1. STANDARD COSTS AND VARIANCE ANALYSIS FOR DECISION MAKING
CHAPTER 17
STANDARD COSTS AND VARIANCE ANALYSIS FOR DECISION MAKING

2. Chapter Overview
What is a price standard and a quantity standard, and how does a company compute standard cost?
What is included in a company’s direct materials price and quantity standards?
When a company compares its actual direct materials costs to its direct material standards, how does it determine what caused the difference between the two?

3. Chapter Overview
What is included in a company’s direct labor price and quantity standards?
When a company compares its actual direct labor costs to its direct labor standards, how does it determine what caused the difference between the two?
How does a company use its manufacturing cost variances to control its operations?

4. Standard Costs
In Chapter 11, we learned that standard costs are the costs that a company should incur in performing an activity or producing a product under a given set of planned operating conditions.
In Chapter 12, we learned how standard costs can be useful in preparing budgets.
The most valuable use of standard costs, however, is in controlling a company’s operations.

5. Standard Costs and Variances
When a manufacturing company uses a standard cost system, it normally assigned standard costs rather than actual costs to each of its inventory accounts.
By using standard costs, managers avoid many tasks relating to assigning costs. In addition, costs due to inefficient operations can be evaluated through variance analysis.
If an actual production cost is greater than the standard cost, an unfavorable variance is said to exist; if an actual production cost is less than the standard cost, a favorable variance is said to exist.

6. Calculating the Standard Cost
The standard cost of a unit is made of two components: a price standard and a quantity standard.
A price standard is the cost that a company should incur to acquire one unit of input for a manufacturing process (i.e., such as raw materials or labor cost).
A quantity standard is the number of units of an input that a company should use to produce one unit of product output (i.e., such as the wage per hour paid to assembly workers).

7. Manufacturing Cost: Cases of Darkly Decadent Candy Bars

8. Direct Materials Price and Quantity Standards
The direct material price standard shows the cost that a company should incur to acquire one unit of a direct material for production.
The direct material quantity standard shows the amount of a direct material that a company should use to produce one unit of product.
Direct material price standard
Direct material quantity
standard X
Standard cost of direct material =

9. Direct Materials Price and Quantity Standards

10. Direct Materials Price and Quantity Variances
Direct material variances isolate the reasons why actual direct material costs are more or less than the standard direct material costs.
Direct Material Price Variance
Variance in the price paid for direct material from the standard price expected.
Direct Material Quantity Variance
Variance in the amount of direct material used from the standard quantity expected.

11. Direct Material Price Variance
The direct material price variance is calculated as follows:
Unfavorable variance
When isolating the price variance use the actual quantity of material purchased.
Actual standard price
Actual actual price -
Direct Material Price Variance =

12. Direct Material Quantity Variance
The direct material quantity variance is calculated as follows:
Unfavorable variance
When isolating the quantity variance, use the standard price for purchasing material.
Standard standard price
Actual standard price -
Direct Material Quantity Variance =

13. Recording Direct Material Price Variances
Using the information from the calculation of the direct materials price variance for the production of Darkly Decadent (slide 11), how would the costs and the variance be recorded in a credit purchase?
Difference between standard and actual cost ($0.01) X actual quantity – an unfavorable variance
Actual cost 1,500,000 $0.36
Assets = Liabilities + Stockholders’ Equity
+$525,000 (Raw Materials inventory)
+$540,000 (Accounts Payable)
-$15,000 (+Direct Materials Price Variance)
Standard cost 1,500,000 $0.35

14. Recording Direct Material Quantity Variances
Using the information from the calculation of the direct material quantity variances for the production of Darkly Decadent (slide 12), how would the quantities and variance be recorded for direct materials used?
Difference between standard and actual quantity (-40,000) X standard price – an unfavorable variance
Standard quantity 1,440,000 $0.35
Assets = Liabilities + Stockholders’ Equity
-$518,000 (Raw Materials inventory)
+$504,000 (Goods-in-Process Inventory)
-$14,000 (+Direct Materials Quantity Variance)
Actual quantity 1,480,000 $0.35

15. Direct Labor Price and Quantity Standards
The direct labor price standard shows the current wage rate that a company should incur per hour for a specific type of direct labor employed in production.
The direct labor quantity standard shows the amount of direct labor time that a company should use to produce one unit of product.
Direct
labor
price standard
Direct
labor
quantity
standard X
Standard cost of direct
labor =

16. Direct Labor Price and Quantity Standards

17. Direct Labor Price and Quantity Variances
Direct labor variances isolate the reasons why actual direct labor costs are more or less than the standard direct labor costs.
Direct Labor Price Variance
Variance in the price paid for direct labor from the standard price expected.
Direct Labor Usage Variance
Variance in the amount of direct labor used from the standard usage (time) expected.

18. Direct Labor Price Variance
The direct labor price variance is calculated as follows:
Favorable variance
When isolating the price variance, use the actual hours used (time) in production.
Actual standard price
Actual actual price -
Direct Labor Price Variance =

19. Direct Material Efficiency Variance
The direct labor efficiency (time) variance is calculated as follows:
Unfavorable variance
When isolating the labor efficiency (time) variance, use the standard price for labor.
Standard standard price
Actual standard price -
Direct Labor Efficiency Variance =

20. Recording Direct Labor Variances
Using the information from the calculation of the direct labor price and quantity variances for the production of Darkly Decadent (from slides 18/19), how would the costs and the variances be recorded on wages incurred?
Difference between standard and actual hours (-2,000) X standard wage - unfavorable variance
Actual hours actual wage $11.90
Assets = Liabilities + Stockholders’ Equity
+$2,160,000 (Goods-in-Process inventory)
+2,165,800 (Wages Payable)
+$18, (-Direct Labor Price Variance)
-$24,000 (+Direct Labor Efficiency Variance)
Standard hours standard wage $12.00
Difference between standard and actual wage ($0.10) X actual hours - favorable

21. Reporting Variances
To be useful, manufacturing variances must be communicated to managers who can evaluate and correct the problems.
Reporting variances to managers is just as important for favorable as well as unfavorable variances.
Favorable variances may not always be good. A favorable variable materials price variance might suggest a quality issue, and a favorable efficiency (time) variance could suggest that workers rushed through processing. Both of these could lead to poor product quality and customer dissatisfaction.