Standard Costs and Variances

Chapter 7
Standard Costs and Variances
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
10-2
Standard Costs
Standards are benchmarks or “norms” for
measuring performance. In managerial accounting,
two types of standards are commonly used.
Price standards Quantity standards

specify how much specify how much of an
should be paid for input should be used to
each unit of the make a product or
input. provide a service.
Examples: Firestone, Sears, McDonald’s, hospitals,

construction, and manufacturing companies.
10-3
Setting Direct Materials Standards

Standard Price Standard Quantity
per Unit per Unit
Final, delivered Summarized in

cost of materials, a Bill of Materials.
net of discounts.
10-4
Setting Direct Labor Standards

Standard Rate Standard Hours
per Hour per Unit
Often a single Use time and

rate is used that reflects motion studies for
the mix of wages earned. each labor operation.
10-5
Setting Variable Manufacturing

Overhead Standards
Price Quantity
Standard Standard
The rate is the The quantity is

variable portion of the the activity in the
predetermined overhead allocation base for
rate. predetermined overhead.
10-6
The Standard Cost Card

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
10-7
Using Standards in Flexible Budgets
Standard costs per unit for direct materials, direct

labor, and variable manufacturing overhead can be
used to compute activity and spending variances.
Spending variances become more

useful by breaking them down into
price and quantity variances.
10-8
A General Model for Variance Analysis
Variance Analysis
Price Variance Quantity Variance
Difference between Difference between

actual quantity and
actual price and standard quantity
standard price
10-9
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.
10-10
Variance Analysis
Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH rate variance VOH efficiency variance
10-11
(1) (2) (3)

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

(2) – (1) (3) – (2)
Spending Variance
(3) – (1)
10-12

Actual quantity is the amount of direct materials, direct
labor, and variable manufacturing overhead actually used.
(1) (2) (3)


(2) – (1) (3) – (2)
Spending Variance
(3) – (1)
10-13

Standard quantity is the standard quantity allowed
for the actual output of the period.
(1) (2) (3)


(2) – (1) (3) – (2)
Spending Variance
(3) – (1)
10-14

Actual price is the amount actually
paid for the input used.
(1) (2) (3)


(2) – (1) (3) – (2)
Spending Variance
(3) – (1)
10-15

Standard price is the amount that should
have been paid for the input used.
(1) (2) (3)


(2) – (1) (3) – (2)
Spending Variance
(3) – (1)
10-16
Learning Objective 1
Compute the direct

materials price and
quantity variances and
explain their
significance.
10-17
Materials Variances – An Example
Glacier Peak Outfitters has the following direct

materials 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 materials cost a
total of $1,029.
10-18
Materials Variances Summary

× × ×
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
10-19

× × ×
210 kgs. 210 kgs. 200 kgs.
× ×  2,000 parkas
0.1 kg per parka ×
$4.90 per kg. = 200 per
$5.00 kgskg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

10-20

× × ×
210 kgs. 210 kgs. 200 kgs.
× $1,029 ×210 kgs ×
$4.90 per kg. $5.00 per
= $4.90 per kg
kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000

10-21
Materials Variances:
Using the Factored Equations
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
Materials quantity variance

MQV = (AQ × SP) – (SQ × SP)
= 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
10-22
Responsibility for Materials

Variances
Materials Price Variance Materials Quantity Variance
Purchasing Manager Production 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.
10-23
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

10-24
Quick Check  Zippy
Hanson Inc. has the following direct materials

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week, 1,700 pounds of materials were
purchased and used to make 1,000 Zippies. The
materials cost a total of $6,630.
10-25
How many pounds of materials should

Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
d. 1,000 pounds.
10-26
How many pounds of materials should

Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
The standard quantity is:
d. 1,000 pounds.
1,000 × 1.5 pounds per Zippy.
10-27
Hanson’s materials quantity variance (MQV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
10-28
Hanson’s materials quantity variance (MQV)

for the week was:
b. $170 favorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
10-29
Hanson’s materials price variance (MPV)

for the week was:
b. $170 favorable.
d. $800 favorable.
10-30
Hanson’s materials price variance (MPV)

for the week was:
b. $170 favorable.
d. $800 favorable.MPV = AQ(AP - SP)
MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable
10-31

× × ×
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

10-32

Recall that the standard quantity for 1,000 Zippies
is 1,000 × 1.5 pounds per Zippy = 1,500 pounds.
× × ×
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

10-33
Compute the direct labor

rate and efficiency
variances and explain
their significance.
10-34
Labor Variances – An Example

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.
10-35
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
10-36

× × ×
× 1.2 hours per parka
×  2,000 ×
$10.50 per hour parkas = 2,400
$10.00 per hours
hour $10.00 per hour
= $26,250 = $25,000 = $24,000

10-37

× × ×
× ×  2,500 hours
$26,250 ×
$10.50 per hour $10.00 per hour
= $10.50 per hour $10.00 per hour
= $26,250 = $25,000 = $24,000

10-38
Labor Variances: Using the

Factored Equations
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
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)
10-39
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
10-40
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.
10-41
Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy 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 Zippies.
10-42
Hanson’s labor rate variance (LRV) for the

week was:
b. $310 favorable.
d. $300 favorable.
10-43
Hanson’s labor rate variance (LRV) for the

week was:
b. $310 favorable.
LRV = AH(AR - SR)
LRV = 1,550 hrs($12.20 - $12.00)
d. $300 favorable.LRV = $310 unfavorable
10-44
Hanson’s labor efficiency variance (LEV)

for the week was:
b. $590 favorable.
d. $600 favorable.
10-45
Hanson’s labor efficiency variance (LEV)

for the week was:
b. $590 favorable.
d. $600 favorable.
LEV = SR(AH - SH)
LEV = $12.00(1,550 hrs - 1,500 hrs)
LEV = $600 unfavorable
10-46

× × ×
× × ×
= $18,910 = $18,600 = $18,000

$310 unfavorable $600 unfavorable
10-47
Compute the variable

manufacturing overhead
rate and efficiency
variances and explain
their significance.
10-48
Variable Manufacturing Overhead

Variances – An Example
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.
10-49

Variances Summary
× × ×
× × ×
= $10,500 = $10,000 = $9,600

10-50

Variances Summary
× × ×
× ×
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

10-51

Variances Summary
× × ×
× $10,500× 2,500 hours ×
$4.20 per hour $4.00 perper
= $4.20 hour
hour $4.00 per hour
= $10,500 = $10,000 = $9,600

10-52

Variances: Using Factored Equations
Variable manufacturing overhead rate variance
VMRV = (AH × AR) – (AH – SR)
= 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 = (AH × SR) – (SH – SR)
= SR (AH – SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
10-53
Hanson Inc. has the following variable

manufacturing overhead standard to
manufacture one Zippy:
1.5 standard hours per Zippy at
$3.00 per direct labor hour
Last week, 1,550 hours were worked to make
1,000 Zippies, and $5,115 was spent for
variable manufacturing overhead.
10-54
Hanson’s rate variance (VMRV) for variable

manufacturing overhead for the week was:
b. $400 favorable.
d. $300 favorable.
10-55
Hanson’s rate variance (VMRV) for variable

manufacturing overhead for the week was:
b. $400 favorable.
VMRV = AH(AR - SR)
VMRV = 1,550 hrs($3.30 - $3.00)
d. $300 favorable. VMRV = $465 unfavorable
10-56
Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
b. $435 favorable.
d. $150 favorable.
10-57
Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
b. $435 favorable. 1,000 units × 1.5 hrs per unit
d. $150 favorable.
VMEV = SR(AH - SH)
VMEV = $3.00(1,550 hrs - 1,500 hrs)
VMEV = $150 unfavorable
10-58

× × ×
× × ×
= $5,115 = $4,650 = $4,500

10-59
Materials Variances―An Important Subtlety
The quantity variance

is computed only on
the quantity used.
The price variance is
computed on the entire
quantity purchased.
10-60

materials 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 at a

cost of $1,029. Glacier used 200 kgs. to make
2,000 parkas.
10-61
Actual Quantity Actual Quantity Actual Quantity

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

$21 favorable $0
10-62
Advantages of Standard Costs

Standard costs are Standards can
a key element of provide benchmarks
the management by that promote economy
exception approach. and efficiency.
Advantages
Standards can Standards can
greatly simplify support responsibility
bookkeeping. accounting systems.
10-63
Potential Problems with Standard

Costs
Standard cost variance If variances are misused
reports are usually as a club to negatively
prepared on a monthly Potential reinforce employees,
basis and may contain Problems morale may suffer and
information that is employees may make
outdated. dysfunctional decisions.
Labor variances assume that the production process is labor-paced

and that labor is a variable cost. These assumptions are often invalid
in today’s automated manufacturing environment where employees
are essentially a fixed cost.
10-64
Potential Problems with Standard

Costs
Just meeting standards
may not be sufficient; In some cases, a
continuous improvement Potential “favorable” variance
may be necessary to Problems can be as bad or
survive in a competitive worse than an
environment. unfavorable variance.
Excessive emphasis on meeting the standards may overshadow other

important objectives such as maintaining and improving quality,
on-time delivery, and customer satisfaction.
10-65
Fixed Overhead Budget Variance

Actual Budgeted Fixed
Fixed Fixed Overhead
Overhead Overhead Applied
Budget
variance
Actual Budgeted
Budget
= fixed – fixed
variance
overhead overhead
10-66
Fixed Overhead Volume Variance

Volume
variance
Fixed
Budgeted
Volume overhead
= fixed –
variance applied to
overhead
work in process
10-67
Fixed Overhead Volume Variance

DH × FPOHR SH × FPOHR
Volume
variance
Volume variance = FPOHR × (DH – SH)
FPOHR = Fixed portion of the predetermined overhead rate

DH = Denominator hours
SH = Standard hours allowed for actual output
10-68
Computing Fixed Overhead Variances
ColaCo
Production and Machine-Hour Data
Budgeted production 30,000 units
Standard machine-hours per unit 3 hours
Budgeted machine-hours 90,000 hours
Actual production 28,000 units
Standard machine-hours allowed for the actual production 84,000 hours
Actual machine-hours 88,000 hours
10-69
Computing Fixed Overhead Variances
ColaCo
Cost Data
Budgeted variable manufacturing overhead $ 90,000
Budgeted fixed manufacturing overhead 270,000
Total budgeted manufacturing overhead $ 360,000
Actual variable manufacturing overhead $ 100,000

Actual fixed manufacturing overhead 280,000
Total actual manufacturing overhead $ 380,000
10-70
Predetermined Overhead Rates

Predetermined Estimated total manufacturing overhead cost
=
overhead rate Estimated total amount of the allocation base
Predetermined $360,000
=
overhead rate 90,000 Machine-hours
Predetermined
= $4.00 per machine-hour
overhead rate
10-71
Predetermined Overhead Rates
Fixed component of the $270,000

=
predetermined overhead rate 90,000 Machine-hours
Fixed component of the

= $3.00 per machine-hour
predetermined overhead rate
10-72
Applying Manufacturing Overhead
Overhead Predetermined Standard hours allowed

= ×
applied overhead rate for the actual output
Overhead $4.00 per

= × 84,000 machine-hours
applied machine-hour
Overhead
= $336,000
applied
10-73
Computing the Budget Variance

Actual Budgeted
Budget
= fixed – fixed
variance
overhead overhead
Budget
= $280,000 – $270,000
variance
Budget
= $10,000 Unfavorable
variance
10-74
Computing the Volume Variance

Fixed
Budgeted
Volume overhead
= fixed –
variance applied to
overhead
work in process
Volume
variance
= $270,000 – ( $3.00 per
machine-hour
×
$84,000
machine-hours)
Volume
= $18,000 Unfavorable
variance
10-75
Computing the Volume Variance

Volume variance = FPOHR × (DH – SH)
FPOHR = Fixed portion of the predetermined overhead rate

DH = Denominator hours
SH = Standard hours allowed for actual output
Volume
variance
=
$3.00 per
machine-hour
× ( 90,000
mach-hours
–
84,000
mach-hours)
Volume = 18,000 Unfavorable
variance
10-76
A Pictorial View of the Variances

Actual Budgeted Fixed Overhead
Fixed Fixed Applied to
Overhead Overhead Work in Process
280,000 270,000 252,000
Budget variance, Volume variance,

Total variance, $28,000 unfavorable

10-77
Fixed Overhead Variances –

A Graphic Approach
Let’s look at a
graph showing
fixed overhead
variances. We will
use ColaCo’s
numbers from the
previous example.
10-78
Graphic Analysis of Fixed

Overhead Variances
Budget
$270,000
at
li ed
p p u r
d a ho
e a a r d
e rh n d
o v s t a
e d e r
x
Fi .00 p Denominator
$3 hours
0
0 Machine-hours (000) 90
10-79

Overhead Variances
Actual
$280,000
Budget { Budget Variance 10,000 U
$270,000
at
li ed
p p u r
d a ho
e a a r d
e rh n d
o v s t a
e d e r
x
Fi .00 p Denominator
$3 hours
0
0 Machine-hours (000) 90
10-80

Overhead Variances
Actual
$280,000
Budget { Budget Variance 10,000 U
$270,000
Applied { Volume Variance 18,000 U
$252,000
at
li ed
p p u r
d a ho
e a a r d
e rh n d
o v s t a
e d e r
x
Fi .00 p Standard Denominator
$3 hours hours
0
0 Machine-hours (000) 84 90
10-81
Reconciling Overhead Variances and

Underapplied or Overapplied Overhead
In a standard
cost system:
Favorable
variances are equivalent
to overapplied overhead.
The sum of the overhead variances

equals the under- or overapplied
overhead cost for the period.
10-82
Reconciling Overhead Variances and

Underapplied or Overapplied Overhead
ColaCo
Computation of Underapplied Overhead
Predetermined overhead rate (a) $ 4.00 per machine-hour
Standard hours allowed for the actual output (b) 84,000 machine hours
Manufacturing overhead applied (a) × (b) $ 336,000
Actual manufacturing overhead $ 380,000
Manufacturing overhead underapplied or
overapplied $ 44,000 underapplied
10-83
Computing the Variable Overhead

Variances
Variable manufacturing overhead rate variance

VMRV = (AH × AR) – (AH × SR)
= $100,000 – (88,000 hours × $1.00 per hour)
10-84
Computing the Variable Overhead

Variances
Variable manufacturing overhead efficiency variance

VMEV = (AH × SR) – (SH × SR)
= $88,000 – (84,000 hours × $1.00 per hour)
10-85
Computing the Sum of All Variances
ColaCo
Computing the Sum of All variances
Variable overhead rate variance $ 12,000 U
Variable overhead efficiency variance 4,000 U
Fixed overhead budget variance 10,000 U
Fixed overhead volume variance 18,000 U
Total of the overhead variances $ 44,000 U
10-86
End of Chapter 10

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Chapter 7

Standard Costs and Variances

Price standards Quantity standards

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

Setting Direct Materials Standards

Final, delivered Summarized in

Setting Direct Labor Standards

Often a single Use time and

Setting Variable Manufacturing

The rate is the The quantity is

The Standard Cost Card

Using Standards in Flexible Budgets

Standard costs per unit for direct materials, direct

Spending variances become more

A General Model for Variance Analysis

Price Variance Quantity Variance

Difference between Difference between

Price and Quantity Standards

 The purchasing manager is responsible for raw

 The buying and using activities occur at different times.

A General Model for Variance Analysis

Price Variance Quantity Variance

Materials price variance Materials quantity variance

A General Model for Variance Analysis

(1) (2) (3)

Price Variance Quantity Variance

A General Model for Variance Analysis

(1) (2) (3)

Price Variance Quantity Variance

A General Model for Variance Analysis

(1) (2) (3)

Price Variance Quantity Variance

A General Model for Variance Analysis

(1) (2) (3)

Price Variance Quantity Variance

A General Model for Variance Analysis

(1) (2) (3)

Price Variance Quantity Variance

Compute the direct

Materials Variances – An Example

Glacier Peak Outfitters has the following direct

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

Last month 210 kgs. of fiberfill were purchased and

Materials Variances Summary

Price variance Quantity variance

Materials Variances Summary

Price variance Quantity variance

Materials Variances Summary

Price variance Quantity variance

Materials quantity variance

Responsibility for Materials

Purchasing Manager Production Manager

The standard price is used to compute the quantity variance

Responsibility for Materials Variances

Production Manager Purchasing Manager

Quick Check  Zippy

Hanson Inc. has the following direct materials

Quick Check  Zippy

How many pounds of materials should