CHAPTER 11

Standard Costs
and Variance
Analysis

Prepared by
Heather Cornish,
CPA-CA, MBA
NAIT JR Shaw
School of Business
 Standard Costs
Predetermined

Used for planning labour,

material and
Standard overhead requirements
Costs are
Benchmarks for
measuring
performance

Used to simplify the

accounting system
 Setting Standard Costs
The standard cost of a resource is the cost of the
input required for a single performance of an
activity or to make one unit of output.
The standard cost of the single performance of an
activity or a single unit of output made will be the
sum of the standard costs of every input
necessary to perform the activity or make one unit
of output.
 Setting Standard Costs
Accountants, engineers, personnel administrators, and
production managers combine efforts to set standards
based on experience and expectations.
Ideal standards: based on perfection, are
unattainable and discourage most
employees

Practical standards: should be set at

levels that are currently attainable with
reasonable and efficient effort.
 Setting Standard Costs
 The argument that ideal standards are
discouraging has been persuasive for many
years. So “normal” defects and waste were
built into the standards.
 In recent years, TQM and other initiatives
have sought to eliminate all defects and
waste.
 Ideal standards, that allow for no waste, have
become more popular.
 The emphasis is on improvement over time, not
attaining the ideal standards right now.
Setting Direct Material
Standards
Standard
Standard price quantity per unit
per unit (SP) (SQI)

Final delivered
cost of the Use product
materials, net design
of any specifications
discounts
 Setting Direct Labour
Standards
Standard rate Standard
per hour (SP) hours per unit

Use time and

Use wage
motion studies
surveys and
for
labour
each labour
contracts
operation
 Setting Variable
Overhead Standards
Activity
Rate Standards
Standards

The activity is
The rate is the
the
variable
base used to
portion of the
calculate the
predetermined
predetermined
overhead
overhead.
rate.
 Standard Cost Card: Variable
Production Cost
A standard cost card for one unit
of product might look like this:
 The Static Budget
A static budget is a budget developed for
a single planned activity level.
It will be prepared before the start of the
operating year.

The information from the standard

cost card is the key to preparing the
budget, along with the planned
activity level.
 Static Budgets and
Performance Reports
Static budgets are
prepared for a single,
planned level of
activity.

Performance evaluation is difficult when

actual activity differs from the planned
level of activity.

© 2010 McGraw-Hill Ryerson Limited. LO1 11

 Static Budgets and
Performance Reports
CheeseCo
Static Actual
Budget Results Variances
Machine hours 10,000 8,000
Variable costs
Indirect labour $ 40,000 $ 34,000
Indirect materials 30,000 25,500
Power 5,000 3,800
Fixed costs
Depreciation 12,000 12,000
Insurance 2,000 2,050
Total overhead costs $ 89,000 $ 77,350

© 2010 McGraw-Hill Ryerson Limited. LO1 13

 Static Budgets and
Performance Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machine hours
Machine hours 10,000
10,000 8,000
8,000 2,000
2,000 U
Variable costs
Variable costs
Indirect
U = unfavourable
Indirectlabour
labor $ 40,000
40,000
variance
$ 34,000
34,000 $6,000 F
Indirect CheeseCo
materials was
Indirectmaterials unable to achieve
30,000
30,000 25,500
25,500 4,500 F
Power the budgeted 5,000
Power level of activity.
5,000 3,800
3,800 1,200 F
Fixedcosts
Fixed costs
Depreciation
Depreciation 12,000
12,000 12,000
12,000 0
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
Total overheadcosts
Total overhead costs $ 89,000
89,000 $ 77,350
77,350 $11,650 F

© 2010 McGraw-Hill Ryerson Limited. LO1 14

 Static Budgets and
Performance Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machinehours
Machine hours 10,000
10,000 8,000
8,000 2,000
2,000 U
Variable costs
Variable costs
Indirectlabour
Indirect labor $ 40,000
40,000 $ 34,000
34,000 $6,000 F
$6,000
Indirectmaterials
Indirect materials 30,000
30,000 25,500
25,500 4,500 F
Power
Power 5,000
F = favourable
5,000 3,800
variance
3,800 1,200 F
Fixedcosts
Fixed costsActual cost is less than budgeted
Depreciation
Depreciation 12,000
12,000 12,000
12,000 0
cost.
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
Total overheadcosts
Total overhead costs $ 89,000
89,000 $ 77,350
77,350 $11,650 F

© 2010 McGraw-Hill Ryerson Limited. LO1 15

 Static Budgets and
Performance Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machinehours
Machine hours 10,000
10,000 8,000
8,000 2,000
2,000 U
Variable costs
Variable costs
Indirectlabour
Indirect labor $ 40,000
40,000 $ 34,000
34,000 $6,000 F
$6,000
Indirectmaterials
Indirect materials 30,000
30,000 25,500
25,500 4,500 F
4,500
Power
Power 5,000
5,000 3,800
3,800 1,200 F
1,200
Fixedcosts
Fixed costs
Depreciation
Depreciation 12,000
12,000 12,000
12,000 00
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
Total overheadcosts
Total overhead costs $ 89,000
89,000 $ 77,350
77,350 $11,650
$11,650 F

© 2010 McGraw-Hill Ryerson Limited. LO1 16

 Static Budgets and
Performance Reports
CheeseCo
Static
Static Actual
Actual
Budget
Budget Results
Results Variances
Variances
Machinehours
Machine hours 10,000
10,000 8,000
8,000 2,000
2,000 U
Variable costs
Variable costs
Indirect
Ind labor
irect labour $ 40,000
40,000 $ 34,000
34,000 $6,000 F
$6,000
Indirectmaterials
Indirect materials 30,000
30,000 25,500
25,500 4,500 F
4,500
Power
Power 5,000
5,000 3,800
3,800 1,200 F
1,200
Sincecosts
Fixed cost variances are favourable, have
Fixed costs
we done a good job controlling
Depreciation
Depreciation 12,000
12,000 costs?
12,000
12,000 00
Insurance
Insurance 2,000
2,000 2,050
2,050 50 U
Total overheadcosts
Total overhead costs $ 89,000
89,000 $ 77,350
77,350 $11,650
$11,650 F

© 2010 McGraw-Hill Ryerson Limited. LO1 17

 Static Budgets and
Performance Reports
I don’t think I Actual activity is below
can answer the budgeted activity.
question using
So, shouldn’t variable costs
a static budget.
be lower if actual activity
is lower?

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© 2010 McGraw-Hill Ryerson Limited.
 Static Budgets and
Performance Reports
• The relevant question is . . .
“How much of the favourable cost variance is
due to lower activity, and how much is due to
good cost control?”
• To answer the question,
we must
the budget to the
actual level of activity.
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© 2010 McGraw-Hill Ryerson Limited.
Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.

May be prepared for any activity

level in the relevant range.

Reveal variances due to good cost

control or lack of cost control.

Improve performance evaluation.

LO1 20
© 2010 McGraw-Hill Ryerson Limited.
 Flexible Budgets
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs
and revenue should have been.

LO1 21
© 2010 McGraw-Hill Ryerson Limited.
 Preparing a Flexible Budget

To a budget we need to know that:

• Total variable costs change
in direct proportion to
changes in activity.
• Total fixed costs remain ble
aria
unchanged within the V
relevant range. Fixed

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© 2010 McGraw-Hill Ryerson Limited.
 Preparing a Flexible Budget
CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Variable costs are expressed as
Indirect labour 4.00 a constant
$ 32,000 amount per hour.
Indirect material 3.00 24,000
Power 0.50 $40,000
4,000 ÷ 10,000 hours is
Total variable cost $ 7.50 $4.00 per hour.
$ 60,000

Fixed costs
Fixed costs are
Depreciation $12,000
Insurance 2,000 expressed as a
Total fixed cost total amount.
Total overhead costs
© 2010 McGraw-Hill Ryerson Limited. LO1 23
 Preparing a Flexible Budget
CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs
Depreciation $4.00 per hour × 8,000 hours = $32,000
$12,000
Insurance 2,000
Total fixed cost
Total overhead costs
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© 2010 McGraw-Hill Ryerson Limited.
 Preparing a Flexible Budget
CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000
Per Hour Cost Hours
Machine hours 8,000
Variable costs
Indirect labour 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000

Fixed costs
Depreciation $12,000 $ 12,000
Insurance 2,000 2,000
Total fixed cost $ 14,000
Total overhead costs $ 74,000 ?
© 2010 McGraw-Hill Ryerson Limited. LO1 25
 Flexible Budget
Performance Report
CheeseCo
Cost Total
FlexibleFormula
budget is
Fixed Flexible Actual
prepared for theCosts
Per Hour Budget Results Variances
Machine hours
same activity level 8,000 8,000 0
(8,000 hours) as
Variable costs
actually$achieved.
Indirect labour 4.00 $ 34,000
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable costs $ 7.50 $ 63,300
Fixed Expenses
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,050
Total fixed costs $ 14,050
Total overhead costs $ 77,350
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© 2010 McGraw-Hill Ryerson Limited.
 Flexible Budget
Performance Report
Overhead Variance Analysis
Static Flexible Actual
Overhead Overhead Overhead
Budget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
$ 89,000 $ 74,000 $ 77,350

Activity Cost control

This $15,000F variance is This $3,350U flexible

due to lower activity. budget variance is due
to poor cost control.
© 2010 McGraw-Hill Ryerson Limited. LO1 29
 Flexible Budget
Performance Report
There are two primary
reasons for unfavourable
variable overhead variances:
What causes 1. Spending too much for
the cost resources.
control variance?
2. Using the resources
inefficiently.

© 2010 McGraw-Hill Ryerson Limited. LO1 30

 The Concept of Variances
A standard cost variance is the amount
by which
an actual cost differs from the standard
cost.

Standar
d
Cost

This variance is unfavourable

because the actual cost
exceeds the standard cost.
 Volume Variance: A Closer
Look

Volume
Varianc
e

Results when standard hours

allowed for actual output differs
from the denominator activity.

Unfavourable Favourable
when standard hours when standard hours
< denominator hours > denominator hours
 Volume Variance: A Closer Does not
Look measure
over-
Volume or
Variance underspendi
ng

Results when standard hours

allowed for actual output differs
Occurs only
from the denominator activity.
because
Unfavourable actual
Favourable
when standard hours activity
when standard hours
< denominator hours > denominator hours
differs from
the
 Variance Analysis and
Management by Exception

How do I know
which variances to
investigate?
Larger
variances, in
dollar amount
or as a
percentage of
the standard,
are
investigated
first.
 Labour Variances
 Price variance for direct labour is commonly
termed labour rate variance.
 The quantity variance for direct labour is called
the labour efficiency variance
Actual rate
 Labour variances: Standard
 Labour rate variance rate
LRV = (AR - SR) X AH Actual hours
 Labour efficiency variance Standard hours
LEV = (AH - SH) X SR allowed for the actual
good output
 Labour Variances Example
Hanson Inc. has the following direct
labour standard to manufacture one
Zippy:
1.5 standard hours per Zippy at $6.00
per
direct labour hour
Last week 1,550 direct labour hours
were worked at a total labour cost of
$9,610 to make 1,000 Zippies.
 Quick Check 
What
What waswas Hanson’s
Hanson’s actual
actual rate
rate
(AR)
(AR)
for
for labour
labour for
for the
the week?
week?
a.
a. $6.20
$6.20 per
per hour.
hour.
b.
b. $6.00
$6.00 per
per hour.
hour.
c.
c. $5.80
$5.80 per
per hour.
hour.
d.
d. $5.60
$5.60 per
per hour.
hour.
Quick Check Solution

What
What waswas Hanson’s
Hanson’s actual
actual
rate
rate (AR)
(AR)
for
for labour
labour for
for the
the week?
week?
AR = $9,610 ÷ 1,550
a. $6.20 per hour.
a. $6.20 per hour.hours
AR = $6.20 per hour
 Quick Check 
Hanson’s
Hanson’s labour
labour rate
rate variance
variance
(LRV)
(LRV) for
for the
the week
week was:
was:
a.
a. $310
$310 unfavourable.
unfavourable.
b.
b. $310
$310 favourable.
favourable.
c.
c. $300
$300 unfavourable.
unfavourable.
d.
d. $300
$300 favourable.
favourable.
Quick Check Solution
Hanson’s
Hanson’s labour
labour rate
rate variance
variance
(LRV)
(LRV) for
for the
the week
week was:
was:
a.
a. $310
$310 unfavourable.
unfavourable.
..
LRV = AH(AR - SR)
LRV = 1,550 hrs($6.20 -
$6.00)
LRV = $310 unfavorable
 Quick Check 
The
The standard
standard hours
hours (SH)
(SH) of
of labour
labour
that
that
should
should have
have been
been worked
worked to
to produce
produce
1,000
1,000 Zippies
Zippies is:
is:
a.
a. 1,550
1,550 hours.
hours.
b.
b. 1,500
1,500 hours.
hours.
c.
c. 1,700
1,700 hours.
hours.
d.
d. 1,800
1,800 hours.
hours.
 Quick Check Solution

The standard hours (SH) of labour
The standard hours (SH) of labour
that
that
should
should have
have been
been worked
worked to
to produce
produce
1,000
1,000 Zippies
Zippies is:
is:

b.
b. 1,500
1,500 hours.
hours.
SH = 1,000 units × 1.5 hours
per unit
SH = 1,500 hours
 Quick Check 
Hanson’s
Hanson’s labour
labour efficiency
efficiency variance
variance
(LEV)
(LEV)
for
for the
the week
week was:
was:
a.
a. $290$290 unfavourable.
unfavourable.
b.
b. $290$290 favourable.
favourable.
c.
c. $300$300 unfavourable.
unfavourable.
d.
d. $300$300 favourable.
favourable.
 Quick Check Solution
Hanson’s 
Hanson’s labour efficiency
labour efficiency variance
variance
(LEV)
(LEV)
for
for the
the week
week was:
was:
c.
c. $300$300 unfavourable.
unfavourable.
LEV = SR(AH - SH)
LEV = $6.00(1,550 hrs -
1,500 hrs)
LEV = $300 unfavorable
 Labour Variances Summary
Actual Hours Actual Hours
Standard Hours
× ×
×
1,550
Actualhours
Rate 1,550 hoursRate
Standard 1,500
Standard Rate
hours
× ×
×
$6.20 per hour $6.00 per hour $6.00
per hour
Rate variance
= $9,610 = Efficiency
$9,300 variance =
$9,000 $310 unfavourable $300 unfavourable
 Labour Efficiency
Variance:
Poorly
A Closer Look Poor
quality
trained materials
workers

Unfavourable
Efficiency
Variance
Poor
supervision Insufficient
of workers Demand or
Bottlenecks
 Responsibility for
Labour Variances
• The manager in charge of production would
generally be responsible for controlling the
labour efficiency variance.

• However, the variance might be chargeable to

purchasing if the acquisition of poor materials
resulted in excessive labour processing time.
 Advantages of Standard
Costs
Possible reductions Management by
in production costs exception

Advantages

Improved cost control Better Information

and performance for planning and
evaluation decision making
 Potential Problems with
Standard Costs
Emphasis on negative Favorable variances
may impact morale. may be misinterpreted.

Continuous
Standard cost improvement
reports may Potential
may be more
not be timely. Problems important than
meeting
Labour quantity standards.
standards
and efficiency Emphasizing standards
variances may exclude other
may not be important objectives.
appropriate.