Putting it Together: Standard Cost Systems

Under full absorption costing, manufacturing companies determine the cost of each unit of product by accumulating the cost of direct materials, direct labor, and manufacturing overhead and dividing that by the number of units manufactured.

Let’s take another look at Boulevard Blanks, and look back to the budget v. actual report:

Boulevard Blanks
Partial Income Statement
For the month ended July 31, 20XX
Actual Budget
Sales revenue $        178,200.00 $        178,200.00
Subcategory, Variable manufacturing costs Single Line Single Line
      Direct materials           38,080.00           38,880.00
      Direct Labor           46,500.00           43,740.00
      Allocated overhead             1,395.00             1,944.00
Subcategory, Fixed manufacturing costs
      Allocated overhead           13,485.00           13,365.00
Cost of Goods Manufactured and sold Single Line          99,460.00 Single Line          97,929.00
Gross Profit Single Line$        78,740.00Double line Single Line$        80,271.00Double line

 

We’re assuming a just-in-time inventory system here, meaning that units produced and units sold are the same. We don’t have to take beginning and ending inventory into account that way, which makes our calculations simpler.

Our production records show that we produced 1,620 units, and we see that the total cost of units manufactured was $99,460, so the cost per unit rounded to the nearest penny was $61.40. (99460 / 1620 = 61.395061728…)

Our budgeted cost per unit was $60.45, so our actual costs per unit were almost a dollar over budget. That may not seem like a lot, but consider that the gross profit has to cover selling, general, and administrative expenses. If those expenses run $79,000 per month, we just went from a budgeted profit to an actual loss.

See below for a summary of the six variances discussed in this module.

  • Standard Cost = SC (sometimes called Standard Price or SP)
  • Standard Quantity = SQ
  • Actual Cost = AC (sometimes called Actual Price or AP)
  • Actual Quantity = AQ
Direct materials cost variance
(sometimes called the price variance)		 (AC – SC) x AQ
OR
(AC x AQ) – (SC x AQ)
Where Quantity = raw materials used/purchased
Direct materials efficiency variance
(sometimes called the usage variance)		 (AQ – SQ) x SC
OR
(AQ x SC) – (SQ x SC)
Where Quantity = raw materials used/purchased
Direct labor cost variance
(sometimes called the rate variance)		 (AC – SC) x AQ
OR
(AC x AQ) – (SC x AQ)
Where Quantity = direct labor hours incurred
Direct labor efficiency variance
(sometimes called the usage variance)		 (AQ – SQ) x SC
OR
(AQ x SC) – (SQ x SC)
Where Quantity = direct labor hours incurred
Variable overhead cost variance
(sometimes called the spending variance)		 (AC – SC) x AQ
OR
(AC x AQ) – (SC x AQ)
Where Quantity = allocation base, such as direct labor hours incurred
Variable overhead efficiency variance (AQ – SQ) x SC
OR
(AQ x SC) – (SQ x SC)
Where Quantity = allocation base, such as direct labor hours incurred
Fixed OH variance = Actual fixed overhead – Budgeted fixed overhead

 

Remember, variances are expressed at the absolute values, meaning we do not show negative or positive numbers. We express variances in terms of FAVORABLE or UNFAVORABLE, and negative is not always bad or unfavorable just as positive is not always good or favorable.

Keep These in mind:

  • When actual materials are more than standard (or budgeted), we have an UNFAVORABLE variance.
  • When actual materials are less than the standard, we have a FAVORABLE variance.
  • The same rule applies to direct labor. If actual direct labor (either hours or dollars) is more than the standard, we have an UNFAVORABLE variance. A FAVORABLE variance occurs when actual direct labor is less than the standard.