1. ACC3200
STANDARD COSTING

2. Learning Objectives
Describe the standard-setting process and explain how standard costs relate to budgets and variances.
Prepare a flexible budget and show how total costs change with sales volume.
Calculate and interpret the direct materials price and quantity variances.
Calculate and interpret the direct labor rate and efficiency variances.
Calculate and interpret the variable overhead rate and efficiency variances.
Calculate and interpret the fixed overhead spending variance.

3. Standard Cost Systems Based on carefully predetermined amounts.
Standard Costs are
Used for planning labor, material and overhead requirements.
The expected level of performance.
Standard costs are preset costs for making a product or delivering a service. We expect to operate within the standard cost allowances under normal conditions. Standard costs are used for both planning and performance evaluation. In a standard cost system, all manufacturing costs are recorded at standard rather than actual amounts.
Benchmarks for measuring performance.
In a standard cost system, all manufacturing costs are recorded at standard rather than actual amounts.

4. Ideal versus Attainable Standards
I recommend using attainable standards that can be achieved with reasonable and efficient effort.
Should we use ideal standards that require employees to work at 100 percent peak efficiency?
Setting standards requires the combined expertise of everyone who has responsibility for purchasing and using resources. In a manufacturing setting, this might include managerial accountants, engineers, purchasing managers, production supervisors, line managers, and production workers. Standards should be designed to encourage efficient future operations, not just a repetition of past inefficient operations. 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 continually work at 100 percent peak efficiency.
Attainable standards are tight, but achievable. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker.
Research suggests that tight but attainable standards—the happy medium in between the extremes of ideal and easily attainable standards—are best for motivating individuals to work hard.

5. Types of Standards
Standard cost systems rely on two types of standards, quantity standards and price standards. Quantity standards specify how much of an input should be used to make one unit of product. Price standards specify how much should be paid for each unit of the input.

6. 10-6
The Standard Cost Card
Here you see a standard cost card for Cold Stone Creamery. First, we see a standard quantity. In this case, direct materials are expressed in terms of ounces, direct labor in hours, and variable manufacturing overhead in hours. Second, we have a standard price or standard rate expressed in dollars per ounce for materials and dollars per hour for labor and variable manufacturing overhead. Finally, we have a standard cost per unit for each input. The price and quantity standards for each input are multiplied to get the standard unit cost. Then all the standard costs are summarized on a standard cost card, which shows what the company should spend to make a single unit of product.
Cold Stone should use 10 ounces of ice cream and 2 ounces of mix-in ingredients to make each unit of product. The standard price is 5 cents per ounce for ice cream and 10 cents per ounce for mix-ins, resulting in a standard unit cost of 50 cents for ice cream and 20 cents for mix-in ingredients. The direct labor standard shows that employees should be able to produce and serve an average of 10 units per hour at a rate of $8.00 per hour, resulting in a direct labor cost per unit of 80 cents. Variable manufacturing costs are applied to the product based on a rate of $1.00 per direct labor hour. When this standard variable overhead is rate is multiplied by the standard quantity of 0.10 labor hours per unit, we get a standard unit cost of 10 cents for variable manufacturing overhead.
Notice that fixed manufacturing overhead is not expressed in terms of ounces or hours as are the other inputs. To determine the fixed manufacturing overhead rate per unit, we divided budgeted fixed manufacturing overhead of $6,000 by the 15,000 units we expect to produce and sell to get a rate of 40 cents per unit.

7. Master Budgets Versus Flexible Budgets
10-7
Master Budgets Versus Flexible Budgets
The master budget is based on managers’ best estimate of activity (15,000 units) multiplied by the standard unit cost.
A master budget is prepared for one level of activity based on a sales forecast. For that reason it is often referred to as a static budget. Because predicting activity with 100 percent certainty is impossible, managers often adjust the master budget for different levels of activity to show how budgeted costs and revenues will change as activity changes. The adjusted budget is referred to as a flexible budget. On your screen, you see Cold Stone Creamery’s manufacturing cost master budget for 15,000 units that is flexed down to 12,000 units and flexed up to 18,000 units. Note that all of the flex is in the variable manufacturing costs. Total variable costs change in direct proportion to changes in activity. For example, when Cold Stone’s activity increases from 15,000 units to 18,000 units, the total cost of ice cream should increase from $7,500 to $9,000. The 20 percent increase in activity produces a 20 percent increase in total cost. Fixed costs remain the same (in total), regardless of changes in activity. Cold Stone’s budgeted fixed cost is $6,000 at all levels of activity shown. The fixed cost of 40 cents per unit is valid only for the master budget of 15,000 units ($6,000 / 15,000 units = 40 cents per unit).
The flexible budget shows how total costs are expected to change if activity is lower (12,000 units) or higher (18,000 units) than expected.

8. Flexible Budget as a Benchmark
10-8
Flexible Budget as a Benchmark
Planning Process
Based on estimated (budgeted) sales volume.
Master Budget
Control Process
Flexible Budget
Actual Results
Compare actual results to the flexible budget to evaluate performance, after controlling for actual sales volume.
The master budget is used for planning, but the flexible budget is used for control. After the actual activity is known, a flexible budget for that level of activity is compared with actual results. Using the flexible budget for performance evaluation allows us to separate the effect of a change in sales volume from the effect of a change in cost. Let’s look at an example.
A flexible budget for the actual activity is compared with actual results.

9. Flexible Budget as a Benchmark
10-9
Flexible Budget as a Benchmark
Cold Stone Creamery’s master budget of $7,500 for ice cream was based on a sales forecast of 15,000 units ($.50 per unit × 15,000 units). During the period, the amount spent for ice cream was $8,000, or $500 higher than the master budget. Did Cold Stone do a good job controlling ice cream costs?
There are two possible reasons why spending exceeded the master budget:
1. Cold Stone may have spent more than $.50 on ice cream for each unit produced.
Cold Stone may have produced more than 15,000 units, requiring more ice cream than planned.
Part I.
Cold Stone Creamery’s master budget of $7,500 for ice cream was based on a sales forecast of 15,000 units (50 cents per unit × 15,000 units). During the period, the amount actually spent for ice cream was $8,000, or $500 higher than the master budget. Did Cold Stone do a good job controlling ice cream costs?
Part II.
To answer this question, we need to think about the two possible reasons that ice cream costs might have been more than the master budget:
• Cold Stone may have spent more than 50 cents on ice cream for each unit produced.
• Cold Stone may have produced more than 15,000 units, requiring more ice cream than planned.
Part III.
Cold Stone actually produced 18,000 units for the period, 3,000 units more than the sales forecast used to develop the master budget. Comparing actual results for 18,000 units with a master budget at 15,000 units makes performance evaluation impossible. It’s like comparing apples and oranges. Let’s prepare a flexible budget at 18,000 units so that we can compare actual results and budgeted results for the same level of activity.
Cold Stone actually produced 18,000 units for the period. Let’s prepare a flexible budget at 18,000 and evaluate performance.

10. Volume Variance versus Spending Variance
10-10
Volume Variance versus Spending Variance
Actual Cost $8,000
Flexible Budget $9,000
Based on 15,000 units
Master Budget $7,500
Volume Variance 1,500 U
Based on 18,000 units
Based on 18,000 units
Part I.
When we compare the flexible budget cost of $9,000 for 18,000 units to the actual cost of $8,000 for 18,000 units, we can see that you spent $1,000 less than the flexible budget on ice cream. This variance is called a spending variance. The lesson here is that to evaluate cost control, we can’t just compare actual results to the master budget. The master budget is useful in planning, but a flexible budget should be used to evaluate performance.
Part II.
Using the flexible budget for performance evaluation allows us to separate the effect of a change in sales volume from the effect of a change in cost. The only difference between the master budget and the flexible budget is the sales volume that is used to create each budget. The comparison of the master budget to the flexible budget creates a volume variance that represents the difference between actual and budgeted sales volume. The volume variance for ice cream is $1,500 (3,000 units X $.50 per unit), because Cold Stone produced 3,000 more units than expected.
SpendingVariance $1,000 F

11. Favorable versus Unfavorable Variances
10-11
Favorable versus Unfavorable Variances
This variance is unfavorable because the actual cost exceeds the standard cost.
These variances are favorable because the actual cost is less than the standard cost.
Standard
Amount
Direct Material
The difference between an actual cost and a standard cost is called a standard cost variance. A favorable variance (F) occurs when actual costs are less than budgeted or standard costs. An unfavorable variance occurs when actual costs are more than budgeted or standard costs.
You can see from this diagram that the actual direct labor cost is less than the standard cost for direct labor, and that the actual direct material cost is also less than the standard cost for direct material. In contrast, the actual manufacturing overhead cost is greater than the standard cost for manufacturing overhead. Therefore, the direct labor and direct material cost variances are favorable while the manufacturing overhead cost variance is unfavorable.
Direct Labor
Manufacturing Overhead
Type of Product Cost

12. Favorable versus Unfavorable Variances
10-12
Favorable versus Unfavorable Variances
Here you see some common causes of favorable and unfavorable variances.

13. Use of Flexible Budgets to Calculate Cost Variances
10-13
Use of Flexible Budgets to Calculate Cost Variances
A standard is the expected cost for one unit.
A budget is the expected cost for all units produced.
Standards are the expected costs of resource inputs expressed on a per unit basis. Budgets deal with total costs for a specific activity level. Standards are often used in the preparation of budgets. Knowing the standard cost for one unit, we can multiply the standard cost times the any number of units to get a budget for that number of units. The total budgeted amount changes as the number of units changes, but the standard cost per unit does not change.
What is the difference between standards and budgets?

14. Calculation of Direct Cost Variances
10-14
Calculation of Direct Cost Variances
Spending variance
Actual cost AP × AQ
SP × AQ
Flexible budget SP × SQ
Master budget SQ × SP
The spending variance for direct costs (such as direct materials and direct labor) can be divided into two components: a price variance and a quantity variance. The price variance relates the actual price paid (AP) for the input to the price the company should have paid (SP). The quantity variance relates the actual quantity of input used (AQ) to create the final product to the quantity the company should have used (SQ).
There are two ways to calculate the price and quantity variances. The first approach is to calculate the value of the three boxes on the lower row, beginning with actual cost and moving to the right to flexible budget. The differences between the amounts calculated for the boxes are the price and quantity variances as shown on your screen. The second approach is to use a formula for each individual variance. The formulas are shown in the two variance boxes. Separating the spending variance into price and quantity variances in this manner helps us to identify the cause of the variances.
Price variance AQ × (SP – AP)
Quantity variance SP × (SQ – AQ)
SQ based on budgeted units
AP = Actual price of input AQ = Actual quantity of input SP = Standard price of input
SQ = Standard quantity of input allowed to achieve the actual units of output
SQ based on actual units

15. Direct Materials Variances
10-15
Direct Materials Variances
Cold Stone’s Standard Cost Information for Ice Cream
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
200,000 ounces of ice cream purchased at a total cost of $8,000.
Part I.
Earlier we saw that Cold Stone Creamery had a $1,000 favorable spending variance for ice cream as the actual cost was $8,000 and the flexible budget was $9,000. Let’s separate the spending variance into price and quantity variances. Cold Stone’s standards for ice cream are:
Standard Quantity = 10 ounces per unit
Standard Price = 5 cents per ounce.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
200,000 ounces of ice cream were purchased at a total cost of $8,000.
Part II.
Let’s start the analysis by computing or identifying amounts that we will use.
Actual Price (AP) = $8,000 ÷ 200,000 ounces = 4 cents per ounce
Actual Quantity (AQ) = 200,000 ounces
Standard Price (SP) = 5 cents per ounce
Standard Quantity (SQ) = 10 ounces per unit × 18,000 actual units = 180, ounces
Actual Price (AP) = $8,000 ÷ 200,000 ounces = $.04 per ounce
Actual Quantity (AQ) = 200,000 ounces
Standard Price (SP) = $.05 per ounce
Standard Quantity (SQ) = 10 ounces per unit × 18,000 actual units = ,000 ounces

16. Direct Materials Variances
10-16
Direct Materials Variances
SQ =18,000 actual units × 10 ounces
AP × AQ
AP × AQ $.04 × 200,000
$8,000
SP × AQ $.05 × 200,000
$10,000
SP × AQ
SP × SQ
Price Variance AQ × (SP – AP)
Quantity Variance SP × (SQ – AQ)
The direct materials price variance is the difference between the actual price (AP = 4 cents) and the standard price (SP = 5 cents), multiplied by the actual quantity (AQ = 200,000 ounces) of direct materials purchased. The direct materials quantity variance is the difference between the actual quantity (AQ = 200,000 ounces) and the standard quantity (SQ = 180,000 ounces) for direct materials, multiplied by the standard price (SP = 5 cents).
The direct materials price variance is $2,000 favorable because the company paid 1 cent less than the standard cost for the 200,000 ounces of materials purchased. The direct materials quantity variance is $1,000 unfavorable because the company used 200,000 ounces of ice cream to make 18,000 units, when only 180,000 ounces were required. The direct materials spending variance combines the direct materials price and quantity variances. Since the price variance is $2,000 favorable and the quantity variance is $1,000 unfavorable, the result is a $1,000 favorable spending variance.
Spending Variance

17. Direct Materials Variances
10-17
Direct Materials Variances
Materials Price Variance
Materials Quantity 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.

18. Direct Labor Variances
10-18
Direct labor variances
Actual cost AR × AH
SR × AH
Flexible budget SR × SH
Rate variance AH × (SR – AR)
Efficiency variance SR × (SH – AH)
We use the same approach to calculate direct labor variances with only two minor modifications:
The price of direct labor is called the direct labor rate, so the price variance for labor is called the direct labor rate (not price) variance.
The direct labor quantity is measured in hours, so the quantity variance for labor is called the direct labor efficiency (not quantity) variance.
AR = Actual hourly labor rate AH = Actual labor hours SR = Standard hourly labor rate
SH = Standard labor hours allowed to achieve the actual units of output
SH Based on actual units produced

19. Direct Labor Variances
10-19
Direct Labor Variances
Cold Stone’s Standard Cost Information for Direct Labor
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Direct labor costs were $16,500 for 2,000 hours worked.
Part I.
Cold Stone’s standards for direct labor are:
Standard Hours = 0.10 hours per unit.
Standard Rate = $8.00 per hour.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual direct labor costs were $16,500 for 2,000 hours worked.
Part II.
Let’s start the analysis by computing or identifying amounts that we will use.
Actual Rate (AR) = $16,500 ÷ 2,000 hours = $8.25 per hour
Actual Hours (AH) = 2,000 hours
Standard Rate (SR) = $8.00 per hour
Standard Hours (SH) = 0.10 hours per unit × 18,000 actual units = 1,800 hours
Actual Rate (AR) = $16,500 ÷ 2,000 hours = $8.25 per hour
Actual Hours (AH) = 2,000 hours
Standard Rate (SR) = $8.00 per hour
Standard Hours (SH) = 0.10 hours per unit × 18,000 actual units = 1,800 hours

20. Direct Labor Variances
10-20
Direct Labor Variances
SH = 18,000 actual units × 0.10 hours
AR × AH
SR × AH
SR × SH
Rate variance AH × (SR – AR)
Efficiency variance SR × (SH – AH)
The direct labor rate variance is the difference between the actual rate (AR = $8.25) and the standard rate (SR = $8.00), multiplied by the actual hours (AH = 2,000 hours) of direct labor. The direct labor efficiency variance is the difference between the actual hours (AH = 2,000 hours) and the standard hours (SH = 1,800 hours) for direct labor, multiplied by the standard rate (SR = $8.00).
The direct labor rate variance is $500 unfavorable because the company paid 25 cents per hour more than the standard rate for the 2,000 hours worked. The direct labor efficiency variance is $1,600 unfavorable because the employees worked 2,000 hours to make 18,000 units, when only 1,800 hours were required. The direct labor spending variance combines the direct labor rate and efficiency variances. Since the rate variance is $500 unfavorable and the efficiency variance is $1,600 unfavorable, the result is a $2,100 unfavorable spending variance.
Spending variance

21. Responsibility for Labor Variances
10-21
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 production supervision.
Quality of training provided to employees.
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;
Level of employee motivation within the department;
 Quality of production supervision; and
Quality of the training provided to the employees.

22. Manufacturing Overhead Cost Variances
10-22
Manufacturing Overhead Cost Variances
Contain fixed overhead that remains constant as activity changes.
Contain variable overhead that increases as activity increases.
Overhead Rates
Manufacturing overhead costs cannot be traced directly to specific units so they must be applied to products using a predetermined overhead rate and an allocation measure, such as direct labor hours. The predetermined overhead rates are estimated before the accounting period begins, based on budgeted costs and budgeted levels of the overhead allocation measures. The predetermined overhead rates contain 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.
During the period overhead is applied to specific units by multiplying the predetermined overhead rates times the quantity of the allocation measure. The overall difference (variance) between actual and applied manufacturing overhead is called over- or underapplied overhead. We can break the overall variance down into more detailed variances, to gain some insight into why manufacturing overhead costs were over- or underapplied. The interpretation of overhead variances will depend on whether an overhead cost is variable or fixed.
Are a function of the activity level chosen to determine the rate.

23. Variable Manufacturing Overhead Variances
10-23
Variable Manufacturing Overhead Variances
Flexible budget SR × SH
Actual VOH AR × AH
SR × AH
VOH rate variance AH × (SR – AR)
VOH efficiency variance SR × (SH –AH)
We use the same approach to analyze variable manufacturing overhead that we used for direct labor. When we compare actual hours times actual variable overhead rate to actual hours times the standard variable overhead rate, we get the rate 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.
Variable manufacturing overhead costs include the costs of indirect materials, such as cleaning supplies and paper products, as well as the power to run machines and other incidentals that vary with some activity measure. We will assume that these costs vary in direct proportion to direct labor hours—a realistic assumption for a labor-oriented business like Cold Stone Creamery.
Variable overhead spending variances
AR = Actual variable overhead rate
SR = Standard variable overhead rate
AH = Actual direct labor hours SH = Standard direct labor hours allowed to achieve the actual units of output

24. Variable Manufacturing Overhead Variances
10-24
Variable Manufacturing Overhead Variances
Cold Stone’s Standard Cost Information for Variable Manufacturing Overhead
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Actual VOH costs were $1,800 for 2,000 direct labor hours.
Part I.
Cold Stone’s standards for variable manufacturing overhead are:
Standard Direct Labor Hours = 0.10 hours per unit.
Standard Variable Overhead Rate = $1.00 per hour.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual direct labor hours were 2,000.
• Actual variable overhead costs were $1,800.
Part II.
Let’s start the analysis by computing or identifying amounts that we will use.
Actual Direct Labor Hours (AH) = 2,000 hours
Standard Direct Labor Hours (SH) = 0.10 hours per unit × 18,000 actual units = 1,800 hours
Actual Variable Overhead Rate (AR) = $1,800 ÷ 2,000 hours = 90 cents per hour
Standard Variable Overhead Rate (SR) = 0.10 hours per unit × $1.00 per hour = cents per unit
Actual Direct Labor Hours (AH) = 2,000 hours
Standard Direct Labor Hours (SH) = 0.10 hours per unit × 18,000 units = 1,800 hours
Actual Variable Overhead Rate (AR) = $1,800 ÷ 2,000 hours = $ per hour
Standard Variable Overhead Rate (SR) = 0.10 hours per unit × $1.00 per hour = $0.10 per unit

25. Variable Manufacturing Overhead Variances
10-25
Variable Manufacturing Overhead Variances
SH = 18,000 actual units × 0.10 hours
Actual VOH AR × AH
Flexible budget SR × SH
AR × SR
VOH rate variance AH × (SR – AR)
VOH efficiency variance SR × (SH –AH)
The variable overhead rate variance is the difference between the actual variable overhead rate (AR = 90 cents) and the standard variable overhead rate (SR = $1.00), multiplied by the actual hours (AH = 2,000 hours) of direct labor. The variable overhead efficiency variance is the difference between the actual hours (AH = 2,000 hours) and the standard hours (SH = 1,800 hours) for direct labor, multiplied by the standard variable overhead rate (SR = $1.00).
The variable overhead rate variance is $200 favorable because the company paid 10 cents per hour less than the standard rate for the 2,000 hours worked. The variable overhead efficiency variance is $200 unfavorable because the employees worked 2,000 hours to make 18,000 units, when only 1,800 hours were required. Since the rate variance is $200 favorable and the efficiency variance is $200 unfavorable, the result is zero over-or-underapplied variable overhead.
Variable overhead spending variance

26. Variable Manufacturing Overhead Variances
10-26
Variable Manufacturing Overhead Variances
Rate 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 allocation measure (direct labor hours). It does not reflect overhead control.
The variable overhead rate 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 allocation measure, direct labor hours for Cold Stone.

27. Fixed Manufacturing Overhead Spending Variance
10-27
Fixed Manufacturing Overhead Spending Variance
Fixed Overhead Spending Variance
Budgeted Fixed Overhead
Actual Fixed Overhead = ‒
Cold Stone budgeted $6,000 for fixed manufacturing overhead but actually incurred $6,300 in fixed manufacturing overhead costs.
Fixed Overhead Spending Variance $300 U
$6,000
$6,300 = ‒
The model used to analyze direct materials, direct labor and variable manufacturing overhead variances does not apply to fixed manufacturing overhead costs. Fixed manufacturing overhead costs are incurred to provide the organization a certain level of capacity, but the total fixed cost does not vary with volume within that range of capacity as do direct materials, direct labor, and variable manufacturing overhead.
The fixed overhead spending variance, also called the fixed overhead budget variance, is calculated by comparing actual fixed overhead costs to budgeted fixed overhead costs. For example, if Cold Stone Creamery budgeted for $6,000 in fixed manufacturing overhead but actually spent $6,300, it would report a $300 unfavorable fixed overhead spending variance. This $300 unfavorable spending variance could be due to an unexpected rise in fixed manufacturing overhead costs such as rent, insurance or supervision.

28. Summary of Spending Variances
10-28
Summary of Spending Variances
Variances are always calculated by comparing actual results to budgeted, or standard, results.
Companies try to hold specific managers responsible for specific variances, while removing the effects of factors that are beyond managers’ control.
The formulas for variances allow only one factor, such as price, quantity or volume to change, while holding everything else constant at either actual or standard values (depending on the type of variance).
The driving factor for a variance always appears in parentheses in the formula, as well as in the name of the variance. For example, the formula for the direct materials price variance is AQ X (SP - AP).
Try not to memorize rules or rely on the formulas to determine whether a variance is favorable or unfavorable; just think about it. Spending or using more of a variable resource is unfavorable. Using more of a fixed resource is favorable, because it drives down the fixed cost per unit.
Let’s step back for a minute and think about the purpose of variances. Here are some general guidelines for calculating and interpreting variances:
Variances are always calculated by comparing actual results to budgeted, or standard, results.
Companies try to hold specific managers responsible for specific variances, while removing the effects of factors that are beyond managers’ control.
The formulas for variances allow only one factor, such as price, quantity, or volume to change, while holding everything else constant at either actual or standard values (depending on the type of variance).
The driving factor for a variance always appears in parentheses in the formula, as well as in the name of the variance. For example, the formula for the direct materials price variance is AQ X (SP - AP).
Try not to memorize rules or rely on the formulas to determine whether a variance is favorable or unfavorable; just think about it. Spending or using more of a variable resource is unfavorable. Using more of a fixed resource is favorable, because it drives down the fixed cost per unit.

29. Total Spending Variance $2,000 U
10-29
Summary of Spending Variances
Actual Costs
Flexible Budget
Spending Variances
Ice Cream $8,000
Ice Cream $9,000
DM Price $2,000 F
DM Quantity $1,000 U
Mix-Ins
$4,200
Mix-Ins $3,600
DM Price $700 U
DM Quantity $100 F
Direct Labor
$16,500
Direct Labor $14,400
DL Rate $500 U
DL Efficiency $1,600 U
Variable OH
$1,800
Variable OH $1,800
VOH Rate $200 F
VOH Efficiency $200 U
Here you see a summary of all of the spending variances related to Cold Stone’s production process. Note that variances for the mix-in ingredients were computed in the self-study quiz in the chapter.
Fixed OH
$6,300
Fixed OH $6,000
FOH Budget $300 U
Actual Cost
$36,800
Budgeted Cost $34,800
Total Spending Variance $2,000 U

30. Budgeted Fixed Overhead Rate Budgeted Fixed Overhead
10-30
Supplement 10A – Fixed Manufacturing Overhead Volume and Capacity Variances
Fixed Overhead Rate Based on Budgeted Volume
Budgeted Fixed Overhead Rate
Budgeted Fixed Overhead
Budgeted Volume = ÷
Budgeted Fixed Overhead Rate $0.40 per unit
$6,000
15,000 units = ÷
Cold Stone budgeted $6,000 for fixed manufacturing overhead for a budgeted volume of 15,000 units. Cold Stone’s budgeted fixed manufacturing overhead rate is:
Part I.
Fixed manufacturing costs are independent of volume. However, fixed manufacturing overhead is assigned to individual units using a fixed overhead rate that is set in advance. The fixed manufacturing overhead rate is computed by dividing budgeted total fixed overhead cost by some measure of activity, such as the number of units produced or the number of direct labor hours.
Part II.
Cold Stone Creamery budgeted fixed overhead costs of $6,000 and the master budget was based on planned production of 15,000 units. Cold Stone Creamery would apply fixed overhead at a rate of 40 cents per unit produced. But the amount of fixed overhead applied to production will only equal $6,000 if the company actually produces 15,000 units. If Cold Stone produces anything other than 15,000 units, the amount of fixed overhead applied to production will be different than the $6,000 budgeted.

31. = ‒ = = Fixed Manufacturing Overhead Volume Variance
10-31
Fixed Manufacturing Overhead Volume Variance
Fixed Overhead Volume Variance
Applied FOH FOH Rate × Actual Volume
Budgeted FOH FOH Rate × Budgeted Volume = ‒
Fixed Overhead Volume Variance
FOH Rate × (Actual Volume ‒ Budgeted Volume) =
Part I.
If actual volume differs from the value used in the denominator of the fixed overhead rate, it will create a fixed overhead volume variance. A volume variance has nothing to do with how much was spent on fixed costs. It simply reflects the accuracy of the denominator used to compute the fixed overhead rate.
Part II.
The only difference in calculation between applied and budgeted fixed overhead is the volume of units produced (actual versus budgeted). The fixed overhead rate is the same in both. The formula shown is an alternative way to compute the fixed manufacturing overhead volume variance.
Part III.
When Cold Stone produces 18,000 actual units, the fixed manufacturing overhead volume variance is $1,200 favorable. The favorable volume variance is computed by multiplying the fixed manufacturing overhead rate of 40 cents per unit times the difference in actual volume (18,000) and budgeted volume (15,000). The fixed manufacturing overhead volume variance is favorable because actual units produced are more than the budgeted units.
Fixed Overhead Volume Variance $1,200 Favorable
$0.40 × (18,000 units ‒ 15,000 units) =

32. Fixed Manufacturing Overhead Spending and Volume Variances
10-32
Fixed Manufacturing Overhead Spending and Volume Variances
Actual FOH
Budgeted FOH FOH Rate × BU
Applied FOH
FOH Rate × AU
FOH Spending Variance Budgeted – Actual FOH
FOH Volume Variance FOH Rate × (AU – BU)
Here you see a variance analysis format for fixed manufacturing overhead. We will use this format to compute the fixed manufacturing overhead spending and volume variances for Cold Stone Creamery.
Over- or Underapplied Fixed Overhead
AU = Actual Units BU = Master Budget Units FOH = Fixed manufacturing overhead
FOH Rate = Budgeted FOH cost ÷ Budgeted units

33. Fixed Manufacturing Overhead Variances
10-33
Fixed Manufacturing Overhead Variances
Cold Stone’s Standard Cost Information for Fixed Manufacturing Overhead
Cold Stone’s budget for fixed overhead was:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’s standard for fixed manufacturing overhead is a fixed overhead rate of 40 cents per unit at a budgeted volume of 15,000 units.
Cold Stone’s budget for fixed overhead for the period was:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual fixed overhead costs were $6,300.
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Actual FOH costs were $6,300.

34. Fixed Manufacturing Overhead Spending and Volume Variances
10-34
Fixed Manufacturing Overhead Spending and Volume Variances
Actual FOH
Budgeted FOH FOH Rate × BU
Applied FOH
FOHR × AU
FOH Spending Variance Budgeted – Actual FOH
FOH Volume Variance FOH Rate × (AU – BU)
The fixed overhead spending variance is the difference between the actual fixed overhead and budgeted fixed overhead. The fixed overhead volume variance is the difference between budgeted fixed overhead at 15,000 units and applied fixed overhead at 18,000 units times the fixed overhead rate of 40 cents per unit. Since the spending variance is $300 unfavorable and the volume variance is $1,200 favorable, the result is over-applied fixed overhead of $900.
The fixed manufacturing overhead spending variance is unfavorable because the actual costs are more than the budgeted costs. The fixed manufacturing overhead volume variance is favorable because actual units produced are more than the budgeted units.
Over- or Underapplied Fixed Overhead

35. Fixed Overhead Rate Based on Practical Capacity
10-35
Fixed Overhead Rate Based on Practical Capacity
Practical capacity is the number of units that could be produced under normal operating conditions.
Fixed Overhead Rate
Budgeted Fixed Overhead
Practical Capacity = ÷
Fixed Overhead Rate $0.30 per unit
$6,000
20,000 units = ÷
Cold Stone budgeted $6,000 for fixed manufacturing overhead and has a practical capacity of 20,000 units. Cold Stone’s fixed manufacturing overhead rate is:
Part I.
Practical capacity is the number of units that could be produced under normal operating conditions. The fixed manufacturing overhead rate is computed by dividing budgeted total fixed overhead cost by a measure of practical capacity.
Part II.
Cold Stone Creamery budgeted fixed overhead costs of $6,000 and the practical capacity is 20,000 units. Cold Stone Creamery would apply fixed overhead at a rate of 30 cents per unit produced. But the amount of fixed overhead applied to production will only equal $6,000 if the company actually produces 20,000 units. If Cold Stone produces anything other than 20,000 units, the amount of fixed overhead applied to production will be different than the $6,000 budgeted.

36. = = Fixed Overhead Capacity Variances
10-36
Fixed Overhead Capacity Variances
The expected capacity variance is computed before the period begins.
Expected Capacity Variance
FOH Rate × Budgeted Volume – Practical Capacity =
Part I.
The expected capacity variance is computed before the period begins based on a comparison of budgeted volume and practical capacity.
Part II.
The planned (expected) cost of unused capacity is $1,500 unfavorable. It is unfavorable because the company planned to produce fewer units than the amount of practical capacity available. This capacity variance tells managers that $1,500 (5,000 units x $0.30) of the total fixed manufacturing overhead cost is expected to be unused or under-utilized.
Expected Capacity Variance
$0.30 × 15,000 units – 20,000 units =
$1,500 Unfavorable

37. = = Fixed Overhead Capacity Variances
10-37
Fixed Overhead Capacity Variances
The unexpected capacity variance is computed after the period is over.
Unexpected Capacity Variance
FOH Rate × Actual Volume – Budgeted Volume =
Part I.
The unexpected capacity variance is computed after the budget period is over, based on a comparison of actual volume and budgeted volume.
Part II.
This unexpected capacity variance of $900 is favorable because the company produced more units than expected, and thus utilized more of the practical capacity than initially planned. The total capacity variance is $600 unfavorable computed by combining the $1,500 unfavorable expected capacity variance with the $900 favorable unexpected capacity variance. The total capacity variance is $600 unfavorable because actual production of 18,000 units was still 2,000 units below practical capacity of 20,000 units (2,000 units x $0.30 = $600).
Unexpected Capacity Variance
$0.30 × 18,000 units – 15,000 units =
$900 favorable

38. Fixed Manufacturing Overhead Spending and Capacity Variances
10-38
Fixed Manufacturing Overhead Spending and Capacity Variances
Cold Stone’s Cost Information for Fixed Manufacturing Overhead
Practical capacity is 20,000 units.
Cold Stone’s budget for fixed overhead was:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’s fixed manufacturing overhead rate is 30 cents per unit at a practical capacity of 20,000 units.
Practical capacity is 20,000 units.
Cold Stone’s budget for fixed overhead for the period was:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual fixed overhead costs were $6,300.
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Actual FOH costs were $6,300.

39. Fixed Manufacturing Overhead Spending and Capacity Variances
10-39
Fixed Manufacturing Overhead Spending and Capacity Variances
Budgeted Cost of Capacity FOH Rate × PC
Cost of Capacity Used
FOHR × AU
Actual FOH
FOH Spending Variance Budgeted – Actual FOH
FOH Capacity Variance FOH Rate × (AU – PC)
When fixed overhead is applied based on practical capacity, over- or underapplied fixed manufacturing overhead is the sum of the fixed overhead spending variance ($300 U) and the total fixed overhead capacity variance ($600 U), or $900 unfavorable (underapplied).
Over- or Underapplied Fixed Overhead

40. 10-40
Supplement 10B – Recording Standard Costs and Variances in a Standard Cost System
Common Rules
• The initial debit to an inventory account (Raw Materials, Work in Process, or Finished Goods) and the eventual debit to Cost of Goods Sold should be based on the standard cost, not the actual cost.
• Cash, payables, or other accounts, such as accumulated depreciation or prepaid assets, should be credited for the actual cost incurred.
• The difference between the standard cost (a debit) and the actual cost (a credit) should be recorded as the cost variance.
• Unfavorable variances should appear as debit entries; favorable variances should appear as credit entries.
• At the end of the accounting period, all the variances should be closed to the Cost of Goods Sold account to adjust the standard cost up or down to the actual cost.
The common rules for preparing journal entries in a standard cost system are:
• The initial debit to an inventory account (Raw Materials, Work in Process, or Finished Goods) and the eventual debit to Cost of Goods Sold should be based on the standard cost, not the actual cost.
• Cash, payables, or other accounts, such as accumulated depreciation or prepaid assets, should be credited for the actual cost incurred.
• The difference between the standard cost (a debit) and the actual cost (a credit) should be recorded as the cost variance.
• Unfavorable variances should appear as debit entries; favorable variances should appear as credit entries.
• At the end of the accounting period, all the variances should be closed to the Cost of Goods Sold account to adjust the standard cost up or down to the actual cost.

41. Recording Standard Costs for Cold Stone Creamery
10-41
Recording Standard Costs for Cold Stone Creamery
Standard Direct Material Cost
Standard Direct Labor and Manufacturing Overhead Costs
No Work in Process or Finished Goods Inventory
Raw Materials Inventory
Cost of Goods Sold
Since Cold Stone does not make the product until a customer orders it, there is no need to keep track of work in process or finished goods inventory costs. Raw Material costs are transferred directly from the raw materials inventory account to the Cost of Goods Sold account. Direct labor and manufacturing overhead costs are recorded directly in the Cost of Goods Sold account.

42. Direct Materials Costs
10-42
Direct Materials Costs
Cold Stone’s Standard Cost Information for Direct Materials
Cold Stone’s actual results for the period were:
200,000 ounces of ice cream were purchased on account for a total of $8,000, at an average actual price of $.04 per ounce.
All 200,000 ounces of ice cream were used to make and sell 18,000 units.
Part I.
Cold Stone’s standards for direct materials:
Standard quantity = 10 ounces per unit
Standard price = 5 cents per ounce.
Cold Stone’s actual results for the period were:
200,000 ounces of ice cream were purchased on account for a total of $8,000, at an average actual price of 4 cents per ounce.
All 200,000 ounces of ice cream were used to make and sell 18,000 units.
Let’s prepare the journal entry to record the purchase of direct materials.
Part II.
The debit to raw materials inventory is based on the standard price per unit of 5 cents, but the credit to accounts payable is based on the actual price paid of 4 cents per unit. The difference between the actual price and the standard price is the direct materials
price variance, calculated by multiplying the 1 cent difference in price by 200,000 ounces of ice cream. The variance is favorable because the actual price was less than the standard price.
The journal entry to record the direct materials purchase is:

43. Direct Materials Costs
10-43
Direct Materials Costs
Cold Stone’s Standard Cost Information for Direct Materials
Cold Stone’s actual results for the period were:
200,000 ounces of ice cream were purchased on account for a total of $8,000, at an average actual price of $.04 per ounce.
All 200,000 ounces of ice cream were used to make and sell 18,000 units.
Part I.
The standard cost information and the actual result have not changed. Let’s prepare the entry to record the use of direct materials.
Part II.
The debit to cost of goods sold is based on the standard price per unit of 5 cents for the amount of ice cream that should have been used to make and sell 18,000 units. The credit to raw materials inventory is based on the standard price of 5 cents for the amount of ice cream actually used to make and sell 18,000 units. The difference between the actual quantity of 200,000 ounces and the standard quantity of 180,000 ounces multiplied the 5 cents per ounce standard price results in the $1,000 unfavorable direct materials quantity variance. The variance is unfavorable because the actual quantity used is greater than the standard quantity that should have been used.
The journal entry to record the direct materials use is:

44. Direct Labor and Manufacturing Overhead Costs
10-44
Direct Labor and Manufacturing Overhead Costs
Cold Stone’s Standard Cost Information for Direct Labor
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Direct labor costs were $16,500 for 2,000 hours worked.
Part I.
Cold Stone’s standards for direct labor are:
Standard hours = 0.10 hours per unit
Standard rate = $8.00 per hour.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual direct labor costs were $16,500 for 2,000 hours worked, an average rate of $8.25 per hour.
Let’s prepare the journal entry to record direct labor.
Part II.
The debit to cost of goods sold is based on the standard hourly rate of $8.00 for the 1,800 standard hours that should have been used to make 18,000 units. The credit to wages payable is based on the actual wage rate of $8.25 per hour and the 2,000 actual hours worked.
The difference between the $8.25 per hour actual wage rate and the $8.00 standard wage rate, multiplied by 2,000 actual hours worked, results in a $500 unfavorable direct labor rate variance. The variance is unfavorable because the actual wage rate is greater than the standard wage rate. The difference between the 2,000 actual hours and the 1,800 standard hours multiplied the $8.00 per hour standard rate results in the $1,600 unfavorable direct labor efficiency variance. The variance is unfavorable because the actual hours worked are greater than the standard hours allowed for the 18,000 units produced.
The journal entry to record direct labor is:

45. Direct Labor and Manufacturing Overhead Costs
10-45
Direct Labor and Manufacturing Overhead Costs
Cold Stone’s Standard Cost Information for Variable Manufacturing Overhead
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Actual VOH costs were $1,800 for 2,000 direct labor hours.
The journal entry to record variable manufacturing overhead is:
Part I.
Cold Stone’s standards for variable manufacturing overhead are:
Standard hours = 0.10 hours per unit
Standard rate = $8.00 per hour.
Cold Stone’s actual results for the period were:
18,000 units produced and sold.
Actual VOH costs were $1,800 for 2,000 direct labor hours, resulting in an average variable manufacturing overhead rate of 90 cents per hour.
Let’s prepare the journal entry to record variable manufacturing overhead costs.
Part II.
The debit to cost of goods sold is based on the standard variable manufacturing overhead rate of $1.00 per hour for the 1,800 standard hours that should have been used to make 18,000 units. The credit to wages payable or cash is based on the actual variable manufacturing overhead rate of 90 cents per hour and the 2,000 actual hours worked.
The difference between the 2,000 actual hours and the 1,800 standard hours multiplied the $1.00 per hour standard variable manufacturing overhead rate results in the $200 unfavorable variable manufacturing overhead efficiency variance. The variance is unfavorable because the actual hours worked are greater than the standard hours allowed for the 18,000 units produced. The difference between the $0.90 per hour actual variable manufacturing overhead rate and the $1.00 standard variable manufacturing overhead rate, multiplied by 2,000 actual hours worked, results in a $200 favorable variable manufacturing overhead rate variance. The variance is favorable because the actual variable manufacturing overhead rate is less than the standard variable manufacturing overhead rate.

46. Direct Labor and Manufacturing Overhead Costs
10-46
Direct Labor and Manufacturing Overhead Costs
Cold Stone’s Standard Cost Information for Fixed Manufacturing Overhead
Cold Stone’s budget for fixed overhead:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’ actual results for the period:
18,000 units produced and sold.
Actual FOH costs were $6,300.
Part I.
Cold Stone’s standard for fixed manufacturing overhead is a fixed overhead rate of 40 cents per unit at a budgeted volume of 15,000 units.
Cold Stone’s budget for fixed overhead for the period was:
15,000 units to be produced and sold.
Budgeted FOH costs were $6,000.
Cold Stone’s actual results for the period were:
18,000 units were produced and sold.
Actual fixed overhead costs were $6,300.
Part II.
The debit to cost of goods sold is based on the fixed overhead rate of 40 cents per unit for 18,000 actual number of units produced and sold. The credit to various accounts (salaries payable, cash, etc.) is for the actual fixed overhead of $6,300. The fixed overhead spending variance is equal to the difference in the fixed overhead budget and the actual fixed overhead costs. It is unfavorable because the actual costs are more than the budgeted costs. The fixed overhead volume variance is the fixed overhead rate times the difference between budgeted units and actual units. It is favorable because the actual number of units produced is greater than the budgeted units.
The journal entry to record fixed manufacturing overhead costs is:

47. Cost of Goods Sold and Cost Variance Summary
10-47
Cost of Goods Sold and Cost Variance Summary
Recall the following from the summary of cost variances:
Actual Cost
$36,800
Standard Cost $36,000
Total Cost Variance $800 U
Cost Variance Summary
Cost of Goods Sold
Applied Standard Cost
= 36,000
Balance = 800
Balance = 0
Actual Cost
= 36,800
Part I.
Recall from our summary of cost variances earlier in the chapter that we had a total cost variance of $800 unfavorable.
Part II.
The cost of goods sold balance is $36,000 before closing the variances accounts. By closing the variance accounts, we will increase cost of goods sold to $36,800 and reduce the balance in all variance accounts to zero.
Now let’s look at the journal entry to close all of the individual variance accounts.

48. Cost of Goods Sold and Cost Variance Summary
10-48
Cost of Goods Sold and Cost Variance Summary
The entry to close the variance accounts to the Cost of Goods Sold is:
The entry to close the individual variance accounts debits the favorable variances to eliminate their credit balances and credits the unfavorable variances to eliminate their debit balances. Cost of Goods Sold is increased by $800 to the actual total of $36, Note that variances for the mix-in ingredients were computed in the self-study quiz in the chapter.

49. End of Topic 4