SIMAD UNIVERSITY

Learning objective

1. Compute the direct materials quantity and price variances and explain their
significance.
2. Compute the direct labor efficiency and rate variances and explain their
significance.
3. Compute the variable manufacturing overhead efficiency and rate variances and
explain their significance.
4. Compute and interpret the fixed overhead volume and budget variances.

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY

Standards are benchmarks or norms for measuring performance.

In managerial accounting,

Examples: Firestone, Sears, McDonalds, hospitals, construction, and manufacturing companies

Two types of standards are commonly used
1. Price standards specify how much should be paid for the quantity of the input to be used.
2. Quantity standards specify how much of the input should be used per unit of output.
Management by exception is a system of management in which standards are set for various operating
activities, with actual results compared to these standards. Any deviations that are deemed significant are
brought to the attention of management as exceptions.

The variance analysis cycle

The variance analysis cycle is a continuous process used to identify and solve problems:
1.

The cycle begins with the preparation of standard cost performance reports in the accounting
department.

2.

These reports highlight variances that are differences between actual results and what should
have occurred according to standards.

3.

The variances raise questions such as:

a. Why did this variance occur?
b. Why is this variance larger than it was last period?

4.

The significant variances are investigated to discover their root causes.

5.

Corrective actions are taken.

6.

Next periods operations are carried out and the process is repeated.

Types of Standards
1. Ideal standards can only be attained under the best of circumstances. They allow for no work
interruptions and they require employees to work at 100% peak efficiency all of the time.
2.

Practical standards are tight, but attainable. They allow for normal machine downtime and
employee rest periods and can be attained through reasonable, highly efficient efforts of the

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY
average worker. Practical standards can also be used for forecasting cash flows and in planning
inventory.

Setting Direct Materials Standards

1. Standard price per unit for direct materials should reflect the final, delivered cost of the
materials, net of any discounts taken.
2. The standard quantity per unit for direct materials should reflect the amount of material
required for each unit of finished product, as well as an allowance for unavoidable waste,
spoilage, and other normal inefficiencies.

Setting Direct Labor Standards

1. The standard rate per hour for direct labor includes not only wages earned but also fringe
benefits and other labor costs.
2. The standard hours per unit reflects the labor hours required to complete one unit of product.

Setting Variable Manufacturing Overhead Standards

1. The price standard for variable manufacturing overhead comes from the variable portion of the
predetermined overhead rate.
2. The quantity standard for variable manufacturing overhead is expressed in either direct labor
hours or machine hours depending on which is used as the allocation base in the predetermined
overhead rate.
The Standard Cost Card

A standard cost card

for one unit of product might look like this:

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

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

Quantity and Price standards are determined separately for two reasons:
Different managers are usually responsible for buying and for using inputs. For example: The
purchasing manager is responsible for raw material purchase prices and the production manager is
responsible for the quantity of raw material used.
2. The buying and using activities occur at different points in time. For example: Raw material
purchases may be held in inventory for a period of time before being used in production.
1.

Learning Objective 1 Compute the direct materials quantity and price variances
and explain their significance
A General Model for Variance Analysis
he total budget variance is the difference between the actual cost of the input and its planned
cost.
a. The planned input cost (flexible budget amount) is SP SQ,
where SP = Standard unit price of an input
SQ = Standard quantity of inputs allowed for the actual output
b. The actual input cost is AQ AP,
where AP = Actual price per unit of the input
AQ = Actual quantity of input used
thus,
Total budget variance = (AP AQ) (SP SQ)

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY
Calculate Direct Materials Price and Usage Variances

1. Price (rate) variance is the difference between the actual and standard unit price of an input
multiplied by the number of inputs used.
2. Usage (efficiency) variance is the difference between the actual and standard quantity of inputs
multiplied by the standard unit price of the input.
3. Unfavorable (U) variances occur whenever the actual prices or usage are greater than the
standard.
4. Favorable (F) variances occur whenever the actual prices or usage are less than the standard

Using formulas to compute direct materials price and usage variances

a. The direct materials price variance (MPV) measures the difference between what should have
been paid for raw materials and what was actually paid.
MPV = (AP AQ) (SP AQ)
or
MPV = (AP SP) AQ
b. The direct materials usage variance (MUV) measures the difference between the direct
materials actually used and the direct materials that should have been used for the actual output.
MUV = (SP AQ) (SP SQ)
or
MUV = (AQ SQ) SP

LEARNING OBJECTIVE 2 COMPUTE THE DIRECT LABOR EFFICIENCY

AND RATE VARIANCES AND EXPLAIN THEIR SIGNIFICANCE
Calculating Direct Labor Variances
1. Using formulas to compute direct labor rate and efficiency variances.
a. The labor rate variance measures the difference between what was paid to direct
laborers and what should have been paid.
LRV = (AR AH ) (SR AH )

or
LRV = (AR SR ) AH

b. The labor efficiency variance measures the difference between the labor hours
that were actually used and the labor hours that should have been used.
LEV = (AH SR ) (SH SR )

or
LEV = (AH SH ) SR

Illustration 1
Canshuur Company employs a standard cost system in which direct materials
inventory is carried at standard cost. The company has established the following
standards for the prime costs of one unit of product:
Lecturer: Yusuf H. Mohamed Ch. 10 Handout
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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY

Direct materials
Direct labor

Standard
Quantity
12.0 pounds
2.6 hours

Standard
Price
$14.00/pound
$44.00/hour

Standard
Cost
168.00
$114.40

During April, the company purchased 330,000 pounds of direct material at a

total cost of $4,686,000. The total factory wages for June were $3,200,000, of
which 90% was for direct labor. The company manufactured 25,000 units of
product during April using 302,000 pounds of direct material and 64,000 direct
labor hours.

Instruction
A. What is the direct material quantity variance for April?
B. What is the price variance for the direct material acquired by the company
during April?
C. What is the direct labor efficiency variance for April?
D. What is the direct labor rate variance for April?

Solution

Part (a) Solution (Learning Objective 1):

First, calculate the standard quantity as follows.
25,000 units x 12.0 pounds per unit = 300,000 pounds
Then calculate the material quantity variance as follows.
Materials quantity variance = SP x (AQ SQ) = $14.00 x (302,000 300,000) = $28,000 (U)
Part (b) Solution (Learning Objective 1):
First, calculate the actual price per unit of materials as follows.
Total cost of $4,686,000 330,000 lbs. = $14.20 per pound
Then calculate the materials price variance as follows.
Materials price variance = AQ x (AP SP) = 330,000 x ($14.20 $14.00) = $66,000 (U)
Part (c) Solution (Learning Objective 2):
First, calculate the standard hours as follows.
25,000 units x 2.6 hours per unit = 65,000 hours
Then calculate the direct labor efficiency variance as follows.
Lecturer: Yusuf H. Mohamed Ch. 10 Handout
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Subject: Mang .Acc

SIMAD UNIVERSITY
Direct labor efficiency variance = SR x (AH SH) = $44.00 x (64,000 65,000) = $44,000 (F)
Part (d) Solution (Learning Objective 2):
First, calculate the actual rate per hour of direct labor as follows.
($3,200,000 x .90) 64,000 hours = $45.00 per hour
Then calculate the labor rate price variance as follows.
Labor rate variance = AH x (AR SR)
Labor rate variance = 64,000 x ($45.00 $44.00) = $64,000 (U)

LEARNING OBJECTIVE 3 COMPUTE THE VARIABLE MANUFACTURING

OVERHEAD EFFICIENCY AND RATE VARIANCES AND EXPLAIN THEIR
SIGNIFICANCE.
Calculating Direct Labor Variances
1. Using formulas to compute direct labor rate and efficiency variances.
a. Variable overhead Rate variance measures the difference between what was paid to
direct laborers and what should have been paid.
VOHRV = (AR AH) (SR AH)

or
VOHRV = (AR SR) AH

b. The Variable overhead efficiency variance measures the difference between the
labor hours that were actually used and the labor hours that should have been used.
VOHEV = (AH SR ) (SH SR )

or
VOHEV = (AH SH ) SR

Illustration 2
Sheybow Company maintains warehouses that stock items carried by its e-retailer clients. When one of
Sheybows clients receives an order from an online customer, the order is forwarded to Sheybow. The
item is then pulled from the warehouse, packed, and shipped to the customer. Sheybow uses a
predetermined variable overhead rate based on direct labor-hours. According to the companys records,
0.04 direct labor-hours are required to fulfill an order for one item and the variable overhead rate is $3.25

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY
per direct-labor hour. During December, Expedient shipped 120,000 orders using 4,600 direct laborhours. The company incurred a total of $14,720 in variable overhead costs.
Instruction
Part (a)What is the variable overhead rate variance during December?
Part (b)What is the variable overhead efficiency variance during December?

Solution

1. Part (a) Solution (Learning Objective 3):

The variable overhead rate variance during December is determined as follows.

Actual Hours of Input, at

Actual Hours of Input, at
the Standard Rate
the Actual Rate
(AH SR)
(AH AR)
4,600 hours (given)
4,600 hours (given)
$3.25 per hour
$3.20 per hour
(given)
(or $14,720 4,600 hours)
= $14,950
= $14,720 (given)
Variable overhead rate variance, $230 F
Alternatively, the variable overhead rate variance is determined as follows.
AH x (AR SR) = 4,600 hours ($3.20 per hour $3.25 per hour) = $230 F
2. Part (b) Solution (Learning Objective 3):
The variable overhead rate variance during December is determined as follows.

Standard Hours Allowed

Actual Hours of Input, at

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Subject: Mang .Acc

SIMAD UNIVERSITY
for Output, at the Standard
the Standard Rate
Rate
(SH SR)
(AH SR)
4,800 hours
4,600 hours (given)
(or 120,000 x 0.04 DLH)
$3.25 per hour
$3.25 per hour (given)
(given)
= $15,600
= $14,950
Variable overhead efficiency variance, $650 F
Alternatively, the variable overhead efficiency variance is determined as
follows.
SR x (AH SH)

= $3.25 per hour (4,600 hours 4,800 hours) = $650

Learning Objective 4 VARIANCE ANALYSIS:OVERHEAD COSTS

The total overhead variance is the difference between the actual and the applied overhead. The fourvariance method breaks down the total overhead variance into

B.

1. Variable overhead variances including

a. the variable overhead spending variance, and
b. the variable overhead efficiency variance.
2. Fixed overhead variances including
a. the fixed overhead spending variance, and
b. the fixed overhead volume variance.
Analyzing Variable Overhead Variances
1. The total variable overhead variance is the difference between the actual and the applied
variable overhead.
Can be split into a spending and efficiency variance.
2. The variable overhead spending variance (VOSV) measures the aggregate effect of
differences in the actual variable overhead rate and the standard variable overhead rate.
VOSV = (AVOR AH) (SVOR AH)
or
VOSV = (AVOR SVOR) AH
a. Variable overhead is not a homogeneous input and, thus, the standard variable
overhead rate represents a weighted average for all of the variable overhead items.
b. A spending variance is affected by price changes and by how efficiently overhead is
used.
Waste or inefficient use of variable overhead causes an unfavorable variable
overhead spending variance.
c. To the extent that the consumption of variable overhead can be traced, responsibility
can be assigned.
Controllability is a prerequisite for assigning responsibility.

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc

SIMAD UNIVERSITY
3. The variable overhead efficiency variance (VOEV) measures the change in variable
overhead consumption that occurs because of efficient (or inefficient) usage of the activity.
VOEV = (AH SH) SVOR
a. The variable overhead efficiency variance is directly related to the direct labor
efficiency variance if the variable overhead cost driver is direct labor hours.
b. The causes of variable overhead efficiency variance are generally the same as those for
the direct labor usage variance.
Analyzing Fixed Overhead Variances
1. The total fixed overhead variance is the difference between actual fixed overhead and
applied fixed overhead.
Applied fixed overhead = Standard fixed overhead rate Standard hours
2. The fixed overhead spending variance (FOSV) is the difference between the actual fixed
overhead (AFOH) and the budgeted fixed overhead (BFOH).
FOSV = AFOH BFOH
3. The fixed overhead volume variance (FOVV) is the difference between budgeted fixed
overhead and applied fixed overhead.
FOVV = Budgeted fixed overhead Applied fixed overhead
FOVV = [Standard fixed overhead rate SH(D)] (Standard fixed overhead rate
SH )

Illustration 3
Jacobs Company applies manufacturing overhead costs to products on the basis of direct labor-hours.
The standard cost card shows that 6 direct labor-hours are required per unit of product. The company
estimated that it would work 180,000 direct labor-hours and incur the following manufacturing
overhead costs for the month of March:
Total fixed overhead costs
$237,600
Total variable overhead costs
$198,000
During March, the company completed 28,000 units of product, worked 172,000 direct labor-hours,
and incurred the following total manufacturing overhead costs:
Total fixed overhead costs
$230,600
Total variable overhead costs
$197,800
The denominator activity used to calculate its predetermined overhead rate was 180,000 direct laborhours.
Instruction
Part (a) what is the variable overhead (VOH) spending variance for March?
Part (b) what is the variable overhead (VOH) efficiency variance for March?
Part (c) What is the fixed overhead budget variance for March?
Lecturer: Yusuf H. Mohamed Ch. 10 Handout
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Subject: Mang .Acc

SIMAD UNIVERSITY
Part (d) what is the fixed overhead volume variance for March?

Solution

Part (A):
First, compute the variable overhead (VOH) rate as follows.
VOH rate = Budgeted variable overhead costs budgeted direct labor hours
VOH rate = $198,000 180,000 direct labor hours = $1.10 per direct labor hour
Then, compute the variable overhead (VOH) spending variance as follows.
VOH spending variance = Actual VOH incurred (Actual direct labor hours x VOH rate per direct
labor hour) = $197,800 (172,000 hours x $1.10 per hour) = $8,600 U
The variance is unfavorable because the actual overhead costs were more than the benchmark (that
is, how much should have been spent in total on variable overhead items during the period).
Part (b):
First, compute the variable overhead (VOH) rate as follows.
VOH rate = Budgeted variable overhead costs budgeted direct labor hours
VOH rate = $198,000 180,000 direct labor hours = $1.10 per direct labor hour
Then, compute the efficiency variance as follows.
VOH efficiency variance = (AH hours x VOH rate) - (SH hours x VOH rate) = (172,000 hours x
$1.10/DL hour) ((28,000 units x 6 DL hours/unit) x $1.10/hour) = $4,400 U
More direct labor hours (172,000) were worked than were allowed at standard (168,000); as such,
the overhead efficiency variance is unfavorable.
Part (c) Solution (Learning Objective 4):
The fixed overhead (FOH) budget variance is determined as follows.
FOH budget variance = Actual fixed overhead Budgeted fixed overhead = $230,600 $237,600 =
$7,000 F
Since actual fixed overhead was less than the amount budgeted for the period, the budget variance is
favorable.
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SIMAD UNIVERSITY
Part (d)
First, compute the fixed overhead (FOH) rate as follows.
FOH rate = Budgeted fixed overhead costs budgeted direct labor hours = $237,600 180,000
direct labor hours = $1.32 per direct labor hour
Then, the FOH volume variance is determined as follows.
FOH Volume variance = Budgeted fixed overhead (Standard hours allowed x FOH rate) =
$237,600 (((28,000 units x 6 DL hrs./unit) x $1.32 per DL hour) = $15,840 U
Since budgeted fixed overhead was more than the amount applied to work in process during the
period, the volume variance is unfavorable.

Problems
PROBLEM 1
ABC Company produced 25,000 units of Product XP-1 during 2000. Each product required 6 pounds of
material at $11 per pound and 2 hours of direct labor at $15 per hour. During 2003, 160,000 pounds of
material were purchased and used for $1,750,000; payroll totaled $743,900 for 49,000 hours.
Required:
Calculate the direct materials price and usage variances and the direct labor rate and efficiency variances.
PROBLEM 2
Acme Corp. applies overhead to production using a rate of $75 per machine hour ($35 variable, $40
fixed). Acme produced 15,000 units and incurred overhead of $3,710,000 (of which $1,495,000 was
variable overhead) while using 43,500 machine hours. The overhead standards assumed each product
would use 3 machine hours. The practical capacity of 18,000 units was used as the denominator activity.
Required:
1.
2.
3.
4.

What is the variable overhead (VOH) spending variance?

What is the variable overhead (VOH) efficiency variance?
What is the fixed overhead spending variance?
what is the fixed overhead volume variance

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SIMAD UNIVERSITY
PROBLEM 3
XYZ Company produces a compound by mixing 3 gallons of AB-5 (costing $2.25 per gallon) and 4
gallons of CR-3 (costing $7.50 per gallon). The output is 5 gallons of the compound. During August,
21,000 gallons of AB-5, costing $46,500, were purchased and used; 26,000 gallons of CR-3, costing
$198,000, were purchased and used. A total of 37,000 gallons of output were obtained.
Required:
1.

Calculate the direct materials price and usage variances.

PROBLEM 4
Scooter Company has the following standard cost sheet using an expected capacity of 120,000 units:
Direct materials......................

25 pounds@$1.20

$30.00

Direct labor............................

2 hours@12.50

25.00

Variable.............................. 3 machine hours@8.00

24.00

Fixed.................................. 3 machine hours@12.00

36.00

Overhead:

Total.......................................

$115.00

During the year, 125,000 units were produced. Actual costs included the following:
Direct materials......................

3,200,000 pounds purchased for $3,725,000.

3,110,000 pounds were used in production.

Direct labor............................

260,000 hours worked; payroll totaled $3,320,000.

Overhead................................

Variable:$3,025,000
Fixed:$4,275,000

Machine hours........................

378,000 actually used

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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SIMAD UNIVERSITY
Required:
1. Calculate the direct materials price and usage variances and the direct labor rate and efficiency
variances
2. What is the variable overhead (VOH) spending variance? And What is the variable overhead
(VOH) efficiency variance?
3. What is the fixed overhead spending variance? And what is the fixed overhead volume variance
4. What is the variable overhead rate variance and What is the variable overhead efficiency variance?

Lecturer: Yusuf H. Mohamed Ch. 10 Handout

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Class: BBF02-PT

Subject: Mang .Acc