CHAPTER 13: STANDARD COSTING

Establishment of Standards

An integral part of any standard cost system is the setting of standards for direct materials, direct labor
and factory overhead.

Direct Materials Standards

1. Direct materials price standard​ – Price standards are the unit price at which direct materials
should purchase.
2. Direct materials usage (efficiency) standards​ – Efficiency (quantity or usage) are predetermined
specifications of the quantity of direct materials that should go into the production of one
finished unit.

Direct Labor Standards

1. Direct labor price standards ​– The standard rate of pay that an individual will receive is usually
based on the type of job being performed and the experience that the person has had on the
job.
2. Direct labor efficiency standards ​– Efficiency standards are predetermined performance
standards for the amount of direct labor hours that should go into the production of one
finished unit.

Factory Overhead Standards

Budgets are commonly used in controlling factory overhead costs. Prior to the period in question a
budget that shows anticipated factory overhead costs is prepared.

Variance Analysis

Differences that arise between actual results and planned results are called ​variances.

Direct Material Variances

Direct materials variances may be divided into (1) price variance and (2) efficiency (usage) variance

Direct material price variance ​– The difference between actual price per unit of direct materials
purchased and standard price per unit of direct materials purchased results in the direct materials price
variance per unit, and if multiplied by the actual quantity purchased, the result is the total direct
material price variance.

Direct material efficiency (usage) variance ​– The difference between actual quantity of direct materials
and standard quantity allowed multiplied by the standard price per unit equals the direct materials
efficiency variance.

Direct Labor Variances

Direct labor variances may be divided into (1) rate/price variance and (2) efficiency variance.
Direct labor rate (price) variance​ – The difference between the actual hourly wage rate and the
standard hourly wage rate results in the direct labor price variance per hour, when multiplied by the
actual direct labor hours worked, the outcome is the total direct labor price variance.

Direct labor efficiency variance​ – The difference between the actual direct labor hours worked and the
standard direct labor hours allowed, multiplied by the standard hourly wage rate, equals the direct labor
efficiency variance.

Factory Overhead Variances

Factory overhead variances may be determined using the two-factor analysis, three-factor analysis, and
four-factor analysis.

One-Factor Analysis

The difference between the actual factory overhead and standard factory overhead applied to
production equals the one-factor analysis variance.

Two-Factor Analysis

Two-factor analysis of factory overhead variances may be divided into (1) controllable (budget) variance
and production volume (idle capacity) variance.

1. Controllable (budget) variance ​– The difference between actual factory overhead and budgeted
overhead on the basis of standard direct labor hours allowed equals the controllable (budget)
variance.
2. Production volume (idle capacity) variance​ – The difference between budgeted overhead on
the basis of standard direct labor hours allowed and standard factory overhead applied to
production.

Three-Factor Analysis

Three-factor analysis of factory overhead variance may be divided into (1) price (spending) variance, (2)
efficiency variance and (3) production (volume) variance.

1. Spending variance ​– The difference between actual factory overhead and budgeted factory
overhead on the basis of actual direct labor hours worked equals the price (spending) variance.
2. Efficiency variance ​– The difference between actual direct labor hours worked and standard
direct labor hours allowed multiplied by the standard variable factory overhead application rate
equals the efficiency variance.
3. Production (volume) variance ​– Same as the volume variance computed under two-factor
analysis. This variance is also known as the denominator variance because the variance is the
result of production of an activity level different from that used as denominator to calculate the
fixed factory overhead application rate.

Four-Factor Analysis

1. Variable overhead spending variance​ – The difference between actual variable overhead and
budgeted variable overhead on actual hours is the variable overhead spending variance.
 2. Variable overhead efficiency variance​ – The difference between budgeted variable overhead
for actual hours and applied variable overhead is the variable efficiency variance.
3. Fixed overhead spending variance​ – The difference between actual fixed factory overhead and
the budgeted fixed overhead is the fixed overhead spending variance.
4. Volume variance​ – This is just the same as the volume variance computed under the two-factor
and three-factor analysis.

Computing Variances

Material variances

A. Material Price Variance

The difference between actual price per unit of direct materials purchased and standard price per unit of
direct materials purchased results in the direct materials price variance per unit when multiplied by the
actual quantity purchased, the outcomes is the total direct material price variance.

(1) (2) (3)

(AQ x AP) (AQ x SP) (SQ x SP)

Price variance Efficiency variance

(1) minus (2) (2) minus (3)

TOTAL VARIANCE

The materials price variance Is caused by paying a higher or lower price than the standard price for
materials.

Formulas

1. Material price variance = Actual quantity x (actual price less standard price)

2. Actual quantity x Actual price XXXX

Actual quantity x Standard price XXXX
Materials price variance XXXX

3. Actual price XXXX

Less: Standard price XXXX
Difference in price XXXX
x Actual quantity XXXX
Materials price variance XXXX

B. Materials Usage Variance

The materials usage variance is caused by using more or less than the standard amount of materials to
produce a product.
Formulas

1. Material usage variance = Standard price x (actual quantity less standard quantity)

2. Actual quantity x Standard price XXXX

Standard quantity x Standard price XXXX
Materials usage variance XXXX

3. Actual quantity XXXX

Less: Standard quantity XXXX
Difference in quantity XXXX
x Standard price XXXX
Materials usage variance XXXX

AQ = Actual quantity
AP = Actual price
SQ = Standard quantity
SP = Standard price

Labor Variances

Labor rate and labor efficiency variances relate to the same period because, unlike materials, labor
services cannot be purchased in one period, stored, and then used in the next period.

(1) (2) (3)

(AH x AR) (AH x SR) (SH x SR)

Labor rate Labor efficiency

(1) minus (2) (2) minus (3)

TOTAL VARIANCE

A. Labor Rate Variances

The labor rate variance is caused by paying a higher or lower rate of pay than standard to produce a
product or complete a process.

Formulas

1. Labor rate variance = Actual hours x (actual rate less standard rate)

2. Actual hours x Actual rate XXXX

Actual hours x Standard rate XXXX
Labor rate variance XXXX

3. Actual rate XXXX

Less: Standard rate XXXX
Difference in rate XXXX
 x Actual hours XXXX
Labor rate variance XXXX

B. Labor Efficiency Variance

The labor efficiency variance is caused by using more or less than the standard amount of labor hours to
produce a product or complete a process.

Formulas

1. Labor efficiency variance = Standard rate x (actual hours less standard hours)

2. Actual hours x Standard rate XXXX

Standard hours x Standard rate XXXX
Labor efficiency variance XXXX

3. Actual hours XXXX

Less: Standard hours XXXX
Difference in hours XXXX
x Standard rate XXXX
Labor efficiency variance XXXX

AH = Actual Hours
AR = Actual Rate
SH = Standard Hours
SR = Standard Rate

The possible causes of labor rate variance

1. Hiring of inexperienced workers

2. Change in labor rate
3. Hiring of workers with pay higher than that assumed when the standard for a job was set.

The possible causes of labor efficiency variance

1. Lack of training for workers

2. Poor scheduling of work
3. Lack of supervision
4. Faulty equipment

Overhead Variances

A. One-Factor Method

(1) (2)
Actual Factory Overhead Applied FO (SO x FO Rate)

TOTAL OVERHEAD VARIANCE

Formula

Actual factory overhead XXXX

Less: Standard hours x Standard FO rate XXXX
Total factory overhead variance XXXX

Combined Manufacturing Overhead (Variable and Fixed Variance Analysis)

If the company is using a flexible budget, the total overhead variance may be analyzed using (a)
Two-variance method, (b) Three-variance method and (c) Four-variance method

B. Two-Variance Method

(1) (2) (3)

Actual Factory Overhead Budget Allowed on Standard Hours SH x FO Rate

Controllable variance Volume variance

(1) minus (2) (2) minus (3)

TOTAL OVERHEAD VARIANCE

Formulas

1. Controllable (Budget) Variance

Actual factory overhead XXXX

Less: Budget allowance based on standard hours:
Fixed overhead XXXX
Variable (std hours x variable rate) XXXX XXXX
Controllable Variance XXXX

2. Volume (Capacity or Production) Variance

Budget allowance based on standard hours XXXX

Less: Standard hours x standard OH rate XXXX
Volume variance XXXX

Denominator direct labor hours (used in computing Fixed OH rate) XXXX

Less: Standard direct labor hours allowed XXXX
Difference in number of hours XXXX
X Standard fixed factory overhead application rate XXXX
Production volume (volume variance) XXXX
 C. Three-Variance Method

(1) (2) (3) (4)

Actual Factory Budgeted allowed Budgeted allowed SH x FO Rate
on actual hours on standard hours

Variable efficiency
Spending variance variance Volume variance
(1) minus (2) (2) minus (3) (3) minus (4)

TOTAL OVERHEAD VARIANCE

Formulas

1. Spending variance
Actual factory overhead XXXX
Less: Budgeted allowance based on actual hours
Fixed overhead XXXX
Variable (actual hours x variable rate) XXXX XXXX
Spending variance XXXX

2. Variable efficiency variance

Budget allowance based on actual hours XXXX
Less: Budget allowance based on standard hours XXXX
Variable efficiency variance XXXX

3. Volume variance
Budget allowance based on standard hours XXXX
Less: Standard hours x factory overhead rate XXXX
Volume variance XXXX

D. Four-Variance Method

1. Variable Overhead Variance

(1) (2) (3)

Actual Variable AH x Variable rate SH x Variable Rate

Variable spending Variable overhead efficiency

(1) minus (2) (2) minus (3)

TOTAL VARIABLE OVERHEAD VARIANCE

Formulas

1. Actual variable factory overhead XXXX

Less: Actual hours x variable overhead rate XXXX
Variable spending variance XXXX

2. Actual hours x variable overhead rate XXXX

Less: Standard hours x variable overhead rate XXXX
Variable efficiency variance XXXX

2. Fixed Overhead Variance

(1) (2) (3)

Actual Fixed Budgeted Fixed at Normal Capacity SH x Fixed Rate

Fixed spending variance Volume variance

(1) minus (2) (2) minus (3)

TOTAL FIXED OVERHEAD VARIANCE

Formulas

1. Actual fixed overhead XXXX

Less: Budgeted fixed overhead at normal capacity XXXX
Fixed spending variance XXXX

2. Budgeted fixed overhead at normal capacity XXXX

Less: Standard hours x fixed overhead rate XXXX
Volume variance XXXX

Possible causes of volume variance

1. Poor production scheduling

2. Unusual machine breakdowns
3. Shortage of skilled workers
4. Decrease in demand from customers
5. Unused plant capacity

For all efficiency variances, an alternative computation may be made as follows:

Actual hours XXXX

Less: Standard hours allowed XXXX
Difference in number of hours XXXX

Illustrative Problem 1
Last month, the following events took place at Shangrila Company:

a. Produced 50,000 plastic microcomputer cases

b. Standard variable costs per unit (per case)
Direct materials; 2 pounds at P1.00 2.00
Direct labor; 0.10 hours at P15 1.50
Variable manufacturing overhead, 0.10 hrs at P5.00 0.50
c. Fixed manufacturing overhead cost
Monthly budget – for 40,000 cases or 4,000 standard hours 80,000
d. Actual production costs
Direct material purchased 200,000 lbs at P1.20 240,000
Direct material used – 110,000 lbs at P1.20 132,000
Direct labor – 6,000 hours at P14.00 84,000
Factory overhead 111,000

Requirements:

1. Compute the materials, labor and overhead variances.

2. Journal entries to record the given information.

Solution

1. Materials variances
a. Materials price (purchase) variances
Actual price 1.20
Less: Standard price 1.00
Difference in price 0.20
x Actual quantity purchased 200,000
Materials price variance – unfavorable 40,000
b. Materials quantity variance
Actual quantity used 110,000
Less: Standard quantity allowed (50,000 x 2) 100,000
Difference in quantity 10,000
x Standard price 1.00
Materials quantity variance 10,000

2. Labor variances
a. Labor rate variance
Actual rate per hour 14.00
Less: Standard rate per hours 12.00
Difference in rate (1.00)
x Actual hours used 6,000
Labor rate variance (6,000)
b. Labor efficiency variance
Actual hours used 6,000
Less: Standard hours allowed (50,000 x 0.10) 5,000
Difference in hours 1,000
 x Standard rate per hour 15.00
Labor efficiency variance 15,000

3. Factory overhead variance

A. Two-variance method
1. Controllable variance
Actual factory overhead 111,000
Less: Budget allowed on standard hours
Fixed 80,000
Variable (50,000 x 0.10 x 5) 25,000 105,000
Controllable variance – unfavorable 6,000
2. Volume variance
Budget allowed on standard hours 105,000
Less: Standard hours x Factory overhead rate
(50,000 x 0.10 x 25) 125,000
Volume variance – favorable (20,000)
B. Three-variance method
1. Spending variance
Actual factory overhead 111,000
Less: Budget allowed on actual hours
Fixed 80,000
Variable (6,000 x 5.00) 30,000 110,000
Spending variance – unfavorable 1,000
2. Variable efficiency variance
Budget allowed on actual hours 110,000
Less: Budget allowed on standard hours 105,000
Variable efficiency variance – unfavorable 5,000
3. Volume variance
Budget allowed on standard hours 105,000
Less: Standard hours x factory overhead rate 125,000
Volume variance – favorable (20,000)
C. Four-variance method
1. Variable spending variance
Actual variable factory overhead 36,000
Less: Actual hours x VO rate (6,000 DLHrs. X 5) ​30,000
Variable spending variance 6,000
2. Variable efficiency variance
Actual hours x variable overhead rate 30,000
Less: Standard hours x VO rate (50,000 x 0.10 x 5) ​25,000
Variable efficiency variance ​ 5,000
3. Fixed spending variance
Actual fixed overhead 75,000
Less: Budgeted fixed overhead at normal capacity ​80,000
Fixed spending variance (5,000)
4. Volume variance
 Budgeted fixed overhead at normal capacity 80,000
Less: Standard hours x Fixed OH rate (5,000 x 20) 100,000
Volume variance (20,000)

Journal Entries

1. Materials inventory (200,000 x 1.00) 200,000

Materials price variance 40,000
Accounts payable (200,000 x 1.20) 240,000

2. Work in process (50,000 x 2.00) 100,000

Materials efficiency variance 10,000
Materials inventory 110,000

3. Payroll 84,000
Accrued payroll 84,000

4. Work in process (5,000 hrs. x 15.00) 75,000

Labor efficiency variance 15,000
Labor rate variance 6,000
Payroll 84,000

5. Factory overhead control 111,000

Various credit accounts 111,000

6. Work in process (5,000 hrs. x 25.00) 125,000

Factory overhead applied 125,000

7. Factory overhead applied 125,000

Factory overhead controllable variance 6,000
Factory overhead volume variance 20,000
Factory overhead control 111,000

Analysis of factory overhead

One-factor

Actual factory overhead 111,000

Less: Applied overhead 125,000
Total variance (14,000)
Two-Factor

Controllable variance Volume variance

6,000 U (20,000) F

Total overhead variance ​(14,000) F

Three-Factor

Spending variance Efficiency variance Volume variance

1,000 U 5,000 U (20,000) F

Total overhead variance ​(14,000) F

Four-Factor

Variable spending Fixed spending

variance variance Efficiency variance Volume variance
6,000 U (5,000) F 5,000 U (20,000) F

Total overhead variance ​(14,000) F