STANDARD COSTING AND
VARIANCE ANALYSIS
Acc 2203 workshop
Sindhu bala
Variances
Managers use variance analysis to compare actual results with expected results and to
investigate why actual results differ from expectations for performance evaluation
purposes.
A firm sets standards for production costs to articulate its expectations with respect to its
operational performance and financial results. Setting production cost standards
requires a collaborative effort by accountants, engineers, personnel administrators, and
production managers

Direct Material Standards:



Direct Labor Standards:



Rate standards – Use labor contracts, wage surveys
Time standards – Use time and motion studies
Variable Overhead Standards:



Price standards – Final cost of materials after delivery and net of discounts
Quantity standards – Use product design specifications
Rate standards – Variable portion of the predetermined overhead rate
Activity standards – Expected usage of the allocation base
Fixed Overhead Standards:

Fixed portion of predetermined overhead rate
Example – Chocolate Co.
Chocolate Co.
Standard Cost For One Chocolate In 2010
Standard quantity
of input to
make one
chocolate
Standard price of
input
1
$7
$7
Direct Labor
.5 DLH
$10/DLH
$5
Variable overhead
.5DLH
$6/DLH
$3
Fixed overhead
.5DLH
$10/DLH
$5
Direct Materials
Total standard
cost per unit
Standard cost of
input per
chocolate
$20
Variance Analysis
Cost variance – the difference between actual cost
and expected/budgeted/standard cost
Favorable cost variance – occurs when actual cost
is lower than expected cost for a given level of
output
Unfavorable cost variance – occurs when actual
cost is greater than expected cost for a given
level of output
Do favorable cost variances always signal that the
company has performed well in keeping its costs
down?
A General Framework For Variance Analysis
Actual Quantity (AQ)
X Actual Price (AP)

Actual Quantity
(AQ) x Standard
Price (SP)
Standard Quantity
(SQ) x Standard Price
(SP)
Price Variance
Quantity Variance
AQ (AP-SP)
SP (AQ-SQ)
IMPORTANT NOTE: SQ is the standard quantity allowed for the
ACTUAL units produced
A General Framework For Variance Analysis
Actual Quantity (AQ)
X Actual Price (AP)
Actual Quantity
(AQ) x Standard
Price (SP)
Standard Quantity
(SQ) x Standard Price
(SP)
Price Variance
Quantity Variance
AQ (AP-SP)
SP (AQ-SQ)
Total Variance

IMPORTANT NOTE: SQ is the standard quantity allowed for the
ACTUAL units produced
General Framework for Variance Analysis
Direct Material Variances – Example 3
The Cane Company produced 500 industrial plastic containers. The standard
cost of making each container is 3lb. of plastic at $1.5/lb. (same as above).
SQ
x
SP
Standard quantity of plastic
Standard price of plastic
allowed for producing 500 containers
3 lb./container x 500 containers = 1,500 lb. x
$1.5/lb =$2,250
To make 500 containers the company purchased and used 2,000 lb. of plastic
and incurred $4,000 for the cost of plastic.
Total Variance:
The cause of the variance: Was the plastic quantity different from the
standard? Was the price paid for plastic different from the standard?
Formulas for computing DM variances



Materials price variance =
AQ x AP – SP x AQ = AQ (AP – SP)
Materials quantity variance =
AQ x SP – SP x SQ = SP (AQ – SQ)
Compute the materials price variance and materials quantity variance
for the Cane Company using the last example
DM price variance =
DM quantity variance =
In the last example, the Cane Company purchased expensive materials
that cost the company $1,000 more than expected; the materials were
not used as efficiently as expected costing the company an additional
$750. How can the company act on this information?
Direct Material Variances When Quantity Of Materials
Purchased Is Not Equal To The Quantity Of Materials Used In
Production
When quantity of materials purchased is not equal to the quantity of materials
used in production:
-Compute materials price variance using quantity of materials purchased
-Compute materials quantity variance using quantity of materials used in
production
Example: Mert Company uses a standard cost system. Information for raw materials
for Product A for the month of October follows:
 Standard price per pound of raw materials:
$1.60
 Actual purchase price per pound of raw materials:
$1.55
 Actual quantity of raw materials purchased:
2,000 pounds
 Actual quantity of raw materials used:
1,900 pounds
 Standard quantity allowed for actual production:
1,800 pounds
Compute Mert’s materials price variance and materials quantity variance for
Product A
Direct Material Variances When Quantity Of Materials
Purchased Is Not Equal To The Quantity Of Materials Used In
Production
AQxAP

AQxSP
SQxSP
Explain why the quantity of materials purchased is
more appropriate in calculating materials price
variance than the quantity of materials used in
production
Concept Check
1. The standard and actual prices per pound of raw material are $4.00 and
$4.50, respectively. A total of 10,500 pounds of raw material was
purchased and then used to produce 5,000 units. The quantity standard
allows two pounds of the raw material per unit produced. What was the
materials quantity variance?
a. $5,000 unfavorable
b. $5,000 favorable
c. $2,000 favorable
d. $2,000 unfavorable
2. Referring to the facts in question 1 above, what was the material price
variance?
a. $5,250 favorable
b. $5,250 unfavorable
c. $5,000 unfavorable
d. $5,000 favorable
Concept Check
3. The actual direct labor wage rate is $8.50 and 4,500 direct labor hours
were actually worked during the month. The standard direct labor wage
rate is $8.00 and the standard quantity of hours allowed for the actual
level of output was 5,000 direct labor hours. What was the direct labor
efficiency variance?
a. $4,000 favorable
b. $4,000 unfavorable
c. $4,500 unfavorable
d. $4,500 favorable
4. Referring to the facts in question 3 above, what is the variable overhead
efficiency variance if the standard variable overhead per direct labor
hour is $5.00?
a. $5,000 favorable
b. $5,000 unfavorable
c. $2,500 unfavorable
d. $2,500 favorable
Variable Overhead Variances
Actual
Variable
Overhead
Incurred
Flexible Budget
for Variable
Overhead at
Actual Hours
AH × AR
Rate
Variance
AH ×
SR
Flexible Budget
for Variable
Overhead at
Standard Hours
SH ×
SR
Efficiency
Variance
Rate variance = AH(AR - SR)
Efficiency variance = SR(AH - SH)
Variable Overhead Variances –
Example
ColaCo’s actual production for the period required 3,200 standard machine
hours. Actual variable overhead incurred for the period was $6,740.
Actual machine hours worked were 3,300. The standard variable
overhead cost per machine hour is $2.00.
Compute the variable overhead rate variance and variable overhead
efficiency variance.
.
Quick Check 
Yoder Enterprises’ actual production for the period
required 2,100 standard direct labor hours. Actual
variable overhead for the period was $10,950.
Actual direct labor hours worked were 2,050. The
predetermined variable overhead rate is $5 per
direct labor hour. What was the variable overhead
rate variance?
a. $450 U
b. $450 F
c. $700 F
d. $700 U
Quick Check 
Yoder Enterprises’ actual production for the period
required 2,100 standard direct labor hours. Actual
variable overhead for the period was $10,950.
Actual direct labor hours worked were 2,050. The
predetermined variable overhead rate is $5 per
direct labor hour. What was the VOH efficiency
variance?
a. $450 U
b. $450 F
c. $250 F
d. $250 U
Overhead Rates and Overhead
Analysis
Recall that overhead costs are assigned to
products and services using a predetermined
overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
POHR
=
Overhead from the
flexible budget for the
denominator level of activity
Denominator level of activity
Overhead Rates and Overhead
Analysis
The predetermined overhead rate can also be broken
down into fixed and variable components:
The variable component is useful for preparing and
analyzing variable overhead variances.
The fixed component is useful for preparing and
analyzing fixed overhead variances.
Normal versus Standard Cost Systems
In a normal cost system, overhead is applied to work
in process based on the actual number of hours
worked in the period.
In a standard cost system, overhead is applied to
work in process based on the standard hours
allowed for the output of the period.
Fixed Overhead Variances
Actual Fixed
Overhead
Incurred
Budget
Variance
Fixed
Overhead
Budget
Fixed
Overhead
Applied
DH × FR
SH × FR
Volume
Variance
FR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
DH = Denominator Hours
Overhead Rates and Overhead
Analysis – Example
ColaCo prepared this flexible budget for overhead:
Machine
Hours
3,000
4,000
Total
Variable
Overhead
$
Variable
Overhead
Rate
6,000
?
8,000
?
Total
Fixed
Overhead
$
Fixed
Overhead
Rate
9,000
?
9,000
?
Let’s calculate overhead rates.
ColaCo applies overhead based
on machine-hour activity.
Fixed Overhead Variances – Example
ColaCo’s actual production required 3,200
standard machine hours. Actual fixed overhead was
$8,450. The predetermined overhead rate is based on
3,000 machine hours.
What is the budget variance?
The volume variance?
Volume Variance – A Closer Look
Volume
Variance
Results when standard hours
allowed for actual output differs
from the denominator activity.
Unfavorable
when standard hours
< denominator hours
Favorable
when standard hours
> denominator hours
Volume Variance – A Closer Look
Volume
Variance
Does not
measure overor under spending
Results when standard hours
actualtreating
output differs
Itallowed
resultsforfrom
fixed
from
the denominator
activity.
overhead
as if it were
a
variable cost.
Unfavorable
when standard hours
< denominator hours
Favorable
when standard hours
> denominator hours
Quick Check 
Yoder Enterprises’ actual production for the
period required 2,100 standard direct labor
hours. Actual fixed overhead for the period was
$14,800. The budgeted fixed overhead was
$14,450. The predetermined fixed overhead
rate was $7 per direct labor hour. What was
the budget variance?
a. $350 U
b. $350 F
c. $100 F
d. $100 U