Week 5: Variance Analysis

Types of Standards
Ideal Standards demand
maximum efficiency and can
be achieved only if everything
operates perfectly.

Currently attainable standards

can be achieved under
efficient operating conditions.
Standard Costs

Based on carefully
predetermined amounts.

Used for planning labor

Standard and material requirements.
Costs are
The expected level
of performance.

Benchmarks for
measuring performance.
Perfection versus Practical Standards: A
Behavioral Issue

Practical standards
should be set at levels
that are currently
attainable with
reasonable and
Should we use efficient effort.
practical standards
or perfection
standards?
Cost Variance Analysis

Standard Cost Variances

Price Variance Quantity Variance

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity
Managerial Uses of Variance Analysis
• Key use of variances is performance evaluation:
– Effectiveness: the degree to which a predetermined objective is met
– Efficiency: the amount of inputs used to achieve a given level of
output
• Use a combination of financial and non-financial
performance measures
• When to investigate variances?
– For critical items, even small variances may be investigated
– For less critical areas, investigate only if significant
– Important to understand the cause for variances and use this
knowledge to promote continuous improvement
Variance Analysis Cycle

Take
Identify Receive corrective
questions. explanations. actions.

Conduct next
Analyze period’s
variances. operations.
Prepare standard
Begin cost performance
report.
Static and Flexible Budgets
• Static budget:
– Based on one level of output
– Is not altered after it is issued even if circumstances change
• Static budget variance:
– The difference between the actual result and the corresponding
static budget amount
• Flexible budget:
– A budget which is adjusted for changes in the actual level of output
or actual revenue and cost drivers
– Allows for more meaningful comparisons between (adjusted)
budget and actual results
Static Budgets and
Performance Reports

Static Actual
Budget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F
Flexible Production Budget
VC Range of
Production
Production Costs per Unit 2,400 3,000 3,600
Variable:
Direct materials $0.26 $ 624 $ 780 $ 936
Direct labour 0.15 360 450 540
Variable overhead:
Supplies 0.03 72 90 108
Indirect labour 0.07 168 210 252
Power 0.02 48 60 72
Total variable costs $0.53 $1,272 $1,590
$1,908
Fixed overhead:
Supervision $ 100 $ 100 $ 100
Amortization 200 200 200
Rent 20 20 20
Total fixed costs $ 320 $ 320 $ 320
Total production costs $1,592 $1,910 $2,228
===== ===== =====
Performance Report
Actual Budgeted Variance
Units produced 3,000 2,400 600 F
==== ==== ====
Direct materials cost $ 927.3 $ 624.0 $303.3 U
Direct labour costs 450.0 360.0 90.0 U
Overhead:
Variable:
Supplies 80.0 72.0 8.0 U
Indirect labour 220.0 168.0 52.0 U
Power 40.0 48.0 (8.0) F
Fixed:
Supervision 90.0 100.0 (10.0) F
Amortization 200.0 200.0 0.0
Rent 30.0 20.0 10.0 U
Total $2,037.3 $1,592.0 $445.3 U ======
====== ======
Actual vs. Flexible Performance Report
Actual Budget Variance
Units produced 3,000 3,000 -----
==== ==== ====
Production costs:
Direct materials $ 927.3 $ 780.0 $ 147.3 U
Direct labour 450.0 450.0 0.0
Variable overhead:
Supplies 80.0 90.0 (10.0) F
Indirect labour 220.0 210.0 10.0 U
Power 40.0 60.0 (20.0) F
Total variable costs $1,717.3 $1,590.0 $ 127.3 U
Fixed overhead:
Supervision $90.0 $100.0 $(10.0) F
Amortization 200.0 200.0 0.0
Rent 30.0 20.0 10.0 U
Total fixed costs $ 320.0 $ 320.0 $0.0
Total production costs $2,037.3 $1,910.0 $ 127.3 U
======= ======= ======
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 resources acquired.
A General Model for Variance Analysis

AQ x AP AQ x SP
SQ*x SP

Price Variance Quantity Variance

AQ(AP - SP) SP(AQ - SQ)
Materials price variance Materials quantity variance
AQ = Actual
Labor Quantity
rate variance Labor efficiency SP = Standard Price
variance
Variable overhead Variable overhead
AP = Actual
spending variance
Price SQ* = Standard
efficiency variance
Quantity
SQ* will always require a calculation
Material Variances Zippy

Hanson Inc. has the following direct material

standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 1,700 pounds of material were
purchased and used to make 1,000 Zippies.
The material cost a total of $6,630.
Material Variances Zippy

What is the actual price per pound

paid for the material?

a. $4.00 per pound.

b. $4.10 per pound.
c. $3.90 per pound.
d. $6.63 per pound.
Material Variances Zippy

Hanson’s material price variance (MPV)

for the week was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
Material Variances Zippy

The standard quantity of material that

should have been used to produce
1,000 Zippies is:

a. 1,700 pounds.
b. 1,500 pounds.
c. 2,550 pounds.
d. 2,000 pounds.
Material Variances Zippy

Hanson’s material quantity variance (MQV) for the week

was:

a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
 Material Variances Summary

Actual Quantity Actual Quantity Standard Quantity*

× ×
×
Actual Price Standard Price Standard Price

1,700 lbs. 1,700 lbs. 1,500

lbs. (1.5lb x 1000)
× × ×
$3.90 per lb. $4.00 per lb.
$4.00 per lb.
$6,630 $ 6,800 $6,000

Price variance Quantity variance

$170 favorable $800 unfavorable
Material Variances
Zippy
Part 2

Hanson Inc. has the following material standard to

manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week 2,800 pounds of material were purchased at a
total cost of $10,920, and 1,700 pounds were used to make
1,000 Zippies.
Material Variances Zippy

Actual Quantity Actual Quantity

Purchased Purchased
× ×
Actual Price Standard Price

2,800 lbs. 2,800 lbs.

× ×
$3.90 per lb. $4.00 per lb.
$10,920 $11,200

Price variance increases because

quantity purchased increases.
Price variance
$280 favorable
Material Variances Zippy

Actual Quantity
USED
Standard Quantity
×
×
Standard Price Standard
Price
1,700 lbs.
1,500 lbs.
×
×
$4.00 per lb.
$4.00 per lb.
Quantity variance is unchanged $6,800
because
$6,000 actual and standard
quantities are unchanged.
Quantity variance
$800 unfavorable
Labor Variances Zippy

Hanson Inc. has the following direct labor

standard to manufacture one Zippy:
1.5 standard hours per Zippy at $10.00 per direct
labor hour
Last week 1,550 direct labor hours were
worked at a total labor cost of $15,810 to
make 1,000 Zippies.
Labor Variances Zippy

What was Hanson’s actual rate (AR)

for labor for the week?

a. $10.20 per hour.

b. $10.10 per hour.
c. $9.90 per hour.
d. $9.80 per hour.
Labor Variances Zippy

Hanson’s labor rate variance (LRV)

for the week was:

a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
Labor Variances Zippy

The standard hours (SH) of labor that

should have been worked to produce
1,000 Zippies is:

a. 1,550 hours.
b. 1,500 hours.
c. 1,700 hours.
d. 1,800 hours.
Labor Variances Zippy

Hanson’s labor efficiency variance (LEV)

for the week was:

a. $510 unfavorable.
b. $510 favorable.
c. $500 unfavorable.
d. $500 favorable.
 Labor Variances Summary
Actual Hours Actual Hours Standard
Hours*
× × ×
Actual Rate Standard Rate
Standard Rate
1,550 hours 1,550 hours 1,500 hours (1.5
x 1000)
× × ×
$10.20 per hour $10.00 per hour $10.00 per hour
$15,810 $15,500
$15,000

Rate variance Efficiency variance

$310 unfavorable $500 unfavorable
 Variable Overhead Variances
Actual Flexible Budget Flexible Budget
Variable for Variable for
Variable
Overhead Overhead at Overhead at
AH × AR
Incurred AH ×Hours
Actual SVR SH × SVR
Standard Hours

Spending Variance Efficiency

Variance

Spending variance = AH(AR - SVR)

Efficiency variance = SVR(AH - SH)
Variable Overhead Variances –
Example
ColaCo’s budgeted to manufacture 1,500 units at 2.0 hours
per unit. Actual production for the period required 3,200
standard machine hours (MH). Actual variable overhead
incurred for the period was $6,740. Actual machine hours
worked were 3,300.
The pre-determined variable manufacturing overhead rate
is $2.00/MH and Budgeted fixed manufacturing overhead is
$9,000.

Compute the variable overhead spending and efficiency

variances.
What was the budgeted Variable Overhead Cost?

• Predetermined variable overhead = $2.00/MH

• Budgeted production was 1,500 units
• Each unit was budgeted to take 2.0 MH

• Thus, budgeted Variable Manufacturing Overhead

=
Variable Overhead Variances –
Example
ColaCo prepared this budget for overhead:

Total budgeted
overhead cost =
Budgeted variable Total Budgeted fixed
× + overhead cost
overhead cost per activity
$2.00 per
Total budgetedactivity unit Total
= units
machine × machine + $9,000
overhead cost
hour hours
Variable Overhead Variances –
Example

Actual Flexible Budget Flexible Budget

Variable for Variable for Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
$6740 3300 hours 3200
hours
×
×
$2.00 per hour
$2.00 per hour
Spending variance Efficiency variance
$140$unfavorable
140U $ 200U
Variable Overhead Variances – A Closer Look
Spending Variance Efficiency Variance

Results from paying more A function of the

or less than expected for selected cost driver.
overhead items and from
It does not reflect
excessive usage of
overhead control.
overhead items.
Planning Fixed Overhead Costs
• Effective planning of fixed overhead costs is a capacity
planning issue
– The quantity of outputs that can be produced from available long-
term resources
– Capacity decisions are strategic decisions
– Cost of capacity must be recovered through sale of outputs (goods
or services) to be profitable
Fixed Overhead Variances

Actual Fixed Fixed

Fixed
Overhead Overhead
Overhead
Incurred Budget SH × POHR
Applied

Spending or Production
Flexible Budget Volume
Variance Variance
POHR (fixed) = Standard Fixed
Overhead Rate
SH = Standard Hours Allowed
Example
• ColaCo budget planned (Jan 1):
– 1,500 units x 2.0 hrs = 3,000 hrs
– Budgeted FMOH = $9,000
• Actual Results
– Actual FMOH $8,450
– Actual Production: 1,600 units
– Actual hours used = 3,300 hours
Fixed Overhead Variances – Example
ColaCo used the following predetermined
fixed overhead rate:

Budgeted Fixed Overhead

POHRf =
Planned Activity in Hours
$9,000
POHRf =
3,000 machine hours

POHRf = $3.00 per machine hour

Fixed Overhead Variances – Example

Actual Fixed Fixed Fixed

Overhead Overhead Overhead
Incurred Budget Applied

hours

×
$ $ $
$3.00 per hour

Budget variance Volume variance

$ $
Fixed Overhead Variances –
A Closer Look
Budget Variance Volume Variance

Results from paying more Results from operating

or less than expected for at an activity
overhead items. level different than
planned for the period.
Has no significance for
cost control.
 Fixed Overhead Variances
3,200 machine hours × $3.00 fixed overhead rate
Cost
$600 $9,600 applied fixed OH
Volume
Variance { $9,000 budgeted fixed OH
$550
Favorable
{ $8,450 actual fixed OH
Budget
Variance e ad
e rh ucts
ov od
ed pr
Fix d to
e
ppli
a Volume
3,000 Hours 3,200
Planned Standard
Activity Hours