issued or used in the manufacturing process.
Cornerstone 9-3: How to Calculate the Total Variance for Materials
Cornerstone 9-4: How to Calculate Materials Variances: Formula and Columnar Approaches
See Mowen and Hansen text for demo problems.
5. VARIANCE ANALYSIS: DIRECT LABOR
A. Direct Labor Variances
The labor rate variance (LR V) is calculated as follows:
Actual labor hours
at actual rate
(AR × AH) |
Actual labor hours
at standard rate
(SR × AH) |
(AR – SR)AH |
Direct labor rate variance |
When labor rate variances occur, it is usually due to:
using the average wage rate as the standard rate, or
using more skilled and higher paid laborers for less skilled tasks. Responsibility for the labor rate variance is often assigned to the individual, such as the production manager, who decides how labor will be used.
B. Labor Efficiency Variance
The labor efficiency variance (LE V) is calculated as follows:
Actual labor hours
at standard rate
(AH × SR) |
Standard labor hours
allowed at standard rate
(SH × SR) |
(AH – SH)SR |
Direct labor efficiency variance |
Usually production managers are responsible for the direct labor efficiency variance; however, once the cause of the variance is discovered, responsibility may be assigned elsewhere.
The total variance for direct labor would be the sum of the rate variance and the efficiency variance. The total variance can also be calculated as follows:
Total direct labor variance =
(Actual quantity × Actual price) – (Standard quantity × Standard price)
Cornerstone 9-5: How to Calculate the Total Variance for Labor
Cornerstone 9-6: How to Calculate Labor Variances: Formula and Columnar Approaches
See Mowen and Hansen text for demo problems.
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