Standard Costing

14
Standard
Costing: A
Managerial
Control Tool
PowerPresentation® prepared by
David J. McConomy, Queen’s University
Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-1

Learning Objectives
 Explain how unit standards are set and

why standard cost systems are
adopted.
 Explain the purpose of a standard cost
sheet.
 Describe the basic concepts
underlying variance analysis and
explain when variances should be
investigated.

Learning Objectives
(continued)
 Compute the materials and labour
variances and explain how they are used
for control.
 Compute the variable and fixed overhead
variances and explain their meaning.
 Use variance analysis as an analytical tool
for profitability analysis. (Appendix A)

Learning Objectives
(continued)
 Prepare journal entries for materials and

labour variances and describe the
accounting for overhead variances.
(Appendix B)

Unit Standard Cost
To determine the unit standard cost for a

particular input, two decisions must be made:
1. How much of the input should be used per
unit of output ? (Quantity decision)
2. How much should be paid for the quantity
of the input to be used ? (Pricing decision)

Types of Standards
Ideal Standards demand

maximum efficiency and
can be achieved only if
everything operates
perfectly.
Currently attainable
standards can be achieved
under efficient operating
conditions.

Sources for Quantitative Standards
1. Historical experience
2. Engineering studies
3. Input from operating
personnel

Factors for Price Standards - Materials
1. Market forces
2. Quality
3. Discounts
4. Freight

Factors for Price Standards - Labour
1. Market forces
2. Trade unions
3. Payroll taxes
4. Qualifications

Purposes of Standards
 To improve planning and control

 To facilitate product costing

Cost Assignment Approaches
Manufacturing Costs
Direct Direct
Materials labour Overhead
Actual costing system Actual Actual Actual
Normal costing system Actual Actual Budgeted
Standard costing system Standard Standard Standard

A Standard Cost Sheet
Standard Standard Standard
Description Price Usage Cost/Unit
Direct materials $1.50/kg. 10 kgs. $15.00

Direct labour $6.00/hr. 2 hours 12.00
Variable overhead $10.00/hr. 2 hours 20.00
Fixed Overhead1 $8.00/hr. 2 hours 16.00
$63.00
Other Operating Data for Period:
Units produced 20,000 units
210,000 kilograms purchased @ $1.55 per kilogram; 205,000 kgs.
used
Direct labour costs 39,000 hours @ $6.10 per hour
Variable overhead $410,000
1Fixed overhead $300,000; Rate = ($310,000/38,750 hrs)

Variable Cost Variance Analysis:
General Description
Actual Quantity of Actual Quantity of Standard Quantity of

Input at Actual Price Input at Standard Price Input at Standard Price
AQ x AP AQ x SP SQ x SP
Price Usage
Variance Variance
AQ x (AP - SP) SP x (AQ - SQ)
Budget
Variance
(AQ x AP) - (SQ x SP)

Variance Investigation
Variances are investigated if two

conditions are met:
1. The variance is material
2. The benefits of investigating and
taking corrective action are
greater than its costs

Control Limits:
Standard + Allowable Deviation
Investigating occurs for values

outside the allowable range.
Example: Assume the allowable deviation may be the

lesser of $8,000 or 10% of the standard. Suppose the
standard is $50,000 and the actual deviation from
standard is $6,000. Will the variance be investigated.
Answer: Yes. Ten percent of standard is $5,000. Since

$6,000 is larger than the allowable deviation, an
investigation will take place.

Material Variances
Formula Approach:
MPV = (AP - SP)AQ MUV = (AQ - SQ)SP
= ($1.55-$1.50)210,000 = (205,000 - 200,000)$1.50
= $10,500 U = $7,500U
SQ = 20,000 units x 10 lbs per unit

Diagram Approach:
AQ x AP AQ x SP AQ x SP SQ x SP
210,000 x $1.55 210,000 x $1.50 205,000 x $1.50 200,000 x $1.50
MPV = $10,500U MUV = $7,500U
Responsibility: Responsibility:
Purchasing Manufacturing
Flexible Budget Variance = $18,000U

Labour Variances
Formula Approach:
LRV = (AR - SR)AH LEV= (AH - SH)SR
= ($6.10 - $6.00)39,000 = (39,000 - 40,000)$6.00
= $3,900 U = $6,000 F
SQ = 20,000 units x 2 hrs. per unit
Diagram Approach:
AH x AR AH x SR SH x SR
39,000 x $6.10 39,000 x $6.00 40,000 x $6.00
LRV = $3,900 U LEV = $6,000 F

Human Resources Manufacturing
Flexible Budget Variance = $2,100 F

Variable Overhead Variances
Formula Approach:
OSV = (AVOR - SVOR)AH OEV = (AH - SH)SVOR
= $410,000 - ($10 X 39,000 hrs) = (39,000 - 40,000)$10.00
= $20,000 U = $10,000 F
SQ = 20,000 units x 2 hrs. per unit

Diagram Approach:
AH x AVOR AH x SVOR SH x SVOR
$410,000 39,000 x $10.00 40,000 x $10.00
OSV = $20,000 U OEV = $10,000 F

Manufacturing Manufacturing
Flexible Budget Variance = $10,000 U

Fixed Overhead Variances
Actual Overhead Budgeted Overhead Applied Overhead
$300,000 $310,000 SOR x SH ($8 x40,000)
OSV = $10,000F DV = 10,000F

Manufacturing Difficult to Assess
Alternative Approach for Computing FOH Denominator Variance
Planned level 38,750 hrs.

Applied level (SOR) 40,000 hrs.
Over 1,250 hrs.
x $8
FOH Denominator Variance $10,000 F
======

APPENDIX A

Further Analysis of the
Profit Volume Variance
 The profit volume variance can be

decomposed further, for example into
industry volume and market share variances
 In the next slide, assume that the master

budget was based on a certain percentage of
market share, and that the industry
experienced an increase in its volume of 10%

Profit Variances from Chapter 13
Master Budget Flexible Budget Actual

(1,000 units) (800 units) (800 units)
Sales $ 100,000 $ 80,000 $ 82,000
Variable Costs 40,000 32,000 39,000
Contribution Margin 60,000 48,000 43,000
Fixed Costs 30,000 30,000 34,000
Operating Income 30,000 18,000 9,000
Comparing the flexible to the static (master) budget isolates the

effects of volume on profits, and comparing actual to flexible budget
isolates the appropriate cost variances as well as the sales price
variance, as follows:
Profit volume variance = 18,000 – 30,000 =$ - 12,000 (U)

Sales price variance = 82,000 – 80,000 = 2,000 (F)
Variable cost variances = 32,000 – 39,000 = - 7,000 (U)
Fixed cost variances = 30,000 – 34,000 = - 4,000 (U)
Total variances =$ - 21,000 (U)

===========

Industry Volume and Market Share Variances
Master Budget Master Flexible Budget Actual
(1,000 units) Budget (800 units) (800 units)
adjusted for
Actual
Industry
Volume
Sales $ 100,000 $ 110,000 $ 80,000 $ 82,000
Variable Costs 40,000 44,000 32,000 39,000
Contribution 60,000 66,000 48,000 43,000

Margin
Fixed Costs 30,000 30,000 30,000 34,000
Operating Income 30,000 36,000 18,000 9,000
Comparing the flexible to the static (master) budget isolates the effects of volume on
profits This in turn can be broken down into an industry volume variance and a market
share variance
Industry volume variance = 36,000 – 30,000 = $ 6,000 (F)

Market share variance = 18,000 – 36,000 = - 18,000 (U)
_______
Profit volume variance = 18,000 – 30,000 =$ - 12,000 (U)
=========
IVV = 10% of CM of $60,000
MSV= 30,000 loss of revenues to maintain the same market share x CMR of 0.60

Sales Mix Variance
 Assume that the previous statement was for a
multi-product company, and that its budgeted
CMR at its budgeted mix was 0.60.
 Assume further that the actual sales mix would

have resulted in a budgeted CMR of 0.58 instead
 How much is the Sales Mix Variance?

Answer: - 0.02 x 80,000 = $ -1,600 U
The following spreadsheet includes a

comprehensive analysis of all profit variances

Profit Variances - A Comprehensive Analysis
Master Budget Master Flexible Budget Flexible Actual
Budget Budget
adjusted for adjusted for
Actual Actual
Industry Sales Mix
Volume
Sales $ 100,000 $ 110,000 $ 80,000 $ 80,000 $ 82,000
Variable Costs 40,000 44,000 32,000 33,600 39,000
Contribution 60,000 66,000 48,000 46,400 43,000

Margin
Fixed Costs 30,000 30,000 30,000 30,000 34,000
Operating Income 30,000 36,000 18,000 16,400 9,000
Summary of Variances
Industry volume variance = 36,000 – 30,000 =$ 6,000 (F)
Market share variance = 18,000 – 36,000 = - 18,000 (U)
Profit volume variance = 18,000 – 30,000 = $ - 12,000 (U)
Sales mix variance = 16,400 – 18,000 = - 1,600 (U)
Sales price variance = 82,000 – 80,000 = 2,000 (F)

Variable cost variances = 33,600 – 39,000 = - 5,400 (U)
Fixed cost variances = 30,000 – 34,000 = - 4,000 (U)
__________
Total variances - 21,000 (U)
=========
Profitability Analysis:
Problem 14-44
1. Total CM per Master Budget

A 9,000 x $8 = $72,000
B 6,500 x 11 = 71,500 $143,500
Total standard CM for Actual Quantities
A 10,000 x $8 = $80,000
B 6,000 x 11 = 66,000 $146,000
Profit Volume Variance (gross) 2,500 F

=======

Problem 14-45 (continued)
2. Weighted average CM per unit based on Master Budget

$143,500/15,500 = 9.2581
Total standard CM for Actual Quantity 146,000

Total standard CM for 16,000 units
assuming budgeted sales mix
16,000 x $9.2581 148,129
Sales mix variance $ 2,129 U
Profit volume variance (net)

(16,000 - 15,500) x $9.2581 = 4,629 F

3. Decline in industry sales

(77,500 - 64,000) x 77,500 = 17.42%
Industry volume variance
.1742 x 15,1500 x 9.2581 = $24,997 U
Budgeted market share: 15,500/77,500 = 20%
Market share variance
(16,000-[0.20 x 64,000]) x 9.2581 = $29,626 F
4. Sales Price Variance

A 10,000($21 - 20) = 10,000 F
B 6,000($32 - 30) = 12,000 F $22,000 F

5. Variable cost flexible budget variances

Variable manufacturing costs
A 10,000($12 - 11) = 10,000 U
B 6,000($20 - 18) = 12,000 U = $22,000 U
Variable marketing and administrative
A 10,000($1.10 - 1) = 1,000 U
B 6,000($1.10 - 1) = 600 U = $ 1,600 U
$23,600 U
6. Fixed cost flexible budget variance
Manufacturing 36,000 - 34,500 = 1,500 U
Mktg and admin 44,000 - 40,000 = 4,000 U $5,500 U

7. Budgeted net income $69,000

Industry volume variance $24,997 U
Market share variance 29,626 F
Profit volume variance (net) 4,629 F
Sales mix variance 2,129 U
Profit Volume Variance (gross) 2,500 F
Sales price variance $22,000 F
Variable cost flex. bud. var. $23,600 U
Fixed cost flex. bud. var. 5,500 U
Total profit variances $ 4,600U
Actual net income $ 64,400

APPENDIX B

Accounting for Variances
Journal Entry for Purchase of Direct Materials
Materials (AQ x SP) 315,000

MPV (AP - SP)AQ 10,500
Accounts Payable (AQ x AP) 325,500
Rule: Unfavourable variances are recorded by a debit

and favourable variances are recorded by a credit.

(continued)
Recording the Issuance of Materials to Production
Work in Process (SQ x SP) 300,000

MUV [(AQ - SQ)SP] 7,500
Materials (AQ x SP) 307,500
AQ = Actual quantity used in production

(continued)
Recording the Direct Labour Costs
Work in Process (SH x SR) 240,000

LEV [(AH - SH) SR] 3,900
Accrued Payroll (AH x AR) 237,900
LRV [(AR - SR) AH] 6,000

(continued)
Recording Variable Overhead

Manufacturing Applied (SQ x SP) 400,000
Manufacturing Overhead (Actual) 410,000

Various Accounts 410,000

(continued)
Recording Fixed Overhead

Manufacturing Overhead Applied 320,000
Manufacturing Overhead (Actual) 300,000

Various Accounts 300,000

(continued)
Recording O/H Variances and Closing the O/H Accounts
Manufacturing O/H Applied (Variable) 400,000

Manufacturing O/H Applied (Fixed) 320,000
OSV (Variable) 20,000
Manufacturing Overhead (Variable) 410,000
Manufacturing Overhead (Fixed) 300,000
OEV (Variable) 10,000
OSV (Fixed) 10,000
DV (Fixed) 10,000

(continued)
Disposition of Overhead Variances
OEV (Variable) 10,000

OSV (Fixed) 10,000
DV (Fixed) 10,000
OSV (Variable) 20,000
Cost of Goods Sold 10,000

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14

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-1

 Explain how unit standards are set and

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-2

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-3

 Prepare journal entries for materials and

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-4

To determine the unit standard cost for a

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-5

Ideal Standards demand

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-6

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-7

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-8

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-9

 To improve planning and control

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-10

Actual costing system Actual Actual Actual

Normal costing system Actual Actual Budgeted

Standard costing system Standard Standard Standard

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-11

Direct materials $1.50/kg. 10 kgs. $15.00

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-12

Actual Quantity of Actual Quantity of Standard Quantity of

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-13

Variances are investigated if two

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-14

Investigating occurs for values

Example: Assume the allowable deviation may be the

Answer: Yes. Ten percent of standard is $5,000. Since

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-15

SQ = 20,000 units x 10 lbs per unit

210,000 x $1.55 210,000 x $1.50 205,000 x $1.50 200,000 x $1.50

MPV = $10,500U MUV = $7,500U

Flexible Budget Variance = $18,000U

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-16

SQ = 20,000 units x 2 hrs. per unit

LRV = $3,900 U LEV = $6,000 F

Flexible Budget Variance = $2,100 F

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-17

SQ = 20,000 units x 2 hrs. per unit

OSV = $20,000 U OEV = $10,000 F

Flexible Budget Variance = $10,000 U

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-18

OSV = $10,000F DV = 10,000F

Alternative Approach for Computing FOH Denominator Variance

Planned level 38,750 hrs.

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-19

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-20

 The profit volume variance can be

 In the next slide, assume that the master

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-21

Master Budget Flexible Budget Actual

Comparing the flexible to the static (master) budget isolates the

Profit volume variance = 18,000 – 30,000 =$ - 12,000 (U)

Total variances =$ - 21,000 (U)

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-22

Variable Costs 40,000 44,000 32,000 39,000

Contribution 60,000 66,000 48,000 43,000

Operating Income 30,000 36,000 18,000 9,000

Industry volume variance = 36,000 – 30,000 = $ 6,000 (F)

Copyright © 2004 by Nelson, a division of Thomson Canada Limited. 14-23

 Assume further that the actual sales mix would

 How much is the Sales Mix Variance?

The following spreadsheet includes a