Standard Costing: A

Managerial Control Tool

Pamela Gonzalez Liriano
Source: Conerstones of Managerial
Accounting, 5th edition

Budgets set standards that are used to control and

evaluate managerial performance

Quantity Standards

Price Standards

To determine the unit standard cost for a particular

input, two decisions must be made:
The quantity decision: The amount of input that
should be used per unit of output
The pricing decision: The amount that should be
paid for the quantity of the input to be used

Standard cost per unit = Quantity

standard x Price standard

Sources for Quantity Standards,

1. Historical Experience
2. Engineering Studies
3. Input from Operating Personnel

WHY STANDARD COST SYSTEMS ARE ADOPTED

To improve planning and control
Comparing actual costs with budgeted costs identifies
variances.
Overall variances can be further broken down into a price
variance or a usage or efficiency variance if unit price or
quantity standards have been developed.
To facilitate product costing
Costs are assigned to products using quantity and price
standards for all three manufacturing costs: direct
materials, direct labor, and overhead.
Standard costing and variance analysis for controlling cost and evaluating
performance can have strong ethical implications.

Advantages of Standard product costing

Greater
Capacity
Control

No need to
distinguish
FiFO &
Weighted
Average

Readily
available unit
cost
information

No unit cost
calculations
for each
equivalent
unit

Standard Cost Sheet

The standard cost sheet provides the production
data needed to calculate the standard unit cost. It
also shows the quantity of each input that should be
used to produce one unit of output.

Variance analysis
Actual cost = AP x AQ
Planned cost = SP x SQ
The total budget variance is the difference
between the actual cost of the input and its
planned cost
Because responsibility for deviations from
planned prices tends to be located in the
purchasing or personnel department and
responsibility for deviations from planned
usage of inputs tends to be located in the
production department, it is important to
separate the total variance into price and
usage (quantity) variances.

Price variance = (AP - SP) x AQ

Usage variance = (AQ - SQ) x SP

Unfavorable (U) variances occur whenever actual prices or actual

usage of inputs are greater than standard prices or standard usage.
When the opposite occurs, favorable (F) variances are obtained.
control limits

The materials price variance is computed

by using the actual quantity of materials
purchased, and the materials usage
variance is computed by using the actual
quantity of materials used

Measures what should

have been paid for raw
materials and what was
actually paid

Measures the direct

materials actually used
and the direct materials
that should have been
used

Using the variance information to exercise

control is fundamental to a standard cost
system.
The responsibility for controlling the
materials price variance usually belongs to
the purchasing agent.
Pressure to produce favorable variances may result in the purchase of materials of lower quality
than desired or excessive inventory purchases in order to get quantity discounts.

Analysis of Materials Price Variance

The first step in variance analysis is to
decide whether the variance is significant.
what is its cause?
Once the reason is known, corrective action
can be taken if necessaryand if possible.

The responsibility for controlling the

materials usage usually belongs to the
production manager.
Pressure to produce favorable variances may allow
defective units to be transferred to finished goods
and ultimately cause customer relations problems.
If variance is significant, investigation is needed to
find out the causes for the deviation.
The importance of evaluating current business conditions and
updating standards to reflect any changes in these conditions
cannot be overlooked.
Typically, materials variances are added to
cost of goods sold if unfavorable and are
subtracted from cost of goods sold if
favorable.

The total labor variance measures the

difference between the actual costs of labor
and their budgeted costs for the actual
level of activity.

The labor rate and labor efficiency

variances always will add up to the
total labor variance.
Total labor variance = Labor rate variance
+ Labor efficiency variance
The labor rate variance (LRV) computes the
difference between what was paid to direct laborers
and what should have been paid,
LRV = (AR - SR) x AH
The labor efficiency variance (LEV) 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
Calculating labor variances initiates the
feedback process.
Responsibility must be assigned, variance significance must be
assessed, and the variances must be accounted for and disposed of at
the end of the year.

In addition to standard costing, some companies choose to employ other

cost management practices, such as kaizen costing and target costing.
Kaizen costing focuses on the continuous reduction of the
manufacturing costs of existing products and processes.
Target costing focuses on the
reduction of the design costs of
existing and future products and
processes.

Target cost per unit = Expected sales

price per unit - Desired profit per unit

Accounting for Variances

The accounts containing the variances between applied standard costs and
actual costs are closed, which allows the amount of actual costs to ultimately
impact the final cost of goods sold number that appears in the financial
statements.
In recording variances, unfavorable variances always are debits, and favorable
variances always are credits.

Exercises
10-33
10-35
10-36
10-43
10-45
10-46
10-47