COST ACCOUNTING & CONTROL

Standard Costing & Variance Analysis

Standard

Standard is a measure of acceptable performance established by management as a guide in making

economic decisions.

Standard Cost

Standard Cost is a scientifically predetermined cost of manufacturing a unit or a specific quantity of

product during a particular period of time. It is a measure of acceptable performance, established by
management as a guide to certain economic decisions. It is in short, a reflection of what a management
thinks a cost ought to be.

Standard Costing

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting
records . Subsequently, variances are recorded to show the difference between the expected and
actual costs. This approach represents a simplified alternative to cost layering systems, such as the
FIFO and LIFO methods, where large amounts of historical cost information must be maintained for
inventory items held in stock.

Standard costing involves the creation of estimated (i.e., standard) costs for some or all activities
within a company. The core reason for using standard costs is that there are a number of
applications where it is too time-consuming to collect actual costs, so standard costs are used as a
close approximation to actual costs.

Since standard costs are usually slightly different from actual costs, the cost accountant periodically
calculates variances that break out differences caused by such factors as labor rate changes and the
cost of materials. The cost accountant may periodically change the standard costs to bring them into
closer alignment with actual costs.

Advantages of Standard Costing

Though most companies do not use standard costing in its original application of calculating the
cost of ending inventory , it is still useful for a number of other applications. In most cases, users are
probably not even aware that they are using standard costing, only that they are using an
approximation of actual costs. Here are some potential uses:

 Budgeting. A budget is always composed of standard costs, since it would be impossible to

include in it the exact actual cost of an item on the day the budget is finalized. Also, since a key
application of the budget is to compare it to actual results in subsequent periods, the standards used
within it continue to appear in financial reports through the budget period.

 Inventory costing. It is extremely easy to print a report showing the period-end inventory
balances (if you are using a perpetual inventory system), multiply it by the standard cost of each
item, and instantly generate an ending inventory valuation. The result does not exactly match the
actual cost of inventory, but it is close. However, it may be necessary to update standard costs
frequently, if actual costs are continually changing. It is easiest to update costs for the highest-peso
components of inventory on a frequent basis, and leave lower-value items for occasional cost
reviews.

 Overhead application. If it takes too long to aggregate actual costs into cost pools for
allocation to inventory, then you may use a standard overhead application rate instead, and adjust
this rate every few months to keep it close to actual costs.

 Price formulation. If a company deals with custom products, then it uses standard costs to
compile the projected cost of a customer’s requirements, after which it adds a margin. This may be
quite a complex system, where the sales department uses a database of component costs that change
depending upon the unit quantity that the customer wants to order. This system may also account for

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changes in the company’s production costs at different volume levels, since this may call for the use
of longer production runs that are less expensive.

Nearly all companies have budgets and many use standard cost calculations to derive product prices,
so it is apparent that standard costing will find some uses for the foreseeable future. In particular,
standard costing provides a benchmark against which management can compare actual performance.

Standards are most frequently established for:

1. Raw materials used in making a product or one of its components.

2. Direct labor needed to perform a manufacturing operation.
3. Manufacturing overhead applied to a unit of output.

Purposes of Standard Costs:

1. Cost control
2. Pricing decisions
3. Motivation and performance appraisal
4. Cost awareness and cost reduction
5. Preparation of budgets
6. Costing of inventories
7. Preparation of cost reports
8. Management by objective

Management by Objective and Management by Exception

In essence, management by objectives (MBO) means that managers establish specific goals or objectives
for all business activities. Eventually, actual results of operations are compared with these objectives. If
actual results fall within the established objectives, little management action is taken. When performance
is significantly different from the desired level, appropriate action is done by management.

This concept is very much related to the so-called management by exception, which states that managers
will maximize their efficiency if they concentrate only on those operational factors showing material
deviations from the plan.

The Standard Cost Accounting System

The standard cost accounting system consists of three basic objectives, they are:

1. Standard setting
2. Accumulation of actual costs
3. Variance analysis

Determination of standard cost is based on physical standards – basic and current. A basic standard is a
yardstick against which both expected and actual performances are compared. It is similar to an index
number against which all subsequent results are measured.

The current standards are of three types:

1. Theoretical standard – is a standard set for an ideal or maximum level of operation and
efficiency. Such standard constitute goals to be aimed for rather than performance that can be
currently achieved.

2. Expected Actual Standard – is a standard set for a normal level of operation and efficiency. It is
reasonably close estimate of actual results.

3. Normal Standard – is a standard set for normal level of operation and efficiency, instead to
represent challenging yet attainable results.

Different Types of Capacity Levels

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Capacity refers to the fixed amount of the company’s human and nonhuman resources for which
management has committed itself and with which it expects to conduct the business and maintain the firm
as a going concern. Different levels of capacity are described as theoretical, practical and normal.

Theoretical capacity refers to the plant’s or department’s capability to produce at full tilt, without
interruptions. Though it is highly impossible to attain, it is a well calculated to serve as a basis for
establishing other capacity levels.

Practical capacity is theoretical capacity less internal factors such as ordinary and expected interruptions
due to delays, breakdowns, inefficiencies, non-working days, and changes in production processes.

Normal capacity is the most commonly used type of capacity level. In calculating normal capacity, not
only internal but also external factors, particularly the market or the demand for the product, are
considered. The normal capacity level is used in calculating the predetermined or standard factory
overhead rate.

Standard Cost Variance Analysis

Variance = Actual Costs (AC) – Standard Costs (SC)

AC > SC = Unfavorable/ Adverse (debit balance)

AC < SC = Favorable / Desirable (credit balance)

Materials Variances

Actual Materials Cost  Actual Quantity Used x Actual Price

– Standard Materials Cost  Standard Quantity x Standard Price
Materials Cost Variance

Analysis:

Quantity Variance : Difference in Quantities Used x Standard Price

Price Variance : Difference in Prices x Actual Quantity (Purchased/Used)

Illustration: Material Variances

Alucard Company has established the following standards for the prime costs of one unit of product:

Direct materials – 8 pounds at P 1.80 per pound P 14.40

Direct labor – 0.25 hour at P 8.00 per hour 2.00

During May, Alucard purchased 160,000 pounds of direct materials at a total cost of P304,000. The total
factory wages for May were P42,000, 90% of which were for direct labor. Alucard manufactured 19,000
units of product using 142,500 pounds of direct materials and 5,000 direct labor hours.

Required:
1. Total actual cost of materials
2. Total standard cost of materials
3. Total material cost variance
4. Materials purchase price variance
5. Materials usage price variance
6. Materials quantity variance

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NOTES: Direct Material Variances

 The materials price variance is also known as materials spending variance, materials money
variance, materials rate variance.

 The materials quantity variance is also known as materials usage variance, materials efficiency
variance.

 Materials price usage variance is a price variance. [(AP-SP) x AQu]

Labor Variances

Actual Labor Cost  Actual Hours x Actual Labor Rate

– Standard Labor Cost  Standard Hours x Standard Labor Rate
Labor Cost Variance

Analysis:

Efficiency Variance: Difference in Hours x Standard Rate

Rate Variance: Difference in Rates x Actual Hours

Illustration: Labor Variances

The following data relate to Product GSX of Suzuki Corporation:

Direct labor standard 5 hours at P14 per hour

Direct labor used in production 45,000 hours at a cost of P639,000
Manufacturing activity, Product GSX 8,900 units completed

Required: Determine the following:

1. Total direct labor variance
2. Direct labor rate variance
3. Direct labor efficiency variance

NOTES: Direct Labor Variances

 The labor rate variance is also known as labor price variance, labor spending variance, labor money
variance.

 The labor efficiency variance is also known as labor hours variance, labor usage variance, labor
time variance.

 The labor efficiency variance excludes idle time spent in the production. If any, idle time is
separately explained through the Idle Time Variance, which is generally regarded as unfavorable.
Idle Time Variance = Idle Time x Standard Labor Rate.

Factory Overhead Variances

Actual FOH Cost  Actual Hours x Actual FOH Rate
Standard FOH Cost  Standard Hours x Standard Rate
FOH Cost Variance

Factory Overhead Variance Analyses:

Two-Way Variance Analysis:

Actual factory overhead (AFOH) XX

Budget allowed based on standard hours (BASH) XX

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 Controllable Variance XX

Budget allowed based on standard hours (BASH) XX

Standard factory overhead (SFOH) XX
Volume Variance XX

Three-Way Variance Analysis:

Actual factory overhead (AFOH) XX

Budget allowed based on actual hours (BAAH) XX
Spending Variance XX

Actual hours (AH) XX

Standard hours (SH) XX
Difference XX
X Standard Variable Overhead Rate XX
Variable Efficiency Variance XX

Volume Variance (same with the 2-way analysis) XX

Four-Way Variance Analysis:

Actual fixed factory overhead (AFFOH) XX

Budget allowed based on actual hours – fixed (BAAH-F) XX
Fixed Spending Variance XX

Actual variable factory overhead (AVFOH) XX

Budget allowed based on actual hours – fixed (BAAH-V) XX
Variable Spending Variance XX

Variable Efficiency Variance (same with the 2-way

& 3-way analyses) XX

Volume Variance (same with the 2-way & 3-way analyses) XX

Budget Allowed based on Standard and Actual Hours

Budgeted fixed factory overhead XX

(Standard variable overhead rate x standard hours) XX
Budget allowed based on standard hours XX

Budgeted fixed factory overhead XX

(Standard variable overhead rate x actual hours) XX
Budget allowed based on actual hours XX

Breaking Down Factory Overhead Variances:

2-WAY 3-WAY 4-WAY

Fixed Spending
Spending
Total FOH Controllable Variable Spending
Variance Variable Efficiency
Volume Variable Efficiency
Volume
Volume

Illustration: Factory Overhead Variance Analysis (Two, Three, Four-Way Variance Analysis)

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Nezuko Company provides the following production data:

Total standard overhead cost per unit of product: 4 hours at P3.00 per hour = P12.00 per unit
Budgeted Fixed FOH P 20,000
Actual production 2,000 units
Actual FOH (75% fixed) P 26,000
Actual hours 7,500 hours
Normal production 2,500 units

Required: Compute for the following:

1. Total factory overhead variance

2. Controllable variance.
3. Volume variance
4. Spending variance
5. Variable efficiency variance
6. Fixed spending variance
7. Variable spending variance

Important Notes: Factory Overhead Variance Analysis

 SFOH = SH x Standard FOH Rate. Under standard costing, SFOH is likewise referred to
as the Applied FOH.

 If AFOH > SFOH, then FOH is said to be under-applied; hence, under-application indicates an
unfavorable variance, while over-application indicates a favorable variance.

 The term capacity variance is also used to mean the volume variance.

 Budget Variance = Actual Cost – Budgeted Cost = Actual FOH – Budgeted FOH (BFOH)
* If BFOH is adjusted based on SH (BASH), then budget variance is controllable variance.
* If BFOH is adjusted based on AH (BAAH), then budget variance is spending variance.

 Volume variance is actually the Fixed Volume Variance; there is no such thing as a variable
volume or variable capacity variance.

 Under the 3-way approach, the FOH Efficiency Variance is actually the Variable Efficiency
Variance. Other than “BAAH-BASH”, variable overhead efficiency variance may also be
computed based on: (AH-SH) x VR

 FOH variances may be classified into:

* Variable FOH Variances = VSV + VEV
* Fixed FOH Variances = FSV + FVV

 Alternatively, another FOH variance analysis may include the following variances (NOTE: this
version is not included in the board exam syllabus for Management Services):
* IDLE Capacity Variance: BAAH – (AH x SOR)
* TOTAL Efficiency Variance: (AH-SH) x SOR
* FIXED Efficiency Variance (Effectiveness) Variance: (AH-SH) x FR

 Manufacturing Efficiency Variance incorporates the effect of both FOH Efficiency Variance and
Labor Efficiency Variance. In rare cases, the materials quantity variance may also be included.

 DM Variance + DL Variance + FOH Variance = Production or Manufacturing Cost Variance.

Variances in the Ledger Accounts

Variances usually do not appear on the FS of a company. They are used for managerial control
and are recorded in the ledger accounts.
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EXERCISES

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I. True or False

1. Standards set as a measure of performance established by management as a guide in making

economic decisions. T

2. In most instances, standard, instead of actual costs, are used in setting selling prices because the
former reflects the desired or expected cost of production, whereas actual costs may include
unexpected efficiencies or inefficiencies of production that cannot be anticipated at the time the
selling price is set. T

3. Management by objective means that managers establish specific goals or objectives for all
business activities. Eventually, actual results are compared with these objectives. T

4. Management by exception states that managers will maximize their efficiency if they concentrate
only on those operational factors showing material deviations from the plans. T

5. Management should conduct investigations only when the variance is unfavorable. F

6. All variances whether favorable or unfavorable should be investigated. T

7. Standards should neither be too tight nor too loose. T

8. When the company uses a standard cost system, there is no more need for actual costs. F

9. A variance should be described as either favorable or unfavorable. T

10. Standard costing applies to both manufacturing and non-manufacturing cost. F

11. The standard cost system is compatible with job order costing, but not with process costing. F

12. A variance with a debit balance indicates unfavorable performance. T

13. Unfavorable variances should be reviewed, but significant favorable variances need not be
reviewed. F

14. Significant variances should be closed to COGS and inventory units while immaterial variances
should be closed to COGS only. T

15. Standards can pinpoint responsibility and, if properly used, can help motivate employees. T

16. There is no capacity or volume variance under standard variable costing system. T

II. Problem-Solving

PROBLEM 1:

Rabbit Corp. determines that the following variances arose in production during March:

Variance Amount
Materials purchase price.......................................................................................... P 2,400 favorable
Materials quantity.................................................................................................... 1,000 favorable
Labor efficiency...................................................................................................... 500 favorable
Labor rate................................................................................................................ 750 unfavorable
Factory overhead volume........................................................................................ 1,700 favorable
Factory overhead controllable................................................................................. 2,950 unfavorable

Materials purchases totaled P90,000 at standard costs, while P77,000 in materials were taken from
inventory for use in production. Labor payroll totaled P144,000, and actual overhead incurred was
P256,000.

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Required: Prepare the journal entries to record the above variances, including the recording of the actual
and applied factory overhead using a single factory overhead control account.

SOLUTION:

Materials......................................................................................................... 90,000
Materials Purchase Price Variance........................................................... 2,400
Accounts Payable..................................................................................... 87,600

Work in Process.............................................................................................. 78,000

Materials................................................................................................... 77,000
Materials Quantity Variance..................................................................... 1,000

Work in Process.............................................................................................. 143,750

Labor Rate Variance....................................................................................... 750
Payroll...................................................................................................... 144,000
Labor Efficiency Variance....................................................................... 500

Factory Overhead Control............................................................................... 256,000

Various Credits......................................................................................... 256,000

Work in Process.............................................................................................. 254,750

Factory Overhead Controllable Variance........................................................ 2,950
Factory Overhead Control........................................................................ 256,000
Factory Overhead Volume Variance........................................................ 1,700

OR;

Work in Process.............................................................................................. 254,750

Factory Overhead Control........................................................................ 254,750

Factory Overhead Controllable Variance........................................................ 2,950

Factory Overhead Volume Variance........................................................ 1,700
Factory Overhead Control........................................................................ 1,250

PROBLEM 2:

Funny Corporation has a standard labor cost of P55 per unit of output. During the past month, 1,500 units
were manufactured. The total labor hours allowed for this output were 11,000 hours. The actual labor
costs were P80,640. Actual labor hours were 11,300.

Required:
1. The total debits to work in process account for direct labor would be: P82,500
2. The total labor variance is: P1,860 - F
3. The labor rate variance is: P4,110 - F
4. The labor efficiency variance is: P2,250 - U

PROBLEM 3:

You have been given the following information for the Lei Company:
Actual labor hours used 315 hours
Standard materials price P 2.50 per unit
Actual labor rate per hour 3.00
Standard quantity of materials 450 units
Standard labor hours 300 hours
Actual materials price P 2.52 per unit
Standard labor rate per hour 3.10
Actual quantity of materials purchased 445 units
Actual quantity of materials used 425 units

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Required:
1. What is the material price variance? P8.9-U
2. What is the materials efficiency variance? P62.5-F
3. What is the labor rate variance? P31.5-F
4. What is the labor efficiency variance? P46.5-U

PROBLEM 4:

You have been given the following list of Uruja Company’s variances:
Direct materials price variance P 7,000 – U
Direct materials efficiency variance 5,000 – U
Direct labor price variance 4,160 – F
Direct labor efficiency variance 4,000 – U

You have also been given the following data:

Actual units produced 10,000
Budgeted units of production 8,000
Standard labor hours 5,000
Actual direct labor costs P 99,840
Actual price paid for direct materials 132,000
Standard units of materials 100,000

The materials purchase price was 2.80 centavos higher than the standard price of 50 centavos per unit.

Required: Determine the following:

1. Actual number of units of direct materials used 110,000 units
2. Actual amount of direct materials purchased 250,000 units
3. Actual labor hours worked 5,200 hours
4. Actual wage rate per hour P19.20

PROBLEM 5:

Hokage Company shows the following data regarding its factory overhead:

 Standard per unit of product: 4 labor hours @ P3.00* per hour

 Normal capacity: 2,500 units
 Budgeted (Denominator) Hours: hours

Fixed FOH P 20,000 Fixed FOH Rate P

Variable FOH Variable FOH Rate
Total Budgeted FOH P Standard FOH Rate P3*

Flexible budget formula: FOH =

Required: Fill-in the blanks.

ANSWERS:
1. Budgeted Hours – 10,000
2. Variable FOH – P10,000
3. Fixed FOH Rate – P2
4. Variable FOH Rate – P1
5. Flexible Budget Formula – Y = P10,000 + P2X

PROBLEM 6:

The normal capacity of Cobra Company is 12,000 labor hours per month. At normal capacity, the
standard factory overhead rate is P13 per labor hour based on P96,000 of budgeted fixed cost per month
and a variable cost rate of P5 per labor hour. During January, the company operated at 12,500 labor

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hours, with actual factory overhead cost of P166,000. The number of standard labor hours allowed for the
production actually attained is 11,000.

Required: Determine (1) the overall factory overhead variance (2) overhead controllable (3) volume
variance.
ANSWERS:

1)
Actual factory overhead P 166,000
Standard factory overhead (P13 x 11,000) 143,000
Total factory overhead variance P 23,000 - U

2)
Actual factory overhead P 166,000
Budget allowed based on standard hours:
Budgeted fixed overhead P 96,000
(SVR x SH)
P5 11,000 55,000 151,000
Controllable Variance P 15,000 - U

3)
Budget allowed based on standard hours (BASH) P 151,000
Standard factory overhead (SFOH) 143,000
Volume Variance P 8,000 - U

PROBLEM 7:

Hamster Co. manufactures screen doors with the following standard quantity and cost information per
door:

Aluminum 4 sheets at P2 P8
Copper 3 sheets at P5 15
Direct Labor 7 hours at P7 49
Variable Overhead 6 machine hours at P3 18
Fixed Overhead 5 machine hours at P2 10

Overhead rates were based on normal monthly capacity of 5,000 machine hours.

During November, the company produced only 800 doors and the following costs were incurred in
October:

Materials:
Aluminum 3,400 sheets purchased and used at P2.20
Copper 2,500 sheets purchased and used at P4.20
Labor:
Direct labor 5,250 hours at P8.00
Overhead:
Variable overhead P11,800 (based on 4,250 machine hours)
Fixed overhead P9,500 (based on 4,250 machine hours)

Required:

1. Prepare journal entries 8. Variable overhead spending variance

2. Materials price variance for each material 9. Variable overhead efficiency variance
3. Materials quantity variance for each material 10. Total variable overhead variance
4. Total materials cost variance for each material 11. Fixed overhead spending variance
5. Labor rate variance 12. Volume variance
6. Labor efficiency variance 13. Total fixed overhead variance
7. Total labor variance

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1) Journal entries:

RM – Aluminum 6,800
MP Variance 680
A/P 7,480

WIP 6,400
MQ Variance 400
RM 6,800

RM – Copper 12,500
MP Variance 2,000
A/P 10,500
WIP 12,000
MQ Variance 500
RM 12,500
WIP 39,200
LR Variance 5,250
LE Variance 2,450
Accrued payroll 42,000
Variable OH 11,800
Fixed OH 9,500
Various accounts 21,300
WIP 22,400
Variable OH 14,400
Fixed OH 8,000

Variable OH 2,600
VOH Spending Variance 950
VOH Efficiency Variance 1,650

FOH Spending Variance 1,000

Volume Variance 500
Fixed OH 1,500

2. Aluminum: P680 U; Copper: P2,000 F 8. P950 F

3. Aluminum: P400 U; Copper: P500 U 9. P1,650 F
4. Aluminum: P1,080 U; Copper: P1,500 F 10. P2,600 F
5. P5,250 U 11. P500 F
6. P2,450 F 12. P2,000 U
7. P2,800 U 13. P1,500 U

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