CHAPTER III

SUMMARY
Tell how unit standards are set and why standard costing systems are adopted.
A standard cost system budgets quantities and costs on a unit basis. These unit budgets are for
labor, materials, and overhead. Standard costs, therefore, are the amount that should be
expended to produce a product or service. Standards are set using historical experience,
engineering studies, and input from operating personnel, marketing, and accounting.
Currently attainable standards are those that can be achieved under efficient operating
conditions. Ideal standards are those achievable under maximum efficiency, or ideal operating
conditions. Standard costing systems are adopted to improve planning and control and to
facilitate product costing. By comparing actual outcomes with standards and breaking the
variance into price and quantity components, detailed feedback is provided to managers. This
information allows managers to exercise a greater degree of cost control than that found in a
normal or an actual costing system. Decisions such as bidding are also made easier when a
standard costing system isin place.
State the purpose of a standard cost sheet.
The standard cost sheet provides the details for the computation of the standard cost per unit.
It shows the standard costs for materials, labor, and variable and fixed overhead. It also
reveals the quantity of each input that should be used to produce one unit of output. Using
these unit quantity standards, the standard quantity of materials allowed and the standard
hours allowed can be computed for the actual output. These computations play an important
role in variance analysis.
Describe the basic concepts underlying variance analysis, and explain when variances
should be investigated.
The budget variance is the difference between actual costs and planned costs. In a standard
costing system, the budget variance is broken down into price and usage variances. By
breaking the budget variances into price and usage variances, managers have more ability to
analyze and control the total variance. Variances should be investigated if they are material
and if the benefits of corrective action are greater than the costs of investigation. Because of
the difficulty of assessing cost and benefits on a case-by-case basis, many firms set up formal
control limitseither a dollar amount, a percentage, or both. Others use judgment to assess
the need to investigate.
Compute the materials and labor variances, and explain how they are used for control.
The materials price and usage variances are computed using either a three-pronged approach
or formulas. The three-pronged approach for materials is illustrated in Exhibit 9-6. The
materials price variance is the difference between what should have been paid for materials
and what was paid (generally associated with the purchasing activity). The materials usage
variance is the difference between the cost of the materials that should have been used and

the amount that was used (generally associated with the production activity). When a
significant variance is signaled, an investigation is undertaken to find the cause. Corrective
action is taken, if possible, to put the system back in control. The labor variances are
computed using either a three-pronged approach or formulas. The three-pronged approach for
labor is illustrated in Exhibit 9-7. The labor rate variance is caused by the actual wage rate
differing from the standard wage rate. It is the difference between the wages that were paid
and those that should have been paid. The labor efficiency variance is the difference between
the cost of the labor that was used and the cost of the labor that should have been used. When
a significant variance is signaled, investigation is called for, and corrective action should be
taken, if possible, to put the system back in control.
Calculate the variable and fixed overhead variances, and give their definitions.
The variable overhead spending variance is the difference between the actual variable
overhead cost and the budgeted variable overhead cost for actual hours worked. Therefore, it
is a budget variance, resulting from price changes and efficient or inefficient use of variable
overhead inputs. The variable efficiency variance is the difference between budgeted variable
overhead at actual hours and applied variable overhead. It is strictly attributable to the
efficiency of labor usage and assumes that the variable overhead items are all driven by direct
labor hours. The fixed overhead spending variance is the difference between the actual fixed
overhead costs and the budgeted fixed overhead costs. Hence, it is simply a budget variance.
The volume variance is the difference between the budgeted fixed overhead and the applied
fixed overhead. It occurs whenever the actual production volume is different from the
expected production volume and, thus, is a measure of capacity utilization.
Appendix: Prepare journal entries for materials and labor variances, and show how to
account for overhead variances.
Assuming that the materials price variance is computed at the point of purchase, all
inventories are carried at standard cost. Actual costs are never entered into an inventory
account. Accounts are created for materials price and usage variances and for labor rate and
efficiency variances. Unfavorable variances are always debits; favorable variances are always
credits. Overhead variances are generally not journalized. Instead, periodic overhead reports
are prepared that provide overhead variance information.

REFERENCES
Hansen, and Mowen. 2006. Managerial Accounting. South-Western: Thomson