chapter
22(8)
Evaluating Variances from
Standard Costs
______________________________________________
OPENING COMMENTS
After studying the chapter, your students should be able to:
1. Describe the types of standards and how they are established.
2. Describe and illustrate how standards are used in budgeting.
3. Compute and interpret direct materials and direct labor variances.
4. Compute and interpret factory overhead controllable and volume variances.
5. Describe and illustrate the recording and reporting of standards and variances.
6. Describe and illustrate nonfinancial performance measures.
ADM: Describe and illustrate the use of the direct labor time variance in evaluating staff performance in a
service setting.
KEY TERMS
budget performance report
budgeted variable factory overhead
controllable variance
cost variance
currently attainable standards
direct labor rate variance
direct labor time variance
Chapter 22(8) Evaluating Variances from Standard Costs 402
direct materials price variance
direct materials quantity variance
factory overhead cost variance report
favorable cost variance
ideal standards
nonfinancial performance measure
process
standard cost
standard cost systems
standards
total manufacturing cost variance
unfavorable cost variance
volume variance
STUDENT FAQS
Do we need to know all these variance formulas? If so, is there a shortcut method we can use to
calculate the six formulas?
What is a standard, and why can it vary from company to company?
How often should a standard change?
Why does management need to evaluate variances and make adjustments?
Factory overhead is divided into fixed and variable costs. Why not call volume, fixed and
controllable, variable? It is easier to remember.
Remind me again, what’s the difference between “applied” and “budgeted”?
What do volume and controllable variances really mean?
OBJECTIVE 1
Describe the types of standards and how they are established.
SYNOPSIS
Manufacturing companies usually use standard costs for direct materials, direct labor, and factory
overhead. Accounting systems use standard cost systems to determine how much a product should cost
and how much it does cost. The differences are reported as cost variances. It requires the efforts of
engineers, accountants, and others to set standards. Ideal standards are those that can be achieved only
under perfect conditions; currently attainable standards are those that can be achieved with reasonable
effort. Standards are periodically reviewed to ensure they reflect current conditions. The use of standards
is often criticized for the following reasons: discourage improvement beyond standard, too difficult to
maintain, cause employees to lose sight of larger goals, and encourage a narrow focus.
Chapter 22(8) Evaluating Variances from Standard Costs 403
Key Terms and Definition
Currently Attainable Standards—Standards that represent levels of operation that can be
attained with reasonable effort.
Ideal Standards—Standards that can be achieved only under perfect operating conditions, such
as no idle time, no machine breakdowns, and no materials spoilage; also called theoretical
standards.
Standard Cost—A detailed estimate of what a product should cost.
Standard Cost Systems—Accounting systems that use standards for each element of
manufacturing cost entering into the finished product.
Standards—Performance goals, often relating to how much a product should cost.
SUGGESTED APPROACH
Manufacturing firms set standards for the amount and price of direct materials, direct labor, and overhead
consumed by their products. Standards establish a benchmark to be used in evaluating actual
performance. They allow management to recognize when costs are not in line with the company’s
projections and to take corrective action.
Ask your students to describe examples of standards in their daily lives. Examples include maximum and
minimum speed limits on highways or rating scales on video games (such as novice, expert, etc.)
This objective also discusses the motivational impact of standards and when they should be revised.
Stress the following points:
3. Standards should be changed when they no longer reflect operating conditions. They should not be
revised simply because workers fail to meet standards.
CLASS DISCUSSION—Motivational Impact of Standards
Ask your students to discuss whether they view the grading standards of this course, or other college
courses, as ideal (theoretical standards) or normal (currently attainable standards). Ask them to comment
on how grading standards impact their motivation to study and complete assignments.
Chapter 22(8) Evaluating Variances from Standard Costs 404
OBJECTIVE 2
Describe and illustrate how standards are used in budgeting.
SYNOPSIS
Budgeting assists managers in their control function or budgetary performance evaluation. Manufacturing
standard costs are split into two components: standard price and standard quantity. The standard cost per
unit is computed as: standard cost per unit = standard price × standard quantity. The differences between
actual and standard costs are variances. A favorable cost variance occurs when the actual cost is less than
the standard cost. An unfavorable variance occurs when the actual cost exceeds the standard cost. The
total manufacturing cost variance is the difference between total standard cost and total actual cost for the
units produced. For control purposes, the total cost variance is separated into direct materials, direct labor,
and factory overhead cost variance. Each of these variances is compared to the standard cost and
investigated so the reasons for the favorable and unfavorable variances can be understood.
Key Terms and Definitions
Budget Performance Report—A report comparing actual results with budget figures.
Cost Variance—The difference between actual cost and the flexible budget at actual volumes.
Favorable Cost Variance—A variance that occurs when the actual cost is less than standard
cost.
Total Manufacturing Cost Variance—The difference between total standard costs and total
actual costs for units produced.
Unfavorable Cost Variance—A variance that occurs when the actual cost exceeds the standard
cost.
Relevant Check Up Corner and Exhibits
Exhibit 1—Standard Cost for XL Jeans
Exhibit 2—Cost Variances
Exhibit 3—Budget Performance Report
Exhibit 4—Manufacturing Cost Variances
SUGGESTED APPROACH
Budgets exist to help companies plan, direct, and control operations. The budget performance report is a
tool that compares actual costs to budgeted costs.
A sample budget performance report is presented in text Exhibit 3. Point out that the column labeled
“Standard Cost at Actual Volume” is essentially a flexible budget. Flexible budgets were introduced in
Chapter 21(7).
The following example can be used to illustrate performance measurement under standard costing.
Assume a pizza company has set $5 as the standard cost of ingredients per pizza. The company
anticipates selling 1,000 pizzas during the next week. The budget at the beginning of the week would be
$5,000. This amount would be used for planning.
Chapter 22(8) Evaluating Variances from Standard Costs 405
Now, assume the actual number of pizzas sold during the week was 1,200. The standard cost for
ingredients to make 1,200 pizzas is $6,000. If the pizza parlor actually used $6,900 in ingredients during
the week, there is a $900 variance from standard. This is an unfavorable variance since actual costs
exceeded the standard cost for 1,200 pizzas.
Standard Cost
Actual at Actual Volume Cost Variance
Cost (1,200 pizzas) (Favorable)/Unfavorable
Pizza Ingredients $6,900 $6,000 $900
OBJECTIVE 3
Compute and interpret direct materials and direct labor variances.
SYNOPSIS
As demonstrated in the prior objective, direct materials and direct labor variances are separated. The direct
materials variance is separated into price and quantity variances. The actual cost is calculated as follows:
The direct labor variance is separated into rate and time variances. The actual costs are calculated as:
actual direct labor cost = actual rate per hour × actual time. The standard costs are calculated as follows:
standard direct labor cost = standard rate per hour × standard time. The direct labor rate variance is: direct
labor rate variance = (actual rate per hour – standard rate per hour) × actual hours. The direct labor time
Key Terms and Definitions
Direct Labor Rate Variance—The cost associated with the difference between the standard rate
and the actual rate paid for direct labor used in producing a commodity.
Direct Labor Time Variance—The cost associated with the difference between the standard
hours and the actual hours of direct labor spent producing a commodity.
Chapter 22(8) Evaluating Variances from Standard Costs 406
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Price Variance—The cost associated with the difference between the standard
price and the actual price of direct materials used in producing a commodity.
Direct Materials Quantity Variance—The cost associated with the difference between the
standard quantity and the actual quantity of direct materials used in producing a commodity.
Relevant Check Up Corner and Exhibits
Exhibit 5—Direct Materials and Direct Labor Cost Variances
Exhibit 6—Direct Materials Variance Relationships
Exhibit 7—Direct Labor Variance Relationships
Check Up Corner 22(8)1 – Direct Materials and Direct Labor Cost Variances
SUGGESTED APPROACH—Direct Material
DEMONSTRATION PROBLEM—Direct Materials Variances
To demonstrate materials variances, use the following data for Martin Manufacturing during the month of
November.
Standard: 5 pounds of direct materials are required per unit at $3.20 per pound
$3.15 per pound
Price Variance: Emphasize that a direct materials price variance shows the difference between the actual
and standard price for the actual quantity of materials used. The formula for this calculation is:
(AP – SP) AQ Used
Using the data from Martin Manufacturing:
($3.15 – $3.20) 104,000 = $5,200 favorable price variance
Quantity Variance: Emphasize that the direct materials quantity variance shows the difference between
the actual and standard quantity of materials used. This difference is measured at the standard price
because the effect of the $0.05 per pound price savings was computed in the price variance. The formula
to compute the quantity variance is:
Chapter 22(8) Evaluating Variances from Standard Costs 407
(AQ Used – SQ) SP per Unit
Using the data from Martin Manufacturing:
(104,000 – 100,000) $3.20 = $12,800 unfavorable quantity variance
Total Variance: The total materials variance is the difference between the actual and standard cost of
materials. It may be computed as follows:
(Actual Quantity Actual Price per Unit) – (Standard Quantity Standard Price per Unit)
Using the data from Martin Manufacturing:
(104,000 pounds $3.15 per pound) – (100,000 pounds $3.20 per pound)
= $327,600 – $320,000
= $7,600 unfavorable total direct materials cost variance
Price variance $ 5,200 favorable
Quantity variance 12,800 unfavorable
Total variance $ 7,600 unfavorable
GROUP LEARNING ACTIVITY—Direct Materials Variances
CLASS DISCUSSION—Interpreting Materials Variances
As you review the solution to the group learning activity above [TM 22(8)-2], ask your students to
identify which department of Brass Works, Inc. should be held accountable for each variance. Also ask
them to brainstorm possible reasons for the variance. Some examples follow:
Amount Responsibility Possible Reason(s) for Variance
Materials $420 U Purchasing Price increase from supplier.
Materials $250 U Production Waste due to machine malfunction.
Quantity Variance Department Poor quality materials.
Chapter 22(8) Evaluating Variances from Standard Costs 408
SUGGESTED APPROACH—Direct Labor
The labor rate and time variances closely mirror the materials price and quantity variances. As you
present the formulas to calculate labor variances, stress the similarity to the materials variances. Ask your
students to apply these formulas using a Group Learning Activity.
LECTURE AID—Direct Labor Variances
(Actual Rate per Hour – Standard Rate per Hour) Actual Hours Worked
(AR per Hour – SR per Hour) AH Worked
The labor time variance computes the labor cost difference due to using more or less labor time than
(Actual Hours Worked – Standard Hours) Standard Rate per Hour
(AH Worked – SH) SR per Hour
Ask your students to identify which labor variances could be caused by new employees. Answer: New
GROUP LEARNING ACTIVITY—Direct Labor Variances
TM 22(8)-3 presents labor data for Brass Works, Inc. Ask your students to work in groups to calculate
labor rate and time variances using the above formulas. The solution is shown on TM 22(8)-4.
CLASS DISCUSSION—Interpreting Materials Variances
As you review the solution on TM 22(8)-4, ask your students to identify which department of Brass
Amount Responsibility Possible Reason(s) for Variance
Labor $2,380 F Production Workers at lower wage rate
Rate Variance Department assigned to job (e.g., temporary
employees, less-skilled workers).
Time Variance Department poor quality materials.
Extra labor time required due to
machine malfunctions.