1. Paper F2 Management Accounting
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2. Chapter 21 Basic variance analysis
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3. Basic variance analysis
Chapter Preview
Basic variance analysis
Total variance
Price variance
Quantityvariance
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4. A standard cost card might look like this:
A standard cost card might look like the one shown on the screen. First, we see a standard quantity. In this case, direct materials is expressed in terms of pounds, direct labor in hours, and variable manufacturing overhead in hours. Second, we have a standard price or standard rate, and finally, we have a standard cost per unit.
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5. Manufacturing Overhead Manufacturing Overhead
Variances
A standard cost variance is the amount by which an actual cost differs from the standard cost.
Direct Material
Direct Material
Standard cost
Amount
Direct Labor
Direct Labor
You can see from this diagram that direct labor cost is equal to the standard cost for labor, while direct material cost is above standard and manufacturing overhead cost is below standard. The difference between actual cost and standard cost is called a standard cost variance.
Manufacturing Overhead
Manufacturing Overhead
Type of Product Cost
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6. Manufacturing Overhead
Variances
This variance is favorable because the actual cost is less than the standard cost.
This variance is adverse because the actual cost exceeds the standard cost.
Direct Material
Standard cost
Direct Labor
In the example shown, the material variance is adverse because the actual cost exceeds the standard cost. The manufacturing overhead cost is favorable because the actual cost is less than standard cost.
Manufacturing Overhead
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7. Variance Analysis Receive explanations Identify questions
Take corrective actions
Identify questions
Analyze variances
Conduct next period’s operations
Variance analysis involves comparing actual costs with standard costs. If variances exists, we investigate by asking appropriate managers for explanations and possible causes for the variances. Our objective is to correct problems that caused adverse variances and to possibly adopt and reward the practices that resulted in favorable variances.
Prepare standard cost performance report
Begin
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8. Standard Cost Variances
Computing Variances
Standard Cost Variances
Quantity Variance
Price Variance
The difference between the actual price and the standard price
The difference between the actual quantity and the standard quantity
Price variances result when we pay an actual price for a resource that differs from the standard price that should have been paid. Quantity variances are caused by using an actual amount of a resource that differs from the standard amount that should have been used.
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9. Computing Variances Price Variance Quantity Variance
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.
Here’s a general model for computing standard cost variances. We multiply the actual quantity times the actual price and compare that to the actual quantity times the standard price. The difference is the price variance. Then we compare the actual quantity times the standard price to the standard quantity at the standard price. The difference is the quantity variance. Standard price is the amount we should pay for the resource acquired.
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10. Computing Variances Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
Standard quantity is the quantity that should have been used for the actual good output.
The standard quantity is the standard quantity for one unit multiplied times the number of good units produced. It is the amount of a resource that should have been used given the actual good output achieved.
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11. Computing Variances Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
We can reduce these relationships to mathematical equations. For example, we can determine the material price variance by multiplying the actual quantity times the difference between the actual price and the standard price, and we can determine the material quantity variance by multiplying the standard price times the difference between the actual quantity and the standard quantity.
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12. Computing Material and Labor Variances
G-Max Company makes golf clubheads with the following standard cost information:
In this example the G-Max Company produces golf clubheads. The direct materials standard allows one pound per clubhead at one dollar per pound. The direct labor standard allows one hour per clubhead at eight dollars per hour.
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13. Material Variances
During May, G-Max produced 3,500 clubheads using 3,600 pounds of material. G-Max paid $1.05 per pound for the material. Compute the material price and quantity variances.
During May, G-Max purchased and used three thousand, six hundred pounds of material to make three thousand, five hundred clubheads. G-Max paid one dollar and five cents per pound for the the three thousand, six hundred pounds of material. Use this information to compute the material price and quantity variances before you go to the next slide.
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14. Material Variances Price variance $180 adverse
SQ = 3,500 units × 1 lb. per unit = 3,500 lbs.
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
3,600 lb ,600 lbs ,500 lbs × × × $1.05 per lb $1.00 per lb $1.00 per lb.
$3, $3, $3,500
Now you can check your work. The total actual price paid for the material was three thousand, seven hundred eighty dollars. Since the standard price was one dollar per pound, G-Max should have paid only three thousand, six hundred dollars for the material. The difference between three thousand, seven hundred eighty dollars and three thousand, six hundred dollars is the one hundred eighty dollars adverse price variance. G-Max actually used three thousand, six hundred pounds of material, one hundred pounds more than the standard quantity of three thousand, five hundred pounds. Using an extra one hundred pounds resulted in the one hundred dollars adverse quantity variance.
Price variance $180 adverse
Quantity variance $100 adverse
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15. Responsibility for Material Variances
You used too much material because of poorly trained workers and poorly maintained equipment.
Also, your poor scheduling requires me to rush order material at a higher price, causing adverse price variances.
I am not responsible for this adverse material quantity variance.
You purchased cheap material, so my people had to use more of it.
The production manager is responsible for material usage. Since his performance evaluation is negatively impacted by the adverse material quantity variance, he is trying to find reasons for the adverse variance other than his own production operation.
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16. Let’s turn our attention to labor variances.
Now that we have computed material variances, we can apply the same concepts to labor.
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17. Labor Variances Rate Variance Efficiency Variance
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
Rate Variance
Efficiency Variance
Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead expenditure variance efficiency variance
AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours
Instead of price and quantity, for direct labor we use the terms rate and hours. Also, instead of price and quantity variances, for labor, we use the terms rate and efficiency variances. The underlying concepts are the same as we saw for material. The standard rate is the amount we should pay per hour for the work performed. Standard hours are the hours that should have been worked for the actual good output achieved. Just as with material, we can reduce these relationships to mathematical equations. For example, we can determine the labor rate variance by multiplying actual hours times the difference between the actual rate and the standard rate, and we can determine the labor efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.
-Quantity is the standard quantity for one unit multiplied times the number of good units produced. It is the amount of a resource that should have been used.
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18. Labor Variances
During May, G-Max produced 3,500 clubheads working 3,400 hours. G-Max paid an average of $8.30 per hour for the hours worked. Compute the labor rate and efficiency variances.
During May, G-Max employees worked three thousand, four hundred hours to make the three thousand, five hundred clubheads. G-Max paid an average of eight dollars and thirty cents per hour to the employees for the three thousand, four hundred hours worked. Use this information to compute the labor rate and efficiency variances before you go to the next slide.
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19. SH = 3,500 units × 1 hour per unit = 3,500 hours
Labor Variances
SH = 3,500 units × 1 hour per unit = 3,500 hours
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
3,400 hours ,400 hours ,500 hours × × × $8.30 per hour $8.00 per hour $8.00 per hour
$28, $27, $28,000
Now you can check your work. The total actual wages paid for three thousand, four hundred hours were twenty eight thousand, two hundred twenty dollars. Since the standard rate was eight dollars per hour, G-Max should have paid only twenty seven thousand, two hundred dollars for three thousand, four hundred hours. The difference between twenty eight thousand, two hundred twenty dollars and twenty seven thousand, two hundred dollars is the one thousand, twenty dollars adverse rate variance. G-Max employees actually worked three thousand, four hundred hours; one hundred hours less than the standard of three thousand, five hundred hours. Working one hundred hours less than allowed by the standard for labor time resulted in the eight hundred dollars favorable efficiency variance
Rate variance $1,020 adverse
Efficiency variance $800 favorable
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20. Labor Variances
Using highly paid skilled workers to perform unskilled tasks results in an adverse rate variance.
High skill, high rate
Low skill, low rate
One possible explanation for an adverse rate variance is that the production manager used highly paid, skilled workers to perform tasks that only required unskilled workers. We pay a higher rate for the same number of hours using workers with higher skills than required for the work. Generally, production managers are responsible for any rate variances.
Production managers who make work assignments are generally responsible for rate variances.
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21. Adverse Efficiency Variance
Labor Variances
Poorly trained workers
Poor supervision of workers
Poor quality materials
Poorly maintained equipment
Adverse Efficiency Variance
A number of factors can cause an adverse efficiency variance. All too often an adverse efficiency variance is blamed on inefficient workers. The reasons listed on your screen are much more likely to be the causes for adverse labor efficiency variances.
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22. Responsibility for Labor Variances
You used too much time because of poorly trained workers and poor supervision.
I am not responsible for the adverse labor efficiency variance!
You purchased cheap material, so it took more time to process it.
If an adverse labor efficiency variances arises, the production manager is generally held responsible. Since his performance evaluation is negatively impacted by adverse labor variances, he may again be trying to find reasons for the the adverse variance other than his own production operation.
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23. Responsibility for Labor Variances
Maybe I can attribute the labor and material variances to personnel for hiring the wrong people and training them poorly.
Since the production manager’s arguments could not shift responsibility for adverse variances to purchasing, he is now thinking of other reasons that might have caused the variances.
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24. Overhead Standards and Variances
Let’s change topics again.
Now that we have mastered material and labor variances, we can apply the same concepts to overhead.
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25. Overhead Standards and Variances
Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR):
Assigned Overhead = POHR × Standard Activity
Recall from our work in previous chapters that the predetermined overhead rate is calculated by dividing estimated overhead costs for the operating period by the estimated activity for the operating period. We then use the predetermined overhead rate to assign overhead costs to products as they are manufactured.
Estimated total overhead costs Estimated activity
POHR =
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26. Setting Overhead Standards
Contains a fixed overhead rate which declines as activity level increases.
Contains a variable unit rate which stays constant at all levels of activity.
Overhead Rate
The predetermined overhead rate contains both fixed and variable components of overhead. The variable overhead rate will be the same for all levels of activity. However, the fixed portion of the overhead rate will differ depending on the activity level used in the denominator of the predetermined overhead rate computation. Flexible budgets for overhead will help us see these relationships.
Function of activity level chosen to determine rate.
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27. Setting Overhead Standards
Flexible budgets, showing budgeted amount of overhead for various levels of activity, are used to analyze overhead costs.
G-Max’s flexible budget for overhead
We will continue the example using the G-Max company to examine variable and fixed overhead standards
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28. Flexible Overhead Budget
Here we see flexible budgets for overhead prepared at several levels of activity. The activity levels are expressed as a percentage of capacity. Notice that the variable overhead rate is one dollar per unit for all levels of activity. Multiplying the one dollar variable overhead rate times the number of units at each production level results in the flexible budget for variable overhead. For example, at the three thousand, five hundred unit level of activity, the variable overhead budget is three thousand, five hundred dollars, computed by multiplying one dollar per unit times three thousand, five hundred units.
Notice that the fixed portion of the overhead budget is unchanged at four thousand dollars for all levels of activity. Including the fixed overhead in the computation of the predetermined overhead rate results in a declining unit cost for overhead, from two dollars and fourteen cents per hour at the three thousand, five hundred unit level of activity to one dollar and eighty cents per hour at the five thousand unit level of activity.
$7,500 ÷ 3,500 hours = $2.14 per hour
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29. Flexible Overhead Budget
Because the predetermined overhead rate is different at each level of activity, G-Max must select an activity for its predetermined overhead rate. In this case, G-Max selected four thousand units. At this level of activity, the predetermined overhead rate is two dollars per hour, made up of one dollar per hour variable overhead rate, and one dollar per hour fixed overhead rate. Choosing any other level of activity would have resulted in the same variable overhead rate, but a different fixed overhead rate.
G-Max predicted an 80 percent activity level
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30. Computing Overhead Variances
Now that we can compute the overhead rates, let’s use them to determine variable and fixed overhead variances.
We now have the fixed and variable overhead rates for G-Max. Next, we can use these overhead rates in a standard cost system to calculate variable and fixed overhead variances.
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31. Computing Variable Overhead Variances
Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
AH × AVR
AH × SVR
SH × SVR
Expenditure Variance
Efficiency Variance
When we compare actual hours times actual variable overhead rate to actual hours times the standard variable overhead rate, we get the expenditure variance for variable overhead. When we compare actual hours times the standard variable overhead rate to standard hours at the standard variable overhead rate, we get the efficiency variance for variable overhead.
AH = Actual Hours of Activity AVR = Actual Variable Overhead Rate SVR = Standard Variable Overhead Rate SH = Standard Hours Allowed
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32. Computing Variable Overhead Variances
During May, G-Max produced 3,500 clubheads working 3,400 hours. G-Max budgeted for 4,000 units (80%). Actual variable overhead was $3,650 and actual fixed overhead was $4,000. Compute the variable overhead expenditure and efficiency variances and the fixed overhead expenditure and volume variances.
Let’s continue with our G-Max example. Production volume and hours worked are the same as we used for the material and labor analysis earlier. Recall that in our flexible budget information for G-Max, four thousand units, eighty percent of capacity, was selected as the activity level used to compute the predetermined overhead rate. The actual costs for variable overhead and fixed overhead on your screen, is new information.
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33. Computing Variable Overhead Variances
Actual Flexible Budget Applied Variable for Variable Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours
3,400 hours ,500 hours × × $1.00 per hour $1.00 per hour
$3,650
$3,400
$3,500
Actual expenditure for variable overhead was three thousand, six hundred fifty dollars. Since the standard variable overhead rate was one dollar per hour, G-Max should have spent three thousand, four hundred dollars for the three thousand, four hundred hours worked. The difference between three thousand, six hundred fifty dollars and three thousand, four hundred dollars is the two hundred fifty dollars adverse expenditure variance. G-Max actually worked three thousand, four hundred hours; one hundred hours less than the standard of three thousand, five hundred hours. Working one hundred hours less than allowed by the standard for direct labor time resulted in the one hundred dollars favorable efficiency variance. The $1.00 per hour is a reasonable estimate of allocating variable costs per hour such as utility costs which include heating, cooling, electricity, etc.
Expenditure variance $250 adverse
Efficiency variance $100 favorable
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34. Variable Overhead Variances
Expenditure Variance
Efficiency Variance
Results from paying more or less than expected for overhead items and from excessive usage of overhead items.
A function of the selected cost driver.
It does not reflect overhead control.
The expenditure variance results from paying more or less than expected for variable overhead items, or from the excessive use of those variable overhead items. The efficiency variance is controlled through proper management of the overhead cost driver activity level, direct labor hours for G-Max.
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35. Computing Fixed Overhead Variances
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
SH × SFR
Expenditure Variance
Volume Variance
The budget variance for fixed overhead is determined by comparing the fixed overhead actually incurred to the budgeted fixed overhead. The volume variance for fixed overhead is determined by comparing the budgeted fixed overhead to the fixed overhead applied. The applied fixed overhead is the product of the fixed overhead rate times standard hours.
SFR = Standard Fixed Overhead Rate SH = Standard Hours Allowed
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36. Computing Fixed Overhead Variances
under-/over- absobed
Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied
3,500 hours × $1.00 per hour
$4,000
$4,000
$3,500
Actual expenditure for fixed overhead was four thousand dollars. The budget for fixed overhead was also four thousand dollars, so the budget variance is zero. G-Max applied three thousand, five hundred dollars of fixed overhead to products using the fixed overhead rate of one dollar per standard hour. Since the three thousand, five hundred standard hours are less than the four thousand hours used to compute the predetermined overhead rate, G-Max has an adverse five hundred dollars volume variance.
Expenditure variance $0
Volume variance $500 adverse
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37. Fixed Overhead Variances
Expenditure Variance
Volume Variance
Results from paying more or less than expected for fixed overhead items.
Results from the inability to operate at the activity planned for the period.
Has no significance for cost control.
The budget variance results from paying more or less than expected for fixed overhead items. The volume variance results from operating at an activity level different from the activity level used to compute the predetermined overhead rate.
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38. $500 Volume Variance adverse 3,500 units × $1.00 fixed overhead rate
$4,000 expected fixed OH
$3,500 applied fixed OH {
$500 Volume Variance adverse
3,500 units × $1.00 fixed overhead rate
Cost
Fixed overhead
applied to products
Part I
Take a few minutes and pay particular attention to this graph of fixed overhead relationships where we have plotted fixed overhead costs on the vertical axis and volume on the horizontal axis. The fixed overhead applied line begins at the origin.
Part II
At a volume of three thousand, five hundred units, we have applied three thousand, five hundred dollars of fixed overhead costs. Since the original fixed overhead budget was five hundred dollars at a volume of four thousand units, the adverse volume variance is four thousand, dollars as shown on the vertical axis.
Volume
3,500 Actual Units
4,000 Expected Units
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39. SH = 3,500 units × 1 hour per unit = 3,500 hours
Volume Variances
SH = 3,500 units × 1 hour per unit = 3,500 hours
Fixed Actual hour Fixed Overhead × Overhead Budget SFR Applied
4,000 hours ,400 hours ,500 hours × × × $1.00 per hour $1.00 per hour $1.00 per hour
$4, $3, $3,500
Now you can check your work. The total actual wages paid for three thousand, four hundred hours were twenty eight thousand, two hundred twenty dollars. Since the standard rate was eight dollars per hour, G-Max should have paid only twenty seven thousand, two hundred dollars for three thousand, four hundred hours. The difference between twenty eight thousand, two hundred twenty dollars and twenty seven thousand, two hundred dollars is the one thousand, twenty dollars adverse rate variance. G-Max employees actually worked three thousand, four hundred hours; one hundred hours less than the standard of three thousand, five hundred hours. Working one hundred hours less than allowed by the standard for labor time resulted in the eight hundred dollars favorable efficiency variance
Volume capacity variance $600 adverse
Volume efficiency variance $100 favorable
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40. Overhead Variance Analysis
Total Overhead Variance
Variable Overhead
Fixed Overhead
Expenditure Variance
Efficiency Variance
Expenditure Variance
Volume Variance
Volume Capacity Variance
Volume Efficiency Variance
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41. Standard Costs for Control
Managers focus on quantities and costs that differ from standards, a practice known as management by exception.
Direct Material
Standard cost
Amount
Direct Labor
Standard cost analysis enables managers to focus on problems that need their attention. As long as operations are functioning without variances, managers are free to deal with other issues. In those instances when variances do occur, manager redirect their efforts to correcting the problems causing the variances. This process is referred to as management by exception.
Manufacturing Overhead
Type of Product Cost
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42. Reasons for Cost Variance
There are many possible reasons:
Favorable
Adverse
Usage variances
Price variances
to investigate or not?
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43. The significance of cost variances
Materiality
Controllability
The type of standard being used
Interdependence between variances
Variance trend
Cost of investigation
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44. Interdependence of variances
Variances may affect each other
e.g.
Cheaper materials
Favourable price variance
Inferior quality
Adverse usage variance (& labour efficiency?)
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45. Interdependence of variances
Variances may affect each other
e.g.
Higher rates for skilled worker
Adverse rate variance
High efficiency
Favourable efficiency variance
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46. End of Chapter 21
I Need Some Help!
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