Standard Costing - A Managerial Control Tool

Unit Standards

Developing standards enhances control. To determine the unit standard cost for a particular input, two decisions must be made. These are the quantity decision and the pricing decision. Quantity decision is the amount of input that should be used per unit of output. This is called the quantity standard. Price decision is the amount that should be paid for the quantity of input to be used. This is called the price standard. Quantity standard, times price standard, is equal to the unit standard. Unit standards are used to enhance cost control. They are budgeted as unit costs, unlike budgets which contain aggregate amounts of total revenue and total costs.

Quantity standards are developed by historical experience, engineering studies, and input from operating personnel. Price standards are the joint responsibility of Operations, Purchasing, Personnel and Accounting. Standards are generally classified in one of two categories. Ideal standards demand maximum efficiency and can be achieved only if everything operates perfectly. Currently attainable standards can be achieved under efficient operating conditions.

There are two reasons why standard cost systems are adopted. The first is to improve planning and control. The second is to facilitate product costing. Advantages of standard costing are:

  1. Greater capacity for control
  2. Provides readily available unit cost information
  3. Simplifies cost assignments in both process and job costing systems

Standard Product Costs

In manufacturing firms, standard costs are developed for direct materials, direct labor and overhead. Using these costs, standard cost per unit is computed. The standard cost sheet provides the production data needed to calculate the standard unit cost.

Variance Analysis

NOTE: The following will explain why they made you take algebra.

Variance Analysis consists of certain components. They are:

SP = Standard unit price of an input
SQ = Standard quantity of input for the actual output
AP = Actual price per unit of the input
AQ = Actual quantity of the input used

The total budget variance is the difference between the actual cost of the input and its planned cost. It is represented by this formula:

Total Variance = Actual cost - Planned cost
Total Variance = (AP X AQ) - (SP X SQ)

Price rate variance is the difference between the actual and standard unit price of an input multiplied by the number of inputs used:

Price Rate Variance = (AP - SP) X Number of inputs used

Usage efficiency variance is the difference between the actual and standard quantity of inputs multiplied by the standard unit price of the input:

Usage Efficiency Variance = (AQ - SQ) X SP

Favorable variance is when the AQ is less than the SQ. Unfavorable variance is when the AQ is greater than the SQ.

The Decision To Investigate

Performance rarely meets established standards exactly. Random variations around the standard are expected. Management should determine an acceptable range of performance.

Direct Material Variances

Materials price variance measures the difference between what should have been paid for raw materials and what was actually paid.

MPV = (AP - SP) X AQ

Materials usage variance measures the difference between the direct materials actually used and the direct materials that should have been used for the actual output.

MUV = (AQ - SQ) X SP

Responsibility for the materials price variance belongs to the purchasing agent. Price can be influenced by quality, quantity discounts, and distance of the source from the plant. Responsibility for the materials usage variance belongs tot he production manager. Variance can be influenced by minimizing scrap, waste, and rework.

Analysis of the Variances

The first step in analyzing the variances is to decide whether the variances is significant. The second step is to find out why it occurred.

Materials variance are added to cost of goods sold if they are unfavorable. They are subtracted from cost of goods sold if they are favorable.

Labor rate variance computes the difference between what was paid to direct laborers and what should have been paid.

LRV = (AR - SR) X AH

Labor efficiency variance measures the difference between the labor hours that were actually used and the labor hours that should have been used.

LEV = (AH - SH) X SR

AR = Actual hourly wage rate
SR = Standard hourly wage rate
AH = Actual direct labor hours used
SH = Standard direct labor hours that should have been used
SR = Standard hourly wage rate

Causes of Labor Rate Variance

Labor rates are largely determined by such external forces as labor markets and union contracts. Labor rates can vary when more skilled and more highly paid laborers are used for less skilled tasks, and when unexpected overtime occurs. Generally speaking, production managers are responsible for the use of direct labor, but once the cause is discovered, responsibility may be assigned elsewhere.