Chapter 10: Standard Costs and Variances

Standard Costs Standards are benchmarks or “norms” for measuring performance. In managerial accounting, two types of standards are commonly used.

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Standard Costs and VariancesChapter 10Standard CostsStandards are benchmarks or “norms” for measuring performance. In managerial accounting,two types of standards are commonly used.Quantity standards specify how much of an input should be used to make a product or provide a service.Price standards specify how much should be paid for each unit of the input.Examples: Firestone, Sears, McDonald’s, hospitals, construction, and manufacturing companies.Setting Direct Materials Standards Standard Price per UnitSummarized in a Bill of Materials.Final, delivered cost of materials, net of discounts.Standard Quantity per UnitSetting Direct Labor Standards Use time and motion studies for each labor operation.Standard Hours per UnitOften a single rate is used that reflects the mix of wages earned.Standard Rate per HourSetting Variable Manufacturing Overhead Standards The rate is the variable portion of the predetermined overhead rate.Price StandardThe quantity is the activity in the allocation base for predetermined overhead.Quantity StandardA General Model for Variance AnalysisVariance AnalysisQuantity VarianceDifference between actual quantity and standard quantityPrice VarianceDifference between actual price and standard pricePrice and Quantity StandardsPrice 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. Variance AnalysisMaterials quantity varianceLabor efficiency varianceVOH efficiency varianceA General Model for Variance AnalysisPrice VarianceQuantity VarianceMaterials price variance Labor rate variance VOH rate varianceA General Model for Variance AnalysisPrice Variance (2) – (1)Quantity Variance (3) – (2)(3)Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)(2) Actual Quantity of Input, at Standard Price (AQ × SP)(1) Actual Quantity of Input, at Actual Price (AQ × AP)Spending Variance (3) – (1)A General Model for Variance AnalysisActual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used.Price Variance (2) – (1)Quantity Variance (3) – (2)(3)Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)(2) Actual Quantity of Input, at Standard Price (AQ × SP)(1) Actual Quantity of Input, at Actual Price (AQ × AP)Spending Variance (3) – (1)A General Model for Variance Analysis Standard quantity is the standard quantity allowed for the actual output of the period.Price Variance (2) – (1)Quantity Variance (3) – (2)(3)Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)(2) Actual Quantity of Input, at Standard Price (AQ × SP)(1) Actual Quantity of Input, at Actual Price (AQ × AP)Spending Variance (3) – (1)A General Model for Variance Analysis Actual price is the amount actually paid for the input used.Price Variance (2) – (1)Quantity Variance (3) – (2)(3)Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)(2) Actual Quantity of Input, at Standard Price (AQ × SP)(1) Actual Quantity of Input, at Actual Price (AQ × AP)Spending Variance (3) – (1)A General Model for Variance Analysis Standard price is the amount that should have been paid for the input used.Price Variance (2) – (1)Quantity Variance (3) – (2)(3)Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)(2) Actual Quantity of Input, at Standard Price (AQ × SP)(1) Actual Quantity of Input, at Actual Price (AQ × AP)Spending Variance (3) – (1) Materials Price VarianceMaterials Quantity VarianceProduction ManagerPurchasing ManagerThe 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 Materials VariancesResponsibility for Labor VariancesProduction ManagerProduction managers are usually held accountable for labor variances because they can influence the:Mix of skill levels assigned to work tasks. Level of employee motivation.Quality of production supervision.Quality of training provided to employees.Advantages of Standard CostsStandard costs are a key element of the management by exception approach.AdvantagesStandards can provide benchmarks that promote economy and efficiency.Standards can greatly simplify bookkeeping.Standards can support responsibility accounting systems.Potential ProblemsIf variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions. Standard cost variance reports are usually prepared on a monthly basis and may contain information that is outdated. Potential Problems with Standard CostsLabor variances assume that the production process is labor-paced and that labor is a variable cost. These assumptions are often invalidin today’s automated manufacturing environment where employees are essentially a fixed cost. Excessive emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction.In some cases, a “favorable” variance can be as bad or worse than an unfavorable variance. Just meeting standards may not be sufficient; continuous improvement may be necessary to survive in a competitive environment.Potential Problems with Standard CostsPotential ProblemsEnd of Chapter 10