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Chapter 11

Standard Costs and Variance

Analysis

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Presentation Outline

I. Types of Standards

II. Variance Calculations

III. Investigation of Standard Cost Variances

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I. Types of Standards

Ideal Standards

Can only be attained

under the bestcircumstances. No

allowance for machine

breakdowns or work

interruptions

Attainable Standards

Tight but attainable

standards. Allows formachine downtime and

employee rest periods.

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II. Variance Calculations

A. 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 VariancesH. Controllable Overhead Variance

I. Overhead Volume Variance

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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

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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

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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 production

SQ = Standard quantity allowed for the output produced

Decision Rule: AQ > SQ Unfavorable

AQ < SQ Favorable

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D. Material Quantity Variance JournalEntry(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

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E. Labor Rate Variance

LRV = (AR SR) AH

where:

LRV = Labor rate variance

AH = Actual labor hours worked

AR = Actual labor rate

SR = Standard labor rate

Decision Rule: AR > SR Unfavorable

AR < SR Favorable

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F. Labor Efficiency Variance

LEV = (AH SH) SR

where:

LEV = Labor efficiency variance

SR = Standard labor rate

AH = Actual labor hours worked

SH = Standard hours allowed for the output produced

Decision Rule: AH > SH Unfavorable

AH < SH Favorable

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G. Journal Entry for Direct LaborVariances

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

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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

Controllableoverhead

variance= -

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I. Overhead Volume Variance

Overhead appliedto production using

standard overhead

rate

Decision Rule:

Flexible budget > O/H applied Unfavorable

Flexible budget < O/H applied Favorable

Flexible

budget level

of overhead

for actual

level of

production

Overheadvolume

variance= -

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III. Investigation of Standard

Cost VariancesA. Management by Exception

B. Favorable Variances May be

UnfavorableC. Process Improvements and Unfavorable

Variances

D. Variance Evaluation and ExcessProduction

E. Variance Analysis and PerformanceEvaluation

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A. Management by Exception

Most managers take a management by

exception approach and investigate only

those variances that they deem to beexceptional.

The absolute dollar value of the variance or

the variance as a percent of actual orstandard cost is often used as the criterion.

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B. Favorable Variances May

be UnfavorableThe 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. Forexample:

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.

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C. Process Improvements and

Unfavorable Variances

Production workers suggest a change in themanufacturing process so that the standardfor labor time per unit is reduced from 4 to3 hours. If the company does not need toincrease production and keeps the same

number of workers, an unfavorable laborefficiency variance will arise.

(See Illustration on page 397)

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D. Variance Evaluation and

Excess ProductionThe 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.

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E. Variance Analysis and

Performance EvaluationResponsibility 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 fromthe purchase of inferior goods (which by the

way resulted in a favorable material price

variance).

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Summary

Ideal vs. Attainable Standards

Material Variances

Labor Variances

Overhead Variances