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Standard costing is the establishment of cost standards for activities and their periodic analysis to
determine the reasons for any variances. Standard costing is a tool that helps management
account in controlling costs.
For example, at the beginning of a year a company estimates that labor costs should be $2 per
unit. Such standards are established either by historical trend analysis of the cost or by an
estimation by any engineer or management scientist. After a period, say one month, the company
compares the actual cost incurred per unit, say $2.05 to the standard cost and determines whether
it has succeeded in controlling cost or not.
This comparison of actual costs with standard costs is called variance analysis and it is vital for
controlling costs and identifying ways for improving efficiency and profitability. If actual cost
exceeds the standard costs, it is an unfavorable variance. On the other hand, if actual cost is less
than the standard cost, it is a favorable variance.
Direct material variance = (SQ) (SP) – (AQ) (AP)
= (1240) ($4) – (1200) ($4.1) = $4960 - $4920 = $40 favourable
1) Direct material Usage Price variance:
Direct material price variance (also called the direct material spending/rate variance) is the
difference between the actual amount spent on direct material purchases during a given period
and the amount that would have been spent had the material been acquired at standard price.
It may also be calculated as the product of actual quantity of direct material used and the
difference between standard price and actual price per unit of direct material. We have the
following formulas:
Direct Material Price Variance
= (SP − AP) × AQ
= AQ×SP − AQ×AP
= AQ×SP − Actual Total Spending
Where,
SP is the standard unit price of direct material;
AP is the actual price per unit of direct material; and
AQ is the actual quantity of direct material used.
Direct material price variance is calculated to determine the efficiency of purchasing department
in obtaining direct material at low cost.
Analysis:
SP > AP (favourable)
SP < AP (unfavourable)
Example:
Calculate the direct material price variance if the standard price and actual unit price per unit of
direct material are $4.00 and $4.10 respectively; and actual units of direct material used during
the period are 1,200. Determine whether the variance is favorable or unfavorable.
Standard Price $ 4.00
− Actual Price 4.10
Difference Per Unit − 0.10
× Actual Quantity 1,200
Direct Material Price
− $ 120
Variance
Since the price paid by the company for the purchase of direct material is more than the standard
price by $120, the DM price variance is unfavorable.
2) Direct Material Quantity Variance:
Direct material quantity variance (also called the direct material usage/efficiency variance) is the
product of standard price of a unit of direct material and the difference between standard quantity
of direct material allowed and actual quantity of direct material used. The formula to calculate
direct material quantity variance is:
DM Quantity Variance = ( SQ − AQ ) × SP
Where,
SQ is the standard quantity allowed
AQ is the actual quantity of direct material used
SP is the standard price per unit of direct material
Standard quantity allowed (SQ) is calculated as the product of standard quantity of direct
material per unit and actual units produced.
Analysis:
Direct material quantity variance is calculated to determine the efficiency of production
department in converting raw material to finished goods.
SQ > AQ (Favourable)
SQ < AQ (Unfavourable)
Example:
Use the following information to calculate direct material quantity variance. Also specify
whether the variance is favorable or unfavorable.
Standard Price of a Unit of Direct Material $4
Standard Quantity of Direct Material Per Unit 2
Actual Units Produced During the Period 620
Actual Quantity Used During the Period 1,200
Solution
Difference 40
× Standard Price of a Unit of Direct Material $4
Where,
SR is the standard direct labor rate
AR is the actual direct labor rate
AH are the actual direct labor hours
Analysis:
Direct labor rate variance determines the performance of human resource department in
negotiating lower wage rates with employees and labor unions.
SR > AR (Favourable)
SR < AR (Unfavourable)
Example:
Calculate the direct labor rate variance if standard direct labor rate and actual direct labor rate are
$18.00 and $17.20 respectively; and actual direct labor hours used during the period are 130. Is
the variance favorable or unfavorable?
Solution
Standard Rate $ 18.00
− Actual Rate 17.20
Where,
SH are the standard direct labor hours allowed
AH are the actual direct labor hours used
SR is the standard direct labor rate per hour
The standard direct labor hours allowed (SH) in the above formula is the product of standard
direct labor hours per unit and number of finished units actually produced.
Analysis
Analysis:
The purpose of calculating the direct labor efficiency variance is to measure the performance of
production department in utilizing the abilities of the workers.
SH > AH (Favourable)
SH < AH (Unfavourable)
Example:
Use the following information to calculate direct labor efficiency variance. State whether the
variance is favorable or unfavorable.
Standard Rate Per Hour of Direct Labor $ 18
Standard Direct Labor Hours Required Per Unit 0.2
Actual Units Produced During the Period 620
Actual Direct Labor Hours Used During the 130
Period
Solution
Actual Units Produced 620
× Standard Direct Labor Hours Per Unit 0.2
Difference −6
× Standard Direct Labor Rate $ 18