Blueprint Problem: Standard Costing: Materials & Labor Variances

Standard Costing

Standard costing systems budget quantities and costs on a unit basis for all manufacturing costs. A standard cost is a budgeted or expected cost per unit. Standards are set in advance and are developed in a number of ways: historical experience, engineering studies, and based on input from operating personnel who are familiar with the process. Because standard setting can be complex and expensive, once standards are set, they are rarely changed.

There are several types of standards. Select the standard type with its appropriate definition.

Definition		Standard Type
Standards that change from year to year and emphasize continuous improvement.
Standards achieved under efficient operating conditions.
Ideal standards requiring maximum efficiency and ideal operating conditions.

As a result, standards that allow no machine breakdowns, or any type of inefficiency are . Suppose a company had direct materials standard cost of $5.00 in year 1, $4.90 in year 2 and $4.75 in year 3 as waste and spoilage of materials in production was reduced. These standards would be are

A standard cost card for one unit of a product may look like the following:

Direct materials (4 pounds @ $1.25 per pound)		$5.00
Direct labor (0.1 DLH @ $18 per hour)		1.80
Variable overhead (0.1 DLH @ $2.00 per hour)		0.20
Fixed overhead (0.1 DLH @ $4.60 per hour)		0.46
Total cost per unit		$7.46

The standard cost to produce one unit is $7.46. The standard cost to produce 600 units are $. Of course, this is a simplification as the standard cost does not take fixed and variable costs into account.

However, if the firm is producing at or near capacity, then the cost per unit of $7.46 could be multiplied by total units to get total standard cost.

The standard cost card gives both unit and cost standards. The direct materials total of $5.00 is based on the use of four pounds of material at $1.25 per pound. Similarly, it should take six minutes (0.1 direct labor hour) to produce one unit. This makes it easy to determine total quantities and cost would be for multiple units.

If 400 units were made, it should take pounds of direct materials with total standard cost of $. If 460 units were made, it should take pounds of direct materials with total standard cost of $. If 400 units were made, it should take direct labor hours with total standard cost of $.

Standard costing is used for planning, control and decision making. Consider the following scenarios:

1. Abel Company has a standard cost of $5 per unit. Next year, Abel plans to make 20,000 units at a total manufacturing cost of $100,000. Abel is using standard costing in .

2. Sanders Company has excess capacity and is considering a special order for 400 units at less than the usual price. In determining whether or not the company can accept the special order, Sanders calculates the standard variable cost per unit at $3. Sanders is using standard costing in .

3. Clooney Company has a standard cost of $8 per unit. Last month, Clooney made 150 units at actual cost of $1,240, which Clooney compared to the total standard cost of $1,200. Clooney is using standard costing in .

Materials Price and Quantity Variances

Companies compare the actual cost with the standard cost. Two basic ways the actual cost of direct materials can deviate from standard cost is: (1) through price or (2) the quantity used in production. Therefore, the materials price variance and the materials quantity variance are typically calculated in determining whether or not the cost of direct materials is as expected or not. When standard costing is used in this way it is used for .

The materials price variance compares the actual price paid per unit of direct materials to the standard price. That difference is multiplied by the actual quantity of materials.

Materials Price Variance = (Actual Price Actual Quantity) - (Standard Price Actual Quantity) or Materials Price Variance = Actual Quantity (Actual Price - Standard Price)

What is the "actual quantity"? For the materials price variance, we typically mean the actual quantity purchased. This aligns the materials price variance with the Purchasing Department, which has responsibility for the price of materials. (Note: Responsibility in accounting means that this department has the most information about the reason for any price difference and can explain it.)

For example, Filmont Company has the following standard cost card for prime costs:

Direct materials (3 yards @ $1.75 per yard)		$5.25
Direct labor (1.2 hours @ $20 per hour)		24.00

Last month, Filmont produced 450 units. Actual cost for direct materials was $2,408 for 1,400 yards of direct materials purchased.

Then, Materials price variance = $2,408 - (1,400 $1.75) = $2,408 - $2,450 = $42 Favorable or Materials price variance = 1,400 ($1.72 - $1.75) = $42 Favorable

Notice that the second equation makes it easier to compare the actual price of $1.72 per yard ($2,408/1,400 yds) with the standard price of $1.75 per yard. Clearly, Filmont Company has paid $0.03 per yard less than standard. Multiplied by 1,400 yards purchased, the variance between actual price paid and standard price expected is $42.

A note about "Favorable" versus "Unfavorable." Variances are tagged as favorable or unfavorable. By doing this, we don't need to remember whether actual is subtracted from standard or vice versa. Instead, if a cost is higher than expected (standard) it is "unfavorable" and if it is lower than expected (standard) it is "favorable." However, favorable does not mean "good" and "unfavorable" does not mean "bad." For example, suppose that the standard quantity of active ingredient in a drug was 1,000 pounds and the actual amount used was 800. That is a "favorable" quantity variance (less used than standard) however, the drug is 20% below the advertised strength of active ingredient - a bad result.

Suppose that Filmont had paid $2,520 for 1,400 yards of material. The materials price variance would be $ .

The materials quantity variance compares the amount of direct material actually used with the amount of material that should have been used at standard for actual production. Thus, we are moving away from direct materials purchased to the direct materials used in production. We can only figure the standard amount if we know: (1) the number of units actually produced and (2) the unit materials standard.

Materials usage variance = (Actual Quantity Standard price) - (Standard Quantity Standard Price) or Materials usage variance = Standard Price (Actual Quantity - Standard Quantity)

Standard quantity = Actual units produced unit standard direct materials

Recall that Filmont Company, has the following standard cost card for prime costs:

Direct materials (3 yards @ $1.75 per yard)		$5.25
Direct labor (1.2 hours @ $20 per hour)		24.00

Last month, Filmont produced 450 units and used 1,410 yards of material.

What is the standard quantity of direct materials allowed for Filmont last month? $ yards

Materials usage variance = $1.75(1,410 - 1,350) = $105 Unfavorable

The materials usage variance is unfavorable because more yards were used (1,410) than the standard amount allowed for the 450 units actually produced or 1,350 yards at standard (450 units 3 yards). Suppose 1,306 yards had been used. The materials usage variance would have been $ .

Filmont purchased 1,400 yards of material but actually used 1,410 yards. Where did the other 10 yards come from?

Direct Labor Wage and Efficiency Variances

Two basic ways in which the actual cost of direct labor can deviate from standard cost is through: (1) wage rate or (2) the number of hours used in production. Therefore, the labor rate variance and the labor efficiency variance are typically calculated in determining whether or not the cost of direct labor is as expected or not. When standard costing is used in this way it is used for .

The labor rate variance compares the actual price paid per unit of direct materials to the standard price. The difference is then multiplied by the actual quantity of materials.

Labor rate variance = (Actual wage Actual hours) - (Standard wage Actual hours) or Labor rate variance = Actual hours (Actual wage - Standard wage)

Unlike materials, labor cannot be inventoried. So actual hours are measured as hours worked in production.

For example, Filmont Company has the following standard cost card for prime costs:

Direct materials (3 yards @ $1.75 per yard)		$5.25
Direct labor (1.2 hours @ $20 per hour)		24.00

Last month, Filmont produced 450 units. Actual cost for direct labor was $10,653 for 530 direct labor hours worked.

Standard hours for actual quantity equaled $ hours.

Then, Labor rate variance = $10,653 - (530 $20) = $10,653 - $10,600 = $53 Unfavorable or Labor rate variance = 530($20.10 - $20.00) = $53 Unfavorable

Notice that the second equation makes it easier to compare the actual wage of $20.10 per hour ($10,653/530 hours) with the standard wage of $20 per hour. Clearly, Filmont Company has paid $0.10 per hour more than standard. Multiplied by 530 actual hours worked the variance between actual wage and standard wage expected is $53.

Suppose that Filmont had paid $10,388 for 530 hour. The labor rate variance would be $ .

The labor efficiency variance compares the direct labor hours actually worked with the standard direct labor hours that should have been worked for actual production. The standard amount is based on the number of units actually produced and the unit direct labor standard.

Labor rate variance = (Actual wage Actual hours) - (Standard wage Actual hours) or Labor rate variance = Actual hours (Actual wage - Standard wage)

Recall that Filmont Company has the following standard cost card for prime costs:

Direct materials (3 yards @ $1.75 per yard)		$5.25
Direct labor (1.2 hours @ $20 per hour)		24.00

Last month, Filmont produced 450 units and had 530 hours of direct labor. What is the number of direct labor hours at standard for last month? hours

Then the labor efficiency variance = $20 X (540 - 530) = $200 Favorable

The labor efficiency variance is favorable because fewer hours were worked than the standard (450 units 1.2 hours per unit) for actual units produced.

Suppose 560 hours had been worked. The labor efficiency variance would have been $ .