8 Standard Costs and Variance Analysis
Learning Objectives LO
LO1 Describe the purpose of standard costs used for manufacturing costs
LO2 Compute the direct materials price and quantity variances and explain their significance
LO3 Compute the direct labor rate and efficiency variances and explain their significance
LO4 Compute the variable manufacturing overhead rate and efficiency variances and explain their significance
Purpose of standard costs LO1
Standards are cost or revenue targets used to make financial projections and evaluate performance. The cost formulas used for budgeting are considered standards. Standards set forth the expected revenue or cost for a particular item. For example, if the cost formula for supplies is $3 per unit ($3Q), it is also considered the standard cost for supplies. Managers can use the standard cost formula to make projections about supplies expense or to evaluate the actual amount spent on supplies.
All manufacturing and the costs associated with providing services should have established standard cost targets. This chapter focuses on standard costs and standard cost variances related to variable manufacturing costs. Manufacturing costs, or the cost incurred to manufacture a product for resell, are also known as product costs. As discussed in previous chapters, three categories comprise total product cost—direct material, direct labor, and manufacturing overhead. Standard costs are established for all three categories of product costs.
Standards for variable manufacturing costs include both quantity and price standards. The quantity standard establishes how much of an input is needed to make a product or provide a service. The price standard specifies how much each quantity of input should cost. These standards can be used to make financial projections and to evaluate performance by comparing the standards to actual performance at the end of the period. Any discrepancy between the standard and actual costs is known as a variance. Standard variances are considered a red flag for management to investigate and determine their cause.
Direct material and direct labor are considered variable manufacturing costs, since the total amount for these costs changes based on production. Manufacturing overhead is typically a mixed cost consisting of a variable and a fixed component. Fixed manufacturing overhead is, by definition, fixed and should not change as long as production remains within the relevant range. The fixed portion of manufacturing overhead is analyzed by comparing the projected or budgeted amount of fixed manufacturing overhead to the actual amount of fixed overhead incurred using the same process presented in the flexible budgeting chapter. The total amount of variable manufacturing overhead changes based on production so it has a quantity and price standard. Since direct material, direct labor, and variable manufacturing overhead have quantity and price standards, they are analyzed using the standard costs