Standard Costing System

Nature of Standard Costing

Standards are very common in all types of business organizations. The use of standard cost is
very effective cost management tool. The objective of setting standards is to measure the
efficiency and to monitor costs by assigning responsibility for deviations from the standards. It
has three basic parts, namely: a predetermined or standard performance level, measure of
actual performance, and a comparison between actual and standard performance.
In standard costing, a company does not need to determine actual unit cost because the
standard cost to produce a unit is the amount charged to the work in process account. The
company gathers the actual cost of production then compares that with the standard cost of
production to determine any deviation from standard. This helps the management determine
whether materials are purchased above or below standard, material usage is above or below
standard quantity set by the management, labor rates are paid above or below the standard and
labor hours utilized are above or below the standard set by the company.
In a standard cost system, all inventories are carried at standard costs. Actual costs are never
entered into an inventory account. At the end of a period, actual costs are compared with
standard costs to determine variances. When the actual price or usage of inputs is greater than
the standard price or usage, unfavorable variance occur. When the opposite occurs, favorable
variances are obtained. In recording variance, unfavorable variances are always debits and
favorable variances are always credits. The total variance is simply the difference between the
actual cost of an input and its budgeted cost.
Advantages of Standard Costing
a. Standard costs provide a very useful tool in measuring the performance of one company and
it helps management in their planning activities.
b. The resulting variances after comparing the actual performance and standard set by the
company provide a means of giving rewards to deserving employees based on performance
evaluation.
c. The use of standard costs helps production managers highlight variances in management by
exception.
d. It is easier to use standard than actual or normal costing because costing of inventories and
cost of sales is simplified.
Journalizing Transactions Under Standard Cost System
Recording purchase of raw materials. If the company uses the standard cost system, the
Raw Materials Inventory account is debited for the standard cost of actual quantity purchased
and credited to Accounts Payable account for the actual price. If there is a price difference
between actual and standard price, the price difference is called Material Purchase Price
Variance. The material price variance is debited if the result is unfavorable, that is, actual price
is greater than standard price. If the result is favorable, meaning, actual price is lesser than
standard price; the material price variance is credited. The following are basic transactions
using standard costing system.
Purchase of raw materials
a) Purchase 1,000 units of Materials X at P20.00 per unit. The standard price is P18.00 per
unit. The entry to record the purchase is:
Raw Materials Inventory (1,000 x P18) 18,000
Materials purchase price variance 2,000
Accounts Payable (1,000 x P20) 20,000

Issuance of raw materials to production. When materials are issued to production, the
standard quantity required to produce the actual output at standard price is debited to the Work
in Process Inventory account. The Raw Materials Inventory is credited for the standard price of
Actual quantity issued. If actual quantity issued differs from the standard quantity required for
the actual output, the quantity difference at standard price is debited or credited to Material
usage Variance or Materials Quantity Variance.
b.) Assume a unit of product requires 2 units of Material X. During a given period, 400 units
were produced. Actual quantity of material X issued was 820 units.

Work in process (800 x P18) 14,400

Material usage variance (20 x P18) 360
Raw Materials ( 820 x P18) 14,760

Illustration

The following are the standard costs per unit product of Sunshine Manufacturing Company:
Materials, 4 lbs. @ P5 P 20
Direct Labor, ½ hr. @ P60 30
Variable overhead @ P30 per DLH 15
Fixed overhead @ P40 per DLH
(Based on budgeted fixed overhead of P200,000 20
per month and normal monthly activity of 5,000 direct labor hours)

Actual results for October of the current year:

Beginning inventory, FG, 1,500 units @ P85 P127,500
Units produced 10,000
Units sold 10,200
Ending inventory, FG, 1,300 units
Material purchases 42,000 @ P5.20
Materials issued to production, 41,000
Direct labor, 4,800 hrs. @P58
Variable overhead 145,000
Fixed overhead 180,000

Required: Give all the entries to record the transactions for the month of October.

Journal entries:
Date Particulars Debit Credit
(1) Materials (42,000 x 5) 210,000
Materials price variance (42,000 x .20) 8,400
Accounts Payable (42,000 x 5.20) 218,400
Purchases of raw materials on account.
MPV= (AP-SP) x Actual Quantity=(5.20-
5)42,000
(2) Work in process (40,000 x 5) 200,000
Material usage variance (1,000 x 5) 5,000
Materials (41,000 x 5) 205,000
Issuance of materials.
MUV=(AQ-SQ)xSP=(41,000-40,000) x 5=5,000
(3) Factory payroll (4,800 x 58) 278,400
Wages payable (4,800 x 58) 278,400
To record factory payroll.

(4) Work in process (5,000 x 60) 300,000

Labor rate variance (4,800 x 2) 9,600
Labor efficiency variance (200 x60) 12,000
Factory payroll 278,400
Applied direct labor to production.
LRV=(ALR-SLR)xAH=(58-60)4,800=9,600 F
LEV=(AH-SH) x SLR =(4,800-5,000)60=12,000F
(5) Manufacturing overhead 325,000
Various accounts 325,000
Various overhead incurred.

4 Factor Analysis for Factory Overhead

Variances
(6) Work in process (SH x VOH rate) (5,000 x P30) 150,000
Variable overhead spending variance 1,000
Variable overhead efficiency variance 6,000
Manufacturing overhead 145,000
Apply variable overhead to production.
 Actual variable overhead 145,000
AH x variable OH rate (4,800 x 30)/budgetedVO 144,000
Variable overhead spending variance 1,000 UF

Actual hours x variable overhead rate 144,000

SH x variable OH rate (5,000 x 30)/Applied VO 150,000
Variable overhead efficiency variance 6,000 F

Alternatively, variable overhead efficiency is

Computed as: (AH – SH) x 30
(4,800-5,000) x 30 6,000 F

(7) Work in process (SH x FOR) 5,000 x 40 200,000

Fixed OH spending variance (200k-180K) 20,000
Manufacturing Overhead 180,000
To apply fixed overhead to production.

Actual fixed overhead 180,000

Budgeted fixed overhead 200,000
Fixed overhead spending variance 20,000 F

Actual hours x fixed OH rate (4,800 x 20) 200,000

Applied fixed overhead:
SH x fixed OH rate (5,000 x 40) 200,000
Volume variance 0

(8) Finished goods 850,000

Work in process 850,000
To record completion of goods.

(9) Cost of Sales (10,200 x 85) 867,000

Finished Goods 867,000
To record cost of sales.
COS/u=P850,000/10,000 units = P85

*The major purpose of using a standard cost system is to aid management in controlling the
costs of production. Standards enable management to make periodic comparisons of actual
results with standard (or planned) results.
Variance – differences that arise between actual results with standard (or planned) results.
Variance Analysis- a technique used by management to measure performance, correct
inefficiencies, and deal with the “accountability function”.
Direct Materials Variances:
1. Direct material price variance = (AP-SP) x Actual Quantity purchased
2. Direct material efficiency (usage) variance = (AQ-SQ) x SP
Direct Labor Variances:
1. Direct labor rate (price) variance = (ALR- SLR) x AH
2. Direct labor efficiency variance = ( AH-SH) x SLR
Factory Overhead Variances:
1. One-Factor Analysis = AFO – SFO
2. Two-Factor Analysis:
a. Controllable (budget) variance
Actual factory overhead xxx
Less: Budget allowance based on std. hours
Fixed overhead xxx
Variable (std. hrs. x VOR) xxx xxx
Controllable Variance xxx
Note: the manager has some control over the combined spending and efficiency variance.

b. Volume (Capacity or Production) Variance

Budget allowance based on std. hrs. xxx

Less: Std. hrs x Std. OH rate xxx
Volume variance xxx

3. Three-Variance Method

1. Spending variance
AFO xxx
Less: Budget allowance based on actual hours:
Fixed overhead xxx
Variable (AH x VOR) xxx xxx
Spending variance xxx

2. Variable efficiency variance

Budget allowance based on AH xxx
Less: Budget allowance based on std. hours xxx
Variable efficiency variance xxx

3. Volume variance
Budget allowance based on std hrs xxx
Less: Std. hrs. x Factory overhead rate xxx
Volume variance xxx

4. Four-Variance Method

1. Variable overhead spending variance = (AVO – BVO) x AH

2. Variable overhead efficiency variance = ( BVO – Applied VO)
3. Fixed overhead spending variance = Actual Fixed FO – Budgeted Fixed Overhead
4. Volume variance = Budget allowance based on std hrs – (Std hrs. x FOR)