Chapter Eleven

VARIANCE ANALYSIS AND STANDARD COSTING

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Outline
The usage of standard costing Setting of standard cost and types of standard

Calculation of variance:
Direct material

Direct labor
Factory overhead
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Standard Costing
The cost that has been pre-determined after considering other factors. Those are estimated costs which are considered to be ideal for each of the cost component ( direct material, direct labor and factory overhead ). The standard cost system enable the management to determine how much a product should cost.

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The usage of standard costing

Planning and controlling:

Compare actual cost & budgeted cost

Improve performance Increase efficiency

Product costing:
Provide readily available unit cost

information
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Setting of Standard Cost

Involve joint efforts on:

Analysis on the historical cost experience: Provide initial guidelines for standard setting

Engineering studies: Determine the most efficient way to operate

Input from operating personnel: Accountable for meeting the standards
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Types of Standards

Ideal standard
Maximum efficiency

Can be achieved if everything operates perfectly.

Normal standard
Currently attainable standard
Allowance is made for breakdown, interruptions etc..
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Variance Analysis
Variances are the difference between the actual manufacturing cost and the standard cost at the

actual level of production.

The significance of the variance for each element in manufacturing cost needs further analysis to determine the corrective actions.

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Calculation of variance

Direct material

Direct labor

Factory overhead

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Standard Cost
The expected cost per unit product

Illustration 1: The followings are the standard cost for each unit (bottle) of peanut butter produced by Syarikat Sedap Selalu :

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Standard Price Direct material:

Standard Usage

Standard Cost RM 2.80/0.15= 0.42 0.27 0.30 0.99 0.08 0.03 0.05 0.12

Peanut Butter Sugar

Direct labor: Machine operator Packaging Factory OH: Variable costs Fixed costs

2.80/kg 2.70/kg 1.20/kg

4.00/hour 3.00/hour 5.00/hour 12.00/hour

0.15kg 0.10kg 0.25kg

0.02hour 0.01hour 0.01hour 0.01hour

0.11

0.17
10 1.27

Standard cost per unit KE1013 Chapter Eleven

If Wang Co. produces 10,000 bottles of peanut butter, the expected total cost would be:

Direct material Direct labor Factory overhead

10,000 x 0.99 10,000 x 0.11 10,000 x 0.17

9,900 1,100 1,700 12,700

Total cost

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Calculation of variance
Cost element
Direct material

Actual cost Standard cost Variance

9,500
1,050
2,000 9,900 400 (F)

Direct labor
Factory overhead

1,100
1,700

50 (F)
300 (U)

F = (Favorable)

U = (Unfavorable)
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Direct Material Variance

To measure the difference between the actual cost and the standard cost of direct materials.

Direct Material Price Variance

Direct Material Usage (Quantity) Variance

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1. Direct material price variance

(Actual Price x Actual Quantity) - (Standard Price x Actual Quantity)

Simplified to be:
Actual Quantity (Actual Price Standard Price)

AQ ( AP SP )
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2. Direct material usage (quantity) variance

(Standard Price x Actual Quantity) - (Standard Price x Standard Quantity)

Simplified to be:
Standard Price (Actual Quantity Standard Quantity)

SP ( AQ SQ )
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Actual Price x Actual Qty Std Price x Actual Qty

Std Price x Std Qty

Price Variance

Usage Variance

Direct material variance

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Illustration 2 The followings are the actual price and quantity for direct material used by the company in producing 10,000 bottles of peanut butter:

Actual Price Peanut RM2.70/kg

Actual Quantity 1,400kg

Butter
Sugar

RM2.505/kg
RM1.18/kg
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1,200kg
2,300kg
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Direct material price variance: AQ ( AP SP )

Peanut: 1,400 (2.70 2.80) = 140 (F)

Butter: 1,200 (2.505 2.70) = 234 (F) Sugar:
2,300 (1.18 1.20) = 46 (F) 420 (F)

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Direct material usage variance: SP ( AQ SQ ) Peanut: Butter: Sugar: 2.80 (1,400 1,500) = 280 (F) 2.70 (1,200 1,000) =
1.20 (2,300 2,500)

540 (U) 240 (F)

20 (U)
Therefore ,

Total direct material variance

= 420 (F) + 20 (U) = 400 (F)

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Direct Labor Variance

Measures the differences between the actual cost and the cost that suppose to be paid to the labor.

Direct Labor Rate Variance Direct Labor Efficiency Variance

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Direct Labor Rate Variance

(Actual Hour x Actual Rate) - (Actual Hour x Standard Rate)

Actual Hour ( Actual Rate Standard Rate )

AH ( AR SR )
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(Standard Rate x Actual Hour) - (Standard Rate x Standard Hour)

Standard Rate ( Actual Hour Standard Hour )

SR ( AH SH )
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Actual Hour x Actual Rate

Std Hour x Actual Rate

Std Hour x Std Rate

Rate Variance

Efficiency Variance

Direct Labor Variance

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Illustration 3:

The followings are actual rate and labor hour in the production of 10,000 bottles of peanut butter:

Actual labor rate Actual labor hour Machine operator RM3.90/hour 190 hours Packaging
RM2.81/hour 110 hours

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Direct Labor Rate Variance: AH ( AR SR )

Machine Operator: 190 (3.90 4.00 ) = Packaging: 19 (F) = 21 (F)

110 (2.81 3.00)

40 (F)

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Direct Labor Efficiency Variance: SR ( AH SH )

Machine Operator:
Packaging: 4.00 (190 200) 3.00 (110 100) = = 40 (F) 30 (U) 10 (F) 50 (M)
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total direct labor variance: = 40 (M) + 10 (M) =

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Factory Overhead Variance

Measures the differences between the actual cost and the supposed related cost of factory overhead.
Variable Factory Overhead Controllable Variance

Fixed Factory Overhead Volume Variance

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Western Rider Inc. Factory Overhead Cost Budget For the Month Ended June 30, 2003 Direct Labor Hours 4,000 4,500 5,000 80% 90% 100%

% of Normal Capacity

Total variable costs $14,400 Variable costs per hour $ 3.60 Total fixed costs $12,000 Fixed costs per hour $ 3.00 Total costs per hour $ 6.60

$16,200 $ 3.60 $12,000 $ 2.67 $ 6.27

$18,000 $3.60 $12,000 $ 2.40 $ 6.00

Overhead is applied at $6.00 per direct labor hour based on estimated 5,000 total hours.
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Western Rider Inc. Factory Overhead Variances For the Month Ended June 30, 2003

Actual Hour 4,000

Revised Budget

Actual Costs

Variance

Variable costs $14,400 ($3.60 x 4,000 hours) Fixed costs 9,600 ($2.40 x 4,000 hours) Total costs $24,000 Factory overhead applied at $6.00 per direct labor hour based on 4,000 actual hours.
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$10,400 $4,000 F

12,000

2,400 U

$22,400 $1,600 F Actual factory overhead per general ledger.

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Western Rider Inc. Factory Overhead Variances For the Month Ended June 30, 2003 Revised Budget Actual Costs Variance

Variable costs $14,400 ($3.60 x 4,000 hours) Fixed costs 9,600 ($2.40 x 4,000 hours) Total costs $24,000

$10,400 $4,000 F

12,000

2,400 U

$22,400 $1,600 F

Controllable variance based on variable costs

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Western Rider Inc. Factory Overhead Variances For the Month Ended June 30, 2003 Revised Budget Actual Costs Variance

Variable costs $14,400 ($3.60 x 4,000 hours) Fixed costs 9,600 ($2.40 x 4,000 hours) Total costs $24,000

$10,400 $4,000 F

12,000

2,400 U

$22,400 $1,600 F

Volume variance based on fixed costs

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Variable Factory Overhead Controllable Variance For the Month Ended June 30, 2003

Actual variable overhead Budgeted variable overhead (4,000 actual hours x $3.60) Favorable controllable variance Controllable variance measures the efficiency of using variable overhead resources.

$10,400 14,400 $(4,000)

A revised budget based on the actual hours used

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Fixed Factory Overhead Volume Variance For the Month Ended June 30, 2003

Budgeted volume (direct labor hours) 5,000 Actual volume (direct labor hours) 4,000 Capacity not used (direct labor hours) 1,000 Standard fixed rate x $2.40 Unfavorable volume variance $2,400 Volume variance measures the utilization of fixed overhead resources. Rate based on 5,000 direct labor hours.

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