Professional Documents
Culture Documents
Department of Accountancy
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AE 212: COST ACCOUNTING AND CONTROL
Week Topic Learning Outcomes Activities
Do graded activity
MODULE 9:
STANDARD COSTING
After the actual operation, a report is generated showing the actual costs incurred, the costs
that should have been incurred for the actual level of activity (planned costs or standard costs), and
the related variances. The management usually establishes a control limit (tolerance level) to serve
as a guide in determining which variances are tolerable and which are not. The manager then
examines the variance column to ascertain which variances require attention. Following up on
significant variances only is called management by exception. It is used so managers can focus their
efforts and used their limited time where they are most needed.
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Purposes and Benefits of Standard Costs
Standard costs are used for reporting, monitoring and controlling business activities. When
such are established carefully and used widely the following benefits may be derived from standard
costing:
1. Cost Control
2. Pricing Decisions
3. Motivation and Performance Appraisal
4. Cost Awareness and Reduction
5. Preparation of Budgets
6. Management by Exception
Setting Standards
As mentioned previously, standard costs include two factors, price and quantity. Setting price
and quantity standards ideally combine the expertise of everyone who has responsibility for
purchasing and using inputs. This will include the accounting, purchasing, engineering and production
departments.
Standards should be designed to encourage efficient future operations, so even though past
records of purchase prices and input usage may be helpful in setting standards, other variables that
may affect future operations, such as expected changes in technology, the production process,
inflation, and other similar factors, should be included. Managers also use task analysis to focus on
how much a product should cost (like time and motion studies). Standards tend to fall into two
categories, either ideal standards or practical standards.
These are set on the basis of theoretical capacity and 100% efficiency. This standard is
established based on a perfect working condition - no machine breakdowns, no delays, wastages,
no materials defects and shortages, no manpower shortages, or other work interruptions. It demands
that employees always work at peak performance. These standards are difficult or even impossible
to attain. It may even discourage workers to some extent because performance will almost always
not attain such standards. Furthermore, variances from ideal standards are difficult to interpret
because variances will include components of normal operational inefficiencies and abnormal
deviations or operational problems that management by exception needs to identify and correct.
These are standards that are set for a normal level of operation and efficiency intended to
represent challenging yet attainable results. They allow for normal machine downtime and employee
rest periods. They can be attained through reasonable, though highly efficient efforts by the average
worker. Behavioral scientists feel that practical standards have a more positive effect on the
productivity of employees. Unlike variances computed with perfection standards, variances
calculated when practical standards are employed tend to be more meaningful as they represent
deviations from a realistic goal. Variances from practical standards typically signal a need for
management attention because they represent deviations that fall outside of normal operating
conditions.
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MATERIALS COST STANDARDS
Price standards permit [1] checking the performance of the purchasing department and
the influence of various internal and external factors and [2] measuring the effect of price
increases or decreases on the company’s profit. Determining the price or cost to be used as the
standard cost is often difficult, because prices used are controlled more by external factors than
by a company’s management. The standard price per unit for direct materials should be the final,
delivered cost of materials. It should reflect a particular grade or quality of material, a specific size
of material, and purchased in particular lot sizes which affects freight cost. It is also adjusted by
volume discounts, allowances for purchase discounts (whether to be taken or not) and receiving
and handling costs.
Quantity and usage standards are generally developed from materials specifications
prepared by the departments of engineering or product design. Quantity standards should be
set after the most economical size, shape and quality of the product and the results expected
from the use of various kinds and grades of materials have been analyzed. The standard quantity
should reflect the amount and quality of material required for each unit of product as specified in
the bill of materials. It must also include allowances for acceptable levels of waste, spoilage,
shrinkage, seepage, evaporation and leakage. However, allowances for waste, spoilage and
rejects should be periodically reviewed and reduced over time to reflect improved processes,
better training, and better equipment. It should be noted that standard quantity also reflects the
materials in expected scrapped units (rejects).
Once the price and quantity standards have been set, then the standard cost of materials
per unit of finished product can be computed. Consider the following information to produce one
unit of t-shirt:
PRICE STANDARD
Price/yard of grade A cloth (1,000 yards) P20.00
Freight, by truck from supplier’s warehouse 1.50
Less: purchase discount (0.50)
Standard price per yard P21.00
QUANTITY STANDARD
Material requirement as specified in bill of materials in yards 1.75
Allowance for waste and spoilage in yards 0.15
Allowance for rejects, in yards 0.10
Standard quantity per unit of t-shirt, in yards 2.00
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LABOR COST STANDARDS
Many companies prepare a single standard rate for all employees in a department, based
on the expected mix of high and low wage rate employees. This procedure simplifies the use of
standard costs and allows monitoring the actual mix of employees in the department
After the rate and the efficiency standards have been established, the standard labor cost
per unit of finished product is computed. For example, to produce one t-shirt the following is
established:
The development of standards for factory overhead is not as simple as for direct materials and
direct labor. This is because factory overhead is composed of many cost items – that is, all
manufacturing costs other than prime costs. Examples are indirect materials, indirect labor, insurance,
light, water, depreciation and others. Furthermore, unlike materials and labor which are assumed to
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be purely variable costs, factory overhead is composed of variable costs, fixed costs and mixed costs.
Thus, there is a need to first segregate mixed costs into their variable and fixed components. As with
direct labor, the price and quantity components for overhead are expressed in terms of rate and
hours.
A. Standard factory overhead rate
It is a predetermined rate that is usually based on direct labor hours or machine hours. The
first step in calculating the overhead rate is to determine the activity level to be used for the base
selected and estimate or budget individual expense at the estimated activity level in order to
arrive at the total standard factory overhead. The individual overhead expenses must also be
classified into fixed or variable expenses. After the activity level for the selected base and the
factory overhead have been estimated, the overhead rate can already be computed.
Since factory overhead is applied based on a cost driver like direct labor hours or machine
hours, the standard hour for labor or for machine is used as standard number of hours. Consider
the following overhead costs:
Factory Overhead Costs Fixed Variable Total
Supervisors P70,000 P70,000
Indirect labor 9,000 P66,000 75,000
Overtime Premium 9,000 9,000
Factory supplies 4,000 21,000 25,000
Repairs and maintenance 3,000 8,000 11,000
Electric power 2,000 20,000 22,000
Fuel 1,000 5,000 6,000
Water 600 3,400 4,000
SSS contributions 3,000 15,000 18,000
PHIC contributions 1,500 6,500 8,000
PAG-IBIG contributions 1,500 2,500 4,000
Pensions 2,000 18,000 20,000
Vacations and holiday pay 2,000 15,000 17,000
Group insurance 1,400 5,600 7,000
Depreciation – building 20,000 - 20,000
Depreciation – equipment 11,000 - 11,000
Property tax 4,000 - 4,000
Fire insurance 3,000 - 3,000
Total P60,000 P120,000 P180,000
Divide by: Practical capacity 6,000 6,000 6,000
Standard FOH rate/DLH P10 P20 P30
STANDARD FOH/UNIT
Standard FOH/hr P30.00
Multiply by: DLH per unit 1.5
Standard FOH/unit P45.00
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To complete the standard cost for one t-shirt:
Direct materials cost P42.00
Direct labor cost 52.50
Factory overhead cost 45.00
Standard cost/unit P139.50
Variance literally means difference. Variance analysis is the process of comparing the actual
costs against the standard costs of manufacturing a product. It is a management tool for evaluating
and controlling purposes.
Variance analysis follows a series of steps. First, actual costs are accumulated from suppliers’
sales invoices, disbursement vouchers and other accounting records. Then, the standard costs are
computed by applying the established standards of input per unit to the actual units of goods
produced. The variance is then computed by getting the difference between the actual costs and
standard costs. Any cost variance is labeled as favorable (F) when actual consumption is less than
the standard (allowed) because this means savings. In the same manner, cost variance will be
labeled as unfavorable (UF) when actual consumption is greater than what is allowable, because this
means overspending. Finally, the costs variances are analyzed into their components to provide
managers vital information in measuring efficiency and effectiveness of their operations and device
necessary controls to improve performance.
ILLUSTRATION:
During July, the firm produced 5,000 units of T-shirts. Relevant data are as follows:
a. Purchased 11,000 yards of cloth for P21.50 per yard. The firm used 9,500 yards of cloth in
producing the 5,000 units of finished goods.
b. The firm incurred 7,000 direct labor hours at P34 per hour.
c. Actual factory overhead costs incurred for the period is P240,000, composed of P72,000 fixed
and P168,000 variable.
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DIRECT MATERIALS VARIANCE
After gathering the necessary data to determine the actual cost and standard costs of
materials, a variance analysis report would be prepared showing the following:
Quantity Price Total Cost
Actual direct materials cost 9,500 P21.50 P204,250
Standard direct materials cost *10,000 21 210,000
Direct materials variance (F) U (500) P.05 (P5,750)
The material variance of P5,750 is favorable since the actual cost incurred is less than the
standard cost allowed in producing 5,000 units of finished goods. This means that the firm was able to
save materials cost.
To analyze the favorable materials variance, it must be broken down into its components:
quantity variance and price variance.
This variance compares the actual quantities of materials used and the standard quantity
allowed on actual production. It shows the ability of the production department in efficiently
utilizing the raw materials in producing finished goods. It is computed as follows:
ALTERNATIVE SOLUTION:
Difference in quantity (9,500–10,000) 500 F
Multiply by: Standard price P21
Materials Quantity Variance P10,500 F
The materials quantity variance is favorable because the firm used less than what is
expected (allowed) to be used in producing 5,000 units of finished goods.
This variance compares the actual cost of direct materials used with the standard costs
allowed based on materials used. It is computed as follows:
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ALTERNATIVE SOLUTION:
Difference in price (P21.50 –P21) P 0.50 UF
Multiply by: Quantity used 9,500
Materials Usage Price Variance P 4,750 UF
The usage price variance is considered as unfavorable because the actual cost incurred
is more than the allowable cost at the given quantity.
As a summary, the analysis of direct materials variance would show the following:
Most companies compute materials price variance when materials are purchased rather
than when they are used in production. This is because such practice would permit earlier recognition
of variance and therefore more timely efforts in effecting the necessary corrective actions or internal
controls. Moreover, it will allow recording of materials in inventory account at standard cost.
This variance compares the actual cost of direct materials purchased with the standard
costs allowed on materials purchased. It is computed as follows:
Actual quantity @ Actual price (11,000 x P21.50) P236,500
Actual quantity @ Standard price (11,000 x P21) 231,000
Materials Purchase Price Variance P 5,500 UF
ALTERNATIVE SOLUTION:
Difference in price (P21.50 –P21) P 0.50 UF
Multiply by: Quantity purchased 11,000
Materials Purchase Price Variance P 5,500 UF
The materials purchase price variance is unfavorable because the company spent
(P21.50) more than the standard price (P21) set.
Direct labor variance determination and analysis is very similar to that of materials variances.
After gathering the necessary data to determine actual cost and standard cost of labor, a variance
analysis report would be prepared showing the following:
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Standard direct labor hours/unit 1.50
Units produced 5,000
Standard direct labors hours * 7,500
The direct labor variance of P24,500 is favorable since the actual cost incurred is less than the
standard cost allowed in producing the 5,000 units of finished goods.
To analyze the favorable direct labor variance, it must be broken down into its components:
time (efficiency/quantity) variance and rate (price) variance.
This variance compares the actual labor hours used and the standard hours allowed on
actual production. Employing highly skilled laborers and production process control measures,
usually lead to favorable variance and vice versa. It is computed as follows:
Actual hours @ Standard rate (7,000 x P35) P245,000
Standard hours @ Standard rate (7,500 x P35) 262,500
Direct Labor Efficiency Variance (P17,500) F
ALTERNATIVE SOLUTION:
Difference in hours (7,000 – 7,500) 500 F
Multiply by: Standard rate P35
Direct Labor Efficiency Variance P17,500 F
The labor efficiency variance is favorable because the firm spent less time than what was
expected or allowed in producing 5,000 units of finished goods.
The direct labor rate variance is the difference between the actual direct labor cost and
the actual hours incurred at standard rate per direct labor hour. This variance result from actually
paying more or less than the standard rate of labor. It is computed as follows:
ALTERNATIVE SOLUTION:
Difference in rate (P34 –P35) P1 F
Multiply by: Actual hours 7,000
Direct Labor Rate Variance P 7,000 F
The rate variance is favorable because the company paid a lower rate of P34 compared
to the standard of P35 per direct labor hour.
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Rate variances can arise because of the way labor is used. Using highly skilled workers who
are receiving higher wages for tasks which require little skill will result in an unfavorable rate
variance. On the other hand, a favorable rate variance may result from paying wages which are
lower than the standard rate. Because labor rate variance generally arise as a result of how labor
is used, production supervisors are usually responsible for seeing that labor rate variances are kept
under control.
As a summary, the analysis of direct labor variance would show the following:
Efficiency Variance (P17,500) F
Rate Variance (P 7,000) F
Total Direct Labor Variance (P24,500) F
In a standard cost system, jobs or processes are charged with costs on the basis of standard
hours allowed multiplied by the standard factory overhead rate. The standard hours allowed is
determined by multiplying the labor hours required to produce one unit times 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 each month, overhead actually incurred is compared with the expenses
charged into process using the standard rate. The difference is called the overall factory overhead
variance.
After gathering the necessary data to determine the actual and standard cost, the overall
factory overhead (FOH) variance for Saplot Company would be:
*Computation:
Standard FOH rate per hour P 30
Standard hours (1.5 hrs x 5,000 units) 7,500
Standard factory overhead P225,000
The factory overhead variance of P15,000 is unfavorable since the actual cost incurred is
greater than the standard cost allowed in producing the 5,000 units of finished goods.
To analyze the unfavorable factory overhead variance, it must be broken down into its
components: quantity variance and price variance. Factory overhead variance analysis may be
done using a flexible budget or a fixed budget.
Flexible budgets are budgets that integrate the cost behavior patterns, identifying which costs
are fixed and which are variable. In so doing, a budget can be prepared for different activity levels.
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Thus, Saplot Company can prepare a flexible budget for factory overhead in case it plans to
operate at different activity levels. For example, at 5,000 direct labor hours and 6,000 direct labor
hours, the factory overhead budget would be:
@ 5,000 hrs @ 6,000 hrs
Variable OH (P20/hr) P100,000 P120,000
Fixed OH 60,000 60,000
Total factory OH P160,000 P180,000
Flexible budgeting can be done for any activity level within the relevant range.
Overhead variance analysis in a flexible budget can be done using the [1] two-variance
method, [2] three-variance method and [3] four-variance method.
For Saplot Company, the unfavorable factory overhead variance of P15,000 will be analyzed
using the 2, 3, and 4 way variance methods as follows:
Under this method, the total overhead variance is broken down into controllable variance
and volume variance. Controllable variance is the difference between the actual factory overhead
and the budget allowance based on standard hours for actual production. This variance reflects the
ability of the production manager in controlling variable overhead costs. On the other hand, volume
(capacity) variance is the difference between budget allowed on standard hours and the standard
cost applied to production. This variance measures the extent by which existing normal capacity is
being utilized.
CONTROLLABLE VARIANCE
Actual Factory Overhead (AFOH) P240,000
Budget Allowed on Standard Hours (BASH)
The controllable variance is unfavorable since the firm spent more than what is budgeted
(expected). On the other hand, the volume variance is favorable since the firm was able to utilize its
production capacity (in terms of hours or units) more than what is budgeted (expected). This leads to
economies of scale, spreading the fixed overhead into more units or hours, causing the favorable
variance.
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B. Three-Variance Method (SVV)
Under this method, the controllable variance is split into two variances, namely [1] Spending
and [2] Variable efficiency. Retaining the [3] volume variance, it forms the 3 way overhead variance
analysis. Spending variance is the difference between actual factory overhead and the budget
allowed based on actual hours worked. It measures the extent by which a responsible manager can
keep actual overhead within the budget. Variable efficiency variance is the difference between the
budget allowed based on actual hours and the budget allowed based on standard hours. It measures
the extent by which actual hours are performed in relation to the standard hours allowed. Volume
variance is the same in the two-variance analysis.
SPENDING VARIANCE
AFOH P240,000
Budget Allowed on Actual Hours (BAAH)BAAC
Fixed Overhead (FxOH) P60,000
Variable Overhead (VOH) (P20x7,000) 140,000 200,000 P40,000 UF
The overall unfavorable controllable variance is analyzed in this method. It is caused largely
by the unfavorable spending variance which means the firm spent more than what is allowed or
expected in the actual activity level. However, it is slightly offset by favorable variable efficiency
variance since the firm spent lesser hours than what is expected. Lesser time spent means lesser cost
incurred for the variable overhead. The concept of volume (capacity) variance is retained.
C. Four-Variance Method
Under this method, the spending variance is split into two variances, namely [1] variable
spending and [2] fixed spending. Retaining the [3] variable efficiency variance and [4] volume
variance, it forms the 4 way overhead variance analysis. Variable spending variance is the difference
between actual and budgeted variable overhead costs at actual activity level. Fixed spending
variance is the difference between actual and budgeted fixed overhead. The other two variances
were discussed earlier.
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Standard FOH (SOR x SH) 225,000 15,000 F
TOTAL OVERHEAD VARIANCE P15,000 UF
The overall unfavorable controllable variance is analyzed deeper in this method by going to
the details of the unfavorable spending variance. We can see that the firm spent more than what is
allowed or expected in the actual activity level, both in variable and overhead costs. The concept
of variable efficiency and volume (capacity) variance is retained.
A fixed budget is a plan based on only one level of activity. The overhead rate is determined
by dividing the total budgeted factory overhead by the planned level of activity regardless of
composition of total overhead cost. Since the behavior of overhead costs is not considered in
determining such overhead rate, a budget for a different level of activity could not be prepared.
For example, the budgeted total overhead costs of Saplot Company is P180,000 at planned
activity level of 6,000 direct labor hours. Thus, the standard overhead rate is P30 per direct labor hour.
Regardless of actual activity level, the company will apply the P30 overhead rate to determine the
standard overhead costs to be incurred that will be used in variance analysis. This differs in flexible
budgeting where only the variable overhead rate is applied to actual activity level and the fixed costs
is not affected.
When factory overhead variance is analyzed on a fixed budget, the budgeted factory
overhead is used regardless of the capacity attained. The analysis may use the [a] two variance
method, or [b] the three variance method.
Under this method, the total overhead variance is broken down into budget variance and
volume variance. Budget variance is the difference between the actual factory overhead and the
budgeted overhead at normal capacity. Volume variance is the difference between budgeted
overhead and the standard cost applied to production. To illustrate, consider the data for Saplot
Company and assume that the budgeted capacity is at practical capacity:
BUDGET VARIANCE
Actual Factory Overhead (AFOH) P240,000
Budgeted Factory Overhead (BFOH) 180,000 P60,000 UF
VOLUME VARIANCE
Budgeted Factory Overhead (BFOH) P180,000
Standard Factory Overhead (SOR x SH) 225,000 (45,000) F
TOTAL OVERHEAD VARIANCE P15,000 UF
The budget variance is unfavorable since the firm spent more than what is budgeted
(expected). The concept of volume variance under the flexible budgeting is retained.
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Under this method, the volume variance is broken down into capacity variance and efficiency
variance. Retaining the budget variance, it forms the 3 variance analysis. Capacity variance
indicates whether or not the planed level of activity was attained. It is computed by multiplying the
standard overhead rate by the difference between budgeted hours and actual hours. Efficiency
variance indicates how fast a company can produce its output. It is computed by multiplying the
standard overhead rate with the difference between actual hours and standard hours based on
actual production.
BUDGET VARIANCE
AFOH P240,000
BFOH 180,000 P60,000 UF
CAPACITY VARIANCE
Budgeted Hours x SOR P180,000
Actual Hours x SOR 210,000 (30,000) F
EFFICIENCY VARIANCE
Actual Hours x SOR P210,000
SORSH 225,000 (15,000) F
TOTAL OVERHEAD VARIANCE P15,000 UF
The capacity variance is favorable since the firm was able to utilize more hours (7,000 hours)
than its budgeted capacity of 6,000 hours. In the same manner, the efficiency variance is favorable
since the firm was able to produce the 5,000 units with lesser time (7,000 hours) than what is expected
(7,500 hours).
The preceding discussions on the computations of variances were based on the actual
production of finished goods with the assumption that there is no work in process inventories.
However, when work-in-process inventories are present, the basis in computing variance should be
the equivalent production. Equivalent units of production may be computed using the FIFO method
or the average method.
ILLUSTRATION:
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Standard costs based on normal capacity of 15,000 units:
The computations of equivalent production using the two methods are as follows:
FIFO AVERAGE
Work Work
Actual Done EUP Done EUP
Work in process, beg 6,500 50% 3,250 100% 6,500
Started and finished 9,500 100% 9,500 100% 9,500
Work in process, end 5,000 80% 4,000 80% 4,000
Equivalent production 16,750 20,000
B. AVERAGE DM DL FOH
Equivalent Production 20,000 20,000 20,000
Multiply by: Standard rate/unit P75 P20 P10
Standard costs P1,500,000 P400,000 P200,000
Assuming further that the standard costs using FIFO method was used in computing direct
materials, direct labor and overhead variances, the computations would be:
DM DL FOH
Actual costs P1,280,000 P336,000 P160,000
Standard costs 1,256,250 335,000 167,500
Variance (F) UF P23,750 P1,000 (P7,500)
The direct materials and direct labor variances are further analyzed as:
Price Variance DM DL
Actual price P16 P21
Standard price 15 20
Difference in price P1 UF P1 UF
x Actual quantity 80,000 16,000
Price Variance P80,000 UF P16,000 UF
Quantity Variance
Actual quantity 80,000 16,000
Standard quantity 83,750 16,750
Difference in quantity (3,750) F (750) F
x Standard price P15 P20
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Quantity Variance (P56,250) F P15,000 F
Mix and Yield variances occurs when production process involves combining or mixing several
materials, labor classes and or factory overhead in varying proportions. The computation of variances
as well as the related variance analysis is basically the same as in normal production discussed earlier,
with little changes due to integration of mixture in related materials and or labor classes.
The materials mix and yield for process type of industry is a significant factor in final product
cost, cost reduction, and profit improvements. Materials specifications, standards for various grades
of materials, and types of secondary materials may at times be changed in anticipation of less costly
grade of materials and an improved yield of good output.
Mix variance, also known as blend variance, is a measure of the difference between the
standard costs of formula materials and the standard costs of materials used. This variance is the result
of mixing basic materials in a ratio different from the standard materials specifications.
Yield variance is the difference between the amount of product manufactured from the given
amount of materials and the expected amount of product on the same basis of input. Labor and
factory overhead are affected by a yield variance. A labor yield variance may occur as a result of
the quality and or quantity of the materials handled. As a result, the number of hours worked, may
increase or decrease which will in turn cause a factory overhead yield variance.
Mix and yield variances constitute the quantity variance of direct materials, direct labor and
factory overhead.
ILLUSTRATION:
CHOCOLATEE Corporation uses the standard cost system. Standard product cost
specification for 1,000 kilograms of chocolate candies are as follows:
DIRECT MATERIALS:
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Sugar 200 30 6,000
Total input 1,200 P76,500
DIRECT LABOR
FACTORY OVERHEAD
SUMMARY
Cost/unit Total Cost
Materials P76.50 P76,500
Labor 18.00 18,000
Factory Overhead 12.00 12,000
Total P106.50 P106,500
Cocoa
Beans Milk Sugar
Inventory, beg 1,500 2,100 1,000
Purchases 8,000 18,000 6,000
Inventory, end 1,900 2,800 2,140
Cost per kg P66 P72 P33
Actual direct labor hours and costs are 5,800 hours for P464,000. Normal capacity is 6,000 hours.
Actual overhead for the month is P320,000. Actual finished production is 26,000 kilos.
Required: As part of performance evaluation, prepare a detailed variance analysis for each
production cost element.
MATERIALS VARIANCES
The materials variances consist of [1] price variance, [2] mix variance, and [3] yield variance.
The mix and yield variances constitute the quantity variance.
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When price variances are recognized at the time of purchase, such variances may be
computed as follows:
Actual materials cost
Cocoa Beans 8,000 x P66 P528,000
Milk 18,000 x 72 1,296,000
Sugar 6,000 x 33 198,000 P2,022,000
Actual materials @ standard costs
Cocoa Beans 8,000 x P60 P480,000
Milk 18,000 x 75 1,350,000
Sugar 6,000 x 30 180,000 (2,010,000)
Materials purchase price variance P12,000 UF
However, if the recognition of the price variance is done at the time materials are issued to
production, the overall materials variance is equal to the total of the different materials variances.
Such variance may be computed as follows:
The total materials variance is further broken down into its three components: price, mix and
yield variances. Consider the following computations:
LABOR VARIANCES
The expected output of 24,800 kilos of chocolate should require 5,952 labor hours (240 hours
per thousand kilograms of chocolate produced). Similarly, 6,240 standard labor hours are expected
for the actual output of 26,000 kilos.
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The labor variances are: [1] Rate variance [2] Efficiency variance [3] Yield variance.
For factory overhead, a yield variance may also be computed. Analysis involving yield
variance may be done by adapting any of the methods earlier discussed for flexible budget.
Presented below is the computation of the factory overhead variance and a sample analysis under
the two way and three way methods.
CONTROLLABLE VARIANCE
Actual Factory Overhead P320,000
BASHEO
FxOH P120,000
VOH 178,560 298,560 P21,440 UF
VOLUME VARIANCE
BASHEO P298,560
Std Hrs. based on expected output
@ std OH rate (SHE0SOR) 5,952 x P50 297,600 960 UF
YIELD VARIANCE
SHEOSOR P297,600
SORSH 312,000 (14,400) F
TOTAL OVERHEAD VARIANCE P8,000 UF
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B. Three Variance Method
SPENDING VARIANCE
Actual FOH P320,000
BAAH
FxOH P120,000
VOH (P30 x 5,800) 174,000 294,000 P26,000 UF
VARIABLE EFFICIENCY VARIANCE
BAAH P294,000
BASHEO 298,560 4,560 F
VOLUME VARIANCE
BASHEO P298,560
Std.hrs @ expected output @ SR 5,952 x P50 297,600 960 UF
(SHEOSOR)
YIELD VARIANCE
SHEOSOR 297,600
SORSH 312,000 (14,400) F
TOTAL FOH Variance P8,000 UF
Determining and analyzing production costs variances has two major concerns. First is the
proper accounting (disposition) of such variances for external reporting purposes and the other is the
accountability (responsibility) for such variance for internal uses.
DISPOSITION OF VARIANCES
When the amount of variances is not significant, they are normally closed to cost of goods sold
(COGS). As an alternative, they may be charged immediately against income summary. In case the
amount is significant, they are used as adjustment to COGS and appropriate inventory account (RM,
WIP or FG) on a prorated basis, using the relative amount of the cost elements at year end.
Management scrutinizes variances in order to know the causes of variances and enable the
management to make corrective actions and fairly reward good performance. Accordingly, the
emphasis of tracing the responsibility for such variances to a particular person or department is not to
determine who is at fault and render the appropriate sanction, but rather to use the knowledge about
the variances to promote learning and continuous improvement in production operations.
The different variances for each production cost input, the causes of such variance and the
person (department) responsible for such variances are presented below.
1. Price variance maybe attributable to the quality of materials purchased or effort exerted in
purchasing. Thus, it is the responsibility of purchasing manager. Factors that influence the price
paid for materials purchased include volume of materials ordered, how the order is delivered,
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whether the order is a rush order, and quality of materials. Price variance results from deviation
of any of these factors from what was assumed when standards were set.
1. Labor Rate variance - variance result from actually paying more or less than the standard rate
of labor. Employing highly skilled laborers as well as overtime premium added to direct labor
cost, usually lead to unfavorable variance.
Supervisors and or person in charge of setting labor rates are mainly responsible for this
variance.
2. Labor Time (efficiency) variance - results from actually using more or less time than the
standard labor time allowed for actual production. Employing highly skilled laborers and
production process control measures usually lead to favorable variance. Thus, it is the
responsibility of the production manager.
2. Capacity (Volume) Variance arises from under or over utilizing the normal production capacity
of the firm. The number of units to be produced (and the corresponding production hours)
depends on the projected sales and ending inventory policy set for the firm. Therefore, the
responsibility should not be charged to the production manager but rather to the sales
department manager that projects the sales and the top management that sets the inventory
policy.
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