STANDARD COSTING

AND VARIANCE
ANALYSIS
Variances
Managers use variance analysis to compare actual results with expected results and to
investigate why actual results differ from expectations for performance evaluation
purposes.

A firm sets standards for production costs to articulate its expectations with respect to its
operational performance and financial results. Setting production cost standards
requires a collaborative effort by accountants, engineers, personnel administrators, and
production managers

 Direct Material Standards:

 Price standards – Final cost of materials after delivery and net of discounts
 Quantity standards – Use product design specifications
 Direct Labor Standards:
 Rate standards – Use labor contracts, wage surveys
 Time standards – Use time and motion studies
 Variable Overhead Standards:
 Rate standards – Variable portion of the predetermined overhead rate
 Activity standards – Expected usage of the allocation base
 Fixed Overhead Standards:
 Fixed portion of predetermined overhead rate
 Example – Chocolate Co.
Chocolate Co.
Standard Cost For One Chocolate In 2010
Standard quantity Standard price of Standard cost of
of input to input input per
make one chocolate
chocolate
Direct Materials 1 $7 $7

Direct Labor .5 DLH $10/DLH $5

Variable overhead .5DLH $6/DLH $3

Fixed overhead .5DLH $10/DLH $5

Total standard $20

cost per unit
Variance Analysis
Cost variance – the difference between actual cost
and expected/budgeted/standard cost
Favorable cost variance – occurs when actual
cost is lower than expected cost for a given level
of output
Unfavorable cost variance – occurs when actual
cost is greater than expected cost for a given
level of output
Do favorable cost variances always signal that the
company has performed well in keeping its costs
down?
A General Framework For Variance Analysis

Actual Quantity (AQ) Actual Quantity Standard Quantity

X Actual Price (AP) (AQ) x Standard (SQ) x Standard Price
Price (SP) (SP)

Price Variance Quantity Variance

AQ (AP-SP) SP (AQ-SQ)

 IMPORTANT NOTE: SQ is the standard quantity allowed for the

ACTUAL units produced
A General Framework For Variance Analysis

Actual Quantity (AQ) Actual Quantity Standard Quantity

X Actual Price (AP) (AQ) x Standard (SQ) x Standard Price
Price (SP) (SP)

Price Variance Quantity Variance

AQ (AP-SP) SP (AQ-SQ)
Total Variance

 IMPORTANT NOTE: SQ is the standard quantity allowed for the

ACTUAL units produced
General Framework for Variance Analysis
Direct Material Variances – Example 3
The Cane Company produced 500 industrial plastic containers. The standard
cost of making each container is 3lb. of plastic at $1.5/lb. (same as above).
SQ x SP
Standard quantity of plastic Standard price of plastic
allowed for producing 500 containers

3 lb./container x 500 containers = 1,500 lb. x $1.5/lb =$2,250

To make 500 containers the company purchased and used 2,000 lb. of plastic
and incurred $4,000 for the cost of plastic.
Total Variance:

The cause of the variance: Was the plastic quantity different from the
standard? Was the price paid for plastic different from the standard?
Formulas for computing DM variances
 Materials price variance =
AQ x AP – SP x AQ = AQ (AP – SP)
 Materials quantity variance =
AQ x SP – SP x SQ = SP (AQ – SQ)
 Compute the materials price variance and materials quantity variance
for the Cane Company using the last example

DM price variance =
DM quantity variance =

In the last example, the Cane Company purchased expensive materials

that cost the company $1,000 more than expected; the materials were
not used as efficiently as expected costing the company an additional
$750. How can the company act on this information?
Direct Material Variances When Quantity Of Materials
Purchased Is Not Equal To The Quantity Of Materials Used In
Production
When quantity of materials purchased is not equal to the quantity of materials
used in production:
-Compute materials price variance using quantity of materials purchased
-Compute materials quantity variance using quantity of materials used in
production

Example: Mert Company uses a standard cost system. Information for raw
materials for Product A for the month of October follows:
 Standard price per pound of raw materials: $1.60
 Actual purchase price per pound of raw materials: $1.55
 Actual quantity of raw materials purchased: 2,000 pounds
 Actual quantity of raw materials used: 1,900 pounds
 Standard quantity allowed for actual production: 1,800 pounds

Compute Mert’s materials price variance and materials quantity variance for
Product A
Direct Material Variances When Quantity Of Materials
Purchased Is Not Equal To The Quantity Of Materials Used In
Production

AQxAP AQxSP SQxSP

 Explain why the quantity of materials purchased is

more appropriate in calculating materials price
variance than the quantity of materials used in
production
Concept Check
1. 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 was the
materials quantity variance?
a. $5,000 unfavorable
b. $5,000 favorable
c. $2,000 favorable
d. $2,000 unfavorable

2. Referring to the facts in question 1 above, what was the material price
variance?
a. $5,250 favorable
b. $5,250 unfavorable
c. $5,000 unfavorable
d. $5,000 favorable
Concept Check
3. The actual direct labor wage rate is $8.50 and 4,500 direct labor hours
were actually worked during the month. The standard direct labor
wage rate is $8.00 and the standard quantity of hours allowed for the
actual level of output was 5,000 direct labor hours. What was the direct
labor efficiency variance?
a. $4,000 favorable
b. $4,000 unfavorable
c. $4,500 unfavorable
d. $4,500 favorable

4. Referring to the facts in question 3 above, what is the variable overhead

efficiency variance if the standard variable overhead per direct labor
hour is $5.00?
a. $5,000 favorable
b. $5,000 unfavorable
c. $2,500 unfavorable
d. $2,500 favorable
Variable Overhead Variances
Actual Flexible Budget Flexible Budget
Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AH × AR AH × SR SH × SR

Rate Efficiency
Variance Variance
Rate variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
Variable Overhead Variances –
Example
ColaCo’s actual production for the period required 3,200 standard machine
hours. Actual variable overhead incurred for the period was $6,740.
Actual machine hours worked were 3,300. The standard variable
overhead cost per machine hour is $2.00.

Compute the variable overhead rate variance and variable overhead

efficiency variance.

.
Quick Check 
Yoder
Yoder Enterprises’
Enterprises’ actual
actual production
production for for the
the period
period
required
required 2,100
2,100 standard
standard direct
direct labor
labor hours.
hours. Actual
Actual
variable
variable overhead
overhead for
for the
the period
period was
was $10,950.
$10,950. Actual
Actual
direct
direct labor
labor hours
hours worked
worked were
were 2,050.
2,050. TheThe
predetermined
predetermined variable
variable overhead
overhead rate
rate is
is $5
$5 per
per direct
direct
labor
labor hour.
hour. What
What was
was the
the variable
variable overhead
overhead rate rate
variance?
variance?
a.
a. $450
$450 UU
b.
b. $450
$450 FF
c.
c. $700
$700 FF
d.
d. $700
$700 UU
Quick Check 
Yoder
Yoder Enterprises’
Enterprises’ actual
actual production
production for for the
the
period
period required
required 2,100
2,100 standard
standard direct
direct labor
labor hours.
hours.
Actual
Actual variable
variable overhead
overhead forfor the
the period
period was
was
$10,950.
$10,950. Actual
Actual direct
direct labor
labor hours
hours worked
worked werewere
2,050.
2,050. The
The predetermined
predetermined variable
variable overhead
overhead rate rate is
is
$5
$5 per
per direct
direct labor
labor hour.
hour. What
What waswas the
the VOH
VOH
efficiency
efficiency variance?
variance?
a.
a. $450
$450 UU
b.
b. $450
$450 FF
c.
c. $250
$250 FF
d.
d. $250
$250 UU
Overhead Rates and Overhead
Analysis

Recall that overhead costs are assigned to

products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity

Overhead from the

flexible budget for the
denominator level of activity
POHR =
Denominator level of activity
Overhead Rates and Overhead
Analysis
The predetermined overhead rate can also be broken
down into fixed and variable components:

The variable component is useful for preparing and

analyzing variable overhead variances.

The fixed component is useful for preparing and

analyzing fixed overhead variances.
Normal versus Standard Cost Systems

In a normal cost system, overhead is applied to work

in process based on the actual number of hours
worked in the period.

In a standard cost system, overhead is applied to

work in process based on the standard hours
allowed for the output of the period.
 Fixed Overhead Variances

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
DH × FR SH × FR

Budget Volume
Variance Variance
FR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
DH = Denominator Hours
 Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this flexible budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 ? $ 9,000 ?
4,000 8,000 ? 9,000 ?

Let’s calculate overhead rates.

ColaCo
ColaCoapplies
appliesoverhead
overheadbased
based
on
on machine-hour
machine-hour activity.
activity.
Fixed Overhead Variances – Example

ColaCo’s actual production required 3,200

standard machine hours. Actual fixed overhead was
$8,450. The predetermined overhead rate is based on
3,000 machine hours.
What is the budget variance?
The volume variance?
Volume Variance – A Closer Look

Volume
Variance

Results when standard hours

allowed for actual output differs
from the denominator activity.

Unfavorable Favorable
when standard hours when standard hours
< denominator hours > denominator hours
Volume Variance – A Closer Look

Volume
Variance
Does not measure over-
or under spending
Results when standard hours
Itallowed
resultsforfrom
actualtreating fixed
output differs
from the denominator
overhead activity.
as if it were a
variable cost.
Unfavorable Favorable
when standard hours when standard hours
< denominator hours > denominator hours
Quick Check 

Yoder
Yoder Enterprises’
Enterprises’ actual
actual production
production for for the
the
period
period required
required 2,100
2,100 standard
standard direct
direct labor
labor
hours.
hours. Actual
Actual fixed
fixed overhead
overhead forfor the
the period
period
was
was $14,800.
$14,800. The
The budgeted
budgeted fixed
fixed overhead
overhead waswas
$14,450.
$14,450. The
The predetermined
predetermined fixed
fixed overhead
overhead
rate
rate was
was $7
$7 per
per direct
direct labor
labor hour.
hour. What
What waswas the
the
budget
budget variance?
variance?
a.
a. $350
$350 UU
b.
b. $350
$350 FF
c.
c. $100
$100 FF
d.
d. $100
$100 UU