Flexible Budgets,

Standard Costs, and

Variance Analysis
Chapter 08

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
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Variance Analysis Cycle

Receive Take
Identify
explanations corrective
questions
actions

Conduct next
Analyze
period’s
variances
operations

Prepare standard Begin

cost performance
report
8-2
Learning Objective 1

Prepare a flexible
budget.

8-3
Characteristics of Flexible Budgets
Planning budgets Hmm! Comparing
static planning budgets
are prepared for
with actual costs
a single, planned is like comparing
level of activity. apples and oranges.

Performance
evaluation is difficult
when actual activity
differs from the planned
level of activity.

8-4
Characteristics of Flexible Budgets
May be prepared for any activity
level in the relevant range.

Show costs that should have been

incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.

Help managers control costs.

Improve performance evaluation.

Let’s look at Larry’s Lawn Service.
8-5
Deficiencies of the Static Planning Budget

Larry’s Lawn Service provides lawn care in a planned

community where all lawns are approximately the same size.
At the end of May, Larry prepared his June budget based on
mowing 500 lawns. Since all of the lawns are similar in size,
Larry felt that the number of lawns mowed in a month would
be the best way to measure overall activity for his business.

Larry’s Budget
8-6
Deficiencies of the Static Planning Budget
Larry’s Planning Budget

8-7
Deficiencies of the Static Planning Budget
Larry’s Actual Results

8-8
 Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget

8-9
 Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
F = Favorable variance that occurs when actual
revenue is greater than budgeted revenue.

U = Unfavorable variance that occurs when

actual costs are greater than budgeted costs.

F = Favorable variance that occurs when

actual costs are less than budgeted costs.

8-10
 Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget

Since these variances are unfavorable, has

Larry done a poor job controlling costs?

Since these variances are favorable, has

Larry done a good job controlling costs?

8-11
Deficiencies of the Static Planning Budget

I don’t think I Actual activity is above

can answer the planned activity.
questions using
a static budget. So, shouldn’t the variable
costs be higher if actual
activity is higher?

8-12
Deficiencies of the Static Planning Budget

 The relevant question is . . .

“How much of the cost variances are
due to higher activity and how much
are due to cost control?”
 To answer the question,
we must
the budget to the
actual level of activity.

8-13
How a Flexible Budget Works

To a budget, we need to know that:

• Total variable costs change
in direct proportion to
changes in activity.
• Total fixed costs remain
unchanged within the Fixed
relevant range.

8-14
How a Flexible Budget Works

Let’s prepare a
budget
for Larry’s Lawn
Service.

8-15
Preparing a Flexible Budget
Larry’s Flexible Budget

8-16
Quick Check 
What should the total wages and salaries cost
be in a flexible budget for 600 lawns?
a. $18,000.
b. $20,000.
c. $23,000.
d. $25,000.

8-17
Quick Check 
What should the be the
totaltotal
wages
wages
andandsalaries
salaries
cost
costinina aflexible
be flexiblebudget
budgetforfor600
600lawns?
lawns?
a. $18,000.
$18,000
b. $20,000.
c. $23,000.
d. $25,000.

Total wages and salaries cost

= $5,000 + ($30 per lawn  600 lawns)
$5,000 + $18,000 = $23,000

8-18
Learning Objective 2

Prepare a report
showing revenue and
spending variances.

8-19
Revenue and Spending Variances
Flexible budget revenue Actual revenue

The difference is a revenue variance.

Flexible budget cost Actual cost

The difference is a spending variance.

8-20
Revenue and Spending Variances

Now, let’s use budgeting

concepts to compute revenue and
spending variances for Larry’s Lawn
Service.

8-21
 Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance

8-22
 Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
Spending
variances

8-23
Learning Objective 3

Prepare a flexible budget

with more than one cost
driver.

8-24
Flexible Budgets with Multiple Cost
Drivers
More than one cost
driver may be needed to
adequately explain all of
the costs in an organization.

The cost formulas used

to prepare a flexible
budget can be adjusted
to recognize multiple
cost drivers.
8-25
 Flexible Budgets with Multiple Cost
Drivers
Because of the large unfavorable wages and salaries spending
variance, Larry decided to add an additional cost driver for
wages and salaries. The variance is due primarily to the number
of hours required for the additional edging and trimming. So
Larry estimates the additional hours and builds those hours into
both his revenue and expense budget formulas.

Larry’s New Budget

8-26
Flexible Budgets with Multiple Cost
Drivers
Larry’s Budget Based on More than One Cost Driver

8-27
 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. 8-28
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.

8-29
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.

8-30
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.

8-31
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

8-32
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
quantity and price variances.
8-33
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

8-34
Quantity and Price Standards
Quantity and price 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.
8-35
A General Model for Variance Analysis

Variance Analysis

Quantity Variance Price Variance

Materials quantity variance Materials price variance

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

8-36
 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)

Spending Variance
(3) – (1)
8-37
 A General Model for Variance Analysis
Actual quantity is the amount of direct materials, direct
labor, and variable manufacturing overhead 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)

Spending Variance
(3) – (1)
8-38
 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)

Spending Variance
(3) – (1)
8-39
 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)

Spending Variance
(3) – (1)
8-40
 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)

Spending Variance
(3) – (1)
8-41
Learning Objective 4

Compute the direct

materials quantity and
price variances and
explain their
significance.

8-42
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.

8-43
 Materials Variances Summary
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 Price variance

$50 unfavorable $21 favorable

8-44
 Materials Variances Summary
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price
200 kgs. 210 kgs. 210 kgs.
0.1 kg per parka  2,000 parkas
× × ×
= 200 kgs
$5.00 per kg. $5.00 per kg. $4.90 per kg.
= $1,000 = $1,050 = $1,029

Quantity variance Price variance

$50 unfavorable $21 favorable

8-45
 Materials Variances Summary
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 Price variance

$50 unfavorable $21 favorable

8-46
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/parka  2,000 parkas))
= $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
8-47
 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.
8-48
 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
You purchased cheap unfavorable price variances.
material, so my people
had to use more of it.

Production Manager Purchasing Manager 8-49

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.

8-50
Quick Check  Zippy

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.

8-51
Quick Check  Zippy

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. The standard quantity is:
1,000 × 1.5 pounds per Zippy.

8-52
Quick Check  Zippy

Hanson’s materials quantity variance (MQV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

8-53
Quick Check  Zippy

Hanson’s materials quantity variance (MQV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
8-54
Quick Check  Zippy

Hanson’s materials price variance (MPV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.

8-55
Quick Check  Zippy

Hanson’s materials price variance (MPV)

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

8-56
 Quick Check  Zippy

Standard Quantity Actual Quantity Actual Quantity

× × ×
Standard Price Standard Price Actual Price

1,500 lbs. 1,700 lbs. 1,700 lbs.

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

Quantity variance Price variance

$800 unfavorable $170 favorable
8-57
 Quick Check  Zippy
Recall that the standard quantity for 1,000 Zippies
is 1,000 × 1.5 pounds per Zippy = 1,500 pounds.
Standard Quantity Actual Quantity Actual Quantity
× × ×
Standard Price Standard Price Actual Price

1,500 lbs. 1,700 lbs. 1,700 lbs.

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

Quantity variance Price variance

$800 unfavorable $170 favorable
8-58
Learning Objective 5

Compute the direct labor

efficiency and rate
variances and explain
their significance.

8-59
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.

8-60
Labor Variances Summary
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 Rate variance

$1,000 unfavorable $1,250 unfavorable

8-61
Labor Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × parka  2,000
1.2 hours per ×
$10.00 per hour parkasper
$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

8-62
Labor Variances Summary
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

8-63
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
8-64
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
8-65
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.

8-66
Quick Check  Zippy

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.

8-67
Quick Check  Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.

8-68
Quick Check  Zippy

Hanson’s labor efficiency variance (LEV)

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

8-69
Quick Check  Zippy

Hanson’s labor rate variance (LRV) for the

week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.

8-70
Quick Check  Zippy

Hanson’s labor rate variance (LRV) for the

week was:
a. $310 unfavorable.
b. $310 favorable.
LRV = AH(AR - SR)
c. $300 unfavorable.
LRV = 1,550 hrs($12.20 - $12.00)
d. $300 favorable.LRV = $310 unfavorable

8-71
Quick Check  Zippy

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
8-72
Learning Objective 6

Compute the variable

manufacturing overhead
efficiency and rate
variances and explain
their significance.

8-73
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.

8-74
Variable Manufacturing Overhead
Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × ×
$4.00 per hour $4.00 per hour $4.20 per hour
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable

8-75
Variable Manufacturing Overhead
Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × parka  2,000
1.2 hours per ×
$4.00 per hour $4.00 per
parkas hour hours $4.20 per hour
= 2,400
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable

8-76
Variable Manufacturing Overhead
Variances Summary
Standard Hours Actual Hours Actual Hours
× × ×
Standard Rate Standard Rate Actual Rate
2,400 hours 2,500 hours 2,500 hours
× × hours
$10,500  2,500 ×
$4.00 per hour $4.00 per
= $4.20 per hour
hour $4.20 per hour
= $9,600 = $10,000 = $10,500

Efficiency variance Rate variance

$400 unfavorable $500 unfavorable

8-77
Variable Manufacturing Overhead
Variances: Using Factored Equations
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
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
8-78
Quick Check  Zippy

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.

8-79
Quick Check  Zippy

Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.

8-80
Quick Check  Zippy

Hanson’s efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
a. $435 unfavorable.
b. $435 favorable. 1,000 units × 1.5 hrs per unit
c. $150 unfavorable.
d. $150 favorable.
VMEV = SR(AH - SH)
VMEV = $3.00(1,550 hrs - 1,500 hrs)
VMEV = $150 unfavorable
8-81
Quick Check  Zippy

Hanson’s rate variance (VMRV) for variable

manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.

8-82
Quick Check  Zippy

Hanson’s rate variance (VMRV) for variable

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

8-83
Quick Check  Zippy

Standard Hours Actual Hours Actual Hours

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

Efficiency variance Rate variance

$150 unfavorable $465 unfavorable
8-84
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.
8-85
Materials Variances―An Important
Subtlety
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 at a
cost of $1,029. Glacier used 200 kgs. to make
2,000 parkas.

8-86
 Materials Variances―An Important
Subtlety
Standard Quantity Actual Quantity
× ×
Standard Price Standard Price
200 kgs. 200 kgs.
× ×
$5.00 per kg. $5.00 per kg.
= $1,000 = $1,000

Quantity variance
$0

8-87
Materials Variances―An Important
Subtlety
Actual Quantity Actual Quantity
× ×
Standard Price Actual Price
210 kgs. 210 kgs.
× ×
$5.00 per kg. $4.90 per kg.
= $1,050 = $1,029

Price variance
$21 favorable

8-88
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.
8-89
Advantages of Standard Costs

Management by Promotes economy

exception and efficiency

Advantages
Enhances
Simplified responsibility
bookkeeping accounting
8-90
 Potential Problems with Standard Costs
Emphasizing standards Favorable
may exclude other variances may
important objectives. be misinterpreted.
Potential
Problems
Standard cost Emphasis on
reports may negative may
not be timely. impact morale.

Invalid assumptions Continuous

about the relationship improvement may
between labor be more important
cost and output. than meeting standards.
8-91
 PREDETERMINED OVERHEAD
RATES AND OVERHEAD
ANALYSIS IN A STANDARD
COSTING SYSTEM
Appendix 8A

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
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 7

(Appendix 8A)
Compute and interpret
the fixed overhead
volume and budget
variances.

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Fixed Overhead Volume Variance
Fixed Budgeted Actual
Overhead Fixed Fixed
Applied Overhead Overhead

Volume
variance

Fixed
Budgeted
Volume overhead
= fixed –
variance applied to
overhead
work in process
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 Fixed Overhead Volume Variance
Fixed Budgeted Actual
Overhead Fixed Fixed
Applied Overhead Overhead
SH × FR DH × FR

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
8-95
Fixed Overhead Budget Variance
Fixed Budgeted Actual
Overhead Fixed Fixed
Applied Overhead Overhead

Budget
variance

Actual Budgeted
Budget
= fixed – fixed
variance
overhead overhead
8-96
 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

8-97
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

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 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

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Predetermined Overhead Rates
Variable component of the $90,000
=
predetermined overhead rate 90,000 Machine-hours

Variable component of the

= $1.00 per machine-hour
predetermined overhead rate

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

8-100
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

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 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
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 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

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Computing the Budget Variance
Actual Budgeted
Budget
= fixed – fixed
variance
overhead overhead

Budget
= $280,000 – $270,000
variance

Budget
= $10,000 Unfavorable
variance

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 A Pictorial View of the Variances
Fixed Overhead Budgeted Actual
Applied to Fixed Fixed
Work in Process Overhead Overhead
252,000 270,000 280,000

Volume variance, Budget variance,

$18,000 unfavorable $10,000 unfavorable

Total variance, $28,000 unfavorable

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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.
8-106
 Graphic Analysis of Fixed
Overhead Variances

Budget
$270,000

Denominator
hours
0
0 Machine-hours (000) 90
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 Graphic Analysis of Fixed
Overhead Variances
Actual
$280,000
Budget { Budget Variance 10,000 U
$270,000

Denominator
hours
0
0 Machine-hours (000) 90
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 Graphic Analysis of Fixed
Overhead Variances
Actual
$280,000
Budget { Budget Variance 10,000 U
$270,000
Applied { Volume Variance 18,000 U
$252,000

Standard Denominator
hours hours
0
0 Machine-hours (000) 84 90
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Reconciling Overhead Variances and
Underapplied or Overapplied Overhead
In a standard
cost system:

Unfavorable Favorable
variances are equivalent variances are equivalent
to underapplied overhead. to overapplied overhead.

The sum of the overhead variances

equals the under- or overapplied
overhead cost for the period.
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 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

8-111
Computing the Variable Overhead
Variances

Variable manufacturing overhead efficiency variance

VMEV = (AH × SR) – (SH × SR)
= $88,000 – (84,000 hours × $1.00 per hour)
= $4,000 unfavorable

8-112
 Computing the Variable Overhead
Variances

Variable manufacturing overhead rate variance

VMRV = (AH × AR) – (AH × SR)
= $100,000 – (88,000 hours × $1.00 per hour)
= $12,000 unfavorable

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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

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 GENERAL LEDGER ENTRIES TO
RECORD VARIANCES
Appendix 8B

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
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 8

(Appendix 8B)
Prepare journal entries
to record standard
costs and variances.

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Glacier Peak Outfitters ― Revisited
We will use information from the Glacier Peak Outfitters
example presented earlier in the chapter to illustrate journal
entries for standard cost variances. Recall the following:

Material Labor
AQ × AP = $1,029 AH × AR = $26,250
AQ × SP = $1,050 AH × SR = $25,000
SQ × SP = $1,000 SH × SR = $24,000
MPV = $21 F LRV = $1,250 U
MQV = $50 U LEV = $1,000 U

Now, let’s prepare the entries to record

the labor and material variances.
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Recording Materials Variances
GENERAL JOURNAL Page 4
Post.
Date Description Ref. Debit Credit
Raw Materials 1,050
Materials Price Variance 21
Accounts Payable 1,029
To record the purchase of material

Work in Process 1,000

Materials Quantity Variance 50
Raw Materials 1,050
To record the use of material

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Recording Labor Variances

GENERAL JOURNAL Page 4

Post.
Date Description Ref. Debit Credit
Work in Process 24,000
Labor Rate Variance 1,250
Labor Efficiency Variance 1,000
Wages Payable 26,250
To record direct labor

8-119
Cost Flows in a Standard Cost System

Inventories are recorded at standard cost.

Variances are recorded as follows:
 Favorable variances are credits, representing
savings in production costs.
 Unfavorable variances are debits, representing
excess production costs.
Standard cost variances are usually closed out
to cost of goods sold.
 Unfavorable variances increase cost of goods sold.
 Favorable variances decrease cost of goods sold.
8-120
End of Chapter 08

8-121