Standard Costs and Variance Analysis

Objectives
1.
2.
3.
4.

Explain how standard costs are developed.

Calculate and interpret variances for direct material.
Calculate and interpret variances for direct labor.
Calculate and interpret variances for manufacturing
overhead.
5. Calculate the financial impact of operating at more or
less than planned capacity.
6. Discuss how the management by exception approach is
applied to investigation of standard cost variances.
7. Explain why a favorable variance may be unfavorable,
how process improvements may lead to unfavorable
variances, and why evaluation in terms of variances may
lead to overproduction

Standard Costs
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 and Budgets

1. Standard cost is the standard cost of a single unit.
2. Budgeted cost is the cost, at standard, of the total
number of budgeted units.

Budgeting

Fixed and Flexible Budgets

Development of Standard Costs

1. Standard costs are developed in a variety of
ways:
a. Specified by formulas or recipes.
b. Developed from price lists provided by
suppliers.
c. Determined by time and motion studies
conducted by industrial engineers.
d. Developed from analyses of past data.

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.

Budgets, Variance, and Responsibility

A General Approach To Variance Analysis

1. Direct material: materials price and materials

quantity variance.
2. Direct labor: labor rate (price) and labor
efficiency (quantity) variance.
3. Overhead: overhead volume variance and
controllable overhead variance.

Material Variances
1. Differences between standard and actual material
costs:
a. Material price variance.
b. Material quantity variance.

Material Price Variance

1.
2.
3.
3.
4.
5.

Material price variance:(AP SP) x AQp

(AP) = actual price per unit of material.
(SP) = standard price per unit of direct material.
(AQp) = actual quantity of material purchased.
Actual price > standard price: unfavorable.
Actual price < standard price: favorable.

Material Quantity Variance

1.
2.
3.
4.
5.
6.

Material quantity variance: (AQu SQ)SP

(AQu) = actual quantity of material used.
(SQ) = standard quantity of material allowed.
(SP) = standard price of material.
Actual quantity > standard quantity: unfavorable.
Actual quantity < standard quantity: favorable.

You Get What You Measure

Direct Labor Variances

1. Differences between standard and actual direct labor
costs:
a. Labor rate (price) variance.
b. Material efficiency (quantity) variance.

Labor Rate Variance

1.
2.
3.
4.
5.
6.

Labor rate (price) variance: (AR SR)AH

(AR) = actual wage rate (price).
(SR) = standard wage rate (price).
(AH) = actual number(quantity) labor hours.
Actual rate > standard rate: unfavorable.
Actual rate < standard rate: favorable.

Labor Efficiency Variance

1. Labor efficiency (quantity) variance:
(AH SH)SR
2. (AH) = actual number of hours worked.
3. (SH) = standard number of hours worked.
4. (SR) = standard labor wage rate.
5. Actual hours > standard hours: unfavorable.
6. Actual hours < standard hours: favorable.

Overhead Variances
1. Differences between overhead applied to inventory
at actual overhead costs:
a. Controllable overhead variance.
b. Overhead volume variance.

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.

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.

Comprehensive Example: Darrington

Ice Cream
Standard Costs Per Unit:
Item
Qty. x
Price
Direct Materials: .8 gal.
2.50
Direct Labor:
.125 hrs. 12.00=
Mfg. Overhead:
Total Cost Per Unit (Standard)

=
Total
=
$2.00
$1.50
$ .75
$4.00

Comprehensive Example: Darrington Ice Cream

Material Variances
1. Material price variance:(AP SP) x AQp : ($2.72 $2.50) x 810,000 = $178,200 unfavorable.
2. Material quantity variance: (AQu SQ)SP: (809,000
800,000) x $2.50 = $22,500 unfavorable.

Labor Variances
1. Labor rate (price) variance: (AR SR)AH: ($12.10 $12.00) x 130,000 = $13,000 unfavorable.
2. Labor efficiency (quantity) variance:
(AH SH)SR: (130,000 125,000) x $12 =
$60,000 unfavorable.

Overhead Variances
1. Controllable overhead variance: Actual overhead ($$)
- flexible budget level of overhead ($$) for actual
volume of production: $680,000 - $700,000 =
$20,000 unfavorable.
2. Overhead volume variance: flexible budget level of
overhead for actual level of production - overhead
applied to production using standard overhead rate:
$700,000 - $750,000 = $50,000 favorable.

Investigation of Standard Cost

Variances
1. Standard cost variances are not a definitive sign of
good or bad performance.
2. Variances are merely indicators of potential problems
which must be investigated.
3. There are many plausible explanations for them.

Management By Exception
1. Investigation of standard cost variances is a costly
activity
2. Management must decide which variances to
investigate.
3. Most managers practice management by exception.
4. What is exceptional? Usually an absolute dollar
amount or a percentage dollar amount.

Favorable Variances May Be

Unfavorable
1. A favorable variance does not mean that it should
not be investigated.
2. Raw materials are good examples of this
phenomenon.
3. Consider inferior, low-priced materials.
4. A favorable price variance may result, but there may
also be substantially more scrap and rework, and thus
a higher quantity variance.

Can Process Improvements Lead to

Unfavorable Variances?
1. Process improvements frequently lead to unfavorable
variances.
2. Process improvements often lead to increased
productivity.
3. Therefore fewer hours may be required to produce a
unit of output.
4. But actual hours will remain unchanged unless the
firm terminates the workers to became more
productive.

Beware-Evaluation in Terms of Variances Can

Lead To Excess Production
1. A department in front of another (bottleneck)
department should not produce more than the
bottleneck department can handle.
2. If it cuts back, it will idle workers.
3. If it doesnt there will be excess work in process and a
negative effect on shareholder value.

Responsibility Accounting and

Variances
1. Managers should be held responsible only for costs
they can control.
2. This is also true in the area of variance analysis.
3. A purchasing agent may be held responsible for direct
material price variances, but certainly not direct
material quantity (usage) variances.

Recording Standard Costs

1.
2.
3.
4.
5.
6.

Material
Labor
Overhead
Finished goods
Cost of goods sold
Closing variance accounts

Recording Material Costs

Purchase of raw materials inventory:
Account
Raw Material Inventory (std.) x
Material Price Variance
x
Accounts Payable (actual)
Usage of raw materials inventory:
Account
Work in Process Inventory
Material Quantity Variance
Raw Material Inventory

dr.

cr.

dr.
x
x
x

cr.

Recording Labor Costs

Recording Labor Cost:
Account
Work in Process Inventory (std.)
Labor Rate Variance
x
Labor Efficiency Variance
Wages/Sal. Payable (actual)

dr.
x
x
x

cr.

Recording Manufacturing Overhead:

Step 1
To record actual overhead cost:

Account
Manufacturing Overhead
*Various Accounts

dr.
x

cr.
x

Recording Manufacturing Overhead:

Step 2
To apply overhead cost to work in process inventory at cost:

Account
Work in Process Inventory
Manufacturing Overhead

dr.
x

cr.
x

Recording Manufacturing Overhead:

Step 3
To close out manufacturing overhead cost to work in process
inventory at cost:
Account
Manufacturing Overhead
Overhead Volume
Variance
Controllable Overhead
Variance

dr.
x

cr.

x
x

Recording Finished Goods

To record completed units sent to finished goods:

Account
Finished Goods Inventory
Work in Process
Inventory

dr.
x

cr.

Recording Cost Of Goods Sold

To apply overhead cost to work in process inventory at cost:

Account
Cost of Goods Sold
Finished Goods
Inventory

dr.
x

cr.

Closing Variance Accounts

Temporary variance accounts must be closed at the end of the period.
Account
dr.
cr.
Cost of Goods Sold
x
Overhead Volume Variance
x
Controllable Overhead Variance
x
Material Price Variance
x
Material Quantity Variance
x
Labor Rate Variance
x
Labor Efficiency Variance
x

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 $3.50.
Actual costs per unit are $3.80 Actual quantity
is 3,000. Standard quantity is 2,800. Material
price variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable

Quick Review Answer #2

2. Standard material costs per unit are $3.50.
Actual costs per unit are $3.80 Actual quantity
is 3,000. Standard quantity is 2,800. Material
price variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable

Quick Review Question #3

2. Standard material costs per unit are $3.50.
Actual costs per unit are $3.80 Actual quantity
is 3,000. Standard quantity is 2,800. Material
quantity variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable

Quick Review Answer #3

2. Standard material costs per unit are $3.50.
Actual costs per unit are $3.80 Actual quantity
is 3,000. Standard quantity is 2,800. Material
quantity variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 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.