ACC 206 STRATEGIC COSTING AND VARIANCE ANALYSIS Chapter 1

Module for

ACC 206

Standard Costing and

Variance Analysis

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 ACC 206 STRATEGIC COSTING AND VARIANCE ANALYSIS Chapter 1

Module 3
Strategic Costing and Variance Analysis
Week 5-6

STANDARD COSTING AND VARIANCE ANALYSIS

At the end of the chapter, you should be able to:
Discuss the concept of standards and standards-setting.
Explain the relevance of the different levels of capacity used in standards-setting.
Interrelate standards with planning, organizing, directing, and controlling.
Determine and analyze the costs variances of direct materials, direct labor, variable overhead and fixed
overhead.
Compute the materials mix and yield variances.
Explain the various ways of disposing cost variances.

DISCUSS THE CONCEPT OF STANDARDS AND STANDARDS-SETTING.

Manufacturing, service, food, not-for-profit organizations and even financial institutions all make use of
standards ( in terms of either costs or quantities) to some extent.
Auto service centers offer set labor time standards for the completion of certain work tasks and then
measure actual performance against these standards. Fast-food outlets such as Jollibee, McDonalds have
exacting standards as to the quantity of meat going into a sandwich, as well as standard for the cost of the
meat. Hospitals have standard cost for laboratory tests, for food, laundry and other items for each occupied
bed.
In short, the business student is likely to run into standard costs concepts in almost any line of business that
she or he may enter.
When you hear the word standard, what comes first into your mind? In every activities and task that you are
doing, be it in school or at home, do you set standards or expectations in your output? If so, were you able
to achieve your target or expectations? Were you able to meet the standard you set?
In this chapter, we are to focus on the use of standards in costing within the organization.
Standards
Expected levels of performance
Established to institute order, discipline, expectations and normalcy.
Expressed and used in many forms:
Societal standards – reflective of ethics, values culture, traditions, beliefs, laws and decrees.
Organizational standards – expressed in policies, procedures, rules, regulations, manuals and systems.
can be financial or non-financial, quantitative or non-quantitative.
Standards are oftentimes quantitative for objectivity in measurement. These are standards established and
followed in accounting, treasury, engineering, design, legal, administration, marketing, human resources,
distribution, customer relations, information technology and other areas of responsibility centers.
In the field mmmmof financial accounting, the standards used are the International Financial Reporting
Standards
In the field of taxation, tax laws and regulations are the standards
Used in almost all facets of management – planning, organizing, directing, and controlling.

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In planning – standards serve as basis for forecasting.

By using standards, we were able to project the expected outcome of a particular undertaking. Given the
output set by management, we can determine what inputs (costs) necessary to produce such output.
In organizing and directing – standards are used as indicators to monitor production yield rate, conformity
or nonconformity with administrative policies, and personnel efficiencies.
In this stage of management, standards serve as guide on whether they are still performing as expected or
they are already deviating from what has been set as standard.
In controlling – standards are used in costs variances analyses for on-line monitoring and adjustments and
for end-of-the line evaluation and remedial actions.
Given that standards were used in forecasting, organizing and directing, it will be necessary to analyze the
variation with the expectations through the controlling function. Here, possible causes and reasons of
variances were identified and analyzed as basis for remedial actions.
Standards setting
Strategic in nature
Could be set by
management,
outsourced from an independent entity,
developed by the industrial engineering department, or
established with the participation and involvement of lower level managers and personnel.
When standards are developed with the participation of operating personnel and officers, there appears no
reason for not meeting them.
Standards set by hands-on personnel are more reflective of the realities in the production line and other
facets of business operations.
It is a matter of managerial prerogative.
This standard setting could either
motivate or de-motivate employees,
if the standards set are too high and improbable to achieve, it will create dysfunctional employee behavior.
give relevance or insignificance in the meaning of their work, or
produce excellent or mediocre performance.
Standards that are set too low would attract mediocre performance and would fail to maximize the
potentials of employees.
Standards setting participated by those directly involve in the operations of the business will likely to
produce outcomes as expected. Since they were the ones who are actually performing the task, they have
the first hand information on what are actually happening in the operations.
Organizations need to be careful in setting the standard to be achieved by different areas or centers. It could
really affect their motivation to perform the task as well as the level of performance that they will exert for
them to achieve the expected target.
EXPLAIN THE RELEVANCE OF THE DIFFERENT LEVELS OF CAPACITY USED IN
STANDARDS-SETTING.
Standard levels
May be theoretical, practical or lax
Theoretical standards (or ideal, maximum efficiency, or perfection standards)

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Set at the highest possible capacity where there are no allowances for waster, spoilage, inefficiencies,
machine breakdowns and other downtimes, and other interruptions in the production line.
Standards bring the organization at the level of business operations where machines, systems, and personnel
are working in the best possible situation without allowances for normal operational interruptions.
It is based on the work of most skilled workers, most efficient machines, and best production design and
processes.
These standards may bring in positive attitude and behavior if employees are motivated to strive for quality
and excellence.
If the standards are perceived to be too high to attain, employees react negatively – this defeats the
motivational purpose of standards.
These are adopted by companies which employ total quality management principles.
Still, these are normally replaced by practical standards in financial planning and controlling to make
estimated financial data more reliable.
These standards are usually not attainable because they do not allow for any machine breakdowns or other
work interruptions and require the most skilled and efficient employees working at peak effort 100% of
time.
Practical standards (or currently attainable standards)
Normal and expected actual standards and are “tight but attainable”
Attain the most reasonable production level, with allowances for machine breakdowns, downtimes,
inefficiencies, waste and spoilage, and other normal production disturbances.
These standards still require utmost efficiency and optimum use of resources under normal circumstances.
They are reasonable and attainable.
Variances from such a standard are very useful to management in that they represent deviations that fall
outside of normal, recurring inefficiencies that signal a need for management attention.
Lax standards (or slack standards)
Provide the maximum allowances for inefficiencies and ineffectiveness and are not geared towards
producing less than the reasonable output from the process.
A sure fire formula to slowdown activities and make the business much less competitive and self-sustaining.
BUDGETS, STANDARDS, AND NORMAL VOLUME
Note: Budgets, standards and normal volume differ in terms of usage (or quantity) but not in their rate per
unit.
Capacity Discussion Formula
Budgeted capacity/
Expected actual capacity The estimated level of performance that the company plans to achieve in the next
12 months.
This is the budgeted production that the company sets at the start of the period.
Budgeted quantity is based on budgeted level of production.
This is the budgeted quantity (e.g., materials/ingredients) to produced the budgeted production
Budgeted quantity = Budgeted unit of production
x
Standard quantity (e.g. pounds or hours) per unit of product
Standard capacity The estimated capacity that should have been used in actual capacity.
Standard quantity = Actual production (in units)

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x
Standard quantity rate per unit produced
Normal capacity/
Normal volume May be set based on the average sales demand of the product, engineering estimates and
technical specifications, legal variables, cultural orientation, or other factors
The average production level of the business over the period covered by the budget
The middle point of variations in the budgeted production levels serving as the basis in budgetary planning
where the concept of stability is of prime importance.
It is also the basis in determining the fixed overhead rate Standard fixed overhead rate =
Budgeted fixed overhead
Normal capacity

Take note of the difference between the term “capacity” and “quantity”. Capacity was the number of units
to be produced or actually produced while quantity is the required inputs (e.g., pounds, hours, kilograms) to
produce such capacity.
Sample Problem 1. Capacity Levels
Melanie Corporation acquired a machine with a 200,000 units level of capacity five years ago. Using this
machine, the standard labor time is 2 hours per unit. Engineering estimates based on attainable
performance is 170,000 units. Management has planned to produce only 160,000 units in the coming year
using the same machine. Total production in the last five years is 828,000 with annual production recorded
as follows:
First year 180,000 units
Second year 140,000 units
Third year 170,000 units
Fourth year 182,000 units
Fifth year 156,000 units

The capacity levels are as follows;

Units Hours
(units x 2 hrs)
Maximum capacity 200,000 units 400,000 hrs
Practical capacity 170,000 340,000
Budgeted capacity 160,000 320,000
Normal capacity (828,000 units/ 5 yrs) 165,600 331,200
Standard capacity first year 180,000* 360,000

* The standard hours is based on the actual capacity, and in this case is 180,000 units.

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In solving standard costing problem, one of the challenges and difficulties commonly experienced by
students was the capacity to be used; was it budgeted, standard or normal? With the table provided earlier,
students will be guided on when to use the different volume of activity in determining the required capacity.
Standard Costs
Comprise the standard quantity and standard price
Standard quantity x Standard price
Used to motivate optimal productivity and efficiency
These are monetary measures with which actual costs are compared to.
It may be based on engineering, accounting and statistical quality control studies.
These are used in all phases of managerial functions.
It is also applied in all types of industries where performance levels could be established based on historical
performance, time and motion study, and other means of establishing performance.
Standard quantities and prices are to be established by the standard-setting committee created for such
purpose.
This sub-committee, under the supervision of the Budget Committee, is composed of the chosen operating
managers from various functional lines of operations such as production, purchasing, human resources,
payroll, legal, industrial engineering, accounting, among others.
Standard costs are bases of intelligent forecasting and projections. The determination of standard unit costs
ordinary needs the participation of middle and lower level managers.
Let us consider the following standard cost per unit:
Table 1. Departmental Standard Costs Sheet
Mela Company Date Established 11.20.2018
Cutting Department Product Tungki
Standard Costs Sheet

Qty Price Unit Cost

Direct materials
AA – 44 3 lbs @ P 2.00 P 6.00
BB – 77 6 pcs @ P 6.20 37.20
CC -12 4 units @ P 3.40 13.60 P 56.80
Direct labor 4 hrs. @ P 7.00 28.00
Variable overhead 4 hrs. @ P 3.00 12.00
Fixed overhead 4 hrs. @ P 5.00 20.00
Total Standard Unit Cost P 116.80

The standard materials per unit (e.g., 3 lbs, 6 pcs., 4 units) may be initially determined by the production
manager and the standard number of hours to make a unit of output may be based on the study of the
industrial engineering department.
The unit materials costs (cost of inputs) shall be primarily determined by the purchasing manager.
The quality and specifications of the materials shall however be that of the production manager.

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The standard labor rate may be estimated on the advice of the human resource manager, legal officer, and
the production manager.
The standard variable overhead rate is determined based on past experiences with adjustments on current
and anticipated developments that impact variable overhead.
The fixed overhead rate is based on normal capacity.
STANDARD RATE OR PRICE should be based on A NET BASIS.
STANDARD HOURS AND QUANTITY should be set AT GROSS BASIS AFTER INCLUDING
ALLOWANCES for spoilage, breakdowns, and similar events.
The standard quantities and prices shall be consensusly developed and recommended for approval by the
standard-setting committee.
As can be seen, different departments are involved in the determination of standard base or rate to be used
in standard costing. Take note also of the basis used in determining standard rate or price (net basis) and
standard hours and quantity (gross basis after including allowances). It is necessary for the students to take
note of these concepts.
Sample Problem 2. Setting Standard Materials Costs
Southern Corporation produces product Durito weighing 3.2 lbs., net of the 20% processing loss. It buy
materials from a supplier at an invoice price of P 40 per lb. with a normal trade discount of 2/10, n/30.
Freight for the delivery of materials costs P 5 per lb. What is the standard materials quantity, price, and cost
per unit?
Solutions/ Discussions:
Since it is not mentioned on when the production loss occurs, it is assumed it is incurred at the beginning of
the process. The standard costs are determined as follows:
Standard materials input = Standard materials output/ (100 - Loss rate)
= 3.2 lbs. / 80% = 4 lbs.
Standard price per lb:
Purchase price P 40 x 98% P 39.20
Freight-in 5.00
Standard price per lb. P 44.20

Standard materials costs = Standard materials input x Standard net price

= 4 lbs. x P 44.20 = P 176.80

Notes:
Again, if we are to look on the previous discussion, standard quantity should be on gross basis including
allowances for shortage, breakdown and similar events. That is why, instead of using only 3.2 lbs, we used
the gross quantity of 4 lbs. which is gross of the loss rate.
On the other hand, in determining standard price, we used the net basis. Meaning, we used the purchase
price net of trade discount. Additionally, since freight-in is a necessary cost of acquiring the materials, we
included such as part of the standard price calculation.
As discussed in the first part of standard cost topic, standard cost is equal to standard rate x standard
quantity. Thus, after determining the standard price (net basis) and standard quantity (gross basis including
allowances), we were able to compute for out standard cost of materials.
Sample Problem 3. Setting Standard Labor Costs

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Northern Corporation produces product Durito after 45 minutes of direct labor time. The company pays
its production personnel for eight (8) hours a day and gives a 30-minute daily paid breaktime. It normally
starts its process with 5,000 units and completes at 4,500 good units. It pays its personnel at an hourly rate
of P 70 plus social welfare benefits of approximately 10% on the basic rate. What is the standard direct
labor hours, rate, and cost per unit?
Solutions/ Discussions:
The productivity rate is 90% (i.e, 4,500/5,000). Since it is not mentioned on when the loss occurs, it is
assumed to have happened at the start of the process. The standards are determined as follows:
Standard direct labor hours = Standard output time/ (100 – loss rate)
= 45 minutes / 90%/ (7.5/8)
= 53.3333 minutes or 0.888889 hr.

Standard direct labor rate per hour:

Basic wage rate per hour P 70.00
Fringe benefits (10%) 7.00
Standard rate per hr. P 77.00

Standard direct labor costs = Standard direct labor time x Standard labor rate
= 0.888889 hrs. x P 77.00 = P 68.4444
Notes:
It should be noted that standard direct labor hours should be stated at gross of allowances for breakdowns,
and similar events while standard direct rate per hour should be stated on a net basis. Thus, standard direct
labor cost is the product of standard direct labor time and standard labor rate.

Mela Company Date established 11.12.2018

Laguna Plant Product Tungki
Standard Costs Sheet
Cutting Assembly Packaging Total
Direct materials
AA – 44 3 lbs @ P 2.00 P 6.00
BB – 77 6 pcs @ P 6.20 37.20
CC – 12 4 units @ P 3.40 13.60 13.60
DD – 55 6 units @ P 2.00 12.00 82.40
Direct labor
Activity – Operation
AA – 12 4 hrs @ P 7.00 28.00
BB – 23 3 hrs @ P 4.00 12.00
CC – 44 2 hrs @ P 6.00 12.00 12.00
DD – 55 3 hrs @ P 6.00 18.00 82.00
Variable Overhead

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Activity/ Operation Allocation Basis Standard Basis Rate

AA – 12 Set-up time P 1.25 P 12.00 15.00
BB – 23 Machine hours 2.00 8.00 16.00
CC – 44 DL hours 0.75 10.00 7.50
DD – 55 DL hours 1.75 10.00 17.50 56.00
Total Standard Unit Costs P 139.80 P 33.10 P 47.50 P 220.40
Each department should have its own standard costs sheet. The plant operations should also have
its plant’s standard costs sheet which is a summary of all departmental standard costs sheets. An example of
a plant standard cost sheet is shown below:

Standard costs shall be regularly evaluated to maintain relevance, validity, and reliability.

Uses of standard costs

Some of the most regular uses of standard costs are as follows:
Profit planning and cost-volume-profit analysis.
Standard costs are used in predicting scenarios under varying conditions of volume, prices, and costs
leading to the basic analysis and sensitivity analysis of contribution margin, margin of safety, and operating
leverage.
Responsibility accounting
Standard costs are used to make the assignment of controllable and non-controllable costs more meaningful
and acceptable to managers of various responsibility centers.
Budgeting
Standard costs are used as reliable bases in anticipating budgeted costs and expenses.
Performance evaluation
Standard costs are used as meaningful benchmarks in evaluating actual performances of center managers,
otherwise known as “costs variances analysis”
Pricing
Standard costs are used in setting regular as well as incremental sales prices used in determining the right
and winning amount of bid prices most specially in a stiff competitive bidding.
Interim reporting
Standard costs are very useful in interim reporting where to compare with actual costs in evaluating
situations and alternatives and in making managerial decisions.
Bases of Costs Variances
Costs variance analysis may be based on master budget or flexible budget.
Static (or master) budget variance
the broadest type of variance
it is the difference between the actual amount and the budgeted amount
composed of the flexible budget variance and the sales volume variance
flexible budget variance
the difference between actual costs and standard costs in a given level of activity

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it is analyzed in relation to sales prices, costs, and input quantities

sales volume (or sales activity) variance
the difference between flexible budget and static budget amounts, assuming sales prices and costs are
constant.
Its components are the sales mix and the sales quantity variances.
Sales quantity variance may still be divided into the market share variance and the market size variance.
Table 3. Costs Variances
Actual Costs
Master Variance Flexible Budget Variance
or Total Variance Flexible Budgets
Production Capacity or Volume
Variance
Master Budgets

Note:
Our focus in this chapter is on the flexible cost variances.

Flexible Costs Variances

The difference between actual and standard cost is called a “variance”
It is sometimes called as the “planning gap”
A variance should be investigated, analyzed, studied, and the same should be avoided in the future.
It may be unfavorable or favorable.
If actual cost is more than the standard cost, the variance is unfavorable. Otherwise, it is favorable.

Note:
It was called as planning gap since there was a deviation when plans at the start of the period were
compared to the cost actually incurred.

Table 4. Costs Variances – Unfavorable or Favorable

Case 1 Case 2
Actual costs P 650,000 P 790,000
Standard costs 600,000 (800,000)
Variances – UF (F) P 50,000 UF P (10,000) F

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Also referred to as Debit variance Credit variance

UF = Unfavorable F = Favorable
Notes:
Unfavorable variance occurred when actual cost is higher compared to standard cost.
Other term for unfavorable variance is debit variance.
Favorable variance occurred when actual cost is lower compared to standard cost.
Other term for favorable variance is credit variance.
Case 1
Cost variance is unfavorable (e.g., positive) because there is an excess cost of P 50,000.
The business is supposed to spend only P 600,000 but spent P 650,000 instead, so there is an increase in
costs, an overspending and an unfavorable variance.
Case 2
The costs variance is favorable (e.g., negative) because there is a saving.
The business is allowed to spend P 800,000 but spent only P 790,000, so there is a reduction in costs.
Unfavorable cost variance
Called a debit variance because it is added (i.e., debited) to cost of goods sold at standard to get the actual
cost of goods sold.
Favorable cost variance
Called a credit variance because it is deducted (i.e., credited) from cost of goods sold at standard to get the
actual cost of goods sold.
Actual results almost always deviate from plans. This deviation is to be considered by management in
determining the normal range of expectations. The normal range (+ or – from average) is bounded by the
maximum estimates (i.e., high-end) and limited below by the minimum estimate (i.e., low-end). Say a
telecommunications cost is expected to hit an average of P 500,000 in 2019, plus or minus a 5% deviation,
or plus or minus P 25,000. The normal range would be:
Table 5. Illustration of Tolerable or Normal Deviation
High-end limit (P 500,000 x 105%) P 525,000
+ P 25,000 normal deviation
Average 500,000
- P 25,000 normal deviation
Low-end limit (P 500,000 x 95%) 475,000

A variance may be a normal variance or an exceptional variance.

If the actual cost is registered at P 520,000, the variance is P 20,000 and is within the P 25,000 normal
deviation.
A normal variance like this is ordinarily delegated to the junior managers for analysis, explanations, and
corrective actions.
Now, if the actual cost is P 540,000, the variance is P 40,000 (i.e., P 540,000 – P 500,000) and is greater
than the normal variance of P 25,000.
The P 40,000 variance is considered as material, unusual or “exceptional” variance.
An exceptional variance is given top priority by upper management (i.e., management by exception)

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Production Cost Variances

Production cost
Composed of direct materials, direct labor, and factory overhead.
Each of these elements of costs has their respective variances.
Direct materials have price and quantity variances.
Direct labor has rate and efficiency variances.
Factory overhead has controllable and volume variances.

To illustrate the production costs variance analysis, let us consider the following sample problems “4 to 6”.

Sample Problem 4. Direct Materials and Direct Labor Costs Variances

The standard unit cost of Melanie Company is given below:
Direct materials 4 lbs. @ P 4.00 P 16.00
Direct labor 3 hrs. @ P 8.00 24.00
Variable overhead 3 hrs. @ P 2.00 6.00
Fixed overhead 3 hrs. @ P 3.00 9.00
Total standard unit cost P 55.00

The company has a normal capacity of 135,000 units and a budgeted capacity of 132,000 units. Actual data
taken from the production records in the month of September 2019 are as follows:
Actual production 130,000 units
Materials purchases (580,000 lbs. @ P 3.90) P 2,262,000
Materials used 525,000 lbs.
Payroll incurred (380,000 lbs. @ P 8.15) P 3,097,000
Factory overhead: Variable P 800,000
Fixed P 1,250,000
Required: Using the 2-way and 3-way analyses, determine the following:
Direct materials costs variances
Direct labor costs variances

Solutions/ Discussions:

Direct Materials Costs Variances Analyses

Note: Before we start this discussion, bear in mind that what we are about to tackle was the inputs or
resources/ingredients necessary for us to produce a unit of product.

Direct materials cost is basically affected by two factors: quantity and price.

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The difference between actual materials and standard materials is materials variance (this is the total
variance for direct material cost). There is a difference between actual and standard in terms of price and
quantity.
Materials Price Variance – the difference in price per quantity
Materials Quantity Variance – the difference in quantity
As such, material variances are classified as price variance and quantity variance, as shown below:

Direct Materials Cost

Quantity Unit Price Amount
Actual1 525,000 lbs. P 3.90 P 2,047,500
- Standard2(130,000 units x 4 lbs.) 520,000 4.00 2,080,000
Variances – UF (F) 5,000 UF P 0.10 F P (32,500) F

1 For illustrative purposes, the actual materials used is applied in the table analysis above.
2 Standard quantity is estimated quantity based on actual production. The phrase “actual quantity used”
also refers to equivalent production, if the business is using process costing in accumulating production
costs.

The standard materials per unit and the standard price remain constant.
The total peso value of these materials variances are computed as follows:

Table 6. Direct Materials Costs Variances, 2-way Analysis

2 – way analysis
Materials Price Variance = (Actual Price – Standard Price) x Actual Quantity = P x AQ

Materials Quantity Variance = (Actual Quantity – Standard Quantity) x Standard Price = Q x SP

MPV = (AP-SP) x AQ = (P 3.90 – P 4.00) x 525,000 lbs. = P (0.10) F x 525,000 lbs. = P (52,500) F
MQV = (AQ-SQ) x SP = (525,000 – 520,000) x P 4.00 = 5,000 UF x P 4.00 = 20,000 UF
Net Direct Materials Costs Variance P (32,500) F

Variances whether favorable or unfavorable need to be studied, analyzed and given solutions to avoid
repeating the same in the next production cycle.

Determining price and quantity (or usage) variances allows management to evaluate the efficiency of the
purchasing and the production departments.

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Materials price variance is primarily the responsibility and accountability of the purchasing department.
However, the Production Planning 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 than those initially included in the bill of
materials.
A favorable materials price variance
indicates savings generated from lower cost of materials purchased, and
contributes to the increase in the overall estimated profit of the business.
Yet, investigations should be done on why there is a favorable variance. Some reasons for a favorable
variance are:
Unforeseen reduction in prices of materials ordered due to market forces
Unnecessary compromise in the quality of materials ordered
Standards set for materials price per unit is impartially overstated

An unfavorable materials quantity (or efficiency) variance indicates overspending in terms of units used.
This variance is primarily the responsibility and accountability of the production manager. Possible
explanations on this variance include:
Frequent machine and production downtimes,
Personnel inefficiencies
Weak production scheduling
Understatement in the standard quantity of materials per unit

Notes:

Another technique of solving direct material cost problem is through the acronym provided below:
Actual Quantity x Actual Price AQAP
Actual Quantity x Standard Price AQSP
Standard Quantity x Standard Price SQSP

As can be observed, in order to compute for the materials price variance, what was different between the
first two formulas was the price used (actual and standard). Both formulas used the actual quantity of
materials. That is why, this can also be computed by multiplying the difference between the price and the
actual quantity of the materials.
On the other hand, for us to compute the materials quantity variance, what we used was the standard price
of the materials. It’s the quantity used that was different (actual and standard) and such difference was
multiplied to the standard price of materials. Thus, we can also compute this by multiplying the difference
between the actual and standard quantity and the standard price of the materials.

The direct materials cost variances may be analyzed using the 3-way analysis, as follows:

Table 7. Direct Materials Costs Variances – 3 –way Analysis

3 – way analysis

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Materials Price Variance = (Actual Price – Standard Price) x Standard Quantity = P x SQ

Materials Quantity Variance = (Actual Quantity – Standard Quantity) x Standard Price = Q x SP

Joint Materials Variance = (Actual Price – Standard Price) x (Actual Quantity – Standard Quantity)
= Px Q

MPV = (AP-SP) x SQ = (P 0.10) F x 520,000 lbs. P (52,000) F

MQV = (AQ-SQ) x SP = 5,000 UF x P 4.00 20,000 UF
Joint Materials Variance = (AP – SP) x (AQ – SQ) = (0.10) F x 5,000 UF (500)
Net Direct Materials Costs Variance P (32,500) F

3-way variance analysis

determines the materials price variance on standard quantity.
This differs from the 2-way variance analysis which determines price variance based on actual quantity.
The materials quantity variance is the same as that of the 2-way analysis.
The third variance is “joint materials variance” which is the product of the difference in price and the
difference in quantity.

There is an issue on when to determine the materials price variance

On the date of purchase, or on the date of issuance to production?
For better internal control, materials price variance should be determined at the earliest possible time,
which is the date of purchase. This would avoid recurring unnecessary price variances from the date the
materials are ordered until the date the materials are issued to production.
When the PROBLEM IS SILENT, the materials price variance should be based on materials purchases, as
follows:

Materials Purchase-Price Variance = (AP-SP) x Actual Quantity Purchased

= P (0.10) F x 580,000 lbs.
= P (58,000) F

2. Direct Labor Cots Variances Analyses

Except for terminologies, the manner in which the direct labor cost variances are analyzed is similar to that
of the direct materials.

Direct labor is also basically affected by two factors – hours and rate per hour.

In variance analysis, we consider the

labor cost as variable
the labor hour(s) per unit as constant, and

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the labor rate per hour as constant

There are differences in actual and standards in terms of hours, rate per hour and total costs.
Labor rate variance – the difference in rate per hour
Labor efficiency variance – the difference in hours
E.g. Efficiency is measured in terms of hours spent in an activity

Using the date in Sample Problem 4, the direct labor cost variances are presented below:
Direct Labor Cost
Quantity Unit Price Amount
Actual1 380,000 P 8.15 P 3,097,000
- Standard2(130,000 units x 3 hrs.) 390,000 8.00 3,120,000
Variances – UF (F) (10,000) F P 0.15 UF P (23,000) F

Total standard hours = Actual production x Standard hours per unit.

= (e.g., 390,000 = 130,000 units x 3 hrs)

Table 8. Direct Labor Costs Variances, 2-way Analysis

2 – way analysis
Labor Rate Variance = (Actual Rate – Standard Rate) x Actual Hours = R x AH

Labor Efficiency Variance = (Actual Hours – Standard Hours) x Standard Rate = H x SR

LRV= (AR-SR) x AH = (P 8.15 – P 8.00) x 380,000 hrs. = P 57,000 UF

LEV = (AH-SH) x SR = (380,000 – 390,000) x P 8.00 = 80,000 F
Net Direct Labor Costs Variance P (23,000) F

The unfavorable labor rate variance is the responsibility and accountability of the human resource manager
and, perhaps, the production supervisor.
In a labor-intensive production environment where direct labor costs immensely consist of the total
manufacturing costs, labor rate variance analysis is of great importance.
A reduction in wage rate will have reverberating effects on the cost competitiveness of an enterprise.
Sometimes, an unfavorable labor rate variance is a result of a negotiated labor contract. In this case, the
variance is no longer within the control of supervisors and middle operating managers.
It may also indicate assigning a multi-skilled, highly paid worker in a job that could be performed by a lowly
paid worker.
The supervisor should always examine unfavorable labor rate variance to be certain that workers are
allocated most efficiently.

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The favorable labor efficiency variance is the accountability of the production manager.
An increase in efficiency means increase in productivity that brings savings in the financial reports of the
business.
Efficiency may indicate more units produced, less idle time, and highly motivated work force which may be
converted into higher return on investment and operating competitiveness.

Favorable or unfavorable labor variances must be investigated, analyzed, and given remedy to minimize the
recurrence of the same variance, if not to abruptly and completely eliminate the variance.

Notes:

Another technique of solving direct labor cost problem is through the acronym provided below:
Actual Hours x Actual Rate AHAR
Actual Hours x Standard Rate AHSR
Standard Hours x Standard Rate SHSR

Table 9. Direct Labor Costs Variances – 3 –way Analysis

3 – way analysis
Labor Rate Variance = (Actual Rate – Standard Rate) x Standard Hours = R x SH

Labor Efficiency Variance = (Actual Hours – Standard Hours) x Standard Rate = H x SR

Joint Labor Variance = (Actual Rate – Standard Rate) x (Actual Hours – Standard Hours) = Rx H

LRV= (AR-SR) x SH = P 0.15 UF x 390,000 hrs. = P 58,500

UF
LEV = (AH-SH) x SR = (10,000) F x P 8.00 = (80,000) F
Joint Labor Variance = (AR – SR) x (AH – SH) = 0.15 UF x (10,000) F = (1,500) F
Net Direct Labor Costs Variance P (23,000) F

The difference between the 2-way and the 3-way direct labor variance analyses are found in the computation
of labor rate variance and the accounting for the joint labor variance.
The labor rate variance in the 3-way analysis is computed based on standard hours in contrast to the 2-way
analysis which is based on actual hours worked. The joint labor variance represents the mix variance of the
rate and efficiency variances.

Factory Overhead Variance Analysis

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Sample Problem 5. Factory Overhead Variances – 1

The following relevant data are taken from the records of Melanie Corporation:

Normal Capacity 135,000 units or 405,000 hours

(i.e., 135,000 units x 3 hrs.)
Standard Hours 390,000 hrs.
Actual Hours 380,000 hrs.
Standard overhead rates:
Fixed overhead rate P 3.00 per hour
Variable overhead rate 2.00 per hour
Total overhead rate P 5.00 per hour
Actual overhead costs
Variable, P 798,000, and Fixed, P 1,250,000

Required:
Variable overhead costs variances.
Fixed overhead costs variances

Solutions/ Discussion:
Variable overhead costs variances
The analysis for the variable overhead variance follows that of the direct materials and direct labor costs
variances. This is true because variable overhead, like direct materials and direct labor, is also a variable
cost.

The two (2) variable overhead costs variances, efficiency and spending variances, are computed as follows:
Variable Overhead Costs
Hours Rate/ Hr. Amount
Actual1 380,000
P 2.10 P 798,000
- Standard2(130,000 units x 3 hrs.) 390,000
2.00 780,000
Variances in units – UF (F) (10,000) F P 0.10 UF P 18,000 UF
x Base P 2.00 380,000
Variances in amount – UF (F) P (20,000) F P 38,000 UF
Variance description Efficiency Spending

Equationally, the variable overhead variances are determined as follows:

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VOH spending variance = (Actual VOH rate – Standard VOH rate) x Actual Hours
= (AR – SR) x AH
= (P 2.10 – P 2.00) x 380,000 = P 38,000 UF

VOH efficiency variance = (Actual hours – Standard hours) x Standard VOH Rate
= (AH – SH) x SVOR
= 380,000 – 390,000) x P 2 = P (20,000) F
Notes:

Another technique of solving variable overhead cost problem is through the acronym provided below:
Actual Hours x Actual Variable Overhead Rate AHAVOR
Actual Hours x Standard Variable Overhead Rate AHSVOR
Standard Hours x Standard Variable Overhead Rate SHSVOR

The computation for variable overhead variance follows the same pattern that we have used in direct labor
cost variance analysis. Actual Rate was replaced by Actual Variable Overhead Rate while Standard Rate was
replaced by Standard Variable Overhead Rate.

Fixed overhead costs variances

The two (2) fixed overhead cost variances are as follows:
Spending variance
Production volume variance

The computation for the fixed overhead variances are shown below

Actual fixed overhead P 1,250,000

FxOH Spending Variance = P 35,000
UF
Budgeted fixed overhead (405,000 x P 3) 1,215,000
FxOH Volume Variance = P 45,000
UF
Standard fixed overhead (390,000 x P 3) 1,170,000

Total fixed overhead variance P 80,000 UF

The budgeted fixed overhead is determined based on the normal capacity.

Alternatively, the fixed overhead volume variance is computed as follows:

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Volume variance = (Normal hours – Standard hours) x Standard fixed overhead rate
= (405,000 – 390,000) x P 3 = P 45,000 UF

The variable overhead has spending and efficiency variances, while the fixed overhead has spending and
volume variances.

Notes:

Another technique of solving fixed overhead cost problem is through the acronym provided below:
Actual Hours x Actual Fixed Overhead Rate AHAFOR
Normal Hours/Capacity x Standard Fixed Overhead Rate NHSFOR
Standard Hours x Standard Fixed Overhead Rate SHSFOR

Comparing with the direct labor cost variance analysis, in computing for fixed overhead cost variance,
Actual Rate was replaced by Actual Fixed Overhead Rate while Standard Rate was replaced by Standard
Fixed Overhead Rate. Also, Actual hours on the 2nd column was replaced with Normal Hours or capacity.

Sample Problem 6. Factory Overhead Costs Variances – 2

The following relevant data are taken from the records of Lanie Corporation

Normal Capacity 135,000 units or 405,000 hours

(i.3e., 135,000 units x 3 hrs.)
Standard Hours 390,000 hrs.
Actual Hours 380,000 hrs.
Standard overhead rates:
Fixed overhead rate P 3.00 per hour
Variable overhead rate 2.00 per hour
Total overhead rate P 5.00 per hour
Actual overhead costs
Variable, P 798,000, and Fixed, P 1,250,000

Required: Analyze the factory overhead variances using the:

2-way analysis (ConVo)
3-way analysis
4-way analysis
5-way analysis

Solutions/ Discussions
First, let us determine the total factory overhead variance, then analyze it into its components. The analyses
for factory overhead variances are presented on the succeeding pages.

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The total factory overhead variance is calculated below:

OVERHEAD
Fixed Variable Total
Actual factory overhead 1,250,000 798,000 2,048,000
Standard factory overhead 1,170,000 780,000 1,950,000
Variances - UF (F) 80,000 UF 18,000 UF 98,000 UF
Standard Factory overhead = Standard Hours x Standard Overhead Rate = SH x SR
Standard Fixed overhead = 390,000 hrs. x P 3.00 = P 1,170,000
Standard Variable Overhead = 390,000 hrs. x P 2.00 = P 780,000

In graphical form, detail of standard factory overhead is computed as follows:

The net factory overhead costs variance could be analyzed into 2 ways, 3 ways, 4 ways or 5 ways. However,
the more relevant variance analyses are the 2-way and the 3-way variance analyses.

2-way analysis (ConVo)

classifies the variances in relation to amount of money spent (i.e., controllable variance) or level of
production (i.e., volume variance).
The 2-way overhead variance analysis is presented below:

Controllable Variance Controllable Variance

Actual factory overhead P 2,048,000 AFOH
Less: Budgeted Allowance on Standard Hours
Fixed (P 405,000 hrs. x P 3.00) P 1,215,000
- BASH
Variable (390,000 hrs. x P 2.00) 780,000 1,995,000 P 53,000
UF

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Volume Variance Volume

Variance
Budgeted Allowance on Standard Hours 1,995,000 BASH
Less: Standard Factory Overhead
(390,000 hrs. x P 5) 1,950,000 45,000 UF
- SH x SR
Total Overhead Variance 98,000 UF

Supplemental discussion

The factory overhead costs 2-way analysis relationship is depicted below:

Actual factory overhead (AFOH)

Controllable Variance
Budgeted allowance on standard hours (BASH)
Volume Variance
Standard factory overhead (SH x SR)

Note: As can be seen in previous discussions that we had, there was a stated formula in computing for
budgeted fixed overhead and standard variable overhead. It will just be discussed again in this topic.

The budgeted fixed overhead is based on normal capacity and is computed as follows:
Budgeted Fixed Overhead = Normal Hours/Capacity xStandard Fixed OH Rate = NH x
SFxOR
= (135,000 units x 3 hrs.) x P 3.00/hr.
= 405,000 hrs. x P 3.00
= P 1,215,000

Budgeted fixed overhead is constant regardless of levels of production volume.

In computing the budget allowance on standard hours (BASH), the fixed overhead is the budgeted fixed
overhead while the variable overhead is standard hours times standard variable overhead rate (SVOR) = y=
a+ bx
Standard Variable Overhead = Standard Hours x SVOR

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You can also compute the Budget allowance on standard hours by using the formula Y = a + bx
Y - budget allowance on standard hours
a - Budgeted fixed overhead (normal capacity x standard Fixed OH rate)
b - standard variable overhead rate
x - standard hours

Controllable variance (AFOH – BASH)

Represents the change in the amount of money spent based on absolute peso amount and on the number
of hours used.
Composed of the spending variance and the variable efficiency variance which are both controllable in the
level of the supervisors.
It is useful in calling attention to a possible short-term problem in the control of overhead costs.
It is consists of both fixed and variable overhead variances.

Volume Variance (BASH – SHSR)

Measures the deviation in hours between the standard capacity from normal capacity.
It is strictly a fixed overhead variance.
Alternative computation:
Normal capacity 405,000 hrs.
Less: Standard capacity 390,000
Under (over) absorbed capacity 15,000 UF
x Fixed OH Rate P 3.00
Volume Variance P 45,000 UF
If the variance is positive, it is unfavorable because it essentially means that actual costs is greater than the
standard costs.
In the factory overhead variance analysis, the overhead rate per hour is a more relevant rate than the
overhead rate per unit.

Note: Again, take note that volume variance is strictly a fixed overhead variance.
Though we used the formula BASH – SHSR, if we are to analyze, they only differ on their fixed cost
component.
BASH = Normal Capacity x Standard Fixed Overhead Rate + Standard Hours x Standard Variable
Overhead Rate
SHSR = Standard Hours x Standard Fixed Overhead Rate + Standard Hours X Standard Variable
Overhead Rate
Difference between BASH and SHSR

3-way analysis … Method 1 (SEV)

The controllable variance could still be divided into two,

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the spending (or budget variance) and

the variable efficiency variance.
As such, we will now have three overhead variances:
Spending,
Efficiency, and
Volume variances.
Computations are as follows:

Table 11. Factory Overhead Costs Variances, 3-way Analysis

Spending (Budget) Variance Spending (Budget)

Variance
Actual factory overhead P 2,048,000 AFOH
Less: Budgeted Allowance on Actual Hours -BAAH
Fixed P 1,215,000
Variable (380,000 hrs. x P 2.00) 760,000 1,975,000 P 73,000 UF

Efficiency Variance Efficiency Variance

Budgeted Allowance on Actual Hours 1,975,000 BAAH
Less: Budgeted Allowance on Standard Hours 1,995,000 (20,000) F
-BASH
Volume Variance Volume Variance
Budgeted Allowance on Standard Hours 1,995,000 BASH
Less: Standard Factory Overhead 1,950,000 45,000 UF
SH X SR
Total Overhead Variance P 98,000 UF

Supplemental Discussions:
The structural relationships among variables used is depicted below:

Actual factory overhead (AFOH)

Spending Variance
Budgeted allowance on actual hours (BAAH)
Efficiency Variance
Budgeted allowance on standard hours (BASH)
Volume Variance
Standard factory overhead (SHSR)

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In determining the budgeted overhead amounts, the budgeted fixed overhead does not change regardless of
level of activity or level of hours used.
The budget allowance on standard hours has already been determined in the 2-way variance analysis and
discussions.
Spending variance is the rate variance.
It indicates the difference in the amount of money spent per unit produced or per hour used.
It is also called a budget variance.
The variable efficiency variance refers to the amount of money spent on the difference in hours used
relative to variable overhead. It may also be computed as shown below:
Actual hours 380,000 hrs.
Less: Standard hours 390,000
Change in hours (10,000) F
x Variable overhead rate P 2.00
Variable efficiency variance P (20,000) F
It should be emphasized that there is only one efficiency variance using the standard costing system, that is,
the variable efficiency variance.
As we have discussed earlier in 2-way analysis, you can also compute the Budget allowance on standard
hours by using the formula Y = a + bx
Y - budget allowance on standard hours
a - Budgeted fixed overhead (normal capacity x standard Fixed OH rate)
b - standard variable overhead rate
x - standard hours

In the same way, you can compute for the budget allowance on actual hours by using the same formula, Y =
a + bx.
The difference this time was that instead of x = standard hours, x now becomes actual hours. Thus,
Y - budget allowance on standard hours
a - Budgeted fixed overhead (normal capacity x standard Fixed OH rate)
b - standard variable overhead rate
x - actual hours

4-way analysis
The spending variance in the 3-way analysis above could still be divided as to fixed spending variance or
variable spending variance. This makes our overhead analysis into a 4-way analysis, as follows:

Table 12. Factory Overhead Costs Variances, 4-way Analysis

Fixed Spending Variance Fixed Spending

Variance
Actual Fixed Overhead P 1,250,000
AFxOH

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Less: Budgeted Fixed Overhead 1,215,000 P 35,000 UF

-BFxOH
Variable Spending Variance Variable Spending
Variance
Actual Variable Overhead 798,000 AVOH
Less: Actual hours x Variable overhead rate
-AH x SVOR
(380,000 x P 2.00) 760,000 38,000 UF
Variable Efficiency Variance Variable Efficiency
Variance
Budgeted Allowance on Actual Hours 1,975,000 BAAH
Less: Budgeted Allowance on Standard Hours 1,995,000 (20,000) F
-BASH
Volume Variance Volume Variance
Budgeted Allowance on Standard Hours 1,995,000 BASH
Less: Standard Factory Overhead 1,950,000 45,000 UF
SH X SR
Total Overhead Variance 98,000 UF

Supplemental Discussions:
The spending variance can be analyzed as follows:
Fixed Variable Total
Actual overhead P 1,250,000 P 798,000 P 2,048,000
Budgeted overhead on
actual hours (405,000 hrs. x P 3) 1,215,000
(380,000 hrs. x P 2) 760,000 1,975,000
Spending variances P 35,000 UF 38,000 UF P 73,000 UF

Just to have a recap, we discussed about the 2-way (controllable – volume) analysis of variance, followed by
3-way (spending – efficiency – volume) analysis of variance. 2- way analysis has an acronym of CON-VOL
while 3-way analysis has an acronym of S-E-VOL.
In the 4-way [spending (variable) – spending (fixed) – efficiency – volume] analysis of variance, we further
divided the spending variance into its fixed and variable components. The remaining computation was just
the same. The acronym for 4-way analysis was S-S-E-VOL.

5-way analysis
Under the normal costing method, the volume variance is composed of the idle capacity variance and the
fixed efficiency variance. Splitting the volume variance into two will bring us to the 5-way overhead variance
analysis:

Table 13. Factory overhead costs variances, 5-way analysis

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Fixed Spending Variance Fixed Spending

Variance
Actual Fixed Overhead P 1,250,000
AFxOH
Less: Budgeted Fixed Overhead 1,215,000 P 35,000 UF
-BFxOH
Variable Spending Variance Variable Spending
Variance
Actual Variable Overhead 798,000 AVOH
Less: Actual hours x Variable overhead rate
-AH x SVOR
(380,000 x P 2.00) 760,000 38,000 UF
Variable Efficiency Variance Variable Efficiency
Variance
Budgeted Allowance on Actual Hours 1,975,000
BAAH
Less: Budgeted Allowance on Standard Hours 1,995,000 (20,000) F
-BASH
Capacity Variance Capacity Variance
Budget Allowance on Actual Hours 1,975,000
BAAH
Less: Actual hours x Standard overhead rate
-AH x SR
(380,000 x P 5) 1,900,000 75,000 UF
Fixed Efficiency Variance Fixed Efficiency
Variance
Actual Hours 380,000 hrs
Less: Standard hours 390,000
Change in hours (10,000) F in hours

x Fixed Overhead Rate P 3.00 (30,000) F

x FxOH rate per hour
Total Overhead Variance P 98,000 UF

Supplemental Discussion:
Capacity variance measures the ability of the business to produce under or over its normal production level.
The idle capacity variance could be alternatively calculated as follows:

Normal capacity 405,000 hrs.

Less: Actual capacity 380,000

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Under (Over) absorbed capacity 25,000 UF

x Fixed Overhead Rate P 3.00/hr.
Idle Capacity Variance P 75,000 UF

The variable overhead efficiency, fixed overhead efficiency, and total overhead efficiency variances are
alternatively calculated as shown below:
Fixed Overhead Variable Overhead Total Overhead
Change in hours (AH-SH) (10,000) F (10,000) F (10,000)
F
x Overhead Rates P 3.00 P 2.00 P 5.00
Spending variances P (30,000) F P(20,000) F P (50,000) F

In standard costing, the fixed overhead efficiency variance is of little significance and is always considered to
be zero. This is because the fixed overhead variance analysis is determined based on hours and not in units.
Fixed overhead is not logically related to hours (i.e., efficiency) but rather is more appropriately related to
units (i.e., volume). In applied costing (normal costing), however, fixed efficiency variance is determined.

SUMMARY OF OVERHEAD VARIANCES

The overhead variances and their interrelationships are summarized as follows:

Table 14. Summary of overhead variances under the standard costing method

Fixed Variable
Spending efficiency P 35,000 UF P 40,000 UF
Efficiency variance 0 (20,000) F
Volume variance 45,000 0
Variances - UF P 80,000 UF P 20,000 UF

Under the standard costing method, fixed overhead efficiency variance is always equal to zero.

Under the normal costing method, which is popularly used in cost accounting, the overhead variances may
be summarized as follows:

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Supporting Formulas:
Controllable Variance = AFOH – BASH
Volume Variance = BASH - (SH x SR)
Variable Efficiency Variance = (AH – SH) x SVOR or
= (AH – SH) – (SH –SVOR)
Spending Variance = AFOH – BAAH
Variable Spending Variance = (Actual VOH) – (AH x SVOR)
Fixed Spending Variance = (Actual FOH)– Budgeted OH
Capacity Variance = (Normal Hours – Actual Hours) x SFxOR

Now, let us look once more at the original overhead variances computed at the start of our overhead
variances discussions

Fixed Variable Overhead

Actual factory overhead P 1,250,000 P 798,000 P 2,048,000
Standard factory overhead 1,170,000 780,000 1,950,000
Variances – UF (F) P 80,000 UF P 18,000 UF P 98,000 UF

The components of the fixed overhead and variable overhead variances are accounted for below:

Fixed Variable
Spending efficiency P 35,000 UF P 38,000 UF (AFOH – BAAH)
Efficiency variance (30,000) F (20,000) F ( in hrs. x OH Rate)

Capacity variance 75,000 UF - ( in capacity x FxOH Rate)

Net overhead variances P 80,000 UF P 18,000 UF

Material Price, Mix, and Yield Variances

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Almost all products need different materials to complete. Companies with complicated production
operations use hundred of materials in their production processes. In this case, materials mix and yield
variances are to be isolated, analyzed, studied, and given proper managerial action. The materials mix and
yield variances represent the quantity variance. The computation of the materials price, mix, and yield
variances are illustrated using the following information:

Sample Problem 7. Materials Price, Mix and Yield Variances

The standard materials costs in producing 400 units of product “Tameme” are as follows:

Materials Qty. in lbs. Price per lb. Total Costs

A 400 P 10.00 P 4,000
B 500 5.00 2,500
C 100 8.00 800
1,000 P 7,300

Actual production data in October 2019 are as follows:

Production, 16,000 units
Materials used:
Materials Qty. in lbs. Price per lb. Total Costs
A 18,000 lbs P 10.20 P 183,600
B 19,000 4.90 93,100
C 5,000 8.05 40,250
42,000 lbs P 316,950

Required: Determine the materials price, mix and yield variances.

Solutions/ Discussions:
First, let us determine the Average Materials Output Cost (AMOC) and the Average Materials Input Cost
(AMIC).
The term “output” refers to the completed production in units, while the term “input” means the materials
put into production. The AMOC and AMIC are computed as follows:
AMOC = Total Standard Materials Costs/ Standard Production Output
AMIC = Total Standard Materials Costs/ Total Standard Materials Input
AMOC = P 7,300/400 units = P 18.25 per unit
AMIC = P 7,300/1,000 lbs. = P 7.30 per lb.

Actual direct materials costs P 316,950

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Less: Actual output @ Standard Output Cost

(16,000 units x P 18.25) 292,000
Total materials costs variance P 24,950 UF

The materials price, mix, and yield variances are as follows:

Materials Price Variance Materials Price Variance

Actual direct material costs P 316,950 Actual material
costs
Less: Actual Materials Input @ Standard Price AMI @ SP
A (18,000 lbs x P 10.00) P 180,000
B (19,000 lbs x P 5.00) 95,000
C (5,000 lbs x P 8.00) 40,000 315,000 P 1,950 UF

Materials Mix Variance Materials Mix Variance

Actual Materials Input @ Standard Price 315,000 AMI @ SP
Less: Actual Materials Input @ Average Materials -AMI @AMIC
Input Cost (42,000 lbs x P 7.30 per lb.) 306,600 8,400 UF

Yield Variance Yield Variance

Actual Materials Input @ AMIC 306,600 AMI @AMIC
Less: Actual Output @ Average Materials Output -AO x AMOC
Cost (16,000 units x P 18.25) 292,000 14,600 UF
Total Materials Costs Variance P 24,950 UF

The materials price variance could be alternatively calculated as follows:

Materials Price Variances = P x AQ

A (P 10.20 – P 10.00) x 18,000 lbs. = P 0.20 UF x 18,000 lbs. = P 3,600 UF
B (P 4.90 – P 5.00) x 19,000 lbs. = P (0.10)F x 19,000 lbs. = (1,900) F
C (P 8.05 – P 8.00) x 5,000 lbs. = P 0.05 UF x 5,000 lbs. = 250 UF
Net materials price variance P 1,950 UF

Materials price variance

the difference in price multiplied by the actual quantity purchased (or quantity used if quantity purchased is
not available)

Materials mix variance

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the difference between the actual quantity used in a material and the standard quantity that should have
been used for that material based on the standard materials mix and out of the total materials used.
The materials mix for materials A, B, and C is 400, 500, and 100, respectively. Or, a standard mix ratio of
4/10, 5/10 and 1/10, for materials A, B, and C, respectively. The materials mix variance is alternatively
calculated as follows:

a b c d (b-c) c f (d x c)
Materials Actual Quantity Used (lbs) Actual Qty @ Standard Mix Mix Variance (lbs) – UF
(F) Standard Price per lb Mix Variance in Pesos – UF (F)
A 18,000 (42,000 lbs x 4/10) 16,800 lbs 1,200 UF P 10.00 P 12,000 UF
B 19,000 (42,000 lbs x 5/10) 21,800 lbs (2,000) F 5.00 (10,000) F
C 5,000 (42,000 lbs x 1/10) 4,800 lbs 800 UF 8.00 6,400 UF
42,000
Net materials mix variance P 8,400 UF

Direct materials mix variance is also determined by getting the difference between the average actual
materials cost per unit and the average standard materials cost per unit and then multiply it by the actual
quantity used.

Average standard materials unit cost on actual quantity P 7.50 (P 315,000/ 42,000 lbs.)
Average standards materials unit costs on standard materials 7.30 (P 7,300/ 1,000 lbs.)
Difference in average unit costs 0.20
x Actual quantity use 42,000 lbs
Materials mix variance P 8,400 UF

The data to be used in computing the average standard materials unit cost on actual quantity are shown on
the next page:

Materials Actual Qty. Standard Price Actual Qty @ Std. Price

A 18,000 lbs. P 10.00 P 180,000
B 19,000 5.00 95,000
C 5,000 8.00 40,000
42,000 P 315,000

The materials yield variance represents the difference in actual output and the expected output (i.e.,
standard) given a particular number of materials used in production. The standard materials yield is equal
to the ratio of output (e.g., finished goods) over the input (e.g., materials used). The materials yield variance
is alternatively computed as follows:

Standard quantity (40%* x 42,000 lbs.) 16,800 Units

Less: Actual quantity 16,000 Units

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Yield variance in quantity 800 UF

x Standard Output Cost P 18.25 per unit
Materials yield variance in pesos P 14,600 UF

*Standard Yield Rate = Output/ Input = 400 units/ 1,000 lbs. = 40%

Materials yield variance could still be determined by getting the difference between the actual quantity of
materials used and the standard quantity of materials multiplied by the average standard materials unit cost.

Actual materials quantity 42,000 lbs.

Less: Standard materials quantity 40,000a lbs
Quantity variance 2,000 UF
x Standard Input Cost P 7.30 per lb.
Materials yield variance P 14,600 UF

a (pls. see computations below)

The total of the materials mix and yield variances is the materials quantity variances.

Materials mix variance P 8,400 UF

Materials yield variance 14,600 UF
Materials quantity variance P 23,000 UF

To prove:
Materials Actual Quantity Standard Quantity* Q
Standard Price Quantity Variance
A 18,000 lbs. 16,000 lbs 2,000 UF P 10.00 P 20,000 UF
B 19,000 20,000 (1,000) F 5.00 (5,000) F
C 5,000 4,000 1,000 UF 8.00 8,000 UF
Net Materials Quantity Variance P 23,000 UF

* SQ = AQ x Standard materials per unit

Std. Qty Standard materials per unit
Mat A= 16,000 units x 1.0 lb = 16,000 lbs. Mat A = 400 lbs./ 400 units 1.0 lb
B = 16,000 units x 1.25 lbs = 20,000 lbs. B = 500 lbs./ 400 units 1.25 lbs
C = 16,000 units x 0.25 lb = 4,000 lbs. C = 100 lbs./ 400 units 0.25 lb
Total 40,000 lbs.

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 ACC 206 STRATEGIC COSTING AND VARIANCE ANALYSIS Chapter 1

Disposition of Variances

A variance may be normal or exceptional.

Normal variances are those within the range of expectations while exceptional variances are those outside
the range of normal expectations. These variances are disposed of as follows:

Normal variance
adjusted to cost of goods sold, i.e., immediately treated as period costs

Exceptional variance
Traditionally, exceptional material variances are allocated among the materials inventory, work-in-process
inventory, finished goods inventory, and cost of goods sold account. Exceptional variances of direct labor
and overhead are allocated among work in process inventory, finished goods inventory, and cost of goods
sold accounts. Modern business philosophies treat exceptional variances as an expense

Sample Problem 8. Disposition of Costs Variances

To illustrate, let us assume that David Corporation has determined its variances as follows:

Debit Credit
Materials purchase price variance P 20,000
Materials quantity variance P 30,000
Labor rate variance 5,000
Labor efficiency variance 34,000
Overhead controllable variance 25,000
Overhead volume variance 60,000

Its standard amounts of work-in-process inventory, finished goods inventory, and cost of goods sold are
composed of the following elements:

How would the cost variances be allocated and recorded if the variances are considered (1) normal or (2)
exceptional?

Solutions/ Discussions:

1. Normal cost variances.

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 ACC 206 STRATEGIC COSTING AND VARIANCE ANALYSIS Chapter 1

Normal variances are normally adjusted to cost of goods sold.

Cost of goods sold at standard P 3,000,000 Journal Entry

Add (Deduct) cost variances:
Materials purchase price variance 20,000 UF Materials quantity variance - F 30,000
Materials quantity variance (30,000) F Labor rate variance – F 5,000
Labor rate variance (5,000) F Volume variance – F 60,000
Labor efficiency variance 34,000 UF Materials purchase price variance – UF
20,000
Controllable variance 25,000 UF Labor efficiency variance – UF 34,000
Volume variance (60,000) F Controllable variance – UF 25,000
Net variance (16,000) F Cost of goods sold 16,000
Cost of goods sold at actual P 2,984,000

Unfavorable (or debit) costs variances are to be closed by crediting the variance account. Favorable (or
credit) variances are to be closed by debiting the variance account. The net favorable cost variance of P
16,000 is credited to cost of goods sold.

2. Abnormal cost variances

International Financial Reporting Standards, specifically International Accounting Standards 2, states that
abnormal costs variances are expensed in the period incurred. The treatment as to normal or abnormal
costs variances disposition would be the same in the sense that they are both immediately charged against
revenues.

Normal cost variances are closed to cost of goods sold. Abnormal cost variances are closed directly to
expenses.

References used:

Agamata, Franklin T. Management Services 2019 Edition. GIC Enterprises & Co., Inc.
Cabrera, Ma. Elenita B. Management Accounting Concepts and Applications. GIC Enterprises & Co., Inc.

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