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MS 3404 – Standard Costing and Variance Analysis MAY 2023

LECTURE NOTES

A standard is a benchmark or “norm” for measuring Where:

performance. In managerial accounting, standards
relate to the cost and quantity of inputs used in AQ = Actual quantity of inputs purchased (or used)
manufacturing goods or providing services. A standard AP = Actual price per unit of inputs purchased
cost is the expected or budgeted cost of materials, SP = Standard price per unit of input
labor, and manufacturing overhead required to produce SQ = Standard input allowed for the actual output
one unit of product.
Computation and Interpretation of Standard Cost
Two reasons for adopting a standard cost system are: Variances. Since direct material, direct labor, and
To improve planning and control. A standard cost variable overhead are all variable manufacturing costs,
system compares actual amounts with standard the process of computing price and quantity variances
amounts to determine variances from the standard. for each cost category is the same. The general model
To facilitate product costing. Standard costing uses can be used in each case to compute the variances.
standard costs for direct materials, direct labor, and The only complication is deciding in each case whether
overhead. Standard cost systems provide readily the actual quantity of inputs refers to the actual
available unit cost information that can be used for quantity purchased or the actual quantity used.
pricing decisions.
Static Budgets. The term static budget refers to the
Setting Standard Costs. Standards should be set so budget that is set at the beginning of a budgeting
that they encourage efficient operations. period and that is geared to only one level of activity—
Ideal versus practical standard. Standards tend to fall the budgeted level of activity.
into one of two categories—either ideal or practical.
• Ideal standards allow for no machine breakdowns Flexible Budgets. A flexible budget is geared to all
or work interruptions and require that workers levels of activity within the relevant range and is used
operate at peak efficiency 100 percent of the time. to plan and control spending. The flexible budget will
Since ideal standards are rarely met, most show the cost formula for each variable cost and total
managers believe they tend to discourage even the cost (possibly including fixed costs) at various levels of
most diligent workers. activity.
• Practical standards are “tight, but attainable.” They
allow for normal machine downtime and employee Applying Overhead in a Standard Cost System.
rest periods and can be attained through Overhead can be applied to units based on actual
reasonable, but highly efficient, efforts by the hours or standard hours allowed for the actual output.
average worker. In a standard cost system it is simplest to apply
overhead on the basis of the standard hours allowed
A General Model for Variance Analysis. A variance is for the actual output. This results in each unit being
the difference between standard prices and quantities assigned the same overhead cost—regardless of how
on the one hand and actual prices and quantities on many hours were actually required to make the unit.
the other hand. A general model can be used to
describe the variable cost variances. 1. Variable overhead variances.
a. The variable overhead spending variance is
VARIANCE ANALYSIS: GENERAL DESCRIPTION computed as follows when the variable
Price and Efficiency Variances overhead rate is expressed in terms of direct
The total budget variance is the difference between labor-hours:
actual cost of inputs and the standard (or planned) Variable overhead spending variance = (Actual
cost of inputs. overhead cost – Actual input hours)  Variable
There are two variances for variable production costs: overhead rate
1. Price or rate variances — the difference between The variable overhead spending variance
actual costs of inputs and what the inputs should compares actual spending on variable overhead
have cost (standard prices). to the amount of spending that would be
2. Usage or efficiency variances — the difference expected, given the actual direct labor-hours
between the actual quantity used and the standard for the period.
quantity allowed for units produced.
b. The variable overhead efficiency variance is
Alternative methods. As an alternative to the general computed as follows when the variable
model, variances can be computed by formulas. The overhead rate is expressed in terms of direct
formulas for the price variance are: labor-hours:
Price (rate) variance = (AQ  AP) - (AQ  SP) Variable overhead efficiency variance = (Actual
or hours – Standard hours allowed)  Variable
Price (rate) variance = AQ (AP - SP) overhead rate

The formulas for the quantity variance are: 2. Fixed Overhead Variances in a Standard Cost
Quantity (efficiency) variance = (AQ  SP) - (SQ  SP) System. Two variances are computed for fixed
or overhead—a budget variance and a volume
Quantity (efficiency) variance = SP (AQ - SQ)

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EXCEL PROFESSIONAL SERVICES, INC.

variance. These variances are quite different from for an average shipment of 100 15-gallon containers of
the variances computed for variable overhead. Echol.
a. Budget Variance. The budget variance is the
difference between the actual fixed overhead Use of Echol: The bill of materials calls for 14.25 quarts
costs incurred during the period and the of Echol per bottle of cleaning solvent. (There are four
budgeted fixed overhead costs contained in the quarts in a gallon.) About 5% of all Echol used is lost
flexible budget. This variance is very useful in through spoilage or evaporation (the 14.25 quarts above
that it indicates how well spending on fixed is the actual content per bottle.) In addition, statistical
items was controlled. analysis has shown that every 31st bottle is rejected at
b. Volume Variance. The volume variance is the final inspection because of contamination.
difference between the total budgeted fixed
overhead and the fixed overhead applied to Requirements:
production. Alternatively, it can be expressed 1. Compute the standard purchase price for one quart
as the difference between the denominator of Echol.
level of activity and the standard hours allowed 2. Compute the standard quantity of Echol (in quarts)
for the output of the period, multiplied by the per salable bottle of cleaning solvent.
fixed portion of the predetermined overhead
rate. The volume variance occurs because the PROBLEM NO. 3.
denominator level of activity differs from the The following standard costs were developed for one of
standard hours allowed for production. Thus, the products of LT Inc.
an unfavorable variance means that the Materials: 2.5 lbs. x P6 per lb. P15
company operates at an activity level below the Direct labor: 1.5 hours x P12 per hour 18
denominator level of activity. Conversely, a Variable OH: 1.5 hours x P4 per hour 6
favorable variance means that the company Fixed OH: 1.5 hours x P8 per hour 12
operates at an activity level greater than the Total standard cost per unit P51
denominator level of activity. The following information is available regarding the
c. Fixed Overhead Rate based on Practical company’s operations for the period:
Capacity. Although fixed overhead are often Units produced: 52,000
based on budgeted production levels, it may be Materials purchased: 150,000 lbs. @ P5.90 per lb.
a better approach if it is based on practical Materials used: 136,000 lbs.
capacity. Practical capacity is the volume Direct labor: 80,000 hours costing 944,000
that could be achieved under normal (not ideal) Manufacturing OH incurred:
operating conditions. It allows some downtime Variable P325,000
for necessary activities such as employee Fixed P640,000
training, shift changes, breaks, and preventive Budgeted fixed manufacturing overhead for the period
maintenance. Using the capacity supplied as is P600,000, and the standard fixed overhead rate is
the denominator when calculating the fixed based on expected capacity of 75,000 direct labor
overhead rate (as opposed to the amount of hours.
capacity actually used) prevents the rate from
fluctuating due to changes in demand. It also Requirements:
highlights the cost of unused capacity for 1. Materials price variance
management attention. 2. Materials usage variance
3. Direct labor rate variance
STRAIGHT PROBLEMS 4. Direct labor efficiency variance
5. Total overhead variance
PROBLEM NO. 1. 6. Two-way overhead variance analysis
May, Inc. prepared the following master budget items for 7. Three-way overhead variance analysis
the month of November: 8. Four-way overhead variance analysis
Production and sales (units) 30,000
Variable manufacturing costs PROBLEM NO. 4.
Direct materials P75,000 Father & Son Corporation manufactured 22,000 helmets
Direct labor 60,000 during September. The overhead cost-allocation base is
Variable manufacturing OH 45,000 P8 per machine-hour. The following variable overhead
Fixed manufacturing OH 120,000 data pertain to September:
Total manufacturing costs P300,000 Actual Budgeted
Requirement: Production (units) 22,000 20,000
During November, May actually produced and sold Machine-hours 28,000 25,000
32,000 units. Prepare a flexible budget for May based Variable OH per MH: P9.00 P8.00
on actual sales.
Requirements:
PROBLEM NO. 2. 1. What is the actual variable overhead cost?
Martina Company manufactures a powerful cleaning 2. What is the variable overhead flexible-budget
solvent. The main ingredient in the solvent is a raw amount?
material called Echol. Information on the purchase and 3. What is the variable overhead spending variance?
use of Echol follows: 4. What is the variable overhead efficiency variance?

Purchase of Echol: Echol is purchased in 15-gallon PROBLEM NO. 5.

container at a cost of P115 per container. A discount of Macao’s Corporation manufactured 12,000 golf bags
5% is offered by the supplier for payment within 10 days, during March. The fixed overhead cost-allocation rate
and Martina Company takes all discounts. Shipping is P15.00 per machine-hour. The following fixed
costs, which Martina Company must pay, amount to P130 overhead data pertain to March:

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EXCEL PROFESSIONAL SERVICES, INC.

Actual Static Budget Fixed OH 445,000

Production 12,000 units 10,000 units Units produced & sold 5,500 units
Machine-hours 8,200 hours 8,000 hours
Fixed OH cost P122,000 P120,000 Requirements:
1. Analyze all the manufacturing cost variances
Requirements: 2. Prepare the journal entries to record the following
1. What is the flexible-budget amount? transactions. Assume Metals does not maintain
2. What is the amount of fixed overhead allocated to inventories other than direct materials.
production? a. purchase of direct materials on account
3. What is the fixed overhead budget and b. issuance of direct materials to production
production-volume variance? c. incurrence of direct labor
d. incurrence of variable overhead
PROBLEM NO. 6. e. incurrence of fixed overhead
The flexible budget formula for total overhead for Star f. application of overhead
Division of Waterous Company is P360,000 + P8 per g. closing of overhead to cost of goods sold
direct labor hour. The combined overhead rate is P20 per
direct labor hour. The following data have been recorded PROBLEM NO. 9.
for the year: Energy Products produces a gasoline additive, Gas Gain.
Actual total overhead P580,000 This product increases engine efficiency and improves
Total overhead spending variance 16,000 U gasoline mileage by creating a more complete burn in the
Volume variance 24,000 U combustion process. Careful controls are required during
the production process to ensure that the proper mix of
Requirements: input chemicals is achieved and that evaporation is
Using a three-variance approach, determine the number controlled. If the controls are not effective, there can be
of standard hours allowed and actual hours of direct labor loss of output and efficiency. The standard cost of
hours worked. producing a 500-liter batch of Gas Gain is P13,500. The
standard materials mix and related standard cost of each
PROBLEM NO. 7. chemical used in a 500-liter batch are as follows:
Sharp Company manufactures a product for which the Chemical Mix SP Standard Cost
following standards have been set: Echol 200 liters P20.00 P4,000
SQ or SH SP or SR Standard Cost Protex 100 liters 42.50 4,250
Direct materials 3 feet P5 per ft. P15 Benz 250 liters 15.00 3,750
Direct labor ? hours ? per hr. ? CT-40 50 liters 30.00 1,500
During March, the company purchased direct materials at 600 liters P13,500
a cost of P55,650, all of which were used in the The quantities of chemicals purchased and used during
production of 3,200 units of product. In addition, 4,900 the current production period are shown in the schedule
hours of direct labor time were worked on the product below. A total of 140 batches of Gas Gain were
during the month. The cost of this labor time was manufactured during the current production period.
P36,750. The following variances have been computed Energy Products determines its cost and chemical usage
for the month: variations at the end of each production period.
Materials quantity variance P4,500 U Chemical Quantity Used
Total labor variance 1,650 F Echol 26,600 liters
Labor efficiency variance 800 U Protex 12,880 liters
Benz 37,800 liters
Requirements: CT-40 7,140 liters
1. For direct materials: 84,420 liters
a. Compute the actual cost per foot for materials for
March. Requirements:
b.Compute the materials price variance and a total Compute the total materials usage variance and then
variance for materials. break down this variance into its mix and yield
2. For direct labor: components.
a. Compute the standard direct labor rate per hour.
b.Compute the standard hours allowed for the PROBLEM NO. 10.
month’s production. Basic Foods expected to sell 30,000 of its fishcharon at
c. Compute the standard hours allowed per unit of P300 each. It actually sold 29,000 at P298. Variable
product. cost per pack is P140. Determine the sales price variance
and sales volume variance.
PROBLEM NO. 8.
Jacinto Metal works has provided the following MULTIPLE CHOICE QUESTIONS
information:
Standards: Per unit 1. Which of the following would produce a labor rate
Materials, 5 m. @ P20 P100 variance?
Direct labor, 3 hours @ P32 96 a. Poor quality materials causing breakage and work
Variable OH, 3 hours @ P8 24 interruptions.
Fixed OH, 3 hours @ P25 75 b. Use of persons with high hourly wage rates in
Budgeted production = 6,000 units tasks that call for low hourly wage rates.
c. Excessive number of hours worked in completing
Actual results: a job.
Materials purchased, 36,000 m. P774,000 d. An unfavorable variable overhead spending
Materials used, 28,875 m. variance.
Direct labor, 16,650 hours 524,475
Variable OH 134,865

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2. Which of the following factors would cause an 9. An unfavorable efficiency variance for direct
unfavorable material quantity variance? manufacturing labor might indicate that:
a. using poorly maintained machinery a. work was efficiently scheduled
b. using higher quality materials b. machines were not properly maintained
c. using more highly skilled workers c. budgeted time standards are too lax
d. receiving discounts for purchasing larger than d. more higher skilled workers were scheduled
normal quantities than planned

3. Using more highly skilled direct laborers might affect 10. One of the primary reasons for using cost variances
which of the following variances? is:
a. direct materials usage variance a. they diagnose the cause of a problem and what
b. direct labor efficiency variance should be done to correct it
c. variable manufacturing overhead efficiency b. for superiors to communicate expectations to
variance lower-level employees
d. all of the above c. to administer appropriate disciplinary action
d. for financial control of operating activities and
4. A company would most likely have an unfavorable understanding why variances arise
labor rate variance and a favorable labor efficiency if
a. the mix of workers used in the production process 11. The fixed overhead cost variance can be further
was more experienced than the normal mix subdivided into the:
b. the mix of workers used in the production process a. price variance and the efficiency variance
was less experienced than the normal mix b. spending variance and flexible-budget variance
c. workers from another part of the plant were c. production-volume variance and the efficiency
used due to an extra heavy production schedule variance
d. the purchasing agent acquired a very high d. flexible-budget variance and the production-
quality of material that resulted in less spoilage volume variance

5. The primary difference between a fixed (static) 12. A favorable fixed overhead spending variance might
budget and a variable (flexible) budget is that a indicate that:
fixed budget: a. more capacity was used than planned
a. cannot be changed after the period begins; b. the denominator level was less than planned
while a variable budget can be changed after c. the fixed overhead cost-allocation base was not
the period begins used efficiently
b. is a plan for a single level of sales (or other d. a plant expansion did not proceed as originally
measure of activity); while a variable budget planned
consists of several plans, one for each of
several levels of sales (or other measure of 13. The variance least significant for purposes of
activity) controlling costs is the
c. includes only fixed costs; while variable budget a. material quantity variance.
includes only variable costs b. variable overhead efficiency variance.
d. is concerned only with future acquisitions of c. fixed overhead spending variance.
fixed assets; while a variable budget is d. fixed overhead volume variance.
concerned with expenses that vary with sales
14. Which of the following statements about the
6. The term “standard hours allowed” measures selection of standards is true?
a. budgeted output at actual hours. a. Ideal standards tend to extract higher
b. budgeted output at standard hours. performance levels since they give employees
c. actual output at standard hours. something to live up to.
d. actual output at actual hours. b. Currently attainable standards may encourage
operating inefficiencies.
7. At the end of a period, a significant material c. Currently attainable standards discourage
quantity variance should be employees from achieving their full performance
a. closed to Cost of Goods Sold. potential.
b. allocated among Raw Material, Work in Process, d. Ideal standards demand maximum efficiency
Finished Goods, and Cost of Goods Sold. which may leave workers frustrated, thus causing
c. allocated among Work in Process, Finished a decline in performance.
Goods, and Cost of Goods Sold. e. None of the above statements is true
d. carried forward as a balance sheet account to
the next period. 15. Which of the following statements regarding
standard cost systems is true?
8. An unfavorable price variance for direct materials a. Favorable variances are not necessarily good
might indicate: variances.
a. that the purchasing manager purchased in b. Managers will investigate all variances from
smaller quantities due to a change to just-in- standard.
time inventory methods c. The production supervisor is generally
b. congestion due to scheduling problems responsible for material price variances.
c. that the purchasing manager skillfully d. Standard costs cannot be used for planning
negotiated a better purchase price purposes since costs normally change in the
d. that the market had an unexpected oversupply future.
of those materials e. None of the above statements is true

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16. The sales price variance is created by a difference 22. The standard cost of one unit of product includes 2
between hours of direct labor at P15.00 per hour. The
a. actual and standard contribution margin. company's labor rate variance was P275, favorable.
b. actual and expected sales price. The efficiency variance was P105, unfavorable.
c. expected and standard net income. Three-hundred and eighty units were produced.
d. actual and expected sales volume. What were the actual labor hours?
a. 774 c. 753
17. The flexible budget of factory overhead at 80% b. 760 d. 767
capacity is P37,600 and at 50% capacity is P28,000.
What will be the flexible budget of factory overhead 23. Eastern Co. has total budgeted fixed costs of
at 85% capacity? P150,000. Actual production of 39,000 units resulted
a. P37,400 c. P39,950 in a P6,000 favorable volume variance. What normal
b. P39,200 d. P47,600 capacity was used to determine the fixed overhead
rate?
18. Hansen Company is a chemical manufacturer that a. 33,000
supplies various products to industrial users. The b. 37,500
company plans to introduce a new chemical c. 40,560
solution called Bysap, for which it needs to d. 40,625
develop a standard product cost. The following e. Cannot be determined without further
labor information is available on the production of information.
Bysap.
• The product, which is bottled in 10-liter 24. Central Winery manufactured two products, A and B.
containers, is primarily a mixture of Byclyn, Estimated demand for product A was 10,000 bottles
Salex, and Protex. and for product B was 30,000 bottles. The estimated
• The finished product is highly unstable, and one sales price per bottle for A was P6.00 and for B was
10-liter batch out of six is rejected at final P8.00. Actual demand for product A was 8,000
inspection. Rejected batches have no commercial bottles and for product B was 33,000 bottles. The
value and are thrown out. actual price per bottle for A was P6.20 and for B was
• It takes a worker 35 minutes to process one 10- P7.70. What amount would be the total selling price
liter batch of Bysap. Employees work eight hours variance for Central Winery?
a day, including one hour per day for rest breaks a. P3,700 unfavorable. c. P3,700 favorable.
and cleanups. b. P8,300 unfavorable. d. P14,100 favorable.
What is the standard labor time to produce one 10-
liter batch of Bysap? 25. The following information is available for the Gabriel
A. 35 minutes. Products Company for the month of July:
B. 40 minutes.. Static Actual
C. 48 minutes. Budget
D. 45 minutes Units 5,000 5,100
Sales revenue P60,000 P58,650
19. ALPHA Co. uses a standard cost system. Direct Variable manufacturing costs P15,000 P16,320
materials statistics for the month of May are Fixed manufacturing costs P18,000 P17,000
summarized below: Variable marketing and
Standard unit price P90.00 administrative expense P10,000 P10,500
Actual units purchased 40,000 Fixed marketing and
Standard units allowed for actual 36,250 administrative expense P12,000 P11,000
production The total sales-volume variance for the month of
Materials price variance- favorable P6,000 July would be
What was the actual purchase price per unit? a. P2,550 U c. P700 F
A. P75.00 D. P90.15 b. P1,350 U d. P100 F
B. P85.89 E. P89.85
C. P88.50 Use the following information for the next five
questions.
20. During April, 80,000 units were produced. The Navarro, Inc. evaluates manufacturing overhead in its
standard quantity of material allowed per unit was factory by using variance analysis. The following
2 pounds at a standard cost of P5 per pound. If information applies to the month of July:
there was a favorable usage variance of P40,000 ACTUAL BUDGETED
for April, the actual quantity of materials used Number of units produced 19,000 20,000
must have been Variable overhead costs P4,100 P2 per DLH
A. 168,000 pounds Fixed overhead costs P22,000 P20,000
B. 152,000 pounds Direct labor hours 2,100 0.1 hour per unit
C. 84,000 pounds
D. 76,000 pounds 26. The controllable variance amounts to
a. P2,500 unfavorable
21. JS Company produce 500 units with a P50 b. P1,000 unfavorable
unfavorable labor rate variance. The labor use c. P2,300 unfavorable
variance was P180 favorable. Actual labor cost was d. P2,000 unfavorable
P8,870. The standard wage rate was P9. Actual
hours were 27. Using the three-way variance analysis, the spending
a. 520 c. 1,000 variance amounts to
b. 980 d. 1,020 a. P100 favorable
b. P1,900 unfavorable

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EXCEL PROFESSIONAL SERVICES, INC.

c. P2,000 unfavorable c. P2,000 unfavorable

d. P2,100 unfavorable d. P1,000 unfavorable

28. The efficiency variance amounts to 30. The fixed overhead efficiency variance is:
a. P400 unfavorable a. P400 unfavorable
b. P1,900 unfavorable b. PP2,000 unfavorable
c. P400 favorable c. P400 favorable
d. P1,000 unfavorable d. 0

29. The non-controllable variance is

a. P2,300 unfavorable
b. P400 unfavorable

“There is only one thing that makes a dream impossible to achieve: the fear of failure.” - Paulo Coelho

– end -

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