Topic Eleven

VARIANCE ANALYSIS
AND
STANDARD COSTING

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 Topic Objectives

1. How standards are used in budgeting

2. The standard-setting process
3. Types of standards and how they are established for
businesses.
a. Ideal standards
b. Normal standards
4. Calculate and interpret direct material price and quantity
variance
5. Calculate and interpret direct labour rate and time
variance
6. Factory overhead controllable and volume variances.

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 Outline

 The usage of standard costing

 Setting of standard cost and types of
standard
 Calculation of variance:
◦ Direct material
◦ Direct labor
◦ Factory overhead

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Standard Costing

• The cost that has been pre-determined after

considering other factors.

• Those are estimated costs which are considered to be

ideal for each of the cost component (direct material,
direct labor and factory overhead).

• The standard cost system enable the management to

determine how much a product should cost.

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The usage of standard
costing

 Planning and controlling:

Compare actual cost & budgeted cost
Improve performance
Increase efficiency

 Product costing:
Provide readily available unit cost
information

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 Setting of Standard Cost

Involve joint efforts on:

• Analysis on the historical cost experience:

Provide initial guidelines for standard setting

• Engineering studies:
Determine the most efficient way to operate

• Input from operating personnel:

Accountable for meeting the standards

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 Types of Standards

Ideal standard

• Maximum efficiency

• Can be achieved if everything operates perfectly.

Normal standard

• Currently attainable standard

• Allowance is made for breakdown, interruptions etc..

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Variance Analysis

Variances are the difference between the

actual manufacturing cost and the standard
cost at the actual level of production.

The significance of the variance for each

element in manufacturing cost needs further
analysis to determine the corrective actions.

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Calculation of variance

1. Direct material

2. Direct labor

3. Factory overhead

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10
 Standard Cost

The expected cost per unit product

Illustration 1:

The followings are the

standard cost for each unit
(bottle) of peanut butter
produced by Tasty Nut :

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 Standard Standard Standard Cost
Price Usage RM
Direct material:
Peanut 2.80/kg 0.15kg 0.42
Butter 2.70/kg 0.10kg 0.27
Sugar 1.20/kg 0.25kg 0.30
0.99
Direct labor:
Machine operator 4.00/hour 0.02hour 0.08
Packaging 3.00/hour 0.01hour 0.03
0.11
Factory OH:
Variable costs 5.00/hour 0.01hour 0.05
Fixed costs 12.00/hour 0.01hour 0.12 0.17
Standard cost per unit 1.27
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If Tasty Nut produces 10,000 bottles of peanut
butter, the expected total cost would be:

Direct material 10,000 x 0.99 9,900

Direct labor 10,000 x 0.11 1,100

Factory overhead 10,000 x 0.17 1,700

Total cost 12,700

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 Calculation of variance

Cost element Actual cost Standard cost Variance

Direct material 9,500 9,900 400 (F)

Direct labor 1,050 1,100 50 (F)

Factory overhead 2,000 1,700 300 (U)

F = (Favorable) U = (Unfavorable)

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 Direct Material Variance

To measure the difference between the actual

cost and the standard cost of direct materials.

Direct Material Price Variance

Direct Material Usage (Quantity) Variance

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(Actual Price x Actual Quantity) - (Standard Price x Actual Quantity)

Simplified to be:

Actual Quantity (Actual Price – Standard Price)

AQ ( AP – SP )

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 2. Direct material usage (quantity)
variance

(Standard Price x Actual Quantity) - (Standard Price x Standard Quantity

Simplified to be:

Standard Price (Actual Quantity – Standard Quantity)

SP ( AQ – SQ )

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Actual Price x Actual Qty Std Price x Actual Qty Std Price x Std Qty

Usage Variance
Price Variance

Direct material variance

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Illustration 2

The followings are the actual price and quantity for

direct material used by the company in producing
10,000 bottles of peanut butter:
Actual Price Actual Quantity

Peanut RM2.70/kg 1,400kg

Butter RM2.505/kg 1,200kg

Sugar RM1.18/kg 2,300kg

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Direct material price variance: AQ ( AP – SP )

Peanut: 1,400 (2.70 – 2.80) = 140 (F)

Butter: 1,200 (2.505 – 2.70) = 234 (F)

Sugar: 2,300 (1.18 – 1.20) = 46 (F)

420 (F)

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 Direct material usage variance: SP ( AQ – SQ )

Peanut: 2.80 (1,400 – 1,500) = 280 (F)

Butter: 2.70 (1,200 – 1,000) = 540 (U)

Sugar: 1.20 (2,300 – 2,500) = 240 (F)

20 (U)
Therefore ,
Total direct material variance = 420 (F) + 20 (U)
= 400 (F)

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Direct Labor Variance

Measures the differences between the actual cost

and the cost that suppose to be paid to the labor.

Direct Labor Rate Variance

Direct Labor Efficiency Variance

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1. Direct Labor Rate Variance

(Actual Hour x Actual Rate) - (Actual Hour x Standard Rate)

Simplified to be:

Actual Hour ( Actual Rate – Standard Rate )

AH ( AR – SR )

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 2. Direct Labor Efficiency Variance

(Standard Rate x Actual Hour) - (Standard Rate x Standard Hour)

Simplified to be:

Standard Rate ( Actual Hour – Standard Hour )

SR ( AH – SH ) *time variance

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Actual Hour x Actual Rate Act Hour x Std Rate Std Hour x Std Rate

Rate Variance Efficiency Variance

Direct Labor Variance

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 Illustration 3:

The followings are actual rate and labor hour in the

production of 10,000 bottles of peanut butter:

Actual labor rate Actual labor hour

Machine operator RM3.90/hour 190 hours

Packaging RM2.81/hour 110 hours

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 AH ( AR – SR )
Direct Labor Rate Variance:

Machine Operator: 190 (3.90 – 4.00 ) = 19 (F)

Packaging: 110 (2.81 – 3.00) = 21 (F)

40 (F)

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 Direct Labor Efficiency Variance: SR ( AH – SH )

Machine Operator: 4.00 (190 – 200) = 40 (F)

Packaging: 3.00 (110 – 100) = 30 (U)

10 (F)
Therefore,
total direct labor variance: = 40 (M) + 10 (M)
= 50 (M)
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 Factory Overhead Variance

Measures the differences between the actual cost

and the supposed related cost of factory overhead.

Factory Overhead Flexible Budget Variance

Factory Overhead Volume Variance

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1. Factory Overhead Flexible Budget
Variance

Actual Overhead Costs - Flexible Overhead Costs

Flexible OH Costs = Variable OH + Fixed OH

= (Variable OH rate x Actual production)

+
(Fixed OH rate x Standard production)

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2. Factory Overhead Volume Variance

Flexible OH Costs - Standard OH at actual production

Standard OH at
= Variable OH + Fixed OH
actual production

= Variable OH rate x Actual production

+ Fixed OH rate x Actual production

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Actual OH Costs Flexible OH Costs Std OH at actual prod.

Flexible Budget Production Volume

Variance Variance

Overhead Variance

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Illustration 4

The followings are the actual factory OH costs incurred

in producing 10,000 unit / bottles of peanut butter:

Variable OH costs RM560

Fixed OH costs RM1,440

Note: Standard fixed OH costs per unit is calculated

based on normal capacity of 12,000 units.

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 Flexible budget variance:

Variable OH:
Actual cost - (Std OH per unit x actual production )
= 560 - (0.05 x 10,000)
= 60 (U)
Fixed OH :
Actual cost - (Std OH per unit x std production )
= 1,440 - (0.12 x 12,000)
= 0

Total flexible budget variance = 60 (U)

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 Production volume variance:

Variable OH :
Variable OH costs - (Std OH per unit x actual production )
= 560 - (0.05 x 10,000)
= 60 U
Fixed OH :
Flexible OH costs - (Std OH per unit x actual production )
= 1,440 - (0.12 x 10,000)
= 240 (U)

Total production volume variance = 300 (U)

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 Total factory OH variance :

Flexible budget variance + Production volume variance

= 60 (U) + 240 (U)

= 300 (U)

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Total variance:

Actual Costs: Variance:

Direct material 9,500 DM 400 (F)
Direct Labor 1,050 DL 50 (F)

Factory OH 2,000 FOH 300 (U)

12,550 150 (F)

Standard cost:
12,700
(1.27 x 10,000)
150 (F)

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