CHAPTER 8

Variance Analysis and Standard Costing

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis

Static vs. Flexible Budgets

Flexible Budget Variance
Standard Costing and Cost Variances
Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 2

Importance of Variance Analysis

Management control is the process by which managers set targets for

performance, measure actual performance and address differences
between actual and targeted performance.

The process of analyzing variances that occur between budgeted amounts

and actual amounts is called management by exception.

In this process, managers attempt to determine the root causes of the

variances and develop methods to ensure they are not repeated.

Copyright © 2018 AME Learning Inc. 3

Importance of Variance Analysis (Continued)

Variance analysis is a control process, also known as a feedback loop.

Copyright © 2018 AME Learning Inc. 4

Importance of Variance Analysis (Continued)

However, comparing actual and targeted performance can be complex

when actual activity fluctuates from what was planned.
This is where flexible budgets come in handy.

Copyright © 2018 AME Learning Inc. 5

 The process of analyzing variances that occur between budgeted
amounts and actual amounts is called?
a. management by control
b. management by exception
c. management’s decisions
d. None of the choices listed

6
Copyright © 2018 AME Learning Inc.
The process of analyzing variances that occur between budgeted amounts and
actual amounts is called?

Correct answer is b.

Copyright © 2018 AME Learning Inc. 7

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis
 Static vs. Flexible Budgets

Flexible Budget Variance

Standard Costing and Cost Variances
Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 8

Static vs. Flexible Budgets

A static budget is prepared using budgeted selling prices, budgeted costs

and budgeted sales volume (i.e. the original master budget that you
created).

The master budget is called the static budget, because it has one inflexible
volume of sales units for the month.

A flexible budget is prepared using budgeted selling prices, budgeted

costs and actual sales volume.

Let us illustrate with the Pine Manufacturers case from the previous
chapters.

Copyright © 2018 AME Learning Inc. 9

Static Budget
Example: Pine Furniture Manufacturers

Here is the January’s static

budget of Pine Manufacturers.

A static budget can also be called a

fixed budget because it is for a fixed
level of output.

Copyright © 2018 AME Learning Inc. 10

Static Budget
Example: Pine Furniture Manufacturers (Continued)

Pine Furniture is expecting to sell 5,000 chairs in January. During this

month, actual sales and actual costs are recorded, and the static budget
variance report is created at the end of January as shown on the next slide..

Copyright © 2018 AME Learning Inc. 11

Static Budget
Example: Pine Furniture Manufacturers (Continued)

Budgeted amounts

Actual amounts

Difference between
actual and budgeted
amounts

Copyright © 2018 AME Learning Inc. 12

Favorable VS Unfavorable Variances
Example: Pine Furniture Manufacturers

Instead of positive and negative values, variances can be labeled favorable

(F) or unfavorable (U) to show whether a variance is good or bad.

Unfavorable
variances result in
a lower income.

Copyright © 2018 AME Learning Inc. 13

Static Budget

The variance report provides a lot of information:

• Pine Furniture actually sold 5,500 chairs instead of 5,000. This contributes
to an increase in total sales revenue.
• As expected, all the variable costs also increased due to the increase in
the number of units produced and sold. However, were these increases
due strictly to an increase in the sales volume or due to an increase in
the costs of these items?

Based on the static budget variance alone, it is impossible to tell what

caused the difference in costs.

Copyright © 2018 AME Learning Inc. 14

Flexible Budget

To determine the root causes of the variances, let us prepare a flexible

budget.
A flexible budget adjusts for different levels of activity.

Copyright © 2018 AME Learning Inc. 15

Flexible Budget
Example: Pine Furniture Manufacturers

Pine Furniture originally budgeted to sell 5,000 chairs, but ended up selling
5,500 chairs. At the beginning of the month, it prepared a flexible budget
for different sales volumes. Next slide shows the flexible budget for sales of
5,000, 5,500 and 6,000 chairs.

Copyright © 2018 AME Learning Inc. 16

Flexible Budget
Example: Pine Furniture Manufacturers (Continued)

Note the different

levels of output

Copyright © 2018 AME Learning Inc. 17

Flexible Budget

In general, the following formulas can be used to calculate the flexible

budget.

Copyright © 2018 AME Learning Inc. 18

 TRUE or FALSE: A flexible budget is prepared using actual selling
prices, budgeted costs and actual sales volume.
a. TRUE
b. FALSE

19
Copyright © 2018 AME Learning Inc.
TRUE or FALSE: A flexible budget is prepared using actual selling prices, budgeted
costs and actual sales volume.

Correct answer is b.

Copyright © 2018 AME Learning Inc. 20

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis
 Static vs. Flexible Budgets
 Flexible Budget Variance

Standard Costing and Cost Variances

Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 21

Flexible Budget Variances

Comparing the information from the static budget, flexible budget and
actual results will help identify and classify variances.

The figure on the next slide shows them all.

Copyright © 2018 AME Learning Inc. 22

Flexible Budget Analysis

Copyright © 2018 AME Learning Inc. 23

Flexible Budget Analysis (Continued)

The variance between the initial static budget and the flexible budget is
called the sales-volume variance. It is strictly due to the change in sales
volume since both budgets use budgeted prices.

For Pine Furniture’s units sold in January, there is a favorable variance of

500 units, because 5,000 were expected to be sold and 5,500 units were
actually sold.

There is also a favorable variance for revenue of $25,000 because this is

the expected increase in the dollar amount of revenue if 5,000 more units
are sold at $50 per unit.

Copyright © 2018 AME Learning Inc. 24

Flexible Budget Analysis (Continued)

The difference between actual results and the flexible budget is called the
flexible budget variance.
The ($11,000) unfavorable flexible budget variance for revenue is caused
by a lower price per unit sold. In January, Pine Furniture sold 5,500 units
and had revenue of $264,000 instead of the expected $275,000.
This results in an average price of $48/unit, which is $2 under the budgeted
price of $50. Practicing management by exception, Pine Furniture
Management should further investigate this price variance.

Copyright © 2018 AME Learning Inc. 25

Flexible Budget Analysis (Continued)

Reviewing the income from operations on the bottom line, Pine Furniture
had actual results of $5,000. The expected income from operations at
5,500 units sold was $25,000.
The difference is caused by a ($20,000) unfavorable flexible budget
variance offset by the favorable $5,000 sales-volume variance because
Pine Furniture sold 500 more chairs
(500 units × $10 contribution margin/unit).

Copyright © 2018 AME Learning Inc. 26

Flexible Budget Analysis (Continued)

All the other variances for each line item can also be analyzed as shown;
however, there is a limitation to this type of analysis.
As mentioned, the flexible budget variances for the variable costs can be
the result of either a change in budgeted costs or a change in quantity
used for production.
At this level of analysis, we are unable to say whether the variance is due
to one or the other or a combination of the two factors.

To perform a deeper analysis, we must discuss standard costs.

Copyright © 2018 AME Learning Inc. 27

 If the static budget variance is 1,500 F, and the flexible-budget
variance is 200 U, what is the sales-volume variance?
a. 1,700 F
b. 200 F
c. 1,700 U
d. 1,500 F

28
Copyright © 2018 AME Learning Inc.
If the static budget variance is 1,500 F, and the flexible-budget variance is 200 U,
what is the sales-volume variance?

Correct answer is a.

Copyright © 2018 AME Learning Inc. 29

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis
 Static vs. Flexible Budgets
 Flexible Budget Variance
 Standard Costing and Cost Variances

Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 30

Standard Costing

It is common practice for many manufacturing companies to use standards

to help prepare the budgets and investigate variances.

A standard cost is the budget for the inputs of production—direct materials,

direct labor and manufacturing overhead—required to produce one unit of
output.

Copyright © 2018 AME Learning Inc. 31

Standard Costing
Example: Pine Furniture Manufacturers

We will now look into cost variances in more detail.

Pine Furniture’s standard costs are shown below.

Copyright © 2018 AME Learning Inc. 32

Standard Costing

A price standard sets a cost for an operating activity that is considered

ideal by the company.

A quantity standard is set to identify how much input should be used.

Standard costs and quantities can also be set for direct labor and
manufacturing overhead.

Copyright © 2018 AME Learning Inc. 33

Standard Costing
Example: Pine Furniture Manufacturers

Review the terms below to learn the common terms used, as applied to
Pine Furniture’s direct materials.

Copyright © 2018 AME Learning Inc. 34

Standard Costing
Example: Pine Furniture Manufacturers (Continued)

From the table you can see that units produced (chairs) are outputs
because they go out from the manufacturing work-in-process.

Direct materials (wood) are inputs because they come into the
manufacturing work-in-process.

Pine Furniture’s production budget plans to use 10 sq ft of wood per chair.

Standard costing translates this to 10 sq ft of direct material per unit
produced or a standard quantity of 10 sq ft/unit of output.

Copyright © 2018 AME Learning Inc. 35

Standard Costing
Example: Pine Furniture Manufacturers (Continued)

Pine Furniture’s purchases budget plans to purchase wood for a cost of

$0.80/sq ft.

Standard costing translates this to a purchase price of $0.80/sq ft or a

standard price per unit of input.

The cost of purchases translates to the price paid for purchases. Also, note
that this is the price per unit of input (wood), not output (chair).

Copyright © 2018 AME Learning Inc. 36

Standard Costing
Example: Pine Furniture Manufacturers (Continued)

On the final line, the total variable manufacturing cost per unit (chair) is
$8.00.

This translates to a total cost per unit produced or the standard cost per
unit of output. This means that the goal for Pine Furniture is to spend less
than $8.00/unit on wood.

The purpose of developing standards is to compare them to actual

operations and eliminate inefficiencies.

Copyright © 2018 AME Learning Inc. 37

Developing Standards

How do managers develop standards?

• Typically, they are set with the input of many different members of the
organization.
• It is believed that with enough discipline and creativity, these standards
are achievable.
• Standards that are too high may demotivate employees
• Standards that are too low may cause budgetary slack.
• It is up to the standard setters to exercise professional judgment.

Copyright © 2018 AME Learning Inc. 38

Variances Analysis

Each of the inputs (direct material, direct labor and variable manufacturing
overhead) can produce a price variance, a quantity variance or both.
The naming of the variances may differ from one input to the next, but
essentially they are price or quantity variances.

Copyright © 2018 AME Learning Inc. 39

Price Variance

All price variance calculations are completed in the same manner for
materials, labor or overhead.

The price variance answers the question “Did we spend more or less on
direct materials/direct labor/overhead?”

Copyright © 2018 AME Learning Inc. 40

Quantity Variance

Quantity variance calculations are completed in the same manner for

materials, labor or overhead.

The quantity variance answers the question “Did we use more or less on
direct materials/direct labor/overhead?”

Copyright © 2018 AME Learning Inc. 41

Total Variance

Once both of these calculations are made, the total variance can be
calculated:

Total variance takes both price variance and quantity variance into
consideration. If both variances are unfavorable or both are favorable, the
results are compounded. If one variable is unfavorable and the other is
favorable, one will offset the other.
It is important to properly use the price and quantity based on units of
input rather than on the number of units produced.

Copyright © 2018 AME Learning Inc. 42

Manufacturing Cost Variances

The cost portion of the flexible budget variance can be broken down into
the Direct Materials, Direct Labor, Variable Overhead and Fixed Overhead
Flexible Budget Variances.

Copyright © 2018 AME Learning Inc. 43

Direct Materials Variance
Example: Pine Furniture Manufacturers

Let us look at how to calculate Pine Furniture’s direct materials variance

using the formula method.

To calculate total variance, Pine Furniture must know the actual quantity,
actual price, standard quantity and standard price.

Copyright © 2018 AME Learning Inc. 44

Direct Materials Variance
Example: Pine Furniture Manufacturers (Continued)

Step 1: Determine all variables.

Based on the previous section, the standard quantity of materials is 50,000
sq ft (5,000 units× 10 sq ft/unit). The standard cost is $40,000 (50,000 sq ft
× $0.80/sq ft).
After looking at the purchase and use of materials, management
determined that 12 sq ft/unit was used, for a total actual quantity of 60,000
sq ft (5,000 units × 12 sq ft).
However, Pine Furniture got a deal on the wood, and spent $0.60/sq ft, for a
total actual price of $36,000 (60,000 sq ft × $0.60/sq ft).

Copyright © 2018 AME Learning Inc. 45

Direct Materials Variance
Example: Pine Furniture Manufacturers (Continued)

Step 2: Calculate direct material price variance.

In this example, the actual price of wood was less than the standard
allowed, which means Pine Furniture spent $12,000 less on direct materials
than what was expected, making it a favorable variance.

Copyright © 2018 AME Learning Inc. 46

Direct Materials Variance
Example: Pine Furniture Manufacturers (Continued)

Step 3: Calculate direct material quantity/efficiency variance.

In our example, the actual quantity was more than the standard allowed,
meaning Pine Furniture spent $8,000 more on materials for 5,000 chairs
than what was allowed, making it an unfavorable variance.

Copyright © 2018 AME Learning Inc. 47

Direct Materials Variance
Example: Pine Furniture Manufacturers (Continued)

Step 4: Calculate total direct material variance.

Pine Furniture ended up with a $4,000 favorable variance on direct

materials. They spent less per square foot of wood purchased, but the
money they saved on wood was offset by production using more square
feet of wood per chair produced.

Copyright © 2018 AME Learning Inc. 48

Direct Materials Variance

A possible follow-up procedure:

• Discussing the price increase with their current supplier.
• Investigating the manufacturing process and identifying where the loss in
efficiency occurs.
• Perhaps, more materials have been wasted or the quality of the materials
purchased was not up to par and had to be thrown away.

Copyright © 2018 AME Learning Inc. 49

Direct Labor Variance

Direct labor can also be separated into its price and efficiency components.

Copyright © 2018 AME Learning Inc. 50

Direct Labor Variance (Continued)

Adding the two variances together, we get the flexible budget variance for
direct labor.

Copyright © 2018 AME Learning Inc. 51

Variable Manufacturing Overhead Variance

The spending variance holds actual activity constant to find the variance
caused by differences in overhead rates.

The efficiency variance holds the standard rate constant to find the
variance caused by differences in activity.

Copyright © 2018 AME Learning Inc. 52

Variable Manufacturing Overhead Variance
(Continued)

Adding the two variances together, we get the flexible budget variance for
variable manufacturing overhead.

Copyright © 2018 AME Learning Inc. 53

Variance Analysis Using Problem Solving Method

One disadvantage of using the formula method is determining unknown

variables before calculating variances.

The problem solving method is another option that can be completed on

paper or in Excel.

The advantages of using this method are that you have all the numbers
that you need in one table and do not need to use traditional formulas.

Copyright © 2018 AME Learning Inc. 54

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers

You can use the problem solving method instead by following these steps to
complete the table.

All numbers are referred to using the cell label as it appears in Excel (e.g.
C3, J5, etc.).

Copyright © 2018 AME Learning Inc. 55

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 1: Fill in known variables in yellow cells.

For the first column, Actual Results/Unit, enter 1 into cell B2. This is the
column that will give us the actual amounts per one unit produced.
Management determined that the wood was purchased at a price of
$0.60/sq ft, which is entered in cell B5.

Copyright © 2018 AME Learning Inc. 56

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 1 Continued: Fill in known variables in yellow cells.

For the Total Actual Results column, Pine Furniture produced 5,000 chairs in
January, entered in cell C2.
We know that the production department actually used 60,000 sq ft of
wood, so this number is entered in cell C4. We also know the total cost of
direct materials was $36,000; this is entered in cell C6.

Copyright © 2018 AME Learning Inc. 57

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 1 Continued: Fill in known variables in yellow cells.

The total standard allowed for units produced in January is 5,000. This
number is entered into cell J2.
Standard Allowed/Unit, enter 1 into cell K2. The production department was
allowed to use 10 sq ft of wood per chair, so we enter that into cell K4.
Finally, the standard price of wood was $0.80/sq ft, which is entered into
cell K5.

Copyright © 2018 AME Learning Inc. 58

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 2: Bring the known variables into the AQ × SP column.

Follow the arrows to bring the known variables into the middle column. In
cell F2 enter 5,000. In cell F4 enter 60,000. In cell F5 enter $0.80.

Copyright © 2018 AME Learning Inc. 59

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 3: Calculate the missing values in the blue cells.

The production department used 60,000 sq ft of wood, so the actual material used
per unit produced was 12 sq ft (60,000 sq ft ÷ 5,000 units). This is entered in cell
B4.

The total cost per unit produced is $7.20 (12 units × $0.60/unit), and is
entered into cell B6.

Copyright © 2018 AME Learning Inc. 60

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 3 Continued: Calculate the missing values in the blue cells.

The total standard of materials allowed is 50,000 sq ft (5,000 units × 10 sq
ft/unit). This amount is entered into cell J4. The total standard cost allowed
is $40,000 ($8.00/unit × 5,000 units),
which is entered into cell J6.

The standard price allowed per unit is $8.00 (10 units × $0.80/unit) and is
entered into cell K6.
Copyright © 2018 AME Learning Inc. 61
DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 4: Calculate the AQ × SP variance.

Multiplying down this middle row, the result is $48,000 (60,000 units ×
$0.80 unit). Enter this number in cell F6.

Copyright © 2018 AME Learning Inc. 62

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 5: Calculate the price variance and quantity variance.

The price variance is the difference between the total actual results and
(AQ × SP). This number is $12,000F ($36,000 – $48,000) and entered into
cell D6.
This is a favorable variance because Pine Furniture spent less on direct
materials than what was allowed.

Copyright © 2018 AME Learning Inc. 63

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 5 Continued: Calculate the price variance and quantity

variance.
The quantity variance is the difference between the total standard allowed
and (AQ × SP). This number is ($8,000) U ($48,000 – $40,000) and entered
into cell H6.
This is an unfavorable variance because Pine Furniture used more direct
materials to produce 5,000 chairs than the standard allowed.

Copyright © 2018 AME Learning Inc. 64

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 6: Calculate the total direct material variance.

Find the difference between the price variance and quantity variance,
which is $4,000 F [$12,000 F – ($8,000) U]. This number is entered into cell
F7.

Copyright © 2018 AME Learning Inc. 65

DM Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Step 7: Analyze the completed table to determine the cause of the

variance.

After some more investigation, root cause analysis has determined that the
excess wood used was because the inexpensive wood was of poor quality.

A lot of wood was wasted when the chairs produced were rejected by
quality control and had to be redone.

Copyright © 2018 AME Learning Inc. 66

DL Variance Using Problem Solving Method

The calculations for direct labor variance are the same as direct materials
however, the terminology changes.

The units are direct labor hours (DLH) worked and the price of direct labor
is the wage rate paid to employees per hour.

The direct labor efficiency variance measures how efficiently employees

are working.

The direct labor rate variance measures the wage rate versus the standard
rate.

Copyright © 2018 AME Learning Inc. 67

DL Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers

Pine Furniture has a standard rate of 2.00 DLH/unit and a standard rate of
pay of $12.00/DLH. During January, Pine Furniture produced 5,000 chairs,
11,000 hours were worked, and the total cost of direct labor was $143,000.
Let us show you how to solve for direct labor variance using the problem
solving method.

Copyright © 2018 AME Learning Inc. 68

DL Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Further investigation has determined that the poor-quality wood that was
used in production caused both unfavorable variances. The ($12,000)
unfavorable efficiency variance was caused by extra time for redoing the
chairs, causing the actual DLH/unit to increase to 2.20 DLH/unit, exceeding
the standard of 2.00 DLH/unit.

Copyright © 2018 AME Learning Inc. 69

DL Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Redoing the chairs also caused the unfavorable labor ratevariance. Some
workers worked overtime, causing the labor rateto increase to $13.00/DLH
versus the standard of $12.00/DLH,which cost Pine Furniture an additional
($11,000).

Copyright © 2018 AME Learning Inc. 70

VOH Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers

Variable overhead in this example is applied using direct labor hours. The
efficiency or inefficiency of direct labor determinesthe number of units
variance.

For Pine Furniture, the standard of 2.00 DLH/unit is applied. Pine Furniture
has a predetermined rate of $3.00/DLH.

The variable overhead spending variance can be more complex.

Copyright © 2018 AME Learning Inc. 71

VOH Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Favorable VOH spending variances mean that the total of all of these costs
is under the total standard cost allowed and unfavorable variances mean
that spending on all VOH is over the standard cost allowed.

Copyright © 2018 AME Learning Inc. 72

VOH Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

The unfavorable efficiency variance resulted from the direct labor efficiency
variance caused by the poor quality of wood purchased.

Copyright © 2018 AME Learning Inc. 73

VOH Variance Using Problem Solving Method
Example: Pine Furniture Manufacturers (Continued)

Even though the favorable spending variance reduced cost in January,

further investigation determined that the root cause was that the
production department did not do routine machine maintenance in January.

The production department has been notified because this could cause
quality problems or equipment breakdowns in the coming months. This
example shows that favorable variances are not necessarily good.

Copyright © 2018 AME Learning Inc. 74

Variance Analysis

It is important to note that not all favorable variances are good, and not all
unfavorable variances are bad for the organization.

Managers should focus on keeping quality at the desired level while

reducing the amount of waste and spoilage in their system.

Copyright © 2018 AME Learning Inc. 75

 The price variance for direct materials is 400 F. The efficiency/quantity variance
for direct materials is 200 F. What is the flexible budget variance for direct
materials?
a. 250 F
b. 600 U
c. 600 F
d. 400 F

76
Copyright © 2018 AME Learning Inc.
The price variance for direct materials is 400 F. The efficiency/quantity variance for
direct materials is 200 F. What is the flexible budget variance for direct materials?

Correct answer is c.

Copyright © 2018 AME Learning Inc. 77

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis
 Static vs. Flexible Budgets
 Flexible Budget Variance
 Standard Costing and Cost Variances
 Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 78

Service Organization – Variance Analysis

Preparing and analyzing variances for a service company is very similar to

a manufacturing company.

The main difference is that there are no materials used in production in a

service company.

Labor is the key driving force behind a service company and what the labor
produces can be used to help prepare a budget.

We will use Merv’s Telemarketing Services as an example.

Copyright © 2018 AME Learning Inc. 79

Standard Costing: A Service Example
Merv’s Telemarketing Services (MTS) provides telemarketing for
various corporate clients. The company employs 10 people who are
constantly calling potential customers on behalf of its clients.

At the end of 2018, a budget was made for January 2019. Clients are being
billed at $1.50 per call.

The standard prices and quantity for direct labor and variable overhead are
as follows:

Copyright © 2018 AME Learning Inc. 80

Standard Costing: A Service Example (Continued)
Each employee is expected to be paid at $10/hr and make 20 calls/hr, so
each call should take 0.05 hours and cost $0.50/call.

Additional budget information is shown below:

Copyright © 2018 AME Learning Inc. 81

Standard Costing: A Service Example (Continued)

The manager was able to create the following static budget.

Copyright © 2018 AME Learning Inc. 82

Standard Costing: A Service Example (Continued)
On January 31, 2019, management prepared a variance report to analyze
revenue and costs. Fixed costs did not change; however there are a number
of differences from the original budget.
• The 10 employees worked 1,550 hours over the month
• An average of 25 calls per hour were made
• Clients were billed at $1.30/call
• The company’s total revenue amounted to $50,375
• The 10 employees were paid $16,275 over the month
• Total variable overhead was $3,813
Based on the actual client billing rate and the total revenue, a total of
38,750 calls were
made during the month.
Copyright © 2018 AME Learning Inc. 83
Standard Costing: A Service Example (Continued)

A flexible budget can be created using this sales volume and the standard
costs.

Copyright © 2018 AME Learning Inc. 84

Standard Costing: A Service Example (Continued)

The performance report is shown below:

Copyright © 2018 AME Learning Inc. 85

Standard Costing: A Service Example (Continued)

The sales volume variance in the performance report measures changes in

volume and shows a favorable variance of $7,525.
This means that if Merv’s Telemarketing had been able to keep the
budgeted sales price and costs for labor and overhead, the
increase in hours worked and the increase in calls per hour would have
created a favorable variance.

Copyright © 2018 AME Learning Inc. 86

Standard Costing: A Service Example (Continued)

However, the flexible budget variance measures actual performance

compared to the flexible budget and shows an unfavorable variance of
$3,038.

This is due to variances in selling price, direct labor cost and variable
overhead cost.

Management can now prepare a detailed report on the flexible budget

variances to measure the price and quantity variances of direct labor and
variable overhead.

Copyright © 2018 AME Learning Inc. 87

Standard Costing: A Service Example (Continued)

The decrease in the amount billed per call from $1.50 to $1.30 is the case
of the unfavorable variance for revenue. The costs for labor and overhead
are different due to several reasons:

• Employees not getting paid $10/DLH

• Employees not working the expected 1,500 hours for the month

• Variable overhead not being charged at $2.80/DLH

Copyright © 2018 AME Learning Inc. 88

Standard Costing: A Service Example (Continued)

For direct labor, we can determine that 38,750 calls at the standard of 20
calls/hour means the employees should have worked a total of 1,937.5
hours.

Merv’s paid the employees $16,275 for 1,550 direct labor hours. As a
result, employees were being paid $10.50/hour ($16,275 ÷ 1,550).

Copyright © 2018 AME Learning Inc. 89

Calculating Variances for a Service Company

Calculating direct labor variance and variable overhead variance for a

service company is the same as for a manufacturing company.

Both variances can be calculated using either the formula method or the
problem solving method. We will show both variances using the problem
solving method with the analysis followed.

Copyright © 2018 AME Learning Inc. 90

Direct Labor Rate Variance – A Service Example

The calculations for direct labor variance for a service company are the
same as for a manufacturing company.

The units are direct labor hours (DLH) worked and the price of direct labor
is the wage rate paid to employees per hour.

Merv’s has a standard rate of 0.05 DLH/unit and a standard rate of pay of
$10.00/DLH.

Copyright © 2018 AME Learning Inc. 91

Direct Labor Rate Variance – A Service Example

The direct labor rate variance measures the wage rate versus the standard
rate. The actual rate of $10.50/hour was higher than the standard
$10/hour, causing an unfavorable variance of ($775).

Copyright © 2018 AME Learning Inc. 92

Direct Labor Efficiency Variance – A Service Example

Merv’s had a favorable variance of $3875. This is because 25 calls per hour
were being made, rather than the standard of 20 calls per hour.
Additionally, only 1,550 hours were required to make the calls, rather than
the expected 1937.5 hours. Employees were more efficient at making calls.

Total DL
Variance

Copyright © 2018 AME Learning Inc. 93

Variable Overhead Variance – A Service Example

The calculations for variable manufacturing overhead variance for a service

company are the same as for a manufacturing company.

The units are direct labor hours (DLH) worked and the price variable
manufacturing overhead per hour worked. Merv’s has a standard rate of
$2.80/unit.

Copyright © 2018 AME Learning Inc. 94

VOH Spending Variance – A Service Example

Since the actual amount of variable overhead was less than expected, the
rate decreased. This caused a favorable overhead spending variance of
$527. This could be due to better equipment (computers, telephones) that
is less expensive to operate.

Copyright © 2018 AME Learning Inc. 95

VOH Spending Variance – A Service Example
(Continued)

The variable overhead efficiency variance shows a favorable variance of

$1,085. This is because the employees were more efficient at making calls,
and the number of hours worked was less than the standard allowed. Since
labor hours drive the overhead rate, fewer hours mean more efficient use
of overhead.

Total VOH
Variance

Copyright © 2018 AME Learning Inc. 96

 What is a price standard?
a. An ideal quantity of input that
should be used in production
b. Another way of analyzing the
revenue variance between the
flexible budget and actual
results
c. The difference between the
flexible budget and static
budget
d. An ideal cost for an operating
activity

97
Copyright © 2018 AME Learning Inc.
What is a price standard?

Correct answer is d.

Copyright © 2018 AME Learning Inc. 98

 What is the sales-volume variance?
a. Difference between the flexible
budget and actual result
b. Difference between actual
quantity and standard
quantities for actual output
c. Holds the standard rate
constant to find the variance
caused by differences in
consumption of units in the
base
d. Difference between the flexible
budget and static budget

99
Copyright © 2018 AME Learning Inc.
What is the sales-volume variance?

Correct answer is d.

Copyright © 2018 AME Learning Inc. 100

 Chapter 8: Variance Analysis and Standard
Costing
 Importance of Variance Analysis
 Static vs. Flexible Budgets
 Flexible Budget Variance
 Standard Costing and Cost Variances
 Service Organization’s Variances

Copyright © 2018 AME Learning Inc. 101

 End of Chapter 8

Copyright © 2018 AME Learning Inc. 102