CHAPTER 6

STANDARD
COSTS &
VARIANCE
ANALYSIS
STANDARD COSTS DEFINED

 are carefully (or scientifically) pre- determined costs

established by management to be used as a basis for
comparison with actual costs.
 are considered as a reflection of what the management
thinks a cost should be. In most cases, standard cases
are computed for manufacturing costs only (and not
for selling and administrative costs).
PURPOSES OF STANDARD COSTS
More specifically, a business can derive important benefits
from standard costs in areas such as:

1. Cost control 5. Preparation of budgets

2. Pricing decision 6. Costing of inventions

3. Motivation and performance 7. Preparation of cost reports

appraisal 8. Management by objective
4. Cost awareness and cost
reduction
 4
1. COST CONTROL
 standard costs are predetermined costs that “should be” incurred in
producing a product.

 They serve as a readily available basis for comparison with actual costs,
thereby allowing preparation of timely reports

2. PRICING DECISIONS
 selling price is set to include all the costs to manufacture and sell a
product, plus a desired amount of mark-up or profits in most
instances

 standard, instead of actual costs are used in setting selling prices because
3. MOTIVATION AND PERFORMANCE APPRAISAL
5

 managers usually find it difficult to evaluate performance of

employees, for this task usually involves a lot of variables. With the
use of standards, performance appraisal is facilitated.

4. COST AWARENESS & COST REDUCTION

 employees have their own line of interest and sets of goals –
perhaps increasing sales and production or optimization of
the use of resources like materials, utilities, etc. but they do
not know, or they do not fully understand the costs associated with
5. PREPARATION OF BUDGET 6

 Budgeting is one of the planning tools used by management. Its

end product is composed of budgeted or projected financial
statements, including forecast schedules.

6. COSTING OF INVENTORIES
 With standard costs, the value of these inventories can readily be
determined, without necessarily waiting for the actual costs to be
accumulated and summarized
7. PREPARATION OF COST REPORTS 7

 Schedules of materials, labor and other manufacturing costs

requirements can be prepared in advance – before actual
production, or before completion of the production process,
thereby enabling management to plan, analyze and control
productive operations.
8. MANAGEMENT BY OBJECTIVES
 Management by objectives (MBO) means that managers
establish specific goals or objectives for all business activities.
Actual results of operations are compared with these objectives.
 8
THE STANDARD COST SYSTEM
• “ a measure of acceptable performance”
– This is the very essence of the word standard. Applied to
standard costs, it is the acceptable amount of cost that ought to be
incurred in producing a product or undertaking an activity.
• “established by management”
– The standard must be established by the authority so that it
may be acceptable to everybody – the users and the analysts
as well.
• “used as a guide in making economic decisions”
–When significant deviations are noted, management takes the
necessary course of action, which, definitely, will be for the
benefit of the company as a whole.
3 activities involved in a standard cost
system

A. Development or establishment of standards

B. Accumulation of actual costs

C. Computation and analysis of variances

A. DEVELOPMENT OF STANDARDS
- Establishment of standards may not be a simple task, depending on
the nature of product and intricate in the process involved in its
manufacture.

1. The basis cost factors

 Cost is computed by multiplying two factors – the physical and the
monetary factors. The physical factors refers to the unit of
measurement of the cost elements involved in the production process,
while the monetary factor refers to the amount paid for the physical
factors. The formula to compute the cost is expressed as follows:

Cost = Physical Factor x Monetary

Factor

2. Specification of the product to be manufactured

 detailed description and specifications of the product to be
manufactured are necessary for the determination of the physical and
monetary factors needed in the computation of the manufacturing cost
 SETTING OF STANDARDS FOR THE COST ELEMENTS OF PRODUCTION
Physical Factors
 A bill (or list) of materials required for the product is prepared,
usually by those who are directly involved in production.
Example:
The direct material needed is plywood . Based on the specifications given,
the materials required to produce one unit of Bengram is 6 pieces of
plywood. Hence, the standard physical factor for materials, or the standard
quantity, is 6 pieces of plywood.
Monetary Factors
 The standard monetary factor, or the standard price, can be
established by determining the prevailing market prices. To do this, the
purchasing department can canvass the price from different possible
suppliers, or the accounting department can just refer to invoices for
previous purchases if the corporation regularly buy this material and
if the price is more or less stable.
Labor 12

 the physical factor for direct labor is usually measured in

terms of time or labor hours. As regards the monetary factor
for labor, which is usually called rate, it can be established by
considering the prevailing wage rates in the area.

Factor Overhead

 usually composed of a lot of cost items, since this includes all

manufacturing costs other than the prime costs (direct materials and
direct labor). We also have to consider that factory overhead is
composed, not only purely variable costs, but of mixed costs as well.
COMPUTATION AND ANALYSIS OF VARIANCES 13

 the word variance literally means difference therefore, variance

means the difference between the actual cost and standard
costs. The basic formula is

Variance = Actual Costs – Standard Costs

 Variances can be computed for all the three elements of production –

materials, labor and factory overhead.

 To facilitate the formula for variance computation and analysis, we
shall use the following codes:

A = Actual M= Materials
B = Standard L= Labor
C = Cost FOH = Factory
V = Variance Overhead
Q = Quantity Var = Variable
T = Time Fx = Fixed
P = Price OH = Overhead
R = Rate F = Favorable
Prod. = Production UF = Unfavorable
Pur. = Purchase(d) D = Difference
 COMPUTATION OF STANDARD COSTS
In the example, the standard quantity for 900 units of Bengram is 5,400
pcs. of plywood, since unit of product requires 6pcs. of plywood
(900 x 6 = 5,400 )
Note that the standard is computed based on the actual production. The
standard cost can be determined as follows :
SMC = SQ x SP
= 5,400 x P20
= P 108,000
 16
COMPUTATION OF VARIANCE

After determining the actual and standard cost data, we can now compare
the two, and compute the total materials cost variance as follows :

Variance = AC – SC
= P113, 906.25 – P108, 000
= P 5,906.25 UF
 THE PRICE VARIANCE 17

The price variance is the portion of total materials cost variance caused
by the difference between the price actually paid and the standard
price that should have been paid for the quantity of materials actually
purchased. The formula to compute this price variance is :
PV = (AQ x AP) – (AQ x SP) or
PV = (AP – SP) x AQ or
PV = DP x AQ
where: PV = Price Variance
AQ = Actual Quantity
AP = Actual Price
SP = Standard Price
 THE QUANTITY VARIABLE 18

The quantity variance ( also called usage variance ) results from actually
using more or less units of materials than the standard quantity
allowed for actual production. It can be computed using the following
formula :

QA = (AQ x SP) – (SQ x SP) or

QV = (AQ – SQ) x SP or
QV = DQ x SP

where:
QV = Quantity Variable
AQ = Actual Quantity
SQ = Standard Quantity
DQ= Difference in Quantity
A
 LABOR RATE VARIANCE
The labor rate variance results from actually paying more or less than the

RV = (AT x AR) – (AT x SR) or

RV = (AR – SR) x AT or
RV = DR x AT
where:
RV = Rate Variance
AT = Actual Time
AR = Actual Rate
SR= Standard Rate
DR= Difference in Rate
 TIME VARIANCE
The time variance, which is also called efficiency variance or labor usage varia

TV = (AT x SR) – (ST x SR) or

TV= (AT – ST) x SR or
TV = DT x SR
where:
TV = Time Variance
AT = Actual Time
ST = Standard Time
SR = Standard Rate
DT = Difference in Time