Managerial Accounting

by James Jiambalvo
Chapter 11:
Standard Costs and
Variance Analysis

Slides Prepared by:

Scott Peterson
Northern State
University
 Objectives
1. Explain how standard costs are developed.
2. Calculate and interpret variances for direct
material.
3. Calculate and interpret variances for direct
labor.
4. Calculate and interpret variances for
manufacturing overhead.
5. Calculate the financial impact of operating
at more or less than planned capacity.
Objectives (Continued)

6. Discuss how the management by

exception approach is applied to
investigation of standard cost variances.
7. Explain why a “favorable” variance may
be unfavorable, how process
improvements may lead to “unfavorable”
variances, and why evaluation in terms
of variances may lead to overproduction.
Standard Costs
1. Standard cost refers to expected costs
under anticipated conditions.
2. Standard cost systems allow for
comparison of standard versus actual
costs.
3. Differences are referred to as standard
cost variances.
4. Variances should be investigated if
significant.
Standard Costs and Budgets
1. Standard cost is the standard cost of a
single unit.
2. Budgeted cost is the cost, at standard,
of the total number of budgeted
units.
Development of Standard
Costs
1. Standard costs are developed in a
variety of ways:
a. Specified by formulas or recipes.

b. Developed from price lists provided

by suppliers.
c. Determined by time and motion
studies conducted by industrial
engineers.
d. Developed from analyses of past
data.
Ideal Versus Attainable
Standards
Two schools of thought:
1. Ideal standards (perfection standards):
developed under the assumption that no
obstacles to the production process will
be encountered.
2. Attainable Standards: developed under
the assumption that there will be
occasional problems in the production
process.
A General Approach To
Variance Analysis
1. Direct material: materials price and
materials quantity variance.
2. Direct labor: labor rate (price) and labor
efficiency (quantity) variance.
3. Overhead: overhead volume variance
and controllable overhead variance.
Material Variances
1. Differences between standard and
actual material costs:
a. Material price variance.
b. Material quantity variance.
Material Price Variance
1. Material price variance:(AP – SP) x AQp
2. (AP) = actual price per unit of material.
3. (SP) = standard price per unit of direct
material.
3. (AQp) = actual quantity of material
purchased.
4. Actual price > standard price:
unfavorable.
5. Actual price < standard price: favorable.
Material Quantity Variance
1. Material quantity variance: (AQu – SQ)SP
2. (AQu) = actual quantity of material used.
3. (SQ) = standard quantity of material
allowed.
4. (SP) = standard price of material.
5. Actual quantity > standard quantity:
unfavorable.
6. Actual quantity < standard quantity:
favorable.
You Get What You Measure
Direct Labor Variances
1. Differences between standard and actual
direct labor costs:
a. Labor rate (price) variance.
b. Material efficiency (quantity) variance.
Labor Rate Variance
1. Labor rate (price) variance: (AR – SR)AH
2. (AR) = actual wage rate (price).
3. (SR) = standard wage rate (price).
4. (AH) = actual number(quantity) labor hours.
5. Actual rate > standard rate: unfavorable.
6. Actual rate < standard rate: favorable.
Labor Efficiency Variance
1. Labor efficiency (quantity) variance:
(AH – SH)SR
2. (AH) = actual number of hours worked.
3. (SH) = standard number of hours worked.
4. (SR) = standard labor wage rate.
5. Actual hours > standard hours:
unfavorable.
6. Actual hours < standard hours: favorable.
Overhead Variances
1. Differences between overhead applied to
inventory at actual overhead costs:
a. Controllable overhead variance.
b. Overhead volume variance.
Controllable Overhead
Variance
1. Actual overhead ($$) - flexible budget level
of overhead ($$) for actual volume of
production.
2. Referred to as controllable because
managers are expected to control costs.
3. Actual > budget: unfavorable.
4. Actual < budget, then the variance is
favorable.
Overhead Volume Variance
1. Overhead volume variance: flexible budget
level of overhead for actual level of
production - overhead applied to production
using standard overhead rate.
2. This variance is solely the result of a
different number of units being produced
than planned in the static budget.
3. Usefulness is limited.
 Calculating The Financial
Impact Of Operating At More or
Less Than Planned Capacity
1. Operating at less than planned capacity
results in an unfavorable variance equal to
the number of units (less than planned) x
the marginal cost per unit.
2. Operating at more than planned capacity
results in a favorable variance equal to the
number of units (more than planned) x the
marginal cost per unit.
Comprehensive Example:
Darrington Ice Cream
Standard Costs Per Unit:
Item Qty. x Price = Total
Direct Materials: .8 gal. 2.50 = $2.00
Direct Labor: .125 hrs. 12.00= $1.50
Mfg. Overhead: $ .75
Total Cost Per Unit (Standard) $4.00
Comprehensive Example:
Darrington Ice Cream
 Material Variances
1. Material price variance:(AP – SP) x AQp :
($2.72 - $2.50) x 810,000 = $178,200
unfavorable.
2. Material quantity variance: (AQu – SQ)SP:
(809,000 – 800,000) x $2.50 = $22,500
unfavorable.
 Labor Variances
1. Labor rate (price) variance: (AR – SR)AH:
($12.10 - $12.00) x 130,000 = $13,000
unfavorable.
2. Labor efficiency (quantity) variance:
(AH – SH)SR: (130,000 – 125,000) x $12 =
$60,000 unfavorable.
 Overhead Variances
1. Controllable overhead variance: Actual
overhead ($$) - flexible budget level of
overhead ($$) for actual volume of
production: $680,000 - $700,000 = $20,000
unfavorable.
2. Overhead volume variance: flexible budget
level of overhead for actual level of
production - overhead applied to production
using standard overhead rate: $700,000 -
$750,000 = $50,000 favorable.
 Investigation of Standard Cost
Variances
1. Standard cost variances are not a definitive
sign of good or bad performance.
2. Variances are merely indicators of potential
problems which must be investigated.
3. There are many plausible explanations for
them.
 Management By Exception
1. Investigation of standard cost variances is
a costly activity
2. Management must decide which variances
to investigate.
3. Most managers practice management by
exception.
4. What is “exceptional?” Usually an absolute
dollar amount or a percentage dollar
amount.
 “Favorable” Variances May Be
Unfavorable
1. A “favorable” variance does not mean that
it should not be investigated.
2. Raw materials are good examples of this
phenomenon.
3. Consider inferior, low-priced materials.
4. A favorable price variance may result, but
there may also be substantially more scrap
and rework, and thus a higher quantity
variance.
 Can Process Improvements
Lead to “Unfavorable”
Variances?
1. Process improvements frequently lead to
unfavorable variances.
2. Process improvements often lead to
increased productivity.
3. Therefore fewer hours may be required to
produce a unit of output.
4. But actual hours will remain unchanged
unless the firm terminates the workers to
became “more productive.”
 Beware-Evaluation in Terms of
Variances Can Lead To Excess
Production
1. A department in front of another
(bottleneck) department should not produce
more than the bottleneck department can
handle.
2. If it cuts back, it will idle workers.
3. If it doesn’t there will be excess work in
process and a negative effect on
shareholder value.
 Responsibility Accounting and
Variances
1. Managers should be held responsible only
for costs they can control.
2. This is also true in the area of variance
analysis.
3. A purchasing agent may be held
responsible for direct material price
variances, but certainly not direct material
quantity (usage) variances.
Appendix: Recording Standard
Costs
1. Material
2. Labor
3. Overhead
4. Finished goods
5. Cost of goods sold
6. Closing variance accounts
Recording Material Costs
Purchase of raw materials inventory:
Account dr. cr.
Raw Material Inventory (std.) x
Material Price Variance x
Accounts Payable (actual) x

Usage of raw materials inventory:

Account dr. cr.
Work in Process Inventory x
Material Quantity Variance x
Raw Material Inventory x
Recording Labor Costs
Recording Labor Cost:
Account dr. cr.
Work in Process Inventory (std.) x
Labor Rate Variance x
Labor Efficiency Variance x
Wages/Sal. Payable (actual) x
 Recording Manufacturing
Overhead: Step 1

To record actual overhead cost:

Account dr. cr.

Manufacturing Overhead x
*Various Accounts x
 Recording Manufacturing
Overhead: Step 2

To apply overhead cost to work in process

inventory at cost:

Account dr. cr.

Work in Process Inventory x
Manufacturing Overhead x
 Recording Manufacturing
Overhead: Step 3

To close out manufacturing overhead cost to work

in process inventory at cost:

Account dr. cr.

Manufacturing Overhead x
Overhead Volume
Variance x
Controllable Overhead
Variance x
 Recording Finished Goods

To record completed units sent to finished goods:

Account dr. cr.

Finished Goods Inventory x
Work in Process
Inventory x
 Recording Cost Of Goods Sold

To apply overhead cost to work in process

inventory at cost:

Account dr. cr.

Cost of Goods Sold x
Finished Goods
Inventory x
 Closing Variance Accounts

Temporary variance accounts must be closed at the end of

the period.
Account dr. cr.
Cost of Goods Sold x
Overhead Volume Variance x
Controllable Overhead Variance x
Material Price Variance x
Material Quantity Variance x
Labor Rate Variance x
Labor Efficiency Variance x
 Quick Review Question #1
1. What does an unfavorable overhead
volume variance mean?
a. Overhead costs are out of control.
b. Overhead costs are under control.
c. Production was greater than
anticipated.
d. Production was less than
anticipated.
 Quick Review Answer #1
1. What does an unfavorable overhead
volume variance mean?
a. Overhead costs are out of control.
b. Overhead costs are under control.
c. Production was greater than
anticipated.
d. Production was less than
anticipated.
 Quick Review Question #2
2. Standard material costs per unit are
$3.50. Actual costs per unit are $3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material price
variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable
 Quick Review Answer #2
2. Standard material costs per unit are
$3.50. Actual costs per unit are $3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material price
variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable
 Quick Review Question #3
2. Standard material costs per unit are
$3.50. Actual costs per unit are $3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material quantity
variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable
 Quick Review Answer #3
2. Standard material costs per unit are
$3.50. Actual costs per unit are $3.80
Actual quantity is 3,000. Standard
quantity is 2,800. Material quantity
variance is:
a. $900 favorable
b. $900 unfavorable
c. $700 favorable
d. $700 unfavorable
 Quick Review Question #4
4. What does a favorable labor efficiency
variance mean?
a. Labor rates were higher than called
for by standards.
b. Inexperienced labor was used,
causing the rate to be lower than
standard.
c. More labor was used than called for
by standards.
d. Less labor was used than called for
by standards.
 Quick Review Answer #4
4. What does a favorable labor efficiency
variance mean?
a. Labor rates were higher than called
for by standards.
b. Inexperienced labor was used,
causing the rate to be lower than
standard.
c. More labor was used than called for
by standards.
d. Less labor was used than called for
by standards.
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