Standard Cost vs. Job Order Cost Overhead & Volume Variance Video

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  • 0:04 Standard Costing
  • 1:25 Uses of a Standard…
  • 1:59 Variances
  • 2:34 Rate Variance
  • 4:36 Volume Variances
  • 7:00 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

Standard costs for manufactured goods are created at the beginning of the year and can differ from actual costs, resulting in variances. In this lesson, you'll learn about rate and volume variances.

Standard Costing

Ivana Sweet owns the Terrific Cookie Company, and she has a good understanding of the costs to manufacture her cookies. Lately, her accountant has suggested that she needs to adjust the standard costs of some of her items because they're producing variances. What does that mean?

Manufacturing a product involves many costs, including:

  • Direct materials: Represents the cost of the raw materials used in the manufacturing process. For Ivana's business, direct materials could be the flour and sugar she uses in her cookie recipes.
  • Direct labor: The wage costs for the employees who mix, bake, and package the products.
  • Manufacturing overhead: Represents costs that cannot be traced directly to the manufacture of a product, such as rent on the company's production facility and salaries of office employees.

The standard cost adds all of these manufacturing costs together. Manufacturing a package of oatmeal raisin cookies is as follows:

direct materials $0.75
direct labor $0.50
manufacturing overhead $0.25
Total $1.50

Therefore, the standard cost for every package is $1.50.

Uses of a Standard Costing System

Standard costing can be used to estimate the overall cost and determine the price to charge in bidding. For example, Ivana might be asked to quote on providing cookies for a large conference. Knowing her standard costs in advance will allow her to create a realistic bid that would not only cover her costs but also provide her with a profit.

Standard costs are also used in the budgeting process. Given that budgets are only an estimate, they must be compared to actual results periodically to evaluate the performance of a division or a product line.


Differences between standard and actual costs are called variances. Variances can be favorable (F) or unfavorable (U) and identify areas that require further investigation by management. Favorable variances arise when the actual costs are less than standard costs. Unfavorable variances are created when actual costs are greater than standard costs. It's important for management to review variances on a timely basis to ensure necessary changes are made to the cost structure or the purchasing process.

Rate Variances

The two main types of variances are rate and volume variances. Rate variance describes differences in the price paid for raw materials (materials price variance) or in the cost of labor in the manufacturing process (direct labor rate variance).

The formula for calculating the materials price variance is:

actual quantity of input x (standard cost per input - actual cost per input)

A positive result indicates a favorable variance (F), and a negative result indicates unfavorable variance (U). Let's assume that the Terrific Cookie Company produced 10,000 packages of cookies in the month of May. The standard cost of raw materials for a package of cookies was $0.75 and the actual cost was $0.87 per package.

The materials price variance will be (10,000 x ($0.75 - $.87)) = -$1,200; unfavorable (U). Ivana should investigate the reasons for the unfavorable variance to decide what to do. She might determine that her supplier has raised the price for sugar. Maybe she can buy from someone else for a lower price. Or, if the worldwide cost of sugar has risen, Ivana may need to change her standard costs to reflect this increase.

Ivana is also interested in calculating her company's direct labor rate variance. She'll use the following formula:

actual quantity of input x (standard cost per input - actual cost per input)

Again, a positive result indicates a favorable variance (F) and a negative result indicates unfavorable variance (U). Using the previous example, let's say the standard cost of direct labor was $0.50 per package but actual costs were $0.45 per package. The direct labor rate variance would be ((10,000 x ($.50 - $.45)) = $500; favorable (F). Ivana's company has a favorable labor variance as the actual cost of direct labor is five cents less than the standard cost.

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