TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY

GE ELEC 6 – BUSINESS LOGIC

STANDARD COSTS AND VARIANCE
ANALYSIS
Standard costs are carefully (or
scientifically) pre-determined costs
established by management to be used as
a basis for comparison with actual costs.
In most cases, standard costs are
computed for manufacturing costs only,
namely, materials, labor, and
manufacturing overhead.
PURPOSES OF STANDARD COSTS
A. Cost control
B. Pricing decisions
C. Motivation and performance appraisal
D. Cost awareness and cost reduction
E. Preparation of budgets
F. Costing of inventories
G. Preparation of cost reports
H. Management by objective
THE STANDARD COST SYSTEM
Three activities are involved in a standard
cost system, namely:
A. Development or establishment of
standards. – In developing standards, the
following should be taken into
consideration:
1. The basic cost factors.
2. Specifications of the product to be
manufactured.
Currently attainable standard is the most
used type of standard. It is established for
a normal level of operation and efficiency,
allowing for expected or normal production
problems.
B. Accumulation of actual costs – Actual
costs should always be made available for
comparison with the standard costs to
determine any deviations.
C. Computation and analysis of variance –
The difference between the actual cost and
standard costs is known as the variance.
Once computed, variances are analyzed
and evaluated to provide managers with
useful information for measuring efficiency
and improving performance.
Variances may be described as either
favorable or unfavorable. When actual
costs incurred are less than the standard,
the variance is favorable, since this means
that the company incurred less that what
it is allowed to spend. Otherwise, an
unfavorable variance, which is a result of
overspending.
DIRECT MATERIAL VARIANCE
SAMPLE PROBLEM 1
During the most recent month, 35,000
ounces of material A were purchased by
Pampanga Company relative to its product
Mekeni at a cost of P2.45 per ounce.
28,000 ounces were used to produce 4,500
units of Mekeni.
The standard direct material per unit of
Mekeni is 7 oz., with a standard price of
P2.50 per oz.
TOTAL VARIANCE
Actual Material Cost
= Act. Qty. Used x Act. Price
= 28,000 ounces x P2.45/oz
= P68,600
Standard Material Cost
= Std. Qty. x Std. Price
= 31,500 ounces x P2.50/oz.
= P78,750
Computation of Variance
= Act. Cost – Std. Cost
= P68,600 – P78,750
= (P10,150) Favorable
The total variance can be analyzed by
breaking it down into the factors that
brought about such variance, which are
the monetary (price) and physical
(quantity) factors.
PRICE VARIANCE (USAGE)
= (Act. Price – Std. Price) x Act. Qty.
= (P2.45 – P2.50) x 28,000
= (P0.05) x 28,000
= (P1,400) Favorable
The price variance in this case is described
as favorable because the company spent
P0.05 less for each ounce of material
purchased.
QUANTITY VARIANCE
= (Act. Qty. – Std. Qty.) x Std. Price
= (28,000 oz. – 31,500 oz.) x
P2.50/oz
= (3,500) x P2.50/oz.

Page 1 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC

= (P8,750) Favorable
The favorable quantity variance results When materials are issued to production,
from the company using less ounces of
WIP* 78,750
materials than the standard quantity
Quantity Variance 8,750
allowed for actual production. Price Usage Variance 1,400
ANALYSIS OF VARIANCE Materials** 68,600
*P2.50 standard price x 31,500 oz. standard
Price Variance (P1,400) F qty.
Quantity Variance (P8,750) F **P2.45 actual price x 28,000 oz. actual qty.
Total Variance (P10,150) F
No accounting problem is encountered in
Note that the two variances were simply this method since your Materials account
added because they have the same is recorded at actual cost.
description (both are favorable). If they
Method 2
were both unfavorable, they should have
likewise been added. When materials are purchased,
DETERMINATION OF POSSIBLE CAUSE Materials* 87,500
OF VARIANCE Accounts Payable** 85,750
Purchase Price Variance 1,750
Any variance, whether favorable or *P2.50 standard price x 35,000 oz. purchased
unfavorable, if significant in amount, **P2.45 actual price x 35,000 oz. purchased
should be carefully investigated.
When materials are issued to production,
For instance, the favorable price variance
WIP* 78,750
can be traced to the purchasing
Quantity Variance 8,750
department. The reasons to be cited by the
Materials** 70,000
purchasing officer may involve an
*Standard Material Cost
unexpected rollback in prices of petroleum **P2.50 standard price x 28,000 oz. used
which caused a decrease in prices of other
commodities, including the materials used Adjusting entry to bring Materials account
for Mekeni. to actual cost,

The favorable quantity variance, on the Purchase Price Variance 1,400

other hand, can be traced to the
production department. For this, the
possible explanations may be the company
used a new equipment for a more
systematic and efficient job processing.
PRICE VARIANCE (PURCHASE)
There are cases however, when price
variance is computed based on actual
quantity purchased.
= (Act. Price – Std. Price) x Act. Qty.
= (P2.45 – P2.50) x 35,000
= (P0.05) x 35,000
= (P1,750) Favorable
INCORPORATING STANDARDS INTO THE
ACCOUNTING RECORDS
Price Usage Variance* 1,400
*P0.05 favorable price variance x 28,000 oz.
used
The remaining balance in the Purchase
Price Variance account at the end of the
period is used to adjust the Materials
account to actual cost.
DIRECT LABOR VARIANCE
SAMPLE PROBLEM 2
Pangasinan Corporation has just developed
a new product called Agii. Standard cost
system was established to help control
costs based on the following standard cost
of direct labor, 1.4 hours per unit at P8 per
hour.

Method 1 In June, the company produced 6,200

units of Agii. Production data for June in
When materials are purchased, relation to direct labor, 8,200 direct labor
Materials* 85,750
hours were worked at a cost of P8.2 per
Accounts Payable 85,750 hour.
*P2.45 actual price x 35,000 oz. purchased

Page 2 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC
TOTAL VARIANCE
Actual Labor Cost
= Act. Time x Act. Rate
= 8,200 hrs. x P8.20
= P67,240
Standard Labor Cost
= Std. Time x Std. Rate
= 8,680 hrs. x P8
= P69,440
Computation of Variance
= Act. Cost – Std. Cost
= P67,240 – P69,440
= (P2,200) Favorable
The only difference between the
computation and analysis of direct labor
variances with that of the direct material
are terminologies. Hence, instead of price
and quantity variance, we breakdown labor
cost variance into rate and time variance.
RATE VARIANCE
= (Act. Rate – Std. Rate) x Act. Time
= (P8.20 – P8) x 8,200
= P0.20 x 8,200
= P1,640 Unfavorable
The rate variance is unfavorable because
the company paid P0.20 higher per hour
than the standard rate of P8.
TIME VARIANCE
= (Act. Time – Std. Time) x Std. Rate
= (8,200 hrs. – 8,680 hrs.) x P8/hr.
= (480 hrs.) x P8/hr.
= (P3,840) Favorable
The favorable time variance resulted from
using less labor hours than the standard
time allowed to produce 6,200 units of
Agii.
ANALYSIS OF VARIANCE
Rate Variance P1,640 UF
Time Variance (P3,840) F
Total Variance (P2,200) F
Note that one variance is unfavorable and
the other one is favorable, therefore, the
net amount was obtained in determining
the total variance, and such net variance
will bear the description of the factor
showing the higher amount of variance.
DETERMINATION OF POSSIBLE CAUSE
OF VARIANCE
As regards to the unfavorable rate
variance, a possible explanation is because
of hiring highly skilled workers who
demand higher wage rates.
The favorable time variance, on the other
hand, may be caused by the improvement
in workers’ efficiency thereby enabling
them to use less time in producing the
product because of hiring high-caliber
workers as mentioned above.
INCORPORATING STANDARDS INTO THE
ACCOUNTING RECORDS
When direct labor is charged to WIP,
WIP* 69,440
Rate Variance 1,640
Time Variance 3,840
Salaries Payable** 67,240
*P8 standard rate x 8,680 hrs. standard time
**P8.20 actual rate x 8,200 hrs. actual time
FACTORY OVERHEAD VARIANCE
Development of standards for factory
overhead is not as simple as for materials
and labor since factory overhead is usually
composed of a lot of cost items, as it
includes all manufacturing costs other
than the prime costs.
Hence, for convenience and for practicality,
a common denominator is simply used in
the application of factory overhead to
production. The physical factor is simply
based on labor hours, and the monetary
factor is simple called rate per hour.
Computation and analysis of overhead
variances involve two approaches:
A. Fixed Budget Approach – Sometimes
called static budget, is based on only one
activity level which usually is a close
approximation of the expected level of
activity.
B. Flexible Budget Approach – Also called
dynamic budgeting, considers possible
changes in activity levels within the
relevant range. The cost behavior patterns
of the different cost items included in
factory overhead are likewise considered,
Page 3 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC

where variable and fixed costs are grouped Actual FOH P34,000
accordingly. FOH chargeable to WIP
(7,200 Std. hrs. x P4.00) P28,800
Total Variance P 5,200 UF
DIFFERENT TYPES OF CAPACITY LEVELS
TWO-WAY VARIANCE METHOD
Capacity refers to the fixed amount of the
CONTROLLABLE VARIANCE
company’s human and nonhuman
resources for which management has Actual FOH P34,000
Budgeted allowance
committed itself and with which it expects based on STANDARD
to conduct the business and maintain the hrs. allowed:
firm as a going concern. Var FOH (7,200 x P3.00) P21,600
Budgeted Fixed FOH 8,000 29,600
A. Theoretical Capacity – The capacity to
Controllable Variance P4,400 UF
produce at full tilt, without interruptions.
Maximum, perfect capacity. The budget allowance can be thought of as
B. Practical Capacity – Is theoretical the amount of factory overhead that would
capacity less internal factors such as have been budgeted if the actual quantity
ordinary and expected inefficiencies. produced had been known in advance.

C. Budgeted Capacity – Estimated level of Simply put, the controllable margin is the
performance the company plans to achieve difference between actual variable factory
in the next 12 months. overhead and the budgeted variable factory
overhead allowed. Assuming that, the
D. Standard Capacity – The estimated actual fixed factory overhead incurred is
capacity that should have been used in equal to the budgeted fixed factory
actual capacity. overhead.
E. Normal Capacity – Considers not only VOLUME VARIANCE
internal but also external factors,
Budgeted allowance
particularly the market or the demand for based on STANDARD
the product. The average production level hrs. allowed: (from
over a long period of time and the most previous computation) P29,600
FOH chargeable to WIP
used type of capacity level. (7,200 Std. hrs. x P4.00) 28,800
SAMPLE PROBLEM 3 Volume Variance P 800UF
The following data are available at the end
of the month: Volume variance indicates the cost of
capacity that was available but not used,
Actual FOH P34,000 or not used efficiently.
Actual units produced 900 units
Std. DL hrs./unit 8 hrs. When standard cost rather than actual
Actual DL hrs. used 7,000 hrs. cost is charged to production, the volume
Var. FOH/hr. P3.00 variance can be thought of the amount of
Fx FOH P8,000 over- or underapplied budgeted fixed
Normal Capacity 1,000 units overhead. It is the difference between the
budgeted fixed overhead and the amount of
The factory overhead rate consists of the fixed overhead chargeable to production
following variable and fixed portions: which is based on the standard hours
Var. FOH Rate/hr. P3.00 allowed for actual production.
Fx FOH Rate/hr. ANALYSIS OF VARIANCE
= P8,000/8,000* = P1.00
Total FOH rate at Controllable Variance P4,400 UF
normal capacity P4.00/Std. DL Volume Variance P 800 UF
hrs. Total Variance P5,200 UF
*Based on 1,000 units normal capacity x std.
direct labor hrs. per unit The controllable variance is the
responsibility of department managers to
TOTAL VARIANCE

Page 4 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC

the extent that they control overhead costs

Idle Capacity Variance P 1,000UF
incurred.
The volume variance on the other hand, is Idle capacity variance is the difference
the responsibility of the department between the budget allowance based on
manager if it was caused by changes in the actual level of the allocation base and
production efficiencies. However, if it was the amount of overhead that would be
caused by unexpected changes in sales charged to production in the absence of
demand, it is the responsibility of executive the standard cost system (actual hours x
management. factory overhead rate). This variance
measures the overuse or underuse of
FOUR-WAY VARIANCE METHOD
capacity.
SPENDING VARIANCE
FIXED EFFICIENCY VARIANCE
Actual FOH P34,000
ACTUAL hrs. x fixed
Budgeted allowance
factory overhead rate
based on ACTUAL hrs.
(7,000 x P1.00) P 7,000
Var FOH (7,000 x P3.00) P21,000
STANDARD hrs. x fixed
Budgeted Fx FOH 8,000 29,000
factory overhead rate
(7,200 x P1.00) 7,200
Spending Variance P5,000 UF
Volume Variance P (200) F
Spending variance is composed of two
elements: The sum of the variable efficiency variance
and fixed efficiency variance is known
A. Variable Spending Variance – The
collectively as the efficiency variance which
difference between actual variable factory
reflects the efficient or inefficient use of the
overhead and the budgeted variable factory
input represented by the allocation base.
overhead based on actual level of the
In this case, the use of labor, since labor
allocation base (direct labor hours).
hours is used as the allocation base.
B. Fixed Spending Variance – The
ANALYSIS OF VARIANCE
difference between actual fixed factory
overhead and the budgeted fixed factory Controllable Variance
overhead allowed. Spending Variance P5,000UF
Variable Efficiency
In the absence of the actual fixed factory Variance (600)F P4,400UF
Volume Variance
overhead incurred, the same is assumed to Idle Capacity
be equal to the budgeted fixed factory Variance P1,000UF
overhead. In which case, the spending Fixed Efficiency
Variance (200)F 800UF
variance is composed only of variable Total Variance P5,200UF
spending variance.
Based on our analysis above, it can be
VARIABLE EFFICIENCY VARIANCE
observed that controllable variance relates
Budgeted allowance based on to variable costs while volume variance
ACTUAL hrs. (from spending
variance computation) P 29,000
relates to fixed costs.
Budgeted Allowance based on
STANDARD hrs. allowed: (from INCORPORATING STANDARDS INTO THE
two-way method computation) 29,600 ACCOUNTING RECORDS

Variable Efficiency Variance P (600)F To record actual factory overhead,

Variable efficiency variance measure how Factory Overhead Control 34,000

much the efficient or inefficient use of the (Various Credits*) 34,000
allocation base affects the cost of variable *May include salaries payable, supplies, cash,
accumulated depreciation, pension liability,
factory overhead.
etc.
IDLE CAPACITY VARIANCE
To record factory overhead applied to WIP,
Budgeted fixed factory
overhead P 8,000 WIP* 28,800
ACTUAL hrs. x fixed factory Applied Factory Overhead 28,800
overhead rate (7,000 x P1.00) 7,000

Page 5 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC

*P4 overhead rate x 7,200 standard hrs. Materia Quantity (kg) Unit cost/kg. Amount
allowed l
A 800 kg. P0.25 P200
To close Applied Factory Overhead B 200 kg. 0.40 80
C 200 kg. 0.10 20
Account, Input 1,200 kg. P300
Applied Factory Overhead* 28,800
Factory Overhead Control 28,800 Materials record indicate:
Materia Inv., Beg. Purchases Inv., End
The Factory Overhead Control account now l
has a debit balance of P5,200 which A 10,000 kg. 162,000 kg. 15,000 kg.
B 12,000 kg. 30,000 kg. 4,000 kg.
represents underapplied overhead, or the C 15,000 kg. 32,000 kg. 11,000 kg.
net overhead variance. It will be closed to Actual purchase prices for materials A, B,
the overhead variance accounts. and C, respectively are P0.24, P0.42, and
Two-way Variance Method P0.11. Actual finished production for
January is 200,000 units.
Controllable Variance 4,400
Volume Variance 800 TOTAL VARIANCE
Factory Overhead Control 5,200
Weighted Average Standard Input Cost
Four-way Variance Method = P300 / 1,200 kg. = P0.25/kg.
Spending Variance 5,000 Weighted Average Standard Output Cost
Idle Capacity Variance 1,000
Fixed Efficiency Variance 200 = P300 / 1,000 units = P0.30/unit
Variable Efficiency Variance 600
Factory Overhead Control 5,200
Computation of Variance
Actual Cost (Usage)
DISPOSITION OF VARIANCES A (P0.24 x 157,000) P 37,680
B (P0.42 x 38,000) 15,960
C (0.11 x 36,000) 3,960 P57,600
A. If the net amount of variance is
Less: Standard Cost
immaterial, variances are closed to: Actual output at
weighted average
1. Cost of Goods Sold or; standard output cost
2. Income Summary account (200,000 units x
P0.30) P60,000
B. If the net amount of variance is Total Variance (P2,400)
F
material, variances are allocated to Cost of
Goods Sold and Ending Inventory accounts
PRICE VARIANCE (USAGE)
(Materials, Work in Process and Finished
Goods). Materials Act. Price Std. Price Difference
A P0.24 P0.25 (P0.01) F
MIX AND YIELD VARIANCES B P0.42 P0.40 P0.02 UF
C P0.11 P0.10 P0.01 UF
Generally, materials cost variances are
analyzed into two – the price and quantity Difference Actual Qty. Variance
(P0.01) F 157,000 kg. (P1,570)F
variance. However, for some products P0.02 UF 38,000 kg. 760UF
which are processed using a variety of P0.01 UF 36,000 kg. 360UF
materials with specific grades or qualities Price Variance (Usage) (P450)F
of input, as well as standard combination,
blending, or mixture of such inputs or MIX VARIANCE
materials, aside from price variance, the Actual Input at Individual Standard
mix and yield variances should also be Input Cost
analyzed. A (157,000 kg. x P39,25
P0.25) 0
SAMPLE PROBLEM 4 B (38,000 kg. x
15,200
P0.40)
C (36,000 kg. x
Assume that Blow Company manufactures P0.10)
3,600 P58,050
plastic balloons and uses a standard cost Actual Input at Weighted Average
system. Standard product and cost Standard Input Cost
specifications for 1,000 units of plastic (231,000 kg. x P0.25) 57,750
Mix Variance P 300 UF
balloons are as follows:

Page 6 of 7
 TARLAC STATE UNIVERSITY – COLLEGE OF BUSINESS AND ACCOUNTANCY
GE ELEC 6 – BUSINESS LOGIC

Mix Variance results from combining input

materials in a ratio different from the
standard input materials specification.
YIELD VARIANCE
Standard Output at Weighted Average
Standard Output Cost**
192,500* units x
P 57,750
P0.30
Actual Output at Weighted Average
Standard Output Cost
200,000 units x P0.30 60,000
Yield Variance (P2,250) F
**Same as Actual Input at Weighted Average
Standard Input Cost from previous computation.
* Expected yield of 1,000 units / 1,200 kg. or 5/6 of
231,000 kg. actual input.

The yield variance occurred because actual

production of P200,000 units exceeded the
expected output of 192,500, for a yield
difference of 7,500 units multiplied by the
weighted average standard output cost of
P0.30 per unit equals the favorable yield
variance of P2,250.
ANALYSIS OF VARIANCE
Price Variance (P 450) F
Quantity Variance
Mix Variance P 300 UF
Yield Variance (P2,250) F (1,950) F
Total Variance (P2,400) F

A variance analysis program identifying

and evaluating the nature, magnitude, and
causes of mix and yield variances is an aid
to operating management for comparative
costs of various grades of materials are
used to find satisfactory materials mix and
changes often are made when possible to
use less costly grades. Substituting
another grade or quality of materials or
using another mixture or proportion of
ingredients to save on cost and increase
production may be allowable without
necessarily affecting the quality of output.

Page 7 of 7