STANDARD COSTING AND VARIANCE ANALYSIS

Cost Accounting and Control

/RCROQUE

STANDARD COSTS AND VARIANCE ANALYSIS

VARIANCE ANALYSIS is the process of comparing the actual expenses and revenues during a certain
period to the budgeted amounts for that same period. Through the use of variance analysis, we are able
to determine why our actual results were different from the budgeted amounts. This will enable us to
focus our efforts on the areas of the operations that have been operating less efficiently than planned.

A STANDARD COST is an estimate of the cost the company expects to incur in the production process.
Without a standard cost, the analysis of actual activities and results is very difficult because there is no
standard against which to measure the performance.

A STANDARD COST is not the same thing as a STANDARD COST SYSTEM. A standard cost
prescribes expected performance is in terms of cost. A standard cost system is an accounting system
that uses standard costs and standard cost variances in the formal accounting system. There are
other types of accounting systems, and standard costs can be used with those accounting systems as
well. In those other types of accounting systems, the standard costs are used for control purposes
outside the formal accounting system.

A standard cost system may be used with either a process costing system or a job-order costing
system. A process costing system is used to assign costs to individual products when the products are
all relatively similar and are mass-produced, as on an assembly line. Job-order costing is a method in
which all of the costs associated with a specific job (or client) are accumulated and charged to that job
(or client).

SOURCES OF STANDARDS

Appropriate standards are often set by using several sources, including activity analysis, historical data,
benchmarking, target costing, and strategic decisions.

ACTIVITY ANALYSIS involves identifying, delineating or outlining, and evaluating all the activities
necessary to complete a job, a project or an operation. An activity analysis considers everything required
to complete the task efficiently and involves personnel from several areas including engineers,
management accountants, and production workers. Product engineers specify product components.
Industrial engineers analyze the steps or procedures necessary to complete the task. Management
accountants work with the engineers to complete the analysis. Activity analysis is time consuming and
expensive. However, if properly executed, activity analysis is the most precise way to determine
standard costs.

Use of HISTORICAL DATA is a less costly way to develop standard costs. Historical data for a similar
product can be a good source for determining the standard cost of an operation, if reliable information is
available. Another advantage to using historical data is that it is based on the way the particular firm has
operated in the past. This can also be a disadvantage, because a standard based on the past can
perpetuate past inefficiencies. Although historical standards are more attainable than ideal standards,
they are not consistent with a philosophy of continuous improvement.

BENCHMARKING to develop standard costs is based on current practices of similar operations in other
firms. Associations of manufacturers often collect industry information and have data available. The firm
can use this data as guidelines for setting standard costs. By using benchmarking to set standard costs,
a firm can have access to the best performance anywhere and this can help sustain its competitive edge.
A disadvantage of using benchmark data is that it might not be completely applicable to the firm’s own
situation.

Use of TARGET COSTING to set standard costs puts the focus on the market and on the price the
product can be sold for. A target price is the price the firm can sell its product for, and the target cost
is the cost that must be attained for the firm to realize its desired profit margin for the product. Once the
target cost has been determined, detailed standards are then set to attain the desired cost.

MANAGEMENT BY EXCEPTION

Once standards have been set, and in a system where variances are identified and reported to the
appropriate level of the company, management can MANAGE BY EXCEPTION. This means that
management can focus time in areas where there are problems, as identified by the fact that there is a
variance from the standard. The disadvantage of this method is that negative trends may be overlooked
at earlier stages. Also, if too many deviations from the budget occur, this approach can become a very
confusing and involved process of trying to fix all of the problems at once.

STATIC BUDGET VARIANCES VS. FLEXIBLE BUDGET VARIANCES

Recall that a static budget is a fixed budget. It is a budget that is prepared for one specific level of
planned activity, and that level of planned activity does not change, no matter what the actual activity is.
A static budget is easy to prepare, but it is not very useful for control and evaluation purposes if the
actual level of activity is different from what had been planned. For instance, a cost may be higher than
budgeted, but if sales were also higher than expected, the portion of the variance that is due to the
increased activity is to be expected and is not a cause for concern.

A more useful and usable budget is a flexible budget. This is a budgeted amount that is adjusted to
the actual level of activity that has occurred. Flexible budget variances are a better indicator of operating
performance than static budget variances are, because they compare actual results to the budgeted
results for the actual volume. If an actual cost is higher than its flexible budget amount, then that
variance may be cause for concern.

TYPES OF VARIANCES: Manufacturing Input Variances

Direct Materials Variances

1) Price variance
2) Quantity or efficiency variance
2a) Mix variance * 2b) Yield variance *

Direct Labor Variance

3) Rate (Price) variance
4) Efficiency (Quantity) variance
4a) Mix variance * 4b) Yield variance *

Factory Overhead Variances

5) Total Variable overhead variance
5a) Variable overhead spending variance 5b) Variable overhead efficiency variance
6) Total Fixed overhead variance
6a) Fixed overhead spending or budget variance 6b) Fixed overhead production-volume variance

Sales Variances:
7) Sales price variance
8) Sales volume variance
8a) Quantity variance ** 8b) Mix variance **

* These specific manufacturing variances are calculated only when there is more than one input (either
classes of labor or types of material) into the final product.
** These specific sales variances are calculated when the company sells more than one product.

SUMMARY OF MANUFACTURING INPUT VARIANCES

Prime Costs Price Variance Quantity Variance

(AP – SP) × AQ (AQ – SQ) × SP
Materials Price Variance Quantity Variance
Labor Rate Variance Efficiency Variance

Efficiency Variance

Mix Variance
Yield Variance
Actual Materials Input @ Standard
Material Inputs Actual Materials Input @ Standard
Price
(both Material and Input Cost
Less: Actual Materials Input @
Labor) Less: Actual Output @ Standard
Standard Input Cost
Output Cost
Standard Output Cost (SOC) = Total Standard Materials Costs ÷ Standard Production
Standard Input Costs (SIC) = Total Standard Materials Costs ÷ Standard Materials Input
 Spending Variance Efficiency Variance
Variable Overhead
(AP – SP) × AQ (AQ – SQ) × SP
Spending (Budget) Variance Production Volume Variance
Labor
Actual OH − Budgeted OH Budgeted OH – Applied OH

MIX AND YIELD VARIANCES

The total material quantity or labor efficiency variance of a weighted mix is the sum of the quantity
variances for each component of the mix, each one calculated individually.

The formula (AQ – SQ) × SP is used to calculate the quantity variance for each component of the mix
separately, and then the individual quantity variances are added together to calculate the total quantity
variance.

We then break down this total material quantity or labor efficiency variance into two sub-variances – the
mix and the yield variances.

The Mix Variance (Materials or Labor)

The mix variance is the part of the quantity variance that results because the mix of materials actually
used or the mix of the labor used was different from the mix that should have been used (i.e., the
standard). An example would be including more corn and less wheat in the cereal than the standard calls
for.

The Yield Variance (Material or Labor)

The yield variance results from the difference between the total actual quantity of the inputs that were
used to produce the actual output and the total standard quantity that should have been used to
produce the actual output.

FACTORY OVERHEAD VARIANCES

Controllable Variance
AFOH – BASH
2-Way Variance Method (ConVo)
Volume Variance
BASH – SH x SR

Spending Variance
AFOH – BAAH

Variable Efficiency Variance

3-Way Variance Method (SVV)
BASH – BASH

Volume Variance
BASH – SH x SR

Variable Spending Variance

AFOH – BAAH

Fixed Spending Variance

AFOH – BAAH
4-Way Variance Method
Variable Efficiency Variance
BAAH – BASH

Volume Variance
BASH – SH x SR

Note: For BAAH and BASH, the Budgeted Fixed Overhead (based on
actual hours or standard hours) is the SAME.
Problem #1
The following data from Division X of Angela Aguas were gathered:

Costs Budget Actual

Sales P 480,000.00 P 470,000.00
Variable COGS 180,000.00 187,000.00
Fixed Manufacturing Cost 40,000.00 46,500.00
Variable Selling 38,000.00 30,000.00
Fixed Admin 20,000.00 22,000.00
Fixed Selling 50,000.00 53,000.00
Operating Income P ??? P ???

1. If the budget was prepared based on 2,000 units, and the actual units happen to be equal with
the plan, what is the total cost variance?
2. If the budget was prepared based on 2,000 units, and the actual units is 85% of the plan, what
is the total cost variance?
3. If the budget was prepared based on 2,000 units, and the actual units is 95% of the plan, what
is the variance on its operating income?
4. If the budget was prepared based on 2,000 units, and the actual units is 5% higher than the
plan, what is the variance on its operating income?

Problem 2

Problem 3

variance
Problem 4

Problem 5

Problem 6

The Gold plant of Melbourne’s Small Motor Division produces a major sub-assembly for
motorcycles. The plant uses a standard costing system for production costing and control. The standard
cost sheet for the sub-assembly follows:

Direct materials (6 lbs. @ ₱6) ₱36

Direct labor (3 hrs. @ ₱12) 36
Variable overhead (3 hrs. @ ₱10) 30
Fixed overhead (3 hrs. @ ₱6) 18
Standard unit cost ₱120

During the year, the Gold plant had following actual production activity:
a. Production of sub-assemblies totaled 75,000 units.
b. A total of 415,000 pounds of materials was purchased at ₱5.80 per pound.
c. There were 16,400 pounds of materials in beginning inventory (carried at ₱6 per pound). There
was no ending inventory.
d. The company used 200,000 direct labor hours at a total cost of ₱2,560,000.
e. Actual fixed overhead totaled ₱1,413,000.
f. Actual variable overhead totaled ₱2,170,000.

The Gold plant’s practical activity is 80,000 units per year. Standard overhead rates are computed based
on practical activity measured in standard direct labor hours.

Requirements:
1. materials price variance
2. materials usage variance
3. labor rate variance
4. labor efficiency variance
5. variable overhead spending variance
6. variable overhead efficiency variance
7. fixed overhead spending variance
8. fixed overhead volume variance
9. controllable overhead variance
10. total overhead variance
Problem #7

NSW Company produces telephones. To help control costs, NSW employs a standard costing
system and uses a flexible budget to predict overhead cost at various levels of activity. For the most
recent year, NSW used a standard overhead rate at ₱18 per direct labor hour. The rate was computed
using practical activity. Budgeted overhead cost are ₱792,000 for 36,000 direct labor hours and
₱1,080,000 for 60,000 direct labor hours. During the past year, NSW generated the following data:

a. Actual production: 100,000 units

b. Fixed overhead volume variance: ₱36,000 unfavorable
c. Variable overhead efficiency variance: ₱24,000 favorable
d. Actual fixed overhead costs: ₱380,000
e. Actual variable overhead costs: ₱620,000

1. Calculate the fixed overhead rate.

2. Determine the fixed overhead spending variance.
3. Determine the variable overhead spending variance.
4. Determine the standard hours allowed per unit of product.
5. Assuming the standard labor rate is ₱13 per hour, compute the labor efficiency variance.

Problem 8

Darwin Company uses a standard cost system. The standard cost card for one of its products shows the
following materials standards:

Materials Inputs Standard Quantity Standard Price per Kilo Total

A 20 kilos ₱0.70 ₱14
B 5 0.40 2
C 25 0.20 5
50 kilos ₱21

The standard mix should produce 40 kilos of finished products. Materials of 500,000 kilos were used as
follows:

Materials Inputs Actual Quantity Actual Unit Price Total

A 230,000 kilos ₱0.80 ₱184,000
B 50,000 kilos 0.35 17,500
C 220,000 kilos 0.25 55,000
₱256,500
The output of the finished product was 390,000 kilos.

1. What is the materials price variance?

2. What is the materials mix variance?
3. What is the materials yield variance?

Problem 9

Valenzuela Plastics, Inc. has set a standard cost, ₱5.25 per unit for Material D and ₱12.25 per
unit for Material E. In June, Valenzuela bought 17,500 units of Material D and 8,750 units of Material E.
All Material D, except 1,400 units, were bought at the standard unit cost. The 1,400 units had a unit cost
of ₱6.15. Valenzuela bought 7,875 units of Material E at standard cost and 875 units at a unit cost of
₱14.

In accordance with the standard, two units of Material D and one unit of Material E should be
used to make each unit of Product F. In January, 7,000 units of Product F were made, and 15,050 units
of Material D were used and 7,175 units of Material E were used.

1. What is the materials price variance?

2. What is the materials mix variance?
3. What is the materials yield variance?
Problem 10

The Chicleros Co., Inc. manufacturer of chewing gum, uses a standard cost system. Standard product
and cost specifications for 1,000 lbs of chewing gum are as follows:

Quantity Price Cost

Gumbase 800 lbs P0.25/lb P200
Corn syrup 200 lbs 0.40/lb 80
Sugar 200 lbs 0.10/lb 20
Input 1,200 lbs P300 P0.25/lb
Output 1,000 lbs P300 P0.30/lb

Materials records indicate:

Opening Purchases Ending
Inventory In January Inventory
Gumbase 10,000 lbs 162,000 lbs @ P0.24 15,000 lbs
Corn syrup 12,000 lbs 30,000 lbs @ P0.42 4,000 lbs
Sugar 15,000 lbs 32,000 lbs @ P0.11 11,000 lbs

To convert 1,200 lbs of raw materials into 1,000 lbs of finished product requires 20 hours at
P3/hour, or P0.6/lb. Actual direct labor hours and cost for January are 3,800 hours at P11,552.

Factory overhead is applied on a direct labor hour basis at a rate of P5/hour (P3 fixed, P2
variable), or P0.10/lb. Normal overhead is P20,000 with 4,000 direct labor hours. Actual overhead for
the month is P22,000. Actual finished production for the month of January is 200,000 lbs.

The standard cost per pound of finished chewing gum is:

Materials P0.30/lb
Labor 0.06/lb
Factory Overhead 0.10/lb
Total P0.46/lb

The materials price variance is assumed to be realized at the time of purchase.

Determine the following

1. material price, mix, and yield variances
2. labor rate and efficiency variances
3. factory overhead variances