Standard Costs and

Variance Analysis
 Learning Objectives
After studying this chapter, you should be able to:
1. Explain how direct materials standards and
direct labour standards are set.
2. Compute the direct materials price and quantity
variances and explain their significance.
3. Compute mix and yield variances for materials
and explain their significance.
4. Compute the direct labour rate and efficiency
variances and explain their significance.
 Learning Objectives
After studying this chapter, you should be able to:

5. Compute the variable manufacturing

overhead spending and efficiency
variances.
6. Understand the advantages of and the
potential problems with using standard
costs.
 Standard Costs

Predetermined.

Used for planning labor, material

Standard and overhead requirements.
Costs are
Benchmarks for
measuring performance.

Used to simplify the

accounting system.
 Standard Costs
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

 Setting Standard Costs

Accountants, engineers, personnel administrators, and

production managers combine efforts to set standards
based on experience and expectations.
An overview of a standard costing
system
 Purposes of standard costing

1. To provide a prediction of future

costs that can be used for
decision-making.

2. To provide a challenging target

that individuals are motivated to
achieve.

3. To assist in setting budgets and

evaluating performance.

4. To act as a control device by

highlighting those activities that
do not conform to plan.

5. To simplify the task of tracing

costs to products for inventory
valuation.
 Setting Direct Material
Standards
Price Quantity
Standards Standards

Final, delivered Use product

cost of materials, design specifications.
net of discounts.
 Setting Direct Labor
Standards
Rate Time
Standards Standards

Use wage Use time and

surveys and motion studies for
labor contracts. each labor operation.
 Setting Variable Overhead
Standards
Rate Activity
Standards Standards

The rate is the The activity is the

variable portion of the base used to calculate
predetermined overhead the predetermined
rate. overhead.
 Standard Cost Card –
Variable Production Cost
A standard cost card for one unit
of product might look like this:
A B AxB
Standard Standard Standard
Quantity Price Cost
Inputs or Hours or Rate per Unit
Direct materials 3.0 lbs. $ 4.00 per lb. $ 12.00
Direct labor 2.5 hours 14.00 per hour 35.00
Variable mfg. overhead 2.5 hours 3.00 per hour 7.50
Total standard unit cost $ 54.50
 Standards vs. Budgets

Are standards the A standard is a per

same as budgets? unit cost.
A budget is set for Standards are often
used when
total costs. preparing budgets.
 Standard Cost Variances
A standard cost variance is the amount by which
an actual cost differs from the standard cost.

Standard
Cost

This variance is unfavorable

because the actual cost
exceeds the standard cost.
 Standard Cost Variances

Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity
 A General Model for Variance
Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
 Material Variances
Example
Glacier Peak Outfitters has the following
direct material standard for the fiberfill in its
mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.

Last month 210 kgs of fiberfill were

purchased and used to make 2,000 parkas.
The material cost a total of $1,029.
 Material Variances
 Materials price variance
MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
 Materials quantity variance
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka× 2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
Standard Costs

Now let’s calculate

standard cost
variances for
direct labor.
 Note
 Materials variances:
 Material price variance
 MPV = AQ (AP - SP)

 Material quantity variance

Actual hours
 MQV = SP (AQ - SQ)
Actual rate
 Labor variances:
 Labor rate variance Standard rate
 LRV = AH (AR - SR)

 Labor efficiency variance Standard hours allowed

 LEV = SR (AH - SH) for the actual good output
 Labor Variances Example Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at $12.00 per
direct labor hour

Last week 1,550 direct labor hours were

worked at a total labor cost of $18,910
to make 1,000 Zippies.
 Quick Check  Zippy

What
What was was Hanson’s
Hanson’s actual
actual rate
rate (AR)
(AR)
for
for labor
labor for
for the
the week?
week?
a.
a. $12.20
$12.20 perper hour.
hour.
b.
b. $12.00
$12.00 perper hour.
hour.
c.
c. $11.80
$11.80 perper hour.
hour.
d.
d. $11.60
$11.60 perper hour.
hour.
 Quick Check  Zippy

Hanson’s
Hanson’s labor
labor rate
rate variance
variance (LRV)
(LRV) for
for
the
the week
week was:
was:
a.
a. $310
$310 unfavorable.
unfavorable.
b.
b. $310
$310 favorable.
favorable.
c.
c. $300
$300 unfavorable.
unfavorable.
d.
d. $300
$300 favorable.
favorable.
 Quick Check  Zippy

The
The standard
standard hours
hours (SH)
(SH) of
of labor
labor that
that
should
should have
have been
been worked
worked to
to produce
produce
1,000
1,000 Zippies
Zippies is:
is:
a.
a. 1,550
1,550 hours.
hours.
b.
b. 1,500
1,500 hours.
hours.
c.
c. 1,700
1,700 hours.
hours.
d.
d. 1,800
1,800 hours.
hours.
 Quick Check  Zippy

Hanson’s
Hanson’s labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was:
was:
a.
a. $590
$590 unfavorable.
unfavorable.
b.
b. $590
$590 favorable.
favorable.
c.
c. $600
$600 unfavorable.
unfavorable.
d.
d. $600
$600 favorable.
favorable.
 Labor Variances Zippy
Summary

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$12.20 per hour $12.00 per hour $12.00 per hour
= $18,910 = $18,600 = $18,000

Rate variance Efficiency variance

$310 unfavorable $600 unfavorable
 Labor Rate Variance –
A Closer Look
Using highly paid skilled workers to
perform unskilled tasks results in an
unfavorable rate variance.

High skill, Low skill,

high rate low rate

Production
Production managers
managers who
who make
make workwork assignments
assignments
are
are generally
generally responsible
responsible for
for rate
rate variances.
variances.
 Labor Efficiency Variance –
A Closer Look
Insufficient
Poorly Poor
demand
trained quality
workers materials

Unfavorable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
Standard Costs

Now let’s calculate

standard cost
variances for the
last of the variable
production costs –
variable
manufacturing
overhead.
 Note
Actual hours of
 Labor variances: the allocation
 Labor rate variance base
 LRV = AH (AR - SR)
Actual variable
 Labor efficiency variance overhead rate
 LEV = SR (AH - SH)
Standard
 Variable overhead variances: variable
 Variable overhead spending variance overhead rate
 VOSV = AH (AR - SR)

 Variable overhead efficiency variance

 VOEV = SR (AH Quick Check 
Standard hours allowed
for the actual good output
 Variance Analysis and
Management by Exception

Larger variances, in
How do I know which dollar amount or as
variances to a percentage of the
investigate? standard, are
investigated first.
Advantages of Standard Costs

Possible reductions Management by

in production costs exception

Advantages

Improved cost control Better Information

and performance for planning and
evaluation decision making
 Disadvantages of
Standard Costs
Emphasis on Favorable variances
negative may Potential may be
impact morale. Problems misinterpreted.

Continuous
improvement
Standard cost may be more
reports may important than
not be timely. meeting standards.

Emphasizing standards
Incentives to build may exclude other
inventories. important objectives.
End of Lesson 9