Standard Costing PDF

A LOOK BACK A LOOK AT THIS CHAPTER A LOOK AHEAD
In Chapter 8, we discussed the budgeting Chapter 9 begins our discussion of In Chapter 10, we continue the
process and each of the schedules in the management control and performance discussion of management control and
master budget. measures. We explain how to prepare performance measures by focusing on how
flexible budgets and how to compare decentralized organizations are managed.
them to actual results for the purposes of
computing revenue and spending variances.
We also describe how standards are used
to isolate the effects of various factors on
actual results. In particular, we compute
material, labor, and overhead variances.
9
Flexible Budgets,
Standard Costs, and
Variance Analysis
CHAPTER OUTLINE
The Variance Analysis Cycle Using Standard Costs—Direct Materials • Overhead Application in a Standard Cost
Flexible Budgets Variances System
• Characteristics of a Flexible Budget • The Materials Price Variance • Budget Variance
• Deficiencies of the Static Planning Budget • The Materials Quantity Variance • Volume Variance
• How a Flexible Budget Works • Graphic Analysis of Fixed Overhead
Using Standard Costs—Direct Labor
Variances Variances
Flexible Budget Variances • The Labor Rate Variance • Cautions in Fixed Overhead Analysis
• Revenue Variances • The Labor Efficiency Variance • Reconciling Overhead Variances and
• Spending Variances Underapplied or Overapplied Overhead
Using Standard Costs—Variable
Flexible Budgets with Multiple Cost Manufacturing Overhead Variances Appendix 9B: Standard Cost Systems:
Drivers • The Variable Manufacturing Overhead Rate A Financial Reporting Perspective
Standard Costs—Setting the Stage and Efficiency Variances Using Microsoft Excel
• Setting Direct Materials Standards • Fundamental Accounting Equations
An Important Subtlety in the Materials • Four Key Assumptions
• Setting Direct Labor Standards Variances
• Setting Variable Manufacturing Overhead • Standard Cost Systems: An Example
Appendix 9A: Predetermined Overhead
Standards Rates and Overhead Analysis in a • Summary of Transactions
• Using Standards in Flexible Budgets Standard Costing System • Calculating the Variances
A General Model for Standard Cost • MicroDrive Corporation: An Example • Recording the Transactions
Variance Analysis • Predetermined Overhead Rates • Preparing the Income Statement
DECISION FEATURE LEARNING
OBJECTIVES
After studying Chapter 9, you

should be able to:
LO9–1 Prepare a planning

budget and a flexible budget
and understand how they
differ from one another.
LO9–2 Calculate and

interpret revenue and
spending variances.
LO9–3 Prepare a flexible

budget with more than one
cost driver.
LO9–4 Compute the direct

materials price and quantity
variances and explain their
significance.
LO9–5 Compute the direct

©Michael Sears/MCT/Newscom
labor rate and efficiency
variances and explain their
Why Do Companies Need Flexible Budgets? significance.
The difficulty of accurately predicting future financial performance can be readily understood by reading the LO9–6 Compute the
annual report of any publicly traded company. For example, Nucor Corporation, a steel manufacturer headquar- variable manufacturing
tered in Charlotte, North Carolina, cites numerous reasons why its actual results may differ from expectations, overhead rate and efficiency
including the following: (1) changes in the supply and cost of raw materials; (2) changes in the availability and variances and explain their
cost of electricity and natural gas; (3) changes in the market demand for steel products; (4) fluctuations in significance.
currency conversion rates; (5) significant changes in laws or government regulations; and (6) the cyclical nature
of the steel industry. LO9–7 (Appendix 9A)
Source: Form 10-K, 8-13. Nucor Corporation, 2016 Compute and interpret the
fixed overhead budget and
volume variances.
LO9–8 (Appendix 9B)

Prepare an income statement
using a standard cost system.
391
392 Chapter 9
I
n the last chapter we explored how budgets are developed before a period begins.
In this chapter, we explain how budgets can be adjusted to help guide actual operations
and influence the performance evaluation process. For example, an organization’s
actual expenses will rarely equal its budgeted expenses as estimated at the beginning of
the period. The reason is that the actual level of activity (such as unit sales) will rarely
be the same as the budgeted activity; therefore, many actual expenses and revenues will
naturally differ from what was budgeted. Should a manager be penalized for spending
10% more than budgeted for a variable expense like direct materials if unit sales are 10%
higher than budgeted? Of course not. After studying this chapter, you’ll know how to
adjust a budget to enable meaningful comparisons to actual results.
THE VARIANCE ANALYSIS CYCLE

Companies use the variance analysis cycle, as illustrated in Exhibit 9–1, to evaluate and
improve performance. The cycle begins with the preparation of performance reports
in the accounting department. These reports highlight variances, which are the differ-
ences between the actual results and what should have occurred according to the budget.
The variances raise questions. Why did this variance occur? Why is this variance larger
than it was last period? The significant variances are investigated so that their root causes
can be either replicated or eliminated. Then, next period’s operations are carried out
and the cycle begins again with the preparation of a new performance report for the lat-
est period. The emphasis should be on highlighting superior and unsatisfactory results,
finding the root causes of these outcomes, and then replicating the sources of superior
achievement and eliminating the sources of unsatisfactory performance. The variance
analysis cycle should not be used to assign blame for poor performance.
Managers frequently use the concept of management by exception in conjunction
with the variance analysis cycle. Management by exception is a management system
that compares actual results to a budget so that significant deviations can be flagged as
exceptions and investigated further. This approach enables managers to focus on the most
important variances while bypassing trivial discrepancies between the budget and actual
results. For example, a variance of $5 is probably not big enough to warrant attention,
whereas a variance of $5,000 might be worth tracking down. Another clue is the size of
the variance relative to the amount of spending. A variance that is only 0.1% of spending
on an item is probably caused by random factors. On the other hand, a variance of 10%
of spending is much more likely to be a signal that something is wrong. In addition to
watching for unusually large variances, the pattern of the variances should be monitored.
For example, a run of steadily mounting variances should trigger an investigation even
though none of the variances is large enough by itself to warrant investigation.
E X H I B I T 9 – 1
The Variance Analysis Cycle Variance Analysis Cycle
Raise Identify Take

questions root causes actions
Conduct next
Analyze
period’s
variances
operations
Prepare Begin
performance
report
Flexible Budgets, Standard Costs, and Variance Analysis 393
Next, we explain how service organizations use flexible budgets to analyze vari-
ances followed by a discussion of how companies can use standard costs for those same
purposes.
FLEXIBLE BUDGETS
Characteristics of a Flexible Budget
The budgets that we explored in the last chapter were planning budgets. A planning LEARNING OBJECTIVE 9–1
budget is prepared before the period begins and is valid for only the planned level of
activity. A static planning budget is suitable for planning but is inappropriate for evalu- Prepare a planning budget and a
ating how well costs are controlled. If the actual level of activity differs from what was flexible budget and understand
how they differ from one another.
planned, it would be misleading to compare actual costs to the static, unchanged planning
budget. If activity is higher than expected, variable costs should be higher than expected;
and if activity is lower than expected, variable costs should be lower than expected.
Flexible budgets take into account how changes in activity affect costs. A flexible
budget is an estimate of what revenues and costs should have been, given the actual level
of activity for the period. When a flexible budget is used in performance evaluation,
actual costs are compared to what the costs should have been for the actual level of
activity during the period rather than to the static planning budget. This is a very impor-
tant distinction. If adjustments for the level of activity are not made, it is very difficult to
interpret discrepancies between budgeted and actual costs.
✓
1 . Which of the following statements is true? (You may select more than one answer.)
a. A planning budget is prepared before the period begins and it is based on the CONCEPT
actual level of activity incurred during the period. CHECK
b. A flexible budget is an estimate of what revenues and costs should have been,
given the actual level of activity for the period.
c. The variance analysis cycle includes analyzing differences between actual results
and what should have occurred according to the budget.
d. The management by exception approach enables managers to focus on the most
important variances while bypassing trivial discrepancies.
Deficiencies of the Static Planning Budget

To illustrate the difference between a static planning budget and a flexible budget, con-
sider Rick’s Hairstyling, an upscale hairstyling salon located in Beverly Hills that is
owned and managed by Rick Manzi. Recently Rick has been attempting to get better
control of his revenues and costs, and at the urging of his accounting and business adviser,
Victoria Kho, he has begun to prepare monthly budgets.
At the end of February, Rick prepared the March budget that appears in Exhibit 9–2.
Rick believes that the number of customers served in a month (also known as the number
of client-visits) is the best way to measure the overall level of activity in his salon. A cus-
tomer who comes into the salon and has his or her hair styled is counted as one client-visit.
Note that the term revenue is used in the planning budget rather than sales. We use
the term revenue throughout the chapter because some organizations have sources of
revenue other than sales. For example, donations, as well as sales, are counted as revenue in
nonprofit organizations.
Rick has identified eight major categories of costs—wages and salaries, hairstyling
supplies, client gratuities, electricity, rent, liability insurance, employee health insurance,
and miscellaneous. Client gratuities consist of flowers, candies, and glasses of cham-
pagne that Rick gives to his customers while they are in the salon.
394 Chapter 9
E X H I B I T 9 – 2
Planning Budget Rick’s Hairstyling
Planning Budget
For the Month Ended March 31
Budgeted client-visits (q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000

Revenue ($180.00q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $180,000
Expenses:
Wages and salaries ($65,000 + $37.00q). . . . . . . . . . . . . 102,000
Hairstyling supplies ($1.50q). . . . . . . . . . . . . . . . . . . . . . . . 1,500
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,100
Electricity ($1,500 + $0.10q). . . . . . . . . . . . . . . . . . . . . . . . 1,600
Rent ($28,500). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300). . . . . . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q). . . . . . . . . . . . . . . . . . . . 1,400
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163,200
Net operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,800
Working with Victoria, Rick estimated a cost formula for each cost. For example,
the cost formula for electricity is $1,500 + $0.10q, where q equals the number of client-
visits. In other words, electricity is a mixed cost with a $1,500 fixed element and a $0.10
per client-visit variable element. Once the budgeted level of activity was set at 1,000
client-visits, Rick computed the budgeted amount for each line item in the budget.
For example, using the cost formula, he set the budgeted cost for electricity at $1,600
(= $1,500 + $0.10 × 1,000). To finalize his budget, Rick computed his expected net
operating income for March of $16,800.
At the end of March, Rick prepared the income statement in Exhibit 9–3, which
shows that 1,100 clients actually visited his salon in March and that his actual net operat-
ing income for the month was $21,230. It is important to realize that the actual results
are not determined by plugging the actual number of client-visits into the revenue and
cost formulas. The formulas are simply estimates of what the revenues and costs should
be for a given level of activity. What actually happens usually differs from what is sup-
posed to happen.
E X H I B I T 9 – 3
Actual Results—Income Rick’s Hairstyling
Statement Income Statement
Actual client-visits . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200
Expenses:
Wages and salaries. . . . . . . . . . . . . . . . . . . . . 106,900
Hairstyling supplies. . . . . . . . . . . . . . . . . . . . . 1,620
Client gratuities. . . . . . . . . . . . . . . . . . . . . . . . . 6,870
Electricity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,550
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance. . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance . . . . . . . . . . . . . . 22,600
Miscellaneous. . . . . . . . . . . . . . . . . . . . . . . . . . 2,130
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . 172,970
Net operating income. . . . . . . . . . . . . . . . . . . . . $ 21,230
The first thing Rick noticed when comparing Exhibits 9–2 and 9–3 is that the actual
profit of $21,230 (from Exhibit 9–3) was substantially higher than the budgeted profit of
$16,800 (from Exhibit 9–2). This was, of course, good news, but Rick wanted to know
more. Business was up by 10%—the salon had 1,100 client-visits instead of the budgeted
1,000 client-visits. Could this alone explain the higher net operating income? The answer
is no. An increase in net operating income of 10% would have resulted in net operating
income of only $18,480 (= 1.1 × $16,800), not the $21,230 actually earned during the
month. What is responsible for this better outcome? Higher prices? Lower costs? Some-
thing else? Whatever the cause, Rick would like to know the answer and then hopefully
repeat the same performance next month.
In an attempt to analyze what happened in March, Rick prepared the report com-
paring actual to budgeted costs that appears in Exhibit 9–4. Note that most of the
variances in this report are labeled unfavorable (U) rather than favorable (F) even
though net operating income was actually higher than expected. For example, wages
and salaries show an unfavorable variance of $4,900 because the actual wages and
salaries expense was $106,900, whereas the budget called for wages and salaries
of $102,000. The problem with the report, as Rick immediately realized, is that it
compares revenues and costs at one level of activity (1,000 client-visits) to revenues
and costs at a different level of activity (1,100 client-visits). This is like comparing
apples to oranges. Because Rick had 100 more client-visits than expected, some of
his costs should be higher than budgeted. From Rick’s standpoint, the increase in
activity was good; however, it appears to be having a negative impact on most of
the costs in the report. Rick knew that something would have to be done to make
the report more meaningful, but he was unsure of what to do. So he contacted his
accountant, Victoria Kho, and asked her to analyze his salon’s performance using the
data in Exhibit 9–2 and 9–3.
E X H I B I T 9 – 4
Rick’s Hairstyling Comparison of Actual Results to
Comparison of Actual Results to the Planning Budget the Static Planning Budget
Actual Planning
Results Budget Variances*
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,000
Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $180,000 $14,200 F
Expenses:
Wages and salaries. . . . . . . . . . . . . . . . . 106,900 102,000 4,900 U
Hairstyling supplies. . . . . . . . . . . . . . . . . 1,620 1,500 120 U
Client gratuities. . . . . . . . . . . . . . . . . . . . . 6,870 4,100 2,770 U
Electricity. . . . . . . . . . . . . . . . . . . . . . . . . . 1,550 1,600 50 F
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance. . . . . . . . . . . . . . . . . . . 2,800 2,800 0
Employee health insurance . . . . . . . . . . 22,600 21,300 1,300 U
Miscellaneous. . . . . . . . . . . . . . . . . . . . . . 2,130 1,400 730 U
Total expense. . . . . . . . . . . . . . . . . . . . . . . . 172,970 163,200 9,770 U
Net operating income. . . . . . . . . . . . . . . . . $ 21,230 $ 16,800 $ 4,430 F
*The revenue variance is labeled favorable (unfavorable) when the actual revenue
is greater than (less than) the planning budget. The expense variances are labeled
favorable (unfavorable) when the actual expense is less than (greater than) the
planning budget.
396 Chapter 9
E X H I B I T 9 – 5
Flexible Budget Based on Actual Rick’s Hairstyling
Activity Flexible Budget
Actual client-visits (q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100

Revenue ($180.00q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000
Expenses:
Wages and salaries ($65,000 + $37.00q). . . . . . . . . 105,700
Hairstyling supplies ($1.50q). . . . . . . . . . . . . . . . . . . . 1,650
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . . . 4,510
Electricity ($1,500 + $0.10q). . . . . . . . . . . . . . . . . . . . 1,610
Rent ($28,500). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300). . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q). . . . . . . . . . . . . . . . 1,420
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167,490
Net operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,510
How a Flexible Budget Works

Victoria responded to Rick’s request by preparing the flexible budget shown in
Exhibit 9–5. Her flexible budget shows what the revenues and costs should have been
given the actual level of activity in March. She calculated the expenses in her flexible
budget by using Rick’s cost formulas from Exhibit 9–2 to estimate what each expense
should have been for 1,100 client-visits—the actual level of activity. For example, using
the cost formula $1,500 + $0.10q, the cost of electricity in March should have been
$1,610 (= $1,500 + $0.10 × 1,100). Also, notice that the amounts of rent ($28,500),
liability insurance ($2,800), and employee health insurance ($21,300) in Victoria’s
flexible budget equal the corresponding amounts included in Rick’s planning budget.
This occurs because fixed costs are not affected by the activity level.
We can see from the flexible budget that the net operating income in March should
have been $30,510, but recall from Exhibit 9–3 that the net operating income was
actually only $21,230. The results are not as good as we thought. Why? We will answer
that question shortly.
To summarize to this point, Rick had budgeted for a profit of $16,800. The actual profit
was quite a bit higher—$21,230. However, Victoria’s analysis shows that given the actual
number of client-visits in March, the profit should have been even higher—$30,510.
What are the causes of these discrepancies? Rick would certainly like to build on the
positive factors, while working to reduce the negative factors. But what are they?
IN BUSINESS
On-Call Scheduling Draws the Attention of the New
York Attorney General
The New York Attorney General has warned Target, Gap, and 11 other companies that their on-
call employee scheduling practices may violate the law. These companies are using software
programs to forecast immediate-term staffing needs based on real-time sales and customer
traffic information. If a store is busy it requires its on-call employees to come to work, whereas if
the store is not busy the employees do not come to work and they are not paid. In other words,
the employees need to plan to be available even though they may or may not be called into
work or get paid.
©Bloomberg/Getty Images (continued)

IN BUSINESS
(concluded)
From a flexible budgeting standpoint, the companies are trying to make their labor costs
variable with respect to sales and customer traffic. From a legal standpoint, the attorney gen-
eral noted that this compensation scheme leaves employees “too little time to make arrange-
ments for family needs, let alone to find an alternative source of income to compensate for
the lost pay.”
Source: Weber, Lauren, “Retailers Under Fire for Work Schedules,” The Wall Street Journal, April 13, 2015,
B1–B2.
FLEXIBLE BUDGET VARIANCES

Recall that the flexible budget based on the actual level of activity in Exhibit 9–5 shows LEARNING OBJECTIVE 9–2
what should have happened given the actual level of activity. Therefore, Victoria’s next
step was to compare actual results to the flexible budget—in essence comparing what Calculate and interpret revenue and
actually happened to what should have happened. Her work is shown in Exhibit 9–6. spending variances.
Revenue Variances
Focusing first on revenue, the actual revenue totaled $194,200. However, the flexible bud-
get indicates that, given the actual level of activity, revenue should have been $198,000.
Consequently, revenue was $3,800 less than it should have been, given the actual num-
ber of client-visits for the month. This discrepancy is labeled as a $3,800 U (unfavor-
able) variance and is called a revenue variance. A revenue variance is the difference
between the actual total revenue and what the total revenue should have been, given the
E X H I B I T 9 – 6
Rick’s Hairstyling Revenue and Spending
Revenue and Spending Variances Variances from Comparing Actual
For the Month Ended March 31 Results to the Flexible Budget
Revenue
and
Actual Flexible Spending
Results Budget Variances*
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,100
Revenue($180.00q). . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $198,000 $3,800 U
Expenses:
Wages and salaries ($65,000 + $37.00q). . . . . . . 106,900 105,700 1,200 U
Hairstyling supplies ($1.50q). . . . . . . . . . . . . . . . . . 1,620 1,650 30 F
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . 6,870 4,510 2,360 U
Electricity ($1,500 + $0.10q). . . . . . . . . . . . . . . . . . 1,550 1,610 60 F
Rent ($28,500). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . 2,800 2,800 0
Employee health insurance ($21,300) 22,600 21,300 1,300 U
Miscellaneous ($1,200 + $0.20q). . . . . . . . . . . . . . 2,130 1,420 710 U
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172,970 167,490 5,480 U
Net operating income. . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,230 $ 30,510 $9,280 U
*The revenue variance is labeled favorable (unfavorable) when the actual revenue is
greater than (less than) the flexible budget. The expense variances are labeled favorable
(unfavorable) when the actual expense is less than (greater than) the flexible budget.
397
398 Chapter 9
actual level of activity for the period. If actual revenue exceeds what the revenue should
have been, the variance is labeled favorable. If actual revenue is less than what the rev-
enue should have been, the variance is labeled unfavorable. Why would actual revenue be
less than or more than it should have been, given the actual level of activity? Basically,
the revenue variance is favorable if the average selling price is greater than expected;
it is unfavorable if the average selling price is less than expected. This could happen for
a variety of reasons including a change in selling price, a different mix of products sold,
a change in the amount of discounts given, poor accounting controls, and so on.
IN BUSINESS The Sales Implications of the World Cup

Actual sales volumes can differ from planned sales volumes for many reasons. For example,
some companies may fail to consider how sporting events such as the World Cup will affect
their planned sales. Corning said TV sales were up 13% in Europe and 64% in Latin America
during the World Cup and Carrefour reported a bump in sales of its beer, soft drinks, and meats
during the same period. Conversely, Whirlpool reported lower demand for its washing machines
(because the company claimed that customers were spending their disposable income on TVs)
and Denny’s reported a drop in full-service dining during the World Cup.
©Lars Baron - FIFA/FIFA/Getty Images
Source: Monga, Vipal, and Chasan, Emily, “When in Doubt, Blame It on the World Cup,” The Wall Street
Journal, July 31, 2014, B1 and B4.
Spending Variances
Focusing next on costs, the actual electricity cost was $1,550; however, the flexible bud-
get indicates that electricity costs should have been $1,610 for the 1,100 client-visits in
March. Because the cost was $60 less than we would have expected for the actual level of
activity during the period, it is labeled as a favorable variance, $60 F. This is an example
of a spending variance. By definition, a spending variance is the difference between
the actual amount of the cost and how much a cost should have been, given the actual
level of activity. If the actual cost is greater than what the cost should have been, the
variance is labeled as unfavorable. If the actual cost is less than what the cost should
have been, the variance is labeled as favorable. Why would a cost have a favorable or
unfavorable variance? There are many possible explanations including paying a higher
price for inputs than should have been paid, using too many inputs for the actual level
of activity, a change in technology, and so on. Later in the chapter we will explore these
types of explanations in greater detail when we begin discussing standard costs.
Note from Exhibit 9–6 that the overall net operating income variance is $9,280 U (unfa-
vorable). This means that given the actual level of activity for the period, the net operating
income was $9,280 lower than it should have been. There are a number of reasons for
this. The most prominent is the unfavorable revenue variance of $3,800. Next in line is
the $2,360 unfavorable variance for client gratuities. Looking at this in another way, client
gratuities were more than 50% larger than they should have been according to the flexible
budget. This is a variance that Rick would almost certainly want to investigate further.
He may find that this unfavorable variance is not necessarily a bad thing. It is possible,
for example, that more lavish use of gratuities led to the 10% increase in client-visits.
Exhibit 9–6 also includes a $1,300 unfavorable variance related to employee health
insurance, thereby highlighting how a fixed cost can have a spending variance. While
fixed costs do not depend on the level of activity, the actual amount of a fixed cost can dif-
fer from the estimated amount included in a flexible budget. For example, perhaps Rick’s
employee health insurance premiums unexpectedly increased by $1,300 during March.
In conclusion, the revenue and spending variances in Exhibit 9–6 will help Rick better
understand why his actual net operating income differs from what should have happened
given the actual level of activity.
Owner of Micro-Brewery DECISION POINT

Hops is an essential ingredient in beer. The brewery’s budget for the current month, which
was based on the production of 800 barrels of beer, allowed for an expense of $960 for hops.
The actual production for the month was 850 barrels of beer and the actual cost of the hops
used to produce that beer was $1,020. Hops is a variable cost. Do you think the expense for
hops for the month was too high?
FLEXIBLE BUDGETS WITH MULTIPLE COST DRIVERS

At Rick’s Hairstyling, we have thus far assumed that there is only one cost driver—the LEARNING OBJECTIVE 9–3
number of client-visits. However, in the activity-based costing chapter, we found that more
than one cost driver might be needed to adequately explain all of the costs in an organization. Prepare a flexible budget with more
For example, some of the costs at Rick’s Hairstyling probably depend more on the number than one cost driver.
of hours that the salon is open for business than the number of client-visits. Specifically,
most of Rick’s employees are paid salaries, but some are paid on an hourly basis. None
of the employees is paid on the basis of the number of customers actually served. Conse-
quently, the cost formula for wages and salaries would be more accurate if it were stated in
terms of the hours of operation rather than the number of client-visits. The cost of electricity
is even more complex. Some of the cost is fixed—the heat must be kept at some minimum
level even at night when the salon is closed. Some of the cost depends on the number of
client-visits—the power consumed by hair dryers depends on the number of customers
served. Some of the cost depends on the number of hours the salon is open—the costs of
lighting the salon and heating it to a comfortable temperature. Consequently, the cost for-
mula for electricity would be more accurate if it were stated in terms of both the number of
client-visits and the hours of operation rather than just in terms of the number of client-visits.
Exhibit 9–7 shows a flexible budget in which these changes have been made. In that
flexible budget, two cost drivers are listed—client-visits and hours of operation—where
q1 refers to client-visits and q2 refers to hours of operation. For example, wages and sala-
ries depend on the hours of operation and its cost formula is $65,000 + $220q2. Because
the salon actually operated 190 hours, the flexible budget amount for wages and salaries
is $106,800 (= $65,000 + $220 × 190). The electricity cost depends on both client-visits
and the hours of operation and its cost formula is $390 + $0.10q1 + $6.00q2. Because the
E X H I B I T 9 – 7
Rick’s Hairstyling Flexible Budget Based on More
Flexible Budget than One Cost Driver
Actual client-visits (q1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100

Actual hours of operation (q2) . . . . . . . . . . . . . . . . . . . . . . . . . 190
Revenue ($180.00q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000
Expenses:
Wages and salaries ($65,000 + $220q2). . . . . . . . . . . . . . 106,800
Hairstyling supplies ($1.50q1). . . . . . . . . . . . . . . . . . . . . . . 1,650
Client gratuities ($4.10q1). . . . . . . . . . . . . . . . . . . . . . . . . . . 4,510
Electricity ($390 + $0.10q1 + $6.00q2). . . . . . . . . . . . . . . 1,640
Rent ($28,500). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300). . . . . . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q1). . . . . . . . . . . . . . . . . . . 1,420
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168,620
Net operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29,380
400 Chapter 9
actual number of client-visits was 1,100 and the salon actually operated for 190 hours, the
flexible budget amount for electricity is $1,640 (= $390 + $0.10 × 1,100 + $6.00 × 190).
Notice that the net operating income in the flexible budget based on two cost drivers is
$29,380, whereas the net operating income in the flexible budget based on one cost driver
(see Exhibit 9–5) is $30,510. These two amounts differ because the flexible budget based
on two cost drivers is more accurate than the flexible budget based on one driver.
The revised flexible budget based on both client-visits and hours of operation can be
used exactly like we used the earlier flexible budget based on just client-visits to compute
revenue and spending variances as in Exhibit 9–6. The difference is that because the cost
formulas based on more than one cost driver are more accurate than the cost formulas
based on just one cost driver, the variances will also be more accurate.
Beyond using more than one cost driver to improve its budgeting and performance
analysis process, a company can also decompose its spending variances into two parts—a
part that measures how well resources were used and a part that measures how well the
acquisition prices of those resources were controlled. For example, at Rick’s Hairstyl-
ing, an unfavorable spending variance for hairstyling supplies could be due to using too
many supplies or paying too much for the supplies, or some combination of the two.
The remainder of the chapter explains how standard cost systems can be used to decom-
pose spending variances into these two parts. Shortly, we’ll transition from our example
involving Rick’s Hairstyling to an example involving a manufacturing company called
The Colonial Pewter Company. Because standard cost systems are frequently used in
manufacturing companies, we are shifting our focus accordingly.
IN BUSINESS
Chilly Spring Weather Brings Big Discounts and
Lower Margins
Cold temperatures can keep shoppers away from malls. When April temperatures dropped
below expectations so did sales at Victoria’s Secret, Bath & Body Works, and Aeropostale.
Fewer shoppers also can lead to big discounts as Aeropostale offered 50% off shorts to those
who did choose to shop in its stores.
When these types of retailers establish their budgets for the spring, it is impossible for
them to foresee months in advance how the weather may influence their sales, which in turn
can have an impact on their revenue activity variances.
©Austin Bush/Getty Images Source: Prior, Anna, and Talley, Karen, “Weather Holds Back Retailers,” The Wall Street Journal, May 10, 2013, B2.
✓
2. A five-star hotel buys bouquets of flowers to decorate its common areas and guest
CONCEPT rooms. Its flexible budget for flowers is $325 per day of operations plus $7.20 per
CHECK room-day. (A room-day is a room rented for one day; a room is decorated with
flowers only if it is occupied.) If this month the hotel operated for 30 days and it had
7,680 room-days, what would be the flexible budget amount for flowers for the month?
a. $55,296
b. $65,046
c. $9,750
d. $332.20
3. Refer to the data in the above question. If the actual spending on flowers for the
month was $61,978 and the hotel originally budgeted for 30 operating days and 7,500
room-days, what was the spending variance for the month?
a. $3,068 Favorable
b. $3,068 Unfavorable
c. $1,772 Favorable
d. $1,772 Unfavorable
STANDARD COSTS—SETTING THE STAGE

A standard is a benchmark for measuring performance. Standards are found everywhere.
Auto service centers like Firestone and Sears, for example, often set specific labor time
standards for the completion of certain tasks, such as installing a carburetor or doing a
valve job, and then measure actual performance against these standards. Fast-food outlets
such as McDonald’s and Subway have exacting standards for the quantity of meat going
into a sandwich, as well as standards for the cost of the meat. Your doctor evaluates your
weight using standards for individuals of your age, height, and gender. The buildings we
live in conform to standards set in building codes.
Standards are also widely used in managerial accounting where they relate to the quan-
tity and acquisition price of inputs used in manufacturing goods or providing services.1
Quantity standards specify how much of an input should be used to make a product or
provide a service. Price standards specify how much should be paid for each unit of the
input. If either the quantity or acquisition price of an input departs significantly from
the standard, managers investigate the discrepancy to find the cause of the problem and
eliminate it.
Next we’ll demonstrate how a company can establish quantity and price standards for
direct materials, direct labor, and variable manufacturing overhead and then we’ll discuss
how those standards can be used to calculate variances and manage operations.
The Colonial Pewter Company makes only one product—an elaborate reproduction of an MANAGERIAL
18th century pewter statue. The statue is made largely by hand, using traditional metal- ACCOUNTING IN ACTION
working tools. Consequently, the manufacturing process is labor intensive and requires a THE ISSUE
high level of skill.
Colonial Pewter has recently expanded its workforce to take advantage of unexpected
demand for the statue as a gift. The company started with a small cadre of experienced
pewter workers but has had to hire less experienced workers as a result of the expansion.
The president of the company, J. D. Wriston, has called a meeting to discuss production
problems. Attending the meeting are Tom Kuchel, the production manager; Janet Warner,
the purchasing manager; and Terry Sherman, the corporate controller.
J. D.: I’ve got a feeling that we aren’t getting the production we should out of our new
people.
Tom: Give us a chance. Some of the new people have been with the company for less
than a month.
Janet: Let me add that production seems to be wasting an awful lot of material—
particularly pewter. That stuff is very expensive.
Tom: What about the shipment of defective pewter that you bought—the one with the
iron contamination? That caused us major problems.
Janet: How was I to know it was off-grade? Besides, it was a great deal.
J. D.: Calm down everybody. Let’s get the facts before we start attacking each other.
Tom: I agree. The more facts the better.
J. D.: Okay, Terry, it’s your turn. Facts are the controller’s department.
Terry: I’m afraid I can’t provide the answers off the top of my head, but if you give me
about a week I can set up a system that can routinely answer questions relating to
worker productivity, material waste, and input prices.
J. D.: Let’s mark it on our calendars.
1
Throughout the chapter, we assume that “tight but attainable” practical standards are used rather than
ideal standards that can only be attained by the most skilled and efficient employees working at peak
effort 100% of the time.
402 Chapter 9
Setting Direct Materials Standards

Terry Sherman’s first task was to prepare quantity and price standards for the company’s
only significant raw material, pewter ingots. The standard quantity per unit defines the
amount of direct materials that should be used for each unit of finished product, includ-
ing an allowance for normal inefficiencies, such as scrap and spoilage.2 After consulting
with the production manager, Tom Kuchel, Terry set the quantity standard for pewter at
3.0 pounds per statue.
The standard price per unit defines the price that should be paid for each unit of
direct materials and it should reflect the final, delivered cost of those materials. After
consulting with purchasing manager Janet Warner, Terry set the standard price of pewter
at $4.00 per pound.
Once Terry established the quantity and price standards he computed the standard
direct materials cost per statue as follows:
3.0 pounds per statue × $4.00 per pound = $12.00 per statue
IN BUSINESS Managing Raw Material Costs in the Apparel Industry

A company’s raw material costs can rise for numerous and often uncontrollable reasons.
For example, severe weather in China, which is the world’s largest producer of cotton,
can influence the cotton prices paid by Abercrombie & Fitch. Rising fuel costs can influence
what Maidenform Brands pays for its petroleum-based synthetic fabrics. When farmers stop
producing cotton in favor of soybeans, it increases the price Jones Apparel Group pays for a
shrinking supply of cotton.
When faced with rising raw material costs, companies can respond three ways. First, they
can maintain existing selling prices and consequently operate with lower margins. Second, they
can pass the cost increases along to customers in the form of higher prices. Third, they can try
to lower their raw material costs. For example, Hanesbrands buys hedging contracts that lock
in its cotton prices, thereby insulating the company from future cost increases. J.C. Penney is
changing the blend of raw materials used in its garments, whereas Maidenform has started
buying some of its raw materials from lower-cost producers in Bangladesh.
Source: Holmes, Elizabeth, and Dodes, Rachel, “Cotton Tale: Apparel Prices Set to Rise,” The Wall Street
©casadaphoto/123RF Journal, May 19, 2010, B8.
Setting Direct Labor Standards

Direct labor quantity and price standards are usually expressed in terms of labor-hours
or a labor rate. The standard hours per unit defines the amount of direct labor-hours
that should be used to produce one unit of finished goods. One approach used to deter-
mine this standard is for an industrial engineer to do a time and motion study, actu-
ally clocking the time required for each task. Throughout the chapter, we’ll assume that
“tight but attainable” labor standards are used rather than “ideal” standards that can only
be attained by the most skilled and efficient employees working at peak effort 100%
of the time. Therefore, after consulting with the production manager and considering
2
Although companies often create “practical” rather than “ideal” materials quantity standards that include
allowances for normal inefficiencies such as scrap, spoilage, and rejects, this practice is often criticized
because it contradicts the zero defects goal that underlies many process improvement programs. If these
types of allowances are built into materials quantity standards, they should be periodically reviewed and
reduced over time to reflect improved processes, better training, and better equipment.
reasonable allowances for breaks, personal needs of employees, cleanup, and machine
downtime, Terry set the standard hours per unit at 0.50 direct labor-hours per statue.3
The standard rate per hour defines the company’s expected direct labor wage rate
per hour, including employment taxes and fringe benefits. Using wage records and in
consultation with the production manager, Terry Sherman established a standard rate per
hour of $22.00. This standard rate reflects the expected “mix” of workers, even though
the actual hourly wage rates may vary somewhat from individual to individual due to
differing skills or seniority.
Once Terry established the time and rate standards, he computed the standard direct
labor cost per statue as follows:
0.50 direct labor-hours per statue × $22.00 per direct labor-hour = $11.00 per statue
Setting Variable Manufacturing Overhead Standards

As with direct labor, the quantity and price standards for variable manufacturing over-
head are usually expressed in terms of hours and a rate. The standard hours per unit
for variable overhead measures the amount of the allocation base from a company’s
predetermined overhead rate that is required to produce one unit of finished goods.
In the case of Colonial Pewter, we will assume that the company uses direct labor-hours
as the allocation base in its predetermined overhead rate. Therefore, the standard hours
per unit for variable overhead is exactly the same as the standard hours per unit for direct
labor—0.50 direct labor-hours per statue.
The standard rate per unit that a company expects to pay for variable overhead
equals the variable portion of the predetermined overhead rate. At Colonial Pewter,
the variable portion of the predetermined overhead rate is $6.00 per direct labor-hour.
Therefore, Terry computed the standard variable manufacturing overhead cost per
statue as follows:
0.50 direct labor-hours per statue × $6.00 per direct-labor hour = $3.00 per statue
This $3.00 per unit cost for variable manufacturing overhead appears along with
direct materials ($12 per unit) and direct labor ($11 per unit) on the standard cost card in
Exhibit 9–8. A standard cost card shows the standard quantity (or hours) and standard
price (or rate) of the inputs required to produce a unit of a specific product. The standard
cost per unit for all three variable manufacturing costs is computed the same way.
The standard quantity (or hours) per unit is multiplied by the standard price (or rate) per
unit to obtain the standard cost per unit.
E X H I B I T 9 – 8
(1) (2) Standard Cost Card—Variable
Standard Standard Standard Manufacturing Costs
Quantity Price Cost
Inputs or Hours or Rate (1) × (2)
Direct materials . . . . . . . . . . . . . . . . . 3.0 pounds $4.00 per pound $12.00

Direct labor . . . . . . . . . . . . . . . . . . . . 0.50 hours $22.00 per hour 11.00
Variable manufacturing
overhead . . . . . . . . . . . . . . . . . . . . 0.50 hours $6.00 per hour 3.00
Total standard cost per unit . . . . . . $26.00
3
Labor quantity standards assume that the production process is labor-paced—if labor works faster,
output will go up. However, output in many companies is determined by the processing speed of
machines, not by labor efficiency.
404 Chapter 9
Using Standards in Flexible Budgets

Once Terry Sherman created the standard cost card shown in Exhibit 9–8, he was ready to
use this information to calculate direct materials, direct labor, and variable manufactur-
ing overhead variances. Therefore, he gathered the following data for the month of June:
Actual output in June . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 statues

Actual direct materials cost in June* . . . . . . . . . . . . . . . . . . . . . . . $24,700
Actual direct labor cost in June . . . . . . . . . . . . . . . . . . . . . . . . . . . $22,680
Actual variable manufacturing overhead cost in June . . . . . . . . $7,140
*There were no beginning or ending inventories of raw materials in June;

all materials purchased were used.
Using the above data and the standard cost data from Exhibit 9–8, Terry computed
the spending variances shown in Exhibit 9–9. Notice that the actual results and flexible
budget columns are each based on the actual output of 2,000 statues. The standard costs
of $12.00 per unit for materials, $11.00 per unit for direct labor, and $3.00 per unit for
variable manufacturing overhead are each multiplied by the actual output of 2,000 statues
to compute the amounts in the flexible budget column. For example, the standard direct
labor cost per unit of $11.00 multiplied by 2,000 statues equals the direct labor flexible
budget of $22,000.
The spending variances shown in Exhibit 9–9 are computed by taking the amounts
in the actual results column and subtracting the amounts in the flexible budget column.
For all three variable manufacturing costs, this computation results in a positive num-
ber because the actual amount of the cost incurred to produce 2,000 statues exceeds the
standard cost allowed for 2,000 statues. Because, in all three instances, the actual cost
incurred exceeds the standard cost allowed for the actual level of output, the variance is
labeled unfavorable (U). Had any of the actual costs incurred been less than the standard
cost allowed for the actual level of output, the corresponding variances would have been
labeled favorable (F).
While the information in Exhibit 9–9 is useful, it would be even more useful if the
spending variances could be broken down into their price-related and quantity-related
components. For example, the direct materials spending variance in the report is $700
unfavorable. This means that, given the actual level of production for the period, direct
materials costs were too high by $700—at least according to the standard costs. Was
this due to higher than expected prices for materials? Or was it due to too much material
being used? The standard cost variances we will be discussing in the rest of the chapter
are designed to answer these questions.
E X H I B I T 9 – 9
Spending Variances for Variable Colonial Pewter
Manufacturing Costs Spending Variances—Variable Manufacturing Costs Only
For the Month Ended June 30
Actual Spending Flexible

Results Variances Budget
Statues produced (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 2,000

Direct materials ($12.00q) . . . . . . . . . . . . . . . . . . . . . . . $24,700 $700 U $24,000
Direct labor ($11.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . $22,680 $680 U $22,000
Variable manufacturing overhead ($3.00q) . . . . . . . . . $7,140 $1,140 U $6,000
A GENERAL MODEL FOR STANDARD COST VARIANCE ANALYSIS

Standard cost variance analysis decomposes spending variances from the flexible budget
into two elements—one due to the price paid for the input and the other due to the amount
of the input that is used. A price variance is the difference between the actual amount
paid for an input and the standard amount that should have been paid, multiplied by the
actual amount of the input purchased. A quantity variance is the difference between
how much of an input was actually used and how much should have been used and is
stated in dollar terms using the standard price of the input.
Why are standards separated into two categories—price and quantity? Price variances
and quantity variances usually have different causes. In addition, different managers
are usually responsible for buying and using inputs. For example, in the case of a raw
material, the purchasing manager is responsible for its price and the production man-
ager is responsible for the amount of the raw material actually used to make products.
Therefore, it is important to clearly distinguish between deviations from price standards
(the responsibility of the purchasing manager) and deviations from quantity standards
(the responsibility of the production manager).
Exhibit 9–10 presents a general model that can be used to decompose the spending vari-
ance for a variable cost into a price variance and a quantity variance.4 Column (1) in this
exhibit corresponds with the Actual Results column in Exhibit 9–9. Column (3) corresponds
with the Flexible Budget column in Exhibit 9–9. Column (2) has been inserted into Exhibit
9–10 to enable separating the spending variance into a price variance and a quantity variance.
Three things should be noted from Exhibit 9–10. First, it can be used to compute a
price variance and a quantity variance for each of the three variable cost elements—direct
materials, direct labor, and variable manufacturing overhead—even though the variances
have different names. A price variance is called a materials price variance in the case
of direct materials, a labor rate variance in the case of direct labor, and a variable over-
head rate variance in the case of variable manufacturing overhead. A quantity variance
E X H I B I T 9 – 1 0 A General Model for Standard Cost Variance Analysis—Variable Manufacturing Costs
(1) (2) (3)

Actual Quantity Actual Quantity Standard Quantity
of Input, of Input, Allowed for Actual Output,
at Actual Price at Standard Price at Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)
Price Variance Quantity Variance

(1) - (2) (2) - (3)
Materials price variance Materials quantity variance
Labor rate variance Labor efficiency variance
Variable overhead Variable overhead
rate variance efficiency variance
Spending Variance
(1) - (3)
4
This general model can always be used to compute direct labor and variable manufacturing overhead
variances. However, it can be used to compute direct materials variances only when the actual quantity
of materials purchased equals the actual quantity of materials used in production. Later in the chapter,
we will explain how to compute direct materials variances when these quantities differ.
406 Chapter 9
is called a materials quantity variance in the case of direct materials, a labor efficiency
variance in the case of direct labor, and a variable overhead efficiency variance in the
case of variable manufacturing overhead.
Second, all three columns in the exhibit are based on the actual amount of output
produced during the period. Even the flexible budget column depicts the standard cost
allowed for the actual amount of output produced during the period. The key to under-
standing the flexible budget column in Exhibit 9–10 is to grasp the meaning of the term
standard quantity allowed (SQ). The standard quantity allowed (when computing direct
materials variances) or standard hours allowed (when computing direct labor and vari-
able manufacturing overhead variances) refers to the amount of an input that should have
been used to manufacture the actual output of finished goods produced during the period.
It is computed by multiplying the actual output by the standard quantity (or hours) per unit.
The standard quantity (or hours) allowed is then multiplied by the standard price (or rate)
per unit of the input to obtain the total cost according to the flexible budget. For example,
if a company actually produced 100 units of finished goods during the period and its stan-
dard quantity per unit of finished goods for direct materials is 3 pounds, then its standard
quantity allowed (SQ) would be 300 pounds (= 100 units × 3 pounds per unit). If the com-
pany’s standard cost per pound of direct materials is $2.00, then the total direct materials
cost in its flexible budget would be $600 (= 300 pounds × $2.00 per pound).
Third, the spending, price, and quantity variances—regardless of what they are
called—are computed exactly the same way regardless of whether one is dealing with
direct materials, direct labor, or variable manufacturing overhead. The spending variance
is computed by taking the total cost in column (1) and subtracting the total cost in column
(3). The price variance is computed by taking the total cost in column (1) and subtracting
the total cost in column (2). The quantity variance is computed by taking the total cost in
column (2) and subtracting the total cost in column (3). In all of these variance calcula-
tions, a positive number should be labeled as an unfavorable (U) variance and a negative
number should be labeled as a favorable (F) variance. An unfavorable price variance indi-
cates that the actual price (AP) per unit of the input was greater than the standard price
(SP) per unit. A favorable price variance indicates that the actual price (AP) of the input
was less than the standard price per unit (SP). An unfavorable quantity variance indicates
that the actual quantity (AQ) of the input used was greater than the standard quantity
allowed (SQ). Conversely, a favorable quantity variance indicates that the actual quantity
(AQ) of the input used was less than the standard quantity allowed (SQ).
With this general model as the foundation, we will now calculate Colonial Pewter’s
price and quantity variances.
USING STANDARD COSTS—DIRECT MATERIALS VARIANCES

LEARNING OBJECTIVE 9–4
After determining Colonial Pewter Company’s standard costs for direct materials, direct
labor, and variable manufacturing overhead, Terry Sherman’s next step was to compute
Compute the direct materials price the company’s variances for June. As discussed in the preceding section, variances are
and quantity variances and explain computed by comparing actual costs to standard costs. Terry referred to the standard
their significance. cost card in Exhibit 9–8 that shows the standard direct materials cost per statue was
computed as follows:
3.0 pounds per statue × $4.00 per pound = $12.00 per statue
Colonial Pewter’s records for June showed that the actual quantity (AQ) of pewter pur-
chased was 6,500 pounds at an actual price (AP) of $3.80 per pound, for a total cost of
$24,700. All of the material purchased was used during June to manufacture 2,000 statues.5
5
Throughout this section, we assume zero beginning and ending inventories of materials and that all
materials purchased during the period are used during that period. The more general case in which
there are beginning and ending inventories of materials and materials are not necessarily used during
the period in which they are purchased is considered later in the chapter.
E X H I B I T 9 – 1 1 Standard Cost Variance Analysis—Direct Materials

(Note: The quantity of materials purchased equals the quantity used in production.)
(1) (2) (3)

6,500 pounds × $3.80 per pound 6,500 pounds × $4.00 per pound 6,000 pounds* × $4.00 per pound
= $24,700 = $26,000 = $24,000
Price variance = $1,300 F Quantity variance = $2,000 U
Spending variance = $700 U
* 2,000 units × 3.0 pounds per unit = 6,000 pounds.

F = Favorable; U = Unfavorable.
Using these data and the standard costs from Exhibit 9–8, Terry computed the price and
quantity variances shown in Exhibit 9–11.
Notice that the variances in this exhibit are based on three different total costs—
$24,700, $26,000, and $24,000. The first, $24,700, is the actual amount paid for the
actual amount of pewter purchased. The third total cost figure, $24,000, refers to how
much should have been spent on pewter to produce the actual output of 2,000 statues.
The standards call for 3 pounds of pewter per statue. Because 2,000 statues were pro-
duced, 6,000 pounds of pewter should have been used. This is referred to as the standard
quantity allowed for the actual output and its computation can be stated in formula form
as follows:
Standard quantity allowed = Actual output × Standard quantity per unit
If 6,000 pounds of pewter had been purchased at the standard price of $4.00 per pound,
the company would have spent $24,000. This is the amount that appears in the company’s
flexible budget for the month. The difference between the $24,700 actually spent and the
$24,000 that should have been spent is the spending variance for the month of $700 U.
This variance is unfavorable (denoted by U) because the amount that was actually spent
exceeds the amount that should have been spent. Also note that this spending variance
agrees with the direct materials spending variance in Exhibit 9–9.
The second total cost figure in Exhibit 9–11, $26,000, is the key that allows us to
decompose the spending variance into two distinct elements—one due to price and
one due to quantity. It represents how much the company should have spent if it had
purchased the actual amount of input, 6,500 pounds, at the standard price of $4.00 a
pound rather than the actual price of $3.80 a pound.
The Materials Price Variance

Using the $26,000 total cost figure in column (2) of Exhibit 9–11, we can make two
comparisons—one with the total cost of $24,700 in column (1) and one with the total
cost of $24,000 in column (3). The difference between the $24,700 in column (1)
408 Chapter 9
and the $26,000 in column (2) is the materials price variance of $1,300, which is
labeled as favorable (denoted by F). A materials price variance measures the dif-
ference between an input’s actual price and its standard price, multiplied by the
actual quantity purchased.
To understand the price variance, note that the actual price of $3.80 per pound of
pewter is $0.20 less than the standard price of $4.00 per pound. Because 6,500 pounds
were purchased, the total amount of the variance is $1,300 (= $0.20 per pound × 6,500
pounds). This variance is labeled favorable (F) because the actual purchase price per
pound is less than the standard purchase price per pound. Conversely, the materials price
variance would have been labeled unfavorable (U) if the actual purchase price per pound
had exceeded the standard purchase price per pound.
Generally speaking, the purchasing manager has control over the price paid for goods
and is therefore responsible for the materials price variance. Many factors influence the
prices paid for goods including how many units are ordered, how the order is delivered,
whether the order is a rush order, and the quality of materials purchased. If any of these
factors deviates from what was assumed when the standards were set, a price variance
can result. For example, purchasing second-grade materials rather than top-grade mate-
rials may result in a favorable price variance because the lower-grade materials may be
less costly. However, the lower-grade materials may create production problems. It also
bears emphasizing that someone other than the purchasing manager could be respon-
sible for a materials price variance. For example, due to production problems beyond
the purchasing manager’s control, the purchasing manager may have to use express
delivery. In these cases, the production manager should be held responsible for the
resulting price variances.
The Materials Quantity Variance

Referring again to Exhibit 9–11, the difference between the $26,000 in column (2) and
the $24,000 in column (3) is the materials quantity variance of $2,000, which is labeled
as unfavorable (denoted by U). The materials quantity variance measures the difference
between the actual quantity of materials used in production and the standard quantity
of materials allowed for the actual output, multiplied by the standard price per unit of
materials. It is labeled as unfavorable (favorable) when the actual quantity of material
used in production is greater than (less than) the quantity of material that should have
been used according to the standard.
To understand the materials quantity variance, note that the actual amount of pewter
used in production was 6,500 pounds. However, the standard amount of pewter allowed
for the actual output is 6,000 pounds. Therefore, too much pewter was used to pro-
duce the actual output—by a total of 500 pounds. To express this in dollar terms, the
500 pounds is multiplied by the standard price of $4.00 per pound to yield the quantity
variance of $2,000 U. Why is the standard price of pewter, rather than the actual price,
used in this calculation? The production manager is ordinarily responsible for the
quantity variance. If the actual price were used in the calculation of the quantity variance,
the production manager’s performance evaluation would be unfairly influenced by the
efficiency or inefficiency of the purchasing manager.
Excessive materials usage can result from many factors, including faulty machines,
inferior materials quality, untrained workers, and poor supervision. Generally speaking,
it is the responsibility of the production manager to see that material usage is kept in line
with standards. There may be times, however, when the purchasing manager is respon-
sible for an unfavorable materials quantity variance. For example, if the purchasing
manager buys inferior materials at a lower price, the materials may be unsuitable for use
and may result in excessive waste. Thus, the purchasing manager rather than the produc-
tion manager would be responsible for the quantity variance.
HELPFUL HINT
The Colonial Pewter Company’s materials price and quantity variances can also be computed
using the equations shown below where:
AQ = Actual quantity of pounds purchased and used in production

SQ = Standard quantity of pounds allowed for the actual output
AP = Actual price per unit of the input
SP = Standard price per unit of the input
Materials Price Variance:

Materials price variance = (AQ × AP) − (AQ × SP)
Materials price variance = AQ (AP − SP)
Materials price variance = 6,500 pounds ($3.80 per pound − $4.00 per pound)
Materials price variance = $1,300 F
The materials price variance is favorable because the actual price paid per pound was
$0.20 less than the standard price per pound.
Materials Quantity Variance:

Materials quantity variance = (AQ × SP) − (SQ × SP)
Materials quantity variance = SP (AQ − SQ)
Materials quantity variance = $4.00 per pound (6,500 pounds − 6,000 pounds)
Materials quantity variance = $2,000 U
The materials quantity variance is unfavorable because the company used 500 more
pounds than it should have to make 2,000 statues.
✓
4 . Which of the following statements is true? (You may select more than one answer.)
a. The standard quantity per unit defines the amount of direct materials that should CONCEPT
be used for each unit of finished goods. CHECK
b. The “standard quantity allowed for actual output” equals the actual output of
finished goods multiplied by the standard quantity per unit.
c. The materials price variance measures the difference between an input’s actual
price and its standard price, multiplied by the standard quantity purchased.
d. The materials quantity variance measures the difference between the actual quan-
tity of materials used in production and the standard quantity of materials allowed
for the actual output, multiplied by the standard price per unit of materials.
5. The standard and actual prices per pound of raw material are $4.00 and $4.50,
respectively. A total of 10,500 pounds of raw material was purchased and then used
to produce 5,000 units. The quantity standard allows two pounds of the raw material
per unit produced. What is the materials price variance?
a. $5,250 favorable
b. $5,250 unfavorable
c. $5,000 unfavorable
d. $5,000 favorable
6. Referring to the facts in question 5 above, what is the material quantity variance?
a. $5,000 unfavorable
b. $5,000 favorable
c. $2,000 favorable
d. $2,000 unfavorable
410 Chapter 9
USING STANDARD COSTS—DIRECT LABOR VARIANCES

Terry Sherman’s next step in determining Colonial Pewter’s variances for June was
to compute the direct labor variances for the month. Recall from Exhibit 9–8 that the
Compute the direct labor rate and standard direct labor cost per statue is $11, computed as follows:
efficiency variances and explain
their significance. 0.50 hours per statue × $22.00 per hour = $11.00 per statue
In addition, Colonial Pewter’s records for June showed that 1,050 direct labor-hours
were actually worked. Given that the company paid its direct labor workers a total of
$22,680 (including payroll taxes and fringe benefits), the average actual wage rate was
$21.60 per hour (= $22,680 ÷ 1,050 hours). Using these data and the standard costs from
Exhibit 9–8, Terry computed the direct labor rate and efficiency variances that appear in
Exhibit 9–12.
Notice that the column headings in Exhibit 9–12 are the same as those used in
Exhibits 9–10 and 9–11, except that in Exhibit 9–12 the terms rate and hours are used
in place of the terms price and quantity.
The Labor Rate Variance

comparisons—one with the total cost of $22,680 in column (1) and one with the total
cost of $22,000 in column (3). The difference between the $22,680 in column (1) and the
$23,100 in column (2) is the labor rate variance of $420 F. The labor rate variance
measures the difference between the actual hourly rate and the standard hourly rate,
multiplied by the actual number of hours worked during the period.
To understand the labor rate variance, note that the actual hourly rate of $21.60 is
$0.40 less than the standard rate of $22.00 per hour. Because 1,050 hours were actu-
ally worked, the total amount of the variance is $420 (= $0.40 per hour × 1,050 hours).
The variance is labeled favorable (F) because the actual hourly rate is less than the
standard hourly rate. If the actual hourly rate had been greater than the standard hourly
rate, the variance would have been labeled unfavorable (U).
In most companies, the wage rates paid to workers are quite predictable. Neverthe-
less, rate variances can arise based on how production supervisors use their direct labor
workers. Skilled workers with high hourly rates of pay may be given duties that require
little skill and call for lower hourly rates of pay. This will result in an unfavorable labor
E X H I B I T 9 – 1 2 Standard Cost Variance Analysis—Direct Labor
(1) (2) (3)

Actual Hours Actual Hours Standard Hours
at Actual Rate at Standard Rate at Standard Rate
(AH × AR) (AH × SR) (SH × SR)
1,050 hours × $21.60 per hour 1,050 hours × $22.00 per hour 1,000 hours* × $22.00 per hour
= $22,680 = $23,100 = $22,000

= $420 F = $1,100 U
*2,000 units × 0.5 hours per unit = 1,000 hours.

rate variance because the actual hourly rate of pay will exceed the standard rate specified
for the particular task. In contrast, a favorable rate variance would result when work-
ers who are paid at a rate lower than specified in the standard are assigned to the task.
However, the lower-paid workers may not be as efficient. Finally, overtime work at
premium rates will result in an unfavorable labor rate variance if the overtime premium
is charged to the direct labor account.
The Labor Efficiency Variance

Referring back to Exhibit 9–12, the difference between the $23,100 in column (2) and
the $22,000 in column (3) is the labor efficiency variance of $1,100 unfavorable (U).
The labor efficiency variance measures the difference between the actual hours used and
the standard hours allowed for the actual output, multiplied by the standard hourly rate.
To understand Colonial Pewter’s labor efficiency variance, note that the actual
amount of hours used in production was 1,050 hours. However, the standard amount of
hours allowed for the actual output is 1,000 hours. Therefore, the company used 50 more
hours for the actual output than the standards allow. To express this in dollar terms, the
50 hours are multiplied by the standard rate of $22.00 per hour to yield the efficiency
variance of $1,100 U.
Standard Cost System Usage in the Turkish IN BUSINESS

Automotive Industry
Survey results from the Turkish automotive industry indicate that 74% of the companies
surveyed use standard costing. About 55% of the companies that use standard costing base
their standards on average past performance, 24% base their standards on maximum efficiency,
and 21% set standards that are achievable but difficult to attain. Rather than investigating all
variances, 70% of the companies only investigate variances that exceed either a dollar or
percentage threshold and 27% rely on statistical control charts to determine which variances
warrant further attention.
Source: Badem, A. Cemkut et al., “Is Standard Costing Still Used? Evidence from Turkish Automotive
Industry,” International Business Research, Vol. 6, No. 7, 2013, 79–90.
Possible causes of an unfavorable labor efficiency variance include poorly trained

or motivated workers; poor-quality materials, requiring more labor time; faulty equip-
ment, causing breakdowns and work interruptions; poor supervision of workers; and
inaccurate standards. The managers in charge of production would usually be respon-
sible for control of the labor efficiency variance. However, the purchasing manager
could be held responsible if the purchase of poor-quality materials resulted in excessive
labor processing time.
Another important cause of an unfavorable labor efficiency variance may be insuf-
ficient demand for the company’s products. Managers in some companies argue that it is
difficult, and perhaps unwise, to constantly adjust the workforce in response to changes
in the amount of work that needs to be done. In such companies, the direct labor work-
force is essentially fixed in the short run. If demand is insufficient to keep everyone busy,
workers are not laid off, which in turn creates an unfavorable labor efficiency variance.
If customer orders are insufficient to keep the workers busy, the work center
manager has two options—either accept an unfavorable labor efficiency variance or
build inventory. A central lesson of Lean Production is that building inventory with no
immediate prospect of sale is a bad idea. Excessive inventory—particularly work in pro-
cess inventory—leads to high defect rates, obsolete goods, and inefficient operations.
412 Chapter 9
As a consequence, when the workforce is basically fixed in the short term, managers
must be cautious about how labor efficiency variances are used. Some experts advocate
eliminating labor efficiency variances in such situations—at least for the purposes of
motivating and controlling workers on the shop floor.
HELPFUL HINT
The Colonial Pewter Company’s direct labor rate and efficiency variances can also be
computed using the equations shown below where:
AH = Actual quantity of hours used in production

SH = Standard quantity of hours allowed for the actual output
AR = Actual rate per direct labor-hour
SR = Standard rate per direct labor-hour
Labor Rate Variance:

Labor rate variance = (AH × AR) − (AH × SR)
Labor rate variance = AH(AR − SR)
Labor rate variance = 1,050 hours ($21.60 per hour − $22.00 per hour)
Labor rate variance = $420 F
The labor rate variance is favorable because the actual hourly rate of $21.60 is $0.40 less
than the standard hourly rate of $22.00.
Labor Efficiency Variance:

Labor efficiency variance = (AH × SR) − (SH × SR)
Labor efficiency variance = SR(AH − SH)
Labor efficiency variance = $22.00 per hour (1,050 hours − 1,000 hours)
Labor efficiency variance = $1,100 U
The labor efficiency variance is unfavorable because the company used 50 more hours
than it should have to make 2,000 statues.
USING STANDARD COSTS—VARIABLE MANUFACTURING OVERHEAD VARIANCES

The final step in Terry Sherman’s analysis of Colonial Pewter’s variances for June was
to compute the variable manufacturing overhead variances. The variable portion of
Compute the variable manufacturing overhead can be analyzed using the same basic formulas that we used
manufacturing overhead rate and to analyze direct materials and direct labor. Recall from Exhibit 9–8 that the standard
efficiency variances and explain variable manufacturing overhead is $3.00 per statue, computed as follows:
their significance.
0.50 hours per statue × $6.00 per hour = $3.00 per statue
Also recall that Colonial Pewter’s cost records showed that the total actual variable
manufacturing overhead cost for June was $7,140 and that 1,050 direct labor-hours were
worked in June to produce 2,000 statues. Terry’s analysis of this overhead data appears
in Exhibit 9–13.
Notice the similarities between Exhibits 9–12 and 9–13. These similarities arise from
the fact that direct labor-hours are being used as the base for allocating overhead cost to
units of product; thus, the same hourly figures appear in Exhibit 9–13 for variable manu-
facturing overhead as in Exhibit 9–12 for direct labor. The main difference between the
two exhibits is in the standard hourly rate being used, which in this company is much
lower for variable manufacturing overhead than for direct labor.
E X H I B I T 9 – 1 3 Standard Cost Variance Analysis—Variable Manufacturing Overhead
(1) (2) (3)

1,050 hours × $6.80 per hour† 1,050 hours × $6.00 per hour 1,000 hours* × $6.00 per hour
= $7,140 = $6,300 = $6,000
Variable overhead rate Variable overhead efficiency

variance = $840 U variance = $300 U
Spending Variance = $1,140 U

†$7,140 ÷ 1,050 hours = $6.80 per hour.
The Variable Manufacturing Overhead Rate

and Efficiency Variances
comparisons—one with the total cost of $7,140 in column (1) and one with the total cost
of $6,000 in column (3). The difference between the $7,140 in column (1) and the $6,300
in column (2) is the variable overhead rate variance of $840 U. The variable
overhead rate variance measures the difference between the actual variable overhead
cost incurred during the period and the standard cost that should have been incurred based
on the actual activity of the period. The difference between the $6,300 in column (2) and
the $6,000 in column (3) is the variable overhead efficiency variance of $300 U.
The variable overhead efficiency variance measures the difference between the actual
level of activity and the standard activity allowed for the actual output, multiplied by the
variable part of the predetermined overhead rate.
To understand Colonial Pewter’s variable overhead efficiency variance, note that
the actual amount of hours used in production was 1,050 hours. However, the standard
amount of hours allowed for the actual output is 1,000 hours. Therefore, the company
used 50 more hours for the actual output than the standards allow. To express this in dol-
lar terms, the 50 hours are multiplied by the variable part of the predetermined overhead
rate of $6.00 per hour to yield the variable overhead efficiency variance of $300 U.
The interpretation of the variable overhead variances is not as clear as the direct mate-
rials and direct labor variances. In particular, the variable overhead efficiency variance
is exactly the same as the direct labor efficiency variance except for one detail—the rate
that is used to translate the variance into dollars. In both cases, the variance is the dif-
ference between the actual hours worked and the standard hours allowed for the actual
output. In the case of the direct labor efficiency variance, this difference is multiplied by
the standard direct labor rate. In the case of the variable overhead efficiency variance,
this difference is multiplied by the variable portion of the predetermined overhead rate.
So when direct labor is used as the base for overhead, whenever the direct labor efficiency
variance is favorable, the variable overhead efficiency variance will also be favorable.
And whenever the direct labor efficiency variance is unfavorable, the variable overhead
efficiency variance will be unfavorable. Indeed, the variable overhead efficiency vari-
ance really doesn’t tell us anything about how efficiently overhead resources were used.
It depends solely on how efficiently direct labor was used.
414 Chapter 9
HELPFUL HINT
The Colonial Pewter Company’s variable overhead rate and efficiency variances can also be
computed using the equations shown below where:
AH = Actual quantity of hours used in production

SH = Standard quantity of hours allowed for the actual output
AR = Actual rate per direct labor-hour
SR = Standard rate per direct labor-hour
Variable Overhead Rate Variance:

Variable overhead rate variance = (AH × AR) − (AH × SR)
Variable overhead rate variance = AH(AR − SR)
Variable overhead rate variance = $1,050 hours ($6.80 − $6.00)
Variable overhead rate variance = $840 U
Variable Overhead Efficiency Variance:

Variable overhead efficiency variance = (AH × SR) − (SH × SR)
Variable overhead efficiency variance = SR(AH − SH)
Variable overhead efficiency variance = $6.00 per hour (1,050 hours − 1,000 hours)
Variable overhead efficiency variance = $300 U
The variable overhead efficiency variance is unfavorable because the company used 50
more hours than it should have to make 2,000 statues.
In preparation for the scheduled meeting to discuss his analysis of Colonial Pewter’s stan-
dard costs and variances, Terry summarized his manufacturing cost variances as follows:
Materials price variance . . . . . . . . . . . . . . . . . . . $1,300 F

Materials quantity variance. . . . . . . . . . . . . . . . . 2,000 U
Labor rate variance . . . . . . . . . . . . . . . . . . . . . . . 420 F
Labor efficiency variance . . . . . . . . . . . . . . . . . . 1,100 U
Variable overhead rate variance. . . . . . . . . . . . 840 U
Variable overhead efficiency variance. . . . . . . 300 U
Total of the variances. . . . . . . . . . . . . . . . . . . . . . $2,520 U
He distributed these results to the management group of Colonial Pewter, which

included J. D. Wriston, the president of the company; Tom Kuchel, the production man-
ager; and Janet Warner, the purchasing manager. J. D. Wriston opened the meeting with
the following question:
MANAGERIAL
J. D.: Terry, I think I understand what you have done, but just to make sure, would you
ACCOUNTING IN ACTION
mind summarizing the highlights of what you found?
THE WRAP-UP Terry: As you can see, the biggest problems are the unfavorable materials quantity
variance of $2,000 and the unfavorable labor efficiency variance of $1,100.
J. D.: Tom, you’re the production boss. What do you think is causing the unfavorable
labor efficiency variance?
Tom: It has to be the new production workers. Our experienced workers shouldn’t have
much problem meeting the standard of half an hour per unit. We all knew that there
would be some inefficiency for a while as we brought new people on board. My plan for
overcoming the problem is to pair up each of the new guys with one of our old-timers
and have them work together for a while. It would slow down our older guys a bit, but
I’ll bet the unfavorable variance disappears and our new workers would learn a lot.
J. D.: Sounds good. Now, what about that $2,000 unfavorable materials quantity variance?
Terry: Tom, are the new workers generating a lot of scrap?
Tom: Yeah, I guess so.

J. D.: I think that could be part of the problem. Can you do anything about it?
Tom: I can watch the scrap closely for a few days to see where it’s being generated. If it
is the new workers, I can have the old-timers work with them on the problem when
I team them up.
J. D.: Janet, the favorable materials price variance of $1,300 isn’t helping us if it is
contributing to the unfavorable materials quantity and labor efficiency variances.
Let’s make sure that our raw material purchases conform to our quality standards.
Janet: Will do.
J. D.: Good. Let’s reconvene in a few weeks to see what has happened. Hopefully, we
can get those unfavorable variances under control.
AN IMPORTANT SUBTLETY IN THE MATERIALS VARIANCES

Most companies use the quantity of materials purchased to compute the materials price
variance and the quantity of materials used in production to compute the materials quan-
tity variance. There are two reasons for this practice. First, delaying the computation of
the price variance until the materials are used would result in less timely variance reports.
Second, computing the price variance when the materials are purchased allows materi-
als to be carried in the inventory accounts at their standard cost. This greatly simplifies
bookkeeping. (See Appendix 9B at the end of the chapter for an explanation of how to
prepare an income statement using a standard costing system.)6
When we computed materials price and quantity variances for Colonial Pewter in
Exhibit 9–11, we assumed that 6,500 pounds of materials were purchased and used in
production. However, it is very common for a company’s quantity of materials purchased
to differ from its quantity used in production. When this happens, the materials price
variance is computed using the quantity of materials purchased, whereas the materials
quantity variance is computed using the quantity of materials used in production.
To illustrate, assume that during June Colonial Pewter purchased 7,000 pounds of
materials at $3.80 per pound instead of 6,500 pounds as assumed earlier in the chapter.
Also assume that the company continued to use 6,500 pounds of materials in production
and that the standard price remained at $4.00 per pound.
Given these assumptions, Exhibit 9–14 shows how to compute the materials price vari-
ance of $1,400 F and the materials quantity variance of $2,000 U. Note that the price vari-
ance is based on the amount of the input purchased whereas the quantity variance is based
on the quantity of the input used in production. Column (2) of Exhibit 9–14 contains two
different total costs for this reason. When the price variance is computed, the total cost
used from column (2) is $28,000—which is the cost of the input purchased, evaluated at the
standard price. When the quantity variance is computed, the total cost used from column (2)
is $26,000—which is the cost of the actual input used, evaluated at the standard price.
Exhibit 9–14 shows that the price variance is computed on the entire amount of mate-
rial purchased (7,000 pounds), whereas the quantity variance is computed only on the
amount of materials used in production during the month (6,500 pounds). What about the
other 500 pounds of material that were purchased during the period, but that have not yet
been used? When those materials are used in future periods, a quantity variance will be
computed. However, a price variance will not be computed when the materials are finally
used because the price variance was computed when the materials were purchased.
Because the price variance is based on the amount purchased and the quantity vari-
ance is based on the amount used, the two variances do not generally sum to the spending
variance from the flexible budget, which is wholly based on the amount used. We would
6
Standard cost systems are typically used as part of a company’s financial reporting system.
Therefore, standard cost variance reports are often prepared on a monthly basis as part of the financial
closing process. As a consequence, the reports may be produced too infrequently to enable real-time
operational improvements. To combat this problem, some companies are now reporting variances and
other key operating data daily or even more frequently.
416 Chapter 9
E X H I B I T 9 – 1 4 Standard Cost Variance Analysis—Direct Materials

(Note: The quantity of materials purchased does not equal the quantity used in production.)
(1) (2) (3)

7,000 pounds × $3.80 per pound 7,000 pounds × $4.00 per pound 6,000 pounds* × $4.00 per pound
= $26,600 = $28,000 = $24,000
Price variance = $1,400 F
6,500 Pounds × $4.00 per pound

= $26,000
Quantity variance = $2,000 U
In this case, the price variance and the quantity variance do not sum to the spending variance because the
price variance is based on the quantity purchased whereas the quantity variance is based on the quantity used
in production, and the two numbers differ.
*2,000 units × 3.0 pounds per unit = 6,000 pounds.

also like to emphasize that the approach shown in Exhibit 9–14 can always be used to
compute direct materials variances. However, Exhibit 9–11 can only be used in the spe-
cial case when the quantity of materials purchased equals the quantity of materials used.
HELPFUL HINT
When Colonial Pewter purchases 7,000 pounds of materials and uses 6,500 pounds in produc-
tion, the materials quantity and price variances can be computed using the equations shown
below:
Materials Price Variance:

AQ = Actual quantity of pounds purchased
AP = Actual price per unit of the input

Materials price variance = AQ(AP − SP)
Materials price variance = 7,000 pounds ($3.80 per pound − $4.00 per pound)
Materials price variance = $1,400 F
Materials Quantity Variance:

AQ = Actual quantity of pounds used in production
SQ = Standard quantity of pounds allowed for the actual output

Materials quantity variance = SP(AQ − SQ)
Materials quantity variance = $4.00 per pound (6,500 pounds − 6,000 pounds)
Materials quantity variance = $2,000 U
SUMMARY
LO9–1 Prepare a planning budget and a flexible budget and understand how they
differ from one another.
A planning budget is prepared before the period begins and is valid for only the planned level of
activity, whereas a flexible budget is a budget that is adjusted to the actual level of activity. The
flexible budget provides the best estimate of what revenues and costs should have been, given
the actual level of activity during the period.
LO9–2 Calculate and interpret revenue and spending variances.

When actual results are compared to the flexible budget, revenue and spending variances are
the result. A favorable revenue variance indicates that revenue was larger than should have
been expected, given the actual level of activity. An unfavorable revenue variance indicates that
revenue was less than it should have been, given the actual level of activity. A favorable spending
variance indicates that the actual cost was less than expected, given the actual level of activity.
An unfavorable spending variance indicates that the actual cost was greater than expected, given
the actual level of activity.
LO9–3 Prepare a flexible budget with more than one cost driver.
A cost may depend on more than one cost driver. If so, the flexible budget for that cost should be
stated in terms of all of the cost drivers.
LO9–4 Compute the direct materials price and quantity variances and explain their
significance.
The materials price variance is the difference between the actual price paid for materials and the
standard price, multiplied by the quantity purchased. An unfavorable variance occurs whenever
the actual price exceeds the standard price. A favorable variance occurs when the actual price is
less than the standard price for the input.
The materials quantity variance is the difference between the amount of materials actu-
ally used and the amount that should have been used to produce the actual good output of the
period, multiplied by the standard price per unit of the input. An unfavorable materials quantity
variance occurs when the amount of materials actually used exceeds the amount that should have
been used according to the materials quantity standard. A favorable variance occurs when the
amount of materials actually used is less than the amount that should have been used according
to the standard.
LO9–5 Compute the direct labor rate and efficiency variances and explain their
significance.
The direct labor rate variance is the difference between the actual wage rate paid and the stan-
dard wage rate, multiplied by the hours worked. An unfavorable variance occurs whenever the
actual wage rate exceeds the standard wage rate. A favorable variance occurs when the actual
wage rate is less than the standard wage rate.
The labor efficiency variance is the difference between the hours actually worked and the
hours that should have been used to produce the actual good output of the period, multiplied by
the standard wage rate. An unfavorable labor efficiency variance occurs when the hours actually
worked exceed the hours allowed for the actual output. A favorable variance occurs when the
hours actually worked are less than hours allowed for the actual output.
LO9–6 Compute the variable manufacturing overhead rate and efficiency variances
and explain their significance.
The variable manufacturing overhead rate variance is the difference between the actual variable
manufacturing overhead cost incurred and the actual hours worked multiplied by the standard
variable manufacturing overhead rate. The variable manufacturing overhead efficiency variance
is the difference between the hours actually worked and the hours that should have been used to
produce the actual good output of the period, multiplied by the standard variable manufacturing
overhead rate.
418 Chapter 9
GUIDANCE ANSWERS TO DECISION POINT

Owner of Micro-Brewery
The cost of hops is a purely variable cost. Since the cost for producing 800 barrels of beer is $960, the
cost of hops in one barrel of beer is $1.20 (= $960 ÷ 800 barrels). Therefore, if 850 barrels of beer are
produced, the cost of the hops should be $1.20 per barrel times 850 barrels, or $1,020. Since that is how
much was actually spent, there is no indication that too much or too little was spent on hops.
GUIDANCE ANSWERS TO CONCEPT CHECKS
✓ 1. Choices b, c, and d. A planning budget is based on the planned level, not the actual level of
activity.
2. Choice b. The cost for flowers according to the flexible budget is $65,046 (= $325 per
operating day × 30 operating days + $7.20 per room-day × 7,680 room-days).
3. Choice a. The spending variance is $3,068 favorable (= $65,046 – $61,978).
4. Choices a, b, and d. The materials price variance is based on the actual quantity purchased.
5. Choice b. The materials price variance is ($4.50 actual price per pound – $4.00 standard
price per pound) × 10,500 pounds purchased = $5,250 unfavorable.
6. Choice d. The materials quantity variance is (10,500 pounds used – 10,000 pounds allowed) ×
$4.00 per pound = $2,000 unfavorable.
REVIEW PROBLEM 1: VARIANCE ANALYSIS USING A FLEXIBLE BUDGET

Harrald’s Fish House is a family-owned restaurant that specializes in Scandinavian-style seafood. Data
concerning the restaurant’s monthly revenues and costs appear below (q refers to the number of meals
served):
Formula
Revenue. . . . . . . . . . . . . . . . $16.50q
Cost of ingredients. . . . . . . $6.25q
Wages and salaries. . . . . . $10,400
Utilities. . . . . . . . . . . . . . . . . $800 + $0.20q
Rent . . . . . . . . . . . . . . . . . . . $2,200
Miscellaneous. . . . . . . . . . . $600 + $0.80q
Required:
1 . Prepare the restaurant’s planning budget for April assuming that 1,800 meals are served.
2. Assume that 1,700 meals were actually served in April. Prepare a flexible budget for this level of
activity.
3. The actual results for April appear below. Compute the revenue and spending variances for the restaurant
for April.
Revenue. . . . . . . . . . . . . . . . . . . . $27,920
Cost of ingredients. . . . . . . . . . . $11,110
Wages and salaries. . . . . . . . . . $10,130
Utilities. . . . . . . . . . . . . . . . . . . . . $1,080
Rent . . . . . . . . . . . . . . . . . . . . . . . $2,200
Miscellaneous. . . . . . . . . . . . . . . $2,240
Solution to Review Problem

1. The planning budget for April appears below:
Harrald’s Fish House

Planning Budget
For the Month Ended April 30
Budgeted meals served (q). . . . . . . . . . . . 1,800

Revenue ($16.50q) . . . . . . . . . . . . . . . . . . $29,700
Expenses:
Cost of ingredients ($6.25q) . . . . . . . . 11,250
Wages and salaries ($10,400). . . . . . . 10,400
Utilities ($800 + $0.20q). . . . . . . . . . . . 1,160
Rent ($2,200) . . . . . . . . . . . . . . . . . . . . . 2,200
Miscellaneous ($600 + $0.80q) . . . . . 2,040
Total expense. . . . . . . . . . . . . . . . . . . . . . . 27,050
Net operating income. . . . . . . . . . . . . . . . $ 2,650
2. The flexible budget for April appears below:

Flexible Budget
Actual meals served (q). . . . . . . . . . . . . . 1,700

Revenue ($16.50q) . . . . . . . . . . . . . . . . . $28,050
Expenses:
Cost of ingredients ($6.25q) . . . . . . . 10,625
Wages and salaries ($10,400). . . . . . 10,400
Utilities ($800 + $0.20q). . . . . . . . . . . 1,140
Rent ($2,200) . . . . . . . . . . . . . . . . . . . . 2,200
Miscellaneous ($600 + $0.80q) . . . . 1,960
Total expense. . . . . . . . . . . . . . . . . . . . . . 26,325
Net operating income. . . . . . . . . . . . . . . $ 1,725
3. The revenue and spending variances for April appear below:

Revenue and Spending Variances
Revenue
(1) and Spending (2)
Actual Variances Flexible
Results (1) − (2) Budget
Meals served. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700 1,700

Revenue ($16.50q) . . . . . . . . . . . . . . . . . . . . . . . $27,920 $130 U $28,050
Expenses:
Cost of ingredients ($6.25q) . . . . . . . . . . . . . 11,110 485 U 10,625
Wages and salaries ($10,400). . . . . . . . . . . . 10,130 270 F 10,400
Utilities ($800 + $0.20q). . . . . . . . . . . . . . . . . 1,080 60 F 1,140
Rent ($2,200) . . . . . . . . . . . . . . . . . . . . . . . . . . 2,200 0 2,200
Miscellaneous ($600 + $0.80q) . . . . . . . . . . 2,240 280 U 1,960
Total expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,760 435 U 26,325
Net operating income. . . . . . . . . . . . . . . . . . . . . $ 1,160 $565 U $ 1,725
420 Chapter 9
REVIEW PROBLEM 2: STANDARD COSTS

Xavier Company produces a single product. Variable manufacturing overhead is applied to products on the
basis of direct labor-hours. The standard costs for one unit of product are as follows:
Direct material: 6 ounces at $0.50 per ounce. . . . . . . . . . . . . . . . . . . . . . $ 3.00

Direct labor: 0.6 hours at $30.00 per hour. . . . . . . . . . . . . . . . . . . . . . . . 18.00
Variable manufacturing overhead: 0.6 hours at $10.00 per hour. . . . . 6.00
Total standard variable cost per unit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $27.00
During June, 2,000 units were produced. The costs associated with June’s operations were as follows:
Material purchased: 18,000 ounces at $0.60 per ounce. . . . . . . . . . $10,800

Material used in production: 14,000 ounces. . . . . . . . . . . . . . . . . . . . . —
Direct labor: 1,100 hours at $30.50 per hour. . . . . . . . . . . . . . . . . . . . $33,550
Variable manufacturing overhead costs incurred. . . . . . . . . . . . . . . . . $12,980
Required:
Compute the direct materials, direct labor, and variable manufacturing overhead variances.
Solution to Review Problem

Direct Materials Variances

of Input, of Input Allowed for Actual Output,
18,000 ounces × $0.60 18,000 ounces × $0.50 per 12,000 ounces* × $0.50
per ounce = $10,800 ounce = $9,000 per ounce = $6,000
Price variance = $1,800 U

14,000 ounces × $0.50
per ounce = $7,000
Quantity variance = $1,000 U
*2,000 units × 6 ounces per unit = 12,000 ounces.
Using formulas, the same variances would be computed as follows:

= AQ(AP − SP)
= 18,000 ounces ($0.60 per ounce − $0.50 per ounce)
= $1,800 U
= SP(AQ − SQ)
= $0.50 per ounce (14,000 ounces − 12,000 ounces)
= $1,000 U
Direct Labor Variances

1,100 hours × $30.50 1,100 hours × $30.00 1,200 hours* × $30.00
per hour = $33,550 per hour = $33,000 per hour = $36,000

= $550 U = $3,000 F
Spending variance = $2,450 F

Using formulas, the same variances can be computed as follows:
Labor rate variance = (AH × AR) − (AH × SR)
= AH(AR − SR)
= 1,100 hours ($30.50 per hour − $30.00 per hour)
= $550 U
Labor efficiency variance = (AH × SR) − (SH × SR)
= SR(AH − SH)
= $30.00 per hour (1,100 hours − 1,200 hours)
= $3,000 F
Variable Manufacturing Overhead Variances

1,100 hours × $11.80† 1,100 hours × $10.00 1,200 hours* × $10.00
per hour† = $12,980 per hour = $11,000 per hour = $12,000
Variable overhead rate Variable overhead efficiency

variance = $1,980 U variance = $1,000 F

†$12,980 ÷ 1,100 hours = $11.80 per hour.
Using formulas, the same variances can be computed as follows:
Variable overhead
rate variance = (AH × AR) − (AH × SR)
= AH(AR − SR)
= 1,100 hours ($11.80 per hour − $10.00 per hour)
= $1,980 U
Variable overhead
= (AH × SR) − (SH × SR)
efficiency variance
= SR(AH − SH)
= $10.00 per hour (1,100 hours − 1,200 hours)
= $1,000 F
422 Chapter 9
GLOSSARY
Flexible budget A report showing estimates of what revenues and costs should have been, given the
actual level of activity for the period. (p. 393)
Labor efficiency variance The difference between the actual hours taken to complete a task and the
standard hours allowed for the actual output, multiplied by the standard hourly labor rate. (p. 411)
Labor rate variance The difference between the actual hourly labor rate and the standard rate, multiplied
by the number of hours worked during the period. (p. 410)
Management by exception A management system in which actual results are compared to a budget.
Significant deviations from the budget are flagged as exceptions and investigated further. (p. 392)
Materials price variance The difference between the actual unit price paid for an item and the standard
price, multiplied by the quantity purchased. (p. 408)
Materials quantity variance The difference between the actual quantity of materials used in production
and the standard quantity allowed for the actual output, multiplied by the standard price per unit of
materials. (p. 408)
Planning budget A budget created at the beginning of the budgeting period that is valid only for the
planned level of activity. (p. 393)
Price variance A variance that is computed by taking the difference between the actual price and the
standard price and multiplying the result by the actual quantity of the input. (p. 405)
Quantity variance A variance that is computed by taking the difference between the actual quantity of
the input used and the amount of the input that should have been used for the actual level of output and
multiplying the result by the standard price of the input. (p. 405)
Revenue variance The difference between how much the revenue should have been, given the actual level of
activity, and the actual revenue for the period. A favorable (unfavorable) revenue variance occurs because
the revenue is higher (lower) than expected, given the actual level of activity for the period. (p. 397)
Spending variance The difference between how much a cost should have been, given the actual level of
activity, and the actual amount of the cost. A favorable (unfavorable) spending variance occurs because
the cost is lower (higher) than expected, given the actual level of activity for the period. (p. 398)
Standard cost card A detailed listing of the standard amounts of inputs and their costs that are required
to produce one unit of a specific product. (p. 403)
Standard cost per unit The standard quantity allowed of an input per unit of a specific product,
multiplied by the standard price of the input. (p. 403)
Standard hours allowed for actual output The time that should have been taken to complete the
period’s output. It is computed by multiplying the actual number of units produced by the standard
hours per unit. (p. 406)
Standard hours per unit The amount of direct labor time that should be required to complete a single
unit of product, including allowances for breaks, machine downtime, cleanup, rejects, and other
normal inefficiencies. (p. 402)
Standard price per unit The price that should be paid for an input. (p. 402)
Standard quantity allowed for actual output The amount of an input that should have been used to
complete the period’s actual output. It is computed by multiplying the actual number of units produced
by the standard quantity per unit. (p. 406)
Standard quantity per unit The amount of an input that should be required to complete a single unit of
product, including allowances for normal waste, spoilage, rejects, and other normal inefficiencies. (p. 402)
Standard rate per hour The labor rate that should be incurred per hour of labor time, including
employment taxes and fringe benefits. (p. 403)
Variable overhead efficiency variance The difference between the actual level of activity (direct
labor-hours, machine-hours, or some other base) and the standard activity allowed, multiplied by the
variable part of the predetermined overhead rate. (p. 413)
Variable overhead rate variance The difference between the actual variable overhead cost incurred
during a period and the standard cost that should have been incurred based on the actual activity of
the period. (p. 413)
QUESTIONS
9–1 What is a static planning budget?
9–2 What is a flexible budget and how does it differ from a static planning budget?
9–3 What are some of the possible reasons that actual results may differ from what had been budgeted
at the beginning of a period?
9–4 Why is it difficult to interpret a difference between how much expense was budgeted at the
beginning of the period and how much was actually spent?
9–5 What is a revenue variance and what does it mean?

Standard Costing PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Standard Costing PDF

Uploaded by

Copyright:

Available Formats

A LOOK BACK A LOOK AT THIS CHAPTER A LOOK AHEAD

After studying Chapter 9, you

LO9–1 Prepare a planning

LO9–2 Calculate and

LO9–3 Prepare a flexible

LO9–4 Compute the direct

LO9–5 Compute the direct

LO9–8 (Appendix 9B)

THE VARIANCE ANALYSIS CYCLE

Raise Identify Take

Deficiencies of the Static Planning Budget

Budgeted client-visits (q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000

Actual client-visits (q). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100

How a Flexible Budget Works

©Bloomberg/Getty Images (continued)

FLEXIBLE BUDGET VARIANCES

IN BUSINESS The Sales Implications of the World Cup

Owner of Micro-Brewery DECISION POINT

FLEXIBLE BUDGETS WITH MULTIPLE COST DRIVERS

Actual client-visits (q1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100

STANDARD COSTS—SETTING THE STAGE

Setting Direct Materials Standards

IN BUSINESS Managing Raw Material Costs in the Apparel Industry

Setting Direct Labor Standards

Setting Variable Manufacturing Overhead Standards

Direct materials . . . . . . . . . . . . . . . . . 3.0 pounds $4.00 per pound $12.00

Using Standards in Flexible Budgets

Actual output in June . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 statues

*There were no beginning or ending inventories of raw materials in June;

Actual Spending Flexible

Statues produced (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 2,000

A GENERAL MODEL FOR STANDARD COST VARIANCE ANALYSIS

E X H I B I T 9 – 1 0 A General Model for Standard Cost Variance Analysis—Variable Manufacturing Costs

(1) (2) (3)

Price Variance Quantity Variance

USING STANDARD COSTS—DIRECT MATERIALS VARIANCES

E X H I B I T 9 – 1 1 Standard Cost Variance Analysis—Direct Materials

(1) (2) (3)

Price variance = $1,300 F Quantity variance = $2,000 U

Spending variance = $700 U

* 2,000 units × 3.0 pounds per unit = 6,000 pounds.

Standard quantity allowed = Actual output × Standard quantity per unit

The Materials Price Variance

The Materials Quantity Variance

AQ = Actual quantity of pounds purchased and used in production

Materials Price Variance:

Materials Quantity Variance:

USING STANDARD COSTS—DIRECT LABOR VARIANCES

LEARNING OBJECTIVE 9–5

The Labor Rate Variance

E X H I B I T 9 – 1 2 Standard Cost Variance Analysis—Direct Labor

(1) (2) (3)

Labor rate variance Labor efficiency variance

*2,000 units × 0.5 hours per unit = 1,000 hours.

The Labor Efficiency Variance

Standard Cost System Usage in the Turkish IN BUSINESS

Possible causes of an unfavorable labor efficiency variance include poorly trained

AH = Actual quantity of hours used in production

Labor Rate Variance:

Labor Efficiency Variance:

USING STANDARD COSTS—VARIABLE MANUFACTURING OVERHEAD VARIANCES

E X H I B I T 9 – 1 3 Standard Cost Variance Analysis—Variable Manufacturing Overhead

(1) (2) (3)