Standard Costing

James Robert D. Aguila, CPA, CMA

ACCO 20073 Cost Accounting and Control
August 31, 2019

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 House Rules

• Inform me if I am speaking too fast or unclear.

• Take an active part in class discussions by
asking questions.
• Professional demeanor is expected from
everyone.
• Avoid using mobile phones/gadgets during class
hours. Mobile phones/gadgets must be switched
off or turned to silent mode.

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 Standard Costs

Standards are benchmarks or “norms”

for measuring performance. Two types
of standards are commonly used.

Quantity standards Cost (price)

specify how much of an standards specify
input should be used to how much should be
make a product or paid for each unit
provide a service. of the input.

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 Standard Costs

Deviations from standard deemed significant

are brought to the attention of management, a
practice known as management by exception.

Standard
Amount

Direct
Material
Direct Manufacturing
Labor Overhead

Type of Product Cost

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 Exh.
10-1
Variance Analysis Cycle

Take
Identify Receive corrective
questions explanations actions

Conduct next
Analyze period’s
variances operations

Prepare standard
Begin
cost performance
report

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 Setting Standard Costs

Accountants, engineers, purchasing

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

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 Setting Standard Costs

Should we use I recommend using practical

ideal standards that standards that are currently
require employees to attainable with reasonable and
work at 100 percent efficient effort.
peak efficiency?

Engineer Managerial
Accountant
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 Setting Direct Material Standards

Price Quantity
Standards Standards

Final, delivered Summarized in

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

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 Setting Standards

In recent years, TQM 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.

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 Setting Direct Labor Standards
The picture can't be display ed.

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.

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 Setting Variable Overhead Standards

Rate Activity
Standards Standards

The rate is the The activity is the

variable portion of the base used to calculate
predetermined overhead the predetermined
rate. overhead.

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 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

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 Standards vs. Budgets

Are standards the A standard is a per

same as budgets? unit cost.
A budget is set for Standards are often
used when
total costs. preparing budgets.

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 Price and Quantity Standards

Price and and quantity standards are

determined separately for two reasons:

ΠThe 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.
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 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

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 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 spending variance VOH efficiency variance

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 A General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

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 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.

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 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 for the period.

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 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 for the input used.

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 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.

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 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

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 Material Variances 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 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

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 Material Variances Summary

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price
210 kgs. 210 kgs. 200 kgs.
× $1,029 ¸ ×
210 kgs ×
$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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 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

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 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

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 Isolation of Material Variances

I’ll start computing

I need the price variance the price variance
sooner so that I can better
when material is
identify purchasing problems.
purchased rather than
You accountants just don’t when it’s used.
understand the problems that
purchasing managers have.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Material Variances

Hanson purchased and The price variance is

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 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.
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 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
You purchased cheap unfavorable price variances.
material, so my people
had to use more of it.

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 Quick Check ü Zippy

Hanson Inc. has the following direct material

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound

Last week 1,700 pounds of material were

purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s material price variance (MPV)

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s material price variance (MPV)

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

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 Quick Check ü Zippy

Hanson’s material quantity variance (MQV)

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s material 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
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 Quick Check ü Zippy

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
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 Quick Check ü Continued Zippy

Hanson Inc. has the following material standard

to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound

Last week 2,800 pounds of material were

purchased at a total cost of $10,920, and 1,700
pounds were used to make 1,000 Zippies.

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 Quick Check ü Continued Zippy

Actual Quantity Actual Quantity

Purchased Purchased
× ×
Actual Price Standard Price
2,800 lbs. 2,800 lbs.
× ×
$3.90 per lb. $4.00 per lb.
= $10,920 = $11,200

Price variance increases

Price variance because quantity
$280 favorable purchased increases.
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 Quick Check ü Continued Zippy

Actual Quantity
Used Standard Quantity
× ×
Standard Price Standard Price
1,700 lbs. 1,500 lbs.
× ×
$4.00 per lb. $4.00 per lb.
= $6,800 = $6,000
Quantity variance is
unchanged because
actual and standard Quantity variance
quantities are unchanged. $800 unfavorable
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 Labor Variances 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 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

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 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 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

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 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

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 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

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 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü 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.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s labor rate variance (LRV) for

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü 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

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 Quick Check ü Zippy

Hanson’s labor efficiency variance (LEV)

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü 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
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check ü Zippy

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
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 Variable Manufacturing Overhead
Variances 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 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

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable

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 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

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable

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 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

Spending variance Efficiency variance

$500 unfavorable $400 unfavorable

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 Variable Manufacturing Overhead
Variances: Using Factored Equations

Variable manufacturing overhead spending variance

VMSV = 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 Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü 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.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s spending variance (VOSV) for

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s spending variance (VOSV) for

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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü Zippy

Hanson’s efficiency variance (VOEV) for

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

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 Quick Check ü Zippy

Hanson’s efficiency variance (VOEV) 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.
VOEV = SR(AH - SH)
VOEV = $3.00(1,550 hrs - 1,500 hrs)
VOEV = $150 unfavorable
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 Quick Check ü Zippy

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

Spending variance Efficiency variance

$465 unfavorable $150 unfavorable
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 Variable Overhead Variances –
A Closer Look

If flexible budget If flexible budget

is based on is based on
actual hours standard hours

Both spending
Only a spending
and efficiency
variance can be
variances can be
computed.
computed.

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Variable Overhead Variances – Example

ColaCo’s actual production for the period required

3,200 standard machine hours. Actual variable
overhead incurred for the period was $6,740.
Actual machine hours worked were 3,300. The
standard variable overhead cost per machine hour
is $2.00.

Compute the variable overhead spending variance

first using actual hours. Then use standard hours
allowed to calculate the variable overhead
efficiency variance.
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 Variable Overhead Variances

Actual Flexible Budget

Variable for Variable
Overhead Overhead at
Incurred Actual Hours
AH × AR AH × SR
AH = Actual hours
AR = Actual variable
Spending overhead rate
Variance SR = Standard variable
overhead rate

Spending variance = AH(AR – SR)

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Variable Overhead Variances – Example

Actual Flexible Budget

Variable for Variable
Overhead Overhead at
Incurred Actual Hours
3,300 hours
×
$2.00 per hour
$6,740 = $6,600

Spending Variance
= $140 unfavorable

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 Variable Overhead Variances –
A Closer Look

Spending Variance
Results from paying more
or less than expected for
overhead items and from Now, let’s use the
excessive usage of standard hours allowed,
overhead items. along with the actual
hours, to compute the
efficiency variance.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Variable Overhead Variances

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
AH × AR AH × SR SH × SR

Spending Efficiency
Variance Variance
Spending variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)

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Variable Overhead Variances – Example

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
3,300 hours 3,200 hours
× ×
$2.00 per hour $2.00 per hour
$6,740 $6,600 $6,400

Spending variance Efficiency variance

$140 unfavorable $200 unfavorable
$340 unfavorable flexible budget total variance
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 Variable Overhead Variances –
A Closer Look

Efficiency Variance

Controlled by
managing the
overhead cost driver.

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 Quick Check ü

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Quick Check ü

Spending variance = AH
Yoder Enterprises’ (AR -production
actual SR) for the
period=required 2,100overhead
Actual variable standard (AH ´ SR)
direct–labor
incurred
hours. Actual variable overhead for the period
= $10,950 – (2,050 hours ´ $5 per hour)
was $10,950. Actual direct labor hours worked
were 2,050. The
= $10,950 predetermined variable
– $10,250
overhead rate is $5 per direct labor hour. What
= $700 U
was the spending variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U

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 Quick Check ü

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
was $10,950. Actual direct labor hours worked
were 2,050. The predetermined variable
overhead rate is $5 per direct labor hour. What
was the efficiency variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U

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 Quick Check ü

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual variable overhead for the period
Efficiency
was variance
$10,950. = SRdirect
Actual (AH – labor
SH) hours worked
were 2,050.
= $5 perThe
hourpredetermined variable
(2,050 hours – 2,100 hours)
overhead rate is $5 per direct labor hour. What
was the= $250 F
efficiency variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U

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 Quick Check Summary

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
2,050 hours 2,100 hours
× ×
$5 per hour $5 per hour
$10,950 $10,250 $10,500

Spending variance Efficiency variance

$700 unfavorable $250 favorable
$450 unfavorable flexible budget total variance
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 Activity-based Costing
and the Flexible Budget

It is unlikely that all

variable overhead will be
driven by a single activity.

Activity-based costing
can be used when multiple
activity bases drive
variable overhead costs.

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Overhead Rates and Overhead Analysis

Recall that overhead costs are assigned to

products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity

Overhead from the

flexible budget for the
denominator level of activity
POHR =
Denominator level of activity

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Overhead Rates and Overhead Analysis

The predetermined overhead rate

can be broken down into fixed
and variable components.

The variable The fixed

component is useful component is useful
for preparing and analyzing for preparing and analyzing
variable overhead fixed overhead
variances. variances.

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 Normal versus Standard Cost Systems

In a normal cost In a standard cost

system, overhead is system, overhead is
applied to work in applied to work in
process based on process based on
the actual number the standard hours
of hours worked allowed for the output
in the period. of the period.

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 Fixed Overhead Variances

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
DH × FR SH × FR

Budget Volume
Variance Variance

FR = Standard Fixed Overhead Rate

SH = Standard Hours Allowed
DH = Denominator Hours
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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 ? $ 9,000 ?
4,000 8,000 ? 9,000 ?

Let’s calculate overhead rates.

ColaCo applies overhead based

on machine-hour activity.
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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 ?
4,000 8,000 2.00 9,000 ?

Rate = Total Variable Overhead ÷ Machine Hours

This rate is constant at all levels of activity.

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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00
4,000 8,000 2.00 9,000 2.25

Rate = Total Fixed Overhead ÷ Machine Hours

This rate decreases when activity increases.

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 Overhead Rates and Overhead
Analysis – Example

ColaCo prepared this budget for overhead:

Total Variable Total Fixed

Machine Variable Overhead Fixed Overhead
Hours Overhead Rate Overhead Rate
3,000 $ 6,000 $ 2.00 $ 9,000 $ 3.00
4,000 8,000 2.00 9,000 2.25

The total POHR is the sum of

the fixed and variable rates
for a given activity level.
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 Fixed Overhead Variances – Example

ColaCo’s actual production required 3,200

standard machine hours. Actual fixed
overhead was $8,450. The predetermined
overhead rate is based on 3,000 machine
hours.

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 Overhead Variances

Now let’s turn

our attention
to calculating
fixed overhead
variances.

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 Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied

$8,450 $9,000

Budget variance
$550 favorable
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 Fixed Overhead Variances –
A Closer Look

Budget Variance

Results from spending

more or less than
Now, let’s use the
expected for fixed
standard hours allowed
overhead items.
to compute the fixed
overhead volume
variance.

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 Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
SH × FR
3,200 hours
×
$3.00 per hour
$8,450 $9,000 $9,600

Budget variance Volume variance

$550 favorable $600 favorable
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 Volume Variance – A Closer Look

Volume
Variance

Results when standard hours

allowed for actual output differs
from the denominator activity.

Unfavorable Favorable
when standard hours when standard hours
< denominator hours > denominator hours
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 Volume Variance – A Closer Look

Volume
Variance
Does not measure over-
or under spending
Results when standard hours
Itallowed
resultsforfrom treating
actual fixed
output differs
from the denominator
overhead activity.
as if it were a
variable cost.
Unfavorable Favorable
when standard hours when standard hours
< denominator hours > denominator hours
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 Quick Check ü

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check ü

Budget
Yoder variance
Enterprises’ actual production for the
period required
= Actual 2,100 standard
fixed overhead – Budgeteddirect labor
fixed overhead
hours. Actual– $14,450
= $14,800 fixed overhead for the period
was $14,800. The budgeted fixed overhead
was= $14,450.
$350 U The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check ü

Yoder Enterprises’ actual production for the

period required 2,100 standard direct labor
hours. Actual fixed overhead for the period
was $14,800. The budgeted fixed overhead
was $14,450. The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check ü

Volume variance
Yoder Enterprises’ actual production for the
= Budgeted fixed overhead – (SH ´ FR)
period required 2,100 standard direct labor
hours. =Actual
$14,450 – (2,100
fixed hours ´ $7
overhead forper
thehour)
period
= $14,450The
was $14,800. – $14,700
budgeted fixed overhead
was $14,450.
= $250 F The predetermined fixed
overhead rate was $7 per direct labor hour.
What was the volume variance?
a. $250 U
b. $250 F
c. $100 F
d. $100 U
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Quick Check Summary

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied
SH × FR
2,100 hours
×
$7.00 per hour
$14,800 $14,450 $14,700

Budget variance Volume variance

$350 unfavorable $250 favorable
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 Overhead Variances

Let’s look at a
graph showing
fixed overhead
variances. We will
use ColaCo’s
numbers from the
previous example.
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 Fixed Overhead Variances

Cost

$9,000 budgeted fixed OH

Activity
3,000 Hours
Expected
Activity
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 Fixed Overhead Variances

Cost

$9,000 budgeted fixed OH

$550
Favorable
{ $8,450 actual fixed OH
Budget
Variance

Activity
3,000 Hours
Expected
Activity
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 Fixed Overhead Variances

3,200 machine hours × $3.00 fixed overhead rate

Cost
$600
Favorable $9,600 applied fixed OH
Volume
Variance { $9,000 budgeted fixed OH
$550 { $8,450 actual fixed OH
Favorable
Budget
Variance

Activity
3,000 Hours 3,200
Expected Standard
Activity Hours
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 Overhead Variances and Under- or
Overapplied Overhead Cost

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 a period.
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 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.

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 Exh.
10-9
A Statistical Control Chart

Warning signals for investigation

Favorable Limit
• •
• • •
Desired Value
• •
Unfavorable Limit •
•
1 2 3 4 5 6 7 8 9
Variance Measurements

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 Advantages of Standard Costs

Management by Promotes economy

exception and efficiency

Advantages
Enhances
Simplified responsibility
bookkeeping accounting

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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.

Continuous
Invalid assumptions improvement may
about the relationship be more important
between labor than meeting standards.
cost and output.
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 Cost Flows in a Standard Cost System

• Inventories are recorded at standard cost.

• Variances are recorded as follows:
w Favorable variances are credits, representing
savings in production costs.
w Unfavorable variances are debits, representing
excess production costs.
• Standard cost variances are usually closed to
cost of goods sold.
w Favorable variances decrease cost of goods sold.
w Unfavorable variances increase cost of goods sold.

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 Questions

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