Standard Costing and Variance Analysis
1. Case A: Effect of assumed standard levels
2. Case B: Factory overhead variance analysis
Effect of Assumed Standard Levels:
Harden Company has experienced increased production costs. The primary area of concern
identified by management is direct labor. The company is considering adopting a standard
cost system to help control labor and other costs. Useful historical data are not available
because detailed production records have not been maintained.
To establish labor standards, Harden Company has retained an engineering consulting firm.
After a complete study of the work process, the consultants recommended a labor standard
of one unit of production every 30 minutes, or 16 units per day for each worker. The
consultants further advised that Harden's wage rates were below the prevailing rate of $ per
Harden's production vice-president thought that this labor standard was too tight, and from
experience with the labor force, believed that a labor standard of 40 minutes per unit or 12
units per day for each worker would be more reasonable.
The president of Harden Company believed the standard should be set at a high level to
motivate the workers and to provide adequate information for control and reasonable cost
comparison. After much discussion, management decided to use a dual standard. The labor
standard of one unit every 30 minutes, recommended by the consulting firm, would be
employed in the plant as a motivation device, while a cost standard of 40 minutes per unit
would be used in reporting. Management also concluded that the workers would not be
informed of the cost standard used for reporting purposes. The production vice-president
conducted several sessions prior to implementation in the plant, informing the workers of
the new standard cost system and answering questions. The new standards were not
related to incentive pay but were introduced when wages were increased to $7 per hour.
The standard cost system was implemented on January 1, 19--. At the end of six months of
operation, these statistics on labor performance were presented to executive management:
January February March April May June
Production (units) 5,100 5,000 4,700 4,500 4,300 4,400
Direct labor hours 3,000 2,900 2,900 3,000 3,000 3,100
Variance based on labor standard (one unit
each 30 minutes) $3150 U* $2,800 U $3,850 U $5,250U
U $6,300 U
Variance based on cost standard (one unit
each 40 minutes) $2,800 F $3,033 F $1,633 F -0- $933U $1,167 U
*U = Unfavorable; F = Favorable
Materials quality, labor mix, and plant facilities and conditions have not changed to any
great extent during the six month period.
1. A discussion of the impact of different types of standards on motivations, and
specifically the likely effect on motivation of adopting the labor standard
recommended for Harden Company by the engineering firm.
2. An evaluation of Harden Company's decision to employ dual standards in its standard
1. Standards are often classified into three types - theoretical (tight), normal
(reasonable), or expected actual (loose). Standards which are too loose or too tight
will generally have a negative impact on workers motivation. If too loose, workers
will tend to set their goals at this low rate, thus reducing productivity below what is
obtainable; if too tight, workers will realize that it is impossible to attain the
standard, become frustrated, and will not attempt to meet the standard. An
attainable or reasonable standard which can be achieved under normal working
conditions is likely to contribute to the worker's motivation to achieve the designated
level of activity.
If executive management imposes standards, workers and plant management will
tend to react negatively because they feel threatened. If workers and plant
management participate in setting the standard, they can more readily identify with
it and it could become one of their personal goals.
In Harden's case, it appears that the standard was imposed on the workers by
management. In addition, management used an ideal standard to measure
performance. Both of these actions appear to have had a negative impact on output
over the first six months.
2. Harden made a poor decision to use dual standards. If the workers learn of the dual
standards, the company's entire measurement system may may become suspect and
credibility will be lost. Company morale could suffer because the workers would not
know for sure how the company evaluates their performance. as a result, disregard
for the present and any future cost control system may develop.
Factory Overhead Variance Analysis:
Strayer Company uses a standard cost system and budgets the following sales and costs for
Unit sales 20,000
Total production cost at standard 130,000
Gross profit 70,000
Beginning inventories None
Ending inventories None
The 19-- budgeted sales level was the normal capacity level used in calculating the factory
overhead predetermined standard cost rate per direct labor hour.
At the end of 19--, Strayer Company reported production and sales of 19,200 units. Total
factory overhead incurred was exactly equal to budgeted factory overhead for the year and
there was under-applied total factory overhead of $2,000 at December 31. Factory
overhead is applied to the work in process inventory on the basis of standard direct labor
hours allowed for units produced. Although there was a favorable labor efficiency variance,
there was neither a labor rate variance nor materials variances for the year.
Require: An explanation of the under-applied factory overhead of $2,000, being as specific
as the data permit and indicating the overhead variances affected. Strayer uses a three
variance method to analyze the total factory overhead.
Under-applied factory overhead will arise when actual factory overhead incurred is larger
than the standard amount of factory overhead applied to work in process. The standard
amount of factory overhead applied to work in process is based on actual rather than on
budgeted units of output.
Based on the information given, the sum of the factory overhead spending, efficiency, and
idle capacity variances resulted in an unfavorable total factory overhead variance of $2,000.
The factory overhead efficiency variance must be favorable because it is computed on the
same basis as the direct labor efficiency variance which was given as favorable.
Strayer would have an unfavorable idle capacity variance because the actual activity level
for the year was less than the capacity level used in calculating the standard cost rate for
As to the factory overhead spending variance, the balance would be unfavorable because
actual costs would have had to exceed the budgeted cost of the actual units produced since
the budget allowance for production of 19,200 units must be less than for 20,000 units and
the actual costs were exactly equal to the budget allowance for 20,000 units. The
magnitude of the spending variance is indeterminate from the information given.
Standard Costing System Discussion
Questions and Answers:
1. (a) Define standard costs.
(b) Name some advantages of standard cost system.
2. A team of management consultants and company executives concluded that a
standard cost installation was desirable vehicle for accomplishing the objectives of a
progressive management. State some uses of standard costs that can be associated
with the above decision.
3. Does a standard cost system increases or decreases the amount of accounting and
clerical effort and expense required to prepare cost reports and financial statements?
4. Is a standard cost system equally applicable to job order costing and process costing
5. A conference speaker discussing budgets and standard costs made the following
statement: "Budgets and standards are not the same thing. They have different
purposes and are set up and used in different ways ; yet a specific relationship exists
(a) Identify distinctions or differences between budgets and standards.
(b) Identify similarities between budgets and standards.
6. The use of standard costs in pricing and budgeting is quite valuable since decisions in
the fields of pricing and budgetary planning are made before the costs under
consideration are incurred. Discuss.
7. Explain how materials, labor and factory overhead standards are set, including the
types of people involved and the method used.
8. What type of variances are computed for materials, labor, and factory overhead?
9. In a paper mill, materials specification standards are set up for various grades of
pulp and secondary furnish (waste paper) for each grade and kind of paper
produced. Yet at regular intervals the cost accountant is able to determine a
materials mix variance. Why does a mix variance occurs?
10. How does the calculation of a mix variance differ from that of a quantity variance?
11. A cost standard in a process industry is often based on an assumed yield rate. Any
difference in actual yield from standard yield will produce a yield variance. Express
this variance in formula form.
12. Select the answer which best completes the statement:
(a) A purpose of standard costing is to: (1) determine the break even production
level; (2) control costs; (3) eliminate the need for subjective decisions by
management ; (4) allocate cost more accurately.
(b) A company employing very tight (theoretical) standards in a standard costing
system should expect that : (1) a large incentive bonus will be paid; (2) most
variances will be unfavorable; (3) employees will be strongly motivated to attain the
standards; (4) costs will be controlled better than if lower standards were used.
(c) Of the different types of standards listed below, the one which best describes
labor costs that should be incurred under forthcoming efficient operating conditions
is : (1) ideal; (2) basic; (3) maximum efficiency; (4) normal.
(d) In standard costing, standard hours allowed is a means of measuring: (1)
standard output at standard hours; (2) actual output at standard hours; (3) standard
output at actual hours; (4) actual output at actual hours.
(e) In preparing cost report at standard for process costing: (1) equivalent units are
not used; (2) equivalent units are computed using an approach that ignores
inventories; (3) the actual equivalent units are multiplied by the standard cost per
unit; (4) the standard equivalent units are multiplied by the actual cost per unit.
(f) In a standard cost system, the materials purchase price variance is obtained by
multiplying the: (1) actual price by the difference between actual quantity purchased
and standard quantity allowed; (2) actual quantity purchased by the difference
between actual price and standard price; (3) standard price by the difference
between standard quantity purchased and standard quantity allowed; (4) standard
quantity purchased by the difference between actual price and standard price.
(g) A favorable labor efficiency variance indicates: (1) the average wage rate paid
was less than the standard rate; (2) the standard labor hours allowed were greater
than the actual labor hours used; (3) the actual total labor cost incurred was less
than the standard labor cost allowed for the units produced; (4) the number of units
produced was less than the number of units budgeted for the period.
(h) Given below are notations and their respective meanings:
AH = Actual hours
SHA = Standard hours allowed for actual production
AR = Actual rate
SR = Standard rate
The formula that represents the labor efficiency variance is: (1) SR × (AH – SHA);
(2) AR × (AH – SHA); (3) AH × (AR – SR); (4) SHA × (AR – SR).
(i) The standard cost variance representing the difference between actual factory
overhead incurred and budgeted factory overhead based on actual hours worked is
the (1) volume variance; (2) spending variance; (3) efficiency variance; (4) quantity
(j) The fixed portion of the standard factory overhead application rate is a function
of a predetermined "normal" activity level. If standard hours allowed for good output
equal this normal activity level for a given period, the volume variance will be: (1)
zero; (2) favorable; (3) unfavorable; (4) either favorable or unfavorable, depending
on the budgeted overhead.
1. (a) Standard costs are the predetermined costs of manufacturing products during a
specific period under current or anticipated operating conditions. Standards aid in
planning and controlling operations.
(b) The advantages of a standard cost system include the following:
1. The process in itself often discloses inefficiencies, because the setting of standards
requires a thorough analysis of all cost functions.
2. The process of setting standards forces management to plan efficient and
3. Standard costs establish clearly defined lines of cost responsibility and authority.
4. Standard costs are likely to be an important aid to management in obtaining
acceptable job performance by providing a clear idea as to what constitutes
5. Variances between actual performance and standard costs facilitate control
through the application of the principle of exception.
6. Faster reporting of operating data is possible; the shortened time between action
and the availability of control information helps management to prevent the
development of unfavorable cost trends.
2. A few uses of standard costs are:
(a) Establishing budgets.
(b) Controlling costs and motivating and measuring efficiencies.
(c) Promoting cost reduction.
(d) Simplifying cost procedures and expediting cost reports.
(e) Assigning costs to inventories.
(f) Setting sales prices.
3. In some way a standard cost system reduces clerical work. Variance reports add new
tasks, which may make expenses about equal. The fact that more information is
available about the operations of the business should be of greater value than the
expenses of operating the accounting system.
4. Yes, standard costs can be used either in job order costing where the cost of specific
jobs put through a factory is ascertained, or process costing where the cost of
production in one or more manufacturing departments for a given period of time is
determined. a standard cost system applied to either job order or process costing will
bring the added advantage of cost analysis hitherto unavailable.
5. (a) Budgets and standards are not the same thing; yet a specific relationship
exists between them. The first difference between budgets and standards is one
of purpose. Budgets are statements of expected cost. At the beginning of a given
period, they are used to forecast requirements of finance, work force, and other
variables related to production and sales. Later in a given period, they are used as
comparison to be sure that actual costs are not exceeding expectations. Standard
costs, on the other hand, do not necessarily show what costs may be expected to be,
but rather, what they might be if certain highly desirable performance are attained.
For this reason they cannot be used alone for forecasting.
The second difference between budgets and standards is one of emphasis. A budget
emphasizes cost levels that should not be exceeded. If they are exceeded, then the
whole foundation upon which profits are predicted is jeopardized. But a standard
emphasizes the levels to which costs should be reduced. I these levels are reached,
profits are increased. Costs are not to exceed budget; they are to approach
A third difference is on of completeness. Budgets are customarily set for all
departments in the company, from sales to manufacturing. Standards, however, are
often set only for the manufacturing divisions. Budgets customarily include both
income and expense, whereas standards are more frequently set for expenses or
A fourth difference is one of analysis and breakdown. When cost differs from budget,
a lower cost indicates good performance; a higher cost tells of a perilous situation.
But when actual cost differs in any marked degree from standards, the nature and
cause of the variance should be investigated so that needed corrective steps may be
taken in time.
These difference may be summarized by saying that a budget is a marker for
keeping out of trouble, whereas a standard is a compass that points the way to
(b) Although standards and budgets have certain differences, they possess
similarities which are of such a nature that the existence of standard costs greatly
facilitates budget preparation. The first similarity is that both budgets and standards
attempt to predetermine expenses. The budget and the standards have been set by
records of current operational methods or procedures and have not just been set by
hopes for so-called "good production."
Second, both consider departmental expenses according to accounts. generally
speaking, all departments have their sub-accounts. They have been budgeted for a
certain amount to be spent for specific uses. If there are cost differences, they
should be investigated at the time they are happening.
Third similarity is that both assume costs are controllable along direct lines of
supervision and responsibility. Supervisors are responsible to manage not only for
production but also for cost of production. Supervisors should be aware of the budget
as well as the standards for their departments.
Finally, both require the issuance of periodic comparative cost reports. When the
costs are much higher or lower than the budgeted amount and are controlled by
standards, these differences should be broken down to show management specific
reasons for these differences at each interim reporting period.
Budgets are similar to standard costs in their methods of approach and
measurement. If standard costs are known, budgeted costs can be derived from
them by the application of ratios.
6. To set sales prices, executives need cost information furnished by the accounting
department. Since standard costs represent the cost that should be attained in a well
managed plant operated at normal capacity, they are ideally suited for furnishing
information which will enable the sales departments to price products.
Budgets are used for planning and coordinating future activities and for controlling
current activities. When budget figures are based on standard costs, the accuracy of
the resulting budget is strongly influenced by the reliability of the standard costs.
With standards available, production figures can be translated into the manufacturing
7. Materials - Materials price standards in most cases should be set by the purchasing
officer. Because prices are determined by the external influences, setting price
standards is mainly a task of accurate prediction.
Materials quantity standards should be set by engineers responsible for product
design. In setting these standards, companies may use engineering studies, sample
runs, historical studies, or a combination thereof depending on specific materials and
Labor - Labor rates are often a result of union negotiations and should be obtained
from the personnel department. Labor time standards are set by properly trained
and experienced methods engineers using time and motion studies.
Factory Overhead - Variable factory overhead standards are based on the
company's flexible budget.
The fixed overhead standard is based on the company's budget for fixed factory
overhead, divided by an appropriate measure of activity.
8. Materials: Price and quantity variance
Labor: Rate and efficiency variance
Factory overhead: (1) Controllable and volume variance (2) Spending variance,
idle capacity variance, efficiency variance (3) Spending variance, variable overhead
efficiency variance, Fixed overhead efficiency variance, Idle capacity variance.
Mix and yield variances also can be calculated for the cost elements.
9. Although specifications are established primarily by the laboratory, mix changes are
made when production people feel the less costly grades of furnish or even pulp can
be used satisfactorily. Production people hope, of course, that the final result will still
be the same high quality product. The difference between the engineered laboratory
standard and the actual usage at different standard costs results in a mix variance.
10. The quantity variance is the result of comparing actual quantity at standard cost with
standard quantity at standard cost. The mix variance results when actual input is
used in ratios or quantities different from standard specifications at standard cost.
11. The yield variance is the difference between actual and standard (or expected) yield
multiplied by the standard value of product (or production). the formula is:
Yield variance = (Actual yield – standard yield) × weighted average of standard
12. (a) 2; (b) 2; (c) 4; (d) 2; (e) 3; (f) 2; (g) 2 (h) 1; (i) 2; (j) 1