Standard Cost
A standard cost is the predetermined cost of manufacturing a single unit or a number of product units
during a specific period in the immediate future. It is the planned cost of a product under current and / or
anticipated operating conditions.
A standard is a "benchmark" or "norm" for measuring performance. Standards are found everywhere
your doctor, for example, evaluates your weight using standards that have been set for individuals of your
age, height and gender. The food we eat in restaurants must be prepared under specified standards of
cleanliness. The buildings we live in must conform to standards set in building codes.
Standards are also widely used in managerial
accounting where they relate to the quantity and
cost of inputs used in manufacturing goods and
producing services. Engineers and accountants
assist managers to set quantity and cost standards
for each major input such as raw materials and
direct labor time. Quantity standards specify how
much of an input should be used to make a product
or provide a service. Cost or price standards specify
how much should be paid for each unit of input.
Actual quantities and actual costs are then
compared with these standards. In case of
significant deviations managers investigate the
i
discrepancies.
In Business | Standards in the Spanish Royal Tobacco Factory
Standards have been used for centuries in commercial enterprises. For example, the Spanish Royal Tobacco
Factory in Seville used standards to control costs in the 1700s. The Royal Tobacco Factory had a monopoly over
snuff and cigar production in Spain and was the largest industrial building in Europe. Employee theft of tobacco was
a particular problem, due to its high value. Careful records were maintained of the amount of tobacco leaf issued to
each worker, the number of cigars expected to be made based on standards, and the actual production. The worker
was not paid if the actual production was less than the expected production. To minimize theft, tobacco was weighed
after each production step to determine the amount of wastage.
Source: Salvador Carmona, Mahmoud Ezzamel, and Fernando Gutierrez, "Control and Cost Accounting
Practices in the Spanish Royal Tobacco Factory, "Accounting, Organizations, and Society 22, no. 5, 1997, pp.
411-446"
Types of Standards
Basic Standards are long term standards that remain unchanged in the long run and are used as a base
from which current standards are developed. The singular role is to reveal cost and revenue patterns over
time. These standards do not reveal current efficiency and are not used in reports except for the use as a
reference. For example, the acceptable current ratio is 2:1, which means for the firm should have $2 of
current assets for every $1 of current liability. This is a “rule of thumb”, however, the entity should seek
to develop its current ratio standard based on its industry, size and unique operating factors.
Ideal standards are those that can be attained only under the best circumstances. They allow for no
machine breakdowns or other work interruptions and they call for a level of effort that can be attained
only by the most skilled and efficient employees working at peak effort 100% of the time. Some
managers feel that such standards have a motivational value These managers argue that even though
employees know that they will rarely meet the standards, it is a constant reminder of the need for ever
increasing efficiency and effort. Few firms use ideal standards.
Most managers feel that ideal standards tend to discourage even the most diligent workers. Moreover,
variances from ideal standards are difficult to interpret. Large variances from the ideal are normal and it is
difficult to manage by exceptions. For example, a college may determine the ideal pupil to lecturer ratio.
However, actual financial and capacity constraints may cause these standards to be unattainable.ii
Attainable standards are those standards that are tight but attainable. They allow for normal machine
downtime and employee rest period. They can be attained through reasonable, though highly efficient,
efforts by the average worker. Variances from such standards represent deviations that fall outside of
normal operating conditions and signal a need for management attention. Furthermore, attainable
standards can serve multiple purposes. In addition to signalling abnormal conditions, they can also be
used in forecasting cash flows and in planning inventory. By contrast, ideal standards cannot be used in
forecasting and planning; they do not allow for normal inefficiencies, and therefore they result in
unrealistic planning and forecasting figures.
Establishing Standards
Setting price and quantity standards require the combined expertise of all persons who have
responsibility over input prices and over effective use of inputs. In a manufacturing firm, this might
include accountants, purchasing managers, engineers, production supervisors, line mangers, and
production workers. Past records of purchase prices and input usage can help in setting standards.
However, the standards should be designed to encourage efficient future operations, not a repetition of
past inefficient operations.
Advantages / Benefits of Standard Costing System:
Standard costing System has the following main advantages or benefits:
1. The use of standard costs is a key element in a management by exception approach. If costs
remain within the standards, Managers can focus on other issues. When costs fall significantly
outside the standards, managers are alerted that there may be problems requiring attention. This
approach helps managers focus on important issues.
2. Standards that are viewed as reasonable by employees can promote economy and efficiency.
They provide benchmarks that individuals can use to judge their own performance.
3. Standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job,
the standard costs for materials, labour, and overhead can be charged to jobs.
4. Standard costs fit naturally in an integrated system of responsibility accounting. The standards
establish what costs should be, who should be responsible for them, and what actual costs are
under control.
Disadvantages / Problems / Limitations of Standard Costing System:
1. Standard cost variance reports are usually prepared on a monthly basis and often are released
days or even weeks after the end of the month. As a consequence, the information in the reports
may be so stale that it is almost useless. Timely, frequent reports that are approximately correct
are better than infrequent reports that are very precise but out of date by the time they are
released. Some companies are now reporting variances and other key operating data daily or even
more frequently.
2. If managers are insensitive and use variance reports as a club, morale may suffer. Employees
should receive positive reinforcement for work well done. Management by exception, by its
nature, tends to focus on the negative. If variances are used as a club, subordinates may be
tempted to cover up unfavourable variances or take actions that are not in the best interest of the
company to make sure the variances are favourable. For example, workers may put on a crash
effort to increase output at the end of the month to avoid an unfavourable labour efficiency
variance. In the rush to produce output quality may suffer.
3. Labour quantity standards and efficiency variances make two important assumptions. First, they
assume that the production process is labour-paced; if labour works faster, output will go up.
However, output in many companies is no longer determined by how fast labour works; rather, it
is determined by the processing speed of machines. Second, the computations assume that labour
is a variable cost. However, direct labour may be essentially fixed, then an undue emphasis on
labour efficiency variances creates pressure to build excess work in process and finished goods
inventories.
4. In some cases, a "favourable" variance can be as bad or worse than an "unfavourable" variance.
For example, McDonald's has a standard for the amount of hamburger meat that should be in a
Big Mac. A "favourable" variance would mean that less meat was used than standard specifies.
The result is a substandard Big Mac and possibly an unsatisfied customer.
5. There may be a tendency with standard cost reporting systems to emphasize meeting the
standards to the exclusion of other important objectives such as maintaining and improving
quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using
supplemental performance measures that focus on these other objectives.
6. Just meeting standards may not be sufficient; continual improvement may be necessary to survive
in the current competitive environment. For this reason, some companies focus on the trends in
the standard cost variances - aiming for continual improvement rather than just meeting the
standards. In other companies, engineered standards are being replaced either by a rolling average
of actual costs, which is expected to decline, or by very challenging target costs.
In sum, managers should exercise considerable care in their use of a standard cost system. It is
particularly important that managers go out of their way to focus on the positive, rather than just on the
negative, and to be aware of possible unintended consequences.
Nevertheless standard costs are still found in the vast majority of manufacturing companies and in many
service companies, although their use is changing. For evaluating performance, standard cost variances
may be supplanted in the future by a particularly interesting development known as the balanced
scorecard.
The following question was used to illustrate the relevance of the topic:
Backyard Craft, located in Moneague St. Ann, produces toys made from bamboo. It uses a standard
costing system to control costs. The cutting department designs and cuts the shapes which are sold as toy
animals. The process is very labour intensive and requires highly skilled labour to minimise the wastage
of the bamboo used. The standard cost card for a set of toy animals are as below:
Bamboo
Direct labour
Fixed overhead
0.1 cubic metres at $160 per cubic metre
30 minutes at $9 per hour
30 minutes at $4 per direct labour hour
Total Cost
$
16.00
4.50
2.00
22.50
During the annual budget meeting the following was determined;
I.
The fixed overhead absorption rates is to be based on budgeted monthly fixed overheads of
$26,000 and a budgeted monthly output of 13,000 sets of animals.
All stocks are to be recorded at standard cost.
In the most recent month 14,000 sets of animals were made using 1,600 cubic metres of bamboo.
Purchases for the period were 1,800 cubic metres of bamboo at $150 per cubic metre. 8,000 direct
labour hours were used and paid at $9.25 per hour. Actual fixed overheads were $23,000 for the
month.
II.
III.
IV.
Required:
(a) Calculate the following variances from standard cost for the most recent month:
Raw material price
Raw material usage
Labour rate
Labour efficiency
Fixed overhead expenditure
Fixed overhead volume
Fixed overhead capacity
Fixed overhead efficiency
You may want to keep this as a separate sheet of paper as you will be referring to it throughout the
lecture.
Direct Materials Price Standards:
Direct materials price variance is the difference between the actual purchase price and standard purchase
price of materials. Direct materials price variance is calculated either at the time of purchase of direct
materials or at the time when the direct materials are used. When this variance is computed at the time
of purchase of materials it is called direct materials purchase price variance. When this variance is
computed at the time of usage this is typically called direct materials price usage variance. It
measures the difference between the quantity of materials used in production and the quantity that should
have been used according to the standard that has been set.
Direct Materials Price Variance formula:
(AQ x AP) – (AQ x SP)
AQ = Actual quantity purchased AP = Actual Price
SP = Standard Price
Using the data from the question, compute the Direct Materials Price variance:
(1,800 cubic metres of bamboo x $150 cubic metre) – (1,800 cubic metres of bamboo x $160 cubic metre)
= $270,000 - $288,000
$18,000 FAV
A favourable material price variance of $18,000 exists
because the actual price of materials purchased is less than the
standard price of materials purchased. A material price
variance is called an unfavourable or an adverse materials
price variance if the actual price of materials purchased is
more than the standard price of materials purchased.
Who is Responsible for Material Price Variance?
Generally speaking, the purchasing manager has control over
the price paid for goods and is therefore responsible for any price variation. Many factors influence the
price paid for the goods, including number of units ordered in a lot, how the order is delivered, and the
quality of materials purchased. A deviation in any of these factors from what was assumed when the
standards were set can result in price variance. For example purchase of second grade materials rather
than top-grade materials may be a reason of favourable price variance, since the lower grade material will
generally be less costly but perhaps less suitable for production and can be a reason of unfavourable
materials quantity variance.
However, someone other than purchasing manager could be responsible for materials price variance. For
example, production is scheduled in such a way that the purchasing manager must request express
delivery. In this situation the production manager should be held responsible for the resulting price
variance. Other factors, such as, government regulations or a change in the structure of the product as
required by the client.
Direct Material Efficiency/Quantity/Usage Variance
Direct materials quantity variance is also known as Direct materials efficiency variance and Direct
materials usage variance. It measures the difference between the quantity of materials used in
production and the quantity that should have been used according to the standard that has been set.
Although the variance is concerned with the physical usage of materials, it is generally stated in dollar
terms to help gauge its importance.
Materials Usage Variance Formula:
(AQ used x SP) – (SQ allowed x SP)
(1,600 cubic metres x $160 cubic metre) – [ (0.1 cubic metres x 14,000 sets) x $160 cubic metre]
= $256,000 – [1,400 x $160]
= $256,000 - $224,000
$32,000 UNFAV
The variance above is unfavourable because the entity used $256,000 of materials based on the standard
price, however, it should have used only $224,000 of materials, based on the standard price. In short, the
entity used more material than it should have. The variance would be favourable if the material used was
less than the standard quantity.
Who is Responsible for Material Usage Variance?
Excessive usage of materials that is usually a reason of unfavourable direct materials quantity
variance may be due to inferior quality of materials, untrained workers, poor supervision etc. Generally
speaking production managers are held responsible for this variance. However purchasing department
may also be held responsible for purchasing materials of inferior quality to economize on prices. Where
purchasing department purchases low grade direct materials at low prices to show a favourable materials
price variance, the materials quantity variance is usually unfavourable due to inferior quality of direct
materials.
A word of caution is in order. Variance analysis should not be used as an excuse to conduct which hunts
or as a means of beating line managers and workers over the head. The emphasis must be on control in
the sense of supporting the line managers and assisting them in meeting the goals that they have
participated in setting for the company. In short, the emphasis should be positive rather than negative.
Excessive dwelling on what has already happened, particularly in terms of trying to find someone to
blame, can destroy morale and kill any cooperative spirit.
Total Direct Materials Variance
This is a measurement of the difference between the actual cost of direct materials incurred and the
standard material cost of the units manufactured. The outcome of this variance reflects the reason for the
two sub-variances, i.e., price and usage variances. It can be computed as followed:
(AQ purchased x AP) – (SQ allowed x SP)
However, when the quantities of materials purchased differs from the quantity of materials used, the total
variance is computed by finding the sum of the price and usage variances. This is the approach used in
this example.
Direct Labour Variances
Direct Labour Price/Rate Variance
Direct Labour price variance is also termed as direct labour rate variance. This variance measures
any deviation from standard in the average hourly rate paid to direct labour workers. In other words,
direct labour rate variance is the difference between the amount of actual hours worked at actual rate and
actual hours worked at standard rate.
Direct Labour Rate Variance Formula:
Following formula is used to calculate direct labour rate variance or direct labour price variance:
(AH* x AR) – (AH x SR)
AH = Actual Hours Worked
AR = Actual Rate
SR = Standard Rate
(8,000 x $9.25) – (8,000 x $9.00)
= $2,000 UNFAV
Calculation shows an unfavourable labour price variance because actual rate paid to workers is more
than the standard rate. When the actual rate is less than the standard rate a favourable labour price
variance results.
Rates paid to the workers are usually predictable. Nevertheless, rate variances can arise through the way
labour is used. Skilled workers with high hourly rates of pay may be given duties that require little skill
and call for low hourly rates of pay. This will result in an unfavourable labour rate variance, since the
actual hourly rate of pay will exceed the standard rate specified for the particular task. In contrast, a
favourable rate variance would result when workers who are paid at a rate lower than specified in the
standard are assigned to the task. However, the low pay rate workers may not be as efficient. Finally,
overtime work at premium rates can be reason of an unfavourable labour price variance if the overtime
premium is charged to the labour account. Government regulations regarding minimum wage must also
be considered, though these changes are not within the control of management.
Who is responsible for the labour rate variance?
Since rate variances generally arise as a result of how labour is used, production supervisors bear
responsibility for seeing that labour price variances are kept under control.
Direct Labour Usage/Efficiency/Time Variance
The quantity variance for direct labour is generally called direct labour efficiency variance or direct
labour usage variance. This variance measures the productivity of labour time. No variance is more
closely watched by management, since it is widely believed that increasing the productivity of direct
labour time is vital to reducing costs. The formula for the labour efficiency variance is expressed as
follows:
Formula of labour efficiency variance:
(AH x SR) – (SH allowed x SR)
(8,000 x $9.00) – [(14,000 x 0.5) x $9.00]
= $72,000 – [7,000 x $9.00]
= $72,000 - $63,000
$9,000 UNFAV
Processing of 14,000 units required 8,000 hours and that was more time than what was allowed by
standards – 7,000 hours. The result is an unfavourable labour efficiency variance. A favourable
labour efficiency variance occurs when actual processing time is less than the time allowed by
standards.
Who is Responsible for Labour Efficiency Variance?
The manager in charge of production is generally considered responsible for labour efficiency variance.
However, purchase manager could be held responsible if the acquisition of poor materials resulted in
excessive labour processing time. Possible causes / reasons of an unfavourable efficiency variance
include poorly trained workers, poor quality materials, faulty equipment, and poor supervision. Another
important cause / reason of an unfavourable labour efficiency variance may be insufficient demand for
company's products.
If customers’ orders are insufficient to keep the workers busy, the work centre manager has two options,
either accept an unfavourable labour efficiency variance or build up inventories. The second option is
opposite to the basic principle of just in time (JIT). Inventory with no immediate prospect of sale is a bad
idea according to just in time approach. Inventories, particularly work in process inventory leads to high
defect rate, obsolete goods, and generally inefficient operations. As a consequence, when the work force
is basically fixed in the short term, managers must be cautious about how labour efficiency variances are
used. Some managers advocate dispensing with labour efficiency variance entirely in such situations―at
least for the purpose of motivating and controlling workers on the shop floor.
Total Direct Labour Variance
This measures the difference between the actual labour cost incurred and what should have been incurred
based on the relevant level of production. In this case, the quantity of labour used is the same as the
quantity of labour ‘purchased’, hence we can proceed to use the Total Direct Labour Variance
formula. It is computed as below:
(AH x AR) – (SH allowed x SR)
(8,000 x $9.25) – [(14,000 x 0.5) x $9.00]
= $74,000 – [7,000 x $9.00]
= $74,000 - $63,000
$11,000 UNFAV
SUMMARY OF POSSIBLE REASONS FOR DIRECT MATERIAL &
DIRECT LABOUR VARIANCES
Material price:
Material usage:
Labour rate:
Lower or higher quality than standard quality
Change in price by supplier
Shortage of material
Lower or higher quality than standard quality
Theft
Inexperienced operators
Unexpected wage increase
Using higher or lower grade labour than normal on the work undertaken
Labour efficiency: Using higher or lower grade labour than normal on the work undertaken
Standard of training
Quality of material
Quality of equipment
Fixed Overhead Expenditure/Spending Variance
Actual Fixed O/H – Flexible Budget Fixed O/H
Using our Backyard Craft example, the Fixed Overhead Expenditure variance is computed as below:
$23,000 - $26,000 = $3,000 FAV
The variance is favourable because actual fixed overheads incurred was less than budgeted. An
unfavourable variance means that actual overhead expenditures were greater than planned. The amount
of expense related to fixed overhead should (as the name implies) be relatively fixed, and so the fixed
overhead spending variance should not theoretically vary much from the budget. However, if the
manufacturing process reaches a step cost trigger point, where a whole new expense must be incurred,
then this can cause a significant unfavourable variance. For example, if a hotel leases a property and
desires to increase their capacity by leasing additional space, the fixed lease expense will now increase
because the hotel exceeded the relevant range of the initial expense.
Also, there may be some seasonality in fixed overhead expenditures, which may cause both favourable
and unfavourable variances in individual months of a year, but which cancel each other out over the full
year. Other than the two points just noted, the level of production should have no impact on this
variance.
Fixed Overhead Efficiency Variance
To fully appreciate the following variances, one must understand the concept of an Overhead Absorption
Rate (OAR). Recall that overheads are costs that cannot be easily traced to a single unit of output.
Business entities must therefore use a method to incorporate these costs into the overall cost of
production. An overhead cost pool can be absorbed based on an estimated level of activity.
In our example, Fixed Overheads were estimated to total $26,000 with an estimated activity level of
13,000 units per month. The management has decided to use Direct Labour Hours as the activity level.
We also note that the firm plans to produce 13,000 animals per month with the labour standard being 30
minutes of labour per unit of output. Therefore 13,000 animals will utilize 0.5 hours of labour, totalling
(13,000 x 0.5 hrs) 6,500 labour hours. The Fixed Overheads will be absorbed as below:
Fixed Overhead Cost Pool = FOAR
Budgeted Activity Level
$26,000 ÷ 6,500 labour hrs = $4.00 per direct labour hour
Note that the $4.00 per labour hour is the FOAR as stated in the question. Let’s now proceed to calculate
the Fixed Overhead Efficiency Variance.
Formula of Fixed Overhead Efficiency Variance:
Following formula is used for the calculation of fixed overhead efficiency variance:
(AH x FOAR) – (SH x FOAR)
(8,000 x $4.00) – [(0.5 hrs x 14,000) x $4.00]
$32,000 – [7,000 x $4.00]
$32,000 - $28,000 = $4,000 UNFAV
The ratio is unfavourable because more hours were actually consumed than budgeted. The 14,000 units
should have used only 7,000 hours; however, 8,000 hours were consumed. Given that overheads are
absorbed based on labour hours, the excess 1,000 labour hours will result in the entity overstating
overheads which will result in overstated total operating costs. Recall that fixed overheads are not driven
by activity level in the short-run. Therefore, if the capacity existed to accommodate the production of the
14,000 units, the additional 1,000 units above the planned 13,000 units will not change the fixed overhead
cost. However, if we use the FOAR to pull in the cost of overheads based on actual production of 14,000
units, this will result in overheads being overstated.
Fixed O/H Capacity Variance
A favourable variance reflects the under-budgeting of Fixed Overheads. Therefore when the actual labour
hours at the standard absorption rate exceeds the Budgeted fixed overheads, this means that the
organisation has used the idle capacity to increase its output and therefore it has shared its fixed
overheads over more units. The variance is computed as below:
(Budgeted Fixed O/Hs – [AH x FOAR])
$26,000 – (8,000 x $4.00)
$26,000 - $32,000 = $6,000 FAV
The variance is favourable because we absorbed more overheads than budgeted. This occurred because
we used the excess capacity to produce units. Recall that fixed overheads remain fixed within the relevant
range. The fixed overhead per unit should therefore decline, making the product less costly to produce.
Fixed Overhead Production-Volume Variance
This is the difference between budgeted fixed overhead and fixed overhead allocated on the basis of
actual output produced. The variance reflects the sum of the capacity and efficiency variances. It is
calculated as per below:
Budgeted Fixed Overheads – (SH x FOAR)
$26,000 – [(0.5 x 14,000) x $4.00]
$26,000 – [7,000 x $4.00]
$26,000 - $28,000 = $2,000 FAV
The variance is favourable because we over-allocated the fixed costs to actual output produced. The
allocation of more cost to each unit was based on the sole fact of producing more than budgeted. Note that
as long as the producer remains within the relevant range, fixed costs per unit remain fixed. Therefore, by
producing more, the producer has spread the fixed costs over more units and in effect, he has reduced his
fixed cost per unit. It is on this basis why we conclude that the variance is favourable.
If we add the results of the Fixed O/H Capacity and Efficiency variances we derive the same answer as
above.
$6,000 FAV + $4,000 UNFAV
= $2,000 FAV
Fixed Overhead Variance
This is a measurement of the overall difference between actual Fixed Overheads and standard Fixed. It is
also equivalent to the sum of the Fixed Overhead Expenditure and Fixed Overhead Volume variances.
Fixed O/H Exp. variance + Fixed O/H Volume variance
$3,000 FAV + $2,000 FAV
$5,000 FAV
Variable Overhead Efficiency variance
Overheads are costs that cannot be easily traced to a single unit of output. Therefore, budgeted costs are
estimated and absorbed using an activity base. An overhead absorption rate (OAR) is then determined:
Budgeted Overhead Cost Pool
Budgeted Activity Level
= OAR
The OAR is then used to pull the cost of overheads into the cost of producing/providing the entity’s
products/services.
Formula of Variable Overhead Efficiency Variance:
Following formula is used for the calculation of variable overhead efficiency variance:
(AH x VOAR) – (SH x VOAR)
*Variable Overhead Absorption Rate. Note the similarity with the Labour efficiency variance
Example:
Esquire Clothing manufactures designer suits. Variable manufacturing overheads are allocated on the
basis of manufacturing labour hours per suit (This is the VOAR). For January 2010, the completion of
each suit is budgeted to take four labour hours. Budgeted variable manufacturing overhead cost per
labour hour is $12. The budgeted number of suits to be manufactured in January 2010 is 1,040.
Actual variable manufacturing costs in January 2010 is $52,164 for 1,080 suits started and completed.
There was no start or ending inventory of suits. Actual direct manufacturing labour hours for January
2010 were 4,536.
Required: Compute the Variable Overhead Efficiency Variance
(4,536 X $12) - [(4hrs per unit x 1,080 suits) x $12]
$54,432 – [4,320 x $12] = $2,592 UNFAV
The variance is unfavourable because the company absorbed more variable overheads given that the
allocation base of 4,536 hours was greater than the standard quantity of labour hours that should have
been used, i.e., 4,320 hours. The higher allocation base resulted in the company absorbing more
overheads.
An unfavourable variance may reflect one or more of the following issues:
•
•
•
•
•
Workers are less skilled than expected
More machine hours were used due to inefficient scheduling of jobs
Workers are experiencing fatigue and are not performing at their best
The need to complete a rush delivery resulted in the use of more labour hours
The budgeted number of labour hours was set too low
A favourable variance means that the actual hours worked were less than the budgeted hours, resulting in
the application of the standard overhead rate across fewer hours, resulting in less expense incurred.
However, a favourable variance does not necessarily mean that a company has incurred less actual
overhead; it simply means that there was an improvement in the allocation base that was used to apply
overhead.
The variable overhead efficiency variance is a compilation of production expense information submitted
by the production department, and the projected labour hours to be worked, as estimated by the industrial
engineering and production scheduling staffs, based on historical and projected efficiency and equipment
capacity levels.
Variable Overhead Expenditure/Spending Variance
This is calculated as below:
(Actual Var. O/Hs – [AH x VOAR])
Example:
Esquire Clothing manufactures designer suits. Variable manufacturing overheads are allocated on the
basis of manufacturing labour hours per suit. For January 2010, the completion of each suit is budgeted to
take four labour hours. Budgeted variable manufacturing overhead cost per labour hour is $12. The
budgeted number of suits to be manufactured in January 2010 is 1,040.
Actual variable manufacturing costs in January 2010 is $52,164 for 1,080 suits started and completed.
There was no start or ending inventory of suits. Actual direct manufacturing labour hours for January
2010 were 4,536.
Required: Compute the Variable Overhead Spending Variance
$52,164 – [4,536 x $12]
= $2,268 FAV
A favourable variance means that the actual variable overhead expenses incurred per labour hour were
less than expected. The variable overhead spending variance is a compilation of production expense
information submitted by the production department, and the projected labour hours to be worked, as
estimated by the industrial engineering and production scheduling staffs, based on historical and projected
efficiency and equipment capacity levels.
There are a number of possible causes of a variable overhead spending variance. For example:
Account misclassification:
The variable overhead category includes a number of accounts, some of
which may have been incorrectly classified and so do not appear as part
of variable overhead (or vice versa).
Outsourcing:
Some activities that had been sourced in-house have now been shifted to
a supplier, or vice versa.
Supplier pricing:
Suppliers have changed their prices, which have not yet been reflected in
updated standards.
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