Lectures-Standard Costing
Standard Costing- is a costing method that uses standard costs. It is designed to determine the cost
of a product under existing conditions. At the end of the accounting period, the standard cost is
compared to the actual cost and any variance between the two is/are investigated to enable the
management to take necessary corrective actions.
Standard costing can be used for:
1. Planning
2. Cost control through exception reporting
3. Pricing decisions
4. Costing of inventories
5. Preparation of cost reports
6. Motivation and performance
Standard Cost is a pre-determined cost of material, labor, and overhead for a prescribed set of
working conditions. It represents the target cost for a product or service and is useful for planning
and controlling within an organization.
Establishment of Standard Cost
Manufacturing Companies that use standard costing system usually establish the
“standards” for manufacturing costs at the beginning of the accounting period after the firm wide
financial budgets have been approved by senior management. These standards are determined
based on collaborative efforts of the production, sales, purchasing, engineering, finance, and other
departments taking into consideration the firm’s historical experience, expected future demands,
and other industry factors. The standard costs are compared to actual costs at the end of the period
and any variances are reviewed and investigated by management.
The common standards for manufacturing costs:
1. Direct Materials
a. Standard materials (purchase) price- is an expected price of each unit of direct materials
purchased. Standard price is usually based on recent purchases and is usually set by
purchasing department.
b. Standard materials usage- is an estimated quantity of direct materials required to
produce one unit of finished product. It is usually developed through engineering
estimates and based on historical data.
c. Standard direct materials- the estimated total cost of direct materials per unit of
output.
2. Direct labor
a. Standard Labor rate- is an estimated hourly labor the rate that will be incurred to
produce one unit of finished product. The standard labor rate is usually the hourly wages
paid to workers with various skills levels.
b. Standard labor efficiency (usage) - represents the estimated direct labor hours required
to produce one unit of finished product. Labor efficiency standard is difficult to set
because individual productivity and performance varies per worker as well as the type of
work they perform. Engineering estimates are often used and standard is adjusted
periodically.
c. Standard direct labor- the estimated total cost of direct labor per unit of output.
3. Variable Factory Overhead
a. Variable overhead rate standard- the estimated variable overhead cost that will be
incurred per unit of output and is usually expressed per direct labor hour but other
application base may also be used. It is calculated by dividing the estimated total
variable overhead costs by the estimated total direct labor hours or machine hours or
other selected base.
b. Standard variable overhead application base- the volume of activity to allocate variable
overhead such as direct labor hours or machine hours for the period.
c. Budgeted variable overhead cost- the estimated total variable factory overhead cost for
a period.
4. Fixed factory overhead
a. Standard fixed overhead rate- the estimated cost of fixed overhead per unit of output. It
is determined by dividing the estimated total fixed overhead costs by the total budgeted
production for the period.
b. Standard fixed overhead application base- the volume of activity to allocate fixed
overhead.
c. Budgeted fixed overhead cost-the estimated total fixed factory overhead.
Summary
Product Costs Price rate standard Usage/efficiency standard Standard cost
DM Std. material price X standard material usage = Direct materials standard
DL Std. labor rate X standard labor usage/efficiency= Direct labor standard
Variable FOH Std. variable OH rate X standard variable OH [Link] = Budgeted variable OH
cost
Fixed FOH Std. fixed OH rate X standard fixed OH appl. Base = Budgeted fixed OH cost
Accumulation of Actual Costs
A manufacturing company that uses standard costing shall nevertheless record and
accumulate actual costs. At the end of each month or every reporting period, standard costs are
compared with actual costs to determine any variances. This will enable the management to identify
the causes of the variances. Therefore, a standard costing should be used in conjunction with other
systems of cost accumulation like process costing and job order costing.
Computation and Analysis of Variances
Under the standard costing, product costs are determined based on standard costs of
materials, labor, and overhead. Hence, inventories and cost of goods sold are reflected at standard
amounts instead of actual costs. As a result, differences between actual costs and standard costs
exist which are known as variances. Variances are analyzed and evaluated to provide management
with useful information for measuring efficiency, controlling costs and improving performance, and
other decision making functions.
Variances are analyzed as either favorable or unfavorable:
1. If actual costs are less than standard costs, the variance is considered favorable. A favorable
variance indicates that, if everything else stays constant, the actual profit will likely exceed
the expected profit.
2. If actual costs are greater than standard costs, the variance is considered unfavorable. An
unfavorable variance indicates that, if everything else stays constant, the actual profit will be
less than expected profit.
TYPES OF VARIANCES
1. Materials
a. Material price variance (MPV)
b. Material Quantity Variance (MQV
2. Labor
a. Labor Rate Variance( LRV)
b. Labor Efficiency variance( LEV)
3. Factory Overhead
a. Controllable Variance( CV)
b. Volume Variance ( VV)
DIRECT MATERIALS VARIANCE
1. Direct Material Variance- indicates whether the amount paid for material used was less than
or more than standard price. It is calculated at the time of purchase; hence it is also called
material price variance. If the materials price variance is calculated at the time materials are
issued to production, it is called material usage price variance. Between the two situations, it
is preferable to calculate the variance at the time materials are purchased.
Formula
MPV= (Standard Price-Actual Price) X Actual Quantity Purchased
2. Material Quantity Variance- indicates whether the actual quantity used was less than or
more than the standard quantity allowed for the actual output. The difference in quantity
multiplied by the standard price per unit of material.
Formula
MQV= (Standard Quantity Allowed-Actual Quantity Used)X Standard Price
APXAQ
SPXAQ Material Price Variance
SPXSQ Materials Quantity Variance
Total direct Materials variance
DIRECT LABOR VARIANCE
1. Labor Rate Variance-indicates whether the actual amount paid for the labor was less
than or more than the standard rate. It is computed by multiplying the difference in
labor rate by the actual time used.
Formula
LRV= (Standard Rate- Actual Rate) X Actual Hours
2. Labor Efficiency Variance (also known as labor time variance or labor usage variance)
results from using more or less labor time than the standard time allowed for actual
production. It is computed by multiplying the difference in time by the standard labor
rate per time.
Formula
LEV= (Standard Hours Allowed-Actual Hours) X Standard Rate
ARXAH
SRXAH Labor rate variance
SRX SH Labor Efficiency Variance
Total direct labor variance
OVERHEAD VARIANCES- can be analyzed in four ways as follows
1. One -Variance Analysis is used when manufacturing overhead costs are not segregated
between fixed and variable component. This approach calculates only one variance called
total overhead variance which is the difference between total actual overhead and total
overhead applied to production. The amount of overhead applied is determined by
multiplying the combined overhead rate by the standard quantity allowed for the actual
production achieved
Formula
Total overhead variance=Actual Factory Overhead (AFOH)-Standard Factory Overhead for
actual output (SFOH)
TOV= Actual Overhead-Applied Overhead
TOH= (Actual Variable OH + Actual Fixed OH)-(Standard OH Rate X Standard Quantity)
2. Two-Variance Analysis- this approach modifies the one-variance model by inserting a middle
column which represents the budgeted total overhead based on standard hours. This
amount represents total budgeted variable overhead at standard hours plus budgeted fixed
overhead which remains constant at all activity levels in the relevant range. The two-
variance approach splits the total overhead variance into controllable variance and volume
variance.
Formula
Actual Factory Overhead (AFOH)
Budget Allowed on Standard Hours (BASH) Controllable Variance
Standard Factory Overhead (SFOH) Volume Variance
Total Overhead Variance
The controllable variance (also known as budget variance) is the difference between the
total actual overhead incurred and the budget allowed on standard hours for actual
production. It consists partly of the difference between the actual and standard variable
overhead and partly of the difference between the actual and budgeted fixed overhead.
CV= Actual Overhead- Budgeted OH for standard hours
CV (Actual Variable OH+ Actual Fixed OH) - Budgeted OH for standard hours
The volume variance is the difference between the budget allowed on standard hours and
the total standard factory overhead (applied overhead)
VV= Budgeted OH for Standard Hours- Applied Overhead
VV=Budgeted OH for Standard Hours- (Standard OH Rate X Standard Quantity)
3. Three –Variance Analysis- this approach modifies the two-variance model by inserting
budgeted total overhead costs based on actual hours. The three-variance approach splits the
controllable (budget) variance into spending variance and efficiency variance.
Formula
Actual factory overhead (AFOH)
Budget allowed on actual hours (BAAH) Spending Variance
Budget allowed on standard hours (BASH) Efficiency variance
Standard factory overhead (SFOH) Volume variance
The spending variance is the difference between the total actual overhead and the total
budgeted overhead at the actual activity level. The spending variance in three-variance
analysis represents the total overhead spending variance, which is the sum of the variable
spending variance and fixed spending variance in four-variance approach.
SV= Actual Overhead- Budgeted OH for Actual Hours
SV= (Actual Variable OH + Actual Fixed OH) – Budgeted OH for Actual Hours
The efficiency variance is equal to the total budgeted overhead at the actual level of activity
minus the total budgeted overhead at the standard level of activity.
EV= Budgeted OH for Actual Hours- Budgeted OH for Standard Hours
VV= Budgeted OH for Standard Hours- Applied Overhead
VV= Budgeted OH for Standard Hours- (Standard OH Rate X Standard Quantity)
The sum of the overhead spending variance and overhead efficiency variance in three
variance analysis is equal to the controllable (budget) variance in two-variance analysis.
Sample Problem
During January 2020, Peter Senen Manufacturing Corp. manufacturer of tables, provided the
following information.
Standard variable cost per unit
Direct materials- 4 pcs of wood at P120 each P480
Direct labor-10 hrs at P60 per hour 600
Variable FOH-10 hrs. at P40 per hour 400
Fixed Factory Overhead at normal capacity P60,000
Annual budget for 1,500 tables or 15,000 hours
Actual
Quantity 2,000 units
Direct materials purchased-10,000 woods at P125 P1,250,000
Direct materials used-8,400 woods at P125 each 1,050,000
Direct labor- 19,000 hours at P62 per hour 1,178,000
Variable factory overhead 798,000
Fixed factory overhead 76,000
Required: Calculate the following:
1. Material price variance based on quantity purchased
2. Material quantity variance
3. Labor rate variance
4. Labor efficiency variance
5. Overhead variance using one- variance approach
6. Overhead variance using two- variance approach
7. Overhead variance using three-variance approach
8. Overhead variance using four-variance analysis
9. Prepare Journal Entries to record variances
Solution:
Direct Materials variance
Actual price P125
Less: Standard price 120
Difference in price P 5
X Actual quantity purchased 10,000
1. Materials price variance-unfavorable P50,000 U
Actual quantity 8,400
Standard quantity 8,000
Difference in quantity 400
X Standard price per wood P120
2. Materials quantity variance –unfavorable P48,000 U
Total direct materials variance P98,000 U
Actual rate P62
Less: Standard rate 60
Difference in rate P 2
X Actual direct labor hours 19,000
3. Labor rate variance-U P38,000
Actual direct labor hours 19,000
Less: Standard hours (2,000 units X 10 hrs.) 20,000 hrs.
Difference in hours (1,000)
X Standard rate per hour P60
4. Labor efficiency variance- favorable (P60,000) F
Total direct labor variance-favorable (P22,000)F
Factory overhead variance
Total at 15,000 hrs. Overhead rate per hour
Fixed P60,000 P4.00
Variable (15,000 hrs. X P40) 600,000 40.00
P660,000 P44.00
5. One-variance analysis
Actual Factory Overhead P798,000+ P76,000) P874,000
Standard Factory overhead (20,000 X P44) 880,000
Total factory overhead variance-favorable (6,000) F
6. Two- variance analysis
Actual factory overhead P874,000
Less: Budget allowed on std. hours
Fixed P60,000
Variable (2,000 X 10 X P40) 800,000 860,000
Controllable variance-Unfavorable P 14,000 U
Budget allowed on std. hours P860,000
Less; Standard overhead (20,000 X P44) 880,000
Volume variance-favorable (P 20,000) F
Total Factory overhead variance-favorable (P 6,000) F
7. Three -variance analysis
Actual factory overhead P874,000
Less: Budget allowed on actual hours
Fixed P60,000
Variable (19,000 X P40) 760,000 820,000
Spending variance-unfavorable P54,000 U
Budget allowed on actual hours P820,000
Budget allowed on standard hours 860,000
Variable efficiency variance-favorable (P40,000) F
Budget allowed on standard hours P860,000
Less: Standard Factory overhead (20,000 X P44) 880,000
Volume variance-favorable (P20,000) F
Total Factory overhead- favorable (P 6,000) F
8. Four -variance analysis
Variable overhead
Actual variable overhead P798,000
Less: Budget variable overhead (19,000 X P40) 760,000
Variable Overhead-Spending variance-unfavorable P38,000 U
Budget variable overhead P760,000
Less: Applied variable overhead (2,000 X 10 hrs. X P40) 800,000
Variable overhead efficiency variance- favorable (P40,000) F
Total Variable overhead variance-favorable (P 2,000) F
Fixed Overhead
Actual fixed overhead P 76,000
Less: Budget fixed overhead at normal capacity 60,000
Fixed Overhead-Spending variance-unfavorable P 16,000 U
Budget fixed overhead at normal capacity P60,000
Less: Applied fixed overhead (2,000 units X 10 hrs. X P4) 80,000
Volume variance-favorable (P20,000) F
Total Fixed Overhead Variance-favorable (P4,000) F
Total Factory Overhead Variance- Favorable (P6,000) F
9. JOURNAL ENTRIES
1. Raw materials inventory (10,000 X P120) P1,200,000
Material price variance 50,000
Accounts Payable (10,000 X P125) P1,250,000
To record the purchase of materials
2. Work in process (8,000 X P120) 960,000
Materials quantity variance 48,000
Raw material inventory (8,400 X P120) 1,008,000
To record the issuance of materials
3. Payroll 1,178,000
Accrued payroll 1,178,000
To record the payroll.
4. Work in process (20,000 X P60) 1,200,000
Labor rate variance 38,000
Labor efficiency variance 60,000
Payroll 1,178,000
To record the distribution of the payroll
5. Factory overhead-variable 798,000
Factory overhead-fixed 76,000
Various accounts 874,000
To record incurrence of actual overhead costs.
6. Work in process ( 20,000 X P40) 800,000
Applied factory overhead-variable 800,000
To record the applied variable overhead
7. Work in process (20,000 X P4) 80,000
Applied factory overhead-fixed 80,000
To record the applied fixed overhead
8. Applied factory overhead-variable 800,000
Variable Overhead spending variance 38,000
Factory overhead-variable 798,000
Variable overhead efficiency variance 40,000
To close the applied variable overhead and to recognize variable overhead
variance
9. Applied factory overhead-fixed 80,000
Fixed overhead spending variance 16,000
Factory overhead –fixed 76,000
Factory overhead volume variance 20,000
To close the applied fixed overhead and to recognize fixed overhead
variance.
