Cost Variance

Analysis
Definitions
STANDARD COSTS are
predetermined or target unit costs
of production which should be
attained under efficient conditions.
It is the amount and costs of direct
material, direct labor, and factory
overhead required to produce one
unit of finished product.

STANDARD COST SYSTEM is

an accounting system which uses
standard costs rather than actual
costs to account for units as they
flow through the manufacturing
process.
Objectives of Standard Cost
System
1. To help a business operate
more effectively and more
efficiently
2. It helps accomplish
organization goals by
obtaining optimum output
from the inputs available.

Uses of Standard Costing

1. Inventory
2. Planning and controlling costs
3. Measurement of performance
4. Budget preparation
5. Motivating employees
Types of Standards
1. Basic (Fixed) Cost Standards
are standards that are unchanged
year after year.
2. Perfection (Ideal or
Theoretical) Cost Standards
are absolute minimum costs
attainable under operating
conditions.
3. Current Attainable Cost
Standards standard that can
be attained under efficient
operating conditions. It is useful
for employee motivation, product
costing and budgeting.
Setting Direct Materials
Standards
Standard Quantity
- Industrial engineers develop
specification for the kinds
and quantities of materials
used in producing the goods
budgeted.
- Operation schedules list the
materials and quantities
required for the expected
volume of production.
Standard Price
- Information from the operation
schedule and bills of material
established jointly by the
engineering department, the
manufacturing supervisor
and the accountant becomes
the basis for the material
price standard.
Variance Analysis

- Analysis of variances reveals that causes of

deviations between standard and actual costs.
This feedback aids in planning future goals,
controlling costs and evaluating performance.

Variances are the difference between

standard and actual costs. A variance is
considered FAVORABLE if actual costs are
less than the standard costs, and
UNFAVORABLE if actual costs exceed
standard costs.
Setting Labor Standards
Standard Time
- Examination of past payroll and
production records can reveal the
worker-hours used on various jobs and
can help determine standard
performance.
- Time reports from the workers for a
limited period will be a good basis for
the standard.
- If possible, time and motion study
should be the basis for the standard
- The time study seeks to develop time
standards and price rates which the
average operator can meet daily
Standard Labor Rate
- Labor rates should be determined by considering the
current rates as well as the competitive markets.

Methods in determining the labor rate standards:

1. A company may establish a standard rate for the job,
regardless of who performs the job, the rates stays
the same, or
2. A company may establish a rate for an individual
worker and the worker receives this rate regardless of
the work performed.

If labor contracts exist, the wage is relatively fixed and can

be used as standard.
Setting Overhead Standards
- Factory overhead cost standards provide
a means of allocating factory overhead
to cost inventories for pricing decisions
and controlling expenses
- A capacity level is selected as the
volume based or denominator capacity.
- Costs are allocated on a volume related
or non-volume related base.
Commonly used volume-related basis:
a. Machine hours
b. Direct labor-hours
c. Direct labor costs
d. Direct materials costs
e. Units or production

- After expressing volume based on

machine hours, the number of
inspection, or another basis, the factory
incurred at this level is estimated.
Responsibility: the Purchasing Department is usually responsible for
material price variances. However, the Production Department
could be responsible for unfavorable price variance occurring (1)
because of a request for rush order due to poor scheduling or (2)
when they specify certain brand-name materials or materials of
certain grade or quality other those initially included in the bill of
materials.

The possible causes of materials quantity or usage variance are

as follows:
1. Waste and loss of materials in handling and processing
2. Substitution of defective or non-standard materials
3. Spoilage or production of excess scrap because or inexperienced
workers or poor supervision
4. Lack of proper tools or machines
5. Variation yields from materials

Responsibility: Production line supervisors should be held

responsible for materials under their control.
Operating Performance
Analysis of Variances
Evaluation
- The variance or difference between actual costs and standard costs
can be separated and analyzed into two components: Price
Variance and Efficiency Variance

DIRECT MATERIALS VARIANCE ANALYSIS

- Difference between actual costs and standard cost of materials used
is called a material cost variance
- This variance is made up of a price variance and a usage or
quantity or efficiency variance

The possible causes of materials price variance are as follows:

1. Fluctuations in market price of materials
2. Purchasing from distant suppliers, which results in additional
transportation costs
3. Failure to take cash discounts available
4. Purchasing materials of substandard quality or in uneconomical lots
5. Unfavorable purchase terms
FORMULAS:
Materials Price Variance
Actual Price P xx
Less: Standard Price xx
Difference in Price xx
Multiplied by:
Actual Quantity Purchased* xx
Unfavorable (Favorable) P xx

Materials Quantity Variance

Actual Quantity P xx
Less: Standard Quantity xx
Difference in Quantity xx
Multiplied by:
Standard Price xx
Unfavorable (Favorable) P xx

*- actual quantity used if quantity purchased is not known

SAMPLE PROBLEM: MATERIALS VARIANCE
ABC Company has budgeted 50,000 units of output using
50,000 units of raw materials at a total material cost of
P100,000. Actual output was 50,000 units of product that
require 45,000 units at a cost of P2.10 per unit. The direct
material price variance and usage variance are:

Price Usage
a. P 4,500 UF P10,000 F
b. P 4,500 F P10,500 F
c. P 5,000 F P10,500 UF
d. P10,000 F P 4,500 UF
SOLUTION:

Materials Price Variance Material Quantity Variance

Actual Price P 2.10 Actual Quantity 45,000
Standard Price Standard Quantity 50,000
(P100,000 / 50,000 units) 2.00 Difference in Qty 5,000
Difference in Price P 0.10 x Standard Price P2
x Actual Qty Used 45,000 Material Usage
Material Price Variance P10,000 F
Variance P 4,500
U

Answer: a
DIRECT LABOR VARIANCE ANALYSIS
- Labor cost variance is the difference between actual labor cost and
standard labor cost.
- This variance may be analyzed into two components namely: the labor
rate variance and the labor usage or efficiency variance

The possible causes of labor rate variance are as follows:

1. Inexperienced workers hired
2. Change in labor rate particularly peak season that has not been
incorporated in standard rate
3. Use of an employee having a wage classification other than that
assumed when the standard for a job was set
4. Use of a greater number of higher-paid employees in the group than
anticipated.

Responsibility: if production line supervisors have the authority to match

workers and machines to task by hiring the proper grade of labor, line
supervisors should be responsible. They will also be responsible if they
control the wage rate of their labor force. If they do not, the Personnel
Department may be responsible.
The possible causes of labor efficiency variance are as follows:

1. Good or poor training of workers

2. Poor materials or faulty equipment
3. Good or poor supervision and scheduling of work
4. Experience or lack or experience on the job
5. Inefficient equipment
6. Machine breakdown
7. Nonstandard materials being used

Responsibility: Production line supervisors should be held

responsible for labor under their control. The Production
Planning Department or the Purchasing Department should be
held responsible for any labor efficiency variance that results
from the use of non-standard material.
FORMULAS:
Labor Rate Variance
Actual Labor Rate P xx
Less: Standard Labor Rate xx
Difference in Rate xx
Multiplied by:
Actual Hours xx
Unfavorable (Favorable) P xx

Labor Efficiency or Time Variance

Actual Hours xx
Less: Standard Hours xx
Difference in Hours xx
Multiplied by:
Standard Labor Rate P xx
Unfavorable (Favorable) P xx
SAMPLE: DIRECT LABOR RATE VARIANCE

Information on XYZ Co.s direct labor costs for May 2005 is

as
follows:
Standard direct labor hours 35,000
Actual direct labor hours
34,500
Total direct labor payroll
P241,500
Direct labor efficiency variance favorable P 3,200

What is XYZ Co.s direct labor rate variance?

a. P17,250 F c. P21,000 F
c. P20,700 UF d. P21,000 F
SOLUTION:
Actual Hours 34,500 Actual Rate P 7.00
Standard Hours 35,000 Standard Rate 6.40
Difference (500) Difference in Rate P0.60
x Standard Rate ?
x Actual Hours 34,500
Direct Labor Rate
Direct Labor Rate
Efficiency Variance P(3,200)F
Variance P20,700
Thus, P3,200 F / 500 = P 6.4 Std. Rate
U

Actual Rate = P241,500 / 34,500 = P7

Answer: b
SAMPLE PROBLEM: DIRECT LABOR EFFICIENCY
VARIANCE
Information on Ace Companys direct labor cost is as
follows:
Standard direct labor rate P 3.75
Actual direct labor rate P 3.50
Standard direct labor hours 10,000
Actual direct labor hours 11,200

What is the direct labor efficiency variance?

a. P4,200 UF c. P4,500 UF
b. P4,200 F d. P4,500 F
SOLUTION:

Actual Hours 11,200

Standard Hours 10,000
Difference in Hours 1,200
x Standard Rate P 3.75
Direct Labor Efficiency VarianceP4,500 UF

Answer: c
FACTORY OVERHEAD VARIANCE
ANALYSIS
VARIABLE MANUFACTURING OVERHEAD
- Total variance manufacturing overhead variance is the difference
between actual variable overhead and standard variable overhead
allowed on actual output.
- This may be broken down into:
a) Variable overhead spending variance
b) Variable overhead efficiency variance

The possible causes of variable overhead spending variance or

price/controllable variance are as follows:
1. Actual costs, e.g. machine power, materials handling, supplies were
different from those expected because of fluctuations in market prices or
rates
2. Increase in energy costs
3. Waste in using supplies
4. Avoidable machine breakdowns
5. Wrong grade of indirect material and indirect labor
6. Lack of operators or tools

Responsibility: Supervisors of cost centers are responsible because they

have some degree of control over these budget or expense factors.
The possible causes of variable overhead efficiency
variances are as follows:

- This is attributable to efficiency in using the base on which

variable overhead is applied. So that if the basis of the
variable overhead application is direct labor hours, the
causes of the labor efficiency variance will also be the
causes of the variable overhead efficiency variance.

Responsibility: Production line supervisors are responsible

for this variance. This variance shows how much of the
factorys capacity has been consumed or released by off-
standard labor performance. If machine-hours are the
basis for applying factory overhead, the variance measures
the efficiency of machine usage.
FIXED MANUFACTURING OVERHEAD VARIANCE ANALYSIS

- In variance analysis, fixed manufacturing costs are treated

differently from variable manufacturing costs.
- It is usually assumed that fixed costs are unchanged when
volume changes, so the amount budgeted for fixed overhead
is the same in both the master and flexible budgets.
- This is consistent with the variable costing method of product
costing.
- There are no input-output-relationships for fixed overhead.
- The difference between the actual fixed overhead and the
budgeted fixed overhead at normal capacity falls under the
category of a price variance (also called spending or
budget variance)
- The difference between the budgeted fixed overhead and
applied fixed overhead represents the volume or capacity
variance
The possible causes of capacity or volume variance are
as follows:

1. Poor production scheduling

2. Unusual machine breakdowns
3. Storms or strikes
4. Fluctuations over time
5. Decrease in customer demand
6. Excess plant capacity
7. Shortage of skilled workers
COMBINED MANUFACTURING OVERHEAD (Variable and
Fixed) VARIANCE ANALYSIS:

TWO-WAY VARIANCE METHOD

Controllable Variance
Actual Factory Overhead (AFOH) Pxx
Less: Budget allowed based on Std. Hrs. (BASH)
Fixed (at normal capacity) Pxx
Variable (Std. Hrs.* x Variable
Overhead Rate) xx xx
Unfavorable (Favorable) Pxx

Capacity or Volume Variance

Budget allowed based on Standard Hours (BASH) Pxx
Less: Standard hours x Standard Overhead Rate (SHSR) xx
Unfavorable (Favorable) Pxx

Total Manufacturing Overhead Variance

Pxx
* Standard Hours = Equivalent Production or Allowed hours based on actual production x Standard h
 THREE-WAY VARIANCE METHOD
Spending Variance
Actual Factory Overhead (AFOH) P xx
Less: Budget allowed on Actual hours (BAAH)
Fixed (at normal capacity) Pxx
Variable (Actual Hrs. x Variable Overhead Rate) xx xx
Unfavorable (Favorable) P xx

Variable Efficiency Variance

Budget allowed on Actual Hours (BAAH) P xx
Less: Budget allowed on Standard hours (BASH)
Fixed (at normal capacity) Pxx
Variable (Std. Hrs. x Variable Overhead Rate) xx xx
Unfavorable (Favorable) P xx

Volume Variance
Budget allowed on Standard Hours (BASH) P xx
Less: Standard hours x Standard Overhead Rate (SHSR) xx
Unfavorable (Favorable) P xx

Total Overhead Variance P xx

 FOUR-WAY VARIANCE METHOD

SPENDING VARIANCE
Actual Factory Overhead (AFOH) P xx
Less: Budget Allowed based on Actual Hours (BAAH) xx
Unfavorable (Favorable) P xx

VARIABLE EFFICIENCY VARIANCE

Budget Allowed based on Actual Hours (BAAH) P xx
Less: Budget Allowed based on Standard Hours (BASH) xx
Unfavorable (Favorable) P xx

FIXED EFFICIENCY or EFFECTIVENESS VARIANCE

Standard Hours xx
Less: Actual Hours xx
Unfavorable (Favorable) xx
Multiplied by: Fixed Overhead Rate xx
Unfavorable (Favorable) P xx

IDLE CAPACITY VARIANCE

Normal Capacity Hours xx
Less: Actual Hours xx
Unfavorable (Favorable) xx
Multiplied by: Fixed Overhead Rate xx
Unfavorable (Favorable) P xx
SAMPLE PROBLEM: FACTORY OVERHEAD
VARIANCES
The STD Household Company has established standard costs for the cabinet department, in
which one size of MX cabinet is made. The standard costs of producing one of these MX
cabinets are shown below:
Standard Cost Card MX Cabinet
Direct Material: Lumber 50 board feet at P4 P200
Direct Labor: 8 hours at P10 80
Overhead Costs: Variable 8 hours at P5 40
Fixed 8 hours at P3 24
Total Standard Unit Cost P344

During June 2004, 500 of these cabinets were produced. The cost of operations during the
month is shown below. There are no work-in-process at the beginning and end of the
month.

Direct material purchased: 30,000 board feet at P4.10 P123,000

Direct materials used: 24,000 board feet
Direct labor: 4,200 hours at P9.50 39,900
Overhead costs: Variable costs 22,000
Fixed costs 11,000

The budgeted overhead for the cabinet department based on normal monthly activity of
4,500 hours is P36,000 of which P22,50 is variable and P13,500 is fixed overhead.

REQUIRED: Compute for the Factory Overhead Variance using: (a) Two-way analysis, (b) Three-way
analysis and (c) Four-way analysis
Thank you!