Cost Accounting — Standard Costing and Variable Cost Variance Analysis

A standard cost is what one unit should cost to make under efficient conditions. Comparing actual costs with the standard shows in which cost element a variance arose and whether it came from price or from usage. This chapter covers variances in variable cost elements; fixed overhead variances and the full standard costing picture continue in chapter 11.

1. Standard costs and the flexible budget

A standard is a price standard (price per kg of materials, wage rate per labor hour) multiplied by a quantity standard (kg of materials and labor hours per unit). Variances must always be calculated against a flexible budget adjusted to actual output. If 1,200 units were planned but only 1,000 were made, comparing with a budget for 1,200 units is meaningless.

Standard cost per unit for Company BB
Element	Quantity standard	Price standard	Standard cost
Direct materials	2 kg	₩5,000 per kg	₩10,000
Direct labor	1.5 hours	₩20,000 per hour	₩30,000
Variable manufacturing overhead (labor-hour basis)	1.5 hours	₩4,000 per hour	₩6,000
Total variable cost			₩46,000

Actual output this month is 1,000 units. 2,100 kg of materials were bought at ₩4,800 per kg and all used; 1,560 labor hours were paid at ₩20,500 per hour; and actual variable manufacturing overhead was ₩6 million.

2. The basic structure of variances

Price and quantity variances

\begin{aligned}\text{Price variance} &= (AP - SP) \times AQ \\ \text{Quantity variance} &= (AQ - SQ) \times SP\end{aligned}

AP and AQ are actual price and quantity, SP is the standard price and SQ the standard quantity allowed for actual output. A positive amount is unfavorable (cost overrun); a negative amount is favorable.

3. Worked example

The standard quantities allowed for the actual output of 1,000 units are 2,000 kg of materials and 1,500 labor hours.

Variable cost variances (unit: ₩)
Element	Price-side variance	Quantity-side variance	Total
Direct materials	Price variance (4,800 − 5,000) × 2,100 = −420,000 F	Quantity variance (2,100 − 2,000) × 5,000 = 500,000 U	80,000 U
Direct labor	Rate variance (20,500 − 20,000) × 1,560 = 780,000 U	Efficiency variance (1,560 − 1,500) × 20,000 = 1,200,000 U	1,980,000 U
Variable manufacturing overhead	Spending variance 6,000,000 − 1,560 × 4,000 = −240,000 F	Efficiency variance (1,560 − 1,500) × 4,000 = 240,000 U	0

F = favorable, U = unfavorable.

A. Interpretation

Materials were bought cheaply (favorable price variance) but more were used (unfavorable quantity variance). The cheap materials may have been of poor quality and increased waste. Looking at the purchasing manager’s performance alone would lead to the wrong conclusion.
The labor efficiency variance is the largest. Check whether the 60 extra labor hours were caused by the poor-quality materials or by a skills problem.
Because variable overhead is applied on labor hours, the labor efficiency variance carries straight through to the overhead efficiency variance.

A variance is a result, not a cause. The purpose of variance analysis is to decide where to investigate.

4. Purchase price variance and usage price variance

When the quantity of materials bought differs from the quantity used, the question is when to calculate the price variance.

Purchase price variance: recognized at purchase on the whole quantity purchased. Raw materials inventory is recorded at standard price. It is commonly used because purchasing performance is known sooner.
Usage price variance: recognized only on the quantity used in production.

If BB had bought 3,000 kg at ₩4,800 per kg and used only 2,100 kg, the purchase price variance would be $(4{,}800 - 5{,}000) \times 3{,}000 = -600{,}000$ won (favorable) and the usage price variance −420,000 won (favorable). The quantity variance is ₩500,000 on quantity used under either method.

Check your understanding

Company BC’s standard labor per unit is 2 hours at ₩15,000 per hour. This month it produced 800 units, used 1,700 hours and paid ₩24.65 million. What are the rate and efficiency variances, and are they favorable or unfavorable?

The actual rate is $24{,}650{,}000 / 1{,}700 = 14{,}500$ won. The rate variance is $(14{,}500 - 15{,}000) \times 1{,}700 = -850{,}000$ won, favorable. Standard hours allowed are $800 \times 2 = 1{,}600$ , so the efficiency variance is $(1{,}700 - 1{,}600) \times 15{,}000 = 1{,}500{,}000$ won, unfavorable. The total is ₩650,000 unfavorable. Investigate whether using cheaper, less skilled workers cost extra time.

References

Charles Horngren, Srikant Datar and Madhav Rajan, Cost Accounting: A Managerial Emphasis, ch. 7
Ray Garrison, Eric Noreen and Peter Brewer, Managerial Accounting, ch. 10
Robert Kaplan and Anthony Atkinson, Advanced Management Accounting, ch. 8