Standard costing at Kyowa Foods: six variances, and where they should land
Kyowa Foods produces one product in a single process. Standards per unit are: 2.0 kg of material at ¥500 per kg; 0.8 direct labour hours at ¥1,200 per hour; and fixed manufacturing overhead absorbed on the basis of a normal capacity of 7,500 direct labour hours and a monthly fixed overhead budget of ¥18,000,000. In June 20X5 the plant produced 9,000 finished units with no opening or closing work in process. Actual results were: 18,400 kg of material consumed at a total cost of ¥9,384,000; 7,400 direct labour hours costing ¥9,028,000; and actual fixed overhead of ¥18,600,000. Standard cost of the closing finished goods inventory is ¥12,000,000 and the standard cost of goods sold for the month is ¥108,000,000. The plant manager's bonus is linked to the size of total unfavourable variances and he has asked, pointedly, whether the capacity variance is really his fault.
1. Compute the material, labour and fixed overhead variances, showing the standard quantities you used.
Read the worked answer
Standard quantities for 9,000 units: material 9,000 × 2.0 = 18,000 kg; labour 9,000 × 0.8 = 7,200 hours; absorbed fixed overhead 7,200 × (18,000,000 / 7,500 = ¥2,400) = ¥17,280,000.
Material (actual price 9,384,000 / 18,400 = ¥510):
- Price variance = (510 - 500) × 18,400 = ¥184,000 unfavourable
- Quantity variance = (18,400 - 18,000) × 500 = ¥200,000 unfavourable
- Check: 9,384,000 - (18,000 × 500 = 9,000,000) = 384,000 = 184,000 + 200,000 ✔
Labour (actual rate 9,028,000 / 7,400 = ¥1,220):
- Rate variance = (1,220 - 1,200) × 7,400 = ¥148,000 unfavourable
- Time variance = (7,400 - 7,200) × 1,200 = ¥240,000 unfavourable
- Check: 9,028,000 - (7,200 × 1,200 = 8,640,000) = 388,000 = 148,000 + 240,000 ✔
Fixed overhead (two-variance method):
- Budget variance = 18,600,000 - 18,000,000 = ¥600,000 unfavourable
- Capacity variance = (7,400 - 7,500) × 2,400 = ¥240,000 unfavourable
- Total 18,600,000 - 17,280,000 = 1,320,000 ✔
Under the three-variance presentation the ¥1,320,000 splits into budget 600,000, efficiency (7,400 - 7,200) × 2,400 = 480,000, and capacity 240,000. Choose one convention and state it - mixing the two produces a spurious fourth variance.
2. Respond to the plant manager's question about the capacity variance, and advise on how the total variances should be disposed of at period end.
Read the worked answer
The capacity variance is not a spending variance. It is the fixed cost of idle capacity: normal capacity is 7,500 hours but only 7,400 were worked, so ¥240,000 of budgeted fixed overhead was never absorbed by production. The manager did not overspend - the ¥600,000 budget variance is the genuine spending signal. The capacity shortfall is driven by volume, which may reflect sales orders, scheduling or the choice of a 7,500-hour normal capacity. The fair response is to separate the variance into its controllable and non-controllable parts rather than let it feed a bonus formula unchecked.
Disposal. The standard rule is that cost variances are charged to cost of sales in the period, because standards are a control device and holding gains and losses on the balance sheet defeats the purpose. Proration between cost of sales and inventories is permitted only where the variance is not abnormal and proration is reasonable.
Total variances = 184,000 + 200,000 + 148,000 + 240,000 + 600,000 + 240,000 = ¥1,612,000 unfavourable.
If the company elects to prorate: rate = 1,612,000 / (108,000,000 + 12,000,000) = 1.3433%; charged to inventory 12,000,000 × 1.3433% = ¥161,200; to cost of sales ¥1,450,800. Whichever route is taken, disclose the choice - the effect on gross profit is about ¥1.5 million, which is material against a ¥108 million cost base.
3. Explain what the material price variance computed on quantity used hides, and why the labour time variance and the material quantity variance may share a single root cause.
Read the worked answer
Price variance on quantity used. Computing it on 18,400 kg rather than on quantity purchased means any price paid on material still sitting in stores is deferred until that material is consumed. In a period of rising prices this flatters the current month and pushes the pain into the next one. Japanese practice conventionally uses quantity consumed, which keeps the variance aligned with the cost actually charged to production, but the purchasing manager should be judged on the purchase-quantity version, since that is the quantity he negotiated.
Shared root cause. A ¥200,000 adverse material quantity variance and a ¥240,000 adverse labour time variance appearing together is a pattern, not a coincidence. Typical explanations:
- Inferior material (paid ¥510 instead of ¥500) that required extra cutting and rework - the price variance in purchasing caused the quantity and time variances downstream.
- New operators working more slowly and wasting material while learning.
- Machine downtime that forced manual rework.
Why the distinction matters. If the price variance is the cause, the purchasing manager owns all three variances and the bonus formula should recognise the linkage. If the cause is a learning curve on a new product, none of the three is a controllable failure and writing them off to cost of sales simply penalises the month that absorbed the start-up cost. A variance is only informative once somebody has walked the floor to find the cause; the arithmetic is the easy part.