1. Standard Costs and Variances
Chapter 10
Chapter 10: Standard Costs and Operating Performance Measures
This chapter extends our study of management control by explaining how standard costs are used by managers to control costs. It demonstrates how to compute direct materials, direct labor, and variable overhead variances. The chapter also defines some nonfinancial performance measures that are frequently used by companies.

2. Standard Costs
Standards are benchmarks or “norms” for measuring performance. In managerial accounting,
two types of standards are commonly used.
Quantity standards specify how much of an input should be used to make a product or provide a service.
Price standards specify how much should be paid for each unit of the input.
A standard is a benchmark or “norm” for measuring performance. In managerial accounting, two types of standards are commonly used by manufacturing, service, food, and not-for-profit organizations:
Quantity standards specify how much of an input should be used to make a product or provide a service. For example:
Auto service centers like Firestone and Sears set labor time standards for the completion of work tasks.
Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat going into a sandwich.
Price standards specify how much should be paid for each unit of the input. For example:
Hospitals have standard costs for food, laundry, and other items.
Home construction companies have standard labor costs that they apply to sub-contractors such as framers, roofers, and electricians.
Manufacturing companies often have highly developed standard costing systems that establish quantity and price standards for each separate product’s material, labor, and overhead inputs. These standards are listed on a standard cost card.
Examples: Firestone, Sears, McDonald’s, hospitals,
construction, and manufacturing companies.

3. Manufacturing Overhead
Standard Costs
Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception.
Standard
Amount
Direct Material
Management by exception is a system of management in which standards are set for various operating activities, with actual results compared to these standards. Any deviations that are deemed significant are brought to the attention of management as “exceptions.”
This chapter applies the management by exception principle to quantity and price standards with an emphasis on manufacturing applications.
Direct Labor
Manufacturing Overhead
Type of Product Cost

4. Variance Analysis Cycle
The variance analysis cycle is a continuous process used to identify and solve problems:
The cycle begins with the preparation of standard cost performance reports in the accounting department.
These reports highlight variances that are differences between actual results and what should have occurred according to standards.
The variances raise questions such as:
Why did this variance occur?
Why is this variance larger than it was last period?
The significant variances are investigated to discover their root causes.
Corrective actions are taken.
Next period’s operations are carried out and the process is repeated.

5. Setting Standard Costs
Should we use ideal standards that require employees to work at 100 percent peak efficiency?
I recommend using practical standards that are currently attainable with reasonable and efficient effort.
Standards tend to fall into one of two categories:
Ideal standards can only be attained under the best of circumstances. They allow for no work interruptions and they require employees to work at 100% peak efficiency all of the time.
Practical standards are tight, but attainable. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Practical standards can also be used for forecasting cash flows and in planning inventory.
Engineer
Managerial Accountant

6. Setting Direct Materials Standards
Standard Price per Unit
Standard Quantity per Unit
Summarized in a Bill of Materials.
Final, delivered cost of materials, net of discounts.
The standard price per unit for direct materials should reflect the final, delivered cost of the materials, net of any discounts taken.
The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies.
A bill of materials is a list that shows the quantity of each type of material in a unit of finished product.

7. Setting Direct Labor Standards
Often a single rate is used that reflects the mix of wages earned.
Standard Rate per Hour
Use time and motion studies for each labor operation.
Standard Hours per Unit
The standard rate per hour for direct labor includes not only wages earned but also fringe benefits and other labor costs. Many companies prepare a single rate for all employees within a department that reflects the “mix” of wage rates earned.
The standard hours per unit reflects the labor hours required to complete one unit of product. Standards can be determined by using available references that estimate the time needed to perform a given task, or by relying on time and motion studies.

8. Setting Variable Manufacturing Overhead Standards
The rate is the variable portion of the predetermined overhead rate.
Price Standard
The quantity is the activity in the allocation base for predetermined overhead.
Quantity Standard
The price standard for variable manufacturing overhead comes from the variable portion of the predetermined overhead rate.
The quantity standard for variable manufacturing overhead is expressed in either direct labor hours or machine hours depending on which is used as the allocation base in the predetermined overhead rate.

9. A standard cost card for one unit of product might look like this:
The Standard Cost Card
A standard cost card for one unit of product might look like this:
The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.

10. Using Standards in Flexible Budgets
Standard costs per unit for direct materials, direct labor, and variable manufacturing overhead can be used to compute activity and spending variances.
Spending variances become more useful by breaking them down into quantity and price variances.
Standard costs per unit for direct materials, direct labor, and variable manufacturing overhead can be used to compute activity and spending variances as described in the previous chapter.
Spending variances become more useful by breaking them down into quantity and price variances. This is our focus in this chapter.

11. A General Model for Variance Analysis
Quantity Variance
Difference between actual quantity and standard quantity
Price Variance
Difference between actual price and standard price
Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of computing and interpreting variances is called variance analysis.
A quantity variance is the difference between how much of an input was actually used and how much should have been used and is stated in dollar terms using the standard price of the input.
A price variance is the difference between the actual price of an input and its standard price, multiplied by the actual amount of the input purchased.

12. Quantity and Price Standards
Quantity and price standards are determined separately for two reasons:
The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.
Quantity and Price standards are determined separately for two reasons:
Different managers are usually responsible for buying and for using inputs. For example: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.
The buying and using activities occur at different points in time. For example: Raw material purchases may be held in inventory for a period of time before being used in production.
The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

13. A General Model for Variance Analysis
Quantity Variance
Price Variance
Quantity and price variances can be computed for all three variable cost elements – direct materials, direct labor, and variable manufacturing overhead – even though the variances have different names as shown.
Materials quantity variance
Labor efficiency variance
VOH efficiency variance
Materials price variance Labor rate variance VOH rate variance

14. A General Model for Variance Analysis
(1)
Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)
(2) Actual Quantity of Input, at Standard Price (AQ × SP)
(3) Actual Quantity of Input, at Actual Price (AQ × AP)
Although quantity and price variances are known by different names, they are computed exactly the same way (as shown on this slide) for direct materials, direct labor, and variable manufacturing overhead.
Quantity Variance (2) – (1)
Price Variance (3) – (2)
Spending Variance (3) – (1)

15. A General Model for Variance Analysis
Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used.
(1)
Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)
(2) Actual Quantity of Input, at Standard Price (AQ × SP)
(3) Actual Quantity of Input, at Actual Price (AQ × AP)
The actual quantity represents the actual amount of direct materials, direct labor, and variable manufacturing overhead used.
Quantity Variance (2) – (1)
Price Variance (3) – (2)
Spending Variance (3) – (1)

16. A General Model for Variance Analysis
Standard quantity is the standard quantity allowed for the actual output of the period.
(1)
Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)
(2) Actual Quantity of Input, at Standard Price (AQ × SP)
(3) Actual Quantity of Input, at Actual Price (AQ × AP)
The standard quantity represents the standard quantity allowed for the actual output of the period.
Quantity Variance (2) – (1)
Price Variance (3) – (2)
Spending Variance (3) – (1)

17. A General Model for Variance Analysis
Actual price is the amount actually paid for the input used.
(1)
Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)
(2) Actual Quantity of Input, at Standard Price (AQ × SP)
(3) Actual Quantity of Input, at Actual Price (AQ × AP)
The actual price represents the actual amount paid for the input used.
Quantity Variance (2) – (1)
Price Variance (3) – (2)
Spending Variance (3) – (1)

18. A General Model for Variance Analysis
Standard price is the amount that should have been paid for the input used.
(1)
Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP)
(2) Actual Quantity of Input, at Standard Price (AQ × SP)
(3) Actual Quantity of Input, at Actual Price (AQ × AP)
The standard price represents the amount that should have been paid for the input used.
Quantity Variance (2) – (1)
Price Variance (3) – (2)
Spending Variance (3) – (1)

19. Learning Objective 1
Compute the direct materials quantity and price variances and explain their significance.
Learning objective number 1 is to compute the direct materials quantity and price variances and explain their significance.

20. Materials Variances – An Example
Glacier Peak Outfitters has the following direct materials standard for the fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased and used to make 2,000 parkas. The materials cost a total of $1,029.
Here’s an example that will give us an opportunity to compute materials quantity and price variances.

21. Materials Variances Summary
Standard Quantity Actual Quantity Actual Quantity × × × Standard Price Standard Price Actual Price
200 kgs kgs kgs × × × $5.00 per kg $5.00 per kg $4.90 per kg.
= $1, = $1, = $1,029
The materials quantity variance, defined as the difference between the quantity of materials used in production and the quantity that should have been used according to the standard, is $50 unfavorable. The quantity variance is labeled unfavorable because the actual quantity exceeds the standard quantity allowed by 10 kilograms.
The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is $21 favorable. The price variance is labeled favorable because the actual price was less than the standard price by $0.10 per kilogram.
Quantity variance $50 unfavorable
Price variance $21 favorable

22. Materials Variances Summary
Standard Quantity Actual Quantity Actual Quantity × × × Standard Price Standard Price Actual Price
200 kgs kgs kgs × × × $5.00 per kg $5.00 per kg $4.90 per kg.
= $1, = $1, = $1,029
0.1 kg per parka  2,000 parkas = 200 kgs
The standard quantity of 200 kilograms is computed by multiplying the standard quantity per parka times the number of parkas made.
Quantity variance $50 unfavorable
Price variance $21 favorable

23. Materials Variances Summary
Standard Quantity Actual Quantity Actual Quantity × × × Standard Price Standard Price Actual Price
200 kgs kgs kgs × × × $5.00 per kg $5.00 per kg $4.90 per kg.
= $1, = $1, = $1,029
$1,029  210 kgs = $4.90 per kg
The actual price of $4.90 per kilogram is computed by dividing the actual cost of the material by the actual number of kilograms purchased.
Quantity variance $50 unfavorable
Price variance $21 favorable

24. Materials Variances: Using the Factored Equations
Materials quantity variance
MQV = (AQ × SP) – (SQ × SP)
= SP(AQ – SQ)
= $5.00/kg (210 kgs – (0.1 kg/parka  2,000 parkas))
= $5.00/kg (210 kgs – 200 kgs)
= $5.00/kg (10 kgs) = $50 U
Materials price variance
MPV = (AQ × AP) – (AQ × SP)
= AQ(AP – SP)
= 210 kgs ($4.90/kg – $5.00/kg)
= 210 kgs (– $0.10/kg) = $21 F
The equations that we have been using thus far can be factored as shown and used to compute price and quantity variances.

25. Materials Quantity Variance Materials Price Variance
Responsibility for Materials Variances
Materials Quantity Variance
Materials Price Variance
Purchasing Manager
Production Manager
The purchasing manager and production manager are usually held responsible for the materials price variance and materials quantity variance, respectively. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the performance of the purchasing manager.
The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance.

26. Responsibility for Materials Variances
Your poor scheduling sometimes requires me to rush order materials at a higher price, causing unfavorable price variances.
I am not responsible for this unfavorable materials quantity variance.
You purchased cheap material, so my people had to use more of it.
The materials variances are not always entirely controllable by one person or department. For example, the production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager.
Production Manager
Purchasing Manager

27. 1.5 pounds per Zippy at $4.00 per pound
Quick Check 
Zippy
Hanson Inc. has the following direct materials standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week, 1,700 pounds of materials were purchased and used to make 1,000 Zippies. The materials cost a total of $6,630.
In this example, the company produces a Zippy. The direct materials standard calls for 1.5 pounds per Zippy at $4.00 per pound. Last week, Hanson purchased and used 1,700 pounds of materials to produce 1,000 Zippies. The 1,700 pounds of materials cost a total of $6,630. Now, we will see several questions based on the information on this screen. You may wish to take some notes to use as you answer the questions. Try to answer each question before advancing to the solution.

28. Quick Check 
Zippy
How many pounds of materials should Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
d. 1,000 pounds.
How many pounds of materials should Hanson have used to make 1,000 Zippies?

29. Quick Check 
Zippy
How many pounds of materials should Hanson have used to make 1,000 Zippies?
a. 1,700 pounds.
b. 1,500 pounds.
c. 1,200 pounds.
d. 1,000 pounds.
The standard quantity is: 1,000 × 1.5 pounds per Zippy.
Hanson should have used 1,500 pounds, the standard quantity for 1,000 Zippies.

30. Quick Check 
Zippy
Hanson’s materials quantity variance (MQV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
What is Hanson’s materials quantity variance for the week?

31. Quick Check 
Zippy
Hanson’s materials quantity variance (MQV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable
The standard quantity is the amount of materials that Hanson should have used to make 1,000 Zippies. We find the standard quantity by multiplying the 1.5 pounds per unit standard for one Zippy times the 1,000 Zippies.
Now that we know the standard quantity, let’s calculate the materials quantity variance. We find the materials quantity variance by multiplying the standard price for one pound of material times the difference between the actual quantity of materials and the standard quantity of materials. The $800 unfavorable materials quantity variance results because Hanson used 200 pounds more than standard to make the 1,000 Zippies, and each pound of material has a standard price of $4.00.

32. Quick Check 
Zippy
Hanson’s materials price variance (MPV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
What is Hanson’s materials price variance for the week?

33. Quick Check 
Zippy
Hanson’s materials price variance (MPV) for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($ ) MPV = $170 Favorable
We find the materials price variance by multiplying the actual quantity of materials purchased times the difference between the actual price per pound and the standard price per pound. We find the actual price per pound by dividing the $6,630 total actual price paid for the materials by the 1,700 pounds purchased.
The $170 favorable materials price variance results because Hanson paid 10 cents per pound less than standard for 1,700 pounds of materials.

34. Quick Check 
Zippy
Standard Quantity Actual Quantity Actual Quantity × × × Standard Price Standard Price Actual Price
1,500 lbs ,700 lbs ,700 lbs × × × $4.00 per lb $4.00 per lb $3.90 per lb.
= $6, = $ 6, = $6,630
Here we see a summary of the materials price and quantity variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous three questions.
Quantity variance $800 unfavorable
Price variance $170 favorable

35. Quick Check 
Zippy
Recall that the standard quantity for 1,000 Zippies is 1,000 × 1.5 pounds per Zippy = 1,500 pounds.
Standard Quantity Actual Quantity Actual Quantity × × × Standard Price Standard Price Actual Price
1,500 lbs ,700 lbs ,700 lbs × × × $4.00 per lb $4.00 per lb $3.90 per lb.
= $6, = $ 6, = $6,630
Recall that the standard quantity for 1,000 Zippies is 1,000 × 1.5 pounds per Zippy = 1,500 pounds.
Quantity variance $800 unfavorable
Price variance $170 favorable

36. Learning Objective 2
Compute the direct labor efficiency and rate variances and explain their significance.
Learning objective number 2 is to compute the direct labor efficiency and rate variances and explain their significance.

37. Labor Variances – An Example
Glacier Peak Outfitters has the following direct labor standard for its mountain parka.
1.2 standard hours per parka at $10.00 per hour
Last month, employees actually worked 2,500 hours at a total labor cost of $26,250 to make 2,000 parkas.
Now let’s turn our attention back to Glacier Peak Outfitters to illustrate the computation of labor rate and efficiency variances.

38. Labor Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $10.00 per hour $10.00 per hour $10.50 per hour
= $24, = $25, = $26,250
The labor efficiency variance, defined as the difference between the actual quantity of labor hours and the quantity allowed according to the standard, is $1,000 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of hours exceeds the standard quantity allowed by 100 hours.
The labor rate variance, defined as the difference between the actual average hourly wage paid and the standard hourly wage, is $1,250 unfavorable. The rate variance is labeled unfavorable because the actual average wage rate was more than the standard wage rate by $0.50 per hour.
Efficiency variance $1,000 unfavorable
Rate variance $1,250 unfavorable

39. Labor Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $10.00 per hour $10.00 per hour $10.50 per hour
= $24, = $25, = $26,250
1.2 hours per parka  2,000 parkas = 2,400 hours
The standard quantity of 2,400 hours is computed by multiplying the standard hours for one parka times the number of parkas made.
Efficiency variance $1,000 unfavorable
Rate variance $1,250 unfavorable

40. Labor Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $10.00 per hour $10.00 per hour $10.50 per hour
= $24, = $25, = $26,250
$26,250  2,500 hours = $10.50 per hour
The actual price (or rate) of $10.50 per hour is computed by dividing the actual total cost for labor by the actual number of hours worked.
Efficiency variance $1,000 unfavorable
Rate variance $1,250 unfavorable

41. Labor Variances: Using the Factored Equations
Labor efficiency variance
LEV = (AH × SR) – (SH × SR)
= SR (AH – SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable
Labor rate variance
LRV = (AH × AR) – (AH × SR)
= AH (AR – SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable
Factored equations can also be used to compute the rate and efficiency variances.

42. Responsibility for Labor Variances
Production managers are usually held accountable for labor variances because they can influence the:
Mix of skill levels assigned to work tasks.
Level of employee motivation.
Quality of training provided to employees.
Quality of production supervision.
Production Manager
Labor variances are partially controllable by employees within the Production Department. For example, production managers/supervisors can influence:
The deployment of highly skilled workers and less skilled workers on tasks consistent with their skill levels.
The level of employee motivation within the department.
The quality of production supervision.
The quality of the training provided to the employees.

43. Responsibility for Labor Variances
I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment.
I am not responsible for the unfavorable labor efficiency variance!
You purchased cheap material, so it took more time to process it.
However, labor variances are not entirely controllable by one person or department. For example:
The Maintenance Department may do a poor job of maintaining production equipment. This may increase the processing time required per unit, thereby causing an unfavorable labor efficiency variance.
The purchasing manager may purchase lower quality raw materials resulting in an unfavorable labor efficiency variance for the production manager.

44. 1.5 standard hours per Zippy at $12.00 per direct labor hour
Quick Check 
Zippy
Hanson Inc. has the following direct labor standard to manufacture one Zippy:
1.5 standard hours per Zippy at $12.00 per direct labor hour
Last week, 1,550 direct labor hours were worked at a total labor cost of $18,910 to make 1,000 Zippies.
Let’s return to the Hanson Company and compute labor variances.
The direct labor standard to produce each Zippy is 1.5 hours at $12.00 per hour. Last week, it took 1,550 direct labor hours to produce 1,000 Zippies, and the total labor cost was $18,910.
Next, we will see several questions based on the information on this screen. Again, you may wish to take some notes to use as you answer the questions. Also, just as you did with the material variance questions, try to answer each question before advancing to the solution.

45. Quick Check 
Zippy
Hanson’s labor efficiency variance (LEV) for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
What is Hanson’s labor efficiency variance for the week?

46. Quick Check 
Zippy
Hanson’s labor efficiency variance (LEV) for the week was:
a. $590 unfavorable.
b. $590 favorable.
c. $600 unfavorable.
d. $600 favorable.
LEV = SR(AH - SH) LEV = $12.00(1,550 hrs - 1,500 hrs) LEV = $600 unfavorable
The total standard hours for labor is the amount of time Hanson’s employees should have worked to make 1,000 Zippies. We find the total standard hours by multiplying the 1.5 standard hours for one Zippy times the 1,000 Zippies made.
Now that we know the total standard hours, let’s calculate the labor efficiency variance.
We find the labor efficiency variance by multiplying the standard rate for one hour of labor times the difference between the actual hours of labor and the standard hours of labor. The $600 unfavorable labor efficiency variance results because Hanson’s employees worked 50 hours more than standard to make 1,000 Zippies, and each hour of labor has a standard rate of $12.00.

47. Quick Check  Hanson’s labor rate variance (LRV) for the week was:
Zippy
Hanson’s labor rate variance (LRV) for the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
What is Hanson’s labor rate variance for the week?

48. Quick Check  Hanson’s labor rate variance (LRV) for the week was:
Zippy
Hanson’s labor rate variance (LRV) for the week was:
a. $310 unfavorable.
b. $310 favorable.
c. $300 unfavorable.
d. $300 favorable.
LRV = AH(AR - SR) LRV = 1,550 hrs($ $12.00) LRV = $310 unfavorable
We find the actual labor rate by dividing the $18,910 total labor cost by 1,550 direct labor hours actually worked.
Now that we know the actual labor rate, let’s calculate the labor rate variance.
We find the labor rate variance by multiplying the actual labor hours worked times the difference between the actual rate per labor hour and the standard rate per labor hour. The $310 unfavorable labor rate variance results because Hanson paid $0.20 per labor hour more than standard for 1,550 labor hours actually worked.

49. Quick Check 
Zippy
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
1,500 hours ,550 hours ,550 hours × × × $12.00 per hour $12.00 per hour $12.20 per hour
= $18, = $18, = $18,910
Here we see a summary of the labor rate and efficiency variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions.
Efficiency variance $600 unfavorable
Rate variance $310 unfavorable

50. Learning Objective 3
Compute the variable manufacturing overhead efficiency and rate variances and explain their significance.
Learning objective number 3 is to compute the variable manufacturing overhead efficiency and rate variances and explain their significance.

51. Variable Manufacturing Overhead Variances – An Example
Glacier Peak Outfitters has the following direct variable manufacturing overhead labor standard for its mountain parka.
1.2 standard hours per parka at $4.00 per hour
Last month, employees actually worked 2,500 hours to make 2,000 parkas. Actual variable manufacturing overhead for the month was $10,500.
Now that we have studied material and labor variances, let’s take a look a variable manufacturing overhead variances. We will return to Glacier Peak Outfitters to illustrate the computation of variable manufacturing overhead efficiency and rate variances.

52. Variable Manufacturing Overhead Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $4.00 per hour $4.00 per hour $4.20 per hour
= $9, = $10, = $10,500
The variable overhead efficiency variance, defined as the difference between the actual activity of a period and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate, is $400 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of the activity (hours) exceeds the standard quantity of the activity allowed by 100 hours.
The variable overhead rate variance, defined as the difference between the actual variable overhead costs incurred during the period and the standard cost that should have been incurred based on the actual activity of the period, is $500 unfavorable. The rate variance is labeled unfavorable because the actual variable overhead rate was more than the standard variable overhead rate by $0.20 per hour.
Efficiency variance $400 unfavorable
Rate variance $500 unfavorable

53. Variable Manufacturing Overhead Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $4.00 per hour $4.00 per hour $4.20 per hour
= $9, = $10, = $10,500
1.2 hours per parka  2,000 parkas = 2,400 hours
The standard quantity of 2,400 hours is computed by multiplying the standard hours for one parka times the number of parkas made.
Efficiency variance $400 unfavorable
Rate variance $500 unfavorable

54. Variable Manufacturing Overhead Variances Summary
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
2,400 hours ,500 hours ,500 hours × × × $4.00 per hour $4.00 per hour $4.20 per hour
= $9, = $10, = $10,500
$10,500  2,500 hours = $4.20 per hour
The actual price of $4.20 per hour is computed by dividing the actual total cost for variable manufacturing overhead by the actual number of hours worked.
Efficiency variance $400 unfavorable
Rate variance $500 unfavorable

55. Variable Manufacturing Overhead Variances: Using Factored Equations
Variable manufacturing overhead efficiency variance
VMEV = (AH × SR) – (SH – SR)
= SR (AH – SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
Variable manufacturing overhead rate variance
VMRV = (AH × AR) – (AH – SR)
= AH (AR – SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
Factored equations can be used to compute the rate and efficiency variances.

56. 1.5 standard hours per Zippy at $3.00 per direct labor hour
Quick Check 
Zippy
Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy:
1.5 standard hours per Zippy at $3.00 per direct labor hour
Last week, 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead.
Now let’s return to the Hanson company and compute the variable manufacturing overhead variances.
The variable manufacturing overhead standard to produce each Zippy is 1.5 hours at $3.00 per hour. Last week, it took 1,550 hours to produce 1,000 Zippies, and the total variable manufacturing overhead cost was $5,115.
Next, we will see several questions based on the information on this screen. Again, you may wish to take some notes to use as you answer the questions. Also, just as you did with the material and labor variance questions, try to answer each question before advancing to the solution.

57. Quick Check 
Zippy
Hanson’s efficiency variance (VMEV) for variable manufacturing overhead for the week was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.
What is Hanson’s efficiency variance for variable manufacturing overhead for the week?

58. Quick Check 
Zippy
Hanson’s efficiency variance (VMEV) for variable manufacturing overhead for the week was:
a. $435 unfavorable.
b. $435 favorable.
c. $150 unfavorable.
d. $150 favorable.
1,000 units × 1.5 hrs per unit
The total standard hours is the amount of time Hanson’s employees should have worked to make 1,000 Zippies. We find the total standard hours by multiplying the 1.5 standard hours for one Zippy times the 1,000 Zippies made.
Now that we know the total standard hours, let’s calculate the variable manufacturing overhead efficiency variance.
We find the variable manufacturing overhead efficiency variance by multiplying the standard rate for variable manufacturing overhead times the difference between the actual hours of labor and standard hours of labor. The $150 unfavorable variable manufacturing overhead efficiency variance results because Hanson’s employees worked 50 hours more than standard to make 1,000 Zippies at a standard variable manufacturing overhead rate of $3.00 per hour.
VMEV = SR(AH - SH) VMEV = $3.00(1,550 hrs - 1,500 hrs) VMEV = $150 unfavorable

59. Quick Check 
Zippy
Hanson’s rate variance (VMRV) for variable manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.
What is Hanson’s rate variance for variable manufacturing overhead for the week?

60. Quick Check 
Zippy
Hanson’s rate variance (VMRV) for variable manufacturing overhead for the week was:
a. $465 unfavorable.
b. $400 favorable.
c. $335 unfavorable.
d. $300 favorable.
VMRV = AH(AR - SR) VMRV = 1,550 hrs($ $3.00) VMRV = $465 unfavorable
We find the actual variable manufacturing overhead rate by dividing the $5,115 total variable manufacturing overhead cost by $1,550 direct labor hours actually worked.
Now that we know the actual variable manufacturing overhead rate, let’s calculate the variable manufacturing overhead rate variance.
We find the variable manufacturing overhead rate variance by multiplying the actual hours worked times the difference between the actual variable manufacturing overhead rate per hour and the standard variable manufacturing overhead rate per hour. The $465 unfavorable variable manufacturing overhead rate variance results because Hanson’s actual variable manufacturing overhead rate per labor hour is $0.30 per hour more than the standard variable manufacturing overhead rate per hour for the 1,550 hours actually worked.

61. Quick Check 
Zippy
Standard Hours Actual Hours Actual Hours × × × Standard Rate Standard Rate Actual Rate
1,500 hours ,550 hours ,550 hours × × × $3.00 per hour $3.00 per hour $3.30 per hour
= $4, = $4, = $5,115
Just as we did with labor and material variances, we can summarize the variable manufacturing overhead variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions.
Efficiency variance $150 unfavorable
Rate variance $465 unfavorable

62. Materials Variances―An Important Subtlety
The quantity variance is computed only on the quantity used.
The price variance is computed on the entire quantity purchased.
When the quantity of materials purchased differs from the quantity used in production, the quantity variance is based on the quantity used in production and the price variance is based on the quantity purchased.

63. Materials Variances―An Important Subtlety
Glacier Peak Outfitters has the following direct materials standard for the fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs. of fiberfill were purchased at a cost of $1,029. Glacier used 200 kgs. to make 2,000 parkas.
Here’s an example that will give us an opportunity to compute materials quantity and price variances.

64. Materials Variances―An Important Subtlety
Standard Quantity Actual Quantity × × Standard Price Standard Price
200 kgs kgs × × $5.00 per kg $5.00 per kg.
= $1, = $1,000
The materials quantity variance, defined as the difference between the quantity of materials used in production and the quantity that should have been used according to the standard, is $0. There is no quantity variance because the actual quantity equals the standard quantity allowed.
Quantity variance $0

65. Materials Variances―An Important Subtlety
Actual Quantity Actual Quantity × × Standard Price Actual Price
210 kgs kgs × × $5.00 per kg $4.90 per kg.
= $1, = $1,029
The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is $21 favorable. The price variance is labeled favorable because the actual price was less than the standard price by $0.10 per kilogram.
Price variance $21 favorable

66. Variance Analysis and Management by Exception
Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
All variances are not worth investigating. Methods for highlighting a subset of variances as exceptions include:
Looking at the size of the variance.
Looking at the size of the variance relative to the amount of spending.
How do I know which variances to investigate?

67. A Statistical Control Chart
Warning signals for investigation • •
Favorable Limit • • • •
Desired Value • •
Unfavorable Limit •
Plotting variance analysis data on a statistical control chart is helpful in variance investigation decisions. Variances are investigated if:
They are unusual relative to the normal level of random fluctuation.
An unusual pattern emerges in the data. 1 2 3 4 5 6 7 8 9
Variance Measurements

68. Advantages of Standard Costs
Management by exception
Promotes economy and efficiency
Advantages
Research has shown that a substantial portion of companies in the United Kingdom, Canada, Japan, and the United States use standard cost systems. This is because standard cost systems offer many advantages including:
Standard costs are a key element of the management by exception approach which helps managers focus their attention on the most important issues.
Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency.
Standard costs can greatly simplify bookkeeping.
Standard costs fit naturally into a responsibility accounting system.
Enhances responsibility accounting
Simplified bookkeeping

69. Potential Problems with Standard Costs
Emphasizing standards may exclude other important objectives.
Favorable variances may be misinterpreted.
Potential Problems
Standard cost reports may not be timely.
Emphasis on negative may impact morale.
The use of standard costs can also present a number of problems. For example:
Standard cost variance reports are usually prepared on a monthly basis and are often released days or weeks after the end of the month; hence, the information can be outdated.
If variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions.
Labor variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. Second, the computations assume that labor is a variable cost. These assumptions are often invalid in today’s automated manufacturing environment where employees are essentially a fixed cost.
In some cases, a “favorable” variance can be as bad or worse than an unfavorable variance.
Excessive emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction.
Just meeting standards may not be sufficient; continual improvement using techniques such as Six Sigma may be necessary to survive in a competitive environment.
Invalid assumptions about the relationship between labor cost and output.
Continuous improvement may be more important than meeting standards.