Variance Analysis

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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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 Exh.

Variance Analysis Cycle

10-1

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 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 Direct Labor Standards

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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 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 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.
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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.

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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.
× × ×
$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:
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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 Material Variances

The price variance is

computed on the entire
quantity purchased.
The quantity variance
is computed only on
the quantity used.

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 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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 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.

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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
× × ×
$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:
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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 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.

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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
× × ×
$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: 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

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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.

A Statistical Control Chart

10-9

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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