Chapter 8

Standard Cost Accounting-Materials, Labour,

and Factory Overhead

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Learning Objectives
• Describe the different standards used in determining standard costs.
• Determine procedures for recording standard costs.
• Compute and analyze variances.
• Prepare journal entries to record variances.
• Examine and interpret variances.
• Recognize the features of a standard cost system.
• Account for standard costs in a departmentalized factory.
• Distinguish between actual and applied factory overhead.
• Compute variances using the two-variance method.
• Compute variances using the four-variance method.
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•
Standard Costing
• The purpose of standard cost accounting is to control costs and
promote efficiency.
• It is not another accounting method for accumulating manufacturing
costs, but is used in conjunction with such methods as job order,
process, or backflush costing.
• Standard costing is based on predetermination of what it should cost
to manufacture a product, and the inventory accounts are debited for
these standard costs.

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Types of Standards
• Standard – norm against which the actual performance can be
measured
• Ideal standard – make no allowances for inefficient conditions such as
lost time, waste, or spoilage.
• Attainable standard – include factors such as lost time and normal
waste and spoilage. Set standards that are high enough to provide
motivation and promote efficiency, yet not so high that they are
unattainable.

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Standard Cost Procedures
• Standard cost accounting is based on the following procedures:
Standard costs are determined for the three elements of cost: direct
materials, direct labour, and factory overhead.
The standard costs, the actual costs, and the variances between the actual
and standard costs are recorded in the appropriate accounts.
Significant variance are analysed and investigated and then appropriate
action is taken.
Materials cost standard is based on estimates of the quantity of materials
required for a unit of product and the unit cost to purchase the materials
used.
Labour cost standard is based on estimates of the labour hours required to
produce a unit of product and the cost of labour per unit. 5
Determination of Variances
• A variance represents the difference between the actual and the
standard costs of materials, labour, and overhead.
• Variances measure efficiencies or inefficiencies in usage and price.
• A debit balance in a variance account indicates an unfavourable
variance. (Actual cost exceeded standard cost)
• A credit balance reflects a favourable variance, indicating that actual
costs were less than the standard.(Actual cost less than standard cost)

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 Standard Actual
Material Used 10,000 units 11,000 units
Price per pound RM4 per pound RM3.80 per pound

Materials price variance

= (actual unit price – standard unit price) x actual quantity
= (RM3.80 – RM4) x RM11,000
= RM2,200 F
Materials quantity(usage) variance
= (actual quantity – standard quantity) x standard unit price
= (11,000 – 10,000) x RM4
=RM4,000 U
Net material variance
=Materials price variance +/- Materials quantity variance
= RM2,200 F – RM4,000 U 8
 Standard Actual
10,000 units 10,000 units
½ hour 0.45 hours
RM10 per hour RM11 per hour

Labour rate (price) variance

= (actual labour rate per hour – standard labour rate per hour) x actual number of
labour hours worked
= (RM11 – RM10) x 4,500 hours = RM 4,500 U
Labour efficiency (usage) variance
= (actual number of labour hours worked – standard number of labour hours
allowed) x standard labour rate per hour
= (4,500 – 5,000) x RM10 = 5,000 F
Net labour variance
= Labour rate variance +/- Labour efficiency variance
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Accounting for Variances
• Work in Process is always debited with the standard cost ( standard
quantity X standard price)
• Materials inventory account is credited for the actual cost of materials
issued to the factory.
• Payroll account is credited with the actual cost of labour incurred for
the period.
• The differences between the debits (at standard costs) and the credits
(at actual costs) are debited (unfavourable variances) or credited
(favourable variances) to the variance accounts.
• The standard cost of units finished is transferred from Work in Process
to Finished Goods. 12
Direct material costs
Dr Work in progress 40,000
Dr Materials quantity variance 4,000
Cr Materials price variance 2,200
Cr Materials 41,800
Direct labour costs
Dr Work in progress 50,000
Dr Labour rate variance 4,500
Cr Labour Efficiency variance 5,000
Cr Payroll 49,500
Finished goods
Dr Finished goods 90,000 13
Disposition of Variances
• Prorate variances to Cost of Goods Sold, Work in Process, and Finished
Goods.
• Show an unfavourable net variance as an addition to the cost of goods
sold for the period and a favourable net variance as a deduction from
costs of goods sold.
• If crediting the entire amount of the variances to Cost of Goods Sold
would materially misstate the financial statements, the variances should
be allocated to Work in Process, Finished Goods, and Cost of Goods
Sold.
• If production seasonal, then the variances should be shown as deferred
charges or credits on interim balance sheets.
• Variances due to abnormal or unusual circumstances should be charged14
Interpreting Variances
• Two components are investigated:
Quantity
Price
• Management should not look at each individual variance in a vacuum
but rather at the relationship of that variance to other variances.

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• Unfavourable material price variance
- Inefficient purchasing methods
- Use of a different material than the standard called for
- An increase in the market price
• Unfavourable materials quantity variance
- More wastage or spoilage of materials than was built into the standards
- The deliberate use of more materials to enhance the product
- Poor quality of materials.
• Favourable materials quantity variance
- Greater efficiency in planning and usage of materials,
- Use of higher quality materials than the standard called for,
- Use of more highly skilled workers resulting in less waste.
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• Unfavourable labour rate variance
- The hiring of more highly skilled workers than needed for the job,
- An unforeseen change in wage rates due to labour-management
negotiations.
• Favourable labour rate variance
- More efficient job of hiring qualified employees
- Less-than-qualified workers are being hired at a lower rate
• Favourable labour efficiency variance
- Hiring of more highly skilled personnel,
- A speed-up in production,
- More efficient supervision
- Working with high-quality materials.
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Features of a Standard Cost System
• The fact that standards are based on estimates does not make them
unreliable.
• Standards will change as conditions change.
• The purpose of using a standard cost system is to provide continual
incentive for factory personnel to keep costs and performance in line
with predetermined management objectives.
• A standard cost system helps focus management’s attention on the
following questions and their causes:
Were materials purchased at prices above or below standard?
Were materials used in quantities above or below standard?
Is labour being paid at rates above or below standard?
Is labour being used in amounts above or below standard? 18
Actual & Applied Factory Overhead
• Actual FOH = Applied FOH, no over or underapplied FOH exist in the
FOH account and no variance
• Actual FOH > Applied FOH, unfavourable variance
• Actual FOH < Applied FOH, favourable balance

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Two-Variance method
• The two-variance method of overhead analysis breaks down the total
variance into a flexible-budget variance and a production-volume
variance.
• Flexible-budget variance measures the amount by which the actual
factory overhead costs differ from the flexible budget for production
attained.
• The production-volume variance measures difference between the
budgeted fixed overhead and the fixed overhead allocated to work in
process.

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 Budget Actual
Quantity 1,000 units 900 units
Required direct labour hours 2,000 hours
RM RM
Depreciation – fixed 4,000 4,000
Taxes and insurance – fixed 1,000 1,000
Supervisory salaries – fixed 4,000 4,000
Maintenance cost – variable 2,000 1,800
Supplies – variable 1,000 1,000
12,000 11,800

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• Flexible-budget variance
• Flexible budget at actual production level - Actual factory overhead
incurred
Standard factory overhead budgeted for actual level of production
RM
Variable costs RM3,000/1,000 units x 900 units 2,700
Fixed costs 9,000
11,700
Actual factory overhead incurred 11,800
Flexible-budget variance 100 U

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• Production-volume variance
• Flexible budget at actual production level – factory overhead applied

Standard overhead rate RM12,000/2,000hours RM6 per hour

Standard overhead cost per unit RM6 x 2 labour hour RM12 per unit
Factory overhead applied 900 units x RM12 RM10,800
RM
Flexible budget at actual production level 11,700
Factory overhead applied 10,800
Production-volume variance 900 U

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• Under or over applied
RM
Flexible-budget variance 100 U
Production-volume variance 900 U
Underapplied factory overhead 1,000

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Four –Variance Method
• Four-variance method recognizes two variable cost variances and two
fixed cost variances.
• It has two important aspects:
separate actual factory overhead accounts must be maintained for
variable costs and fixed costs
actual direct labour hours must be known

Three-Variance Method
Three-variance method separates actual and applied overhead into
three variances: spending, efficiency, and production-volume.

End of Topic 25