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Accounting: A Malaysian Perspective, 4
th
ed
(Adapted from Accounting 22
nd
ed)
Warren, Reeve and Duchac
Performance
Evaluation Using
Variances From
Standard Costs
10
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1. Describe the types of standards and
how they are established for
businesses.
2. Explain and illustrate how standards
are used in budgeting.
3. Compute and interpret direct
materials price and quantity
variances.
After studying this chapter, you should
be able to:
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4. Calculate and interpret direct labor
rate and time variances.
5. Compute and interpret factory
overhead controllable and volume
variances.
After studying this chapter, you should
be able to:
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Describe the types of
standards and how
they are established
for businesses.
Objective 1
10-1
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Standards 10-1
Standards are performance
goals. Manufacturers normally
use standard costs for each of
the three manufacturing costs:
Direct materials
Direct labor
Factory overhead
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10-1
Accounting systems that use
standards for direct
materials, direct labor, and
factory overhead are called
standard cost systems.
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10-1
When actual costs are compared
with standard costs, only the
exceptions or variances are reported
for cost control (called reporting by
the principle of exceptions).
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The standard-setting
process normally
requires the joint efforts
of accountants,
engineers, and other
management personnel.
Setting Standards 10-1
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Unrealistic standards that can be
achieved only under perfect
operating conditions (such as no
idle time, no machine breakdowns,
no materials spoilage) are called
ideal standards or theoretical
standards.
Types of Standards 10-1
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Currently attainable standards or
normal standards can be attained
with reasonable effort. Standards
set at this level allow for
disruptions, such as material
spoilage and machine breakdowns.
10-1
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Standard costs should be
continuously reviewed and
should be revised when
they no longer reflect
operating conditions.
Reviewing and Revising Standards 10-1
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Standards limit operating improvements
by discouraging improvements beyond
the standard.
Standards are too difficult to maintain in
a dynamic manufacturing environment,
resulting in stale standards.
Critics of Using Standards 10-1
Critics of standards believe the following:
(Continued)
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Critics of Using Standards 10-1
Standards can cause workers to lose
sight of the larger objectives of the
organization by focusing only on
efficiency improvements.
Standards can cause workers to
unduly focus upon their own
operations to the possible harm of
other operations that rely on them.
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Explain and
illustrate how
standards are used
in budgeting.
Objective 2
10-2
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10-2 Standard Cost for XL Jeans
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10-2 Budget Performance Report
The budget performance report
summarizes the actual costs, the
standard amounts for the actual
level of production achieved, and
the differences between the two
amounts (called cost variances).
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10-2
A favorable cost variance occurs
when the actual cost is less than the
standard cost (at actual volumes).
An unfavorable cost variance occurs
when the actual cost exceeds the
standard cost (at actual volumes).
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10-2 Budget Performance Report
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10-2 Relationship of Variances to the Total
Manufacturing Cost Variances
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Calculate and
interpret direct
materials price and
quantity variances.
Objective 3
10-3
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Standard square yards per
pair of jeans 1.50 sq. yards
Actual units produced x 5,000 pairs of jeans
Standard square yards of
denim budgeted for
actual production 7,500 sq. yards
Standard price per sq. yd. x RM5.00
Standard direct materials cost
at actual production RM37,500
Direct Materials 10-3
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Actual price per unit RM5.50 per sq. yd.
Standard price per unit 5.00 per sq. yd.
Price variance (unfavorable)RM0.50 per sq.
yd.
RM0.50 x the actual quantity of 7,300 sq. yds.
= RM3,650 unfavorable price variance
Direct Materials Price Variance 10-3
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Actual quantity used 7,300 sq. yds.
Standard quantity at
actual production 7,500
Quantity variance (favorable) (200) sq. yds.
(200) square yards x the standard price of
RM5.00 = (RM1,000) favorable
Direct Materials Quantity Variance 10-3
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RM3,650 U
Materials price
variance
Actual quantity x
Standard price
7,300 x RM5.00
= RM36,500
Actual quantity x
Actual price
7,300 x RM5.50 =
RM40,150
Standard
quantity x
Standard price
7,500 x RM5.00
= RM37,500
(RM1,000) F
Material quantity
variance
Direct Materials Variance
Relationships
10-3
Actual cost: Standard cost:
(Continued)
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RM2,650 U
Total direct materials cost variance
Actual quantity x
Standard price
7,300 x RM5.00
= RM36,500
Actual quantity x
Actual price
7,300 x RM5.50 =
RM40,150
Standard
quantity x
Standard price
7,500 x RM5.00
= RM37,500
10-3
Actual cost: Standard cost:
Direct Materials Variance
Relationships
(Concluded)
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Example Exercise 10-1
10-3
Serba Bagus Sdn Bhd produces a product that
requires six standard pounds per unit. The
standard price is RM4.50 per pound. If 3,000
units required 18,500 pounds, which were
purchased at RM4.35 per pound, what is the
direct materials (a) price variance, (b) quantity
variance, and (c) cost variance?
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For Practice: PE10-1

Follow My Example 10-1
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10-3
a. Direct materials price variance (favorable)
(RM2,775) [(RM4.35 RM4.50) x 18,500 pounds]
b. Direct materials quantity variance (unfavorable)
RM2,250 [(18,500 pounds 18,000 pounds) x
RM4.50]
c. Direct materials cost variance (favorable)
(RM525) [(RM2,775) + RM2,250] or[(RM4.35 x
18,500 pounds) (RM4.50 x 18,000 pounds)] =
RM80,475 RM81,000
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Compute and
interpret direct
labor rate and time
variances.
Objective 4
10-4
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Standard direct labor hours
per pair of XL jeans 0.80 direct labor hour
Actual units produced x 5,000 pairs of jeans
Standard direct labor hours
budgeted for actual
production 4,000 direct labor hours
Standard rate per DLH x RM9.00
Standard direct labor cost
at actual production RM36,000
Direct Labor Variances 10-4
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Actual rate RM10.00
Standard rate 9.00
Rate varianceunfavorableRM 1.00 per hour
RM1.00 x the actual time of 3,850
hours = RM3,850 unfavorable
Direct Labor Rate Variance 10-4
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Actual hours 3,850 DLH
Standard hours at actual
production 4,000
Time variancefavorable (150)DLH
(150) Direct labor hours x the standard rate
of RM9.00 = (RM1,350) favorable
Direct Labor Time Variance 10-4
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Actual hours x
Standard rate
3,850 x
RM9.00 =
RM34,650
Actual hours x
Actual rate
3,850 x RM10
= RM38,500
RM3,850 U
Direct labor rate
variance
Standard hours x
Standard rate
4,000 x RM9.00 =
RM36,000
(RM1,350) F
Direct labor time
variance
Direct Labor Variance
Relationships
10-4
Actual cost: Standard cost:
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(Continued)
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RM2,500 U
Total direct labor cost variance
Actual hours x
Standard rate
3,850 x
RM9.00 =
RM34,650
Actual hours x
Actual rate
3,850 x RM10
= RM38,500
Standard hours x
Standard rate
4,000 x RM9.00 =
RM36,000
10-4
Actual cost: Standard cost:
Direct Labor Variance
Relationships
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(Concluded)
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Example Exercise 10-2
10-4
Serba Bagus Sdn Bhd. produces a product that
requires 2.5 standard hours per unit at a
standard hourly rate of RM12 per hour. If
3,000 units required 7,420 hours at an hourly
rate of RM12.30 per hour, what is the direct
labor (a) rate variance, (b) time variance, and
(c) cost variance?
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For Practice: PE10-2
Follow My Example 10-2
10-4
a. Direct labor rate variance (unfavorable)
RM2,226 [(RM12.30 RM12.00) x 7,420 hours]
b. Direct labor time variance (favorable)
(RM960) [7,420 hours 7,500 hours) x RM12.00]
c. Direct labor cost variance (unfavorable)
(RM1,266) [RM2,226 + (RM960)] or [(RM12.30
x 7,420 hours) (RM12.00 x 7,500 hours)] =
RM91,266 RM90,000
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Compute and
interpret factory
overhead controllable
and volume
variances.
Objective 5
10-5
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10-5
Factory overhead costs are more
difficult to manage than direct
labor and materials costs because
the relationship between
production volume and indirect
costs is not easy to determine.
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Factory Overhead Cost
Budget Indicating Standard
Factory Overhead Rate
10-5
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Variances from standard for factory
overhead cost result from:
1. Actual variable factory overhead cost
greater or less than budgeted variable
factory overhead for actual production.
2. Actual production at a level above or
below 100% of normal capacity.
The Factory Overhead Flexible Budget 10-5
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Variable Factory Overhead
Controllable Variance
10-5
Actual variable factory overhead RM 10,400
Budgeted variable factory overhead
for actual amount produced
(4,000 hrs. x RM3.60) 14,400
Controllable variance
favorable RM (4,000) F

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Example Exercise 10-3
10-5
Serba bagus Sdn Bhd. produced 3,000 units of
product that required 2.5 standard hours per
unit. The standard variable overhead cost per
unit is RM2.20 per hour. The actual variable
factory overhead was RM16,850. Determine
the variable factory overhead controllable
variance.
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For Practice: PE10-3
Follow My Example 10-3
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10-5
RM350 unfavorable

RM16,850 [RM2.20 x (3,000 units x 2.5
hours)]
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Fixed Factory Overhead Volume
Variance
10-5
100% of normal capacity 5,000 direct labor hours
Standard hours at actual
production 4,000
Capacity not used 1,000 direct labor hours
Standard fixed overhead rate x RM2.40
Volume varianceunfavorableRM 2,400 U
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10-5
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Example Exercise 10-4
10-5
Serba Bagus Sdn Bhd. produced 3,000 units of
product that required 2.5 standard hours per
unit. The standard fixed overhead cost per unit
is RM0.90 per hour at 8,000 hours, which is
100% of normal capacity. Determine the fixed
factory overhead volume variance.
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For Practice: PE10-4
Follow My Example 10-4
10-5
RM450 unfavorable

RM0.90 x [8,000 hours (3,000 units x 2.5
hours)]
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Reporting Factory Overhead Variances 10-5
Total actual factory overhead RM22,400
Factory overhead applied (4,000
hours x RM6.00 per hour) 24,000
Total factory overhead cost
variancefavorable RM(1,600) F
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Factory Overhead Cost
Variance Report
10-5
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Factory Overhead Variances and the
Factory Overhead Account
10-5
Factory Overhead
Actual factory
overhead 22,400
Applied factory
overhead 24,000
RM10,400 +
RM12,000
4,000 hours
x RM6.00
per hour
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10-5
Factory Overhead
Actual factory
overhead 22,400
Applied factory
overhead 24,000
Balance, June 30 1,600
Overapplied
factory overhead
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10-5
Actual
Factory
Overhead
RM22,400
RM(4,000) F
Controllable
Variance
Applied
Factory
Overhead
RM24,000
RM2,400 U
Volume
Variance
Budgeted Factory
Overhead for
Amount Produced
Variable factory OHRM14,400
Fixed factory OH 12,000
Total RM26,400
Factory Overhead
Actual factory OH 22,400 Applied factory OH 24,000
(Continued)
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10-5
RM(1,600) F
Total Factory Overhead
Cost Variance
Applied
Factory
Overhead
RM24,000
Actual
Factory
Overhead
RM22,400
Budgeted Factory
Overhead for
Amount Produced
Variable factory OHRM14,000
Fixed factory OH 12,000
Total RM26,400
Factory Overhead
Actual factory OH 22,400 Applied factory OH 24,000
(Concluded)