TASMANIAN SCHOOL OF

BUSINESS AND ECONOMICS

BFA312: Management Accounting

Week 7 – Standard Costing and

Variance Analysis
 Learning objectives
1. Explain how unit standards are set and why standard cost systems are
adopted.
2. Explain the purpose of a standard cost sheet.
3. Prepare a flexible budget and use it for performance reporting.
4. Compute the materials variances and explain how they are used for control.
5. Compute the labour variances and explain how they are used for control.
6. Compute the variable overhead variances and explain their meaning.
7. Compute the fixed overhead variances and explain their meaning.

8. Prepare an activity-based flexible budget.

 Unit standards

• Budgets set standards that are used to control and evaluate managerial
performance.

• To determine the unit standard cost for a particular input, two standards
are developed:
– the quantity standard determines the amount of input that should be used per
unit of output.
– the price standard determines the amount that should be paid per unit of input.

Standard cost per unit = Quantity standard × Price standard

 How standards are developed
• Three potential sources of quantitative standards are:
• 1- Historical Experience
• 2- Engineering studies
• 3- Input from operating personal
 Types of standards

• Standards are generally classified as either ideal or currently attainable.

–Ideal standards demand maximum efficiency and can

be achieved only if everything operates perfectly.

–Currently attainable standards can be achieved

under efficient operating conditions.

–Of the two types, currently attainable standards offer

the most behavioral benefits.
 Why standard cost systems are adopted
• In a standard costing system, costs are assigned to products using quality
and price standards.

• Two reasons for adopting a standard cost system:

1. To enhance planning and control through the

calculation of variances
2. To facilitate product costing.
 Advantages of standard costing
• Greater capacity for control

• Provides readily available unit cost information

• No unit cost calculations for each equivalent unit

category in process costing

• No need to distinguish between FIFO and weighted

average methods of accounting for beginning inventory
costs.
 Standard product costs
• In manufacturing firms, standard costs are developed for direct materials,
direct labour and overhead.

• Using these costs, the standard cost per unit is computed.

• The standard cost sheet provides the production data needed to calculate
the standard unit cost.

• The standard cost sheet also shows the quantity of each input that should
be used to produce one unit of output.
 Standard product costs
• A manager should be able to compute the standard quantity of
materials allowed (SQ) and the standard hours allowed (SH)
for the actual output, where:

SQ ¿
  Unit quantity standard ×
  Actual output
And
SH ¿
  Unit labour standard ×
  Actual output
 Static budgets versus flexible budgets
• Budgets are useful for both planning and control, where they are used as
benchmarks for performance evaluation.

• A performance report compares actual costs with budgeted costs. There

are two ways to make this comparison:
– Compare actual costs with the budgeted costs for the budgeted level of activity (static
budget).
– Compare actual costs with the budgeted costs for the actual level of activity (flexible
budget).
 Static budget and performance reports
• A static budget is a budget created in advance that is based on a level of
output or activity. For example, a master budget.

• One way to prepare a performance report is to compare actual costs with

budgeted costs from the master budget.

• However, actual output might differ from budgeted output resulting in

comparison of costs not providing good control information.
 Static budget and performance reports
• As an example, assume that the Managers often use
this budget to compare actual with budgeted
amounts.
 Static (master) Budget based on 350 unit
D.M. (SP $80 x SQ 3x 350) 84,000
D.L. (SR $25 x SH 5 x 350) 43,750
V.O.H.C (SR $6 x SH 5x 350) 10,500
F.O.H.C 4,000
Total cost 142,250
 Static budget and performance reports
• Assume that at the end of the period the actual output were 400 units.

Actual Results based on 400 unit

D. M. (AP $85 x AQ 2.5 x 400) 85,000
D. L (AR $26 x AH 6 x 400) 62,400
V.O.H.C (AR $8 x AH 6 x 400) 12,000
F.O.H.C 4,000
Total cost 163,400

• For controlling, at the end of the period, it is important to prepare the

performance report to compare the real costs with the planned one, to see if
there is any variance.
 Static budget and performance reports
Performance report using a budget based on expected production.
Actual Results based on 400 unit Master Budget based on 350 unit Variance

D. M. (AP $85 x AQ 2.5 x 85,000 M. (SP $80 x SQ 3x 350) 84,000 $1,000 U

400)
D. L (AR $26 x AH 6 x 400) 62,400 D.L (SR $25 x SH 5 x 350) 43,750 18,650 U

V.O.H.C (AR $8 x AH 6 x 12,000 V.O.H.C (SR $6 x SH 5x 10,500 1,500 U

400) 350)
F.O.H.C 4,000 F.O.H.C 4,000 0
Total cost 163,400 Total cost 142,250 21,150U

Variance = Actual amount – Budgeted amount

If the actual cost is less than the budgeted cost the variance is F (Favourable).
If the actual cost is more than the budgeted cost, the variance is U (Unfavourable )
 Static budget and performance reports
• Notes:
• 1- The actual performance is based on 400 units while the master budget
based on 350.
• 2- Actual costs for production of 400 units are being compared with planned
costs for production of 350 units.
• 3- Because direct materials, direct labour and VOH are variable costs, they
should be higher at higher production levels.
• 4-Thus, even if cost control were perfect for the production of 400 units,
unfavourable variances would be produced for at least some of the variable
costs. Therefore, the above compassion is meaningless.
• 5-To create a meaningful performance report, actual costs and expected
costs must be compared at the same level of activity.
• 6-Therefore, the master budget must be adjusted to reflect the actual
output, and this is what we call Flexible Budget.
 Flexible budget and performance reports
• To compare the actual performance with budgeted one, it is
important to prepare the flexible budget by using the standard cost at
the actual level:
Performance report using budgeted costs for the actual level of activity.

 Actual Results based on 400 unit Flexible Budget based on Flexible

400 unit Variance
D. M. (AP $85 x AQ 2.5 85,000 D.M. (SP $80 x SQ 3 x400) 96,000 $11,000 F
x 400)
D. L (AR $26 x AH 6 x 62,400 D.L (SR $25 x SH 5x400) 50,000 12,400 U
400)
V.O.H.C (AR $5 x AH 6 12,000 V.O.H.C (SR $6 x SH 5x400) 12,000 0
x 400)
F.O.H.C 4000 F.O.H.C 4,000 0
Total cost 163,400   162,000 1,400 U
Mowen Exercise 9-20-Flexible budget with different levels
of production

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 Mowen Exercise 9-20-Flexible budget
with different levels of production
2,500 units 3,000 units 3,200 units
Direct Materials (3kg @$0.6 per kg) $4,500 $5,400 $5,760
Direct labour (0.5 hr @ $16.00 per hr) 20,000 24,000 25,600
Variables overhead (0.5 hr @ 2.20) 2,750 3,300 3,520
Fixed overhead:
Materials handling 6,200 6,200 6,200
Depreciation 2,600 2,600 2,600
Total cost $36,050 $41,500 $43,680
 Mowen Exercise 9-21-Performance report

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 Mowen Exercise 9-21-Performance report
Performance report
Actual Budgeted Variance*
Units produced………………………………………………………………………………………
3,800 3,800 -
Direct materials………………………………………………………………………………………
$ 6,800 $ 6,840 $ (40) F
Direct labour………………………………………………………………………………………
30,500 30,400 100 U
Variable overhead………………………………………………………………………………………
4,200 4,180 20 U
Fixed overhead:
Materials handling………………………………………………………………………………………
6,300 6,200 100 U
Depreciation………………………………………………………………………………………
2,600 2,600 -
Total………………………………………………………………………………………
$ 50,400 $ 50,220 $ 180 U

Variances equal actual amounts minus budgeted amounts. If actual cost is less than
budgeted cost, the variance is F (favourable). If actual cost is more than budgeted cost, the
variance is U (unfavourable).
Budgeted:
Direct Materials (3kg @$0.6 per kg x 3,800 units)
Direct labour (0.5 hr @ $16.00 per hr x 3,800 units)
Variables overhead (0.5 hr @ 2.20 x 3,800 units)
 Variance analysis

• The total budget variance is the difference between

the actual cost of the input and its planned cost:

  Total Variance Actual cost Planned cost

  (AP AQ) (SP SQ)
where
AP = Actual price per unit
AQ = Actual quantity of input used
SP = Standard price per unit
SQ = Standard quantity of input allowed for the actual output (standard
quantity per unit x actual level of unit)
 Price and usage variances
•
• Price (rate) and usage (efficiency) variances are separated as
 responsibilities for these variances vary across different departments.
• Price (rate) variance is the difference between the actual and
standard unit price of an input multiplied by the number of inputs used:

Price (rate) variance (AP SP) × AQ

• Usage (efficiency) variance is the difference between the actual and
standard quantity of inputs multiplied by the standard unit price of the
input:

Usage (efficience) variance (AQ SQ) × SP

Price and usage variances
 Variance analysis: Materials
• Eg. Cinturon Corporation produces high-quality leather belts. The company’s plant
in Newcastle uses a standard costing system and has set the following standards
for materials and labour:
Leather (3 strips @ $4) $12.00
Direct labour (0.75 hr @ $18) 13.50
Total prime cost $25.50

• during the first month of the year, the Newcastle plant produced 92,000 belts.
Actual leather purchased was 287,500 strips at $3.60 per strip. There was no
beginning or ending inventories of leather. Actual direct labour was 78,200 hours
at $18.50 per hour.
• Required:
• 1- Compute the total budget variances for materials
• 2- Break down the total variance for materials into a price variance and a
usage variance using the columnar and formula approaches.
 Variance analysis: Materials

• 1- Compute the total budget variances for materials

• Flexible-budget variance = (AP x AQ) – (SP x SQ)
• = ($3.6 x287,500) - ($4 x 3 x 92,000)
• = $1,035,000 - 1,104,000
• = $69,000 F
 Variance analysis: Materials
• 2-a: Price variance and a usage variance using
the columnar approach
AP x AQ SP x AQ SP x SQ
287,500 x $3.60 287,500 x $4 3 x 92,000 x $4
$1,035,000 1,150,000 1,104,000

-115,000 F 46,000 U
Price variance Usage variance

$69,000 F
Flexible-budget
variance
 Variance analysis: Materials

• 2-b: Price variance and a usage variance using

the formula columnar
• Price variance= (AP-SP) AQ
• = ($3.60-$4) x 287,500 strips =
• = -115,000 F

• Usage variance= (AQ-SQ) SP

• = (287,500 strips – (3 strips/belts x 92,000 belts)) x $4
• = (287,500 strips – 276,000 strips) x $4
• = 46,000 U
 Variance analysis: Labor
• E.g., Cinturon Corporation produces high-quality leather belts. The company’s
plant in Newcastle uses a standard costing system and has set the following
standards for materials and labour:
Leather (3 strips @ $4) $12.00
direct labour (0.75 hr @ $18) 13.50
Total prime cost $25.50

• during the first month of the year, the Newcastle plant produced 92 000 belts.
Actual leather purchased was 287 500 strips at $3.60 per strip. There was no
beginning or ending inventories of leather. Actual direct labour was 78 200 hours
at $18.50 per hour.
• Required:
• 1- Compute the total budget variances for Labour
• 2- Break down the total variance for Labour into a rate variance and a
efficiency variance using the columnar and formula approaches.
 Variance analysis: Labor

1- Compute the total budget variances for Labour

•  
• Flexible-budget variance = (AH x AR) – (SH x SR)
• Flexible-budget variance = (78,200 x $18.50) – (0.75 hr x 92000 x $18)
• = $1,446,700 - $1,242,000
• = $204,700 U
 Variance analysis: Labor
• 2-a: Break down the total variance for labour
into a rate variance and a efficiency variance
using the columnar approach.
AR x AH SR x AH SR x SH
78,200 x $18.50 78,200 x $18 0.75 hr x 92000 x $18

$1,446,700 $1,407,600 $1,242,000

$39,100 U $165,600 U
Rate variance efficiency variance
$204,700
Flexible-budget
variance
 Variance analysis: Labour
• 2-b Break down the total variance for labour
into a rate variance and an efficiency variance
using the formula approach.
• Rate variance =($18.50-$18) 78,200
• = $39,100 U
• Efficiency variance= (78,200 -(0.75 hr x 92000)) $18
• Efficiency variance= (78,200 - 69,000) $18
• = $165,600 U
• Flexible-budget variance = $39,100 U + $165,600 U = $204,700 U

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Variable overhead variances analysis: Mowen Exercise 9-23
• Mandai Company provided the following information:
Standard variable overhead rate (SVOR) per direct labour $3.70
hour
Actual variable overhead rate (AVOR) per direct labour $3.68
hour
Actual direct labour hours worked (AH) 56,200

Actual production in units 14,000

Standard hours allowed for actual units produced (SH) 56,000

• Required:
• Using the columnar approach, calculate the variable overhead spending and efficiency variances.
• Using the formula approach, calculate the variable overhead spending variance.
• Using the formula approach, calculate the variable overhead efficiency variance.
• Calculate the total variable overhead variance.

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Variable overhead variances analysis: Mowen Exercise 9-
23
1. Columnar approach:
1. AH × AVOR 2. AH × SVOR 3. SH × SVOR
56,200 × $3.68 56,200 × $3.70 56,000 × $3.70
$206,816 $207,940 $207,200
$1,124 F $740 U
Spending Efficiency

2. Variable Overhead Spending Variance = (AVOR – SVOR) AH

= ($3.68 – $3.70)56,200
= (-$1,124.00
$(1,124) F F

3. Variable Overhead Efficiency Variance = (AH – SH) SVOR

= (56,200 – 56,000)$3.70
= $740 U

4. Variable overhead spending variance………………………………………………………………………

$(1,124) F
Variable overhead efficiency variance………………………………………………………………………
740 U
Total variable overhead variance……………………………………………………………………………
$ (384) F

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 Fixed overhead variances analysis
• Total variance = Actual fixed overhead – Applied fixed overhead
•  
• Total variance can be break down into:
• 1- Fixed overhead spending variance: is defined as the difference
between the actual fixed overhead (AFOH) and the budgeted fixed
overhead (BFOH):
Fixed overhead spending variance AFOH BFOH
• 2- Fixed overhead volume variance: is the difference between
budgeted fixed overhead (BFOH) and applied fixed overhead:

 Volume variance Budgeted fixed overhead Applied fixed overhead

BFOH (SH SFOR)
 Fixed overhead variances analysis
• Mandai Company provided the following information:

Standard fixed overhead rate (SFOR) per direct labour hour $5.00
Actual fixed overhead rate (AFOR) per direct labour hour $5.03
Actual direct labour hours worked (AH) 56,200
Actual production in units 14,000
Standard hours allowed for actual units produced (SH) 56,000
Budgeted fixed overhead $285000

• Required:
• Using the columnar approach, calculate the fixed overhead spending and Volume variances.
• Using the formula approach, calculate the fixed overhead spending variance.
• Using the formula approach, calculate the fixed overhead volume variance.
• Calculate the total fixed overhead variance.

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 Fixed overhead variances analysis
Budgeted
fixed
1- AH x AFOR
56,200  $5.03
overhead
$285000
SH x SFOR
56,000  $5.00
$282,686 $280,000

- $2,314F $5000 U
Spending variance Volume
variance
$2,686U
variance
Flexible-budget variance

2- Fixed overhead spending variance = AFOH − BFOH

= $282,686- $285,000
= -$2,314 F
3- Volume variance = Budgeted fixed overhead − Applied fixed overhead
= BFOH −(SH × SFOR)
= $285,000- (56,000 x $5.00)
= $5,000 U
4- Total variance = (AH x AFOR)- (SH × SFOR)
= $282,686 - $280,000
= $2,686U
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 Mowen Exercise 9-27

Salaries (6 inspectors × $32,000)………………………………………………………

$ 192,000
Supplies (170,000 × $0.70)………………………………………………………………
119,000
Workbenches, computer depreciation…………………………………………………
18,300
Factory space, utilities……………………………………………………………………
12,600
Total inspection cost……………………………………………………………………
$ 341,900

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 Mowen Exercise 9-29
Performance report
Actual Budgeted Variance*
Units produced……………………………………………………………………………………………………
— 40,000 40,000 —
Maintenance………………………………………………………………………………………………………
$ 158,300 $ 158,000 $ 300 U
Machining…………………………………………………………………………………………………………
205,400 205,000 400 U
Setting up…………………………………………………………………………………………………………
106,700 105,000 1,700 U
Purchasing…………………………………………………………………………………………………………
158,800 159,000 - 200 F
Total…………………………………………………………………………………………………………………
$ 629,200 $ 627,000 $ 2,200 U

Variances equal actual amounts minus budgeted amounts. If actual cost is less than
budgeted cost, the variance is F (favourable). If actual cost is more than budgeted cost, the
variance is U (unfavourable).

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