Performance

Using
Cost
Behavior Evaluation
and Cost-Volume-Profit
Budgeting
Performance
Evaluation
Using
Analysis
Variances
from Standard
Costs

Variances from Standard Costs

11e

Principles of Managerial Accounting

Chapter 7
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University

Reeve Warren Duchac

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Learning Objectives
1. Describe the types of standards and
how they are established.
2. Describe and illustrate how
standards are used in budgeting.
3. Compute and interpret direct
materials and direct labor variances.
4. Compute and interpret factory
overhead controllable and volume
variances.

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Learning Objectives
5. Journalize the entries for recording
standards in the accounts and
prepare an income statement that
includes variances from standard.
6. Describe and provide examples of
nonfinancial performance measures.

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Learning Objective 1

Describe the types

of standards and
how they are
established.

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LO 1

Standards
Standards are performance goals.
Manufacturing companies normally
use standard cost for each of the
three following product costs:
1. Direct materials
2. Direct labor
3. Factory overhead

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LO 1

Standards
Accounting systems that use
standards for product costs are
called standard cost systems.
Standard cost systems enable
management to determine the
following:
How much a product should cost (standard
cost)
How much it does cost (actual cost)

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LO 1

Standards
When actual costs are compared with
standard costs, only the exceptions
or variances are reported for cost
control. This reporting by the
principle of exceptions allows
management to focus on correcting
the cost variances.

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LO 1

Setting Standards
The standard-setting process
normally requires the joint efforts of
accountants, engineers, and other
management personnel.

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LO 1

Types of Standards
Unrealistic standards that can be
achieved only under perfect
operating conditions (such as no idle
time, no machine breakdowns, and
no materials spoilage) are called
ideal standards or theoretical
standards.

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LO 1

Types of Standards
Currently attainable standards,
sometimes called normal standards,
can be attained with reasonable
effort. Such standards, which are
used by most companies, allow for
normal production difficulties and
mistakes.

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LO 1

Reviewing and Revising

Standards

Standard costs should be periodically

reviewed to ensure that they reflect
current operating conditions.
Standards should not be revised,
however, just because they differ
from actual costs.

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LO 1

Criticisms of Standard Costs

Standards limit operating improvements
by discouraging improvement beyond
the standard.
Standards are too difficult to maintain in
a dynamic manufacturing environment,
resulting in stale standards.
Standards can cause workers to lose
sight of the larger objectives of the
organization by focusing only on
efficiency improvements.

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LO 1

Criticisms of Standard Costs

Standards can cause workers to
unduly focus on their own operations
to the possible harm of other
operations that rely on them.

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Learning Objective 2

Describe and
illustrate how
standards are used
in budgeting.

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LO 2

Budgetary Performance
Evaluation

The standard cost per unit for direct

materials, direct labor, and factory
overhead is computed as follows:
Standard
Standard Standard
x
Cost Per Unit =
Price
Quantity

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LO 2

Budgetary Performance
Evaluation

Western Riders standard costs per unit for XL

jeans are shown in Exhibit 1.

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LO 2

Budget Performance Report

The report that summarizes actual
costs, standard costs, and the
differences for the units produced is
called a budget performance report.

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LO 2

Budget Performance Report

The differences between actual and
standard costs are called costs
variances.
A favorable cost variance occurs
when the actual cost is less than the
standard cost (at actual volumes).
An unfavorable cost variance occurs
when the actual cost exceeds the
standard cost.
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LO 2

Budget Performance Report

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LO 2

Manufacturing Cost Variances

The total manufacturing cost
variance is the difference between
total standard costs and total actual
costs for the units produced.
For control purposes, each product
cost variance is separated into two
additional variances as shown in
Exhibit 3 (next slide).

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LO 2

Manufacturing Cost Variances

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LO 2

Manufacturing Cost Variances

The total direct materials variance is
separated into a price and quantity
variance.

Price Difference + Quantity Difference

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LO 2

Manufacturing Cost Variances

The total direct labor variance is
separated into a rate and a time
variance.

Rate Difference + Time Difference

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Learning Objective 3

Compute and
interpret direct
materials and direct
labor variances.

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LO 3

Direct Materials Variances

During June, Western Rider reported an
unfavorable total direct materials cost variance
of $2,650 for the production of 5,000 XL style
jeans, as shown in Exhibit 2 and reproduced
below.

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LO 3

Direct Materials Variances

Actual Direct Materials Cost = Actual Price x Actual Quantity
Actual Direct Materials Cost = ($5.50 per sq. yard) x (7,300 sq.
yards.)
Actual Direct Materials Cost = $40,150
Standard Direct Materials Cost = Standard Price x Standard
Quantity
Standard Direct Materials Cost = ($5.00 per sq. yard) x (7,500 sq.
yards.)
Actual
costs
($40,150)
Standard
costs ($37,500) = $2,650
Standard
Direct
Materials
Cost = $37,500
Total Unfavorable
Materials Variance

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LO 3

Direct Materials Price Variance

Direct Materials Price Variance = (Actual Price
Standard
Price) x Actual Quantity
Direct Materials Price Variance = ($5.50 $5.00) x
7,300 sq.
yds.
Direct Materials Price Variance = $3,650
Unfavorable direct
materials price
variance

Western
Western Rider
Rider paid
paid $0.50
$0.50 more
more per
per
square
square yard
yard of
of material
material than
than the
the standard.
standard.
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LO 3

Direct Materials Quantity

Variance
Direct Materials Quantity Variance = (Actual
Quantity
Standard Quantity)
x
Standard Price
Direct Materials Quantity Variance = (7,300 sq. yds.
7,500
sq. yds.) x $5.00
Direct Materials Quantity Variance = $1,000

Western
Western Rider
Rider used
used 200
200
square
square yards
yards less
less than
than the
the
standard.
standard.
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Favorable direct
materials quantity
variance

LO 3

Direct Materials Variance

Relationships

The relationship among the total

direct materials cost variance, the
direct materials price variance, and
the direct materials quantity
variance is shown in an animated
reproduction of Exhibit 4 in the next
slide.

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LO 3

Direct Materials Variance

Relationships
Actual cost:
Actual quantity x
Actual price
7,300 x $5.50 =
$40,150

Actual quantity x
Standard price
7,300 x $5.00 =
$36,500

Direct materials
price variance

Standard cost:
Standard quantity
x Standard price
7,500 x $5.00 =
$37,500

Direct materials
quantity variance

$3,650 U
$1,000 F
Total direct materials cost variance
$40,150 $37,500 = $2,650 U

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EE 7-1

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LO 3

Direct Labor Variances

During June, Western Rider reported an unfavorable
total direct labor cost variance of $2,500 for the
production of 5,000 XL style jeans, as shown in
Exhibit 2 and reproduced below.

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LO 3

Direct Labor Variances

Actual Direct Labor Cost = Actual Rate per Hour x Actual Time
Actual Direct Labor Cost = $10.00 per hr. x 3,850 hrs.
Actual Direct Labor Cost = $38,500
Standard Direct Labor Cost = Standard Rate per Hour x
Standard Time
Standard Direct Labor Cost = $9.00 per hr. x 4,000 hrs.
Standard Direct Labor Cost = $36,000
Actual costs ($38,500) Standard costs ($36,000) = $2,500

Total unfavorable direct

labor cost variance
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LO 3

Direct Labor Rate Variance

Direct Labor Rate Variance =
(Actual Rate per Hour
Standard Rate per
Hour) x Actual Hours
Direct Labor Rate Variance = ($10.00 $9.00) x 3,850 hours
Direct Labor Rate Variance = $3,850
Unfavorable direct
labor rate variance

The
Theunfavorable
unfavorablevariance
variancecould
couldhave
have
been
beencaused
causedby
byimproper
improperscheduling
scheduling
and
anduse
useof
ofemployees.
employees.

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LO 3

Direct Labor Time Variance

Direct Labor Time Variance = (Actual Direct Labor
Hours Standard Direct Labor
Hours)
x Standard Rate per Hour
Direct Labor Time Variance = (3,850 hours 4,000
direct
labor hours) x $9.00
Direct Labor Time Variance = $1,350
Favorable
IfIfthere
direct labor
therehad
hadbeen
beenan
anunfavorable
unfavorabletime
time
variance,
time variance
variance,ititmight
mighthave
havebeen
beencaused
caused
by
byaashortage
shortageof
ofskilled
skilledworkers.
workers.

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LO 3

Direct Labor Variance

Relationships
Actual cost:
Actual hours x
Actual rate
3,850 x $10 =
$38,500

Actual hours x
Standard rate
3,850 x $9 =
$34,650

Direct labor rate

variance

Standard cost:
Standard hours x
Standard rate
4,000 x $9 =
$36,000

Direct labor time

variance

$3,850 U
$1,350 F
Total direct labor cost variance
$38,500 $36,000 = $2,500 U

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EE 7-2

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Learning Objective 4

Compute and
interpret factory
overhead
controllable volume
variances.

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LO 4

Factory Overhead Variances

Factory overhead costs are more
difficult to analyze than direct labor
and materials costs. This is because
factory overhead costs have fixed
and variable cost elements.

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LO 4

Factory Overhead Flexible

Budget

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LO 4

Factory Overhead Flexible

Budget
Budgeted Factory Overhead at
Normal Capacity
=
Factory Overhead Rate
Normal Productive Capacity
Factory Overhead Rate =

$30,000
5,000 direct labor hours

Factory Overhead Rate = $6.00 per direct labor hour

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LO 4

Factory Overhead Flexible

Budget
Variable Factory Overhead Rate =

Budgeted Variable Overhead

at Normal Capacity
Normal Productive Capacity

Variable Factory Overhead Rate =

$18,000
5,000 direct labor hours

Variable Factory Overhead Rate =

$3.60 per direct labor hour

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LO 4

Factory Overhead Flexible

Budget
Fixed Factory Overhead Rate =

Fixed Factory Overhead Rate =

Fixed Factory Overhead Rate =

Budgeted Fixed Overhead

at Normal Capacity
Normal Productive Capacity
$12,000
5,000 direct labor hours
$2.40 per direct labor hour

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LO 4

Variable Factory Overhead Controllable

Variance
Variable Factory
Overhead
=
Controllable
Variance

Actual Variable Budgeted Variable

Factory Overhead
Factory Overhead

Standard Hours for

Actual Units Produced

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Variable
x Factory
Overhead
Rate

LO 4

Variable Factory Overhead Controllable

Variance
The budgeted variable factory
overhead is the standard variable
overhead for the actual units
produced.

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LO 4

Variable Factory Overhead Controllable

Variance
Variable Factory
Overhead Controllable
=
Variance
Variable Factory
Overhead Controllable
=
Variance
Variable Factory
Overhead Controllable
=
Variance

Actual Variable
Factory Overhead

Budgeted Variable
$14,400
Factory Overhead

4,000 direct labor hours x $3.60

$10,400 $14,400

$4,000 Favorable Variance

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EE 7-3

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LO 4

Fixed Factory Overhead Volume

Variance
Fixed Factory
Overhead
=
Volume
Variance
Fixed Factory
Overhead
=
Volume
Variance

Standard
Hours for
100% of
Normal
Capacity

Standard
Hours for

Actual Units
Produced

5,000 direct 4,000 direct

labor hours
labor hours

Fixed Factory
Overhead = $2,400 Unfavorable
Variance
Volume
Variance
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Fixed
Factory
x
Overhead
Rate

x $2.40

LO 4

Fixed Factory Overhead Volume

Variance

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LO 4

Fixed Factory Overhead Volume

Variance
An unfavorable volume variance may
be due to factors such as:
Failure to maintain an even flow of work
Machine breakdowns
Work stoppages caused by lack of
materials or skilled labor
Lack of enough sales orders to keep the
factory operating at normal capacity

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EE 7-4

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LO 4

Reporting Factory Overhead

Variances

A factory overhead cost variance

report is useful to management in
controlling factory overhead costs.
Exhibit 8 (next slide) illustrates this
report for Western Rider Inc. for
June.

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LO 4

Reporting Factory Overhead

Variances

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LO 4

Factory Overhead Account

Applied
Standard Hours for
Factory
=
Actual Units Produced
Overhead
Applied
Factory
=
Overhead

Total Factory
Overhead Rate

5,000 jeans x 0.80

direct labor hr. per pair x $6.00
of jeans

Applied
Factory
= 4,000 direct labor hrs. x $6.00 = $24,000
Overhead

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LO 4

Factory Overhead Account

Total Factory Overhead
Actual Factory
Applied Factory

=
Cost Variance
Overhead
Overhead

Standard Hours for x Total Factory

Actual Units Produced Overhead Rate

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LO 4

Factory Overhead Account

Total Factory Overhead
Actual Factory
Applied Factory

=
Cost Variance
Overhead
Overhead
5,000 jeans x 0.80
x $6.00
direct labor hr. per
pair of jeans

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 4

Factory Overhead Account

Total Factory Overhead
Actual Factory
$24,000
=
Cost Variance
Overhead
5,000 jeans x 0.80
x $6.00
direct labor hr. per
pair of jeans

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 4

Factory Overhead Account

Total Factory Overhead
Actual Factory
$24,000
=
Cost Variance
Overhead
Total Factory Overhead
=
Cost Variance

$22,400 $24,000

Total Factory Overhead

=
Cost Variance

$1,600 Favorable Variance

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LO 4

Factory Overhead Account

Underapplied and overapplied
factory overhead account balances
represent the following total factory
overhead cost variances:
Underapplied Factory Overhead =
Unfavorable Total Factory Overhead Cost
Variance
Overapplied Factory Overhead =
Favorable Total Factory Overhead Cost
Variance
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LO 4

Factory Overhead Account

Factory Overhead
Actual factory
overhead
22,400

$10,400 + $12,000

Applied factory
overhead

24,000

4,000 hours x $6.00 per hour

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LO 4

Factory Overhead Account

Factory Overhead
Actual factory
overhead
22,400

Applied factory
overhead
Balance, June 30

24,000
1,600

Overapplied
factory
overhead

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LO 4

Factory Overhead Account

Actual factory overhead $22,400 Applied factory overhead $24,000

Actual Factory
Overhead
$22,400

Budgeted Factory
Overhead for Amount
Produced
Variable factory OH
Fixed factory OH
Total

Applied Factory
Overhead

$14,400
12,000
$26,400

$4,000 F
Controllable
Variance
$1,600 F

$24,000

$2,400 U
Volume
Variance

Total Factory Overhead Cost Variance

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Learning Objective 5

Journalize the entries for

recording standards in the
accounts and prepare an
income statement that
includes variances from
standard.

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LO 5

Recording and Reporting

Variances

Standard costs may be used as a

management tool to control costs
separately from the accounts in the
general ledger.
However, many companies include
both standard costs and variances, in
addition to actual costs, in their
accounts.

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LO 5

Recording and Reporting

Variances

Western Rider Inc. purchased, on account, the

7,300 square yards of blue denim at $5.50 per
square yard. The standard price is $5.00 per square
yard. The entry to record the purchase and the
unfavorable direct materials price variance is as
follows:

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LO 5

Recording and Reporting

Variances

$5.50 x 7,300 =
$40,150
$5.00 x 7,300 =
$36,500

$3,650 unfavorable
direct materials price
variance

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Recording and Reporting

Variances

Western Rider Inc. used 7,300 square yards of blue

denim to produce 5,000 pairs of XL jeans. The
standard quantity of denim for the 5,000 jeans
produced is 7,500 square yards. The entry to record
the materials used is as follows:

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Recording and Reporting

Variances

$5.00 x 7,500 =
$37,500
$5.00 x 7,300 =
$36,500

$1,000 favorable direct

materials quantity
variance

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EE 7-5

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

LO 5

Recording and Reporting

Variances

Two journal entries are usually

required for the purchase and use of
direct materials because they are
rarely the same amount.
Direct labor can be recorded in a
single entry because what you buy
is what you use.
The diagram in the next slide was
taken from Exhibit 5 where direct
labor variances were illustrated.

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LO 5

Recording and Reporting

Variances

Work in Progress
Direct Labor Rate Variance
Direct Labor Time Variance
Wages Payable
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36,000
3,850
1,350
38,500

LO 5

Recording and Reporting

Variances

Work in Progress
Direct Labor Rate Variance
Direct Labor Time Variance
Wages Payable
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36,000
3,850
1,350
38,500

LO 5

Recording and Reporting

Variances

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EE 7-6

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EE 7-6

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 6

Describe and
provide examples
of nonfinancial
performance
measures.

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LO 6

Nonfinancial Performance
Measures

A nonfinancial performance measure

expresses performance in a measure
other than dollars.

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LO 6

Nonfinancial Performance
Measures
Inventory turnover
Percent on-time delivery
Elapsed time between a customer order
and product delivery
Customer preference rankings
compared to competitors
Response time to a service call
Time to develop new products
Employee satisfaction
Number of customer complaints
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LO 6

Nonfinancial Performance
Measures

Nonfinancial measures can be linked

to either the inputs or outputs of an
activity or process.
A process is a sequence of activities
linked together for performing a
particular task.

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LO 6

Nonfinancial Performance
Measures
Counter Service Activity of a
Fast-Food Restaurant

Inputs
Number of employees
Employee experience
Employee training
Fryer reliability
Number of new menu
items
Fountain drinks
available

Activity
Counter
service

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Outputs
Line wait
Percent order
accuracy
Friendly service
score

EE 7-7

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Budgeting
Performance Evaluation Using

Variances from Standard Costs

The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
2012 Cengage
Learning.
All distributed
Rights Reserved.
not product
be copied,
duplicated,
whole or in part, except
for for
useclassroom
as
permitted
in a license
with aMay
certain
or scanned,
service oror
otherwise
on ainpassword-protected
website
use.
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.