Chapter 4

Standard costing and variance

analysis

McGraw-Hill/Irwin Slide 1
 Standard Costs
Standards are benchmarks or “norms” for measuring
performance. 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.

McGraw-Hill/Irwin Slide 2
 Standard Costs
Deviations from standards considered significant
are brought to the attention of management,
the practice is known as management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

McGraw-Hill/Irwin Slide 3
 Variance Analysis Cycle

Take
Identify Receive corrective
questions explanations actions

Conduct next
Analyze period’s
variances operations

Prepare standard
Begin
cost performance
report

McGraw-Hill/Irwin Slide 4
 Setting Standard Costs

Accountants, engineers, purchasing

agents, and production managers
combine efforts to set standards that encourage
efficient future operations.

McGraw-Hill/Irwin Slide 5
 Learning Objective 1

Explain how direct materials

standards and direct labor
standards are set.

McGraw-Hill/Irwin Slide 6
 Setting Direct Material Standards

Price Quantity
Standards Standards

Final, delivered Summarized in

cost of materials, a Bill of Materials.
net of discounts.

McGraw-Hill/Irwin Slide 7
 Setting Standards

Six Sigma advocates have sought to

eliminate all defects and waste, rather than
continually build them into standards.

As a result allowances for waste and

spoilage that are built into standards
should be reduced over time.

McGraw-Hill/Irwin Slide 8
 Setting Direct Labor Standards

Rate Time
Standards Standards

Often a single Use time and

rate is used that reflects motion studies for
the mix of wages earned. each labor operation.

McGraw-Hill/Irwin Slide 9
 Setting Variable Manufacturing Overhead
Standards

Rate Quantity
Standards Standards

The rate is the The quantity is

variable portion of the the activity in the
predetermined overhead allocation base for
rate. predetermined overhead.

McGraw-Hill/Irwin Slide 10
 Standard Cost Card – Variable Production
Cost

A standard cost card for one unit

of product might look like this:
A B AxB
Standard Standard Standard
Quantity Price Cost
Inputs or Hours or Rate per Unit
Direct materials 3.0 lbs. $ 4.00 per lb. $ 12.00
Direct labor 2.5 hours 14.00 per hour 35.00
Variable mfg. overhead 2.5 hours 3.00 per hour 7.50
Total standard unit cost $ 54.50

McGraw-Hill/Irwin Slide 11
 Price and Quantity Standards

Price and quantity standards are

determined separately for two reasons:

 The purchasing manager is responsible for raw

material purchase prices and the production manager
is responsible for the quantity of raw material used.

 The buying and using activities occur at different times.

Raw material purchases may be held in inventory for a
period of time before being used in production.
McGraw-Hill/Irwin Slide 12
 A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Difference between Difference between

actual price and actual quantity and
standard price standard quantity

McGraw-Hill/Irwin Slide 13
 A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH rate variance VOH efficiency variance

McGraw-Hill/Irwin Slide 14
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

McGraw-Hill/Irwin Slide 15
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Actual quantity is the amount of direct

materials, direct labor, and variable
manufacturing overhead actually used.

McGraw-Hill/Irwin Slide 16
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard quantity is the standard quantity

allowed for the actual output of the period.

McGraw-Hill/Irwin Slide 17
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Actual price is the amount actually

paid for the input used.

McGraw-Hill/Irwin Slide 18
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard price is the amount that should

have been paid for the input used.

McGraw-Hill/Irwin Slide 19
 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

(AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity

McGraw-Hill/Irwin Slide 20
 Learning Objective 2

Compute the direct materials

price and quantity variances
and explain their
significance.

McGraw-Hill/Irwin Slide 21
 Material Variances – An Example

Glacier Peak Outfitters has the following direct

material standard for the fiberfill in its mountain
parka.

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

Last month 210 kgs. of fiberfill were purchased and

used to make 2,000 parkas. The material cost a
total of $1,029.

McGraw-Hill/Irwin Slide 22
 Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× × ×
$4.90 per kg. $5.00 per kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable

McGraw-Hill/Irwin Slide 23
 Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× × kgs
$1,029  210 ×
$4.90 per kg. $5.00per
= $4.90 perkg
kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable

McGraw-Hill/Irwin Slide 24
 Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× 0.1 kg per parka× 2,000 parkas ×
$4.90 per kg. $5.00
= 200 per
kgs kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

Price variance Quantity variance

$21 favorable $50 unfavorable

McGraw-Hill/Irwin Slide 25
 Material Variances:
Using the Factored Equations

Materials price variance

MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
Materials quantity variance
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka  2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U

McGraw-Hill/Irwin Slide 26
 Isolation of Material Variances
I need the price variance
sooner so that I can better
identify purchasing problems.
You accountants just don’t
understand the problems that
purchasing managers have.
McGraw-Hill/Irwin
I’ll start computing
the price variance
when material is
purchased rather
than when it’s used.
Slide 27
 Material Variances

The price variance is

Hanson purchased and
computed on the entire
used 1,700 pounds.
quantity purchased.
How are the variances
computed if the amount The quantity variance
purchased differs from is computed only on
the amount used? the quantity used.

McGraw-Hill/Irwin Slide 28
 Responsibility for Material 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.

McGraw-Hill/Irwin Slide 29
 Responsibility for Material Variances

Your poor scheduling

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

McGraw-Hill/Irwin Slide 30
 Quick Check 

Hanson Inc. has the following direct material

standard to manufacture one Gear:
1.5 pounds per Gear at $4.00 per pound
Last week, 1,700 pounds of material were
purchased and used to make 1,000 Gears. The
material cost a total of $6,630.

McGraw-Hill/Irwin Slide 31
 Quick Check 

Hanson’s
Hanson’s material
material price
price variance
variance (MPV)
(MPV)
for
for the
the week
week was:
was:
a.
a. $170
$170 unfavorable.
unfavorable.
b.
b. $170
$170 favorable.
favorable.
c.
c. $800
$800 unfavorable.
unfavorable.
d.
d. $800
$800 favorable.
favorable.

McGraw-Hill/Irwin Slide 32
 Quick Check 

Hanson’s
Hanson’s material
material price
price variance
variance (MPV)
(MPV)
for
for the
the week
week was:
was:
a.
a. $170
$170 unfavorable.
unfavorable.
b.
b. $170
$170 favorable.
favorable.
c.
c. $800
$800 unfavorable.
unfavorable.
d. $800 MPV = AQ(AP - SP)
favorable.
d. $800 favorable.
MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable

McGraw-Hill/Irwin Slide 33
 Quick Check 

Hanson’s
Hanson’s material
material quantity
quantity variance
variance (MQV)
(MQV)
for
for the
the week
week was:
was:
a.
a. $170
$170 unfavorable.
unfavorable.
b.
b. $170
$170 favorable.
favorable.
c.
c. $800
$800 unfavorable.
unfavorable.
d.
d. $800
$800 favorable.
favorable.

McGraw-Hill/Irwin Slide 34
 Quick Check 

Hanson’s
Hanson’s material
material quantity
quantity variance
variance (MQV)
(MQV)
for
for the
the week
week was:
was:
a.
a. $170
$170 unfavorable.
unfavorable.
b.
b. $170
$170 favorable.
favorable.
c.
c. $800
$800 unfavorable.
unfavorable.
d.
d. $800
$800 favorable.
favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable

McGraw-Hill/Irwin Slide 35
 Quick Check 

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price
1,700 lbs. 1,700 lbs. 1,500 lbs.
× × ×
$3.90 per lb. $4.00 per lb. $4.00 per lb.
= $6,630 = $ 6,800 = $6,000

Price variance Quantity variance

$170 favorable $800 unfavorable
McGraw-Hill/Irwin Slide 36
 Learning Objective 3

Compute the direct labor rate

and efficiency variances and
explain
their significance.

McGraw-Hill/Irwin Slide 37
 Labor Variances – An Example

Glacier Peak Outfitters has the following direct labor

standard for its mountain parka.

1.2 standard hours per parka 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
parkas.

McGraw-Hill/Irwin Slide 38
 Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× × ×
$10.50 per hour $10.00 per hour. $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable

McGraw-Hill/Irwin Slide 39
 Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× $26,250×  2,500 hours ×
$10.50 per hour $10.00 per hour.
= $10.50 per hour $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable

McGraw-Hill/Irwin Slide 40
 Labor Variances Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× ×
1.2 hours per parka  2,000 ×
$10.50 per hour parkas
$10.00 per hour.
= 2,400 hours $10.00 per hour
= $26,250 = $25,000 = $24,000

Rate variance Efficiency variance

$1,250 unfavorable $1,000 unfavorable

McGraw-Hill/Irwin Slide 41
 Labor Variances:
Using the Factored Equations

Labor rate variance

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

McGraw-Hill/Irwin Slide 42
 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

McGraw-Hill/Irwin Slide 43
 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.

McGraw-Hill/Irwin Slide 44
 Quick Check 

Hanson Inc. has the following direct labor

standard to manufacture one Gear:
1.5 standard hours per Gear 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 Gears.

McGraw-Hill/Irwin Slide 45
 Quick Check 

Hanson’s
Hanson’s labor
labor rate
rate variance
variance (LRV)
(LRV) for
for the
the
week
week was:
was:
a.
a. $310
$310 unfavorable.
unfavorable.
b.
b. $310
$310 favorable.
favorable.
c.
c. $300
$300 unfavorable.
unfavorable.
d.
d. $300
$300 favorable.
favorable.

McGraw-Hill/Irwin Slide 46
 Quick Check 

Hanson’s
Hanson’s labor
labor rate
rate variance
variance (LRV)
(LRV) for
for the
the
week
week was:
was:
a.
a. $310
$310 unfavorable.
unfavorable.
b.
b. $310
$310 favorable.
favorable.
c.
c. $300 LRV = AH(AR - SR)
$300 unfavorable.
unfavorable.
LRV = 1,550 hrs($12.20 - $12.00)
d.
d. $300
$300 favorable.
favorable.LRV = $310 unfavorable

McGraw-Hill/Irwin Slide 47
 Quick Check 

Hanson’s
Hanson’s labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was:
was:
a.
a. $590
$590 unfavorable.
unfavorable.
b.
b. $590
$590 favorable.
favorable.
c.
c. $600
$600 unfavorable.
unfavorable.
d.
d. $600
$600 favorable.
favorable.

McGraw-Hill/Irwin Slide 48
 Quick Check 

Hanson’s
Hanson’s labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was:
was:
a.
a. $590
$590 unfavorable.
unfavorable.
b.
b. $590
$590 favorable.
favorable.
c.
c. $600
$600 unfavorable.
unfavorable.
d.
d. $600
$600 favorable.
favorable.
LEV = SR(AH - SH)
LEV = $12.00(1,550 hrs - 1,500 hrs)
LEV = $600 unfavorable

McGraw-Hill/Irwin Slide 49
 Quick Check 

Actual Hours Actual Hours Standard Hours

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

Rate variance Efficiency variance

$310 unfavorable $600 unfavorable
McGraw-Hill/Irwin Slide 50
 Learning Objective 4

Compute the variable

manufacturing overhead rate
and efficiency variances.

McGraw-Hill/Irwin Slide 51
 Variable Manufacturing Overhead Variances
– An Example

Glacier Peak Outfitters has the following direct variable

manufacturing overhead labor standard for its mountain
parka.
1.2 standard hours per parka at $4.00 per hour
Last month, employees actually worked 2,500 hours to
make 2,000 parkas. Actual variable manufacturing
overhead for the month was $10,500.

McGraw-Hill/Irwin Slide 52
 Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× × ×
$4.20 per hour $4.00 per hour $4.00 per hour
= $10,500 = $10,000 = $9,600

Rate variance Efficiency variance

$500 unfavorable $400 unfavorable

McGraw-Hill/Irwin Slide 53
 Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× $10,500× 2,500 hours ×
$4.20 per hour $4.00 per per
= $4.20 hourhour $4.00 per hour
= $10,500 = $10,000 = $9,600

Rate variance Efficiency variance

$500 unfavorable $400 unfavorable

McGraw-Hill/Irwin Slide 54
 Variable Manufacturing Overhead Variances
Summary
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× ×
1.2 hours per parka  2,000 ×
$4.20 per hour parkas$4.00 per hour
= 2,400 hours $4.00 per hour
= $10,500 = $10,000 = $9,600

Rate variance Efficiency variance

$500 unfavorable $400 unfavorable

McGraw-Hill/Irwin Slide 55
 Variable Manufacturing Overhead Variances:
Using Factored Equations

Variable manufacturing overhead rate variance

VMRV = AH (AR - SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
Variable manufacturing overhead efficiency variance
VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable

McGraw-Hill/Irwin Slide 56
 Quick Check 

Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Gear:
1.5 standard hours per Gear at
$3.00 per direct labor hour
Last week, 1,550 hours were worked to make
1,000 Gears and $5,115 was spent for
variable manufacturing overhead.

McGraw-Hill/Irwin Slide 57
 Quick Check 

Hanson’s
Hanson’s rate
rate variance
variance (VMRV)
(VMRV) for for variable
variable
manufacturing
manufacturing overhead
overhead for
for the
the week
week was:
was:
a.
a. $465
$465 unfavorable.
unfavorable.
b.
b. $400
$400 favorable.
favorable.
c.
c. $335
$335 unfavorable.
unfavorable.
d.
d. $300
$300 favorable.
favorable.

McGraw-Hill/Irwin Slide 58
 Quick Check 

Hanson’s
Hanson’s rate
rate variance
variance (VMRV)
(VMRV) for for variable
variable
manufacturing
manufacturing overhead
overhead for
for the
the week
week was:
was:
a.
a. $465
$465 unfavorable.
unfavorable.
b.
b. $400
$400 favorable.
favorable.
VMRV = AH(AR - SR)
c.
c. $335 unfavorable.
$335 unfavorable.
VMRV = 1,550 hrs($3.30 - $3.00)
d.
d. $300
$300 favorable.
favorable.
VMRV = $465 unfavorable

McGraw-Hill/Irwin Slide 59
 Quick Check 

Hanson’s
Hanson’s efficiency
efficiency variance
variance (VMEV)
(VMEV) forfor
variable
variable manufacturing
manufacturing overhead
overhead for
for the
the week
week
was:
was:
a.
a. $435
$435 unfavorable.
unfavorable.
b.
b. $435
$435 favorable.
favorable.
c.
c. $150
$150 unfavorable.
unfavorable.
d.
d. $150
$150 favorable.
favorable.

McGraw-Hill/Irwin Slide 60
 Quick Check 

Hanson’s
Hanson’s efficiency
efficiency variance
variance (VMEV)
(VMEV) forfor
variable
variable manufacturing
manufacturing overhead
overhead for
for the
the week
week
was:
was:
a.
a. $435
$435 unfavorable.
unfavorable.
b.
b. $435
$435 favorable.
favorable. 1,000 units × 1.5 hrs per unit
c.
c. $150
$150 unfavorable.
unfavorable.
d.
d. $150
$150 favorable.
favorable.
VMEV = SR(AH - SH)
VMEV = $3.00(1,550 hrs - 1,500 hrs)
VMEV = $150 unfavorable
McGraw-Hill/Irwin Slide 61
 Quick Check 

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$3.30 per hour $3.00 per hour $3.00 per hour
= $5,115 = $4,650 = $4,500

Rate variance Efficiency variance

$465 unfavorable $150 unfavorable
McGraw-Hill/Irwin Slide 62