B124 - Book 7 Part

2
Standard Costing and Variance Analysis
 10-2

Standard Costs
Standards are benchmarks or “norms” for
measuring performance. In managerial accounting,
two types of standards are commonly used.

Quantity standards Price standards

specify how much of an specify how much
input should be used to should be paid for
make a product or each unit of the
provide a service. input.

Examples: Firestone, Sears, McDonald’s, hospitals,

construction, and manufacturing companies.
 10-3

Standard Costs
Deviations from standards that considered significant
are brought to the attention of management, a
practice known as management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

 10-4

Variance Analysis Cycle

 10-5

A General Model for Variance Analysis

Variance Analysis

Quantity Variance Price Variance

Difference between Difference between

actual quantity and actual price and
standard quantity standard price
 10-6

A General Model for Variance Analysis

Variance Analysis

Quantity Variance Price Variance

- Materials quantity variance - Materials price variance

- Labor efficiency variance - Labor rate variance
 10-7

A General Model for Variance Analysis

(1) (2) (3)

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

Quantity Variance Price Variance

(2) – (1) (3) – (2)

+ Unfavorable - Favorable
 10-8

A General Model for Variance Analysis

Actual quantity is the amount of direct materials and direct
labor, actually used.

(1) (2) (3)

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

Quantity Variance Price Variance

(2) – (1) (3) – (2)
 10-9

A General Model for Variance Analysis

Standard quantity is the standard quantity allowed
for the actual output of the period.

(1) (2) (3)

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

Quantity Variance Price Variance

(2) – (1) (3) – (2)
 10-10

A General Model for Variance Analysis

Actual price is the amount actually
paid for the input used.

(1) (2) (3)

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

Quantity Variance Price Variance

(2) – (1) (3) – (2)
 10-11

A General Model for Variance Analysis

Standard price is the amount that should
have been paid for the input used.

(1) (2) (3)

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

Quantity Variance Price Variance

(2) – (1) (3) – (2)
 10-12

Learning Objective 1

Compute the direct

materials quantity and
price variances and
explain their
significance.
 10-13

Materials Variances –Example 1

Glacier Peak Outfitters has the following direct

materials standard for the fiberfill in its mountain
Jacket.

0.1 kg. of fiberfill per Jacket at $5.00 per kg.

Last month 210 kgs. of fiberfill were purchased and

used to make 2,000 Jackets. The materials cost a
total of $1,029.
 10-14

Answer 
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
× × ×
$5.00 per kg. $5.00 per kg. $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance 1,050 – 1,000 Price variance 1,029-1,050

$50 unfavorable ($21) favorable
 10-15

Answer 
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
0.1 kg per Jacket  2,000
× × ×
Jackets = 200 kgs
$5.00 per kg. $5.00 per kg. $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance 1,050 – 1,000 Price variance 1,029-1,050

$50 unfavorable ($21) favorable
 10-16

Answer 
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
× ×  210 kgs
$1,029 ×
$5.00 per kg. $5.00 per kg.
= $4.90 per kg $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance 1,050 – 1,000 Price variance 1,029-1,050

$50 unfavorable ($21) favorable
 10-17

Materials Variances:
Using the Factored Equations
Materials quantity variance
MQV = (AQ × SP) – (SQ × SP)
= SP(AQ – SQ)
= $5.00/kg (210 kgs – (0.1 kg/Jacket  2,000 Jackets))
= $5.00/kg (210 kgs – 200 kgs)
= $5.00/kg ×10 kgs = $50 U

Materials price variance

MPV = (AQ × AP) – (AQ × SP)
= AQ(AP – SP)
= 210 kgs ($4.90/kg – $5.00/kg)
= 210 kgs × – $0.10/kg = $(21) F
 10-18

Responsibility for Materials

Variances
Materials Quantity Variance Materials Price Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity variance

so that the production manager is not held responsible for
the purchasing manager’s performance.
 10-19

Responsibility for Materials Variances

Your poor scheduling
I am not responsible for sometimes requires me to
this unfavorable materials rush order materials at a
quantity variance. higher price, causing
unfavorable price variances.
You purchased cheap
material, so my people
had to use more of it.

Production Manager Purchasing Manager

 10-20

Materials Variances –Example 2 Unit

Hanson Inc. has the following direct materials

standard to manufacture one Unit:
1.5 Kgs per Unit at $4.00 per Kg
Last week, 1,700 Kgs of materials were purchased
and used to make 1,000 Units. The materials cost
a total of $6,630.
 10-21

Answer  Unit

Standard Quantity Actual Quantity Actual Quantity

× × ×
Standard Price Standard Price Actual Price

1,500 kgs. 1,700 kgs. 1,700 kgs.

× × ×
$4.00 per kg. $4.00 per kg. $3.90 per kg.
= $6,000 = $ 6,800 = $6,630

Quantity variance Price variance

$800 unfavorable $170 favorable
 10-22

Answer  Unit
Recall that the standard quantity for 1,000 Units
is 1,000 × 1.5 Kgs per Unit = 1,500 Kgs.
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price

1,500 kgs. 1,700 kgs. 1,700 kgs.

× × ×
$4.00 per kg. $4.00 per kg. $3.90 per kg.
= $6,000 = $ 6,800 = $6,630

Quantity variance Price variance

$800 unfavorable $170 favorable
 10-23

Learning Objective 2

Compute the direct labor

efficiency and rate
variances and explain
their significance.
 10-24

Labor Variances –Example 1

Glacier Peak Outfitters has the following direct

labor standard for its mountain Jacket.

1.2 standard hours per Jacket at $10.00 per hour

Last month, employees actually worked 2,500

hours at a total labor cost of $26,250 to make
2,000 Jackets.
 10-25

Answer 
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × ×
$10.00 per hour $10.00 per hour $10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance 25,000- 24,000 Rate variance 26,250 – 25,000

$1,000 unfavorable $1,250 unfavorable
 10-26

Answer 
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × Jacket  2,000
1.2 hours per ×
$10.00 per hour Jacketsper
$10.00 = 2,400
hour hours$10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance Rate variance

$1,000 unfavorable $1,250 unfavorable
 10-27

Answer 
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × hours
$26,250  2,500 ×
$10.00 per hour = $10.50
$10.00per
perhour
hour $10.50 per hour
= $24,000 = $25,000 = $26,250

Efficiency variance Rate variance

$1,000 unfavorable $1,250 unfavorable
 10-28

Labor Variances: Using the

Factored Equations
Labor efficiency variance
LEV = (AH × SR) – (SH × SR)
= SR (AH – SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour ×100 hours
= $1,000 unfavorable
Labor rate variance
LRV = (AH × AR) – (AH × SR)
= AH (AR – SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ×$0.50 per hour
= $1,250 unfavorable
 10-29

Responsibility for Labor Variances

Production managers are Mix of skill levels
usually held accountable assigned to work tasks.
for labor variances
because they can
Level of employee
influence the:
motivation.

Quality of production
supervision.

Quality of training
provided to employees.
Production Manager
 10-30

Responsibility for Labor Variances

I think it took more time
to process the
I am not responsible for materials because the
the unfavorable labor Maintenance
efficiency variance! Department has poorly
maintained your
You purchased cheap equipment.
material, so it took more
time to process it.
 10-31

Labor Variances –Example 2 Unit

Hanson Inc. has the following direct labor

standard to manufacture one Unit:
1.5 standard hours per Unit at
$12.00 per direct labor hour
Last week, 1,550 direct labor hours were
worked at a total labor cost of $18,910
to make 1,000 Units.
 10-32

Answer  Unit

Standard Hours Actual Hours Actual Hours

× × ×
Standard Rate Standard Rate Actual Rate
1,500 hours 1,550 hours 1,550 hours
× × ×
$12.00 per hour $12.00 per hour $12.20 per hour
= $18,000 = $18,600 = $18,910

Efficiency variance Rate variance

$600 unfavorable $310 unfavorable
 10-33

Variance Analysis and Management

by Exception

Larger variances, in
How do I know dollar amount or as
which variances to a percentage of the
investigate? standard, are
investigated first.
 10-34

Exercise:
Orange Company manufactures chairs. The following unitary standards have
been set by the production- engineering staff and the controller:
Direct Material: Direct Labor:
Quantity : 3 M2 Quantity, 0.2 hour
Price, $4 per M2 Price, $8 per hour
Actual costs incurred in the production of 10,000 chairs were as follows:
Direct Material: $94,500 for 27,000 M2
Direct Labor: $15,400 for 2,200 hours
Requirements
1.Calculate the direct material and direct labor variances, indicate whether each
variance is Favorable (F) or Unfavorable (U).
2.What are the possible reasons behind each variance (you should mention at
least 2 reasons for each variance?
3.Should only unfavorable variances be investigated? Explain
 10-35

Answer
Direct Materials Variances
SQ 3× 10,000 AQ 27,000 AQ 27,000
 ×  ×  ×  ×  ×  ×
SP 4 SP 4 AP 3.5 94500/27000
           
  120,000   108,000   94,500
           
  Quantity variance 2 -1   Price variance 3 – 2
108,000 – 120,000 94,500 – 108,000
  (12,000)   (13,500)
       
  F   F
       
Reasons There are many possible   There are many possible
reasons. Among the most reasons. Among the most
likely are: likely are:
A change in The price of the materials
manufacturing process fell
resulted in lower material
wastage than expected.

Answer
Direct Materials Variances
Favorable Quantity variance
Reasons  A change in manufacturing  
process resulted in lower
material wastage than expected.
 Higher quality workers caused
a lower than expected level of
wastage of materials during
production.
 Lower than expected pilferage
of raw material stocks.
 Errors in calculating the usage
rate when the budgets were set.
 Higher quality materials than
anticipated from the supplier.
 Higher quality materials as a
result of buying more
expensive materials than
anticipated.
10-36
Favorable Price variance
 The price of the materials fell
 Errors in estimating the price
of materials when the budgets
were set
 A reduced price was charged
by the supplier because the
amount purchased increased
 A different supplier was found
who charged a lower price for
the same or better quality of
material
 The supplier charged a lower
price for a poorer quality of
material
 A different supplier was found
who charged a lower price for
a poorer quality of material.
 10-37

Answer
Direct Labor Variances

SH .2× 10,000 AH 2,200 AH 2,200

 ×  ×  ×  ×  ×  ×
SR 8 SR 8 AR 7 15400/2200
           
  16,000   17,600   15,400
           
  Efficiency variance 2 -1   Rate variance 3 – 2
17,600 – 16,000 15,400 – 17,600
  1600   (2,200)
       
  U   F
 Reasons      
 10-38

Answer
Direct Labor Variances

Unfavorable Efficiency variance Favorable Rate variance

Reasons  There are many possible reasons.    There are many possible
Among the most likely are: reasons. Among the most
A change in manufacturing likely are:
process resulted in higher labor The hourly wage rate dropped
hours being needed than unexpectedly
anticipated. Less skilled workers paid at a
Lower quality material resulted lower rate.
in higher wastage levels and so
resulted in higher labor hours
being required than anticipated.
The workers worked slower
than anticipated
 10-39

Answer
3- Both unfavorable and favorable variances should be investigated. A
favorable expense variance for example could indicate costs are being cut that
might impact future operations.

You can answer this question by using equations also

 10-40

Types of Errors
Errors can be classified into those that do and those that do not affect the trial
balance. Errors that do not affect the trial balance means that it still balances. Errors
that affect the trial balance result in a discrepancy that prevents it balancing.
 Errors not affecting the trial balance:
1.Errors of omission (double-entry error)
2.Errors of principle
3.Errors of commission
4.Compensating errors
5.Complete reversal of entries
6.Errors of original entry.
 

Errors producing a discrepancy in the trial balance:

1. Error of omission (single-entry error)
2.Transposition errors
3.Addition (known as casting errors)
4.Posting errors
5.Extracting errors.