STANDARD COSTING - Variance Analysis

STANDARD COSTING - Variance Analysis

A variance is the difference between an actual result and an expected result. The process by which the total difference between standard and actual results is analyzed is known as variance analysis. When actual results are better than the expected results, we have a favorable variance (F). If, on the other hand, actual results are worse than expected results, we have an unfavorable variance (U).

Reasons for variances

Material price

• (F) – unforeseen discounts received, greater care taken in purchasing, change in material standard
• (U)– price increase, careless purchasing, change in material standard.

Material usage

• (F) – material used of higher quality than standard, more effective use made of material
• (U) – defective material, excessive waste, theft, stricter quality control

Labor rate

• (F) – use of workers at rate of pay lower than standard
• (U) – wage rate increase

Idle time

• Machine breakdown, non-availability of material, illness

Labor efficiency

• (F) – output produced more quickly than expected because of work motivation, better quality of equipment or materials
• (U) – lost time in excess of standard allowed, output lower than standard set because of deliberate restriction, lack of training, sub-standard material used.

Overhead expenditure

• (F) – savings in cost incurred, more economical use of services.
• (U) – increase in cost of services used, excessive use of services, change in type of services used

Overhead volume

• (F) – production greater than budgeted
• (U) – production less than budgeted

Interdependence between variances

The cause of one (unfavorable variance) variance may be wholly or partly explained by the cause of another (favorable) variance.

• Material price or material usage and labor efficiency
• Labor rate and material usage
• Sales price and sales volume

The significance of variances

The decision as to whether or not a variance is so significant that it should be investigated should take a number of factors into account.

• The type of standard being used
• Interdependence between variances
• Controllability
• Materiality

Use this example throughout this Exercise: Standard cost of Product A Materials (5kgs x P10 per kg) P50 Labor (4hrs x P5 per hr)   20 Variable OH(4 hrs x P2 per hr)          8 Fixed OH(4 hrs x P6 per hr)   24 102
Budgeted results    Production: 1,200 units Sales: 1,000 units Selling price: P150 per unit	ACTUAL Results    Production: 1,000 units Sales: 900 units Materials: 4,850 kgs, P46,075 Labor: 4,200 hrs, P21,210 Variable OH: P9,450 Fixed OH: P25,000 Selling price: P140 per unit

1. Variable cost variances

Direct material variances

The direct material total variance is the difference between what the output actually cost and what it should have cost, in terms of material.

From the example above the material total variance is given by:

1,000 units should have cost (x P50)	P50,000
But did cost	46,075
Direct material total variance	3, 925 (F)

It can be divided into two sub-variances

The direct material price variance

This is the difference between what the actual quantity of material used did cost and what it should have cost.

4,850 kgs should have cost (x P10)	P 48,500
But did cost	46,075
Direct material price variance	2,425 (F)

The direct material usage variance

This is the difference between how much material should have been used for the number of units actually produced and how much material was used, valued at standard cost

1,000 units should have used (x 5 kgs)	5,000 kgs
But did use	4,850 kgs
Variance in kgs	150 kgs (F)
Valued at standard cost per kg	x P10
Direct material usage variance in P	P1,500 (F)

The direct material price variance is computed on material purchases in the period if closing stocks of raw materials are valued at standard cost or material used if closing stocks of raw materials are valued at actual cost (FIFO).

Direct labor total variance

The direct labor total variance is the difference between what the output should have cost and what it did cost, in terms of labor.

1,000 units should have cost (x P20)	P20,000
But did cost	21,210
Direct material price variance	1,210 (U)

Direct labor rate variance

This is the difference between what the actual number of hours worked should have cost and what it did cost.

4200hrs should have cost (4200hrs x P5)	P21000
But did cost	P21210
Direct labor rate variance	P210(U)

The direct labor efficiency variance

The is the difference between how many hours should have been worked for the number of units actually produced and how many hours were worked, valued at the standard rate per hour.

1,000 units should have taken (x 4 hrs)	4,000 hrs
But did take	4,200 hrs
Variance in hrs	200 hrs
Valued at standard rate per hour	x P5
Direct labor efficiency variance	P1,000 (U)

When idle time occurs the efficiency variance is based on hours actually worked (not hours paid for) and an idle time variance (hours of idle time x standard rate per hour) is computed.

2. Variable production overhead total variances

The variable production overhead total variance is the difference between what the output should have cost and what it did cost, in terms of variable production overhead.

1,000 units should have cost (x P8)	P8,000
But did cost	9,450
Variable production OH expenditure variance	1,450 U)

The variable production overhead expenditure variance

This is the difference between what the variable production overhead did cost and what it should have cost

4,200 hrs should have cost @ P2/hr	P8,400
But did cost	9,450
Variable production OH expenditure variance	1,050 (U)

The variable production overhead efficiency variance

This is the same as the direct labor efficiency variance in hours, valued at the variable production overhead rate per hour.

Labor efficiency variance in hours	200 hrs (U)
Valued @ standard rate per hour	x P2
Variable production OH efficiency variance	P400 (U)

3. Fixed production overhead variances

The total fixed production variance is an attempt to explain the under- or over-absorbed fixed production overhead.

Remember that overhead absorption rate =	Budgeted fixed production overhead
	Budgeted level of activity

If either the numerator or the denominator or both are incorrect then we will have under- or over-absorbed production overhead.

• If actual expenditure ± budgeted expenditure (numerator incorrect) » expenditure variance
• If actual production / hours of activity » budgeted production / hours of activity (denominator incorrect) » volume variance.
• The workforce may have been working at a more or less efficient rate than standard to produce a given output » volume efficiency variance (similar to the variable production overhead efficiency variance).
• Regardless of the level of efficiency, the total number of hours worked could have been more or less than was originally budgeted (employees may have worked a lot of overtime or there may have been a strike and so actual hours worked were less than budgeted) » volume capacity variance.

4. The fixed production overhead variances are computed as follows:

Fixed production overhead variance

This is the difference between fixed production overhead incurred and fixed production overhead absorbed (= the under- or over-absorbed fixed production overhead)

Overhead incurred	P25,000
Overhead absorbed (1,000 units x P24)	24,000
Overhead variance	1,000 (U)

Fixed production overhead expenditure variance

This is the difference between the budgeted fixed production overhead expenditure and actual fixed production overhead expenditure

Budgeted overhead (1,200 x P24)	P28,800
Actual overhead	25,000
Expenditure variance	3,800 (F)

Fixed production overhead volume variance

This is the difference between actual and budgeted production volume multiplied by the standard absorption rate per unit.

Actual production at std rate (1,000 x P24)	P24,000
Budgeted production at std rate (1,200 x P24)	28,800
	4,800(U)

Fixed production overhead volume efficiency variance

This is the difference between the number of hours that actual production should have taken, and the number of hours actually worked (usually the labor efficiency variance), multiplied by the standard absorption rate per hour.

Labor efficiency variance in hours	200 hrs (U)
Valued @ standard rate per hour	x P6
Volume efficiency variance	P1,200 (U)

Fixed production overhead volume capacity variance

This is the difference between budgeted hours of work and the actual hours worked, multiplied by the standard absorption rate per hour

Budgeted hours (1,200 x 4)	4,800 hrs
Actual hours	4,200 hrs
Variance in hrs	600 hrs (U)
x standard rate per hour	x P6
	P3,600 (U)

KEY. The fixed overhead volume capacity variance is unlike the other variances in that an excess of actual hours over budgeted hours results in a favorable variance and not an unfavorable variance it does when considering labor efficiency, variable overhead efficiency and fixed overhead volume efficiency. Working more hours than budgeted produces an over absorption of fixed overheads, which is a favorable variance.

-o-o-o-

Sales variances

5. Selling price variance

The selling price variance is a measure of the effect on expected profit of a different selling price to standard selling price. It is computed as the difference between what the sales revenue should have been for the actual quantity sold, and what it was.

Revenue from 900 units should have been (x P150)	135,000
But was (x P140)	126,000
Selling price variance	9,000 (U)

Sales volume variance

The sales volume variance is the difference between the actual units sold and the budgeted quantity, valued at the standard profit per unit. In other words it measures the increase or decrease in standard profit as a result of the sales volume being higher or lower than budgeted.

Budgeted sales volume	1,000 units
Actual sales volume	900 units
Variance in units	100 units (U)
x standard margin per unit (x P (150 – 102) )	x P48
Sales volume variance	P4,800 (U)

KEY.

Don’t forget to value the sales volume variance at standard contribution marginal costing is in use.

PROBLEM

Thompson Company

Thompson Company has the following information available for the current year:

Standard:
Material	3.5 feet per unit @ $2.60 per foot
Labor	5 direct labor hours @ $8.50 per unit
Actual:
Material	95,625 feet used (100,000 feet purchased @ $2.50 per foot)
Labor	122,400 direct labor hours incurred per unit @ $8.35 per hour
	25,500 units were produced

     1.   Refer to Thompson Company. Compute the material purchase price and quantity variances.

ANS: 

Material price variance:
100,000 ´ $2.50 =	$250,000
100,000 ´ $2.60 =	260,000
	$ 10,000	F
Material quantity variance:
95,625 ´ $2.60 =	$248,625
89,250 ´ $2.60 =	232,050
	$ 16,575	U

     2.   Refer to Thompson Company. Compute the labor rate and efficiency variances.

ANS: 

Labor rate variance:
122,400 ´ $8.35 =	$1,022,040
122,400 ´ $8.50 =	1,040,400
	$   18,360	F
Labor efficiency variance:
122,400 ´ $8.50 =	$1,040,400
127,500 ´ $8.50 =	1,083,750
	$   43,350	F

McKinley Company

McKinley Company applies overhead based on direct labor hours and has the following available for November:

Standard:
Direct labor hours per unit	5
Variable overhead per DLH	$.75
Fixed overhead per DLH
(based on 8,900 DLHs)	$1.90
Actual:
Units produced	1,800
Direct labor hours	8,900
Variable overhead	$6,400
Fixed overhead	$17,500

     3.   Refer to McKinley Company. Compute all the appropriate variances using the two-variance approach.

ANS: 

Actual ($6,400 + $17,500)	$23,900
Budget Variance:			$240 U
BFOH (8,900 ´ $1.90)	$16,910
VOH (1,800 ´ 5 ´ $.75)	6,750	$23,660
Volume Variance:			$190 F
Applied OH:
(1,800 ´ 5 ´ $2.65)	$23,850

     4.   Refer to McKinley Company. Compute all the appropriate variances using the four-variance approach.

ANS: 

Actual VOH	$6,400
Variable Spending Variance:			$275 F
Flex. Bud. Based on Actual
Input Hours (8,900 ´ $.75)	$6,675
Variable Efficiency Variance:			$75 F
Applied VOH
(1,800 ´ 5 ´ $.75)	$6,750
Actual FOH	$17,500
FOH Spending Variance:			$590 U
BUDGETED FOH	$16,910
FOH Volume Variance:			$190 F
Applied FOH
(1,800 ´ 5 ´ $1.90)	$17,100

     5.   Refer to McKinley Company. Compute all the appropriate variances using the three-variance approach.

ANS: 

Actual	$23,900
Spending Variance:			$315 U
Flexible Budget Based on Actual Input
BFOH	$16,910
VOH (8,900 ´ $.75)	6,675	$23,585
Efficiency Variance:			$75 F
Flexible Budget Based on Standard DLHs
BFOH	$16,910
VOH (1,800 ´ 5 ´ $.75)	6,750	$23,660
Volume Variance:			$190 F
Applied OH:
(1,800 ´ 5 ´ $2.65)	$23,850

     6.   The Texas Company has made the following information available for its production facility for the month of June. Fixed overhead was estimated at 19,000 machine hours for the production cycle. Actual machine hours for the period were 18,900, which generated 3,900 units.

Material purchased (80,000 pieces)	$314,000
Material quantity variance	$6,400	U
Machine hours used (18,900 hours)
VOH spending variance	$50	U
Actual fixed overhead	$60,000
Actual labor cost	$40,120
Actual labor hours	5,900

Michigan’s standard costs are as follows:

Direct material	20 pieces @ $4 per piece
Direct labor	1.5 hours @ $6 per hour
Variable overhead
(applied on a machine hour basis)	4.8 hours @ $2.50 per hour
Fixed overhead
(applied on a machine hour basis)	4.8 hours @ $3 per hour

Determine the following items:

a.	material purchase price variance
b.	standard quantity allowed for material
c.	total standard cost of material allowed
d.	actual quantity of material used
e.	labor rate variance
f.	standard hours allowed for labor
g.	total standard cost of labor allowed
h.	labor efficiency variance
i.	actual variable overhead incurred
j.	standard machine hours allowed
k.	variable overhead efficiency variance
l.	budgeted fixed overhead
m.	applied fixed overhead
n.	fixed overhead spending variance
o.	volume variance
p.	total overhead variance

ANS: 

a.	actual material cost	$314,000
	actual pieces at standard cost (80,000 ´ $4)	320,000
	material purchase price variance	$  6,000	F
b.	3,900 units ´ 20 pieces per unit = 78,000 standard quantity allowed
c.	total standard cost of material (78,000 ´ $4) $312,000
d.	standard cost of actual material used
	$312,000 + $6,400 U quantity variance	$318,400
	$318,400 ÷ $4 = 79,600 actual pieces used
e.	actual labor cost	$ 40,120
	5,900 actual DLHs ´ $6	35,400
	labor rate variance	$  4,720	U
f.	3,900 units ´ 1.5 standard hours per unit	5,850	SHA
g.	5,850 SHA ´ $6	$ 35,100
h.	actual hours ´ standard rate (from e)	$ 35,400
	standard cost of labor allowed (from g)	35,100
	labor efficiency variance	$    300	U
i.	actual machine hours ´ standard VOH rate (18,900 ´ $2.50)	$ 47,250
	VOH spending variance	50	U
	actual VOH	$ 47,300
j.	3,900 units ´ 4.8 standard hours per unit = 18,720 MH allowed
k.	standard hours allowed (from j) ´ standard VOH rate
	(18,720 ´ $2.50)	$ 46,800
	actual machine hours ´ standard rate (from i)
	(18,900 ´ $2.50)	47,250
	variable overhead efficiency variance	$    450	U
l.	19,000 machine hours ´ $3	$ 57,000
m.	3,900 units ´ 4.8 hours per unit ´ $3.00	$ 56,160
n.	actual fixed overhead	$ 60,000
	budgeted fixed overhead (from l)	57,000
	fixed overhead spending variance	$  3,000	U
o.	budgeted fixed overhead (from l)	$ 57,000
	applied fixed overhead (from m)	56,160
	volume variance	$    840	U
p.	total actual overhead	$107,300
	[$60,000 + $47,300 (from i)]
	total applied overhead (18,720 SHA ´ $5.50)	102,960
	Total overhead variance	$  4,340	U

Blackridge Company

The following information is available for Blackridge Company for the current year:

Standard:

Material X: 3.0 pounds per unit @ $4.20 per pound

Material Y: 4.5 pounds per unit @ $3.30 per pound

Class S labor: 3 hours per unit @ $10.50 per hour

Class US labor: 7 hours per unit @ $8.00 per hour

Actual:

Material X: 3.6 pounds per unit @ $4.00 per pound (purchased and used)

Material Y: 4.4 pounds per unit @ $3.25 per pound (purchased and used)

Class S labor: 3.8 hours per unit @ $10.60 per hour

Class US labor: 5.7 hours per unit @ $7.80 per hour

Blackridge Company produced a total of 45,750 units.

     7.   Refer to Blackridge Company.  Compute the material price, mix, and yield variances (round to the nearest dollar).

ANS: 

Standard:		X	3.0/7.5 = 40%
		Y	4.5/7.5 = 60%
Actual:
X	3.6 ´ 45,750 ´ $4.00 =				$  658,800
Y	4.4 ´ 45,750 ´ $3.25 =				654,225
					$1,313,025
					$43,005 F price
Actual ´ Standard Prices:
X	3.6 ´ 45,750 ´ $4.20 =				$  691,740
Y	4.4 ´ 45,750 ´ $3.30 =				664,290
					$1,356,030
						$16,470 U mix
Standard Qty. ´ Actual Mix ´ Standard Prices:
X	40% ´ 366,000* ´ $4.20 =				$  614,880
Y	60% ´ 366,000 ´ $3.30 =				724,680
					$1,339,560	$83,722 U yield
Standard ´ Standard:
X	40% ´ 343,125** ´ $4.20 =				$  576,450
Y	60% ´ 343,125 ´ $3.30 =				679,388
					$1,255,838

*(45,750 ´ 8 = 366,000)

**(45,750 ´ 7.5 = 343,125)

     8.   Refer to Blackridge Company. Compute the labor rate, mix, and yield variances (round to the nearest dollar).

ANS: 

Standard:		S	3/10 = 30%			Actual:		S		3.8/9.5 = 40%
		US	7/10 = 70%					US		5.7/9.5 = 60%
Actual ´ Actual Prices:
S	3.8 ´ 45,750 ´ $10.60 =				$1,842,810
US	5.7 ´ 45,750 ´ $7.80 =				2,034,045
					$3,876,855
							$34,770 F rate
Actual ´ Standard Prices:
S	3.8 ´ 45,750 ´ $10.50 =				$1,825,425
US	5.7 ´ 45,750 ´ $ 8.00 =				2,086,200
					$3,911,625
							$108,656 U mix
Standard Qty. ´ Actual Mix ´ Standard Prices:
S	30% ´ 434,625* ´ $10.50 =				$1,369,069
US	70% ´ 434,625 ´ $ 8.00 =				2,433,900
					$3,802,969
							$200,156 F yield
Standard ´ Standard:
S	30% ´ 457,500** ´ $10.50 =				$1,441,125
US	70% ´ 457,500 ´ $ 8.00 =				2,562,000
					$4,003,125

*(45,750 ´ 9.5 = 434,625)

**(45,750 ´ 10 = 457,500)

     9.   Houston Corporation produces a product using the following standard proportions and costs of material:

Pounds

Cost Per Pound

Amount

Material A	50	$5.00	$250.00
Material B	40	6.00	240.00
Material C	60	3.00	180.00
	150	4.4667	$670.00
Standard shrinkage (33 1/3%)	50
Net weight and cost	100	6.70	$670.00

A recent production run yielding 100 output pounds required an input of:

	Amount	Cost Per Pound
Material A	40	$5.15
Material B	50	6.00
Material C	65	2.80

Required: Material price, mix, and yield variances.

ANS: 

MATERIAL PRICE VARIANCE

MATERIAL A     ($5.15 - 5.00) ´ 40 =	$ 6	U
MATERIAL B     ($6.00 - 6.00) ´ 50 =	0
MATERIAL C     ($2.80 - 3.00) ´ 65 =	13	F
	$ 7	F

	MIX VARIANCE		YIELD VARIANCE
A	40 ´ $5 = $200	51 2/3 ´ $5 = $258.33			50 ´ $5 = $250
B	50 ´ $6 = $300	41 1/3 ´ $6 = $248.00			40 ´ $6 = $240
C	65 ´ $3 = $195	62 ´ $3 = $186.00			60 ´ $3 = $180
	$695	$692.33			$670
	$2.67 UNF			$22.33 UNF

   10.   Moonlight Company began business early in January using a standard costing for its single product. With standard capacity set at 10,000 standard productive hours per month, the following standard cost sheet was set up for one unit of product:

Direct material-5 pieces @ $2.00		$10.00
Direct labor (variable)-1 sph @ $3.00		3.00
Manufacturing overhead:
Fixed-1 sph @ $3.00	$3.00
Variable-1 sph @ $2.00	2.00	5.00

Fixed costs are incurred evenly throughout the year. The following unfavorable variances from standard costs were recorded during the first month of operations:

Material price	$    0
Material usage	4,000
Labor rate	800
Labor efficiency	300
Overhead volume	6,000
Overhead budget (2 variance analysis)	1,000

Required:  Determine the following: (a) fixed overhead budgeted for a year;  (b) the number of units completed during January assuming no work in process at January 31;  (c) debits made to the Work in Process account for direct material, direct labor, and manufacturing overhead;  (d) number of pieces of material issued during January;  (e) total of direct labor payroll recorded for January;  (f) total of manufacturing overhead recorded in January.

ANS: 

a.	$3 ´ 10,000 ´ 12 = $360,000
b.	$6,000/$3 = 2,000 under 10,000 - 2,000 = 8,000 units
c.	DM = 8,000 ´ $10 = $80,000, DL = 8,000 ´ $3 = $24,000,
	MOH = 8,000 ´ $5 = $40,000
d.	STD Q = 40,000   (X - 40,000) ´ $2 = $4,000 unit, X = 42,000 pieces issued
e.	$24,000 + $800 + $300 = $25,100

f.	$40,000 + $6,000 + $1,000 = $47,000