Discuss the importance of evaluating variances from standard costs in managerial accounting. What are some reasons for variances, and how can they be addressed?
Directions:
Chapter 9
Evaluating
Variances from
Standard Costs
Standards
(slide 1 of 2)
• Standards are performance goals.
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Standards
(slide 2 of 2)
• Accounting systems that use standards for
product costs are called standard cost systems.
o Standard cost systems enable management to
determine the following:
▪ How much a product should cost (standard cost)
▪ How much it does cost (actual cost)
• When actual costs are compared with standard
costs, the exceptions or variances are reported.
o This reporting by the principle of exceptions allows
management to focus on correcting the cost variances.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Setting Standards
Convert the results of
judgments and process
studies into dollars and
cents.
Assisted by operation managers in
identifying materials, labor, and
machine requirements.
Accountants
Engineers
Standard-setting process
Other Management Personnel
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Types of Standards
(slide 1 of 2)
• Ideal standards, or theoretical standards,
are standards that can be achieved only
under perfect operating conditions, such as
no idle time, no machine breakdowns, and
no materials spoilage.
o Such standards may have a negative impact on
performance because they may be viewed by
employees as unrealistic.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Types of Standards
(slide 2 of 2)
• Normal standards, sometimes called currently
attainable standards, are standards that can be
attained with reasonable effort.
o Such standards, which are used by most
companies, allow for normal production difficulties
and mistakes.
o When reasonable standards are used, employees
focus more on cost and are more likely to put forth
their best efforts.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reviewing and Revising Standards
• Standard costs should be periodically reviewed
to ensure that they reflect current operating
conditions.
o Standards should not be revised just because they
differ from actual costs.
o Standards should be revised when prices, product
designs, labor rates, or manufacturing methods
change.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Criticisms of Standard Costs
• Some criticisms of using standard costs for
performance evaluation include the following:
o Standards limit operating improvements by discouraging
improvement beyond the standard.
o Standards are too difficult to maintain in a dynamic
manufacturing environment, resulting in “stale standards.”
o Standards can cause employees to lose sight of the larger
objectives of the organization by focusing only on
efficiency improvement.
o Standards can cause employees to unduly focus on their
own operations to the possible harm of other operations
that rely on them.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budgetary Performance Evaluation
(slide 1 of 2)
• The budgetary performance evaluation
compares actual performance against its
planned budget.
• Western Rider Inc., a manufacturer of blue
jeans, uses standard costs in its budgets.
o The standards for direct materials, direct labor, and
factory overhead are separated into the following two
components:
▪ Standard price
▪ Standard quantity
o The standard cost per unit for direct materials, direct
labor, and factory overhead is computed as follows:
Budgetary Performance Evaluation = Standard Price × Standard Quantity
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budgetary Performance Evaluation
(slide 2 of 2)
• The master budget is prepared based on planned
sales and production.
o The budgeted costs for materials purchases, direct
labor, and factory overhead are determined by
multiplying their standard costs per unit by the planned
level of production.
o Budgeted (standard) costs are then compared to
actual costs during the year for control purposes.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cost Variances
(slide 1 of 2)
• The differences between actual and standard
costs are called costs variances.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cost Variances
(slide 2 of 2)
• In a favorable cost variance, the actual cost is
less than the standard cost at actual volumes
• In an unfavorable cost variance, the actual cost
is greater than the standard cost at actual
volumes
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budget Performance Report
(slide 1 of 3)
Summarizes actual costs,
standard costs, and the
differences for the units
produced
Based on actual
production rather than
planned production
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 1 of 4)
• The total manufacturing cost variance is
the difference between total standard costs
and total actual cost for the units produced.
• For control purposes, each product cost
variance is separated into two additional
variances.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 2 of 4)
• The total direct materials variance is separated
into a price and a quantity variance.
o This is because standard and actual direct materials
costs are computed as follows:
Actual Direct Materials Cost
=
Actual Price
×
Actual Quantity
Standard Direct Materials Cost
=
Standard Price
×
Standard Quantity
Direct Materials Cost Variance
=
Price Difference
+
Quantity Difference
▪ Thus, the actual and standard direct materials costs may
differ because of a price difference (variance), a quantity
difference (variance), or both.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 3 of 4)
• The total direct labor variance is separated into
a rate variance and a time variance.
o This is because standard and actual direct labor costs
are computed as follows:
Actual Direct Labor Cost
= Actual Rate
×
Actual Time
Standard Direct Labor Cost
= Standard Rate
×
Standard Time
Direct Labor Cost Variance
= Rate Difference
+
Time Difference
▪ Therefore, the actual and standard direct labor costs may
differ because of a rate difference (variance), a time
difference (variance), or both.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 4 of 4)
• The total factory overhead variance is separated
into a controllable variance and a volume
variance.
o Because factory overhead has fixed and variable cost
elements, it uses different variances than direct
materials and direct labor, which are variable costs.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials and Direct Labor Variances
• As mentioned earlier, the total direct materials
and direct labor variances are separated into the
direct materials cost and direct labor cost
variances for analysis and control purposes.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials and Direct Labor
Cost Variances
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Price Variance
(slide 1 of 2)
• The direct materials price variance is
computed as follows:
Direct Materials Price Variance = (Actual Price – Standard Price) Actual Quantity
o If the actual price per unit exceeds the standard price
per unit, the variance is unfavorable.
▪ This positive amount (unfavorable variance) can be thought
of as increasing costs (a debit).
o If the actual price per unit is less than the standard
price per unit, the variance is favorable.
▪ This negative amount (favorable variance) can be thought of
as decreasing costs (a credit).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Price Variance
(slide 2 of 2)
• The direct materials price variance for Western
Rider Inc. for June is computed as follows:
Direct Materials Price Variance = (Actual Price – Standard Price) × Actual Quantity
= ($5.50 – $5.00) × 7,300 sq. yds.
= $3,650 Unfavorable Variance
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Quantity Variance
• The direct materials quantity variance is
computed as follows:
Direct Materials Quantity Variance = (Actual Quantity – Standard Quantity) × Standard Price
o If the actual quantity for the units produced exceeds
the standard quantity, the variance is unfavorable.
▪ This positive amount (unfavorable variance) can be thought
of as increasing costs (a debit).
o If the actual quantity for the units produced is less
than the standard quantity, the variance is favorable.
▪ This negative amount (favorable variance) can be thought of
as decreasing costs (a credit).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Direct Materials Variances
(slide 1 of 2)
• The direct materials quantity variances should
be reported to the manager responsible for the
variance.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Direct Materials Variances
(slide 2 of 2)
• Not all variances are controllable.
o For example, an unfavorable materials price variance
might be due to market-wide price increases.
▪ In this case, there is nothing the Purchasing Department
might have done to avoid the unfavorable variance.
▪ If materials of the same quality could have been purchased
from another supplier at the standard price, the variance was
controllable.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Labor Rate Variance
• The direct labor rate variance is computed as
follows:
Direct Labor Rate Variance = (Actual Rate per Hour – Standard Rate per Hour) Actual Hours
o If the actual rate per hour exceeds the standard rate
per hour, the variance is unfavorable.
▪ This positive amount (unfavorable variance) can be thought
of as increasing costs (a debit).
o If the actual rate per hour is less than the standard
rate per hour, the variance is favorable.
▪ This negative amount (favorable variance) can be thought of
as decreasing costs (a credit).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Labor Time Variance
• The direct labor time variance is computed as
follows:
Direct Labor Time Variance = (Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour
o If the actual direct labor hours for the units produced
exceed the standard direct labor hours, the variance
is unfavorable.
▪ This positive amount (unfavorable variance) can be thought
of as increasing costs (a debit).
o If the actual direct labor hours for the units produced
are less than the standard direct labor hours, the
variance is favorable.
▪ This negative amount (favorable variance) can be thought of
as decreasing costs (a credit).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Direct Labor Variances
• Production supervisors are normally responsible for
controlling direct labor cost.
o
For example, an investigation could reveal the following
causes for unfavorable rate and time variances:
▪ An unfavorable rate variance may be caused by the improper
scheduling and use of employees. In such cases, skilled, highly
paid employees may have been used in jobs that are normally
performed by unskilled, lower-paid employees.
– In this case, the unfavorable rate variance should be reported to
the managers who schedule work assignments.
▪ An unfavorable time variance may be caused by a shortage of
skilled employees. In such cases, there may be an abnormally
high turnover rate among skilled employees.
– In this case, production supervisors with high turnover rates should
be questioned as to why their employees are quitting.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Labor Standards for
Nonmanufacturing Activities
• Direct labor time standards can also be
developed for use in administrative, selling, and
service activities.
o This is most appropriate when the activity involves a
repetitive task that produces a common output.
• When labor-related activities are not repetitive,
direct labor time standards are less commonly
used.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Variances
• Factory overhead costs are analyzed
differently than direct labor and materials costs.
o This is because factory overhead costs have fixed
and variable cost elements.
• Factory overhead costs are budgeted and
controlled by separating factory overhead into
fixed and variable components.
o Doing so allows the preparation of flexible budgets
and the analysis of factory overhead controllable
and volume variances.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variable Factory Overhead Controllable Variance
(slide 1 of 2)
• The variable factory overhead controllable
variance is the difference between the actual
variable overhead costs and the budgeted
variable overhead for actual production.
• The variable factory overhead controllable
variance is computed as follows:
Variable Factory Overhead Controllable Variance = Actual Variable Factory Overhead
– Budgeted Variable Factory Overhead
o
If the actual variable overhead is less than the budgeted
variable overhead, the variance is favorable.
o
If the actual variable overhead exceeds the budgeted
variable overhead, the variance is unfavorable.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variable Factory Overhead Controllable Variance
(slide 2 of 2)
• The variable factory overhead controllable
variance indicates the ability to keep the
factory overhead costs within the budget
limits.
• Because variable factory overhead costs are
normally controllable at the department level,
responsibility for controlling this variance
usually rests with department supervisors.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Fixed Factory Overhead Volume Variance
(slide 1 of 3)
• The fixed factory overhead volume variance is
the difference between the budgeted fixed
overhead at 100% of normal capacity and the
standard fixed overhead for the actual units
produced.
• The fixed factory overhead volume variance is
computed as follows:
Fixed Factory Overhead Volume Variance = (Standard Hours for 100% of Normal Capacity
– Standard Hours for Actual Units Produced)
Fixed Factory Overhead Rate
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Fixed Factory Overhead Volume Variance
(slide 2 of 3)
• The volume variance measures the use of fixed overhead
resources (plant and equipment).
• The interpretation of an unfavorable and a favorable fixed
factory overhead volume variance is as follows:
o
An unfavorable fixed factory overhead volume variance occurs when
the actual units produced is less than 100% of normal capacity.
▪ Thus, the company used its fixed overhead resources (plant and
equipment) less than would be expected under normal operating
conditions.
o
A favorable fixed factory overhead volume variance occurs when the
actual units produced is more than 100% of normal capacity.
▪ Thus, the company used its fixed overhead resources (plant and
equipment) more than would be expected under normal operating
conditions.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factors Contributing to Unfavorable Volume Variance
Failure to maintain an even flow of work
Machine breakdowns
Work stoppages caused by lack of materials
or skilled labor
Lack of enough sales orders to keep the factory
operating at normal capacity
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Factory Overhead Variances
• A factory overhead cost variance report is useful
to management in controlling factory overhead costs.
• Budgeted and actual costs for variable and fixed
factory overhead along with the related controllable
and volume variances are reported by each cost
element.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 1 of 3)
• At the end of the period, the factory overhead
account normally has a balance.
o A debit balance in Factory Overhead represents
underapplied overhead.
▪ Underapplied overhead occurs when actual factory
overhead costs exceed the applied factory overhead.
o A credit balance in Factory Overhead represents
overapplied overhead.
▪ Overapplied overhead occurs when actual factory
overhead costs are less than the applied factory overhead.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 2 of 3)
• The difference between the actual factory
overhead and the applied factory overhead is
the total factory overhead cost variance.
• Thus, underapplied and overapplied factory
overhead account balances represent the
following total factory overhead cost variances:
o Underapplied Factory Overhead = Unfavorable Total
Factory Overhead Cost Variance
o Overapplied Factory Overhead = Favorable Total
Factory Overhead Cost Variance
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 3 of 3)
• The variable factory overhead controllable variance and
the volume variance can be computed by comparing the
factory overhead account with the budgeted total
overhead for the actual level produced.
o
The difference between the actual overhead incurred and the
budgeted overhead is the controllable variance.
▪ If the actual factory overhead exceeds (is less than) the budgeted
factory overhead, the controllable variance is unfavorable
(favorable).
o
The difference between the applied overhead and the budgeted
overhead is the volume variance.
▪ If the applied factory overhead is less than (exceeds) the budgeted
factory overhead, the volume variance is unfavorable (favorable).
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 1 of 5)
• Standard costs may be used as a management
tool to control costs separately from the accounts
in the ledger.
o However, many companies include standard costs in
their accounts.
▪ One method for doing so records sustained costs and
variances at the same time the actual product costs are
recorded.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 2 of 5)
• The journal entries to record the standard costs
and variances for direct labor are similar to those
for direct materials. These entries are summarized
as follows:
o Work in Process is debited for the standard cost of direct
labor.
o Wages Payable is credited for the actual direct labor
cost incurred.
o Direct Labor Rate Variance is debited for an unfavorable
variance and credited for a favorable variance.
o Direct Labor Time Variance is debited for an unfavorable
variance and credited for a favorable variance.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 3 of 5)
• The factory overhead account already incorporates
standard costs and variances into its journal entries.
o
Factory Overhead is debited for actual factory overhead and
credited for applied (standard) factory overhead.
o
The ending balance of factory overhead (overapplied and
underapplied) is the total factory overhead cost variance.
o
By comparing the actual factory overhead with the budgeted
factory overhead, the controllable variance can be determined.
o
By comparing the budgeted factory overhead with the applied
factory overhead, the volume variance can be determined.
• When goods are completed, Finished Goods is debited
and Work in Process is credited for the standard cost of
the product transferred.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 4 of 5)
• At the end of the period, the balances of each of the
variance accounts indicate the net favorable or unfavorable
variance for the period.
o
These variances may be reported in an income statement prepared
for management’s use.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 5 of 5)
• Variances are not reported to external users.
• In preparing an income statement for external
users, the balances of the variance accounts
are normally transferred to Cost of Goods Sold.
o However, if the variances are significant or if many of
the products manufactured are still in inventory, the
variances should be allocated to Work in Process,
Finished Goods, and Cost of Goods Sold.
▪ Such an allocation, in effect, converts these account
balances from standard cost to actual cost.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Service Staffing Variances
• Standards can be used in nonmanufacturing
settings where the tasks are repetitive in nature.
o Standards are used in hotels, hospitals, restaurants,
transportation services, banks, retail stores,
professional services, software development,
automotive services, and many other service settings.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix Revenue Variances (slide 1 of 3)
• In addition to cost variances, operating income is
also affected by differences between expected
(planned) revenues and actual revenues, called
revenue variances.
• A difference between actual and planned
revenues may be due to an increase or
decrease in one or more of the following:
o Unit sales price
o Units sold
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix Revenue Variances (slide 2 of 3)
• The effects of the preceding two factors on
revenue may be analyzed by computing the
following two variances:
o Revenue price variance
o Revenue volume variance
• The revenue price variance is caused by a
difference in the planned and actual unit sales
price on the actual units sold.
Revenue Price Variance = (Planned Selling Price per Unit – Actual Selling Price per Unit)
Actual Units Sold
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix Revenue Variances (slide 3 of 3)
• The revenue volume variance is caused by a
difference in the planned and actual units sold,
assuming no change in unit sales price or unit
cost.
Revenue Volume Variance = (Planned Units Sold – Actual Units Sold) Planned Sales Price
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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