COST ACCOUNTING

 Cost accounting is an expanded phase of general or

financial accounting which informs management
promptly with the cost of rendering a particular
service, buying and selling a product, and
producing a product.

 It is the field of accounting that measures, records,

and reports information about cost.
Uses of Cost Accounting Data
 Determining the Product Cost

 Planning and Control

Merchandising vs. Manufacturing
Operations
COGS for a Merchandising Company
Balance Sheet Income Statement
Transaction
Preparation Preparation

Purchases

Plus:
Mdse.
Inventory,
beginning

Cost of
Mdse. Inventory, Cost of goods Cost of Cost of goods
ending unsold available for sold sold
items sale items
 COGS for a Manufacturing Company
Income
Balance Sheet Statement
Transaction
Preparation Preparation

Purchase of

Factory
Materials Labor
OH

UNUSED
Materials Materials
Inventory storage
WHEN USED
WIP UNFINISHED
Production Process
inventory

FG UNSOLD PRODUCTS
Finished Goods Storage COGS
inventory PRODUCTS SOLD
Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
 Purchase finished  Purchases raw
goods from suppliers materials from
for resale to suppliers.
customers.  Produce and sell
finished goods to
customers.
MegaLoMart
Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables  Receivables
 Prepaid Expenses  Prepaid Expenses
 Merchandise Inventory  Inventories:
1. Raw Materials
2. Work in Process
3. Finished Goods
Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables  Receivables
Materials waiting to
 Prepaid Expenses  Prepaid Expenses
be processed.
 Merchandise Inventory
Partially complete  Inventories:
products – some 1. Raw Materials
material, labor, or 2. Work in Process
overhead has been 3. Finished Goods
added.
Completed products
awaiting sale.
Quick Check 
If your inventory balance at the beginning of
the month was P1,000, you bought P100
during the month, and sold P300 during the
month, what would be the balance at the end
of the month?
A. P1,000.
B. P 800.
C. P1,200.
D. P 200.
Quick Check 
If your inventory balance at the beginning of
the month was P1,000, you bought P100
during the month, and sold P300 during the
month, what would be the balance at the end
of the month?
A. P1,000. P1,000 + P100 = P1,100
B. P 800. P1,100 - P300 = P800
C. P1,200.
D. P 200.
Cost vs. Expense
 Cost: cash or cash equivalent value sacrificed for goods
and services that are expected to bring a current or
future benefit

 Expenses: expired costs that are deducted from

revenues
Manufacturing Costs
Direct Direct Manufacturing
Materials Labor Overhead

The Product
Direct Materials
Raw materials that become an integral
part of the product and that can be
conveniently traced directly to it.

Example: The limestone that was mixed in the

product.
Direct Labor
Those labor costs that can be easily
traced to individual units of
product.

Example: Wages paid to the machine operators in the

factory.
Manufacturing Overhead
Manufacturing costs cannot be traced
directly to specific units produced.
Examples: Indirect materials and indirect labor

Materials used to support Wages paid to employees

the production process.
Examples: Lubricants and
cleaning supplies used in the
fertilizer factory.
who are not directly
involved in production
work.
Examples: Maintenance
workers, janitors and
security guards.
Manufacturing Costs
 Prime Cost= Direct materials used + Direct labor

 Conversion Cost = Direct Labor + Factory OH

 Total Manufacturing Cost= Direct materials used +

Direct labor + Factory OH
Schedule of Cost of Goods
Manufactured
Manufacturing Work
As items are removed from
Raw Materials Costs In Process
raw materials inventory and
Beginning raw
materials inventory
placed into the production
+ Raw materials process, they are called direct
purchased
= Raw materials materials.
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Schedule of Cost of Goods
Manufactured
Manufacturing Work
Conversion
Raw Materials Costs In Process
costs are costs
Beginning raw Direct materials incurred to
materials inventory + Direct labor convert the
+ Raw materials + Mfg. overhead
purchased = Total manufacturing
direct materials
= Raw materials costs into a finished
available for use product.
in production
– Ending raw materials
inventory
= Raw materials used As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
Schedule of Cost of Goods
Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory
All manufacturing– costs
Ending work in
incurred
process inventory
= Raw materials used during the period are added
= Cost to the
of goods
in production beginning balance of work in
manufactured.
process.
 Schedule of Cost of Goods
Manufactured
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
are in
completed
production
during the period are manufactured.
transferred to finished goods
inventory.
Cost of Goods Sold
Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold
Quick Check 
Beginning raw materials inventory was
P32,000. During the month, P276,000 of raw
material was purchased. A count at the end of
the month revealed that P28,000 of raw
material was still present. What is the cost of
direct material used?
A. P276,000
B. P272,000
C. P280,000
D. P 2,000
Quick Check 
Beginning raw materials inventory was
P32,000. During the month, P276,000 of raw
material was purchased. A count at the end of
the month revealed that P28,000 of raw
material was still present.
Beg. What is the cost$of32,000
raw materials
direct material used? + Raw materials
purchased 276,000
A. P276,000 = Raw materials available
B. P272,000 for use in production $ 308,000
– Ending raw materials
C. P280,000 inventory 28,000
D. P 2,000 = Raw materials used
in production $ 280,000
Quick Check 
Direct materials used in production totaled
P280,000. Direct labor was P375,000 and
factory overhead was P180,000. What were
total manufacturing costs incurred for the
month?
A. P555,000
B. P835,000
C. P655,000
D. Cannot be determined.
Quick Check 
Direct materials used in production totaled
P280,000. Direct labor was P375,000 and
factory overhead wasDirect Materials
P180,000. $ 280,000
What were
+ Direct Labor 375,000
total manufacturing +costs incurred for the 180,000
Mfg. Overhead
month? = Mfg. Costs Incurred
A. P555,000 for the Month $ 835,000

B. P835,000
C. P655,000
D. Cannot be determined.
Quick Check 
Beginning work in process was P125,000.
Manufacturing costs incurred for the month
were P835,000. There were P200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. P1,160,000
B. P 910,000
C. P 760,000
D. Cannot be determined.
Quick Check 
Beginning work in process was P125,000.
Manufacturing costs incurred for the month
were P835,000. There were P200,000 of
partially finished goods remaining in work in
process inventory at the Beginning
end work in
processthe
of month.$ 125,000
inventory
What was the cost of goods manufactured
+ Mfg. costs incurred
for the period 835,000
during the month? = Total work in process
A. P1,160,000 during the period $ 960,000
– Ending work in
B. P 910,000 process inventory 200,000
C. P 760,000 = Cost of goods
manufactured $ 760,000
D. Cannot be determined.
Quick Check 
Beginning finished goods inventory was
P130,000. The cost of goods manufactured for
the month was P760,000. The ending finished
goods inventory was P150,000. What was the
cost of goods sold for the month?
A. P 20,000.
B. P740,000.
C. P780,000.
D. P760,000.
Quick Check 
Beginning finished goods inventory was
P130,000. The cost of goods manufactured for
the month was P760,000. The ending finished
goods inventory was P150,000. What was the
cost of goods sold for the month?
A. P 20,000.
B. P740,000. P130,000 + P760,000 = P890,000
P890,000 - P150,000 = P740,000
C. P780,000.
D. P760,000.
Product vs. Period Costs
 Product Costs – are costs that are identified with
goods purchased or produced. (asset)

 Period Costs – are those costs that are not included in

the inventory valuation and as a result are treated as
expenses in the period in which they are incurred.
(expense)
Product Costs Versus Period Costs
Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company? (There may be
more than one correct answer.)
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
Quick Check 
Which of the following costs would be
considered a period rather than a product cost
in a manufacturing company? (There may be
more than one correct answer.)
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
Classifications of
Nonmanufacturing Costs
Administrative
Selling Costs
Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.
Flow of Costs Illustrated

General and
administrative expenses
Costing Systems
 Job-Costing: system accounting for distinct cost
objects called Jobs. Each job may be different from
the next, and consumes different resources
 Wedding organizer, aircraft, advertising

 Process-Costing: system accounting for mass

production of identical or similar products
 Pestisides, molluscoside, herbiside, insectisides
Costing Approaches
Cost of Product Actual Costing Normal Costing Standard Costing

Direct Material Actual Actual Standard

Direct Labor Actual Actual Standard

Factory Overhead Actual Applied Standard

Job-order Costing
 Unique jobs are work on during the period.
 Cost are accumulated by individual job.
 Unit costs are determined by dividing the total costs
on the job cost sheet by the number of units on the
job.
 The job cost sheet provides the detail for the work in
process account.
Seven-step Job Costing
1. Identify the Job that is the Chosen Cost Object
2. Identify the Direct Costs of the Job
3. Select the Cost-Allocation base(s) to use for
allocating Indirect Costs to the Job
4. Match Indirect Costs to their respective Cost-
Allocation base(s)
5. Calculate an Overhead Allocation Rate:
• Actual OH Costs ÷ Actual OH Allocation Base
6. Allocate Overhead Costs to the Job:
• OH Allocation Rate x Actual Base Activity For the Job
7. Compute Total Job Costs by adding all direct and
indirect costs together
Sample
Job
Cost
Document
Sample Job Cost Source
Documents
Job Costing
Overview
Process Costing
 Homogenous unit pass through a series of similar
processes.
 Costs are accumulated by processing department
 Unit costs are computed by dividing the individual
departments’ cost by the equivalent production
 The cost of production report provides the detail for
work in process account for each department.
Illustrating Process Costing
Direct Materials, Direct Labor
Manufacturing Overhead Costs

Mixing Grinding Refining

Department Department
Department

Finished Goods Cost of Goods Sold

 Five Steps in Process Costing
Step 1: Summarize the flow of physical units of
output.
Step 2: Compute output in terms of equivalent units.
Step 3: Compute equivalent unit costs.
Step 4: Summarize total costs to account for.
Step 5: Assign total costs to units completed and to
units in ending work in process inventory.
Physical Units (Step 1)
Physical units
Flow of Production
Work in process, beginning 0
Started during current period 35,000
To account for 35,000
Completed and transferred out
during current period 30,000
Work in process, ending (100%/20%) 5,000
Accounted for 35,000
 Compute Equivalent Units
(Step 2)
Equivalent units
Direct Conversion
Materials Costs
Completed and
transferred out 30,000 30,000
Work in process,
ending 5,000 (100%) 1,000 (20%)
Equivalent Units of Production 35,000 31,000
Compute Equivalent Unit Costs
(Step 3)
Total production costs are P146,050.
Direct Conversion
Materials Costs
P84,050 P62,000
Equivalent units 35,000 31,000
Cost per equivalent unit P2.4014 P2.00
Summarize and Assign Total
Costs (Steps 4 and 5)
Step 4: Total costs to account for: P146,050
Step 5: Assign total costs:
Completed and transferred out
30,000 × P4.4014 P132,043
Work in process, ending (5,000 units)
Direct materials 5,000 × P2.4014 12,007
Conversion costs 1,000 × P2.00 2,000
Total P146,050
ACCOUNTING FOR FACTORY
OVERHEAD
 Factors to consider in the computation of Overhead
rate
Base to be used
• physical output -direct labor cost
• direct materials cost -direct labor hours
• machine hours

Activity level to use

• normal capacity
• expected actual capacity
Use of Single rate or several rates

• Plant-wide or blanket rate

one rate for all producing department

• Departmental rate
one rate for each producing department
Formulas
 Direct labor hours
FOH rate= estimated factory overhead/estimated DL hours

 Direct labor cost

FOH rate= est. FOH/est. DL cost x 100

 Machine Hours
FOH rate= est. FOH/ est. Machine hours

 Direct material cost

FOH rate= est. FOH/ est. DM cost x 100

 Units of production
FOH rate= est. FOH/ est. units of production
Factory overhead variance
FOH variance= actual OH- applied OH
Accounting for Overhead
 Manufacturing Overhead Control was debited for the
actual overhead costs incurred.

 Manufacturing Overhead Allocated was credited for

estimated (budgeted) overhead applied to production
through the Work-in-Process account.

• Any overapplied overhead is credited to cost of goods

sold and any underapplied overhead is debited.
Causes of FOH variance
 Spending variance- the variance due to expense factors

 Volume Variance- the variance due to difference in

volume and activity factors.
 Definitions
• Standard Cost: (CIMA) “Standard cost is the pre-
determined cost based on the technical estimates for
materials, labor and overhead for a selected period of
time for a prescribed set of working conditions.”

• Standard Costing: (CIMA) “the preparation of standard

costs and applying them to measure the variations from
the actual costs and analyzing the causes of variations
with a view to maintain maximum efficiency of the
operations so that any remedial action may be taken
immediately.
Basic Concepts
1. Standard cost refers to expected costs
under anticipated conditions.
2. Standard cost systems allow for
comparison of standard versus actual
costs.
3. Differences are referred to as standard
cost variances.
4. Variances should be investigated if
significant.
 Standard Costs
Based on carefully
predetermined amounts.

Standard Used for planning labor, material

Costs are and overhead requirements.

The expected level

of performance.

Benchmarks for
measuring performance.
Setting Standard Costs
Accountants, engineers, personnel administrators, and
production managers combine efforts to set standards
based on experience and expectations.
Ideal Versus Attainable Standards
Two schools of thought:
1. Ideal standards (perfection standards):
developed under the assumption that no
obstacles to the production process will be
encountered.
2. Attainable Standards: developed under the
assumption that there will be occasional
problems in the production process.
What all could be
the reasons for
the actual
manufacturing
cost or the
sales/profit to
vary from their
standard costs
and price/profit?
 Cost Variance: is the difference between the standard
cost and the actual costs.

 Variance Analysis: is the resolution into constituent

parts and the explanation of the variances.
 1. Material 2. Labour 3. Overhead 4. Other
Variance Variance Variance Variances

Material Cost Labour Cost Overhead Cost Sales Value

variance Variance Variance variance

Types of
Variances Material Price Labour Rate Variable Sales price
Variance Variance overheads Var. variance

Labour
Material Usage Variable o/h Sales volume
Efficiency
Variance efficiency var. variance
Variance

Labour Mix
Material Mix Variance Variable o/h
Profit Variance
Variance expenditure var.

Idle Time
Variance
Material Yield Fixed overhead
Variance variance
Variances may either be:
 Favorable or Unfavorable Variances.

Controllable or Uncontrollable Variances

Favorable & Unfavorable Variances
 Favorable variances(F) arise when actual costs are less
than budgeted costs or actual sales/profit exceed
budgeted.
 Unfavorable variances(U) arise when actual costs exceed
budgeted or actual sales/profit are less than budgeted.

Profit Revenue Costs

Actual > Expected F F U
Actual < Expected U U F
Total Material Cost Variance
 Material cost variance arises due to variance in the price of
material and its usage.

 This can be calculated by using the following formula,

 Material Cost Variance = (SQ x SP) – (AQ x AP) ,

 Where,
SQ = Standard quantity for the actual output
SP = Standard price per unit of material
AQ = Actual quantity
AP = Actual price per unit of material

 A positive result implies favorable variance and a negative

result implies unfavorable variance (adverse variance).
Material Price Variance
 Material price variance may arise due to number of reasons like
fluctuations in market prices, error in buying due to wrong
purchasing policy etc,

 This can be calculated by using the following formula,

 Material Price Variance = (SP – AP) x AQ

 Where,
SP = Standard price per unit of material
AQ = Actual quantity
AP = Actual price per unit of material

 A positive result implies favorable variance and a negative

result implies unfavorable variance (adverse variance).
Material usage Variance
 Material Usage variance is the difference between the
actual quantities of raw materials used in production and
the standard quantities that should have been used to
produce the product,

 MUV may arise due to number of reasons like Pilferage of

materials , Wastage , Sub-standard or defective materials
etc,

 This can be calculated by using the following formula,

 Material Usage Variance = (SQ – AQ) x SP
Material Mix Variance
 MMV is calculated when a product uses mixture of
different raw materials,

 MMV is that portion of the materials quantity

variance, which is due to the difference between the
standard and actual composition of a mixture.

 It can be represented by the following formula:

 Material mix variance =
 (Standard cost of actual quantity of the standard
mixture – Standard cost of actual quantity of the
actual mixture) or (Revised SQ – AQ) x SP
 How will the material price
variance and material usage be
computed if the quantity
purchased is different from the
quantity used?

The price variance is computed

on the entire quantity
purchased.
The quantity variance is
computed only on the quantity
used.
Practical Problems
1. A fertilizer company uses ammonia for its product. It
provides the following data:
St. Quantity for ammonia per sack 4kg
St. price per kg of ammonia P 45.00
Actual prod. Of tables 1000
Ammonia actually used 3,900 kg
Actual purchase price per kg p 49.00

Calculate Material variances.

St. price x St. Quantity 45 x 4000 = 180000
St. price x Actual Quanity 45 x 3900 = 175500
Actual Price
x Actual Quanity 49 x 3900 = 191100

Material Cost Variance -11100

Material Usage Variance 4500
Material Price Variance -15600
You Get What You Measure
Material Mix Variance
 Material Mix Variance
= [Revised St. Qty – Actual Qty] x St. Price
Rev. St. Qty = St. Qty of 1 Mat. x Actual Total
Standard Total
 From the following information regarding a standard product,
compute 1. Mix 2. Price 3. Usage Variance:
Raw Material Standard Actual
X 40 units @ P 50 p.u. 50 units @ P 50 p.u.
Y 60 units @ P 40 p.u. 60 units @ P 45 p.u.
Total 100 units 110 units
Rev.ST. QtySt. PriceSt. Qty Act.Price Act. Qty
Revised St. Qty X 40/100 x 110 = units 44 50 40 50 50
Revised St. Qty Y 60/100 x 110 = units 66 40 60 45 60
Material Mix Variance
For X -300
For Y 240 -60 MMV
Material Usage Variance
For X -500
For Y 0 -500 MUV
Material Price Variance
For X 0
For Y -300 -300 MPV
 Labor Variances
• Total Labor Cost Variance SH*SR – AH*AR
• Labor Usage/Efficie. Var (SH-AHactual)*SR
• Labor Rate Variance (SR-AR)* AH
• Idle time Variance SR*Idle time
Practice Problem
A firm gives you the following data:
Standard time per unit 2.5 hours
Actual hours worked 2,000 hours
Standard rate of pay Rs. 2 per hour
25 % of the actual hours has been lost as idle time.
Actual output 1,000 units
Actual wages Rs. 4,500
Calculate all labour variances.

St. Rate 2 LUV 2000F

St. Hrs 2500 LPV -500U
Actual Rate 2.25 ITV 1000F
Actual Hrs 2000 LCV 500F
Idle time 500
Practice Problems
Compute the Labor variances from the information
given below:
Standard time 3 hours per unit
Standard rate of wages Rs. 6 per hour
Actual production 700 units
Actual time taken 2000 hours
Actual Wages Rs. 14000
Idle time 50 hours

St. Rate 6 LUV 900F

St. Hrs 2100 LPV -2000U
Actual Rate 7 LCV -1400U
Actual Hrs 2000 IDV 300
Idle time 50
Labor Efficiency Variance- Causes
Poorly Poor
trained quality
workers materials

Unfavorable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
Responsibility for Labor Variances
You used too much
time because of poorly
trained workers and I am not responsible for
poor supervision. the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
Overhead Variances
 Overhead variances arise due to the difference between
actual overheads and absorbed overheads. The estimate of
budget of the overheads is to be divided into fixed and
variable elements. i.e.
1. Variable overhead variances.
 Variable overhead budget or expenditure variance, and
 Variable overhead efficiency variance.
2. Fixed overhead variances.
Formulas
1. Variable overhead variances.
(Standard variable o/h for actual prodn. – Actual variable o/h)

2. Variable overhead budget or expenditure variance, (Budgeted

variable overhead for actual hours – Actual variable
overhead) i.e. AH*BR – Actual Cost

3. Variable overhead efficiency variance.

Standard variable overhead rate per hour [Std. hours
for actual output – Actual hours] i.e. (SH-AH) *SR

4. Fixed Overhead Spending Variance

Budgeted FO- AFO

5. Fixed Overhead Volume Variance

Standard FO- Budgeted FO
Sales Variances
 Sales Margin Price Margin = (AP-BP)*AQ

 Sales Margin Volume variance = (AQ-BQ)*BC

 Total Sales Margin variance = AQ*AC – BQ*BC

 Practice Problems
The ABC Appliance Manufacturing Corporation manufactures two vacuum cleaners,
the Standard and the Super. The following information was gathered about the two
products:
Standard Super
Budgeted sales in units 3,200 800
Budgeted selling price 300 850
Budgeted distribution margin per unit 210 550
Actual sales in units 3,500 1,500
Actual selling price 325 840
1. What is the budgeted sales-mix percentage for the
Standard and the Super vacuum cleaners, respectively?
a. .80 and .20 c. .20 and .80
b. .70 and .30 d. .30 and .70

2. What is the total sales-volume variance in terms of the

contribution margin?
a. 108,000 unfavorable c. 278,000 favorable
b. 108,000 favorable d. 448,000 favorable

3. What is the total sales quantity variance in terms of the

contribution margin?
a. 110,000 favorable c. 278,000 favorable
b. 170,000 favorable d. 448,000 favorable

4. What is the total sales mix variance in terms of the

contribution margin?
a. 110,000 favorable c. 278,000 favorable
b. 170,000 favorable. d. 448,000 favorable
 Overhead Variances
Two-factor analysis
1. Differences between overhead applied to inventory at
actual overhead costs:
a. Controllable overhead variance.
b. Overhead volume variance (Uncontrollable)
Controllable Overhead Variance

1. Actual overhead (-) flexible budget level of

overhead for actual volume of production.
2. Referred to as controllable because managers are
expected to control costs.
3. Actual > budget: unfavorable.
4. Actual < budget, then the variance is favorable.
Overhead Volume Variance

1. Overhead volume variance: flexible budget level

of overhead for actual level of production (-)
overhead applied to production using standard
overhead rate.
2. This variance is solely the result of a different
number of units being produced than planned in
the static budget.
3. Usefulness is limited.
Three-factor analysis
a. Spending variance
=Actual FOH (-) budgeted FOH on the
basis of actual DL hrs.
b. Efficiency variance
=Actual DL hrs. (-) (DL hrs. allowed x
Standard FOH rate)
c. Production(Volume) variance
= Budget allow based on std. hrs. (-) (std.
hrs. x std. OH rate)
Four-factor Analysis
a. Variable Spending Variance
- Actual variable FOH (-) Actual hrs. x
Variable OH rate
b. Variable Efficiency Variance
- (Actual hrs. – Standard hrs.) x Variable
OH rate
c. Fixed Spending Variance
- Actual Fixed OH (-) Budgeted OH at
normal capacity
d. Volume Variance
- Budgeted fixed OH at normal capacity (-)
Standard hrs. x Fixed OH rate
Calculating The Financial Impact Of
Operating At More or Less Than
Planned Capacity
1. Operating at less than planned capacity results in
an unfavorable variance equal to the number of
units (less than planned) x the marginal cost per
unit.
2. Operating at more than planned capacity
results in a favorable variance equal to the number
of units (more than planned) x the marginal cost per
unit.
Aljay Company uses a standard cost system for its production process.
Aljay Company applies overhead based on direct labor hours.
The following information is available for July:

Standard:
Direct labor hours per unit 2.20
Variable overhead per hour P2.50
Fixed overhead per hour
(based on 11,990 DLHs) P3.00

Actual:
Units produced 4,400
Direct labor hours 8,800
Variable overhead P29,950
Fixed overhead P42,300
1. Using the four-variance approach, what is the
variable overhead spending variance? -> 7950 U

2. Using the four-variance approach, what is the

variable overhead efficiency variance? -> 2200 F

3. Using the four-variance approach, what is the

fixed overhead spending variance?
-> 6330 U

4. Using the four-variance approach, what is the

volume variance? -> 6930 U

5. Using the three-variance approach, what is the

spending variance?
-> 14280 U
6. Using the three-variance approach, what is the
efficiency variance? -> 2200 F

7. Using the three-variance approach, what is the volume

variance? -> 6930 U

8. Using the two-variance approach, what is the

controllable variance? -> 12080 U

9. Using the two-variance approach, what is the

noncontrollable variance? -> 6930 U

10. Using the one-variance approach, what is the total

variance? -> 19010 U
Quick Review Question #1
1. What does an unfavorable overhead
volume variance mean?
a. Overhead costs are out of control.
b. Overhead costs are under control.
c. Production was greater than
anticipated.
d. Production was less than
anticipated.
Quick Review Answer #1
1. What does an unfavorable overhead
volume variance mean?
a. Overhead costs are out of control.
b. Overhead costs are under control.
c. Production was greater than
anticipated.
d. Production was less than
anticipated.
Quick Review Question #2
2. Standard material costs per unit are
P3.50. Actual costs per unit are P3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material price variance
is:
a. P900 favorable
b. P900 unfavorable
c. P700 favorable
d. P700 unfavorable
Quick Review Answer #2
2. Standard material costs per unit are
P3.50. Actual costs per unit are P3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material price variance
is:
a. P900 favorable
b. P900 unfavorable
c. P700 favorable
d. P700 unfavorable
Quick Review Question #3
2. Standard material costs per unit are
P3.50. Actual costs per unit are P3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material quantity
variance is:
a. P900 favorable
b. P900 unfavorable
c. P700 favorable
d. P700 unfavorable
Quick Review Answer #3
2. Standard material costs per unit are
P3.50. Actual costs per unit are P3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material quantity
variance is:
a. P900 favorable
b. P900 unfavorable
c. P700 favorable
d. P700 unfavorable
Quick Review Question #4
4. What does a favorable labor efficiency
variance mean?
a. Labor rates were higher than called
for by standards.
b. Inexperienced labor was used,
causing the rate to be lower than
standard.
c. More labor was used than called
for by standards.
d. Less labor was used than called for
by standards.
Quick Review Answer #4
4. What does a favorable labor efficiency
variance mean?
a. Labor rates were higher than called
for by standards.
b. Inexperienced labor was used,
causing the rate to be lower than
standard.
c. More labor was used than called
for by standards.
d. Less labor was used than called for
by standards.
Different Ways to Describe Costs
 Costs can be defined by how they relate to a cost
object, which is defined as any thing or activity for
which we measure costs.
• Costs can also be categorized as to how they are used in
decision making.

• Costs can also be distinguished by the way they change as

activity or volume levels change.
Linear Cost Behavior Terminology
 Total fixed costs are costs that do not change (in total) as
activity levels change.
• Total variable costs are costs that increase (in total)
in proportion to the increase in activity levels.
• Total costs equal total fixed costs plus total variable
costs.
• The relevant range is the span of activity levels for
which the cost behavior patterns hold.
• A cost driver is a measure of activity or volume
level; increases in a cost driver cause total costs to
increase.
Behavior of Total (Linear) Costs
P Total Costs

If costs are linear, then total costs

graphically look like this.

Cost Driver
Total fixed costs do not change as the cost
P Total Fixed Costs driver increases.

Higher total fixed costs are higher above

the x axis.
Cost Driver
Behavior of Total (Linear) Costs
P Total Costs

If costs are linear, then total costs

graphically look like this.

Cost Driver

Total variable costs increase as the cost

P Total Variable Costs driver increases.

A steeper slope represents higher variable

costs per unit of the cost driver.

Cost Driver
 Total Versus Per-unit (Average) Cost Behavior

P Total Variable Costs

If total variable costs look
like this . . .
slope =
Pm/unit

Cost Driver

P/unit Per-Unit Variable Costs . . . then variable costs per

unit look like this.

Cost Driver
 Total Versus Per-Unit (Average) Cost Behavior

P Total Fixed Costs

If total fixed costs look
like this . . .

Cost Driver

P/unit Per-Unit Fixed Costs . . . then fixed costs per

unit look like this.

Cost Driver
 Total Versus Per-Unit (Average) Cost Behavior
Lari’s corporation produces industrial fertilizer. A sack of fertilizer costs P50,
and Lari rents a factory for P450/month. Compute the total costs per month
and the average cost per sack if the corporation made only one sack per
month. What if it made 10 sacks of fertilizer per month?

Average variable costs are constant

Total variable costs go up
1 sack of fertilizer 10 sacks of fertilizer
Total Average Total Average
Costs/ Cost/ Costs/ Cost/
Month Jacket Month Jacket
P50 P50 P500 P50
Ammonia Ammonia
P450 P450 P450 P45
Factory Rent Factory Rent
P500 P500 P950 P95
Total Total
Total fixed costs are constant Average fixed costs go down
The Cost Function
When costs are linear, the cost function is:
TC = F + V x Q, where
F = total fixed cost, V = variable cost per unit of the cost
driver, and Q = the quantity of the cost driver.

P The intercept is the total fixed cost.

Total Costs
The slope is the variable cost per
unit of the cost driver.

slope = PV/unit of cost driver

F A cost that includes a fixed cost
element and a variable cost
element is known as a mixed cost.
Cost Driver
 Nonlinear Cost Behavior
Sometimes nonlinear costs exhibit linear cost behavior over a
range of the cost driver. This is the relevant range of activity.

intercept = total fixed costs

Total
Costs

slope = variable cost per

unit of cost driver

Cost Driver
Relevant Range
 Stepwise Linear Cost Behavior
Some costs are fixed at one level for one range of activity and
fixed at another level for another range of activity. These are
known as stepwise linear costs.

Total Supervisor Salaries Cost in P1000s

Example: A production
120 supervisor makes
P40,000 per year and
the factory can produce
80 100,000 units annually
for each 8-hour shift it
40 operates.

100 200 300

Number of units produced, in 1000s
Cost Terms for Decision Making
• Opportunity costs are the benefits of an alternative
one gives up when that alternative is not chosen.
• Opportunity costs are difficult to measure because they
are associated with something that did not occur.
• Opportunity costs are always relevant in decision
making.

• Sunk costs are costs that were incurred in the past.

• Sunk costs are never relevant for decision making.
Cost Terms for Decision Making
• Discretionary costs are periodic costs incurred for
activities that management may or may not
determine are worthwhile.
• These costs may be variable or fixed costs.
• Discretionary costs are relevant for decision making
only if they vary across the alternatives under
consideration.
• Marginal cost is the incremental cost of producing
the next unit.
• When costs are linear and the level of activity is within
the relevant range, marginal cost is the same as
variable cost per unit.
• Marginal costs are often relevant in decision making.
Separating Mixed Costs
Account Analysis Method

High-Low Method

Scatterplot

Least squares
Account Analysis Method of
Estimating a Cost Function
 Review past costs in the general ledger and past activity
levels to determine each cost’s past behavior.

• For example, a company producing clay wine

goblets might review its records and find:
• the cost of clay is piecewise linear with respect to the number of
pounds of clay purchased
• skilled production labor is variable with respect to the number of
goblets produced
• unskilled production labor is mixed, and the variable portion varies
with respect to the number of times the kiln is operated
• production supervisors’ salary costs are stepwise linear
• distribution costs are mixed, with the variable portion dependent
upon the number of retailers ordering goblets
High-Low Method of
Estimating a Cost Function
 The high-low method is a two-point method
• the two data points used to estimate costs are
observations with the highest and the lowest activity
levels

• The extreme points for activity levels may not

be representative of costs in the relevant
range
• this method may underestimate total fixed costs
and overestimate variable costs per unit,
• or vice versa.
Illustration:
Con Inc. has accumulated the following data for the cost of
maintenance on its machinery for the last four months of
2017:
Month Maintenance costs Maintenance hours
September 26,020 21,000
October 24,600 18,500
November 22,300 15,000
December 25,100 19,000
1. Assuming Con uses the high-low method of analysis, the fixed cost of maintenance would be:
a. 14,500 c. 13,000
b. 5,020 d. 12,320

2. If machine hours are budgeted to be 20,000 hours during January 2009, the budgeted total
maintenance cost would be:
a. 25,400 c. 23,700
b. 25,560 d. 24,720
How Does a Scatterplot
Assist with Categorizing a Cost?
 A scatterplot shows cost observations plotted
against levels of a possible cost driver.

• A scatterplot can assist in determining:

• which cost driver might be the best for

analyzing total costs, and
• the cost behavior of the cost against the
potential cost driver.
 Which Cost Driver Has the Best
Cause & Effect Relationship with Total Cost?
8 observations of total selling expenses plotted against 3 potential cost drivers

# units sold
P

# customers

The number of salespersons

appears to be the best cost
driver of the 3. # salespersons
What is the Underlying Cost Behavior?

This cost is probably linear and fixed.

# units sold
P

This cost is
probably linear and
variable.
# units sold
What is the Underlying Cost Behavior?

This cost is probably linear and mixed.

# units sold
P

This is likely a
stepwise linear
cost.
# units sold
Least Squares Method of
Estimating a Cost Function
 is a statistical technique that may be used to estimate the total cost at
the given level of activity (units, labor/machine hours etc.) based on
past cost data.

 It mathematically fits a straight cost line over a scatter-chart of a

number of activity and total-cost pairs in such a way that the sum of
squares of the vertical distances between the scattered points and the
cost line is minimized.
Formulas
By using mathematical techniques beyond the scope of this
article, the following formulas to calculate a and b may be
derived:
Unit Variable Cost=b=nΣxy-Σx.ΣynΣx2-Σx2
Total Fixed Cost=a=Σy-bΣxn
Where,
n is number of pairs of units—total-cost used in the
calculation;
Σy is the sum of total costs of all data pairs;
Σx is the sum of units of all data pairs;
Σxy is the sum of the products of cost and units of all data
pairs; and
Σx2 is the sum of squares of units of all data pairs.
Illustration:
Below is an examination of last year’s financial statements of Aljay
Co., which manufactures and sells trivets. Labor hours and production
cost for the last 4 months of the year, which are representative for the
year, were as follows:
Month Labor hours Total production costs
September 2,500 20,000
October 3,500 25,000
November 4,500 30,000
December 3,500 25,000
14,000 100,000
======== ==========
Using the least squares method of computation, the fixed production
cost of trivets is approximately:
a. 100,000 c. 7,500
b. 25,000 d. 20,000
Content
● CVP Analysis
● Contribution Margin Ratio
● Target Profit Analysis
● Break Even Point
● Margin of Safety
Cost-Volume- Profit (CVP) Analysis
● Helps managers understand the
relationships among costs, volume, and
profit
● Looks at how profits are affected by selling
prices, sales volume, unit variable costs,
total fixed costs, and mix of products sold
3 Types of costs
Variable: Vary directly proportional with changes
in activity
Ex. Direct Labor, Direct Materials
Fixed: Remain the same regardless of the level of
activity
Ex. Rent, Property Tax
Mixed: Have a variable & a fixed element (Change
in total but not proportionally
Ex. Utility bill
Contribution Margin
CM = Sales - Variable cost

CM ratio = Contribution Margin/ Sales

CM ratio Example
Total Per Unit Percent of
Sales
Sales (200 P80,000 P400 100%
toasters)

Variable expenses (P35,000) (P175) ????

Contribution ????
margin
Fixed expenses P20,000

Net operating
income
CM ratio Example
Total Per Unit Percent of
Sales
Sales (200 P80,000 P400 100%
toasters)

Variable expenses (P35,000) (P175) (43%)

Contribution P45,000 P225 57%

margin
Fixed expenses P20,000

Net operating P25,000

income
Break Even Point

 The level of output at which costs are balanced by

sales revenue and neither a profit nor a loss will occur.

You can find the break even point in units or

in Pesos.
Break Even Point in Units

Unit sales to break even = Fixed costs/

Unit Contribution Margin (CM)
Break Even Example

Lary’s Corporation wants to know how

many sacks of fertilizer they have to sell
in order to break even. Fixed expenses
are P10,000 and has a unit contribution
margin of P200. What is the break even
point in units?
Break Even Example

Unit sales to break even = Fixed

expenses/ Unit CM

Unit sales to break even = P10,000/ P200

Unit sales to break even = 50

Break Even Point in Peso

Peso sales to break even =

Fixed expenses/ CM ratio
Break Even Example

Lary’s Corporation wants to know how many

sacks of fertilizer they have to sell in order to
break even. Fixed expenses are P10,000 and
has a contribution margin ratio of 35%.What
is the break even point in peso?
Break Even Example

Peso sales to break even =

Fixed expenses/ CM ratio
Peso sales to break even =P10,000/ .35
Peso sales to break even =P28,571.43
Target Profit Analysis

● Is used to estimate what sales volume is

needed to achieve a specific target profit

● For example: Lary’s Corporation wants to know

how many sacks of fertilizer they have to sell in order
to have a profit of P20,000 per month.
Target Profit

Peso amount:
Target profit = Fixed cost + Target profit / CM%

Total Units:
Target profit = Fixed cost + Target profit / CM per
unit
Target Profit Example

Lary’s Corporation wants to know how many

sacks of fertilizer they have to sell in order to
have a profit of
P20,000 per month. Fixed expenses are
P10,000 and has a unit contribution margin of
P200. What's the target profit in units?
Target Profit Example
Unit sales to attain the target profit =
Target Profit + Fixed expenses/ Unit CM

Unit sales to attain the target profit =

P20,000 + P10,000/ 200

Unit sales to attain the target profit = 150

Target Profit Example
Same example and the
Contribution ratio is 35%.
What’s the Target Profit in
Pesos?
Target Profit Example

Peso sales to attain a target profit=

Target Profit + Fixed expenses/CM ratio

Peso sales to attain a target profit=

P20,000 + P10,000/35%

Peso sales to attain a target profit= P85,714.28

Margin of Safety
 Is the excess of budgeted or
actual sales Pesos over the break-
even volume of sales Pesos.
Margin of Safety
Margin of safety in Pesos= Total budgeted
(or actual) sales - break-even sales

Margin of safety percentage= Margin of

safety in Pesos/ Total budgeted (or actual)
sales in Pesos
Margin of Safety

Sales (at the current ???

volume of 75 guitars) (X)

Break-even sales (50 P28,571.43

guitars)
Margin of safety in Pesos ???
(Y)

Margin of Safety, (Y)/(X) ???

Margin of Safety

Sales (at the current P42,857.14

volume of 75 guitars) (X)

Break-even sales (50 P28,571.43

guitars)
Margin of safety in Pesos P14,285.72
(Y)

Margin of Safety, (Y)/(X) 33.33%

Practice Sets/Drills – Manufacturing Costs
A. The following costs relate to Antonio Industries for the last quarter:
Conversion Cost P435,ooo
Direct Materials 215,000
Manufacturing Overhead 190,000
Selling and Administrative expense 185,000
 What is Antonio’s prime cost for last quarter?
a. 460,000 c. 405,000
b. 410,000 d. 375,000

 Antonio’s total period cost is

a. 185,000 c. 275,000
b. 400,000 d. 620,000
 B. Raw Materials Inventory Work in Process Inventory
RM, beg. - 63,000 ???? – RM used WIP, beg – 90,000 440,000 - CGM
Purchases- ???? DM(RM) – 235,000
DL - ????
RM, end – 67,000 OH – 115, 000
WIP, end – 90, 000

Manufacturing OH control Factory Payroll

Indirect Mat. – 165,000 115,000- Applied OH DL – 90,000 90,000 – DL
Indirect Labor –65,000 IL – 65,000 65, 000 – IL

Overapplied OH- ????

 Finished Goods Inventory Cost of Goods Sold
FGI, beg – 100,000 405,000 – COGS COGS- 405,000
CGM- 440,000 Overapplied OH - ????

FGI, end - ????

 Purchased raw materials from suppliers costing P363, 000, on July

5, 2016.
 Purchased raw materials from another supplier on July 8, 2016
worth P41, 000.
 Raw materials put into production P400, 000, July 10, 2016. of this
amount includes P235, 000 worth of direct materials and the
balance is indirect.
 Machines personnel worked 200 machine hours costing
P450/hour.
 Salaries of a stocking room personnel P65, 000.
 Direct Labor applied in production is P90, 000 and indirect labor P65,
000.
 Applied Overhead 50%
 Completed and transferred to Finished Goods Inventory P440, 000
 Cost of goods sold P405, 000.
 Sales amounts to P560, 000.
 Operating expenses amounts to P100, 000. Administrative expenses
amounts to P10,000.

 COMPLETE THE MISSING AMOUNTS

 Compute the gross profit for the period
 What is the Net Income?
Practice Sets/Drills – Standard Costing
A. Aljay Company manufactures fertilizers. The company employs both skilled and
unskilled workers. To produce one 55kg sack of fertilizer requires Materials A and
B as well as skilled labor and unskilled labor. The standard and actual material
and labor information is presented below:

Standard:
Material A: 30.25 kgs @ 1.25 per kg
Material B: 24.75 kgs @ 2.00 per kg

Skilled Labor: 4 hours @ 12 per hour

Unskilled Labor: 2 hours @ 7 per hour

Actual:
Material A: 10,716 kgs purchased and used @ 1.50 per kg
Material B: 17,484 kgs purchased and used @ 1.90 per kg

Skilled labor hours: 1,950 @ 11.90 per hour

Unskilled labor hours: 1,300 @ 7.15 per hour
During the current month Aljay Company manufactured 500 55-kg.

Round all answers to the nearest whole peso.

1. What is the total material price variance?

2. What is the total material mix variance?

3. What is the total material yield variance?

4. What is the labor rate variance?

5. What is the labor mix variance?

6. What is the labor yield variance?

B. Aljay Company has developed standard overhead costs based on a capacity of 180,000
machine hours as follows:
During November, 85,000 units were scheduled for production, but only 80,000 units were
actually produced. The following data relate to November:
Actual machine hours used were 165,000.
Actual overhead incurred totaledP1,378,000 (P518,000 variable plus P860,000 fixed).
All inventories are carried at standard cost.

Standard costs
per unit:
Variable portion 2 hours @ 3 = P 6
Fixed portion 2 hours @ 5 = 10
P16

1. The variable overhead spending variance for November was

2. The variable overhead efficiency variance for November was

3. The fixed overhead spending variance for November was

4. The fixed overhead volume variance for November was

Practice Sets/Drills – CVP Analysis
Catie’s Couches makes and sells expensive couches.
Below is the company’s contribution format income
statement for the most recent year.
Total Per Unit Percent of Sales

Sales (50,000 P35,000,000 P700 100%

units)
Variable expenses 15,000,000 300 ?

Contribution 20,000,000 400 ?

Margin
Fixed expenses 15,000,000

Net operating 5,000,000

income
Compute the company’s CM ratio

Compute the break-even point in units and

Pesos

Compute the target profit of P7 million in

units and Pesos

Compute the margin of safety in Pesos and

units
THANK YOU