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Chapter 22(8) Evaluating Variances from Standard Costs 409
SUGGESTED APPROACH—Nonmanufacturing Businesses
Standards can be applied to nonmanufacturing businesses, provided that they use repetitive activities to
produce a common product or service. For example, businesses that specialize in fast, no-appointment-
needed oil changes provide a standard service comprised of repetitive activities. A standard cost to
perform an oil change could be developed based on the (1) standard labor time to change a customer’s oil,
(2) standard wage rate, (3) standard quantity of supplies used (motor oil, filters, etc.), and (4) standard
price of supplies.
Public accounting firms are another example of businesses that rely heavily upon standards. Budgets and
standards are used to measure performance on various client engagements, such as audits and tax work.
WRITING EXERCISE—Standards in a Nonmanufacturing Environment
Ask your students to answer the following in writing [TM 22(8)-8].
Describe a nonmanufacturing business that could benefit from the use of standards. Also
explain how standards would help that business control its operations.
Possible response: One example of a business that could benefit from the use of standards in a
nonmanufacturing environment would be medical or legal transcription. The number of words
transcribed per minute is an easy measurement to determine how employees are performing
OBJECTIVE 4
Compute and interpret factory overhead controllable and volume variances.
SYNOPSIS
The factory overhead costs are analyzed differently than materials and labor due to fixed and variable
components. Factory overhead is first separated to allow its components to be analyzed. The factory
factory overhead controllable variance = actual variable factory overhead – budgeted variable factory
overhead. The budgeted variable overhead is computed as: budgeted variable factory overhead = standard
hours for actual units produced × variable factory overhead rate. The variable factory controllable
variance is computed as: variable factory overhead controllable variance = actual variable factory
Chapter 22(8) Evaluating Variances from Standard Costs 410
hours for 100% of normal capacity – standard hours for actual units produced) × fixed factory overhead
rate. The volume variance measures the use of fixed overhead resources. Management should determine
overhead. If the actual factory overhead exceeds the budgeted factory overhead, the controllable variance
is unfavorable. If the actual factory overhead is less than the budgeted factory overhead, the volume
variance is unfavorable.
Key Terms and Definitions
produced.
Controllable Variance—The difference between the actual amounts of variable factory overhead
cost incurred and the amount of variable factory overhead budgeted for the standard product.
Factory Overhead Cost Variance Report—Reports budgeted and actual costs for variable and
fixed factory overhead along with the related controllable and volume variances.
Relevant Check Up Corner and Exhibits
Exhibit 8—Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate
Exhibit 9—Graph of Fixed Overhead Volume Variance
Exhibit 10—Factory Overhead Cost Variance Report
Exhibit 11—Factory Overhead Variances
SUGGESTED APPROACH
Consider spending extra time covering factory overhead variances, since students seem to have the most
difficulty with these variances. One of the major reasons for this is that, while direct materials and direct
labor costs are variable, factory overhead costs have both fixed and variable components. You can
continue the pattern of demonstrating variance calculations and asking students to practice these
computations, using the aids below.
DEMONSTRATION PROBLEM—Overhead Variances
rate, calculated as follows:
Estimated Total Factory Overhead Costs
Estimated Activity Base (or Driver) (e.g., direct labor or machine hours)
Chapter 22(8) Evaluating Variances from Standard Costs 411
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Factory overhead variances result when factory overhead applied to products does not equal actual
overhead. Therefore, factory overhead variances occur whenever:
1. Factory overhead costs were greater or less than estimated.
2. The company operated above or below the capacity anticipated when estimating the activity driver.
Use the following data to illustrate factory overhead variances.
Martin Manufacturing applies factory overhead to products using direct labor hours. To calculate a
predetermined overhead rate, Martin developed the following estimates for one month of production.
Direct labor hours at 100 percent of normal capacity 12,000 hrs.
Estimated fixed factory overhead costs $120,000
Estimated variable factory overhead costs at 100 percent of normal capacity $ 84,000
As a result, Martin’s predetermined factory overhead rate is $17 per direct labor hour. Of that rate, fixed
factory overhead is $10 per hour ($120,000/12,000 hrs.) and variable factory overhead is $7 per hour
($84,000/12,000 hrs.).
Martin’s labor standards allow 0.5 direct labor hours for each unit produced. During November, 20,000
units were produced. Actual fixed factory overhead costs were $120,000. Actual variable factory
overhead costs were $88,000.
Variable Factory Overhead Controllable Variance: The text defines this variance as the difference
between actual variable overhead costs and variable overhead budgeted for the amount of product actually
produced. (Note that the text is essentially presenting a two-way overhead analysis.) This can be
expressed in the following formula:
Actual Var. OH – (Var. OH Rate per Hr. Units Produced Standard Hrs. per Unit)
Using data from Martin Manufacturing:
Actual Variable Factory Overhead = $88,000
Budgeted Variable Factory Overhead for
Actual Amount Produced = $7 20,000 units 0.50 hrs. per unit = $70,000
Controllable Variance = $88,000 – $70,000 = $18,000 unfavorable
Fixed Factory Overhead Volume Variance: This variance measures the difference between the budgeted
fixed overhead at 100 percent of normal capacity and the standard fixed overhead for the amount of
product actually produced. In essence, it measures the impact of spreading fixed overhead over the wrong
number of units, whenever actual production does not equal the amount anticipated by the predetermined
fixed overhead rate. This can be expressed in the following formula:
(Hrs. at 100% of normal capacity – Std. Hrs. for Actual Production) Fixed OH Rate per Hr.
Chapter 22(8) Evaluating Variances from Standard Costs 412
Remind students that the term “Hrs. at 100% of normal capacity” is the hours used in computing the
predetermined overhead rate.
Using the data from Martin Manufacturing:
(12,000 hours – 10,000 hours) $10 per hr. = $20,000 unfavorable
Therefore, Martin’s total overhead variance is as follows:
Controllable variance $ 18,000 unfavorable
Volume variance 20,000 unfavorable
Total overhead variance $ 38,000 unfavorable
Emphasize that the total factory overhead variance is also the difference between actual overhead costs
GROUP LEARNING ACTIVITY—Overhead Variances
TM 22(8)-5 presents data for your students to use in calculating overhead variances. The solution to the
exercise is provided on TM 22(8)-6.
OBJECTIVE 5
Describe and illustrate the recording and reporting of standards and variances.
SYNOPSIS
depending on whether the amount requested was above or below the standard, and Materials would be
credited. A debit balance in the direct materials quantity variance account represents an unfavorable
variance. The direct labor entries are summarized as: Work in Process is debited, Wages Payable is
credited for the actual direct labor cost, Direct Labor Rate Variance is debited for an unfavorable variance
Chapter 22(8) Evaluating Variances from Standard Costs 413
Relevant Check Up Corner and Exhibits
Exhibit 12—Variance from Standards in Income Statement
SUGGESTED APPROACH
Some companies choose to integrate standards and variances into their accounting records. When this
occurs, entries to the materials, work in process, and finished goods inventory accounts are recorded at
standard, not actual, costs. It is helpful to illustrate these entries for your students. A demonstration
problem is included below for that purpose.
DEMONSTRATION PROBLEM—Journal Entries at Standard
Purchase of Materials: Brass Works used 1,050 pounds of direct materials that cost $5.40 per pound. The
effect of paying $0.40 more per pound than standard was a $420 unfavorable price variance. The purchase
of these materials would be recorded as follows:
Materials (1,050 pounds $5.00) 5,250
Direct Materials Price Variance 420
Accounts Payable (1,050 pounds $5.40) 5,670
Requisition of Materials: Brass Works used 1,050 pounds of direct materials for production when the
standard materials quantity was only 1,000 pounds. The effect of using more materials than standard is
recorded when the materials are transferred to Work in Process.
Work in Process (1,000 pounds $5.00) 5,000
Direct Materials Quantity Variance 250
Materials (1,050 pounds $5.00) 5,250
amount of materials still on hand.
Payment of Direct Labor Costs: Brass Works incurred 2,380 direct labor hours at a cost of $9 per hour.
The standard was 2,000 hours at $10 per hour. The payroll entry to record direct labor wages is:
Work in Process (2,000 hours $10) 20,000
Direct Labor Time Variance 3,800
Direct Labor Rate Variance 2,380
Chapter 22(8) Evaluating Variances from Standard Costs 414
Wages Payable 21,420
The work in process account is debited for the standard labor rate and standard labor time.
Remind students that variances are usually transferred to Cost of Goods Sold at the end of the year.
management use. Exhibit 12 in the text provides an example of an income statement that reports
variances. The key to this exhibit is understanding how the variances affect gross profit. Use the chart on
TM 22(8)-7 to explain the impact of favorable and unfavorable variances on gross profit.
OBJECTIVE 6
SYNOPSIS
A nonfinancial performance measure expresses performance in a measure other than dollars. Using
financial and nonfinancial performance measures aids managers and employees in considering multiple
performance objectives. Examples of nonfinancial performance measures are listed in Exhibit 13.
Nonfinancial measures are often linked to either the inputs or outputs of an activity or process. A process
Key Terms and Definitions
Nonfinancial Performance Measure—A performance measure expressed in units rather than
dollars.
Process—A sequence of activities linked together for performing a particular task.
Relevant Check Up Corner and Exhibits
Exhibit 13—Nonfinancial Performance Measures
Chapter 22(8) Evaluating Variances from Standard Costs 415
SUGGESTED APPROACH
WRITING EXERCISE—Nonfinancial Performance Measures
Ask your students to write their opinion on the following questions [TM 22(8)-9]:
Students’ scores on exams may be equated to financial measures used to evaluate
employee performance in a business. Should college professors limit their evaluation of
Possible response: Professors use optional measures to evaluate students all the time. Attendance,
extra credit, and the subjective nature of some assignments provide options for evaluation on
course work other than exam scores. Benefits include motivating students to put in extra time and
effort to grasp the subject. In academia as in business, financial measures are not always the final
or only performance measure.
CLASS DISCUSSION—Nonfinancial Performance Measures
ADM OBJECTIVE
Describe and illustrate the use of the direct labor time variance in evaluating staff
performance in a service setting.
SYNOPSIS
are repetitive in nature.
Relevant Check Up Corner and Exhibits
Make a Decision – Service Staffing Variances
Type Item Description Video Excel CLGL LO(s) Difficulty Time Est BUSPROG AICPA
ACBSP - Primary Bloom's ADM Service Real World
Writing
Ethics
MC 1 3 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
MC 2 3 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
MC 3 4 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
MC 4 4 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
MC 5 4 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 1 Direct materials variances x 3 Easy 10 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 2 Direct labor variances x 3 Easy 10 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 3 Factory overhead controllable variance x 4 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 4 Factory overhead volume variance x 4 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 5 Standard cost journal entries x 5 Easy 5 min. Analytic FN - Measurement Budgeting and Responsibility Applying
LREX 6 Income statement with variances x 5 Easy 15 min. Analytic FN - Measurement Budgeting and Responsibility Applying
Focus
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