First off, why do we need to compute for the variances?

Standard costs are costs the company would have acquired/paid the things needed in the production. These costs may not be the actual costs the company would be able to acquire them. I mean, hey, the prices go up, sometimes they go down. Some companies offer huge discounts, some don’t. Some materials are sold as cheap but of low quality. Some materials are expensive but of high quality. But don’t be deceived. There are also materials that are relatively cheap, but of good quality. Not to mention, there are also materials that are expensive but of low quality.

The point being: setting standard costs is all about balancing price and quality.

We won’t be discussing the complex procedure of how companies actually compute for standard costs. Come to think of it, it’s never discussed in school. It would only be worth studying if all students would be financial analysts in the future. Which, we won’t.

So they usually leave the interesting stuff for when you are already on the field. Let the companies that would hire you to train you. That is, if they haven’t assumed that you already know. Which would lead to you making things up, or just simplifying it like our earlier simple example. Right?

Or if you want to be a bit more complex than that, you might want to look at average market prices of materials and average wage rates in your area, and use the average figure as your standard amounts.

Your options are very wide. But if you believe you won’t be doing a job like that, let’s leave it for others to do.

Moving on… we’re going to discuss first the variances for direct materials and direct labor. We’ll have a separate section for the overhead variances, alright?

Price variance – this is the difference between the standard price set by the company and the actual price the materials are acquired

Rate variance – this is the difference between the standard rate set by the company and the actual rate the labor work is paid

The price of materials (actual or standard) includes the purchase price (net of discount), freight-in, and receiving and handling costs.

The rate of labor (again, actual or standard) includes the hourly wage rate, payroll taxes and other benefits.

Total price variance is computed as:

(the difference between the standard price set by the company and the actual price the materials are acquired) x actual units of materials used or purchased.

Yep, the materials price variance can be computed two ways, depending on what the company needs to know.

• 1)units used in production
• 2)units actually purchased

Some problems do state which variance you have to compute, but if nothing is mentioned you go for units used.

For rate variance:

(the difference between the standard rate per hour set by the company and the actual rate per hour the labor work is paid) x actual hours worked

As simple as that.

To give you my version of solving for price and efficiency variances, see video below: (Hurray! I’m putting videos again. XD Forgive the quality, we are yet to invest in equipment.)