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Managerial Accounting
by James Jiambalvo
Chapter 9:
Standard Costs and Variance
Analysis
Slides Prepared by:
Scott Peterson
Northern State University
Chapter 9: Standard Costs
and Variance Analysis
Chapter Themes:

It’s all about standards
and benchmarks.

It is important to measure
actual values against
goals and standards.

Responsibility should be
commensurate with
controllability.
Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Standard Costs
The term standard cost refers
to the cost that management
believes should be incurred
to produce a good or service
under anticipated conditions.
The primary benefit of a
standard cost system is that
it allows for comparison of
standard versus actual costs.
Differences are referred to as
standard cost variances and
should be investigated if
significant.
Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Standard Costs and Budgets
At the outset, it is important
to understand the subtle
differences in definitions of
standard cost and budgeted
cost.
Related Learning Objectives:
1.
2.
3.
Standard cost: the standard
cost of a single unit.
4.
5.
Budgeted cost: the cost, at
standard, of the total number
of budgeted units.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of Standard
Costs
1.
Standard costs are
developed in a variety of
ways. They are
specified in engineering
plans.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of Standard
Costs
1.
2.
Standard costs are
developed in a variety of
ways. They are
specified by formulas or
recipes.
developed from price lists
provided by suppliers.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of Standard
Costs
1.
2.
3.
Standard costs are
developed in a variety of
ways. They are
specified by formulas or
recipes.
developed from price lists
provided by suppliers.
determined time and motion
studies conducted by
industrial engineers.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Development of Standard
Costs
1.
2.
3.
4.
Standard costs are
developed in a variety of
ways. They are
specified by formulas or
recipes.
developed from price lists
provided by suppliers.
determined time and motion
studies conducted by
industrial engineers.
developed from analyses of
past data.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Ideal Versus Attainable
Standards
In developing standard costs,
there are two schools of thought.
Ideal standards: developed
under the assumption that no
obstacles to the production
process will be encountered.
They are sometimes referred to
as perfection standards.
Attainable Standards: developed
under the assumption that there
will be occasional problems in
the production process such as
equipment failure, labor
turnover, and materials defects.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
A General Approach to
Variance Analysis
An analysis of the difference
between a standard cost and and
actual cost is called variance
analysis. The process
decomposes the difference in
two components.
For direct material: materials
price and materials quantity
variance.
For direct labor: labor rate (price)
and labor efficiency (quantity)
variance.
For overhead: overhead volume
variance and controllable
overhead variance.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret
variances for direct material.
Calculate and interpret
variances for direct labor.
Calculate and interpret
variances for manufacturing
overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Material Price Variance
The material price variance is
expressed as (AP – SP)AQp
where:
(AP) = actual price per unit of
material.
(SP) = standard price per unit of
direct material.
(AQp) = actual quantity of
material purchased.
If actual price > standard price,
then the variance is unfavorable.
If actual price < standard price,
then the variance is favorable.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret
variances for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Material Quantity Variance
The material quantity variance is
expressed as (AQu – SQ)SP
where:
(AQu) = actual quantity of
material used.
(SQ) = standard quantity of
material allowed.
(SP) = standard price of
material.
If actual quantity > standard
quantity, then the variance is
unfavorable.
If actual quantity < standard
quantity, then the variance is
favorable.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret
variances for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Labor Rate Variance
The labor rate (price) variance is
expressed as (AR – SR)AH
where:
(AR) = actual wage rate (price).
(SR) = standard wage rate
(price).
(AH) = actual number(quantity) of
labor hours.
If actual rate > standard rate,
then the variance is unfavorable.
If actual rate < standard rate,
then the variance is favorable.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret
variances for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Labor Efficiency Variance
The labor efficiency (quantity)
variance is expressed as (AH –
SH)SR where:
(AH) = actual number of hours
worked.
(SH) = standard number of
hours worked.
(SR) = standard labor wage rate.
If actual hours > standard hours,
then the variance is unfavorable.
If actual hours < standard hours,
then the variance is favorable.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret
variances for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Controllable Overhead
Variance
The controllable overhead
variance is expressed as (actual
overhead - flexible budget level
of overhead) for actual level of
production. It is referred to as
controllable because managers
are expected to control costs so
they are not substantially
different from budget.
If actual > budget, then the
variance is unfavorable.
If actual < budget, then the
variance is favorable.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret
variances for manufacturing
overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Overhead Volume Variance
The overhead volume variance is
expressed as (flexible budget
level of overhead for actual level
of production - overhead applied
to production using standard
overhead rate). This variance is
solely the product of more or
less units being produced than
planned in the static budget. Its
usefulness is limited.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret
variances for manufacturing
overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Investigation of Standard Cost
Variances
It is important to note that
standard cost variances are not
a definitive sign of good or bad
performance. These variances
are merely indicators of potential
problems which must be
investigated. And there are many
plausible explanations for them.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret
variances for direct material.
Calculate and interpret
variances for direct labor.
Calculate and interpret
variances for manufacturing
overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Management by Exception
Because investigation of
standard cost variances is itself
a costly activity, management
must decide which variances to
investigate. Most managers
practice management by
exception. What is
“exceptional?” Usually an
absolute dollar amount or a
percentage dollar amount.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
“Favorable” Variances May Be
Unfavorable
The fact that a variance is
“favorable” does not mean that it
should not be investigated. Raw
materials are good examples of
this phenomenon, especially
considering the competitive
pricing environment for most
commodities. Suppose inferior,
low-priced materials are ordered.
One the one hand, a favorable
price variance will arise. On the
other hand, most likely there will
be substantially more scrap and
rework, and thus a higher
quantity variance.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret variances
for direct material.
Calculate and interpret variances
for direct labor.
Calculate and interpret variances
for manufacturing overhead.
Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Responsibility Accounting and
Variances
As noted previously,
managers should be held
responsible only for costs
they can control. This is true
in the area of variance
analysis. For example, a
purchasing agent may be
held responsible for direct
material price variances, but
certainly not direct material
quantity (usage) variances.
Related Learning Objectives:
1.
2.
3.
4.
5.
Explain how standard costs are
developed.
Calculate and interpret
variances for direct material.
Calculate and interpret
variances for direct labor.
Calculate and interpret
variances for manufacturing
overhead.
Discuss how the management
by exception approach is
applied to investigation of
standard cost variances.
Appendix A: Recording
Standard Costs in Accounts
In a standard costing system,
the costs added to the Raw
Materials Inventory, Work in
Process Inventory, Finished
Goods Inventory, and Cost of
Goods Sold accounts are all
recorded at standard rather
than actual cost. Variances
are also calculated and
recorded for management’s
use in performance
evaluation.
Related Learning Objectives:
1.
Record standard costs in the
account of a manufacturing
firm.
Recording Material Costs
Purchase of raw materials inventory:
Account
dr.
cr.
Raw Material Inventory (std.)
x
Material Price Variance
x
Accounts Payable (actual)
x
(This is an unfavorable price variance)
Usage of raw materials inventory:
Account
dr.
cr.
Work in Process Inventory
x
Material Quantity Variance
x
Raw Material Inventory
x
(This is an unfavorable quantity variance)
Related
Learning
Objectives:
Record standard
costs in the
account of a
manufacturing firm.
Recording Labor Cost
Account
dr.
cr.
Work in Process Inventory (std.) x
Labor Rate Variance
x
Labor Efficiency Variance
x
Salaries Payable (actual)
x
(Note: both the labor rate variance and
efficiency variance are unfavorable)
Related
Learning
Objectives:
Record standard
costs in the
account of a
manufacturing firm.
Recording Manufacturing
Overhead
Recording manufacturing overhead in a
standard costing system is a three-step
process:
1.
2.
3.
Actual overhead is recorded in the
manufacturing overhead account.
Overhead is applied to Work in Process
Inventory at the standard cost.
The difference between actual overhead
and overhead applied at standard is
closed and overhead variances are
identified.
More
Related
Learning
Objectives:
Record standard
costs in the
account of a
manufacturing firm.
Recording Manufacturing
Overhead (Step 1)
To record actual overhead cost:
Account
Manufacturing Overhead
*Various Accounts
dr.
x
cr.
*Various accounts include indirect wages
payable, utilities payable and accumulated
depreciation.
x
Related
Learning
Objectives:
Record standard
costs in the
account of a
manufacturing firm.
Recording Manufacturing
Overhead (Step 2)
To apply overhead cost to work in process
inventory at cost:
Related
Learning
Objectives:
Account
dr.
Work in Process Inventory
x
Manufacturing Overhead
Record standard
costs in the
account of a
manufacturing firm.
cr.
x
Recording Manufacturing
Overhead (Step 3)
To close out manufacturing overhead cost to
work in process inventory at cost:
Related
Learning
Objectives:
Account
Manufacturing Overhead
Overhead Volume
Variance
Controllable Overhead
Variance
Record standard
costs in the
account of a
manufacturing firm.
dr.
x
cr.
x
x
Recording Finished Goods
To record completed units sent to finished
goods:
Related
Learning
Objectives:
Account
Finished Goods Inventory
Work in Process
Inventory
Record standard
costs in the
account of a
manufacturing firm.
dr.
x
cr.
x
Recording Cost of Goods Sold
To apply overhead cost to work in process
inventory at cost:
Related
Learning
Objectives:
Account
Cost of Goods Sold
Finished Goods
Inventory
Record standard
costs in the
account of a
manufacturing firm.
dr.
x
cr.
x
Closing Variance Accounts
At the end of the accounting period, the
temporary variance accounts must be closed.
As a practical matter this is usually
accomplished by debiting or crediting the
variances to cost of goods sold.
Account
dr.
cr.
Cost of Goods Sold
x
Overhead Volume Variance
x
Controllable Overhead Variance x
Material Price Variance
x
Material Quantity Variance
x
Labor Rate Variance
x
Labor Efficiency Variance
x
Related
Learning
Objectives:
Record standard
costs in the
account of a
manufacturing firm.
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