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Review Materials Management Services

Standard Costing
Standard Costing is a budgeting control technique with 3 components: (1) a standard, predetermined
performance level; (2) a measure of actual performance; and (3) a measure of the variance, the difference,
between the standard and the actual. This is generally best suited to organizations with repetitive activities. It is
probably most relevant to manufacturing organizations with repetitive production processes. Standard costing
cannot be applied easily to non-repetitive activities because there is no clear basis for observing and recording
operations. It is difficult to determine a clear standard.
Standard Costing may be defined basically as a technique of cost accounting which compares the
standard cost of each product or service with the actual cost, to determine the efficiency of the operation, so
that any remedial action may be taken immediately.
A standard cost is a predetermined cost of manufacturing, servicing, or marketing an item during
a given future period. It is based on current and projected future conditions. The norm is also dependent on
quantitative and qualitative measurements. Standards may be based on engineering studies looking at time and
motion. The formulated standard must be accurate and useful for control purposes. Standards are set at the
beginning of the period. They may be in physical and peso terms. Standards assist in the measurement of both
effectiveness and efficiency. Examples: sales quotas, standard costs (e.g., material price, wage rate), and
standard volume. Variances are not independent, so a favorable variance in one responsibility area may result in
an unfavorable one in other segments of the business.
Variance is the difference between a budgeted or standard amount and the actual amount during a
given period. Variance Analysis is defined to be an analysis of the cost variances into its component parts and
the explanation of the same. It is that part of the process of control which involves the calculation of a variance
and interpretation of results for identifying the causes thereof and also for pinpointing responsibility. Variances
are normally calculated for all the cost components such as Materials, Labor and Overheads. Variances are also
calculated for Revenues, i.e., Sales and also for Net profits (Sales - Costs).
Variance analysis compares standard to actual performance. It could be done by division,
department, program, product, territory, or any other responsibility unit. When more than one department
is used in a production process, individual standards should be developed for each department in order to assign
accountability to department managers. Variances may be as detailed as necessary, considering the cost/benefit
relationship. Evaluation of variances may be done yearly, quarterly, monthly, daily, or hourly, depending on the
importance of identifying a problem quickly. Because actual figures (e.g., hours spent) are not known until the
end of the period, variances can be determined only at this time. A material variance requires notifying the
person responsible and taking corrective action. Insignificant variances need not be looked into further unless
they recur repeatedly and/or reflect potential difficulty. Generally, a variance should be investigated when the
inquiry is anticipated to result in corrective action that will reduce costs by an amount exceeding the cost of the
inquiry.

STEPS IN STANDARD COSTING

Standard costing involves:


The setting of standards
Ascertaining actual results
Comparing standards and actual costs to determine the variances
Investigating the variances and taking appropriate action where necessary.
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ADVANTAGES OF STANDARDS AND VARIANCES


1.
2.
3.
4.
5.
6.
7.
8.

9.
10.
11.
12.

Aid in inventory costing


Assist in decision making
Sell price formulation based on what costs should be
Aid in coordinating by having all departments focus on common goals
Set and evaluate divisional objectives
Allow cost control and performance evaluation by comparing actual to budgeted figures. The objective
of cost control is to produce an item at the lowest possible cost according to predetermined quality
standards.
Highlight problem areas through the management by exception principle
Pinpoint responsibility for undesirable performance so that corrective action may be taken. Variances in
product activity (cost, quality, quantity) are typically the production managers responsibility. Variances
in sales orders and market share are often the responsibility of the marketing manager. Variances in
prices and methods of deliveries are the responsibility of purchasing personnel. Variances in profit
usually relate to overall operations. Variances in return on investment relate to asset utilization.
Motivate employees to accomplish predetermined goals
Facilitate communication within the organization, such as between top management and supervisors
Assist in planning by forecasting needs (e.g., cash requirements)
Establish bid prices on contracts

STANDARD SETTING
Standards may be set by engineers, production managers, purchasing managers, and personnel
administrators. Depending on the nature of the cost item, computerized models can be used to corroborate what
the standard costs should be. Standards may be established through test runs or mathematical and technological
analysis. Standards are based on the particular situation being appraised. Capacity may be expressed in units,
weight, size, peso, selling price, and direct labor hours. It may be expressed in different time periods (e.g.,
weekly, monthly, yearly).

TYPES OF STANDARDS
1. Basic. These are not changed from period to period and are used in the same way as an index number.
They form the basis to which later period performance is compared. What is unrealistic about basic
standards is that no consideration is given to a change in the environment.
2. Maximum efficiency. These are perfect standards assuming ideal, optimal conditions, allowing for no
losses of any kind, even those considered unavoidable. They will always result in unfavorable variances.
Realistically, certain inefficiencies will occur, such as materials will not always arrive at workstations on
time and tools will break. Ideal standards cannot be used in forecasting and planning because they do
not provide for normal inefficiencies.
3. Currently attainable (practical).These refer to the volume of output possible if a facility operated
continuously, but after allowing for normal and unavoidable losses such as vacations, holidays, and
repairs. Currently attainable standards are based on efficient activity. They are possible but difficult to
achieve. Considered are normal occurrences such as anticipated machinery failure and normal materials
shortage. Practical standards should be set high enough to motivate employees and low enough to
permit normal interruptions. Besides pointing to abnormal deviations in costs, practical standards may
be used in forecasting cash flows and in planning inventory. Attainable standards typically are used in
practice.
4. Expected. These are expected figures based on foreseeable operating conditions and costs. They come
very close to actual figures.

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Standards should be set at a realistic level. Those affected by the standards should participate in
formalizing them so there will be internalization of goals. When reasonable standards exist, employees typically
become cost conscious and try to accomplish the best results at the least cost. Standards that are too tight will
discourage employee performance. Standards that are too loose will result in inefficient operations. If employees
receive bonuses for exceeding normal standards, the standards may be even more effective as motivation tools.
A standard is not an absolute and precise figure. Realistically, a standard constitutes a range of
possible acceptable results. Thus, variances can and do occur within a normal upper-lower limit. In determining
tolerance limits, relative magnitudes are more important than absolute values. For instance, if the standard cost
for an activity is P 100,000, a plus or minus range of P 4,000 may be tolerable.

Direct Materials Standards and Variance Analysis:


Standard price per unit of direct materials is the price that should be paid for a single unit of materials,
including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net of any
discounts allowed.
I.
Direct Materials Price Variance:
Direct materials price variance is the difference between the actual purchase price and standard
purchase price of materials. Direct materials price variance is calculated either at the time of purchase of
direct materials or at the time when the direct materials are used.
II.
Direct Materials Quantity Variance:
Direct materials quantity variance or Direct materials usage variance measures the difference
between the quantity of materials used in production and the quantity that should have been used
according to the standard that has been set. Although the variance is concerned with the physical usage
of materials, it is generally stated in dollar terms to help gauge its importance.
III.
Direct Materials mix and Yield Variance:
Basically, the establishment of standard product cost requires the determination of price and
quantity standards. In many industries, particularly of the process type, materials mix and materials
yield play significant parts in the final product cost, in cost reduction, and in profit improvement.
Materials mix variance formula
(Actual quantities at individual standard materials costs) (Actual quantities at weighted average of
standard materials costs)
Materials yield variance formula
(Actual quantities at weighted average of standard materials costs) (Actual output quantity at standard
materials cost)

Direct Labor Standards and Variance Analysis:


Direct labor price and quantity standards are usually expressed in terms of a labor rate and labor hours.
The standard rate per hour for direct labor includes not only wages earned but also fringe benefit and other labor
costs.
I.
Direct Labor Rate | Price Variance:
Direct Labor price variance is also termed as direct labor rate variance. This variance measures
any deviation from standard in the average hourly rate paid to direct labor workers.
II.
Direct Labor Efficiency | Usage | Quantity Variance:
The quantity variance for direct labor is generally called direct labor efficiency variance or
direct labor usage variance.
III.
Direct labor yield variance formula:
(Standard hours allowed for expected output Standard labor rate) (Standard hours allowed for actual
output Standard labor rate)

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Manufacturing Overhead Standards and Variance Analysis:


Procedures for the establishing and using standard factory overhead rates are similar to the methods of
dealing with the estimated direct and indirect factory overhead and its application to jobs and products. Jobs or
processes are charged with cost on the basis of standard hours allowed multiplied by the standard factory over
head rate. The standard overhead rate or predetermined overhead rate is discussed in detail at our job order
costing system page. The standard hours allowed figure is determined by multiplying the labor hours required to
produce one unit (the standard labor hours per unit) times the actual number of units produced during the period.
The units produced are the equivalent units of production for the departmental factory overhead cost being
analyzed. At the end of the month, overhead actually incurred is compared with the expenses charged into
process using the standard factory overhead rate. The difference between these figures is called the overall or
net factory overhead variance. Overall or net factory overhead variance needs further analysis to reveal
detailed causes for the variance and to guide management toward remedial action. This analysis may be made by
using (1) the two variance method, (2) the three variance method, or (3) the four variance method.
The two variance method: When an overall or net factory overhead variance is further analyzed by
using two variance approach, the following two variances are calculated: (1) Controllable variance; and (2)
Volume variance.
Factory overhead controllable variance formula:
(Actual factory overhead) (Budgeted allowance based on standard hours allowed*)
Factory overhead volume variance:
(Budgeted allowance based on standard hours allowed*) (Factory overhead applied or charged
to production**)
The three variance method: When an overall or net factory overhead variance is further analyzed by
using three variance approach, the following three variances are calculated: (1) Spending variance; (2) Idle
capacity variance; and (3) Efficiency variance.
Factory overhead spending variance:
(Actual factory overhead) (Budgeted allowance based on actual hours worked***)
Factory overhead idle capacity variance formula:
(Budgeted allowance based on actual hours worked***) (Actual hours worked Standard
overhead rate)
Factory overhead efficiency variance formula:
(Actual hours worked Standard overhead rate) (Standard hours allowed for expected output
Standard overhead rate)
The four variance method: When an overall or net factory overhead variance is further analyzed by
using four variance approach, the following four variances are calculated: (1) Spending variance; (2) Variable
efficiency variance; (3) Fixed efficiency variance; and (4) Idle capacity variance.
Factory overhead spending variance:
(Actual factory overhead) (Budgeted allowance based on actual hours worked***)
Factory overhead idle capacity variance formula:
(Budgeted allowance based on actual hours worked***) (Actual hours worked Standard
overhead rate)
Variable overhead efficiency variance formula:
(Actual hours worked Standard variable overhead rate) (Standard hours allowed Standard
variable overhead rate)
Fixed overhead efficiency variance formula:
(Actual hours worked Fixed overhead rate) (Standard hours allowed Fixed overhead rate)
* Fixed overhead budgeted + Standard hours allowed Standard variable overhead rate
** Standard hours allowed for actual production Standard overhead rate
***Fixed overhead budgeted + Actual hours worked Standard variable overhead rate
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VARIANCE ANALYSIS ILLUSTRATION


To illustrate how cost variance analysis works, assume you are the plant manager for Bases, Inc., a
company that makes a set of soft bases for playing baseball in gymnasiums. The budget assumes 150,000 sets of
bases will be produced annually. The following standard cost per set of bases was developed:
Quantity per set
Cost
Cost per set
Direct materials
4.5 feet
$1.10
$4.95
Direct Labor
.5 hour
$9 per hour
4.50
Manufacturing Overhead
.5 hour
$1.30 per hour
.65
Total Cost per Unit
$10.10

The predetermined overhead rate of $1.30 will result in $0.65 of overhead being allocated to each set of
bases produced. (It is calculated using .5 direct labor hours per set times $1.30 per hour.)
Bases, Inc. Manufacturing Overhead Budget 20X1
Production in Units 150,000
Direct Labor Hours per Unit = .5
Direct Labor Hours = 75,000 ***
Cost per Direct Labor Hour Total Cost Monthly Cost
Variable Costs
Indirect Materials
$0.02
$ 1,500 *
Indirect Labor
.40
30,000 *
Maintenance
.30
22,500 *
Total Variable Costs
$0.72
54,000 *
Fixed Cost
Depreciation, Machinery
6,300 $525 **
Building Rent
12,000 1,000 **
Supervisor's Salary
25,200 2,100 **
Total Fixed Costs
0.58
43,500 $ 3,625 **
Total Manufacturing Overhead (1)
$1.30
$97,500
Budgeted Direct Labor Hours (2)
75,000
Predetermined (standard) Overhead Rate (1) (2)
$1.30
The overhead costs per direct labor hour are:
Variable Costs ($54,000/75,000 hours)
Fixed Costs ($43,500/75,000 hours)
Total Overhead Cost per Direct Labor Hour

$0.72
0.58
$1.30

For the month of October, the company produced 13,300 sets of bases. The following information was
taken from the October financial report.
Direct Materials Purchased and Used (60,000 feet)
$ 63,000
Direct Labor Hours (6,500 hours)
63,375
Overhead
Variable
$5,330
Fixed
3,800
Total Overhead
9,130
Total Actual Product Cost
135,505
Total Standard Product cost (13,300 $10.10)
134,330
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Unfavorable Variance

$ 1,175

In order to understand the $1,175 unfavorable monthly variance, it must be analyzed by its component
parts: direct materials variances, direct labor variances, and overhead variances. Each of these variances can
further be broken down into a price (rate) variance and a quantity (usage or efficiency) variance. A general
template that can be used for direct materials variances, direct labor variances, and variable overhead variances
uses three amounts actual, flexible budget, and standard as a basis for calculating the variances.

The price variance is favorable if actual costs are less than flexible budget costs. The quantity variance
is favorable if flexible budget costs are less than standard costs. The total variance is favorable if the actual costs
are less than standard costs.

Direct Materials Variances


The total direct materials variance is $2,835 favorable and consists of a $3,000 favorable price variance
and a $165 unfavorable quantity variance.

Actual costs of $63,000 are less than flexible budget costs of $66,000, so the materials price variance is
$3,000 favorable. The variance can also be thought of on a price per unit basis. The actual costs of $63,000 were
for 60,000 feet of direct material, so the actual price per foot is $1.05 ($63,000 60,000). The original budget
was for a direct materials cost of $1.10 per foot, so it was expected that 60,000 feet of material would cost
$66,000. The direct materials actually cost less than budget by $0.05 per foot ($1.10 budget versus $1.05
actual), so the variance is favorable. The direct materials quantity variance of $165 unfavorable means this
company used more direct materials than planned because flexible budget costs of $66,000 are higher than the
standard costs of $65,825. To produce 13,300 sets of bases, the company expected a cost of $4.95 per set (4.5
feet of material at $1.10 per foot), for a total cost of $65,835. This can also be analyzed by identifying the total
feet of material it should have taken to produce 13,300 sets of bases and multiplying by the cost per foot of
material (13,300 sets 4.5 feet per unit = 59,850 feet of direct materials $1.10 per foot = $65,835). It actually
used 60,000 feet, which prices out at an expected $1.10 per foot to be $66,000. The total direct materials
variance is calculated by adding the price and quantity variances together or by comparing actual cost of direct
materials with the standard cost of producing 13,300 sets of bases.
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Another way of computing the direct materials variance is using formulas.

Using the formulas to calculate the variances would work like this:
Direct materials price variance:
$3,000 F = [(60,000 $1.05) (60,000 $1.10)]

or

60,000($1.05 - 1.10)

$3,000F = $63,000 - $66,000

or

60,000 $0.05

Direct materials quantity variance:


$165 U = [(60,000 $1.10) - ((13,300 4.5) $1.10)] or

$1.10(60,000 - (13,300 4.5))

($165 U = ($66,000 - (59,850 $1.10))

or

$1.10(60,000 - 59,850)

$165 U = $66,000 - 65,835

or

$1.10 150

Once the variances are calculated, management completes the analysis by obtaining explanations for
why the variances occurred. For example, a question raised is Why did materials cost less than planned? As an
answer, management may learn there was a price decrease, or the direct materials were acquired from another
source, or lower quality materials were obtained. The explanations for price variances must relate to the cost of
the direct materials, not the quantity of the materials used. Similarly, the reasons for the quantity variance need
to relate to the amount of materials used, not the price paid for the materials. Reasons for a quantity variance
could be more waste or scrap than was planned, or that lower quality materials were used, or less skilled
workers were hired or used on the production line, or machine problems occurred that damaged materials.
Recording direct materials variances. The direct materials price variance is recorded when the direct materials
are purchased. The materials are recorded using actual quantity and standard cost. A separate account is used to
track each variance.
General Journal
Date
Account and Title Description Ref. Debit Credit
Oct. 16, 20X1

Raw Materials Inventory

66,000

Direct Materials Price Variance

3,000

Accounts Payable

63,000

Record Materials Purchased


The materials quantity variance is recorded when direct materials are requested by production. Direct
materials are taken out of raw materials inventory at the same cost they were put in (actual materials quantity at
standard price), and work-in-process inventory is increased based on the units produced at standard cost.
General Journal
Date
Account and Title Description
Ref. Debit Credit
Oct. 31, 20X1

Work-in-Process Inventory

65,835
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Date

Account and Title Description


Direct Materials Quantity Variance
Raw Materials Inventory

Ref. Debit

Credit

165
66,000

Record Materials Added to Production

Direct Labor Variances


The total direct labor variance is $3,525 unfavorable and consists of a $4,875 unfavorable rate variance
and a $1,350 favorable efficiency variance.
Actual labor costs of $63,375 are more than flexible budget costs of $58,500, so the labor rate variance
is $4,875 unfavorable. As with materials, the labor can also be thought of on a price per hour basis. The actual
costs of $63,375 were for 6,580 hours, which calculates to an average pay rate of $9.75 per direct labor hour.
The budget used a rate of $9.00 per direct labor hour. This $0.75 per hour difference resulted in the unfavorable
rate variance because actual costs were higher than budgeted costs. This could result from unplanned but
negotiated wage rate increases or the use of a more skilled work force.

The efficiency variance is favorable because flexible costs of $58,500 are less than standard costs of
$59,850. This means that the employees took less time than budgeted to produce the 13,300 sets of bases.
13,300 units were produced, and the company expected that the labor cost would be $4.50 per set, for a total
labor cost of $59,850. This can also be analyzed by identifying the total hours of labor it should have taken to
produce 13,300 sets of bases and multiplying by the cost per hour of labor (13,300 sets .5 hours = 6,650 hours
$9 per hour = $59,850). Because only 6,500 direct labor hours were needed instead of the 6,650 hours
expected, the direct labor efficiency variance is favorable.

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Recording direct labor variances. The direct labor rate variance is recorded when payroll is accrued.
General Journal
Date
Account and Title Description Ref. Debit Credit
Oct. 31, 20X1

Factory Labor

58,500

Direct Labor Rate Variance

4,875

Wages Payable

63,375

Record Direct Labor


The direct labor efficiency variance is recorded when the direct labor is assigned to work-in-process
inventory.
General Journal
Date
Account and Title Description
Ref. Debit Credit
Oct. 31, 20X1 Work-in-Process Inventory

59,850

Direct Labor Efficiency Variance

1,350

Factory Labor

58,500

Assign Direct Labor to Work-in Process Inventory

Overhead Variances
Variances may occur for both the variable and fixed cost components of manufacturing overhead.
Before looking at the variances, a summary of the overhead information for Bases, Inc., might be helpful. The
original plan was for 12,500 units per month, and the actual production for October was 13,300 units.
Bases, Inc. Manufacturing Overhead For the Month of October 20X1
Variable Costs
Indirect Materials

$0.02

$390

$130

$133

Indirect Labor

.40

2,795

2,600

2,660

Maintenance

.30

2,145

1,950

1,995

.72

5,330

4,680

4,788

600

525

525

Total Variable Costs


Fixed Costs
Depreciation, machinery

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Building Rent

1,000

1,000

1,000

Supervisor Salary

2,200

2,100

2,100

Total Fixed Costs


Total Overhead Costs

.58

3,800

3,625( )

3,625 ( 2 )

$1.30

$9,130

$8,305

$8,413

$8,645( 1 )

The variances can be calculated in total for variable and fixed costs, in which case the variances are
referred to as the controllable (price) variance and the volume variance. Alternatively, the variances can be
calculated separately for variable manufacturing overhead costs and fixed manufacturing overhead costs. The
variable overhead cost variances are called the spending (rate) variance and the efficiency variance, and fixed
overhead cost variances are known as the spending and volume variances. The variable overhead cost spending
variance, the variable overhead cost efficiency variance, and the fixed overhead cost spending variance added
together are the same as the controllable variance.

Using the two-variance approach, the controllable cost variance shows how well management controls
its overhead costs. If a volume variance exists, it means the plant operated at a different production level than
budgeted. For the Bases, Inc., the total overhead variance is $485 unfavorable. It consists of a $717 unfavorable
controllable variance and a $232 favorable volume variance. An unfavorable controllable variance indicates that
overhead costs per direct labor hour were higher than expected. The variance is calculated by subtracting the
$8,413 budgeted overhead from the $9,130 actual overhead costs. The budgeted overhead is calculated by
adding budgeted variable costs for the actual number of units (think of this as the flexible budget amount) to the
budgeted fixed costs (unchanged from original budget).
For Bases, Inc., production was 13,300 units and variable costs were $0.72 per direct labor hour. As
each unit takes .5 direct labor hours to make, the variable overhead is 13,300 units times .5 hours times $0.72, or
$4,788. When added to fixed costs of $3,625, the total budgeted overhead costs are $8,413 for the month.
Possible reasons for the unfavorable variance are: indirect materials were purchased from a different supplier
with higher costs, or more indirect materials were used due to waste; indirect labor rates were higher due to a
change in personnel or higher negotiated raises than budgeted; and/or fixed overhead costs were more than
budgeted.
The $232 volume variance indicates an over-application of fixed costs. This occurred because actual
production is higher than the budget. Remember that as more units are produced, fixed costs per unit decrease.
However, the predetermined overhead rate is established when the budget is prepared, and the same rate is used
throughout the year regardless of the actual number of units produced. So even though the fixed costs per unit

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decreased when 13,300 units were produced rather than the 12,500 budgeted, the same predetermined overhead
rate using the higher cost per unit was used to allocate overhead to production.

Using the separate overhead variance calculations for variable and fixed costs, the total overhead
variance is the same $485 unfavorable. The total variable overhead cost variance is $542 unfavorable, indicating
actual variable costs were higher than standard variable costs and, therefore, the overhead is underapplied. The
total fixed overhead variance is $57 favorable, indicating overhead is overapplied, because the actual fixed costs
are less than the standard fixed costs.
The $650 unfavorable variable cost spending variance is calculated by subtracting the $4,680 flexible
budget for variable overhead (actual direct labor hours times variable overhead per direct labor hour, or 6,500
$0.72) from the actual variable overhead of $5,330. It is unfavorable because more was spent on variable
overhead costs per direct labor hour than the $0.72 that was budgeted. Knowing that total variable costs are
$5,330 and that 6,500 direct labor hours were incurred, the actual variable overhead costs per direct labor hour
rate was $0.82. The $108 favorable efficiency variance is determined by subtracting $4,788 standard overhead
(13,300 units by the variable overhead per unit predetermined rate of $0.36) from the flexible budget variable
overhead cost of $4,680. It occurred because it took only 6,500 direct labor hours instead of 6,650 (13,300 units
.5 hours per unit) direct labor hours to produce the 13,300 units. The total variable cost variance of $542 is
calculated by adding the $650 unfavorable spending variance and the $108 favorable efficiency variance.

The $175 unfavorable fixed cost spending variance indicates more was spent on fixed costs than was
budgeted. It is calculated by subtracting the budgeted fixed overhead per month of $3,625 from the $3,800
actual fixed overhead. The $232 favorable volume variance indicates fixed overhead costs are overapplied. This
occurred because there were more units produced than planned. It is calculated by subtracting the applied fixed
overhead based on standard cost for units produced of $3,857 (13,300 sets $0.29 per unit) from budgeted fixed

Page | 11

overhead of $3,625. The total fixed overhead cost variance of $57 favorable is the combination of the $175
unfavorable spending variance and the $232 favorable volume variance.

When combined together, the variable overhead spending variance, the variable overhead efficiency
variance, and the fixed cost spending variance equal the $717 unfavorable controllable variance calculated under
the two-variance method previously discussed.
Recording overhead variances. As manufacturing overhead is incurred, it is recorded in the manufacturing
overhead account. The entry to record the variable and fixed components of manufacturing overhead is:
General Journal
Date
Account and Title Description
Ref. Debit Credit
Oct. 31, 201X1
(1)

Manufacturing Overhead

9,130

Raw Materials Inventory (Indirect materials)

390

Wages Payable (Indirect labor, variable)

2,795

Maintenance Expense

2,145

Accumulated Depreciation (depreciation exp.)

600

Accounts Payable (rent)

1,000

Wages Payable (Indirect labor, fixed)

2,200

Record October Overhead Costs


Manufacturing overhead is applied to production based on direct labor hours.
General Journal
Date
Account and Title Description
Ref. Debit Credit
Oct. 31, 30X1
(2)

Work-in-Process Inventory (13,300 units x $0.65)


Manufacturing Overhead

8,645
8,645

To Apply Overhead
At the end of the period, overhead variances are recognized. Under the two variance methods, the entry is:
General Journal

Date

Account and Title Description Ref. Debit Credit

Oct. 31, 20X1 Controllable Variance


(3)

717

Volume Variance
Manufacturing Overhead

232

To Record Overhead Variances


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Once these entries are recorded, the manufacturing overhead account is zero.
Manufacturing Overhead
(1)

9,130

9,130

8,645

(2)

485

(3)

9,130

0
Using the second method described for manufacturing overhead variances, the entry to record the
overhead variances would be:
General Journal
Date
Account and Title Description
Ref. Debit Credit
Oct. 31, 20X1

Variable Overhead Costs Spending Variance

650

Fixed Overhead Costs Spending Variance

175

Variable Overhead Efficiency Variance

108

Volume Variance

232

Manufacturing Overhead

485

Record October Overhead Variances

Total Variance
The $1,175 total unfavorable variance has now been analyzed into its components for further follow-up
by management:
Direct Materials Price Variance
$3,000 F
Direct Materials Quantity Variance

165 U

Direct Labor Price Variance

4,875 U

Direct Labor Quantity Variance

1,350 F

Overhead Controllable Variance

717 U

Overhead Volume Variance

232 F

Total Variance
$1,175 U
The balances in the variance accounts are usually closed to the cost of goods sold account, particularly
when the amounts are small. Alternatively, the balances in the variance accounts may be allocated to the
appropriate inventory accounts and the cost of goods sold account.
ILLUSTRATIVE PROBLEMS

1. The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as standard for
the production of its Type A lawn chair. During one month's operations, 100,000 meters of the pipe were
purchased at $0.78 a meter, and 7,200 chairs were produced using 87,300 meters of pipe. The materials
price variance is recognized when materials are purchased.
Required: Materials price and quantity variances.
Page | 13

2. The standard price for material 3-291 is $3.65 per liter. During November, 2,000 liters were purchased at
$3.60 per liter. The quantity of material 3-291 issued during the month was 1775 liters and the quantity
allowed for November production was 1,825 liters. Calculate materials price variance, assuming that:
Required: Materials price variance, assuming that:
a) It is recorded at the time of purchase (Materials purchase price variance).
b) It is recorded at the time of issue (Materials price usage variance).

3. The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4-802 at a
standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct labor hours at a cost of
$6.90 per hour.
Required: Calculate:
a) Labor rate variance or Labor price variance.
b) Labor efficiency or usage or quantity variance.
4. Cactus Company developed the following standards for 2006:
CACTUS COMPANY
Standard Cost Card
Cost Elements
Direct materials
Direct labor
Manufacturing overhead

Standard Quantity
5 pounds
1 hour
1 hour

Standard Price
$ 5
$18
$10

Standard Cost
$ 25
18
10
$53

The company planned to produce 30,000 units of product and work at the 30,000 direct labor level of
activity in 2006. The company uses a standard cost accounting system which records standard costs in the
accounts and recognizes variances in the accounts at the earliest opportunity. During 2006, 29,000 actual
units of product were produced.
Required: Prepare the journal entries to record the following transactions for Norris Company during
2006.
a) Purchased 147,000 pounds of raw materials for $4.90 per pound on account.
b) Actual direct labor payroll amounted to $527,000 for 28,500 actual direct labor hours worked.
Factory labor cost is to be recorded and distributed to production.
c) Direct materials issued for production amounted to 147,000 pounds which actually cost $4.90 per
pound.
d) Actual manufacturing overhead costs incurred were $288,000 in 2006.
e) Manufacturing overhead was applied when the 29,000 units were completed.
f) Transferred the 29,000 completed units to finished goods.
5. The Osage Company uses a standard cost system. The factory overhead standard rate per direct labor hour
is:
Fixed:
$4,500 / 5,000 hours
=
$0.90
Variable:
$7,500 / 5,000 hours
=
$1.50
$2.40
For October, actual factory overhead was $11,000 actual labor hours worked were 4,400 and the standard
hours allowed for actual production were 4,500.

Page | 14

Required: Factory overhead variances using two, three and four variance methods.
6. The standard overhead cost for a product manufactured by Continental Corporation is given below;
15 mins @ P 12 per
Variable overhead
= P 3.00
hour
Fixed overhead
15 mins @ P 5 per hour
=
1.25
P 4.25 per unit
Last period, the company produced 32,000 units and worked 8,200 actual direct labor hours. Overhead is
applied to production on the basis of direct labor hours. The companys normal capacity is 30,000 units or
7,500 hours (i.e. 30,000 units x 15/60). Actual variable overhead is P 99,400 and actual fixed overhead is P
38,200.
Required: Compute the following overhead variances:
a) Net overhead variance
b) Controllable variance and Volume variance (2-way)
c) Spending variance, Variable efficiency variance and Volume variance (3-way)
d) Budget variance, Capacity variance, and Efficiency variance (3-way)
e) Fixed overhead spending variance and Variable overhead spending variance
7. On May 1, Bovar Company began the manufacture of a new mechanical device known a "Dandy." The
company installed a standard cost system in accounting for manufacturing costs. The standard costs for a
unit of Dandy are:
Materials: 6 lbs. at $1 per lb.
$ 6.00
Direct labor: 1 hour at $4 per hour
$ 4.00
Factory overhead: 75% of direct labor cost
$ 3.00
Total
$13.00
The following data were obtained from Bovar's record for May:
Actual production of Dandy
4,000 units
Units sold of Dandy
2,500
Sales
$50,000
Purchases (26,000 pounds)
27,300
Materials price variance (applicable to May purchase)
$1,300 unfavorable
Materials quantity variance
1,000 unfavorable
Direct labor rate variance
760 unfavorable.
Direct labor efficiency variance
800 favorable
Factory overhead total variance
500 unfavorable
Required:
a) Standard quantity of materials allowed (in pounds).
b) Actual quantity of materials used (in pounds).
c) Standards hours allowed.
d) Actual hours allowed.
e) Actual direct labor rate.
f) Actual total factory overhead.
8. Oceanbeach Company uses a standard cost accounting system. During January, 2006, the company reported
the following manufacturing variances:
Material price variance
$2,000 F
Material quantity variance
2,400 U
Labor price variance
800
U
Page | 15

Labor quantity variance


1,200 U
Overhead controllable
500
F
Overhead volume
3,000 U
In addition, 15,000 units of product were sold at $18 per unit. Each unit sold had a standard cost of $12.
Selling and administrative expenses for the month were $10,000.
Required: Prepare an income statement for management for the month ending January 31, 2006.
9. A company produces a gasoline additive. The standard costs and input for a 500-liter batch of the additive
are represented below:
Chemical
Standard input quantity in liters Standard cost per liter Total cost
Echol
200
P 0.200
P 40.00
Protex
100
0.425
42.25
Benz
250
0.150
37.50
CT-40
50
0.300
15.00
The quantities purchases and used during the current period are shown below. A total of 140 batches were
made during the current period.
Chemical
Quantity purchased (Liters)
Total Purchased Price
Quantity Used (Liters)
Echol
25,000
P 5,365
26,600
Protex
13,000
6,240
12,880
Benz
40,000
5,840
37,800
CT-40
7,500
2,220
7,140
Required:
a) What is the material mix variance for this operation?
b) What is the material yield variance for this operation?

MULTIPLE CHOICE (THEORIES)

1. In traditional manufacturing environment, there is


a. more emphasis on material and labor price and efficiency variances
b. more emphasis on quality products and customer satisfaction
c. more emphasis on throughput efficiency
d. all of the above
2. The journal entry for material usage, excluding variances, should
a. debit accounts payable and credit work in process
c. debit work in process and credit inventory
b. debit inventory and credit accounts payable
d. debit inventory and credit work in process
3. Material mix variance is indicative of
a. having used a higher or lower share of material times total actual usage times actual rates
b. having used a higher or lower share of materials times total standard usage times actual rates
c. having used a higher or lower share of materials times total actual usage times standard rates
d. total actual usage minus standard usage times standard share of material times actual rates
e. total actual usage minus standard usage times standard share of material times standard rates
4. Standard cost may be used in
a. full costing but not variable costing
d. neither full costing nor variable costing
b. variable costing but not full costing
e. variable and normal costing only
Page | 16

c. full costing or variable costing


5. Which of the following factors should not be considered when deciding whether to investigate a variance?
a. magnitude of the variance and the cost of investigation
b. trend of the variances over time
c. likelihood that an investigation will eliminate future occurrences of the variance
d. whether the variance is favorable or unfavorable

6. Which department is customarily responsible for an unfavorable material price variance?


a. Quality control
c. Purchasing
b. Engineering
d. Production
7. Total material variance is the difference between
a. actual quantity of inputs times actual price minus actual quantity of inputs times standard price
b. actual quantity of inputs times actual price minus standard quantity allowed for output times standard
price
c. actual quantity of inputs times actual price minus standard quantity allowed for output times standard
price
d. actual output times actual price minus actual output times standard price
8. Which of the following statements about overhead variances is false?
a. Standard hours allowed are used in calculating the controllable variance.
b. Standard hours allowed are used in calculating the volume variance.
c. The controllable variance pertains solely to fixed costs.
d. The total overhead variance pertains to both variable and fixed costs.
9. Each of the following may cause an unfavorable controllable variance except
a. higher than expected use of indirect materials.
b. greater than expected use of indirect labor.
c. increases in indirect manufacturing costs.
d. inefficient use of direct labor.
10. If the labor quantity variance is unfavorable and the cause is inefficient use of direct labor, the responsibility
rests with the
a. sales department.
b. production department.
c. budget office.
d. controller's department.

Problem 1:

Materials Variance Analysis:


The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as
standard for the production of its Type A lawn chair. During one month's operations, 100,000
meters of the pipe were purchased at $0.78 a meter, and 7,200 chairs were produced using
87,300 meters of pipe. The materials price variance is recognized when materials are purchased.
Required: Materials price and quantity variances.

Solution:
Actual quantity purchased

Meters of pipe

Unit Cost

Amount

100,000

$0.78 actual

$78,000

Page | 17

actual quantity purchased

Materials purchase price variance

100,000

$0.80 standard

$80,000

-----------

-----------

-----------

100,000

$(0.02)

$(2,000) fav.

=======

=======

=======

Actual quantity used

87,300

0.80 standard

$69,840

Standard quantity allowed

86,400

0.80 standard

$69120

-------------

-------------

-------------

900

0.80

$720 Unfav

=======

=======

=======

Materials quantity variance

Problem 2:

Materials Variance Analysis:

The standard price for material 3-291 is $3.65 per liter. During November, 2,000 liters were
purchased at $3.60 per liter. The quantity of material 3-291 issued during the month was 1775
liters and the quantity allowed for November production was 1,825 liters. Calculate materials
price variance, assuming that:
Required: Materials price variance, assuming that:
It is recorded at the time of purchase (Materials purchase price variance).
It is recorded at the time of issue (Materials price usage variance).

Solution:
Liters

Unit cost

Amount

Actual quantity purchased

2,000

3.60 actual

$7,200

Actual quantity purchased

2,000

3.65 standard

7,300

---------

-------------

---------

2,000

$ (0.05)

$(100) fav.

======

======

======

Actual quantity used

1775

3.60 actual

$6390.00

Actual quantity used

1775

3.65 standard

$6478.75

--------

-----------

-----------

1775

$(0.05)

(88.75)

======

======

=======

Materials purchase price variance

Materials price usage variance

Problem 3:

Labor Variance Analysis:

The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4802 at a standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct
labor hours at a cost of $6.90 per hour.
Required: Calculate:
labor rate variance or Labor price variance.
Labor efficiency or usage or quantity variance.

Solution:
Time

Rate

Amount

Actual hours worked


Actual hours worked

1,580
1.580
--------

$6.90 actual
$6.75 standard
--------

$10,902
10,665
--------

Labor rate variance

1,580

$0.15

$237 unfav.

=====

=====

=====

Actual hours worked

1,580

$6.75 standard

$10,665

Standard hours allowed

1,600

$6.75 standard

$10,800

----------

------------

-----------

Page | 18

Labor efficiency variance

(20)

6.75 standard

$(135) fav.

======

======

======

Problem 4:

Factory Overhead Variance Analysis:

The Osage Company uses a standard cost system. The factory overhead standard rate per direct
labor hour is:
Fixed:
Variable:

$4,500 / 5,000 hours


$7,500 / 5,000 hours

=
=

$0.90
$1.50

-------$2.40

For October, actual factory overhead was $11,000 actual labor hours worked were 4,400 and the
standard hours allowed for actual production were 4,500.
Required: Factory overhead variances using two, three and four variance methods.

Solution:
Two Variance Method:
Actual factory overhead
Budgeted allowance based on standard hours allowed:
Fixed expenses budgeted
Variable expenses (4,500 standard hours allowed $1.50 variable overhead rate)

$11,000
$4,500
$6,750
-----------

$11,250
-----------

Favorable controllable variance

$ (250) fav.
======

Budgeted allowance based on standard hours allowed


Overhead charged to production (4,500 standard hours allowed $2.40 standard rate)

$11,250
$10,800
------------

Unfavorable volume variance

$450 unfav.
======

Three Variance Method:


Actual factory overhead
Budgeted allowance based on actual hours worked:
Fixed expenses budgeted
Variable expenses (4,400 actual hours worked $1.50 variable overhead rate)

$11,000
$4,500
$6,600
-----------

$11,100
-----------

Favorable spending variance

$ (100) fav.
======

Budgeted allowance based on actual hours worked


Actual hours worked Standard overhead rate (4,400 hours $2.40)

$11,100
$10,560
------------

Unfavorable spending variance

$540 unfav.
======
$10,560
$10,800

Actual hours worked Standard overhead rate (4,400 hours $2.40)


Overhead charged to production (4,500 standard hours allowed $2.40 standard rate)

----------Favorable efficiency variance

$ (240) fav.
=====

Four Variance Method:


Actual factory overhead
Budgeted allowance based on actual hours worked:
Fixed expense budgeted
Variable expenses (4,400 actual hours worked $1.50 variable overhead rate)

$11,000
$4,500
$6,600
-----------

$11,100
-----------

Favorable spending variance

$ (100) fav.

Page | 19

======
Budgeted allowance based on actual hours worked

$11,100

Budgeted allowance based on standard hours allowed

$11,250
-----------

Favorable variable overhead efficiency variance

$ (150) fav.
======

Actual hours fixed overhead rate (4,400 actual hours $0.90 fixed overhead rate)

$3,960

Standard hours allowed fixed overhead rate (4,500 actual hours $0.90)

4,050
-----------

Favorable fixed overhead efficiency variance

$ (90) fav.
======

Normal capacity hours (5000) Fixed overhead rate ($0.90)


Actual hours worked (4,400) Fixed overhead rate ($0.90)

$4,500
$3,960
------------

Unfavorable Idle capacity variance (600 hours $0.90)

$540 unfav.
======

Problem 5:

Variance Analysis:

On May 1, Bovar Company began the manufacture of a new mechanical device known a "Dandy."
The company installed a standard cost system in accounting for manufacturing costs. The
standard costs for a unit of Dandy are:
Materials: 6 lbs. at $1 per lb.
Direct labor: 1 hour at $4 per hour
Factory overhead: 75% of direct labor cost

$ 6.00
$ 4.00
$ 3.00
-----------

Total

$13.00
======

The following data were obtained from Bovar's record for may:
Actual production of Dandy

4,000 units

Units sold of Dandy

2,500

Sales

$50,000

Purchases (26,000 pounds)

27,300

Materials price variance (applicable to May purchase)

$1,300 unfavorable

Materials quantity variance

1,000 unfavorable

Direct labor rate variance

760 unfavorable.

Direct labor efficiency variance


Factory overhead total variance

800 favorable
500 unfavorable

Required:
Standard quantity of materials allowed (in pounds).
Actual quantity of materials used (in pounds).
Standards hours allowed.
Actual hours allowed.
Actual direct labor rate.
Actual total factory overhead.

Solution:
Actual production
Standard materials per unit

4,000 units
6 pounds
------------

Standard quantity of materials allowed

24,000 pounds
=======

Standard quantity of materials allowed


Unfavorable materials quantity variance ($1,000 variance / $1 standard price per pound)

24,000 pounds
1,000 pounds

Page | 20

------------Actual quantity of materials used

25,000 pounds
========

Actual production
Standard hours per unit

4,000 units
1 hour
------------

Standard hours allowed

4,000 hours
========

Standard hours allowed


Favorable direct labor efficiency variance ($800 variance / $4 standard rate per direct labor hour)

4,000 hours
(200) hours
-------------

Actual hours worked

3,800 hours
=======

Standard direct labor rate


Unfavorable direct labor rate variance ($760 variance / 3,800 hours actually worked)

$4.00
0.20
------------

Actual direct labor rate

$4.20
======

Standard factory overhead (4,000 units produced $3 standard overhead rate per unit)
Unfavorable factory overhead variance

$12,000
500
-------------

Actual total factory overhead

$12,500
=======

*Solution 144 (2025 min.)


(a)
Raw Materials Inventory
735,000
Materials Price Variance
Accounts Payable
(To record purchase of materials)
(b)

Factory Labor
513,000
Labor Price Variance 14,000
Wages Payable
527,000
(To record direct labor costs)
Work in Process Inventory
522,000
Labor Quantity Variance
Factory Labor
(To assign factory labor to jobs)

(c)

(d)

(e)

(f)

14,700
720,300

Work In Process Inventory


725,000
Materials Quantity Variance
10,000
Raw Materials Inventory
(To record issuance of raw materials)

9,000
513,000

735,000

Manufacturing Overhead
288,000
Accounts Payable/Cash/Acc. Depreciation
(To record overhead incurred)
Work In Process Inventory
290,000
Manufacturing Overhead
(To assign overhead to jobs)
Finished Goods Inventory
Work In Process Inventory

288,000

290,000

1,537,000
1,537,000
Page | 21

(To record transfer of completed units to finished goods)


Solution 143 (1520 min.)
Oceanbeach COMPANY
Income Statement
For the Month Ended January 31, 2006
Sales (15,000 $18)
Cost of goods sold (15,000 $12)
Gross profit (at standard)

$270,000
180,000
90,000

Variances:
Materials price
$(2,000)
Materials quantity
2,400
Labor price
800
Labor quantity
1,200
Overhead controllable
(500)
Overhead volume
3,000
Total variances (unfavorable)
Gross profit (actual)
Selling and administrative expenses
Net income

4,900
85,100
10,000
$ 75,100

Page | 22