CHAPTER8STANDARD COST ACCOUNTING MATERIALS, LABOR, AND FACTORY OVERHEAD

Review Summa !
1. The purpose of standard cost accounting is to control costs and promote efficiency. It is used in conjunction with methods such as job order or process costing. It is based on a predetermination of what it should cost to manufacture a product, which is compared to the actual costs incurred. Standard costing allows for management by exception because deviations from standard can be quickly detected and responsibility pinpointed so the company may take appropriate action. 2. Standard costs usually are determined for a period of one year and revised annually. A standard is a norm against which performance can be measured. Some companies use ideal standards that make no allowance for inefficient conditions such as lost time, waste, or spoilage. ost companies reali!e that some inefficiencies cannot be completely eliminated, so they use attainable standards that include allowances for lost time, spoilage, and waste. The standard should be high enough to provide motivation and promote efficiency, but not so high that it is unattainable and, thus, discourages workers. 3. A materials cost standard represents the quantity of material required for a unit of product times the unit cost that should be paid. A labor cost standard is based on estimates of the labor hours required to produce a unit of product times the hourly rate that should be paid. "actors to be considered in setting standards for materials and labor might include raw materials price trends, the use of substitute materials, labor negotiations with unions, the types of labor needed and the use of labor#saving devices. $nce the standard cost of manufacturing a product has been determined, the standard costs, the actual costs, and the variances are recorded in the various journals and in the general ledger. 4. A variance represents the difference between the actual and the standard costs of materials, labor, and overhead. The materials price variance is computed by comparing the actual unit cost of materials to the standard unit cost and multiplying the difference by the actual quantity of materials used or purchased if variances are recogni!ed when they are first known. The materials quantity variance is computed by comparing the actual quantity of materials used to the standard quantity that should have been used and multiplying the difference by the standard unit price. The labor rate variance is computed by comparing the actual hourly rate paid to the standard hourly rate that should have been paid and multiplying the difference by the actual number of hours worked. The labor efficiency variance is computed by comparing the actual number of direct labor hours worked to the standard hours that should have been worked and multiplying the difference by the standard labor rate. A debit balance %unfavorable& in a variance account indicates that actual costs e'ceed standard costs, and a credit balance %favorable& means that standard costs e'ceed actual costs. 5. Sample entries for a standard cost system follow( a. To record the entry for direct materials cost, assuming a favorable quantity variance and an unfavorable price variance( )ork in *rocess %at standard cost&................................. aterials *rice ,ariance................................................ aterials -uantity ,ariance.................................... aterials %at actual cost&......................................... ++ ++ ++ ++

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b. To record the entry for direct labor cost, assuming a favorable rate variance and an unfavorable efficiency variance( )ork in *rocess %at standard cost&................................. .abor /fficiency ,ariance............................................. .abor 0ate ,ariance............................................... *ayroll %at actual cost&............................................ )ork in *rocess............................................................ Applied "actory $verhead...................................... "inished 1oods.............................................................. )ork in *rocess...................................................... ++ ++ ++ ++ ++ ++ ++ ++

c. To record the entry applying factory overhead to work in process, assuming no variances(

d. To record the transfer, at standard cost, of work in process to finished goods(

At the end of the accounting period, the difference between actual costs and standard costs must be reflected in the financial statements. Some companies prorate the variances to cost of goods sold, work in process, and finished goods. A more common approach is to show the unfavorable or favorable variances as an addition to or reduction from the cost of goods sold for the period, respectively. 6. In analy!ing materials and labor variances, both price and usage have to be considered. In analy!ing materials price variances, inefficient purchasing methods, the substitution of different materials, and increases in market price are all possible e'planations. In analy!ing materials quantity variances, possible e'planations include spoiled or wasted materials and the decision to use higher quality materials subsequent to the budget preparation. In analy!ing labor rate variances, changes in labor wage rates subsequent to standard#setting and the use of employees with wage rates different from those called for in the standards are possible reasons. In analy!ing labor efficiency variances, the skill level of workers, the frequency of machine breakdowns, and improper scheduling should all be considered. 7. Things to remember about standard cost systems are that( a. the actual unit cost of manufacturing a product is not determined2only the total actual and total standard costs. b. the fact that standards are based on estimates does not make them unreliable. c. standards will change as conditions change. d. a standard cost system provides continual incentive to keep costs and performance in line with predetermined objectives. e. a standard cost system helps focus management3s attention on prices paid for materials and labor and on materials and labor quantity usage. f. to allow for more timely action in correcting inefficiencies, most manufacturers calculate variances on a weekly or even daily basis 8. The t o!variance met"od, t"ree!variance met"od, and four!variance met"od commonly are used for analy!ing overhead variances. The two variances in the two#variance method are the controllable or budget variance and the volume variance. The controllable variance is the difference between the actual overhead for a given period and the standard amount of overhead allowed by the budget for that level of production. If the actual overhead e'ceeds the standard overhead allowed, the difference is an unfavorable variance, and if the actual overhead is less than the standard allowed, the difference is a favorable variance. The volume variance is a result of operating at a level of production different from the standard, or normal, level. It is computed as follows( %production for period 4 standard factory overhead unit cost& 5 standard factory overhead budgeted for period3s production. 6ecause fi'ed costs will
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remain the same in total, whether production is above or below standard, the volume variance will be favorable if actual production e'ceeds standard and unfavorable if actual production is less than standard. If the factory is producing below its normal capacity, it has idle capacity that nevertheless requires e'penditures for depreciation, insurance, property ta'es, etc. #. The net variance is the difference between the actual factory overhead for the period and the standard overhead costs applied to work in process. 7nder the two#variance method, its components are the controllable variance and the volume variance. The reasons for the individual variances should be investigated. "or e'ample, an unfavorable volume variance may be the result of either production inefficiencies, such as machine breakdowns and unskilled laborers, or it may be due to a lack of product demand, which would be the responsibility of marketing and sales. An unfavorable controllable variance may be the result of unanticipated price increases, inefficient supervision, weak control of e'penditures, or increased maintenance and repair costs caused by utili!ation of production facilities beyond normal capacity. 1$. The four!variance met"od recogni!es two variable cost variances and two fi'ed cost variances. The variable cost variances are identified as a spending variance, which measures the differences in the actual variable overhead rate and the standard variable overhead rate, and an efficiency variance, which measures the change in the variable overhead consumption that occurs due to efficient or inefficient use of the cost allocation base. "or fi'ed cost, a budget variance, which is the difference between actual fi'ed overhead and budgeted fi'ed overhead, and a volume variance, which results from operating at a level of production different than the standard, are determined. The controllable variance under the two#variance method encompasses the spending, efficiency, and budget variance of the four#variance method. The volume variance is a separate item under both methods. 11. The t"ree!variance met"od of factory overhead cost analysis breaks down the difference between actual and applied overhead into the following variances( the efficiency variance measures the difference between the overhead applied %standard hours 4 standard rate& and the actual hours worked multiplied by the standard rate8 the capacity variance reflects the under or over#absorption of fi'ed costs and is measured by the difference between the actual hours worked multiplied by the standard overhead rate and the budget allowance based on actual hours worked8 and the budget %spending& variance, which reflects the difference between the amount allowed by the budget for the actual hours worked and the actual costs incurred. )hether the two, three, or four#variance method of overhead analysis is used, the overhead applied to production, the actual overhead, and the net variance would be the same.

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I#$" u%"i&#$'Indicate your answer in the Answers column by writing a 9T: for True or an 9": for

"alse.
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1. Standard costs are usually determined for a period of one year..................... ..................................................................................................;;;;;;;;; 2. 9Ideal standards: include allowances for lost time, spoilage, and waste........ ;;;;;;;;; 3. In establishing standard costs, the standard should be high enough to provide motivation and promote efficiency, but not so high that it is unattainable...... ;;;;;;;;; 4. If variances are to be recogni!ed at the time when they are first known, the materials price variance is computed by comparing the actual unit cost of materials to the standard unit cost and multiplying the difference by the standard quantity of materials used............................................................................ ;;;;;;;;; 5. A variance is favorable if the actual cost incurred is less than the standard cost allowed........................................................................................................ ;;;;;;;;; 6. A debit balance in a variance account indicates that standard costs e'ceed actual costs............................................................................................................ ;;;;;;;;; 7. A method of disposing of the difference between actual costs and standard costs prior to financial statement preparation is to close the variance accounts to <ost of 1oods Sold............................................................................................. ;;;;;;;;; 8. Inefficient purchasing methods, the substitution of different materials, and increases in market price are all possible e'planations for materials price variances..................................................................................................... ;;;;;;;;; #. It is not necessary to investigate the reasons behind favorable variances. ;;;;;;;;; 1$. The volume variance in a two#variance analysis of factory overhead is equal to the volume variance in a four#variance analysis of factory overhead............. ..................................................................................................;;;;;;;;; 11. The standards used in a standard cost system will change as conditions change. ..................................................................................................;;;;;;;;; 12. The fact that standards are based on estimates tends to make a standard cost system unreliable......................................................................................... ..................................................................................................;;;;;;;;; 13. A standard cost system can be used in conjunction with process costing or job order costing............................................................................................... ..................................................................................................;;;;;;;;;

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14. In a standard cost system, the entry to record the issuance of materials into production would include a debit to )ork in *rocess for the actual cost of the materials..................................................................................................... ..................................................................................................;;;;;;;;; 15. Some companies reflect the difference between actual and standard costs in the financial statements by prorating the variances to <ost of 1oods Sold, )ork in *rocess, and "inished 1oods........................................................................ ;;;;;;;;; 16. The two#variance method of analy!ing overhead variances is the most commonly used approach............................................................................................. ;;;;;;;;;

17. A credit balance in the factory overhead account indicates that the factory did not incur as much overhead as was allowed by the standard at that level of production................................................................................................... ;;;;;;;;; 18. An unfavorable volume variance may be the result of inefficiencies in labor and supervision, machine breakdowns due to faulty maintenance, and even lack of sales demand............................................................................................... ;;;;;;;;; 1#. )hen factory overhead is applied to production, "actory $verhead is debited and )ork in *rocess is credited.................................................................... ;;;;;;;;; 2$. $n the financial statements, overhead variances usually are treated as additions to or subtractions from cost of goods sold.................................................... ..................................................................................................;;;;;;;;;

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I#$" u%"i&#$'In the Answers column, place the letter from the list below that identifies the term that

best matches the statement. =o letter should be used more than once. a. b. c. d. e. f. g. h. i. Attainable standard "avorable variance aterials price variance aterials usage variance Ideal standard Standard .abor rate variance .abor cost standard aterials cost standard j. k. l. m. n. o. p. q. r. 7nfavorable variance .abor efficiency variance .earning effect anagement by e'ception <ontrollable variance <apacity variance "our#variance method ,olume variance 6udget variance

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''''' ;;;;;

1. This is the e'planation as to why employees become more proficient at a task the more often that they perform it. 2. This is represented by a debit balance in a variance account.
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;;;;; ;;;;; ;;;;; ;;;;; ;;;;;

3. A norm against which performance can be measured. 4. It can be achieved only under the most efficient operating conditions, and for all practical purposes it is unattainable. 5. Some inefficiencies were built into this so that it can be met or bettered in efficient production situations. 6. This represents the quantity of material required for a unit of product times the cost per unit of material. 7. In determining this, the services of work#study engineers may be used to establish the time necessary to perform each operation.

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;;;;; ;;;;;

8. This is represented by a credit balance in a variance account. #. This indicates the number of actual direct labor hours worked above or below the standard hours times the standard labor rate.

;;;;; 1$. This indicates the actual unit cost of materials above or below the standard unit cost multiplied by the actual quantity of materials used or purchased. ;;;;; 11. This represents the average of the actual hourly direct labor rates paid above or below the standard hourly rate multiplied by the actual number of hours worked. ;;;;; 12. This represents the actual quantity of direct materials used above or below the standard quantity allowed for the actual level of production times the standard price. ;;;;; 13. This is the practice of e'amining those occurrences that vary greatly from the norm. ;;;;; 14. To compute this, a comparison must be made between the actual factory overhead for a given period and the standard amount of overhead allowed by the budget at a given level of production. ;;;;; 15 It results from operating at a level of production different from the standard, or normal, level. ''''' 16. This method of variance analysis identifies a spending variance and an efficiency variance for variable costs. ;;;;; 17. In the three#variance method, this is measured by the difference between the actual hours worked multiplied by the standard overhead rate and the budget allowance based on actual hours worked. ;;;;; 18. In the four#variance method, this measures the difference between actual fi'ed cost e'penditures and the amount of fi'ed cost budgeted.

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I#$" u%"i&#$'In the Answers column, place the letter of the choice that most correctly completes

each item.
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;;;;; 1. The best basis upon which cost standards should be set to measure controllable production efficiencies is( a. Theoretical standards c. Attainable standards b. /'pected actual standards d. *ractical capacity
;;;;; 2. If a company follows a practice of isolating variances at the earliest time, the appropriate time to isolate and recogni!e a direct material price variance would be( a. )hen material is issued b. )hen material is purchased c. )hen material is used in production d. )hen the purchase order is originated 3. )orkbench <ompany manufactures tables with vinyl tops. The standard material cost for the vinyl used for one type of table is >?.@A, based on si' square feet of vinyl at a cost of >B.CA per square foot. A production run of B,AAA tables in Danuary resulted in usage of E,FAA square feet of vinyl at a cost of >B.GA per square foot, for a total cost of >?,E@A. The materials quantity variance resulting from this production run was( a. >BGA favorable c. >F@A unfavorable b. >HGA unfavorable d. >EFA favorable 4. Actual units of direct materials used were GA,AAA at an actual cost of >FA,AAA. Standard unit cost is >G.BA. Assuming the materials price variance is recogni!ed when the materials are used, the materials price variance is( a. >B,AAA favorable c. >G,AAA favorable b. >B,AAA unfavorable d. >G,AAA unfavorable 5. Information on 0odgers <ompany3s direct labor costs for the month of Danuary follows( Actual direct labor hours.......................... Standard direct labor hours...................... Total direct labor payroll.......................... Standard direct labor rate......................... 0odgers3 direct labor rate variance is( a. >B?,GHA unfavorable b. >GA,?AA unfavorable ;;;;; CF,HAA CH,AAA >GFB,HAA >E.FA c. >GB,AAA unfavorable d. >GB,AAA favorable

;;;;;

;;;;;

;;;;;

6. The direct labor standards for producing a unit of a product are two hours at >BA per hour. 6udgeted production was B,AAA units. Actual production was IAA units, and direct labor cost was >BI,AAA for G,AAA direct labor hours. The direct labor efficiency variance was( a. >B,AAA favorable c. >G,AAA favorable b. >B,AAA unfavorable d. >G,AAA unfavorable

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;;;;;

7. $f the following, the most probable reason a company would e'perience an unfavorable labor rate variance and a favorable labor efficiency variance is that( a. The mi' of workers assigned to the particular job was weighted heavily toward the use of higher#paid, e'perienced individuals b. The mi' of workers assigned to the particular job was weighted heavily toward the use of new, relatively low paid, unskilled workers c. 6ecause of the production schedule, workers from other production areas were assigned to assist this particular process d. Jefective materials caused more labor to be used in order to produce a standard unit 8. A debit balance in the labor#efficiency variance account indicates that( a. Standard hours e'ceed actual hours b. Actual hours e'ceed standard hours c. Standard rate and standard hours e'ceed actual rate and actual hours d. Actual rate and actual hours e'ceed standard rate and standard hours #. Kow should a usage variance that is significant in amount be treated at the end of an accounting periodL a. 0eported as a deferred charge or credit b. Allocated among work#in#process inventory, finished goods inventory, and cost of goods sold c. <harged or credited to cost of goods manufactured d. Allocated among cost of goods manufactured, finished goods inventory, and cost of goods sold )ork in *rocess............................................. .abor 0ate ,ariance....................................... .abor /fficiency ,ariance........................ *ayroll..................................................... This entry indicates that( a. Actual labor cost is less than standard labor cost b. The labor rate variance is favorable c. The labor efficiency variance is unfavorable d. Actual labor cost is more than standard labor cost BA,AAA G,AAA B,AAA BB,AAA

;;;;;

;;;;;

;;;;; 1$. The following journal entry has been recorded(

''''' 11. 7nder the two#variance method for analy!ing factory overhead, the factory overhead applied to production is used in the computation of( (ontrollable )ariance Mes Mes =o =o )olume )ariance =o Mes Mes =o

a. b. c. d.

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''''' 12. A spending variance for factory overhead is the difference between actual factory overhead cost and factory overhead cost that should have been incurred for the actual hours worked. It results from( a. *rice differences for factory overhead costs b. -uantity differences for factory overhead costs c. *rice and quantity differences for factory overhead costs d. Jifferences caused by production volume variation ''''' 13. 7nder the two#variance method for analy!ing factory overhead, the difference between the actual factory overhead and the factory overhead applied to production is the( a. <ontrollable variance c. /fficiency variance b. =et overhead variance d. ,olume variance *tems 14 and 15 are based on t"e follo ing information+ The data below relate to the month of ay for Sosa Inc., which uses a standard cost system and two#variance analysis of overhead( Actual total direct labor.................................................................... Actual hours used............................................................................. Standard hours allowed for good output............................................ Jirect labor rate variance2debit...................................................... Actual total overhead........................................................................ 6udgeted fi'ed costs......................................................................... 9=ormal: activity in hours................................................................ Total overhead application rate per standard direct labor hour........... ;;;;; 14. )hat was Sosa3s volume variance for a. >B,GHA favorable b. >B,GHA unfavorable ayL c. >B,HAA favorable d. >B,HAA unfavorable ayL c. >B,HAA favorable d. >B,HAA unfavorable >FC,FAA BF,AAA BH,AAA >B,FAA >FA,GHA >I,AAA B@,AAA >C.AA

;;;;; 15. )hat was Sosa3s controllable variance for a. >B,GHA favorable b. >E,GHA favorable

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Pa " IV
(omputing materials and labor variances )onderland, Inc. has a budgeted normal monthly capacity of GA,AAA labor hours with a standard production of BA,AAA units at this capacity. )onderland records the materials price variance when the materials are used. Standard costs are as follows( aterials.................................... C lbs. N >B .abor.......................................... >BH per hour Juring arch, BI,HAA actual labor hours cost >G@G,?HA, and I,HAA units were produced using GI,GAA pounds of materials at a cost of >B.BA per pound.
I#$" u%"i&#$'

1. <ompute the materials cost variances and label each as favorable or unfavorable.
,ounds -nit (ost .mount

Actual quantity used................. Actual quantity used................. aterials price variance............ Actual quantity used................. Standard quantity allowed......... aterials quantity variance.......

> > >

Actual Standard Standard Standard

> > > >

2. <ompute the labor cost variances and label each as favorable or unfavorable.
/ime 0ate .mount

Actual hours worked................. Actual hours worked................. .abor rate variance................... Actual hours worked................. Standard hours allowed............. .abor efficiency variance..........

> > >

Actual Standard Standard Standard

> > > >

3. *repare the same variance analysis as above, using the diagram format as illustrated in "igure @#F of the te't.

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1ournal entries for materials and labor variances Oarl <orp., which uses a standard cost accounting system, determines that the following variances arose in production during Dune( )ariance aterials purchase price.................... aterials quantity............................. .abor efficiency................................ .abor rate......................................... .mount >IAA favorable ?HA unfavorable B,AAA unfavorable EAA unfavorable

Jirect materials purchases totaled >IA,AAA at standard cost, while >?H,AAA in materials were taken from inventory for use in production. Actual direct labor totaled >@A,AAA, while actual overhead incurred was >EA,AAA. %Assume no variance for factory overhead.& Ten thousand units were transferred to "inished 1oods at a standard cost of >BH per unit.
I#$" u%"i&#$'*repare the journal entries to record(

1. 2. 3. 4. 5.

The purchase of materials %The materials price variance is recorded at the time of purchase.& The use of materials in production The use of labor in production The charging of overhead to production The transfer of finished goods to the storeroom
.ccount 2ebit (redit

%1&

%2&

%3&

%4&

%5&

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Pa " V(
/ o!variance over"ead analysis "actory overhead for /li!abeth <ompany has been estimated as follows( "i'ed factory overhead.............................................. ,ariable factory overhead.......................................... /stimated direct labor hours...................................... >HA,AAA >BAA,AAA GA,AAA

*roduction for the month reached BBAP of the budget, and actual factory overhead totaled >BEC,AAA.
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1. Jetermine the over or underapplied factory overhead. Actual factory overhead................................................. Applied factory overhead............................................... $ver or underapplied factory overhead.......................... 2. Jetermine the controllable and volume variances. Actual factory overhead................................................. $verhead for capacity attained( "i'ed factory overhead.............................................. ,ariable factory overhead.......................................... <ontrollable variance..................................................... "actory overhead for capacity attained........................... "actory overhead applied............................................... ,olume variance............................................................ > > > > > > >

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/ o!variance and four!variance over"ead analysis 6ass <ompany has a budgeted normal monthly capacity of GA,AAA labor hours with a standard production of BA,AAA units at this capacity. Standard costs for factory overhead are as follows( "actory overhead at normal capacity( "i'ed................................................. ,ariable............................................. >GA,AAA >H per labor hour

Juring arch, actual factory overhead totaled >BB?,AAA, of which >I?,AAA was for variable overhead8 and BI,HAA labor hours were required to produce I,HAA units.
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1. <ompute the factory overhead variances using the two#variance method. Actual factory overhead................................................. 6udget allowance based on standard hours allowed( "i'ed overhead budgeted........................................... ,ariable overhead...................................................... <ontrollable variance............................................ 6udget allowance based on standard hours allowed........ $verhead charged to production.................................... ,olume variance........................................................ > > > > >

2. <ompute the factory overhead variances using the four#variance method %appendi'&. Actual variable factory overhead......................................................... 6udget allowance based on actual hours worked( ,ariable overhead........................................................................... Spending variance...................................................................... 6udget allowance based on actual hours worked................................. ,ariable overhead........................................................................... ,ariable overhead charged to production............................................. /fficiency variance......................................................................... Actual fi'ed cost................................................................................. 6udgeted fi'ed cost............................................................................. 6udget variance.............................................................................. 6udgeted fi'ed cost............................................................................. Standard hours 4 fi'ed rate................................................................. ,olume variance............................................................................. >

> > > > > > >

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