These lectures cover standard costing and examine variances such as direct labor variance, direct material variance, overhead variance and fixed overhead variance.
Standard Costing | Managerial Accounting
Variance Analysis | Managerial Accounting
A standard is a benchmark for measuring performance. Standards are set for both the quantity and the cost of inputs needed to manufacture goods or to provide services. Quantity standards indicate how much of an input, such as labor time or raw materials, should be used to make a product or provide a service. Cost standards indicate what the cost of the input should be.
When standards are compared to actual performance, the difference is referred to as a variance. Variances are computed and reported to management on a regular basis for both the quantity and the price elements of direct materials, direct labor, and variable overhead. Price variances are computed by taking the difference between actual and standard prices and multiplying the result by the amount of input purchased. Quantity variances are computed by taking the difference between the actual amount of the input used and the amount of input that is allowed for the actual output, and then multiplying the result by the standard price of the input.
Standard cost systems provide companies with a number of advantages, such as supporting the management by exception approach, simplifying bookkeeping, and providing a benchmark that employees can use to judge their own performance. However, critics of standard cost systems argue that they provide information that is outdated, they can motivate employees to make poor decisions in an effort to generate favorable variances, and they fail to adequately embrace the mindset of continuous process improvement.
Traditional standard cost variance reports are often supplemented with other performance measures to ensure that overemphasis on standard cost variances does not lead to problems in other critical areas such as product quality, inventory levels, and on-time delivery.
A standard is a benchmark for measuring performance. The standard price per unit defines the price that should be paid for each unit of direct materials and it should reflect the final, delivered cost of those materials.
Setting Direct Labor Standards
Direct labor quantity and price standards are usually expressed in terms of labor-hours or a labor rate. The standard hours per unit defines the amount of direct labor-hours that should be used to produce one unit of finished goods. One approach used to determine this standard is for an industrial engineer to do a time and motion study, actually clocking the time required for each task. Throughout the chapter, we’ll assume that “tight but attainable” labor standards are used rather than “ideal” standards that can only be attained by the most skilled and efficient employees working at peak effort 100% of the time.
Setting Variable Manufacturing Overhead Standards
As with direct labor, the quantity and price standards for variable manufacturing overhead are usually expressed in terms of hours and a rate. The standard hours per unit for variable overhead measures the amount of the allocation base from a company’s predetermined overhead rate that is required to produce one unit of finished goods. In the case of Colonial Pewter, we will assume that the company uses direct labor-hours as the allocation base in its predetermined overhead rate. Therefore, the standard hours per unit for variable overhead is exactly the same as the standard hours per unit for direct labor—0.50 direct labor-hours per statue.