Chapter 7

Standard Costs

Lectured by: Associate Professor, Noun Rachana

Standard Costs

Standards are benchmarks or “norms”

for measuring performance. Two types
of standards are commonly used.

Quantity standards Cost (price)

specify how much of an standards specify
input should be used to how much should be
make a product or paid for each unit
provide a service. of the input.
Standard Costs
Deviations from standard deemed significant
are brought to the attention of management, a
practice known as management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

Exh.
10-1

Variance Analysis Cycle

Take
Identify Receive corrective
questions explanations actions

Conduct next
Analyze period’s
variances operations

Prepare standard
Begin
cost performance
report
Learning Objective
LO1

To explain how direct

materials standards and
direct labor standards are set
Setting Standard Costs
Accountants, engineers, purchasing
agents, and production managers
combine efforts to set standards that
encourage efficient future production.
Setting Standard Costs
Should we use I recommend using practical
ideal standards that standards that are currently
require employees to attainable with reasonable and
work at 100 percent efficient effort.
peak efficiency?

Engineer Managerial
Accountant
Setting Direct Material Standards

Price Quantity
Standards Standards

Final, delivered Summarized in

cost of materials, a Bill of Materials.
net of discounts.
Setting Standards

The zero defects mentality that underlies

improvement programs such as Six Sigma
advocate for the elimination defects and waste,.

If allowances for waste and spoilage are built

into the standard quantity, those allowances
should be reduced over time.
Setting Direct Labor Standards

Rate Time
Standards Standards

Often a single Use time and

rate is used that reflects motion studies for
the mix of wages earned. 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.
Price and Quantity Standards

Price and and quantity standards are

determined separately for two reasons:

 The purchasing manager is responsible for raw

material purchase prices and the production manager
is responsible for the quantity of raw material used.

 The buying and using activities occur at different times.

Raw material purchases may be held in inventory for a
period of time before being used in production.
A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Difference between Difference between

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

Variance Analysis

Price Variance Quantity Variance

Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH spending variance VOH efficiency variance
A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Actual quantity is the amount of direct

materials, direct labor, and variable
manufacturing overhead actually used.
A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard quantity is the standard quantity

allowed for the actual output for the period.
A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Actual price is the amount actually

paid for the input used.
A General Model for Variance Analysis

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 input used.
A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

(AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
Learning Objective
LO2

To compute the direct

materials price and quantity
variances and explain their
significance
Material Variances Example
Glacier Peak Outfitters has the following
direct material standards 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 Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× × ×
$4.90 per kg. $5.00 per kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable
Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× $1,029  ×
210 kgs ×
$4.90 per kg. $5.00per
= $4.90 perkg
kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable
Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× 0.1 kg per parka× 2,000 parkas ×
$4.90 per kg. $5.00
= 200 per
kgs kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable
Material Variances:
Using the Factored Equations
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)
= $50 U
Isolation of Material Variances
I’ll start computing
I need the price variance the price variance
sooner so that I can better
when material is
identify purchasing problems.
purchased rather than
You just don’t when it’s used.
understand the problems that
purchasing managers have.
Material Variances

The price variance is

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

Materials Quantity Variance Materials Price Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity variance

so that the production manager is not held responsible for
the purchasing manager’s performance.
Responsibility for Material Variances

Your poor scheduling

I am not responsible for sometimes requires me to
this unfavorable material rush order material at a
quantity variance. higher price, causing
You purchased cheap unfavorable price variances.
material, so my people
had to use more of it.
Quick Check 
Zippy

Hanson Inc. has the following direct

materials 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.
Quick Check 
Zippy

Hanson’s material price variance

(MPV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
Quick Check 
Zippy

Hanson’s 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
Quick Check 
Zippy

Hanson’s material quantity variance

(MQV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
Quick Check 
Zippy

Hanson’s material quantity variance

(MQV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
Quick Check 
Zippy

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
Quick Check  Continued
Zippy

Hanson Inc. has the following materials

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.
Quick Check  Continued
Zippy

Actual Quantity Actual Quantity

Purchased Purchased
× ×
Actual Price Standard Price
2,800 lbs. 2,800 lbs.
× ×
$3.90 per lb. $4.00 per lb.
= $10,920 = $11,200

Price variance increases

Price variance because quantity
$280 favorable purchased increases.
Quick Check  Continued
Zippy

Actual Quantity
Used Standard Quantity
× ×
Standard Price Standard Price
1,700 lbs. 1,500 lbs.
× ×
$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
Learning Objective
LO3

To compute the direct labor

rate and efficiency variances
and explain their significance
Labor Variances Example

Glacier Peak Outfitters has the following

direct labor standard for its mountain parka.
1.2 standard hours per parka at $10.00 per hour

Last month, employees actually worked

2,500 hours at a total labor cost of $26,250
to make 2,000 parkas.
Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× × ×
$10.50 per hour $10.00 per hour. $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable
Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× $26,250×  2,500 hours ×
$10.50 per hour $10.00 per hour.
= $10.50 per hour $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable
Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× 1.2 hours per ×parka  2,000 ×
$10.50 per hour parkas
$10.00 per hour.
= 2,400 hours $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable
Labor Variances:
Using the Factored Equations
Labor rate variance
LRV = AH (AR - SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable
Labor efficiency variance
LEV = SR (AH - SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable
Responsibility for Labor Variances
Production managers are Mix of skill levels
usually held accountable assigned to work tasks.
for labor variances
because they can
Level of employee
influence the:
motivation.

Quality of production
supervision.

Quality of training
provided to employees.
Production Manager
Responsibility for
Labor Variances
I think it took more time
to process the
I am not responsible for materials because the
the unfavorable labor Maintenance
efficiency variance! Department has poorly
maintained your
You purchased cheap equipment.
material, so it took more
time to process it.
Quick Check 
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

Hanson’s labor rate variance (LRV) for

the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
Quick Check 
Zippy

Hanson’s labor rate variance (LRV) for

the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
LRV = AH(AR - SR)
d. $300 favorable.
LRV = 1,550 hrs($12.20 - $12.00)
LRV = $310 unfavorable
Quick Check 
Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
Quick Check 
Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
LEV = SR(AH - SH)
LEV = $12.00(1,550 hrs - 1,500 hrs)
LEV = $600 unfavorable
Quick Check 
Zippy

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
Learning Objective
LO4

To compute the variable

manufacturing overhead
spending and efficiency
variances
Variable Manufacturing Overhead Variances
Example
Glacier Peak Outfitters has the following
direct variable manufacturing overhead
labor standard for its mountain parka.
1.2 standard hours per parka at $4.00 per hour

Last month, employees actually worked

2,500 hours to make 2,000 parkas. Actual
variable manufacturing overhead for the
month was $10,500.
Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× × ×
$4.20 per hour $4.00 per hour $4.00 per hour
= $10,500 = $10,000 = $9,600

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable
Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× $10,500×  2,500 hours ×
$4.20 per hour $4.00 per per
= $4.20 hourhour $4.00 per hour
= $10,500 = $10,000 = $9,600

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable
Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× 1.2 hours per ×parka  2,000 ×
$4.20 per hour parkas$4.00 per hour
= 2,400 hours $4.00 per hour
= $10,500 = $10,000 = $9,600

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable
Variable Manufacturing Overhead
Variances: Using Factored Equations
Variable manufacturing overhead spending
variance
VMSV = AH (AR - SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
Variable manufacturing overhead efficiency
variance
VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
Quick Check 
Zippy

Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Zippy:
1.5 standard hours per Zippy at $3.00 per
direct labor hour

Last week, 1,550 hours were worked to make

1,000 Zippies, and $5,115 was spent for
variable manufacturing overhead.
Quick Check 
Zippy

Hanson’s spending variance (VOSV) for

variable manufacturing overhead for
the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.
Quick Check 
Zippy

Hanson’s spending variance (VOSV) for

variable manufacturing overhead for
the week was:
a. $465 unfavorable.
b. $400 favorable.
VOSV = AH(AR - SR)
c. $335 unfavorable.
VOSV = 1,550 hrs($3.30 - $3.00)
d. $300 favorable. VOSV = $465 unfavorable
Quick Check 
Zippy

Hanson’s efficiency variance (VOEV) for

variable manufacturing overhead for the
week was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.
Quick Check 
Zippy

Hanson’s efficiency variance (VOEV) for

variable manufacturing overhead for the
week was:
a. $435 unfavorable.
b. $435 favorable. 1,000 units × 1.5 hrs per unit
c. $150 unfavorable.
d. $150 favorable.
VOEV = SR(AH - SH)
VOEV = $3.00(1,550 hrs - 1,500 hrs)
VOEV = $150 unfavorable
Quick Check 
Zippy

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$3.30 per hour $3.00 per hour $3.00 per hour
= $5,115 = $4,650 = $4,500

Spending variance Efficiency variance

$465 unfavorable $150 unfavorable
Variance Analysis and
Management by Exception

Larger variances, in
How do I know dollar amount or as
which variances to a percentage of the
investigate? standard, are
investigated first.
Advantages of Standard Cost Systems
Standard costs are a key element of the
management by exception approach which
helps managers focus their attention on the
most important issues.
• Standards that are viewed as reasonable by employees
can serve as benchmarks that promote economy and
efficiency.
• Standard costs can greatly simplify
bookkeeping.
• Standard costs fit naturally into a responsibility
accounting system.
Potential Problems with Standard Costs
Emphasizing standards Favorable
may exclude other variances may
important objectives. be misinterpreted.

Potential
Standard cost Problems Emphasis on
reports may negative may
not be timely. impact morale.

Invalid assumptions Continuous

about the relationship improvement may
between labor be more important
cost and output. than meeting standards.
The Balanced Scorecard

A balanced scorecard consists of an

integrated set of performance measures
that are derived from and support a
company’s strategy.

Specific
Company
Strategy

Performance measures included in the balanced scorecard.

The Balanced Scorecard: From
Nonfinancial Performance Measures
Specific
Company
Strategy

Financial Nonfinancial
Performance Performance
Measures Measures

Example: Examples:
Standard Cost Variances. Product Quality
Customer Satisfaction.
Appendix 8A

General Ledger Entries

to Record Variances.
Learning Objective
LO5

Prepare journal entries to

record standard costs and
variances
Appendix 8A
Journal Entries to Record Variances
We will use information from the Glacier Peak Outfitters
example presented earlier in the chapter to illustrate journal
entries for standard cost variances. Recall the following:

Material Labor
AQ × AP = $1,029 AH × AR = $26,250
AQ × SP = $1,050 AH × SR = $25,000
SQ × SP = $1,000 SH × SR = $24,000
MPV = $21 F LRV = $1,250 U
MQV = $50 U LEV = $1,000 U

Now, let’s prepare the entries to record

the labor and material variances.
Appendix 8A
Direct Material Variances

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Raw Materials 1,050
Materials Price Variance 21
Accounts Payable 1,029
To record the purchase of material

Work in Process 1,000

Materials Quantity Variance 50
Raw materials 1,050
To record the use of material
Appendix 8A
Direct Labor Variances

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process 24,000
Labor Rate Variance 1,250
Labor Efficiency variance 1,000
Wages Payable 26,250
To record direct labor

Variable manufacturing overhead variances are usually not

recorded in the accounts separately, but are determined as part of
the general analysis of overhead.
Cost Flows in a Standard Cost System
 Inventories are recorded at standard cost.
 Variances are recorded as follows:
 Favorable variances are credits, representing savings
in production costs.
 Unfavorable variances are debits, representing excess
production costs.
 Standard cost variances are usually closed to
cost of goods sold.
 Favorable variances decrease cost of goods sold.
 Unfavorable variances increase cost of goods sold.
End of Chapter 8