Chapter 11Standard Costs and Variance

Analysis

Presentation Outline

I. Types of Standards

II. Variance Calculations

III. Investigation of Standard Cost Variances

I. Types of Standards

Ideal Standards

Can only be attained under the best

circumstances. No allowance for machine breakdowns or work

interruptions

Attainable Standards

Tight but attainable standards. Allows for

machine downtime and employee rest

periods.

II. Variance CalculationsA. Material Price Variance

B. Material Price Variance Journal Entry

C. Material Quantity Variance

D. Material Quantity Variance Journal Entry

E. Labor Rate Variance

F. Labor Efficiency Variance

G. Journal Entry for Direct Labor Variances

H. Controllable Overhead Variance

I. Overhead Volume Variance

A. Material Price Variance

MPV = (AP – SP) AQ

where:

MPV = Material price variance

AQ = Actual quantity of materials purchased

AP = Actual unit price of materials

SP = Standard unit price of materials

Decision Rule: AP > SP Unfavorable

AP < SP Favorable

B. Material Price Variance Journal Entry

(Recorded at Time of Purchase)

Raw Materials (AQ x SP) XXX

Materials Price Variance [(AP-SP)AQ] XXX or XXX

Accounts Payable (AQ x AP) XXX

C. Material Quantity Variance

MQV = (AQ – SQ) SP

where:

MQV = Material quantity variance

SP = Standard unit price of materials

AQ = Actual quantity of materials put into productionSQ = Standard quantity allowed for the output produced

Decision Rule: AQ > SQ Unfavorable

AQ < SQ Favorable

D. Material Quantity Variance Journal Entry

(Recorded when materials are put into production)

Work in Process (SQ x SP) XXX

Materials Quantity Variance [(AQ-SQ)SP] XXX or XXX

Raw Materials (AQ x SP) XXX

E. Labor Rate Variance

LRV = (AR – SR) AH

where:

LRV = Labor rate variance

AH = Actual labor hours worked

AR = Actual labor rateSR = Standard labor rate

Decision Rule: AR > SR Unfavorable

AR < SR Favorable

F. Labor Efficiency Variance

LEV = (AH – SH) SR

where:

LEV = Labor efficiency variance

SR = Standard labor rate

AH = Actual labor hours workedSH = Standard hours allowed for the output produced

Decision Rule: AH > SH Unfavorable

AH < SH Favorable

G. Journal Entry for Direct Labor Variances

Work in Process (SH x SR) XXX

Labor Rate Variance [(AR-SR)AH] XXX or XXX

Labor Efficiency Variance [(AH-SH)SR] XXX or XXX

Wages Payable (AH x AR) XXX

H. Controllable Overhead Variance

Flexible budget level of overhead

for the actual level of production

Decision Rule: Actual > Flexible budget Unfavorable

Actual < Flexible budget Favorable

Actual overhead

Controllable overhead variance

= -

I. Overhead Volume Variance

Overhead applied to production using standard overhead

rate

Decision Rule:Flexible budget > O/H applied UnfavorableFlexible budget < O/H applied Favorable

Flexible budget level of overhead for actual

level of production

Overhead volume

variance= -

III. Investigation of Standard Cost Variances

A. Management by ExceptionB. “Favorable” Variances May be

UnfavorableC. Process Improvements and “Unfavorable

VariancesD. Variance Evaluation and Excess

ProductionE. Variance Analysis and Performance

Evaluation

A. Management by Exception

Most managers take a “management by exception” approach and investigate only

those variances that they deem to be exceptional.

The absolute dollar value of the variance or the variance as a percent of actual or

standard cost is often used as the criterion.

B. “Favorable” Variances May be Unfavorable

The fact that a variance is favorable does not mean that it should not be investigated. Indeed, a favorable variance may be indicative of poor management decisions. For

example:A favorable material price variance may be arisen from

purchasing goods of inadequate quality for production.A favorable overhead volume variance could mean that

excessive inventory has been produced beyond customer demand.

C. Process Improvements and Unfavorable Variances

Production workers suggest a change in the manufacturing process so that the standard for labor time per unit is reduced from 4 to 3 hours. If the company does not need to increase production and keeps the same

number of workers, an unfavorable labor efficiency variance will arise.

(See Illustration on page 397)

D. Variance Evaluation and Excess Production

The Theory of Constraints tells us that production departments in front of bottleneck departments should

not produce excess work-in-process inventory.Evaluation in terms of standard cost variances could

result in this dysfunctional behavior.For example, rather than lay off workers, a department

with a temporary demand slump may produce excess units simply to avoid an unfavorable labor efficiency

variance.

E. Variance Analysis and Performance Evaluation

Responsibility accounting states that managers should only be held accountable

for variance that they can control.Unfavorable variances do not imply poor performance. For example, an unfavorable labor efficiency variance could result from

the purchase of inferior goods (which by the way resulted in a favorable material price

variance).

Summary

Ideal vs. Attainable StandardsMaterial VariancesLabor Variances

Overhead Variances