Garrison Chapter 011

Standard Costs and Operating
Performance Measures
Chapter 11
2010 The McGraw-Hill Companies, Inc.
Standard Costs
Standards are benchmarks or norms for
measuring performance. In managerial accounting,
two types of standards are commonly used.
Quantity standards
specify how much of an
input should be used to
make a product or
provide a service.
Price standards
specify how much
should be paid for
each unit of the
input.
Examples: Firestone, Sears, McDonalds, hospitals,

construction and manufacturing companies.
McGraw-Hill/Irwin
Slide 2
Standard Costs
Amount
Deviations from standards deemed significant

are brought to the attention of management, a
practice known as management by exception.
Standard
Direct
Labor
Direct
Material
Manufacturing
Overhead
Type of Product Cost

McGraw-Hill/Irwin
Slide 3
Variance Analysis Cycle

Identify
questions
Receive
explanations
Conduct next
periods
operations
Analyze
variances
Prepare standard
cost performance
report
McGraw-Hill/Irwin
Take
corrective
actions
Begin
Slide 4
Setting Standard Costs

Accountants, engineers, purchasing
agents, and production managers
combine efforts to set standards that encourage
efficient future operations.
McGraw-Hill/Irwin
Slide 5
Setting Standard Costs

Should we use
ideal standards that
require employees to
work at 100 percent
peak efficiency?
Engineer
McGraw-Hill/Irwin
I recommend using practical

standards that are currently
attainable with reasonable
and efficient effort.
Managerial Accountant
Slide 6
Learning Objective 1
Explain how direct materials

standards and direct labor
standards are set.
McGraw-Hill/Irwin
Slide 7
Setting Direct Material Standards

Price
Standards
Quantity
Standards
Final, delivered
cost of materials,
net of discounts.
Summarized in
a Bill of Materials.
McGraw-Hill/Irwin
Slide 8
Setting Standards
Six Sigma advocates have sought to
eliminate all defects and waste, rather than
continually build them into standards.
As a result allowances for waste and
spoilage that are built into standards
should be reduced over time.
McGraw-Hill/Irwin
Slide 9
Setting Direct Labor Standards

Rate
Standards
Time
Standards
Often a single
rate is used that reflects
the mix of wages earned.
Use time and

motion studies for
each labor operation.
McGraw-Hill/Irwin
Slide 10
Setting Variable Manufacturing Overhead

Standards
Rate
Standards
Quantity
Standards
The rate is the

variable portion of the
predetermined overhead
rate.
The quantity is
the activity in the
allocation base for
predetermined overhead.
McGraw-Hill/Irwin
Slide 11
Standard Cost Card Variable Production

Cost
A standard cost card for one unit of

product might look like this:
Inputs
Direct materials
Direct labor
Variable mfg. overhead
Total standard unit cost
McGraw-Hill/Irwin
AxB
Standard
Quantity
or Hours
Standard
Price
or Rate
Standard
Cost
per Unit
3.0 lbs.
2.5 hours
2.5 hours
$ 4.00 per lb.

$
14.00 per hour
3.00 per hour
$
12.00
35.00
7.50
54.50
Slide 12
Price and Quantity Standards

Price and quantity standards are
determined separately for two reasons:
The purchasing manager is responsible for raw
material purchase prices and the production manager
is responsible for the quantity of raw material used.
The buying and using activities occur at different times.

Raw material purchases may be held in inventory for a
period of time before being used in production.
McGraw-Hill/Irwin
Slide 13
A General Model for Variance Analysis

Variance Analysis
Price Variance
Quantity Variance
Difference between
actual price and
standard price
Difference between
actual quantity and
standard quantity
McGraw-Hill/Irwin
Slide 14

Variance Analysis
Price Variance
Quantity Variance
Materials price variance

Labor rate variance
VOH rate variance
Materials quantity variance

Labor efficiency variance
VOH efficiency variance
McGraw-Hill/Irwin
Slide 15

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
McGraw-Hill/Irwin
Standard Quantity
Standard Price
Quantity Variance
Slide 16

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
Standard Quantity
Standard Price
Quantity Variance
Actual quantity is the amount of direct

materials, direct labor, and variable
manufacturing overhead actually used.
McGraw-Hill/Irwin
Slide 17

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
Standard Quantity
Standard Price
Quantity Variance
Standard quantity is the standard quantity

allowed for the actual output of the period.
McGraw-Hill/Irwin
Slide 18

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
Standard Quantity
Standard Price
Quantity Variance
Actual price is the amount actually

paid for the input used.
McGraw-Hill/Irwin
Slide 19

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
Standard Quantity
Standard Price
Quantity Variance
Standard price is the amount that should

have been paid for the input used.
McGraw-Hill/Irwin
Slide 20

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Price Variance
(AQ
AP) (AQ
SP)
AQ = Actual Quantity
AP = Actual Price
McGraw-Hill/Irwin
Standard Quantity
Standard Price
Quantity Variance
(AQ
SP) (SQ
SP)
SP = Standard Price
SQ = Standard Quantity
Slide 21
Compute the direct

materials price and quantity
variances and explain their
significance.
McGraw-Hill/Irwin
Slide 22
Material Variances An Example

Glacier Peak Outfitters has the following direct
material standard for the fiberfill in its mountain
parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased and

used to make 2,000 parkas. The material cost a
total of $1,029.
McGraw-Hill/Irwin
Slide 23
Material Variances Summary

Actual Quantity
Actual Price
Actual Quantity
Standard Price
210 kgs.
$4.90 per kg.
210 kgs.
$5.00 per kg.
= $1,029
Price variance
$21 favorable
McGraw-Hill/Irwin
= $1,050
Standard Quantity
Standard Price
200 kgs.
$5.00 per kg.
= $1,000
Quantity variance
$50 unfavorable
Slide 24

Actual Quantity
Actual Price
210 kgs.
$4.90 per kg.
Actual Quantity
Standard Price
210 kgs.
$1,029
210 kgs
$5.00per
perkg
kg.
= $4.90
= $1,029
Price variance
$21 favorable
McGraw-Hill/Irwin
= $1,050
Standard Quantity
Standard Price
200 kgs.
$5.00 per kg.
= $1,000
Quantity variance
$50 unfavorable
Slide 25

Actual Quantity
Actual Price
Actual Quantity
Standard Price
Standard Quantity
Standard Price
210 kgs.
210 kgs.
200 kgs.
0.1 kg per parka 2,000 parkas

$4.90 per kg.
$5.00
$5.00 per kg.
= 200 per
kgs kg.
= $1,029
Price variance
$21 favorable
McGraw-Hill/Irwin
= $1,050
= $1,000
Quantity variance
$50 unfavorable
Slide 26
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
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U
McGraw-Hill/Irwin
2,000 parkas))
Slide 27
Isolation of Material Variances

I need the price variance
sooner so that I can better
identify purchasing problems.
You accountants just dont
understand the problems that
purchasing managers have.
McGraw-Hill/Irwin
Ill start computing

the price variance
when material is
purchased rather
than when its used.
Slide 28
Material Variances
Hanson purchased and

used 1,700 pounds.
How are the variances
computed if the amount
purchased differs from
the amount used?
McGraw-Hill/Irwin
The price variance is

computed on the entire
quantity purchased.
The quantity variance
is computed only on
the quantity used.
Slide 29
Responsibility for Material Variances

Materials Quantity Variance
Production Manager
Materials Price Variance
Purchasing Manager
The standard price is used to compute the quantity variance

so that the production manager is not held responsible for
the purchasing managers performance.
McGraw-Hill/Irwin
Slide 30
Responsibility for Material Variances

I am not responsible for
this unfavorable material
quantity variance.
You purchased cheap

material, so my people
had to use more of it.
McGraw-Hill/Irwin
Your poor scheduling

sometimes requires me to
rush order material at a
higher price, causing
unfavorable price variances.
Slide 31
Quick Check
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
Slide 32
Quick Check
Zippy
Hansons material price variance (MPV)

for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
McGraw-Hill/Irwin
Slide 33
Zippy
Quick Check
Hansons material price variance (MPV)

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

MPV = $170 Favorable
McGraw-Hill/Irwin
Slide 34
Quick Check
Zippy
Hansons material quantity variance (MQV)

for the week was:
b. $170 favorable.
d. $800 favorable.
McGraw-Hill/Irwin
Slide 35
Zippy
Quick Check
Hansons material quantity variance (MQV)

for the week was:
b. $170 favorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
McGraw-Hill/Irwin
Slide 36
Zippy
Quick Check
Actual Quantity
Actual Price
Actual Quantity
Standard Price
Standard Quantity
Standard Price
1,700 lbs.
$3.90 per lb.
1,700 lbs.
$4.00 per lb.
1,500 lbs.
$4.00 per lb.
= $6,630
= $ 6,800
= $6,000
Price variance
$170 favorable
McGraw-Hill/Irwin
Quantity variance
$800 unfavorable
Slide 37
Quick Check 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.
McGraw-Hill/Irwin
Slide 38
Zippy

Actual Quantity
Purchased
Actual Price
Actual Quantity
Purchased
Standard Price
2,800 lbs.
$3.90 per lb.
2,800 lbs.
$4.00 per lb.
= $10,920
= $11,200
Price variance
$280 favorable
McGraw-Hill/Irwin
Price variance increases

because quantity
purchased increases.
Slide 39
Zippy

Actual Quantity
Used
Standard Price
1,700 lbs.
$4.00 per lb.
1,500 lbs.
$4.00 per lb.
= $6,800
= $6,000
Quantity variance is
unchanged because
actual and standard
quantities are unchanged.
McGraw-Hill/Irwin
Standard Quantity
Standard Price
Quantity variance
$800 unfavorable
Slide 40
Compute the direct labor

rate and efficiency variances
and explain
their significance.
McGraw-Hill/Irwin
Slide 41
Labor Variances An Example

Glacier Peak Outfitters has the following direct labor
standard for its mountain parka.
1.2 standard hours per parka at $10.00 per hour
Last month, employees actually worked 2,500 hours
at a total labor cost of $26,250 to make 2,000
parkas.
McGraw-Hill/Irwin
Slide 42
Labor Variances Summary

Actual Hours
Actual Rate
Actual Hours
Standard Rate
Standard Hours
Standard Rate
2,500 hours
$10.50 per hour
2,500 hours
$10.00 per hour.
2,400 hours
$10.00 per hour
= $26,250
= $25,000
Rate variance
$1,250 unfavorable
McGraw-Hill/Irwin
= $24,000
Efficiency variance
$1,000 unfavorable
Slide 43

Actual Hours
Actual Rate
2,500 hours
$10.50 per hour
= $26,250
Actual Hours
Standard Rate
2,500 hours
2,400 hours
2,500 hours
$26,250
$10.00
per hour.
= $10.50
per hour $10.00 per hour
= $25,000
Rate variance
$1,250 unfavorable
McGraw-Hill/Irwin
Standard Hours
Standard Rate
= $24,000
Efficiency variance
$1,000 unfavorable
Slide 44

Actual Hours
Actual Rate
Actual Hours
Standard Rate
Standard Hours
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.
$10.00 per hour
= 2,400
hours
= $26,250
= $25,000
Rate variance
$1,250 unfavorable
McGraw-Hill/Irwin
= $24,000
Efficiency variance
$1,000 unfavorable
Slide 45
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)
McGraw-Hill/Irwin
Slide 46
Responsibility for Labor Variances

Production managers are
usually held accountable
for labor variances
because they can
influence the:
Mix of skill levels

assigned to work tasks.
Level of employee
motivation.
Quality of production
supervision.
Production Manager
McGraw-Hill/Irwin
Quality of training
provided to employees.
Slide 47
Responsibility for Labor Variances
I am not responsible for

the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
McGraw-Hill/Irwin
I think it took more time

to process the
materials because the
Maintenance
Department has poorly
maintained your
equipment.
Slide 48
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.
McGraw-Hill/Irwin
Slide 49
Quick Check
Zippy
Hansons labor rate variance (LRV) for the

week was:
b. $310 favorable.
d. $300 favorable.
McGraw-Hill/Irwin
Slide 50
Quick Check
Zippy
Hansons labor rate variance (LRV) for the

week was:
b. $310 favorable.
LRV = AH(AR - SR)
LRV = 1,550 hrs($12.20 - $12.00)
d. $300 favorable.LRV = $310 unfavorable
McGraw-Hill/Irwin
Slide 51
Quick Check
Zippy
Hansons labor efficiency variance (LEV)

for the week was:
b. $590 favorable.
d. $600 favorable.
McGraw-Hill/Irwin
Slide 52
Zippy
Quick Check
Hansons labor efficiency variance (LEV)

for the week was:
b. $590 favorable.
d. $600 favorable.
LEV = SR(AH - SH)
LEV = $12.00(1,550 hrs - 1,500 hrs)
LEV = $600 unfavorable
McGraw-Hill/Irwin
Slide 53
Zippy
Quick Check
Actual Hours
Actual Rate
Actual Hours
Standard Rate
1,550 hours
$12.20 per hour
1,550 hours
$12.00 per hour
= $18,910
= $18,600
Rate variance
$310 unfavorable
McGraw-Hill/Irwin
Standard Hours
Standard Rate
1,500 hours
$12.00 per hour

= $18,000
Efficiency variance
$600 unfavorable
Slide 54
Compute the variable

manufacturing overhead rate
and efficiency variances.
McGraw-Hill/Irwin
Slide 55
Variable Manufacturing Overhead Variances

An Example
Glacier Peak Outfitters has the following direct variable
manufacturing overhead labor standard for its mountain
parka.
1.2 standard hours per parka at $4.00 per hour
Last month, employees actually worked 2,500 hours to
make 2,000 parkas. Actual variable manufacturing
overhead for the month was $10,500.
McGraw-Hill/Irwin
Slide 56

Summary
Actual Hours
Actual Rate
Actual Hours
Standard Rate
Standard Hours
Standard Rate
2,500 hours
$4.20 per hour
2,500 hours
$4.00 per hour
2,400 hours
$4.00 per hour
= $10,500
= $10,000
= $9,600
Rate variance
$500 unfavorable
McGraw-Hill/Irwin
Efficiency variance
$400 unfavorable
Slide 57

Summary
Actual Hours
Actual Rate
2,500 hours
$4.20 per hour
= $10,500
Actual Hours
Standard Rate
2,500 hours
2,400 hours
$10,500 2,500 hours

$4.00
per per
hourhour
$4.00 per hour
= $4.20
= $10,000
Rate variance
$500 unfavorable
McGraw-Hill/Irwin
Standard Hours
Standard Rate
= $9,600
Efficiency variance
$400 unfavorable
Slide 58

Summary
Actual Hours
Actual Rate
Actual Hours
Standard Rate
2,500 hours
2,500 hours
1.2 hours per parka 2,000

$4.20 per hour parkas
$4.00
per hour
= 2,400
hours
= $10,500
= $10,000
Rate variance
$500 unfavorable
McGraw-Hill/Irwin
Standard Hours
Standard Rate
2,400 hours
$4.00 per hour
= $9,600
Efficiency variance
$400 unfavorable
Slide 59
Variable Manufacturing Overhead Variances:

Using Factored Equations
Variable manufacturing overhead rate variance
VMRV = AH (AR - SR)
= 2,500 hours ($4.20 per hour $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
Variable manufacturing overhead efficiency variance

VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
McGraw-Hill/Irwin
Slide 60
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.
McGraw-Hill/Irwin
Slide 61
Quick Check
Zippy
Hansons rate variance (VMRV) for variable

manufacturing overhead for the week was:
b. $400 favorable.
d. $300 favorable.
McGraw-Hill/Irwin
Slide 62
Quick Check
Zippy
Hansons rate variance (VMRV) for variable

manufacturing overhead for the week was:
b. $400 favorable.
VMRV = AH(AR - SR)
VMRV = 1,550 hrs($3.30 - $3.00)
d. $300 favorable. VMRV = $465 unfavorable
McGraw-Hill/Irwin
Slide 63
Quick Check
Zippy
Hansons efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
b. $435 favorable.
d. $150 favorable.
McGraw-Hill/Irwin
Slide 64
Quick Check
Zippy
Hansons efficiency variance (VMEV) for

variable manufacturing overhead for the week
was:
b. $435 favorable.
1,000 units 1.5 hrs per unit
d. $150 favorable.
VMEV = SR(AH - SH)
VMEV = $3.00(1,550 hrs - 1,500 hrs)
VMEV = $150 unfavorable
McGraw-Hill/Irwin
Slide 65
Zippy
Quick Check
Actual Hours
Actual Rate
Actual Hours
Standard Rate
Standard Hours
Standard Rate
1,550 hours
$3.30 per hour
1,550 hours
$3.00 per hour
1,500 hours
$3.00 per hour
= $5,115
= $4,650
Rate variance
$465 unfavorable
McGraw-Hill/Irwin
= $4,500
Efficiency variance
$150 unfavorable
Slide 66
Variance Analysis and Management by

Exception
How do I know
which variances to
investigate?
McGraw-Hill/Irwin
Larger variances, in
dollar amount or as
a percentage of the
standard, are
investigated first.
Slide 67
A Statistical Control Chart

Warning signals for investigation
Favorable Limit
Desired Value
Unfavorable Limit
Variance Measurements
McGraw-Hill/Irwin
Slide 68
Advantages of Standard Costs

Management by
exception
Promotes economy
and efficiency
Advantages
Simplified
bookkeeping
McGraw-Hill/Irwin
Enhances
responsibility
accounting
Slide 69
Potential Problems with Standard Costs

Emphasizing standards
may exclude other
important objectives.
Standard cost
reports may
not be timely.
Invalid assumptions
about the relationship
between labor
cost and output.
McGraw-Hill/Irwin
Potential
Problems
Favorable
variances may
be misinterpreted.
Emphasis on
negative may
impact morale.
Continuous
improvement may
be more important
than meeting standards.
Slide 70
Compute delivery cycle time,

throughput time, and
manufacturing cycle
efficiency (MCE).
McGraw-Hill/Irwin
Slide 71
Delivery Performance Measures

Order
Received
Wait Time
Production
Started
Goods
Shipped
Process Time + Inspection Time

+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time
Process time is the only value-added time.

McGraw-Hill/Irwin
Slide 72
Delivery Performance Measures

Order
Received
Wait Time
Production
Started
Goods
Shipped
Process Time + Inspection Time

+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time

Manufacturing
Cycle
=
Efficiency
McGraw-Hill/Irwin
Value-added time
Manufacturing cycle time
Slide 73
Quick Check
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the throughput time?

a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
McGraw-Hill/Irwin
Slide 74
Quick Check
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the throughput time?

a. 10.4 days.
b. 0.2 days.
Throughput time = Process + Inspection + Move + Queue
c. 4.1 days. = 0.2 days + 0.4 days + 0.5 days + 9.3 days
d. 13.4 days. = 10.4 days
McGraw-Hill/Irwin
Slide 75
Quick Check
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the Manufacturing Cycle Efficiency (MCE)?

a. 50.0%.
b. 1.9%.
c. 52.0%.
d. 5.1%.
McGraw-Hill/Irwin
Slide 76
Quick Check
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the Manufacturing Cycle Efficiency (MCE)?

a. 50.0%.
MCE = Value-added time Throughput time
b. 1.9%.
= Process time Throughput time
c. 52.0%.
= 0.2 days 10.4 days
d. 5.1%.
= 1.9%
McGraw-Hill/Irwin
Slide 77
Quick Check
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the delivery cycle time (DCT)?

a. 0.5 days.
b. 0.7 days.
c. 13.4 days.
d. 10.4 days.
McGraw-Hill/Irwin
Slide 78
Quick Check
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days

Queue 9.3 days
What is the delivery cycle time (DCT)?

a. 0.5 days.
b. 0.7 days.
DCT = Wait time + Throughput time
c. 13.4 days.
= 3.0 days + 10.4 days
d. 10.4 days.
= 13.4 days
McGraw-Hill/Irwin
Slide 79
Predetermined Overhead Rates and Overhead

Analysis in a Standard Costing System
Appendix 11A
(Appendix 11A)
Compute and interpret the
fixed overhead budget and
volume variances.
McGraw-Hill/Irwin
Slide 81
Fixed Overhead Budget Variance

Actual
Fixed
Overhead
Budgeted
Fixed
Overhead
Fixed
Overhead
Applied
Budget
variance
Budget
variance
McGraw-Hill/Irwin
Actual
fixed
overhead
Budgeted
fixed
overhead
Slide 82
Fixed Overhead Volume Variance

Actual
Fixed
Overhead
Budgeted
Fixed
Overhead
Fixed
Overhead
Applied
Volume
variance
Volume
variance
McGraw-Hill/Irwin
Budgeted
fixed
overhead
Fixed
overhead
applied to
work in process
Slide 83
Fixed Overhead Volume Variance

Actual
Fixed
Overhead
Budgeted
Fixed
Overhead
DH FR
Fixed
Overhead
Applied
SH 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
McGraw-Hill/Irwin
Slide 84
Computing Fixed Overhead Variances
ColaCo
Production and Machine-Hour Data
Budgeted production
Standard machine-hours per unit
Budgeted machine-hours
Actual production
Standard machine-hours allowed for the actual production
Actual machine-hours
McGraw-Hill/Irwin
30,000
3
90,000
28,000
84,000
88,000
units
hours
hours
units
hours
hours
Slide 85
Computing Fixed Overhead Variances

ColaCo
Cost Data
Budgeted variable manufacturing overhead
Budgeted fixed manufacturing overhead
Total budgeted manufacturing overhead
Actual variable manufacturing overhead

Actual fixed manufacturing overhead
Total actual manufacturing overhead
McGraw-Hill/Irwin
90,000
270,000
360,000
100,000
280,000
380,000
Slide 86
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
McGraw-Hill/Irwin
Slide 87
Predetermined Overhead Rates

Variable component of the
predetermined overhead rate
$90,000
=
Variable component of the

Fixed component of the

$270,000
=
Fixed component of the

McGraw-Hill/Irwin
Slide 88
Applying Manufacturing Overhead

Overhead
applied
Predetermined
overhead rate
Standard hours allowed

for the actual output
Overhead
applied
$4.00 per
machine-hour
84,000 machine-hours
Overhead
applied
$336,000
McGraw-Hill/Irwin
Slide 89
Computing the Budget Variance
McGraw-Hill/Irwin
Actual
fixed
overhead
Budgeted
fixed
overhead
Budget
variance
Budget
variance
$280,000 $270,000
Budget
variance
$10,000 Unfavorable
Slide 90
Computing the Volume Variance

Volume
variance
Budgeted
fixed
overhead
Fixed
overhead
applied to
work in process
$3.00 per
machine-hour
Volume
variance
= $270,000
Volume
variance
= $18,000 Unfavorable
McGraw-Hill/Irwin
$84,000
machine-hours
Slide 91
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
Volume
variance
= 18,000 Unfavorable
McGraw-Hill/Irwin
90,000
84,000
mach-hours
mach-hours
Slide 92
A Pictorial View of the Variances

Actual
Fixed
Overhead
280,000
Budgeted
Fixed
Overhead
270,000
Budget variance,
$10,000 unfavorable
Fixed Overhead
Applied to
Work in Process
252,000
Volume variance,
$18,000 unfavorable
Total variance, $28,000 unfavorable

McGraw-Hill/Irwin
Slide 93
Fixed Overhead Variances

A Graphic Approach
Lets look at a
graph showing
fixed overhead
variances. We will
use ColaCos
numbers from the
previous example.
McGraw-Hill/Irwin
Slide 94
Graphic Analysis of Fixed

Overhead Variances
Budget
$270,000
Denominator
hours
0
0
McGraw-Hill/Irwin
Machine-hours (000)
90
Slide 95

Overhead Variances
Actual
$280,000
Budget
$270,000
Budget Variance 10,000 U
Denominator
hours
0
0
McGraw-Hill/Irwin
Machine-hours (000)
90
Slide 96

Overhead Variances
Actual
$280,000
Budget
$270,000
Applied
$252,000
{
{
Budget Variance 10,000 U

Volume Variance 18,000 U
Standard
hours
Denominator
hours
0
0
McGraw-Hill/Irwin
Machine-hours (000)
84
90
Slide 97
Reconciling Overhead Variances and

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

equals the under- or overapplied
overhead cost for the period.
McGraw-Hill/Irwin
Slide 98
Reconciling Overhead Variances and

Underapplied or Overapplied Overhead
ColaCo
Computation of Underapplied Overhead
Predetermined overhead rate (a)
Standard hours allowed for the actual output (b)
Manufacturing overhead applied (a) (b)
Actual manufacturing overhead
Manufacturing overhead underapplied or
overapplied
McGraw-Hill/Irwin
$
$
$
$
4.00 per machine-hour

84,000 machine hours
336,000
380,000
44,000 underapplied
Slide 99
Computing the Variable Overhead Variances
Variable manufacturing overhead rate variance

VMRV = (AH AR) (AH SR)
= $100,000 (88,000 hours
McGraw-Hill/Irwin
$1.00 per hour)
Slide 100
Computing the Variable Overhead Variances
Variable manufacturing overhead efficiency variance

VMEV = (AH SR) (SH SR)
= $88,000 (84,000 hours
McGraw-Hill/Irwin
$1.00 per hour)
Slide 101
Computing the Sum of All Variances
ColaCo
Computing the Sum of All variances
Variable overhead rate variance
Variable overhead efficiency variance
Fixed overhead budget variance
Fixed overhead volume variance
Total of the overhead variances
McGraw-Hill/Irwin
12,000
4,000
10,000
18,000
44,000
U
U
U
U
U
Slide 102
Journal Entries
to Record Variances
Appendix 11B
(Appendix 11B)
Prepare journal entries
to record standard
costs and variances.
McGraw-Hill/Irwin
Slide 104
Appendix 11B
Journal Entries to Record Variances
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
AQ AP = $1,029
AQ SP = $1,050
SQ SP = $1,000
MPV = $21 F
MQV = $50 U
Labor
AH AR = $26,250
AH SR = $25,000
SH SR = $24,000
LRV = $1,250 U
LEV = $1,000 U
Now, lets prepare the entries to record

the labor and material variances.
McGraw-Hill/Irwin
Slide 105
Appendix 11B
Recording Material Variances
GENERAL JOURNAL
Date
Description
Raw Materials
Post.
Ref.
Page 4
Debit
Credit
1,050
Materials Price Variance
21
Accounts Payable
1,029
To record the purchase of material

Work in Process
Materials Quantity Variance
Raw Materials
1,000
50
1,050
To record the use of material

McGraw-Hill/Irwin
Slide 106
Appendix 11B
Recording Labor Variances
GENERAL JOURNAL
Date
Description
Work in Process
Post.
Ref.
Page 4
Debit
24,000
Labor Rate Variance
1,250
Labor Efficiency Variance
1,000
Wages Payable
Credit
26,250
To record direct labor
McGraw-Hill/Irwin
Slide 107
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.
McGraw-Hill/Irwin
Slide 108
End of Chapter 11
McGraw-Hill/Irwin
Slide 109

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Standard Costs and Operating

2010 The McGraw-Hill Companies, Inc.

Examples: Firestone, Sears, McDonalds, hospitals,

Deviations from standards deemed significant

Type of Product Cost

Variance Analysis Cycle

Setting Standard Costs

Setting Standard Costs

I recommend using practical

Explain how direct materials

Setting Direct Material Standards

Setting Direct Labor Standards

Use time and

Setting Variable Manufacturing Overhead

The rate is the

Standard Cost Card Variable Production

A standard cost card for one unit of

$ 4.00 per lb.

Price and Quantity Standards

The buying and using activities occur at different times.

A General Model for Variance Analysis

A General Model for Variance Analysis

Materials price variance

Materials quantity variance

A General Model for Variance Analysis

A General Model for Variance Analysis

Actual quantity is the amount of direct

A General Model for Variance Analysis

Standard quantity is the standard quantity

A General Model for Variance Analysis

Actual price is the amount actually

A General Model for Variance Analysis

Standard price is the amount that should

A General Model for Variance Analysis

Compute the direct

Material Variances An Example

Last month 210 kgs. of fiberfill were purchased and

Material Variances Summary

$4.90 per kg.

$5.00 per kg.

$5.00 per kg.

Material Variances Summary

$4.90 per kg.

$5.00 per kg.

Material Variances Summary

0.1 kg per parka 2,000 parkas

Materials quantity variance

Isolation of Material Variances

Ill start computing

Hanson purchased and

The price variance is

Responsibility for Material Variances

Materials Price Variance

The standard price is used to compute the quantity variance

Responsibility for Material Variances

You purchased cheap

Your poor scheduling

Hanson Inc. has the following direct material

Hansons material price variance (MPV)

Hansons material price variance (MPV)

MPV = 1,700 lbs. ($3.90 - 4.00)

Hansons material quantity variance (MQV)

Hansons material quantity variance (MQV)

$3.90 per lb.