Chapter 10

Standard Costing and

Analysis of Direct
Costs

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Learning Objective 10-1 – Describe the elements of a cost
control system.

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10-2
 Managing Costs
Standard Actual
cost cost

Comparison between
standard and actual
performance
level

Cost
variance
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10-3
 Management by Exception
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception..

Standard
Amount

Direct
Material
Direct
Labor

Type of Product Cost

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10-4
Learning Objective 10-2 – Describe two ways to set cost
standards and distinguish between perfection and practical
standards.

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10-5
 Setting Standards

Cost
Standards

Analysis of Task
Historical Data Analysis

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 Participation in Setting Standards

Accountants, engineers, personnel administrators, and

production managers combine efforts to set standards
based on experience and expectations.

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10-7
 Perfection versus Practical Standards:
A Behavioral Issue 1/2
Question: Should we use practical (attainable)
standards or perfection standards?

Perfection standards are

unattainable and therefore
discouraging to most
employees.
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 Perfection versus Practical Standards:
A Behavioral Issue 2/2

Practical standards should

be set at levels that are
currently attainable with
reasonable and efficient
effort.

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10-9
 Use of Standards by Service
Organizations

Standard cost analysis may be used in

any organization with repetitive tasks.
A relationship between tasks and output
measures must be established.

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10-10
Learning Objective 10-3 – Compute and interpret the direct-
material price and quantity variances and the direct-labor
rate and efficiency variances.

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10-11
 Cost Variance Analysis

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.

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10-12
 A General Model for Variance Analysis 1/3

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

  AQ(AP
Materials priceSP)
variance SP(AQ
Materials SQ)variance
quantity
Labor rate variance Labor efficiency variance
AQ =Variable
Actual overhead
Quantity SP = Standard
Variable Price
overhead
AP = spending
Actual Price
variance SQ = Standard
efficiency Quantity
variance
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A General Model for Variance Analysis 2/3

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard price is the amount that should

have been paid for the resources acquired.

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A General Model for Variance Analysis 3/3

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard quantity is the quantity that should

have been used.

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10-15
 Standard Costs 1/2

Let’s use the concepts

of the general model to
calculate standard cost
variances, starting with
direct material.

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10-16
 Material Variances 1/13

Hanson Inc. has the following direct

material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were
purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.
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10-17
 Material Variances 2/13

What is the actual price per pound

paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.
c. $3.90 per pound.
d. $6.63 per pound.

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10-18
 Material Variances 3/13

What is the actual price per pound

paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.
AP = $6,630 ÷ 1,700 lbs.
c. $3.90 per pound. AP = $3.90 per lb.
d. $6.63 per pound.

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10-19
 Material Variances 4/13
Hanson’s direct-material price variance
(MPV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

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10-20
 Material Variances 5/13
Hanson’s direct-material price variance
(MPV) for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
  MPV = AQ(AP SP)
d. $800 favorable.MPV = 1,700 lbs. × ($3.90 4.00)
MPV = $170 Favorable

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10-21
 Material Variances 6/13

The standard quantity of material that

should have been used to produce
1,000 Zippies is:

a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.
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10-22
 Material Variances 7/13

The standard quantity of material that

should have been used to produce
1,000 Zippies is:
SQ = 1,000 units ×
a. 1,700 pounds. 1.5 lbs. per unit
SQ = 1,500 lbs.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.

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10-23
 Material Variances 8/13

Hanson’s direct-material quantity

variance (MQV) for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
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10-24
 Material Variances 9/13

Hanson’s direct-material quantity

variance (MQV) for the week was:

= SP(AQ SQ)   MQV

a. $170 unfavorable.
MQV = $4.00(1,700 lbs. 1,500 lbs.)
b. $170 favorable.MQV = $800 unfavorable
c. $800 unfavorable.
d. $800 favorable.

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10-25
 Material Variances Summary

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price
1,700 lbs. 1,700 lbs. 1,500 lbs.
× × ×
$3.90 per lb. $4.00 per lb. $4.00 per
lb.
$6,630 $ 6,800 $6,000

Price variance Quantity variance

$170 favorable $800 unfavorable
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10-26
 Material Variances 10/13

Hanson purchased The price variance

and used 1,700 is computed on the
pounds. How are entire quantity
the variances purchased.
computed if the The quantity
amount purchased variance is
differs from the computed only on
amount used? the quantity used.

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10-27
 Material Variances 11/13

Hanson Inc. has the following material

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 2,800 pounds of material were
purchased at a total cost of $10,920, and
1,700 pounds were used to make 1,000
Zippies.
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10-28
 Material Variances 12/13

Actual Quantity Actual Quantity

Purchased Purchased
× ×  MPV = AQ(AP SP)
Actual Price Standard Price
MPV = 2,800 lbs.
2,800 lbs. 2,800 lbs. ×
× × ($3.90 $4.00)
$3.90 per lb. $4.00 per lb. MPV = $280
Favorable
$10,920 $11,200

Price variance increases

Price variance because quantity
$280 favorable purchased increases.
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10-29
 Material Variances 13/13

Actual Quantity
Used Standard Quantity
  MQV
× ×
= SP(AQ SQ) Standard Price Standard Price
MQV = $4.00(1,700 lbs.
1,500 lbs.) 1,700 lbs. 1,500 lbs.
MQV = $800 unfavor. × ×
$4.00 per lb. $4.00 per lb.
$6,800 $6,000
Quantity variance is
unchanged because
actual and standard Quantity variance
quantities are unchanged. $800 unfavorable
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10-30
 Standard Costs 2/2

Now let’s
calculate
standard cost
variances for
direct labor.

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10-31
 Labor Variances 1/9

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at $10.00 per
direct labor hour
Last week 1,550 direct labor hours were
worked at a total labor cost of $15,810 to
make 1,000 Zippies.

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10-32
 Labor Variances 2/9

What was Hanson’s actual rate (AR)

for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.
c. $9.90 per hour.
d. $9.80 per hour.

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10-33
 Labor Variances 3/9

What was Hanson’s actual rate (AR)

for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.
AR = $15,810 ÷ 1,550
c. $9.90 per hour. hours
d. $9.80 per hour. AR = $10.20 per hour

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 Labor Variances 4/9

Hanson’s labor rate variance (LRV)

for the week was:

a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.

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10-35
 Labor Variances 5/9

Hanson’s labor rate variance (LRV)

for the week was:

a. $310 unfavorable.
b. $310 favorable.
  LRV = AH(AR SR)
c. $300 unfavorable.
LRV = 1,550 hrs. ($10.20
d. $300 favorable. $10.00)
LRV = $310 unfavorable

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10-36
 Labor Variances 6/9

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:

a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
d. 1,800 hours.
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10-37
 Labor Variances 7/9

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:

a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours. SH = 1,000 units × 1.5
d. 1,800 hours. hours per unit
SH = 1,500 hours
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10-38
 Labor Variances 8/9

Hanson’s labor efficiency variance (LEV)

for the week was:

a. $510 unfavorable.
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.

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10-39
 Labor Variances 9/9

Hanson’s labor efficiency variance (LEV)

for the week was:
= SR(AH SH)   LEV
LEV = $10.00(1,550 hrs. 1,500
a. $510 unfavorable.
hrs.)
b. $510 favorable.LEV = $500 unfavorable
c. $500 unfavorable.
d. $500 favorable.

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10-40
 Labor Variances Summary

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$10.20 per hour $10.00 per hour $10.00 per hour
$15,810 $15,500 $15,000

Rate variance Efficiency variance

$310 unfavorable $500 unfavorable
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10-41
Learning Objective 10-4 – Explain several methods for
determining the significance of cost variances.

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10-42
 Significance of Cost Variances
• Size of variance
What clues help • Dollar amount
me • Percentage of
to determine the standard
variances that I • Recurring variances
should • Trends
investigate? • Controllability
• Favorable variances
• Costs and benefits of
investigation
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10-43
 Statistical Control Chart

Warning signals for investigation

Favorable Limit
• •
• • •
Desired Value
• •
Unfavorable Limit •
•
1 2 3 4 5 6 7 8 9
Variance Measurements

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10-44
Learning Objective 10-5 – Describe some behavioral effects
of standard costing.

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10-45
Behavioral Impact of Standard Costing

If I buy cheaper materials, my

direct-materials expenses will be
lower than what is budgeted.
Then I’ll get my bonus. But we
may lose customers because of
lower quality

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10-46
 Controllability of Variances

Direct-Material Direct-Material
Price Variance Quantity Variance

Purchasing
Manager?
Production
Supervisor?

Direct-Labor Direct-Labor
Rate Variance Efficiency Variance
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10-47
 Interaction among Variances
Interactions among variances can make it difficult to
determine the responsibility for a particular variance.

Example:
A company makes a conscious decision to use a lower-grade raw
material to save money, realizing that scrap and/or direct-labor
costs might increase slightly. Should they do it??

 It will cause potentially an unfavorable direct-labor efficiency

variance and an unfavorable direct-material quantity variance!!!!
 If the amount of the favorable direct-material price variance
exceeds these however, the company may have made a wise
decision.

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10-48
Learning Objective 10-6 – Explain how standard costs are
used in product costing.

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10-49
Standard Costs and Product Costing

Standard
Standard material
material and
and labor
labor costs
costs
are
are entered
entered into
into Work-in-Process
Work-in-Process
inventory
inventory instead
instead of
of actual
actual costs.
costs.

Standard
Standard cost
cost variances
variances
are
are closed
closed directly
directly to
to
Cost
Cost of
of Goods
Goods Sold.
Sold.

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10-50
Learning Objective 10-7 – Summarize some advantages of
standard costing.

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10-51
 Advantages of Standard Costing
Sensible Cost Management by
Comparisons Exception

Advantages
Performance Employee
Evaluation Motivation

Stable Product
Costs

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10-52
Learning Objective 10-8 – Explain several common
criticisms of standard costing.

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10-53
 Criticisms of Standard Costing
Too aggregate, Not specific
too late

Too much focus Stable production

on direct-labor Disadvantages required

Shorter life Narrow

cycles definition

Focus on cost
minimization
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10-54
Learning Objective 10-9 – Prepare journal entries to record
and close out cost variances (appendix).

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10-55
Record the purchase of raw materials - T

Raw-material Inventory Accounts Payable

Actual quantity at Actual quantity at

standard cost actual cost

Direct-Material Price Variance

Unfavorable Favorable
variance variance

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10-56
Record the purchase of raw materials - JE

Journal Entry Debit Credit

Raw Material Inventory $6,800

Direct-Material Purchase Price $ 170
Variance
Accounts Payable 6,630

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10-57
 Record the use of raw materials in
production - T

Work-in-Process Inventory Raw-material Inventory

Standard quantity Actual quantity at

at standard price standard cost

Direct-Material Quantity Variance

Unfavorable Favorable
variance variance

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10-58
 Record the use of raw materials in
production - JE

Journal Entry Debit Credit

Work-in-Process Inventory $ 6,000

Direct-Material Quantity 800
Variance $ 6,800
Raw-Material Inventory

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10-59
 Record the use of direct-labor in
production - T
Work-in-Process Inventory Wages Payable

Standard quantity Actual quantity at

at standard price actual cost

Direct-Labor Rate Variance Direct-Labor Efficiency Variance

Unfavorable Favorable Unfavorable Favorable

variance variance variance variance

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10-60
 Record the use of direct-labor in
production - JE

Journal Entry Debit Credit

Work-in-Process Inventory $ 15,000

Direct-Labor Rate Variance 310
Direct-Labor Efficiency Variance 500
Wages Payable $15,810

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10-61
 Close variances to the cost of goods sold
account - T

Cost of Goods Sold

Unfavorable Favorable
variance variance

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10-62
 Close variances to the cost of goods sold
account - JE

Journal Entry Debit Credit

Cost of Goods Sold $ 1,440

Direct-Material Purchase Price 170
Direct-Labor Rate Variance
Variance $ 310
Direct-Labor Efficiency Variance 500
Direct-Material Quantity 800
Variance

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10-63
 End Chapter 10

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10-64