TM 10-1
AGENDA: STANDARD COSTS AND VARIANCES
A. Standard costs
1. Setting standard costs
a. Ideal vs. practical standards
b. Direct materials standards
c. Direct labor standards
d. Variable manufacturing overhead standards
2. Standard cost card
3. Computing variances
a. The general variance model
b. Direct materials variances
c. Direct labor variances
d. Variable manufacturing overhead variances
4. Potential problems with standard costs
5. (Appendix A) Predetermined overhead rates and overhead
analysis in standard costing systems
TM 10-2
SETTING STANDARD COSTS
• A standard is a benchmark or “norm” for measuring performance.
• Price standard: How much an input should cost.
• Quantity standard: How much of a given input should be used to
make a unit of output.
IDEAL VS. PRACTICAL STANDARDS
Ideal standards allow for no machine breakdowns or work interruptions,
and can be attained only by working at peak effort 100% of the time.
Such standards:
• often discourage workers.
• shouldn’t be used for decision making.
Practical standards allow for “normal” down time, employee rest
periods, and the like. Such standards:
• are felt to motivate employees because the standards are “tight but
attainable.”
• are useful for decision-making purposes because variances from
standard will contain only “abnormal” elements.
TM 10-3
DIRECT MATERIAL STANDARDS
Speeds, Inc. makes a popular jogging suit. The company wants to
develop standards for material, labor, and variable manufacturing
overhead.
The standard price per unit for direct materials should be the final,
delivered cost of materials. The standard price should reflect:
• Specified quality of materials.
• Discounts for quantity purchases.
• Discounts for early payment, if any.
• Transportation (freight) costs.
EXAMPLE: A material known as verilon is used in the jogging suits. The
standard price for a yard of verilon is determined as follows:
Purchase price, grade A verilon ................... $5.70
Less purchase discount in 20,000 yard lots .. (0.20)
Shipping by truck ....................................... 0.50
Standard price per yard .............................. $6.00
TM 10-4
DIRECT MATERIAL STANDARDS (continued)
The standard quantity per unit for direct materials is the amount of
material that should go into each finished unit of product. The standard
quantity should reflect:
• Engineered (bill of materials) requirements.
• Expected spoilage of raw materials.
• Unavoidable waste of materials in the production process.
• Materials in expected scrapped units (rejects).
EXAMPLE: The standard quantity of verilon in one jogging suit is
computed as follows:
Bill of materials requirement ........... 2.8 yards
Allowance for waste ....................... 0.6 yards
Allowance for rejects ...................... 0.1 yards
Standard quantity per jogging suit... 3.5 yards
Once the price and quantity standards have been set, the standard
cost of materials (verilon) for one unit of finished product can be
computed:
3.5 yards per jogging suit × $6 per yard = $21 per jogging suit
TM 10-5
DIRECT LABOR STANDARDS
The standard rate per hour for direct labor should include all the
costs of direct labor workers, including:
• Hourly wage rates.
• Fringe benefits.
• Employment taxes.
Many companies prepare a single standard rate for all employees in a
department, based on the expected mix of high and low wage rate
employees. This procedure:
• Simplifies the use of standard costs
• Allows monitoring the actual mix of employees in the department
EXAMPLE: The standard rate per hour for the expected labor mix is
determined by using average wage rates, fringe benefits, and
employment taxes as follows:
Average wage rate per hour .............. $13
Average fringe benefits...................... 4
Average employment taxes ................ 1
Standard rate per direct labor-hour .... $18
TM 10-6
DIRECT LABOR STANDARDS (continued)
The standard hours per unit for direct labor specifies the amount of
direct labor time required to complete one unit of product. This standard
time should include:
• Engineered labor time per unit.
• Allowance for breaks, personal needs, and cleanup.
• Allowance for setup and other machine downtime.
• Allowance for rejects.
EXAMPLE: The standard hours required to produce a jogging suit have
been determined as follows:
Basic labor time per unit .................. 1.4 hours
Allowance for breaks and cleanup .... 0.1 hours
Allowance for setup and downtime ... 0.3 hours
Allowance for rejects ....................... 0.2 hours
Standard hours per jogging suit ....... 2.0 hours
Once the time and rate standards have been set, the standard cost of
labor for one unit of product can be computed:
2.0 hours per jogging suit × $18 per hour = $36 per jogging suit.
TM 10-7
THE GENERAL VARIANCE MODEL
The standard quantity allowed (standard hours allowed in the case of
labor and overhead) is the amount of materials (or labor) that should
have been used to complete the output of the period.
TM 10-8
DIRECT MATERIAL VARIANCES
To illustrate variance analysis, refer to the standard cost card for
Speeds, Inc.’s jogging suit. The following data are for last month’s
production:
Number of suits completed ............ 5,000 units
Cost of material purchased
(20,000 yards × $5.40 per yard) . $108,000
Yards of material used ................... 20,000 yards
Using these data and the data from the standard cost card, the
material price and quantity variances are:
Actual Quantity Actual Quantity Standard Quantity
of Input, at of Input, at Allowed for Output,
Actual Price Standard Price at Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)
20,000 yards × 20,000 yards × 17,500 yards* ×
$5.40 per yard $6.00 per yard $6.00 per yard
= $108,000 = $120,000 = $105,000
Price Variance, Quantity Variance,
$12,000 F $15,000 U
Total Variance,
$3,000 U
* 5,000 suits × 3.5 yards per suit = 17,500 yards
F = Favorable
U = Unfavorable
TM 10-9
DIRECT LABOR VARIANCES
The following data are for last month’s production:
Number of suits completed (as before) ............... 5,000 units
Cost of direct labor
(10,500 hours @ $20 per hour) ....................... $210,000
Using these data and the data from the standard cost card, the labor
rate and efficiency variances are:
Actual Hours Actual Hours Standard Hours
of Input, at the of Input, at the Allowed for Output,
Actual Rate Standard Rate at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
10,500 hours × 10,500 hours × 10,000 hours* ×
$20 per hour $18 per hour $18 per hour
= $210,000 = $189,000 = $180,000
Rate Variance, Efficiency Variance,
$21,000 U $9,000 U
Total Variance,
$30,000 U
* 5,000 suits × 2.0 hours per suit = 10,000 hours.
F = Favorable
U = Unfavorable
TM 10-10
POTENTIAL PROBLEMS WITH STANDARD COSTS
• Variances are often reported too late to be useful.
• If used as a tool for punishing people, standards can undermine
morale.
• Labor efficiency standards encourage high output. This may lead to
excessive work-in-process if a workstation is not a bottleneck.
• A favorable quantity variance may be worse than an unfavorable
quantity variance.
• Quality may suffer if undue emphasis is placed on just meeting the
standards.
• Just meeting standards may not be sufficient; continual improvement
is often necessary.
TM 10-11
PREDETERMINED OVERHEAD RATES AND OVERHEAD
ANALYSIS IN A STANDARD COSTING SYSTEM (APPENDIX A)
This example illustrates how to use predetermined overhead rates in
a standard costing system and how to compute fixed overhead
variances.
The following information pertains to MicroDrive Corporation, a
company that produces miniature electric motors:
Budgeted production ................................... 25,000 motors
Standard machine-hours per motor .............. 2 machine-hours
Budgeted machine hours ............................. 50,000 machine-hours
Actual production ........................................ 20,000 motors
Standard machine hours allowed ................. 40,000 machine-hours
Actual machine hours .................................. 42,000 machine-hours
Budgeted variable manufacturing overhead .. $75,000
Budgeted fixed manufacturing overhead ...... $300,000
Total Budgeted manufacturing overhead ...... $375,000
Actual variable manufacturing overhead ....... $71,000
Actual fixed manufacturing overhead ........... $308,000
Total actual manufacturing overhead ........... $379,000
TM 10-12
PREDETERMINED OVERHEAD RATE
Recall from the job-order costing chapter, the following formula is
used to establish the predetermined overhead rate at the beginning of
the period:
Predetermined = Estimated total manufacturing overhead cost
overhead rate Estimated total amount of the allocation base
MicroDrive uses budgeted machine-hours as its denominator activity
in its predetermined overhead rate. Therefore, the company’s
predetermined overhead rate would be computed as follows:
Predetermined = $375,000 =$7.50 per MH
overhead rate 50,000 MHs
This predetermined rate can be broken down into its variable and
fixed components as follows:
Variable component of the = $75,000 =$1.50 per MH
predetermined overhead rate 50,000 MHs
Fixed component of the = $300,000 =$6.00 per MH
predetermined overhead rate 50,000 MHs
TM 10-13
CALCULATING BUDGET AND VOLUME VARIANCES
Two fixed manufacturing overhead variances are computed in a
standard costing system—a budget variance and a volume variance.
Budget Variance:
The budget variance is the difference between the actual fixed
manufacturing overhead and the budgeted fixed manufacturing
overhead for the period. The formula is:
Budget variance = Actual fixed overhead − Budgeted fixed overhead
Applying this formula to MicroDrive, the budget variance is computed
as follows:
Budget variance = $308,000 − $300,000 = $8,000 U
Volume Variance:
The volume variance is the difference between the budgeted fixed
manufacturing overhead and the fixed manufacturing overhead applied
to work in process for the period. The formula is:
Volume variance = Budgeted fixed overhead – Fixed overhead applied
Applying this formula to MicroDrive, the volume variance is computed as
follows:
Volume variance = $300,000 − $240,000 = $60,000 U
TM 10-14
VISUAL DEPICTION OF FIXED OVERHEAD VARIANCES
TM 10-15
GRAPHIC ANALYSIS OF FIXED OVERHEAD VARIANCES
TM 10-16
RECONCILING OVERHEAD VARIANCES AND UNDERAPPLIED
AND OVERAPPLIED OVERHEAD
The following table shows how the underapplied or overapplied
overhead for MicroDrive is computed.
Predetermined overhead rate (a) ........ $7.50 per machine-hour
Standard hours allowed for the
actual output (b) ........................... 40,000 machine-hours
Manufacturing overhead applied (a)
× (b) ............................................ $300,000
Actual manufacturing overhead ........... $379,000
Manufacturing overhead
underapplied or overapplied ........... $79,000 underapplied
TM 10-17
VARIABLE OVERHEAD VARIANCE COMPUTATIONS
MicroDrive’s variable overhead rate and efficiency variances would be
computed as follows:
Variable overhead rate variance:
Variable overhead rate variance (VORV) = (AH × AR ) − (AH × SR )
VORV = ($71,000) − (42,000 machine-hours × $1.50 per machine-hour)
VORV = $71,000 − $63,000 = $8,000 U
Variable overhead efficiency variance:
Variable overhead efficiency variance (VOEV) = (AH × SR ) − (SH × SR )
VOEV = ($63,000) − (40,000 machine-hours × $1.50 per machine-hour)
VOEV= $63,000 − $60,000 = $3,000 U
TM 10-18
VARIANCE RECONCILIATION
We can now compute the sum of all overhead variances as follows:
Variable overhead rate variance .......... $8,000 U
Variable overhead efficiency variance .. $3,000 U
Fixed overhead budget variance .......... $8,000 U
Fixed overhead volume variance ......... $60,000 U
Total of the overhead variances .......... $79,000 U
Note that as claimed above, the total of the overhead variances is
$79,000, which equals the underapplied overhead of $79,000. In
general, if the overhead is underapplied, the total of the standard cost
overhead variances is unfavorable. If the overhead is overapplied, the
total of the standard cost overhead variances is favorable.