Standard Costs and Balanced
Scorecard
Learning Objectives
1. Distinguish between a standard and a budget.
2. Identify the advantages of standard costs.
3. Describe how companies set standards.
4. Discuss the reporting of variances.
5. Prepare an income statement for management use under a
standard costing system.
6. Describe the balanced scorecard approach to performance
evaluation.
Why there is a need for Standards?
➢Standards are predetermined unit costs, which companies use as
measures of performance.
➢Standards are common in business. They may extend to personnel
matters, such as employee absenteeism and ethical codes of conduct.
Quality control standards for products, and standard costs for goods
and services.
For instance, fast-food restaurants like McDonald's are aware of their
prices it should pay for things such as pickles, steak, and rolls. It also
knows how long an employee should spend flipping hamburgers. If the
corporation pays too much for pickles or if employees take too much
time to make Big Macs.
McDonald's observes the deviations and corrects them. Universities,
philanthropic organizations, and government agencies, among others,
may also use standard costs as success indicators.
Standards vs Budgets
➢Both are predetermined costs, and contribute to management
planning and control.
➢A standard is a unit amount; while a budget is a total amount.
➢A standard is the budgeted cost per unit of a product. A standard is
concerned with each individual cost component that makes up the
entire budget.
Why Standard Costs?
1. Facilitate management planning
2. Promote greater economy by making employees more cost-
conscious.
3. Useful in setting prices.
4. Contribute to management control by providing basis for evaluation
of cost control.
5. Useful in highlighting variances in management by exception.
6. Simplify costing of inventories and reduce clerical costs.
Ideal vs Normal Standards
Companies establish standards at either the ideal or normal level.
Ideal standards offer optimal levels of performance under perfect
conditions of operation.
Normal standards describe efficient performance levels that are
attainable under normal operating conditions.
Direct Materials Standard
➢Direct materials price standard is the cost per unit of direct materials
that should be incurred.
➢Direct materials quantity standard is the quantity of direct materials
that should be used per unit of finished goods.
➢The standard direct materials cost per unit is the standard direct
materials price times the standard direct materials quantity.
Direct Labor Standards
➢Direct labor price standard is the rate per hour that should be
incurred for direct labor. It is based on current wage rates, adjusted
for anticipated changes such as cost of living adjustments.
➢Direct labor quantity standard is the time that should be required to
make one unit of the product.
➢The standard direct labor cost per unit is the standard direct labor
rate times the standard direct labor hours.
Overheads
Companies use a standard predetermined overhead rate in setting the
standard. This overhead rate is determined by dividing budgeted
overhead costs by an expected standard activity index.
For example, the index may be standard direct labor hours or standard
machine hours.
Illustration
Bionic Beverage Company uses standard costs to measure performance
at the production facility of its caffeinated energy drink, Bionic Tonic.
Bionic produces one-gallon containers of concentrated syrup that it
sells to coffee and smoothie shops, and other retail outlets.
Direct materials
Setting direct materials price Setting direct materials quantity
standard: standard:
Item Price Item Quantity (Kg)
Purchase price, net of discounts $ 2.70 Required materials 3.5
Freight 0.20 Allowance for waste 0.4
Receiving and handling 0.10 Allowance for spoilage 0.1
Standard direct materials per Kg $ 3.00 Standard direct materials quantity
per unit 4.0
Direct Labor
Setting direct labor rate standard: Setting direct labor hours
standard:
Item Rate Item Quantity (Hours)
Hourly wage rate $ 12.50 Actual production time 1.5
COLA 0.25 Rest periods and cleanup 0.2
Payroll taxes 0.75 Setup and downtime 0.3
Fringe benefits 1.25 Standard direct labor hours
per unit 2.0
Standard direct labor
rate per hour $ 15.00
Overheads
Bionic uses standard direct labor hours as the activity index. The
company expects to produce 13,200 gallons of Bionic Tonic during the
year at normal capacity. Normal capacity is the average activity output
that a company should experience over the long run. Since it takes two
direct labor hours for each gallon, total standard direct labor hours are
26,400 (13,200 gallons x 2 hours). At normal capacity of 26,400 direct
labor hours, overhead costs are expected to be $132,000. Of that
amount, $79,200 are variable and $52,800 are fixed
Computing Pre-determined Overhead rates
Budgeted Overhead Standard direct labor Overhead rate per
Costs Amount ÷ hours
= direct labor hour
Variable $ 79,200 26,400 $ 3.00
Fixed 52,800 26,400 $ 2.00
Total $ 132,000 $ 5.00
Total Standard Cost per Unit
After a company has established the standard quantity and price per unit of
product, it can determine the total standard cost. The total standard cost per unit is
the sum of the standard costs of direct materials, direct labor, and manufacturing
overhead. The total standard cost per gallon of Bionic Tonic is $52, as shown on the
following standard cost card:
Cost elements Standard quantity X Standard Rate = Standard Cost
Direct materials 4 Kgs. $ 3.00 $ 12.00
Direct labor 2 hours $ 15.00 $ 30.00
Overhead 2 hours $ 5.00 $ 10.00
$ 52.00
Analyzing Variances
One of the major management uses of standard costs is to identify variances from
standards. Variances are the differences between total actual costs and total
standard costs.
To illustrate, assume that in producing 1,000 gallons of Bionic Tonic in the month of
June, the company incurred the following costs:
Item Amount
Direct materials $ 13,020
Direct labor $ 31,080
Variable overhead $ 6,500
Fixed overhead $ 4,400
Total $ 55,000
The total standard cost of Bionic Tonic is $52,000 (1,000 gallons x $52). Thus, the total variance is
$3,000, as shown below:
Particulars Amount
Actual costs $ 55,000
Less: Standard costs $ 52,000
Total Variance $ 3,000
Note that the variance is expressed in total amount, and not on a per unit basis.
When actual costs is more than the standard costs, the variance is unfavorable. An unfavorable variance suggests that
the company paid too much for one or more of the manufacturing cost elements or that it used the elements
inefficiently.
When actual costs is less than the standard costs, the variance is favorable. A favorable variance suggests that the
company has efficiently employed the use of all the manufacturing costs elements – direct materials, direct labor, and
manufacturing overheads.
Total Variance
Materials variance + Labor variance + Overhead variance = Total Variance
Materials variance
In completing the order for 1,000 gallons of Bionic Tonic, the company used 4,200
kilograms of direct materials. The direct materials were purchased at a price of
$3.10 per unit.
Materials Price Variance + Materials Quantity Variance = Total Materials Variance
The materials price variance is computed as the difference between the actual amount
paid and the standard amount that should have been paid multiplied by the actual quantity
purchased.
The materials quantity variance is the difference between the actual quantity used and the
standard quantity that should have been used multiplied by the standard price.
Causes of Materials Variance
Direct Labor variances
In completing the Bionic Tonic order, the company incurred 2,100 direct labor hours
at an average hourly rate of $14.80. The standard hours allowed for the units
produced were 2,000 hours (1,000 gallons x 2 hours). The standard labor rate was
$15 per hour.
Labor Price Variance + Labor Quantity Variance = Total Labor Variance
The labor price variance is computed as the difference between the actual amount
paid and the standard amount that should have been paid multiplied by the actual
hours worked.
The labor quantity variance is the difference between the actual hours used and
the standard hours that should have been used multiplied by the standard labor
rate.
Causes of Labor Variance
Labor price variances usually result from two Labor quantity variances relate to the efficiency of
factors: (1) paying workers different wages than workers. The cause of a quantity variance generally
expected, and (2) misallocation of workers. can be traced to the production department. The
causes of an unfavorable variance may be poor
training, worker fatigue, faulty machinery, or
carelessness.
Overhead variances
The total overhead variance is the difference between the actual overhead costs
and overhead costs applied based on standard hours allowed for the amount of
goods produced.
Actual Overhead – Overhead Applied = Total Overhead Variance
Causes of Overhead
variances
One reason for an overhead
variance relates to over- or
underspending on overhead items.
This may include indirect labor for
which a company paid wages higher
than the standard labor price
allowed. Or, the price of electricity
to run the company’s machines
increased, and the company did not
anticipate this additional cost.
Companies should investigate any
spending variances, to determine
whether they will continue in the
future.
Reporting Variances
All variances should be reported to appropriate levels of management as soon as
possible. The sooner managers are informed, the sooner they can evaluate
problems and take corrective action.
The form, content, and frequency of variance reports vary considerably among
companies. One approach is to prepare a weekly report for each department that
has primary responsibility for cost control.
Income Statement Presentation of Variances
for Management Purposes
In income statements prepared for management under a standard cost accounting
system, cost of goods sold is stated at standard cost and the variances are disclosed
separately.
Unfavorable variances increase cost of goods sold, while favorable variances
decrease cost of goods sold.
To illustrate, let’s assume that Bionic Beverage Company sold 1,000 gallons at
US$70/gallon of the Bionic Tonic for the month of June. For management purposes,
income statement will be reported as:
Bionic Beverage Company
Income Statement
For the month ended June 30, 2021
Sales (1,000 @ $70) $ 70,000
Less: Cost of goods sold (at standard) 52,000
Gross Profit (at standard) 18,000
Variances
Materials price $ 420 U
Materials quantity 600 U
Labor price 420 F
Labor quantity 1,500 U
Overhead 900 U
Total Variance Unfavorable 3,000
Gross Profit (actual) 15,000
Practice Test
Wonder Company makes a cologne called Aramis. The standard cost for one bottle of Aramis cologne is as follows:
Standard
Cost elements Quantity Price Cost
Direct materials 6 oz. $ 0.90 $ 5.40
Direct labor 0.5 hours $ 12.00 6.00
Overhead 0.5 hours $ 4.80 2.40
Total $ 13.80
During the month, the following transactions occurred in producing 10,000 bottles of cologne:
1. 58,000 ounces of materials were purchased at $ 1.00 per ounce.
2. All the materials purchased were used to produce 10,000 bottles of Aramis.
3. 4,900 direct labor hours were worked at a total cost of $ 56,350.
4. Variable manufacturing overhead incurred was $15,000 and fixed overhead was $10,400.
The manufacturing overhead rate was based on 5,200 direct labor hours . The total budget at this capacity is $ 10,400 fixed and
$14,560 variable.
Required: Compute for the variances
Balanced Scorecard
Performance can be assessed with the help of financial measurements (measures
expressed in money), such as variance analysis and return on investment (ROI). To
better evaluate performance and predict future outcomes, many businesses now
combine these financial indicators with non-financial measures.
The majority of businesses are aware that both financial and non-financial metrics
can offer helpful information about how the business is doing. As a result, many
businesses now assess performance using a broad-based measuring strategy
known as the balanced scorecard. The balanced scorecard joins performance
evaluation with a company's strategic objectives by combining financial and
nonfinancial variables in a seamless framework.
The financial perspective is the most traditional view
of the company. It employs financial measures of
performance used by most firms.
ROA
Net Income
Share Price
Return on Investment
The customer perspective evaluates the
company from the viewpoint of those people
who buy its products or services. This view
compares the company to competitors in terms
of price, quality, product innovation, customer
service, and other dimensions.
The internal process perspective evaluates the
internal operating processes critical to success.
All critical aspects of the value chain—including
product development, production, delivery, and
after-sale service—are evaluated to ensure that
the company is operating effectively and
efficiently.
The learning and growth perspective evaluates
how well the company develops and retains its
employees. This would include evaluation of
such things as employee skills, employee
satisfaction, training programs, and information
dissemination.
Indicate which of the four perspectives in the balanced scorecard is most likely
associated with the objectives that follow.
1. Percentage of repeat customers
2. Number of suggestions for improvement from employees
3. Contribution margin
4. Brand recognition
5. Number of cross-trained employees
6. Amount of setup time
