1. Cost Variance Analysis

2. Definitions
STANDARD COSTS – are predetermined or target unit costs of production which should be attained under efficient conditions. It is the amount and costs of direct material, direct labor, and factory overhead required to produce one unit of finished product.
STANDARD COST SYSTEM – is an accounting system which uses standard costs rather than actual costs to account for units as they flow through the manufacturing process.

3. Objectives of Standard Cost System
To help a business operate more effectively and more efficiently
It helps accomplish organization goals by obtaining optimum output from the inputs available.
Uses of Standard Costing
Inventory
Planning and controlling costs
Measurement of performance
Budget preparation
Motivating employees

4. Types of Standards
Basic (Fixed) Cost Standards – are standards that are unchanged year after year.
Perfection (Ideal or Theoretical) Cost Standards – are absolute minimum costs attainable under operating conditions.
Current Attainable Cost Standards – standard that can be attained under efficient operating conditions. It is useful for employee motivation, product costing and budgeting.

5. Setting Direct Materials Standards
Standard Quantity
Industrial engineers develop specification for the kinds and quantities of materials used in producing the goods budgeted.
Operation schedules list the materials and quantities required for the expected volume of production.
Standard Price
- Information from the operation schedule and bills of material established jointly by the engineering department, the manufacturing supervisor and the accountant becomes the basis for the material price standard.

6. Variance Analysis
Analysis of variances reveals that causes of deviations between standard and actual costs. This feedback aids in planning future goals, controlling costs and evaluating performance.
Variances – are the difference between standard and actual costs. A variance is considered FAVORABLE if actual costs are less than the standard costs, and UNFAVORABLE if actual costs exceed standard costs.

7. Setting Labor Standards
Standard Time
Examination of past payroll and production records can reveal the worker-hours used on various jobs and can help determine standard performance.
Time reports from the workers for a limited period will be a good basis for the standard.
If possible, time and motion study should be the basis for the standard
The time study seeks to develop time standards and price rates which the average operator can meet daily

8. Standard Labor Rate
Labor rates should be determined by considering the current rates as well as the competitive markets.
Methods in determining the labor rate standards:
A company may establish a standard rate for the job, regardless of who performs the job, the rates stays the same, or
A company may establish a rate for an individual worker and the worker receives this rate regardless of the work performed.
If labor contracts exist, the wage is relatively fixed and can
be used as standard.

9. Setting Overhead Standards
Factory overhead cost standards provide a means of allocating factory overhead to cost inventories for pricing decisions and controlling expenses
A capacity level is selected as the volume based or denominator capacity.
Costs are allocated on a volume related or non-volume related base.
Commonly used volume-related basis:
Machine hours
Direct labor-hours
Direct labor costs
Direct materials costs
Units or production
- After expressing volume based on machine hours, the number of inspection, or another basis, the factory incurred at this level is estimated.

10. Responsibility: the Purchasing Department is usually responsible for material price variances. However, the Production Department could be responsible for unfavorable price variance occurring (1) because of a request for rush order due to poor scheduling or (2) when they specify certain brand-name materials or materials of certain grade or quality other those initially included in the bill of materials.
The possible causes of materials quantity or usage variance are as follows:
Waste and loss of materials in handling and processing
Substitution of defective or non-standard materials
Spoilage or production of excess scrap because or inexperienced workers or poor supervision
Lack of proper tools or machines
Variation yields from materials
Responsibility: Production line supervisors should be held responsible for materials under their control.

11. Operating Performance Evaluation
Analysis of Variances
The variance or difference between actual costs and standard costs can be separated and analyzed into two components: Price Variance and Efficiency Variance
DIRECT MATERIALS VARIANCE ANALYSIS
Difference between actual costs and standard cost of materials used is called a material cost variance
This variance is made up of a price variance and a usage or quantity or efficiency variance
The possible causes of materials price variance are as follows:
Fluctuations in market price of materials
Purchasing from distant suppliers, which results in additional transportation costs
Failure to take cash discounts available
Purchasing materials of substandard quality or in uneconomical lots
Unfavorable purchase terms

12. FORMULAS: Materials Price Variance Materials Quantity Variance
Actual Price P xx
Less: Standard Price xx
Difference in Price xx
Multiplied by:
Actual Quantity Purchased* xx
Unfavorable (Favorable) P xx
Materials Quantity Variance
Actual Quantity P xx
Less: Standard Quantity xx
Difference in Quantity xx
Standard Price xx
* - actual quantity used if quantity purchased is not known

13. SAMPLE PROBLEM: MATERIALS VARIANCE
ABC Company has budgeted 50,000 units of output using 50,000 units of raw materials at a total material cost of P100,000. Actual output was 50,000 units of product that require 45,000 units at a cost of P2.10 per unit. The direct material price variance and usage variance are:
Price Usage
a. P 4,500 UF P10,000 F
b. P 4,500 F P10,500 F
c. P 5,000 F P10,500 UF
d. P10,000 F P 4,500 UF

14. SOLUTION: Materials Price Variance Material Quantity Variance
Actual Price P 2.10
Standard Price
(P100,000 / 50,000 units)
Difference in Price P 0.10
x Actual Qty Used 45,000
Material Price
Variance P 4,500 U
Material Quantity Variance
Actual Quantity 45,000
Standard Quantity 50,000
Difference in Qty 5,000
x Standard Price P 2
Material Usage
Variance P10,000 F
Answer: a

15. DIRECT LABOR VARIANCE ANALYSIS
Labor cost variance is the difference between actual labor cost and standard labor cost.
This variance may be analyzed into two components namely: the labor rate variance and the labor usage or efficiency variance
The possible causes of labor rate variance are as follows:
Inexperienced workers hired
Change in labor rate particularly peak season that has not been incorporated in standard rate
Use of an employee having a wage classification other than that assumed when the standard for a job was set
Use of a greater number of higher-paid employees in the group than anticipated.
Responsibility: if production line supervisors have the authority to match workers and machines to task by hiring the proper grade of labor, line supervisors should be responsible. They will also be responsible if they control the wage rate of their labor force. If they do not, the Personnel Department may be responsible.

16. The possible causes of labor efficiency variance are as follows:
Good or poor training of workers
Poor materials or faulty equipment
Good or poor supervision and scheduling of work
Experience or lack or experience on the job
Inefficient equipment
Machine breakdown
Nonstandard materials being used
Responsibility: Production line supervisors should be held responsible for labor under their control. The Production Planning Department or the Purchasing Department should be held responsible for any labor efficiency variance that results from the use of non-standard material.

17. FORMULAS: Labor Rate Variance Actual Labor Rate P xx
Less: Standard Labor Rate xx
Difference in Rate xx
Multiplied by:
Actual Hours xx
Unfavorable (Favorable) P xx
Labor Efficiency or Time Variance
Less: Standard Hours xx
Difference in Hours xx
Standard Labor Rate P xx

18. SAMPLE: DIRECT LABOR RATE VARIANCE
Information on XYZ Co.’s direct labor costs for May 2005 is as
follows:
Standard direct labor hours ,000
Actual direct labor hours ,500
Total direct labor payroll P241,500
Direct labor efficiency variance – favorable P 3,200
What is XYZ Co.’s direct labor rate variance?
a. P17,250 F c. P21,000 F
c. P20,700 UF d. P21,000 F

19. SOLUTION: Actual Hours 34,500 Standard Hours 35,000 Difference (500)
x Standard Rate ?
Direct Labor Rate
Efficiency Variance P(3,200)F
Thus, P3,200 F / 500 = P 6.4 Std. Rate
Actual Rate = P241,500 / 34,500 = P7
Actual Rate P 7.00
Standard Rate
Difference in Rate P0.60
x Actual Hours 34,500
Direct Labor Rate
Variance P20,700 U
Answer: b

20. SAMPLE PROBLEM: DIRECT LABOR EFFICIENCY VARIANCE
Information on Ace Company’s direct labor cost is as follows:
Standard direct labor rate P 3.75
Actual direct labor rate P 3.50
Standard direct labor hours 10,000
Actual direct labor hours 11,200
What is the direct labor efficiency variance?
a. P4,200 UF c. P4,500 UF
b. P4,200 F d. P4,500 F

21. SOLUTION: Actual Hours 11,200 Standard Hours 10,000
Difference in Hours ,200
x Standard Rate P 3.75
Direct Labor Efficiency Variance P4,500 UF
Answer: c

22. FACTORY OVERHEAD VARIANCE ANALYSIS
VARIABLE MANUFACTURING OVERHEAD
Total variance manufacturing overhead variance is the difference between actual variable overhead and standard variable overhead allowed on actual output.
This may be broken down into:
a) Variable overhead spending variance
b) Variable overhead efficiency variance
The possible causes of variable overhead spending variance or price/controllable variance are as follows:
Actual costs, e.g. machine power, materials handling, supplies were different from those expected because of fluctuations in market prices or rates
Increase in energy costs
Waste in using supplies
Avoidable machine breakdowns
Wrong grade of indirect material and indirect labor
Lack of operators or tools
Responsibility: Supervisors of cost centers are responsible because they have some degree of control over these budget or expense factors.

23. The possible causes of variable overhead efficiency variances are as follows:
This is attributable to efficiency in using the base on which variable overhead is applied. So that if the basis of the variable overhead application is direct labor hours, the causes of the labor efficiency variance will also be the causes of the variable overhead efficiency variance.
Responsibility: Production line supervisors are responsible for this variance. This variance shows how much of the factory’s capacity has been consumed or released by off-standard labor performance. If machine-hours are the basis for applying factory overhead, the variance measures the efficiency of machine usage.

24. FIXED MANUFACTURING OVERHEAD VARIANCE ANALYSIS
In variance analysis, fixed manufacturing costs are treated differently from variable manufacturing costs.
It is usually assumed that fixed costs are unchanged when volume changes, so the amount budgeted for fixed overhead is the same in both the master and flexible budgets.
This is consistent with the variable costing method of product costing.
There are no input-output-relationships for fixed overhead.
The difference between the actual fixed overhead and the budgeted fixed overhead at normal capacity falls under the category of a price variance (also called spending or budget variance)
The difference between the budgeted fixed overhead and applied fixed overhead represents the volume or capacity variance

25. The possible causes of capacity or volume variance are as follows:
Poor production scheduling
Unusual machine breakdowns
Storms or strikes
Fluctuations over time
Decrease in customer demand
Excess plant capacity
Shortage of skilled workers

26. TWO-WAY VARIANCE METHOD
COMBINED MANUFACTURING OVERHEAD (Variable and Fixed) VARIANCE ANALYSIS:
TWO-WAY VARIANCE METHOD
Controllable Variance
Actual Factory Overhead (AFOH) Pxx
Less: Budget allowed based on Std. Hrs. (BASH)
Fixed (at normal capacity) Pxx
Variable (Std. Hrs.* x Variable
Overhead Rate) xx xx
Unfavorable (Favorable) Pxx
Capacity or Volume Variance
Budget allowed based on Standard Hours (BASH) Pxx
Less: Standard hours x Standard Overhead Rate (SHSR) xx
Unfavorable (Favorable) Pxx
Total Manufacturing Overhead Variance Pxx
* Standard Hours = Equivalent Production or Allowed hours based on actual production x Standard hours per unit

27. THREE-WAY VARIANCE METHOD
Spending Variance
Actual Factory Overhead (AFOH) P xx
Less: Budget allowed on Actual hours (BAAH)
Fixed (at normal capacity) Pxx
Variable (Actual Hrs. x Variable Overhead Rate) xx xx
Unfavorable (Favorable) P xx
Variable Efficiency Variance
Budget allowed on Actual Hours (BAAH) P xx
Less: Budget allowed on Standard hours (BASH)
Fixed (at normal capacity) Pxx
Variable (Std. Hrs. x Variable Overhead Rate) xx xx
Unfavorable (Favorable) P xx
Volume Variance
Budget allowed on Standard Hours (BASH) P xx
Less: Standard hours x Standard Overhead Rate (SHSR) xx
Unfavorable (Favorable) P xx
Total Overhead Variance P xx

28. FOUR-WAY VARIANCE METHOD
SPENDING VARIANCE
Actual Factory Overhead (AFOH) P xx
Less: Budget Allowed based on Actual Hours (BAAH) xx
Unfavorable (Favorable) P xx
VARIABLE EFFICIENCY VARIANCE
Budget Allowed based on Actual Hours (BAAH) P xx
Less: Budget Allowed based on Standard Hours (BASH) xx
Unfavorable (Favorable) P xx
FIXED EFFICIENCY or EFFECTIVENESS VARIANCE
Standard Hours xx
Less: Actual Hours xx
Unfavorable (Favorable) xx
Multiplied by: Fixed Overhead Rate xx
Unfavorable (Favorable) P xx
IDLE CAPACITY VARIANCE
Normal Capacity Hours xx
Less: Actual Hours xx
Unfavorable (Favorable) xx
Multiplied by: Fixed Overhead Rate xx
Unfavorable (Favorable) P xx

29. SAMPLE PROBLEM: FACTORY OVERHEAD VARIANCES
The STD Household Company has established standard costs for the cabinet department, in
which one size of MX cabinet is made. The standard costs of producing one of these MX
cabinets are shown below:
Standard Cost Card – MX Cabinet
Direct Material: Lumber 50 board feet at P4 P200
Direct Labor: 8 hours at P
Overhead Costs: Variable – 8 hours at P
Fixed – 8 hours at P
Total Standard Unit Cost P344
During June 2004, 500 of these cabinets were produced. The cost of operations during the
month is shown below. There are no work-in-process at the beginning and end of the
month.
Direct material purchased: 30,000 board feet at P4.10 P123,000
Direct materials used: 24,000 board feet
Direct labor: 4,200 hours at P ,900
Overhead costs: Variable costs ,000
Fixed costs ,000
The budgeted overhead for the cabinet department based on normal monthly activity of
4,500 hours is P36,000 of which P22,50 is variable and P13,500 is fixed overhead.
REQUIRED: Compute for the Factory Overhead Variance using: (a) Two-way analysis, (b) Three-way analysis and (c) Four-way analysis

30. Thank you!