STANDARDS – are measure of acceptable performance established by management as a guide in

making economic decisions. It is a benchmark or norm for measuring performances.

- can be financial or non-financial, quantitative or qualitative.
- used in almost all functions of management:
a. Planning – standards serves as basis for forecasting
b. Organizing – standards are used as monitoring indicators on production yield rate,
conformity with administrative policies and personnel efficiencies.
c. Controlling – standards are used in variance analyses, for on line monitoring and
corrections and for end of the line evaluation and remedial actions.

Setting Standards
Standards are strategic in nature and therefore a matter of managerial prerogative. It can be set by the
top management, outsourced from an independent entity, developed by industrial engineering
department, or established with the participation of lower levels of management and personnel.

Types of Standards
1. Ideal/Theoretical (Maximum Efficiency) Standards – attainable only under the best conditions
(based on work of most skilled workers, most efficient machines, best production processes). This type
of standard provides no allowance for: machine breakdown, work interruption, wastages, spoilage, etc.

2. Practical (Currently Attainable) Standards – tight but attainable under normal, though highly
efficient, operating conditions. It allows normal machine downtimes and employee rest periods, work
interruptions and wastages. It is the one normally used for product costing and budgeting purposes.

Standard Costs – systematically predetermined costs established by management to be used as basis

for comparison with actual costs. It is used to motivate optimal efficiency of operations.
- can be based on engineering, accounting and statistical quality control studies.
- can be applied by any type of industry, profit or nonprofit, where performance levels could be
established based on historical performance, time and motion studies and other means.
- can be used for both job order and process costing systems.

1. The direct materials price standard should be based on the delivered cost of raw materials plus an
allowance for receiving and handling. The direct materials quantity standard should establish the
required quantity plus an allowance for waste and spoilage.
2. The direct labor price standard should be based on current wage rates and anticipated adjustments
such as COLAs. It also generally includes payroll taxes and fringe benefits. Direct labor quantity
standards should be based on required production time plus an allowance for rest periods, cleanup,
machine setup, and machine downtime.
3. For manufacturing overhead, a standard predetermined overhead rate is used. It is based on an
expected standard activity index such as standard direct labor hours or standard machine hours

Uses & Advantages of Standard Costs

1. Budget Preparation – standard costs are used as basis for projecting costs.
2. Management by exception (and management by objective)
3. Motivation and performance appraisal
4. Pricing decisions - regular and incremental sales price, competitive bid prices
5. Useful in sensitivity planning and interim reporting.
6. Promotes economy & efficiency among employees
7. Simplifies bookkeeping and costing procedures.

Standard Costing Procedures

1. Establish the standards
2. Measure the actual performance
3. Compare actual performance with standards
4. Analyze the variances. Investigate the cause of variances
5. Take corrective actions when needed

Management by Exception – only variances that are significant in amount, whether favorable or
unfavorable, are investigated. Managers therefore focus their time and effort with these items.
Production Standards
1. Quantity Standards – quantity of raw materials or labor time needed to produce a product.
It is normally expressed per unit of output. Ex. 10 kg of RM/unit of FG

2. Cost Standards – the “should be” cost of the quantity standards. Normally expressed per unit of
input. Ex. P3/kg of RM

Materials Standards
1. Standard Quantity – should reflect the units of materials required to produce each unit of product,
including allowances for unavoidable wastages, spoilage as well as other normal inefficiencies.

2. Standard Price – should reflect the final, delivered costs of materials, net of any discount and
inclusive of allowance for handling costs.
Standard Materials Cost/unit of product = std. RM /unit of product x std. price/unit of RM

PRODUCTION COSTS VARIANCE ANALYSIS

Variance – difference between actual and standard costs
Actual Costs (Actual Quantity x Actual Cost/qty) ₱xx
Standard Costs (Standard Quantity x Standard Cost/qty) (xx)
Unfavorable Variance/(Favorable Variance) ₱xx

Note: If actual costs exceed standards cost, the resulting variance is said to be unfavorable because
the company spent more than what should have been spent. The opposite applies if standards costs
exceed actual costs.

The variances would also be analyzed into two factors.

Quantity (Usage/Time/Efficiency) Variance = Difference in quantity x Standard Cost per unit
Cost (Price/Rate/Spending) Variance = Difference in cost per unit x Actual quantity

Illustration:
During March, Telahan Corporation manufactured 1,000 units of a special multilayer fabric with the
trade name Kurduroy. The following information from the Kurduroy production department also pertains
to March.
Direct material purchased: 36,000 yards at P1.38 per yard P49,680
Direct material used: 19,000 yards at P1.38 per yard 26,220
Direct labor: 4,200 hours at P9.15 per hour 38,430
The standard prime costs for one unit of Kurduroy are as foliows:
Direct material: 20 yards at P1.35 per yard P27
Direct labor: 4 hours at P9.00 per hour 36
Total standard prime cost per unit of output Р6З
REQUIRED: Compute the following variances for the month of March, indicating whether each variance
is favorable or unfavorable.
a. Direct-materials spending variance. d. Direct-labor rate variance.
b. Direct-materials efficiency variance. e. Direct-labor efficiency variance.
c. Direct-materials purchase price variance.

Solution
Notice that standard quantity and costs are presented on a per unit basis. We must compute the total
standard quantity for 1,000 units:
Direct materials: 20 yards x 1,000 units = 20,000 yards
Direct labor: 4 hrs x 1,000 units = 4,000 hours

a. Direct material spending variance

Spending variance = Difference in price of direct material x Actual quantity used*
SV = (AP − SP)AQ
SV = (1.38 − 1.35)19,000
SV = ₱570 UF

The actual price exceeds the standard price so the spending variance is ₱570 unfavorable. A possible
reason that might cause the variance is that the actual price in the market is higher than the standard
price being used.

*Note: Notice that spending variance was based on actual quantity used. This is because the
requirement in ‘c’ is the purchase price variance. If there is no other requirement to compute for
purchase price variance, then spending variance should be based on quantity purchased unless the
problem specifically states that spending variance is based on quantity used.

b. Direct material efficiency variance

Efficiency variance = Difference in total quantity x Standard price of direct materials
EV = (AQ − SQ)SP
EV = (19,000 − 20,000)1.35
EV = ₱1,350 F

The actual quantity of direct materials used was less than the standard quantity. This means that the
company was efficient in using its direct materials.

c. Direct material price variance

Purchase price variance = Difference in price of direct material x Actual quantity purchased
PV = (AP − SP)AQ
PV = (1.38 − 1.35)36,000
PV = ₱1,080 UF
Purchase price variance / price variance / spending variance should always be based on quantity of
direct materials purchased unless the problem states that price variance or spending variance should
be based on quantity of direct materials used.
d. Direct labor rate variance
Rate variance = Difference in rate per hour x Actual hours used
RV = (AR − SR)AH
RV = (9.15 − 9)4,200
RV = ₱630 UF

Unfavorable rate variance results from direct laborers’ rate per hour being higher than the standard rate
of the company. This can arise if the company hires more skilled laborers but with higher rate.

d. Direct labor efficiency variance

Efficiency variance = Difference in total hours x Standard rate per hour
EV = (AR − SR)SH
EV = (4,200 − 4000)9
EV = ₱1,800 UF

Unfavorable labor efficiency variance results from working more than the standard hours of work. This
can be improved by hiring more skilled laborers.

Legend:
AP = Actual price AH = Actual hours PV = Purchase price
variance
SP = Standard price SH = Standard hours RV = Rate variance
AQ = Actual quantity SV = Spending variance F = favorable
SQ = Standard quantity EV = Efficiency variance UF = Unfavorable

Quiz 1
Fitzhugh Company has the following information available for the current year:
Standard:
Material 3.5 feet per unit @ ₱2.60 per foot
Labor 5 direct labor hours @ ₱8.50 per unit

Actual:
Material 95,625 feet used (100,000 feet purchased @ ₱2.50 per foot)
Labor 122,400 direct labor hours incurred per unit @ ₱8.35 per hour

25,500 units were produced

Require: Compute the following
a. Material purchase price variance c. Labor rate variance
b. Material quantity variance d. Labor efficiency variance

Quiz 2
Zoom Co. uses standard costing for the single product it makes and sells. The following data are for the
month of April:
Direct material purchased and ₱ 62,400 Standard cost per direct labor hour ₱8
used
Material price variance ₱ 4,800 U Actual direct labor hours 3,800 hours
Total materials variance ₱ 14,400 U Labor efficiency variance ₱ 1,600 F
Standard cost per pound of ₱ 6 Total labor variance ₱ 680 U
material
The standard direct labor hour per unit of product is 2 hours.
REQUIRED:
a. The total number of units produced during April was:
b. The standard quantity of material allowed to produce one unit of product was:
c. The actual material cost per pound was:
d. The actual direct labor rate per hour was:
Standards and Budgets – both are predetermined amounts but standards are based on actual
production while budgets are based on budgeted production.

1. Total Budgeted Costs – the cost that should be incurred for budgeted production
Total Budgeted Costs = budgeted production (units) x std. cost/u
Budget Variance = actual costs – budgeted costs

2. Total Standard Costs – the cost that should have been incurred for actual production
Total Standard Costs = actual production (units) x std. cost/u
Standard Cost variance = actual costs – standard costs
➢ For control purposes, it is better to compute and analyze variance using the standard costs.

Manufacturing Overhead Standards

1. Variable FOH standards – computed in the same manner as direct labor standards
Variable FOH/unit of product = std. variable FOH rate/time x std. time/u

2. Fixed FOH standards – total fixed OH costs under normal (practical) capacity level of activity.

Lesson Objective 2
Overhead Variance Analysis
2 Way Analysis (CV) 3 Way Analysis (SEV) 4 Way Analysis (S2EV)
Actual FOH ₱ xx Actual FOH ₱ xx Actual VOH ₱ xx
BASH BAAH BAAH – Variable OH (xx)
Variable OH (SVOHR x SH) ₱ xx Variable OH (SVOHR x AH) (xx) Variable Spending Variance ₱ xx
Fixed OH (at normal capacity) xx (xx) Fixed OH (at normal capacity) (xx)
Controllable Variance ₱ xx Spending Variance ₱ xx Actual Fixed OH ₱ xx
BAAH- Fixed OH (at normal) (xx)
Fixed Spending Variance ₱ xx
BAAH – BASH (Budget Variance)
Variable OH (SVOHR x AH) ₱ xx
Variable OH (SVOHR x SH) (xx)
Efficiency (Time) Variance ₱ xx Efficiency (Time) Variance ₱ xx

BASH ₱ xx
Standard FOH (SFOHR x SH) (xx)
Volume (Capacity)Variance ₱xx Volume (Capacity)Variance ₱xx Volume (Capacity)Variance ₱xx

Legend:
FOH = factory overhead SVOHR = standard variable overhead rate
BASH = budget allowed for standard hours SFOHR = standard factory overhead rate
BAAH = budget allowed for actual hours SH = standard hours
AH = actual hours
Important Notes:
1. Under Standard Costing, Standard FOH (std. hrs x std. FOH rate) is referred to as Applied FOH.
2. Budget Variance (BV) = Actual cost – Budgeted Cost = Actual FOH – Budgeted FOH
a. If Budgeted FOH is based on standard hours (BASH), BV is the controllable variance.
b. If Budgeted FOH is based on actual hours (BAAH), BV is the spending variance.

3. Volume (Capacity) Variance refers only to Fixed OH. Variable OH Volume variance doesn’t exist.
4. Factory Variance can be subdivided into:
a. Variable OH variances = variable spending variance + variable efficiency variance
b. Fixed OH variances = fixed spending variance + volume variance
5. Production (Manufacturing) efficiency variance = sum of efficiency variances in DM, DL and
 FOH
6. Production (Manufacturing) spending variance = sum of spending variances in DM, DL and FOH
7. Production (Manufacturing) Costs variance (5+6) = sum of variances in DM, DL and FOH

If variable and fixed components are separated, overhead variances can be analyzed as follows:
Spending Efficiency
Variance Controllable Variance
Variance
Volume
Variance

AFOH BAAH BASH Standard

Variable AR x AH SR x AH SR x SH SR x SH
Fixed Actual Normal Capacity Normal Capacity Standard

Variable
Spending

Fixed
Spending
Note:
• If we will observe, fixed overhead under BAAH and BASH are the same. That is why fixed
efficiency variance is always zero.
• Again, as we can observe, variable overhead under BASH and Standard are the same. That is
why variable volume variance is always zero.

The overhead variances can further be summarized as follows:

Variable

Actual (AR x AH) Variable

Spending
Spending
Budget (SR x AH) Efficiency
Variance
Variance
Standard (SR x SH)
Controllable
Variance
Fixed

Actual
Fixed
Spending
Budget (Normal Capacity)
Volume
Standard Variance

Under- and Overapplied Overhead. The sum of the four manufacturing overhead variances-variable
overhead spending, variable overhead efficiency, fixed overhead budget, and fixed overhead volume
equals the under- or overapplied overhead for the period

Illustration:
Ganda Co. employs standard absorption system for product costing. Standard cost of its product is as
follows:
Raw Materials ₱14.50
Direct labor 2 hrs @ ₱8/hr 16.00
Manufacturing overhead 2 hrs @ ₱11/hr 22.00
Total Cost/unit ₱52.50

Factory overhead rate is based upon normal annual activity level of 600,000 direct labor hours. The firm
planned to produce 25,000 units each month during 2014. Budgeted factory overhead for 2014 is
composed of P3,600,000 variable and P3,000,000 fixed.

During April 2014, 26,000 units of product were produced using 53,500 direct labor hours at a cost of
P433,350. Actual factory overhead for April was P260,000 fixed and P315,000 variable. Total factory
overhead applied during April was P572,000.
Required:
a. The variable overhead spending variance must be
b. The variable overhead efficiency variance must be
c. The fixed overhead spending (budget) variance must be
d. The fixed overhead volume variance must be
e. The total under-/overapplied overhead variance must be

Solution
a-b. Variable overhead spending & efficiency variance

Actual 315,000
6,000 F → Variable spending
Budgeted (₱6 x 53,500 hrs) 321,000
9,000 UF → Efficiency
Standard (₱6 x 52,000 hrs) 312,000

• Remember in the above discussion that:

Total Budgeted Costs = budgeted production (units) x std. cost/u

• The standard variable overhead rate of ₱6 per hour is computed as ₱3,600,000 budgeted
variable overhead divided by 600,000 direct labor hours.

• For variable overhead, budgeted cost is computed as: standard rate x actual hours

• Standard cost is computed as: standard rate x standard hours. This is for both variable and
fixed overhead.

• Standard hour is computed as 2 standard hrs per unit x 26,000 actual units. Remember that
standard costs are based on actual units.

c-d. Fixed overhead spending (budget) variance

Actual 260,000
10,000 UF → Fixed spending (Budget)
Budgeted (₱5 x 50,000 hrs) 250,000
10,000 F → Volume
 Standard (₱5 x 52,000 hrs) 260,000

• Budgeted fixed overhead should be based on normal capacity. The annual normal capacity of
the company is 600,000 direct labor hours or 50,000 monthly (600,000 ÷ 12).

• The standard fixed overhead rate of ₱5 per hour is computed as ₱3,000,000 budgeted fixed
overhead divided by 600,000 direct labor hours.

• Standard hour is computed as 2 standard hrs per unit x 26,000 actual units.

e. Total under-/overapplied overhead variance

Variable spending 6,000 F

Efficiency 9,000 UF
Fixed spending (Budget) 10,000 UF
Volume 10,000 F
Under-/overapplied OH variance 3,000 UF or 3,000 underapplied

• If the sum of the overhead variances appeared to be unfavorable, then it is underapplied. When
it appeared to be favorable, then it is overapplied.

Let us analyze:
If actual cost is greater than budgeted cost, then the variance is unfavorable. (A > B = UF)
If actual cost is greater than budgeted cost, then the overhead is underapplied. (A > B =
Under). Refer to Cost Accounting for the discussion of under-/overapplied overhead.

Exercise 1
Tuxla Products Co. charges factory overhead into production at the rate of ₱10 per direct labor hour,
based on a standard production of 15,000 direct labor hours for 15,000 units; 60% of factory overhead
costs are variable. Production data for May and June are:

May June
Production ............................................................................... 12,000 hrs. 14,200 hrs.
Units produced ........................................................................ 12,000 15,000
Actual factory overhead .......................................................... ₱140,100 ₱149,300
Require: Compute the following variances and indicate whether each variance is favorable or
unfavorable.
c. Controllable variance b. Volume variance

Exercise 2
Standard direct labor hours budgeted for May production were 5,000, with factory overhead at that level
budgeted at ₱25,000, of which ₱15,000 is variable. Actual labor hours for the month were 4,800;
however, the number of standard labor hours allowed for actual May production is 5,200. Actual factory
overhead incurred during the month was ₱25,600.
Required: Compute the following variances and indicate whether each variance is favorable or
unfavorable.
a. Total spending variance c. Volume variance
Exercise #3
Taylor Company applies overhead based on direct labor hours and has the following available for
November:
Actual:
Standard: Units produced 1,800
Direct labor hours per unit 5 Direct labor hours 8,900
Variable overhead per DLH ₱.75 Variable overhead ₱6,400
Fixed overhead per DLH Fixed overhead ₱17,500
(based on 8,900 DLHs) ₱1.90

Required: Compute the following variances and indicate whether each variance is favorable or
unfavorable.
a. Variable spending variance d. Fixed spending variance
b. Variable Efficiency variance e. Fixed efficiency variance
c. Variable volume variance f. Fixed volume variance