Module 22
Standard Costs and
Variance Analysis
1
Standard Costing
Definition: Standard costs are benchmarks for the cost
of a product, process, or subcomponent.
Used for Planning and Decision Making:
• Standards can be better predictors of future costs than
actual past costs.
• Can be used in product pricing, bidding, and
outsourcing decisions.
Used for Controlling Operations:
• Set performance expectations.
• Variances from standards get attention of managers.
• Management by exception - investigate variances.
Ideal versus Practical Standards:
• Ideal - attained at near perfect conditions.
• Practical - set at near normal, efficient operations
(better motivator).
2
Variances and Flexible Budget
Variances measure the difference between actual and
standard costs:
• Favorable (F) variance, if actual < standard.
• Unfavorable (U) variance, if actual > standard.
Note: variances may also be calculated for sales, but
the interpretation is reversed.
For best interpretation, we need to calculate the flexible
budget for each activity.
Flexible budget is defined as:
Actual Activity * Standard Price
FB is necessary to decompose variances into price and
quantity components, and allows managers to
investigate the components.
3
Format for Variance Analysis
Symbols: AQ = Actual quantity used;
SQ = Standard quantity allowed;
SP = Standard price per unit;
AP = Actual price per unit.
Total
actual
cost
AQ
x AP
Flexible budget
based on
actual input
AQ
x SP
|______________________|
AQ  (AP - SP)
Price variance
Total
standard
cost
SQ
x SP
|___________________|
(AQ - SQ)  SP
Quantity variance
|____________________________________________|
(AQ  AP) - (SQ  SP)
Total variance
4
Direct Labor Variance
Symbols:AQ = Actual quantity of hours used;
SQ = Standard quantity of hours allowed;
SP = Standard wage rate per hour;
AP = Actual wage rate.
Total
Flexible budget
Total
actual
based on
standard
cost
actual input
cost
AQ
AQ
SQ
 AP
 SP
 SP
|_____________________| |___________________|
AQ  (AP - SP)
(AQ - SQ)  SP
Rate variance
Efficiency variance
|_____________________________________________|
(AQ  AP) - (SQ  SP)
Total flexible budget labor variance
5
Interpreting Direct Labor Variances
Large variances in either direction indicate performance
is not as planned, due to either poor planning, poor
management, or random fluctuation.
Unfavorable rate variance:
• Could indicate overtime had to be paid, depending on
how overtime is accounted for.
• Workers were not available at lower rates.
Unfavorable wage rate variance with favorable
efficiency variance:
• Higher-paid workers performed work more efficiently.
Favorable wage variance with unfavorable efficiency
variance:
• Lower-paid workers performed work less efficiently.
6
Direct Materials Variance
(assumes quantity purchased equals quantity used)
Symbols:AQ = Actual quantity of materials used;
SQ = Standard quantity of materials allowed;
SP = Standard price per unit;
AP = Actual price per unit.
Total
Flexible budget
Total
actual
based on
standard
cost
actual input
cost
AQ
AQ
SQ
 AP
 SP
 SP
|_____________________| |___________________|
AQ  (AP - SP)
(AQ - SQ)  SP
Price variance
Quantity variance
|_____________________________________________|
(AQ  AP) - (SQ  SP)
Total flexible budget material variance
7
Interpreting Direct Materials Variances
Price variance - usually as a result of purchasing
department, but other factors may intervene
Quantity variances - usually as a result of production, but
other factors may intervene.
Unfavorable price variance with favorable quantity
variance: Higher priced materials may have less flaws,
increase production efficiency and and decrease the
use of materials quantity.
Favorable price variance with unfavorable quantity
variance: Lower priced materials may cause increased
use of materials and production problems; may also
affect labor efficiency.
8
Variable Manufacturing Overhead Variance
Total
Flexible budget
Total
actual
based on
standard
VMOH
actual use
cost
costs
AQ
AQ
SQ
x AP
x SP
x SP
|____________________| |___________________|
(AP – SP) AQ
(AQ - SQ)  SP
Spending variance
Efficiency variance
|___________________________________________|
(AQ x AP) - (SQ  SP)
Total Variable MOH variance
9