MANAGEMENT SERVICES TRINIDAD/CRUZ

HO04 – Standard Costing and Variance Analysis MAY 2024

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

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 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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 Actual Static Budget d. receiving discounts for purchasing larger than
Production 12,000 units 10,000 units normal quantities
Machine-hours 8,200 hours 8,000 hours
Fixed OH cost P122,000 P120,000 3. Using more highly skilled direct laborers might affect
which of the following variances?
Requirements: a. direct materials usage variance
1. What is the flexible-budget amount? b. direct labor efficiency variance
2. What is the amount of fixed overhead allocated to c. variable manufacturing overhead efficiency
production? variance
3. What is the fixed overhead budget and d. all of the above
production-volume variance?
4. A company would most likely have an unfavorable
PROBLEM NO. 6. labor rate variance and a favorable labor efficiency if
Energy Products produces a gasoline additive, Gas Gain. a. the mix of workers used in the production process
This product increases engine efficiency and improves was more experienced than the normal mix
gasoline mileage by creating a more complete burn in the b. the mix of workers used in the production process
combustion process. Careful controls are required during was less experienced than the normal mix
the production process to ensure that the proper mix of c. workers from another part of the plant were
input chemicals is achieved and that evaporation is used due to an extra heavy production schedule
controlled. If the controls are not effective, there can be d. the purchasing agent acquired a very high
loss of output and efficiency. The standard cost of quality of material that resulted in less spoilage
producing a 500-liter batch of Gas Gain is P13,500. The
standard materials mix and related standard cost of each 5. The primary difference between a fixed (static)
chemical used in a 500-liter batch are as follows: budget and a variable (flexible) budget is that a
Chemical Mix SP Standard Cost fixed budget:
Echol 200 liters P20.00 P4,000 a. cannot be changed after the period begins;
Protex 100 liters 42.50 4,250 while a variable budget can be changed after
Benz 250 liters 15.00 3,750 the period begins
CT-40 50 liters 30.00 1,500 b. is a plan for a single level of sales (or other
600 liters P13,500 measure of activity); while a variable budget
The quantities of chemicals purchased and used during consists of several plans, one for each of
the current production period are shown in the schedule several levels of sales (or other measure of
below. A total of 140 batches of Gas Gain were activity)
manufactured during the current production period. c. includes only fixed costs; while variable budget
Energy Products determines its cost and chemical usage includes only variable costs
variations at the end of each production period. d. is concerned only with future acquisitions of
Chemical Quantity Used fixed assets; while a variable budget is
Echol 26,600 liters concerned with expenses that vary with sales
Protex 12,880 liters
Benz 37,800 liters 6. The term “standard hours allowed” measures
CT-40 7,140 liters a. budgeted output at actual hours.
84,420 liters b. budgeted output at standard hours.
c. actual output at standard hours.
Requirements: d. actual output at actual hours.
Compute the total materials usage variance and then
break down this variance into its mix and yield 7. At the end of a period, a significant material
components. quantity variance should be
a. closed to Cost of Goods Sold.
PROBLEM NO. 7. b. allocated among Raw Material, Work in Process,
Basic Foods expected to sell 30,000 of its fishcharon at Finished Goods, and Cost of Goods Sold.
P300 each. It actually sold 29,000 at P298. Variable c. allocated among Work in Process, Finished
cost per pack is P140. Determine the sales price variance Goods, and Cost of Goods Sold.
and sales volume variance. d. carried forward as a balance sheet account to
the next period.
MULTIPLE CHOICE QUESTIONS
8. An unfavorable price variance for direct materials
1. Which of the following would produce a labor rate might indicate:
variance? a. that the purchasing manager purchased in
a. Poor quality materials causing breakage and work smaller quantities due to a change to just-in-
interruptions. time inventory methods
b. Use of persons with high hourly wage rates in b. congestion due to scheduling problems
tasks that call for low hourly wage rates. c. that the purchasing manager skillfully
c. Excessive number of hours worked in completing negotiated a better purchase price
a job. d. that the market had an unexpected oversupply
d. An unfavorable variable overhead spending of those materials
variance.
9. An unfavorable efficiency variance for direct
2. Which of the following factors would cause an manufacturing labor might indicate that:
unfavorable material quantity variance? a. work was efficiently scheduled
a. using poorly maintained machinery b. machines were not properly maintained
b. using higher quality materials c. budgeted time standards are too lax
c. using more highly skilled workers

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 |-----------------------END--------------------------|
d. more higher skilled workers were scheduled
than planned

10. One of the primary reasons for using cost variances

is:
a. they diagnose the cause of a problem and what
should be done to correct it
b. for superiors to communicate expectations to
lower-level employees
c. to administer appropriate disciplinary action
d. for financial control of operating activities and
understanding why variances arise

11. The fixed overhead cost variance can be further

subdivided into the:
a. price variance and the efficiency variance
b. spending variance and flexible-budget variance
c. production-volume variance and the efficiency
variance
d. flexible-budget variance and the production-
volume variance

12. A favorable fixed overhead spending variance might

indicate that:
a. more capacity was used than planned
b. the denominator level was less than planned
c. the fixed overhead cost-allocation base was not
used efficiently
d. a plant expansion did not proceed as originally
planned

13. The variance least significant for purposes of

controlling costs is the
a. material quantity variance.
b. variable overhead efficiency variance.
c. fixed overhead spending variance.
d. fixed overhead volume variance.

14. Which of the following statements about the

selection of standards is true?
a. Ideal standards tend to extract higher
performance levels since they give employees
something to live up to.
b. Currently attainable standards may encourage
operating inefficiencies.
c. Currently attainable standards discourage
employees from achieving their full performance
potential.
d. Ideal standards demand maximum efficiency
which may leave workers frustrated, thus causing
a decline in performance.
e. None of the above statements is true

15. Which of the following statements regarding

standard cost systems is true?
a. Favorable variances are not necessarily good
variances.
b. Managers will investigate all variances from
standard.
c. The production supervisor is generally
responsible for material price variances.
d. Standard costs cannot be used for planning
purposes since costs normally change in the
future.
e. None of the above statements is true

16. The sales price variance is created by a difference

between
a. actual and standard contribution margin.
b. actual and expected sales price.
c. expected and standard net income.
d. actual and expected sales volume.

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