University of San Jose – Recoletos

School of Business and Management

Accountancy and Finance Department

Cost Accounting and Control

Mr. Jun Brian Alenton, CPA, CMA, CAT, RCA, MICB, MBA

Module 11
Standard Costing and Variance Analysis

Development of a Standard Cost System

 A standard is a benchmark or norm used for planning and control purposes; it is a model or budget
against which actual results are compared and evaluated.
 A standard cost system is a product costing system that determines product cost by using standards
or norms for quantities and/or prices of component elements; it allows actual costs to be compared
against norms for cost control purposes.
 A standard cost is a budgeted or estimated cost to manufacture a single unit of product or perform
a single service.
 Developing a standard cost involves judgment and practicality in identifying the material and
labor types, quantities, and prices as well as understanding the types of organizational overhead
and how they behave.
 A primary objective in manufacturing a product is to minimize unit cost while achieving certain
quality specifications.
 After management has determined the input resources needed to achieve desired output quality
at reasonable cost, it can develop quantity and price standards.
 Standards should be developed by a group, composed of representatives from the following
areas:
o cost accounting;
o industrial engineering;
o personnel;
o data processing;
o purchasing; and
o management.
 To ensure credibility of the standards and to motivate people to operate close to the standards
as possible, standard-setting involvement of managers and workers whose performance will be
compared to standards is vital.

Variance Computations
 A variance is any difference between an actual cost and a standard or budgeted cost.
 Such a difference is favorable if actual cost is less than standard cost.
 A variance is unfavorable if actual cost is greater than standard cost.
 A total variance is the difference between total actual cost incurred and total standard cost for
the output produced during the period.
 A total variance can be computed for each production cost element.
 Total variances indicate differences between actual and expected production costs, but they do
not provide useful information for determining why such differences occurred.
 Total variances for materials and labor are subdivided into price and usage variances in order to
help managers in their control objectives.
 A price variance reflects the difference between what was actually paid for inputs and what
should have been paid for inputs during the period.
 A usage variance shows the difference between the quantity of actual inputs and the quantity
of standard inputs allowed for the actual output of the period. Usage variances focus on the
efficiency of results—the relationship of inputs to outputs.
 The standard quantity allowed is the quantity of input (in hours or some other cost driver
measurement) required at standard for the output actually achieved for the period.

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 Material Variances
 The total material usage variance can be subdivided into the material price variance and the
material quantity variance.
AP × AQP SP × AQP SP × SQP

Material Material
Purchase Price Variance Quantity Variance

Total Material Variance

 The material price variance (MPV) is the total actual cost of materials purchased minus
(actual quantity of materials × standard price); it is the amount of money spent below
(favorable) or in excess (unfavorable) of the standard price for the quantity of materials
purchased; it can be computed based on the actual quantity of materials purchased or the
actual quantity used.
 The material purchase price variance is the materials price variance when computed based
on the quantity of materials purchased during the period rather than the quantity of materials
used, and is used in what is referred to as the point of purchase material variance model.
 The material price usage variance is the material price variance when computed based on
the quantity of materials used during the period.
 The material quantity variance (MQV) is the standard cost saved (favorable) or
expended (unfavorable) due to the difference between the actual quantity of materials used
and the standard quantity of materials allowed for the goods produced during the period;
(actual quantity × standard price) minus (standard quantity allowed × standard price).

Labor Variances
 The total labor variance can be subdivided into the labor rate variance and the labor efficiency
variance.
AP × AQ SP × AQ SP × SQ

Labor Labor
Rate Variance Efficiency Variance

Total Labor Variance

 The labor rate variance (LRV) is the actual rate (or actual weighted average rate) paid to
labor for the period minus the standard rate multiplied by all hours actually worked during
the period; actual labor cost minus (actual hours × standard rate).
 The labor efficiency variance (LEV) is the number of hours actually worked minus the
standard hours allowed for the production achieved multiplied by the standard rate to
establish a value for efficiency (favorable) or inefficiency (unfavorable) of the workforce.

Overhead Variances
 Capacity refers to any measure of activity.

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  The most common capacity measures are theoretical capacity, practical capacity, normal
capacity, and expected capacity.
 Variable Overhead
a. The total variable overhead variance is the difference between actual variable overhead costs
incurred for the period and standard variable overhead cost applied to the period’s actual
production or service output.

Actual VOH Budgeted VOH Applied VOH

AP × AQ SP × AQ SP × SQ

(Price Subvariance) (Usage Subvariance)

VOH VOH
Spending Variance Efficiency Variance

Total Variable Overhead Variance

(Underapplied or Overapplied Variable Overhead)

b. The variable overhead spending variance is the difference between total actual variable
overhead and the budgeted amount of variable overhead based on actual hours; it is
computed as part of the four-variance analysis.
c. The variable overhead efficiency variance is the difference between budgeted variable
overhead based on actual hours and variable overhead applied based on standard hours
allowed for the production achieved; it is computed as part of the four-variance analysis.

 Fixed Overhead
a. The total fixed overhead variance is the difference between actual fixed overhead costs
incurred and standard fixed overhead cost applied to the period’s actual production.

Budgeted FOH Applied FOH

Actual FOH (budgeted) SP × SQ

FOH
Spending Variance Volume Variance

Total Fixed Overhead Variance

(Underapplied or Overapplied Fixed Overhead)

b. The fixed overhead spending variance is the difference between the total actual fixed
overhead and budgeted fixed overhead.
c. The fixed overhead volume variance is the difference between budgeted and applied fixed
overhead and is equal to the overhead volume variance. The volume variance is also called
the noncontrollable variance.

 Alternative Overhead Variance Approaches

a. A four-variance approach is unworkable if the accounting system does not distinguish
between variable and fixed costs.
b. The total overhead variance is the difference between total actual overhead and total
applied overhead, and is the only variance computed under the one-variance approach.
Total Applied Overhead
(Combined OH Rate × Standard
Input Allowed for Actual
Total Actual Overhead Production)
(Variable OH + Fixed OH) (SP × SQ)

Total Overhead Variance

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 c. A middle column representing budgeted overhead based on standard quantity is inserted
between total actual overhead and total applied overhead under the two-variance approach.
Budgeted OH
Based on
Standard
Quantity
Total Actual OH for Overhead
(Variable OH Output Total Applied OH
+ Fixed OH) Achieved SP × SQ

Budget Variance Volume Variance

(Controllable (Noncontrollable
Variance) Variance)

Total Overhead Variance

i. The budget variance is the difference between total actual overhead and budgeted
overhead based on standard hours allowed for the production achieved; it is computed
as part of the two-variance analysis; it is also referred to as the controllable variance.
ii. The volume variance can be computed under the four-variance, three-variance, or two-
variance analysis.

d. A column representing budgeted overhead based on actual hours is inserted immediately to

the right of total actual overhead under the three-variance approach.
Budgeted
Overhead
Based on
Standard
Budgeted Quantity
Total Actual Overhead Allowed for Total Applied
Overhead Based on Output Overhead
(VOH + FOH) Actual Hours Achieved (SP × SQ)

Overhead Overhead Overhead

Spending Efficiency Volume
Variance Variance Variance

Total Overhead Variance

i. The overhead spending variance is the difference between total actual overhead and
total budgeted overhead at actual input activity; thus, a flexible budget is required. It is
computed as part of the three-variance analysis; it is equal to the sum of the variable
and fixed overhead spending variances.
ii. The overhead efficiency variance is the difference between total budgeted overhead
at actual input activity and total budgeted overhead at standard input allowed (output
activity); it is computed as part of the three-variance analysis; it is the same as variable
overhead efficiency variance.

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Why Standard Cost Systems are Used
 Clerical efficiency—a company that uses standard costs to trace the flow of costs through its
accounting system usually discovers that less clerical time and effort are required than in an
actual cost system.
 Motivation—standards represent a technique of communicating management’s expectations of
efficiency to workers.
 Planning—managers can use currently available standard costs to estimate future quantities and
costs.
 Controlling—the control process begins with the establishment of standards which provide a
basis against which actual costs can be measured so variances may be computed.
a. Variance analysis is the process of categorizing the nature (favorable or unfavorable) of
the differences between standard and actual costs and determining the reasons for those
differences.
b. The setting of upper and lower tolerance limits for deviations allows managers to implement
the management by exception concept.
 Decision making—standard cost information availability facilitates many decisions.
 Performance evaluation—summary variance reports focus attention on the operating
performance of subordinate managers, allowing top managers to determine when costs were
and were not controlled by which managers. Top management can then provide vital feedback
to the subordinate managers.

Considerations in Establishing Standards

 Appropriateness
a. Appropriateness and attainability need to be considered when standards are established.
b. Appropriateness, in relation to a standard, refers to the basis on which the standards are
developed and how long they are expected to last.
c. Standards are developed from past and current information, and they should reflect technical
and environmental factors expected during the period in which the standards are to be
applied.
d. Factors such as the materials quality, normal ordering quantities of materials, expected
employee wage rates, degree of plant automation, facility layout, and mix of employee skills
should be considered.
e. Standards must evolve over the organization’s life to reflect its changing methods and
processes.
 Attainability refers to management’s belief about the degree of difficulty or rigor that should be
incurred in achieving the standard. Standards can be classified by their degree of rigor and,
thus, their motivational value from easy to difficult as follows: expected, practical, and ideal.
a. Expected standards are standards set at a level that reflects what is actually expected to
occur in the future period; these standards anticipate future waste and inefficiencies and
allow for them; they are not of significant value for control and performance evaluation
purposes.
b. Practical standards are standards that can be reached or slightly exceeded approximately
60 to 70 percent of the time with reasonable effort by workers; they allow for normal,
unavoidable time problems or delays and for worker breaks; they are believed to be most
effective in inducing the best performance from workers, since such standards represent an
attainable challenge.
c. Ideal standards are standards that provide for no inefficiencies of any type, are impossible
to attain, and are sometimes called theoretical standards.

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Problem 1
McDaniel Company manufactures 100-pound bags of fertilizer that have the following unit standard
costs for direct materials and direct labor:
Direct materials (100 lbs. @ P1.00 per lb.) P100.00
Direct labor (0.5 hours at P24 per hour) 12.00
Total standard prime cost per 100 lb. bag P112.00

The following activities were recorded for October:

• 1,000 bags were manufactured.
• 95,000 lbs. of materials costing P76,000 were purchased.
• 102,500 lbs. of materials were used.
• P12,000 was paid for 475 hours of direct labor.

There were no beginning or ending work-in-process inventories.

Required:
A. Compute the direct materials variances.
B. Compute the direct labor variances.

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Problem 2
Just Right Inc. produces jeans. The following standards have been established:
Direct materials (4 yards of denim @ P1.20) P4.80
Direct labor (1.5 hours @ P9) P13.50
Standard prime cost P18.30

During the year 25,000 pairs of jeans were produced. 150,000 yards of denim were purchased and
used at P1.23 per yard. Actual direct labor hours were 36,800 at P9.25 per hour.

Required:
A. Compute the materials variances and indicate if they are favorable or unfavorable.
B. Compute the labor variances and indicate if they are favorable or unfavorable.
C. Prepare the journal entries for the following:
Purchase of raw materials
Issuance of raw materials
Addition of labor to Work in Process
Closing of variances to Cost of Goods Sold

Problem 3
Eider Company has the following information:

Direct Materials: Direct Labor:

Standard Quantity 100,000 Standard Hours 1,000
Actual Quantity 99,500 Actual Hours 1,050
Standard Price P5 Standard Rate P12
Actual Price P4 Actual Rate P13

A. Determine the materials price variance and whether it is favorable or unfavorable.

B. Determine the materials usage variance and whether it is favorable or unfavorable.
C. Determine the labor rate variance and whether it is favorable or unfavorable.
D. Determine the labor efficiency variance and whether it is favorable or unfavorable.
E. Provide the journal entries to record the purchase of materials, the issuance and usage of
materials, and direct labor variances.
F. Provide the closing entries for the immaterial variances.

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 Problem 4
The following standard overhead costs were developed for one of the products of Mildey Company:

Variable overhead: 5 hours  P4 per hour 20.00

Fixed overhead: 5 hours  P15 per hour 75.00
Total standard overhead cost per unit P95.00
The following information is available regarding the company's operations for the period:

Units produced 20,000

Direct labor 115,000 hours
Overhead incurred:
Variable P437,500
Fixed P1,320,000

Budgeted fixed overhead for the period is P1,350,000, and the standard fixed overhead rate is based
on expected capacity of 90,000 direct labor hours.
Required:
A. Calculate the variable overhead spending variance and indicate whether it is favorable or unfavorable.
B. Calculate the variable overhead efficiency variance and indicate whether it is favorable or unfavorable.
C. Calculate the fixed overhead spending variance and indicate whether it is favorable or unfavorable.
D. Calculate the fixed overhead volume variance and indicate whether it is favorable or unfavorable.

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Problem 5
Littleton Company uses a standard costing system. The following monthly cost functions apply to its
manufacturing overhead items:
Overhead Item Cost Function
Indirect materials P0.80 per DLH
Indirect labor P1.00 per DLH
Utilities P0.40 per DLH
Insurance P8,000
Depreciation P32,000

Information for the month of October is as follows:

Actual overhead costs incurred:
Indirect materials P20,800
Indirect labor 24,000
Utilities 9,600
Insurance 8,800
Depreciation 32,000
Total P95,200

Actual direct labor hours worked 24,000

Standard direct labor hours allowed for production achieved 27,000

Littleton uses expected capacity to calculate standard overhead rates. The monthly expected capacity
is 25,000 hours.
A. Calculate the following standard overhead rates based upon expected capacity:
Variable overhead rate
Fixed overhead rate
Total overhead rate
B. Calculate the following variances:
Variable overhead spending variance
Variable overhead efficiency variance
Fixed overhead spending variance
Fixed overhead volume variance

Problem 6
At the beginning of the year, Folsom Company had the following standard cost sheet for one of its food
products:
Direct materials (10 lb @ 3.20) P32.00
Direct labor (4 hr @ P9.00) 36.00
Fixed overhead (4 hr @ P4.00) 16.00
Variable overhead (4 hr @ P0.75) 3.00
Standard cost per unit P87.00
Folsom computes its overhead rates using practical capacity, which is 72,000 units. The actual results
for the year are:
Units produced 70,000
Direct labor hours 290,000
Actual wage per hour P9.05
Fixed overhead P1,160,000
Variable overhead P 218,000
A. Compute the fixed overhead spending and volume variances.
B. Compute the variable overhead spending and efficiency variances.

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