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11 STANDARD COSTING

Overview of Product Costing

Introduction

Standards in the Organisation

Types of Standards

- Material Standards

- Labour Standards

- Overhead Standards

Illustration: The Pine Chair Company

When Purchases Do Not Equal Consumption

Summary of Variances

Summary

Overview of Product CostingThe issue of how to accumulate costs in order to manage and control resources and

aid in the pricing decision has been the focus of much debate over the last decade.

The issue, in many ways, is highlighted in the difference between the management

accounting techniques taught at universities and other institutions, and what is

actually practised in industry. Part of the difference has resulted from short

production runs resulting in increasing setup costs as opposed to production costs,

and the general move to niche production marketing. The result of more flexible production has been a decline in the relevance of the traditional costing systems.

One response to this has been the ‘discovery’ of activity based costing in industry

and the realisation that costs are driven by certain activities. These costs should be

‘attached’ or traced to those activities. Two general comments should be made.

Firstly, the standard costing systems and allocation systems that have been severely

criticised in recent times have become mis-matched to business needs due to a lack

of change on the part of many accountants and system designers. However, in

modified form with more flexible adaptations, they are still potentially powerful and

useful tools. Secondly, many accountants have been trapped into using existing

software and costing packages. Unfortunately, people typically revise systems only

when there is a substantial misfit; it is this misfit and consequent period of criticism

that has been observed over the last decade.



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218 Financial Management and Decision Making

Chapters 11 and 12 should be seen as providing examples of product costing insimplified situations, yet the principles are sound and generalisable as long as they

are applied with care and thought to fit the actual production environment.

IntroductionEarlier we discussed the concepts and implications of planning and control. The

necessity for feedback was emphasised so that adjustments can be made to the

business that will better meet business goals. Standard costing is one of the tools

used in determining the performance of a product and how efficiently it is being

produced. The development of standards is also a major part of the planning and

budgeting process before production begins. There are several ways of

approaching the standard costing area as well as various levels at which it may be

examined. This text takes a middle approach in that we pursue the different

variances to a level suitable for most small to medium businesses but not in

sufficient detail for the needs of large corporations. However, the principles are the

same and it is straightforward to extend the level of analysis given here to cater for

any depth of problem.

Several key terms must be understood when dealing with standard costs. The first

is standard cost itself. A standard cost is a measure of cost performance that is

efficient and attainable. A standard cost is a predetermined figure based on what

individuals in the area consider to be an efficient level of production, given no

untoward breakdowns or holdups and presuming things are running smoothly. It is

not a theoretic maximum output unlikely to ever be achieved. One of the principlesof setting budgets and responsibility accounting is that the target is attainable and

that under favourable circumstances the workers will actually achieve the target.

When targets are set too high, the desired level is never attained and the

consequence can be one of worker insecurity and alienation.

The difference between the actual performance and the standard performance or

standard cost is the variance. The variance will either be favourable or

unfavourable depending upon whether the actual position was more efficient than

the standard position.

Standard costs can be used in virtually any business organisation from

manufacturing through to professional service organisations such as doctors,

accountants, lawyers. Generally, standard costing is used where there is a fairly

standard product, produced in a relatively repetitive situation. (Later in this chapter

we use an example of a small joinery firm that is producing wooden chairs).

As the task, or product, becomes more individual or unique, such as might be

associated with the product from professional or service organisations, the variation

in the form of the product means that standard costing must be much more carefully

and critically calculated. At some stage management must make a determination as

to whether it is cost effective to introduce a standard costing system or whether it is

better merely to review the performance of members of the organisation from time

to time, and compare members doing like tasks. With the increasing pressure on

organisations to be more accountable - especially in many professional areas -

people are now questioning both the efficiency of professional organisations as well



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Chapter 11: Standard Costing 219

as whether they should in fact be doing the jobs that they are doing. This has led toa movement of standard costing into the areas of professional service organisations,

private hospitals, although in these instances the form of standard costing is less

structured and less regular than is found in a manufacturing situation. Part of the

move to a much broader acceptance of standard costing has also come from low

cost data processing facilities enabling the user to manipulate and adjust the raw

data to a number of alternate ends.

Standards may be derived in a number of ways. For example, historical standards

are derived from accumulated cost data that take no account of changing factors of

prices or efficiency. Thus, they are of little relevance in standard setting. Theoretic

or ideal standards are almost never attainable and should not be used since they

abstract from the real world of breakdown and human factors. Currently attainable

standards should be used and are described here.

The standard should be seen as achievable when the relevant factors are pursued in

an efficient manner. It should not be seen as an ultimate standard as this would

virtually never be achieved. Equally, it must not be seen as something that is

normally easily reached. In the everyday work situation, breakdowns will occur,

workers will not be as efficient as they could be for one reason or another, the

quality of the raw material may be variable, or any number of other reasons will

mean that an efficient standard is not reached. Thus, the standard must be set above

some ‘average’ level but it should be at a realistically attainable target. The

standard may be summarised as something that can be attained but is not always

attainable.

Standards in the OrganisationThe standard is in place to provide feedback to the organisation’s planning and

control system. It is therefore an integral part of the firm’s overall management

system and, as such, associated issues such as motivation and the psychology of the

workers cannot be ignored. It is important that when standards are set the workers

likely to be affected are involved in the standard setting process. For example, in an

organisation producing wooden stools it would be important to involve the fitters

and woodworkers in determining normal production levels, types of problems faced

in timber selection and quality, as well as problems with resins, stains, etc. By

involving the workers, management can better put together a realistic standard that

also has the understanding and support of the workers. A ready course for

obtaining worker dissatisfaction and disloyalty is for management to unilaterally

impose standards which bear little relation to the reality of the workplace.

When standards are put in place the inevitable favourable or unfavourable variances

will result in the supervisor attempting to sort out what went ‘wrong’ and discussing

this with the workers. It is therefore critical that the workers have confidence in

both the system and the information given to them. Thus, standards are seen as a

way to achieve efficient and harmonious operations in a business. It cannot be

stressed too much that the standards:

- must be attainable (at least occasionally),

- must be fair, and



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- yet they must involve high achievement if they are to be met.

Standards are based on a number of specific pieces of information and as these

elements change, it is essential that the standard itself is updated. All too often

firms do not update the standards frequently enough, the standards become out of

date and people then lose confidence in the system. Price changes can easily and

quickly be adjusted for, as can labour rate changes. Questions of productivity and

labour efficiency as well as material usage will change over time depending on

many factors such as the performance of workers and their learning curves, format

of the factory floor and the use of different sorts of machines. Thus, it is critical

that the standard be monitored and changes incorporated.

The implementation of a standard costing system will result in favourable and

unfavourable variances. It is important that both favourable and unfavourablevariances that are material (important) are investigated by management. Often a

favourable variance in one area may be associated with an unfavourable variance in

another. For example, a discount purchase of timber might lead to a significant

favourable price variance. However, the timber may be of a poorer quality than

usual or not in the normal lengths leading to both an unfavourable material usage

variance as well as an unfavourable labour efficiency variance. Thus, when

working in the area of standard costing and variances it is critical that management

be aware of the interactions between the different variances and view the production

process from an overall perspective, as an integrated whole.

Although there will always be a variance from the standard, the minor or immaterial

variances should be treated as such and virtually ignored. Only when a major variance takes place, or a trend is perceived, should corrective action be initiated. It

costs money to run a standard cost system and therefore the costs of savings through

using the system must be balanced against the cost of running the system itself. In

large organisations threshold levels for intervention would be set based on past

experience and having evaluated the cost of taking action versus not taking action.

These levels or thresholds for intervention can themselves be seen as standards

which should change over time.

Types of StandardsWe will deal with three principal areas of standards, these being material, labour,

and overhead.

Material

Standards

There are two principal areas to be considered. Firstly, the price of the material on

a per unit basis and, secondly, the amount of the material used. The variance

between what the flexible budget expected you to pay for material and what you

actually paid is the price variance. The variance between what you expected to use

per unit of output and what you actually used is the usage variance. These two

variances together make up the materials variance. They are illustrated in Exhibit

11.1. A negative figure indicates an unfavourable (U) variance and a positive figure

indicates a favourable (F) variance.



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Exhibit 11.1

Labour

Standards

These again fall into two elements. The labour rate variance is the difference

between the expected labour rate and the labour rate that is actually paid when

calculated on a total payment basis. The labour efficiency variance is the difference

between the hours expected to complete each unit of output and the actual hours

involved in each unit of output, multiplied by the standard rate. These two

variances combined make the labour variance, as illustrated in Exhibit 11.2. As withmaterials variances, a negative figure indicates an unfavourable (U) variance and a

positive figure indicates a favourable (F) variance.

Exhibit 11.2



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Overhead

Standards

Exhibit 11.3

Overhead costs are generally divided into variable overheads and fixed overheads.

Variable overheads comprise items such as power, heat, lighting and any other

items which generally vary with respect to the level of output. Note that the term

‘generally vary’ is used since the reason such items are classed as variable

overheads (as opposed to being itemised as direct materials) is that it is not cost

effective to itemise them nor to determine the direct relationship between these

variable items and the product output. Thus, variable overheads represent an

approximation to what is actually going on - they are a cost effective approximation

to the reality of the workplace.

The variable overheads are related to the units produced via a common

denominator. This denominator should vary as closely as possible with fluctuations

in the overhead costs themselves, in order that as representative a measure as possible of the efficiency of production with respect to variable overheads may be

obtained. Direct labour hours are commonly used as a basis for the allocation of

variable overhead costs since typically, variable overheads such as lighting and

power will vary according to the number of direct hours employed. Although this is

obviously a generalisation, it is sustained by the argument that it fairly approximates

the real world and it is not cost effective to use a more direct relationship. In some

circumstances, machine hours might be a better basis for allocating variable

overheads, but this is not commonly the case.

Variable overheads are examined under two categories in a similar manner to direct

materials and direct labour, these being a spending variance based on the difference

between the actual costs incurred and the standard costs of variable overheads based on the actual hours (labour or machine whichever is the case), and, an

efficiency variance, the difference between the standard variable costs based on the

actual hours and the standard variable costs based on the standard hours.

These can be shown as follows:



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Exhibit 11.4

Fixed overheads include items such as rent and rates as well as supervisorysalaries. These can also be analysed under a two part format as above, but the fixed

overhead analysis is on a slightly different basis. This is best shown

diagrammatically, as in Exhibit 11.4.

The left-hand item (A) is the actual fixed overhead cost incurred. In other words,

the actual amount the firm paid to the suppliers of overhead services. The centre

amount (B) is the budgeted expenditure on fixed overhead costs which will of

course be the same under a fixed and variable budgeting system. The fixed

overheads should not change as long as there are only modest changes in output.

Note that when output becomes severely different from that which was budgeted,

there is likely to be a difference between the flexible budget for fixed overhead and

the fixed budget. (Remember that the determination of fixed and variable items is

virtually never ‘black and white’ and is always to some extent a mixed item.) Thus,

for these fixed costs it is held that, in the main, they closely approximate thecharacteristics of a fixed item. However, we are not saying that for every

conceivable level of output they are fixed (refer to the relevant range). The third

element of the calculation of the fixed overhead variance (C), is the actual fixed

overhead allocated. This is based on the actual units of output multiplied by the

standard rate. Since lower and middle management will often have no control over

fixed overheads, the volume variance should not normally be used for control

purposes.

These various elements of standard costing are demonstrated in the following

example of the Pine Chair Company.



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Illustration: The Pine Chair CompanyThe Pine Chair Company manufactures pine furniture, specialising in the high

quality chair and furniture market. Their trademark is furniture with a natural finish

using high quality timber made by highly skilled artisans. The Pine Chair Company

has recently been successful in tendering for a large volume of stools for a new

hotel. The order has been completed and delivered and the client was particularly

pleased with the product. As a result, there is the likelihood of several further

orders for the Pine Chair Company. Although the company management is pleased,

they are also concerned that the job does not appear to have been as profitable as

was initially expected. Before quoting on these subsequent orders, management

wants an in-depth analysis of the variances.

The following data were obtained from the records of the Pine Chair Company and

pertain to the 200 stool hotel order.

Materials purchased and used 1,050 metres @ $2.10 per metre

Direct labour 108 hours @ $7.50 per hour

Overhead incurred $2,350 of which $950 was fixed

The standards per stools were initially based on an expected order of 180 stools.

During production the client requested a further 20 stools:

Direct materials 4.8 metres @ $2 per metre

Direct labour 0.5 hours @ $7.80 per hour

Variable overheads $7.50 per labour hour

Fixed overheads $1,000

Materials Variance

Actual Materials Actual Materials Standard Materials

Used at Used at to achieve Actual Output

Actual Cost Standard Cost at Standard Cost

1,050 x 2.10 1,050 x 2 200 x 4.8 x 2

= 2,205 2,100 1,920

Price Variance Usage Variance

$105 U $180 U

Overall Materials Variance $285 U

This means that the materials cost more than was expected ($105) and that more

inventory was used in production than expected ($180).

These two unfavourable factors resulted in an overall unfavourable materials

variance of $285.



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Labour VarianceActual Labour Actual Labour Standard Labour

Hours Worked Hours Worked Hours for Actual Output

at at at

Actual Labour Standard Labour Standard Labour

Hour Rate Hour Rate Hour Rate

108 x 7.50 108 x 7.80 200 x 0.5 x 7.80

= 810.08 42.40 780.0

Labour Rate Variance Labour Efficiency Variance

$32.40 F $62.40 U

Overall Labour Variance $30 U

This indicates a favourable labour rate variance (possibly caused by anticipating a

higher wage settlement than took place) combined with an unfavourable efficiency

variance.

Overall, there is an unfavourable labour variance of $30.

Variable Overhead Variance

Actual Variable Flexible Budget Variable Overhead Applied

Overhead Costs Variable Overhead (Flexible Budget Overhead

Incurred Rate Rateon the on the

Actual Hours Standard Hours)

1,400 7.50 x 108 7.50 x 200 x 0.5

= 1,400 810 750

Spending Variance Efficiency Variance

$590 U $60 U

Variable Overhead Variance $650 U

There has clearly been a problem in the variable overhead spending variance. $590

is a significant amount when compared with the total applied figure of $750, an

overrun of 79%. Several factors could explain this, such as a coding error, a change

in tariffs or duties, air freight costs to avoid stock-outs or simply a mistake in the

purchasing department. The unfavourable efficiency variance ($60) is a direct

result of the excess labour hours used in producing the stools.



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Fixed Overhead VarianceFixed Overhead Budgeted Fixed Overhead

Costs Incurred Fixed Overhead Applied

200 x 5.55

= 950 1,000 1,111

Fixed Overhead Fixed Overhead

Budget Variance Volume Variance

$50 F $111 F

Fixed Overhead Variance $161 F

The spending variance is the difference between the incurred or actual expenditureand the budgeted overhead figure. The volume variance is the difference between

the budgeted figure and what is actually applied to jobs, in this case making the

over application $111, this being due to the extra 20 stools being produced. The

$5.55 is derived from the budgeted fixed overheads of $1,000 divided by the

expected output of 180 stools or $5.55 per stool. The application rate is then

multiplied by 200 stools, this being the actual output. This highlights how the

volume variance of $111, which is a direct recovery from the client arising from

extra volume of sales beyond that budgeted, is achieved.

Thus, the favourable volume variance and favourable spending variance combined

give the total fixed overhead variance of $161 favourable.

In making further bids for supplying stools, management must consider the

following points:

1. Whether the standard for materials should be changed, as both price and usage

were unfavourable.

2. Whether there are likely to be any wage rate changes that will affect the costs if

the contract were won.

3. What caused the ‘blow-out’ in variable overhead spending as this could put

future jobs in jeopardy.

4. To what extent the firm will gain efficiencies, firstly by moving down itslearning curve, and secondly on bulk purchase of materials (depending on the

size of future contracts).

5. Any other factors that are relevant.

When Purchases Do Not Equal ConsumptionUp until now we have assumed that the raw materials purchased are used in the

production for a particular order. However, this is seldom the case and generally

there is an inventory question to be addressed. The principal element here is to

what function should the price variance be allocated, for instance, on excess



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inventory? It is normal practice for the purchasing decision to be consideredseparate from the production or usage decision. Thus, if a firm buys 50% more

inventory than it needs for a particular job then any price variance on the purchase

of that inventory should in total be recorded as a price variance at that time and

whether favourable or unfavourable should be recorded in the accounts of the firm.

In other words, the decision to purchase those goods, whether a good or bad

decision, should be recorded as such, separate from the use to which some of those

inventory items may be put.

Concomitant with this, the materials usage variance is calculated solely on the

materials used and the materials that should have been used (the standard). This

implies that the previous two elements of the materials standard that were brought

together for a total variance on materials cannot now legitimately be summed,

because the two elements are measuring different levels of materials. One is

inventory purchased and the other inventory used. These should be handled as

shown below.

Example of

Excess

Purchase of

Materials

Inventory

If in the Pine Chair Company illustration, the company had purchased a larger

amount of inventory than was necessary for the initial job (perhaps in anticipation

of follow-up orders) then this would be handled as follows:

Purchase of inventory 2,000 metres @ $2.10 per metre

Standards remain the same:

Direct Materials 4.8 metres @ $2 per metre

Materials Variance

Actual Materials Purchased Actual Materials Purchased

at Actual Cost at Standard Cost

2,000 @ 2.10 2,000 @ 2.0

= 4,200 4,000

Price Variance $200 U

Actual Materials Used Standard Materials to achieve

at Standard Cost actual output at Standard Cost

1,050 @ 2.0 200 x 4.8 x 2

= 2,100 1,920

Usage Variance 180 U



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Summary of VariancesThe analysis of variances via the use of standard measures may be

summarised as follows:

Direct Materials

Direct Labour



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Variable Overhead

Fixed Overhead

SummaryThe use of standards to evaluate the efficiency of production, whether it be of

material items or service goods, is becoming increasingly widespread and a

commonly accepted practice in business. It is important that standard costing be

seen as an integrated part of the management process with the involvement of staff

in the planning and control process; in other words, an integral component of the

business itself. If used sensitively, with explanation and feedback, a standard

costing system can pay dividends far beyond the mere tracking of efficiency in the

business. However, if a standard cost system is treated as a mechanistic tool by

management with little thought of the consequences on the motivation and



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behaviour of the staff then it is likely to have quite significant negative impacts onthe feeling of staff towards management and the business, and hence on output and

productivity.

Finally, it should be said that standard costing is a relatively straightforward tool

when viewed from a theoretic or conceptual point of view. However, in practice,

the successful continuing usage of standard costing in a business requires sensitivity

and empathy on the part of those instigating and running the system.

Glossary of

Key Terms

Flexible Budget

A budget that changes with respect to volume changes and typically includes both

fixed and variable costs.

Standard Cost

A measure of performance that is efficient and attainable.

Variance

The difference between attained performance and standard performance.

Commonly evaluated in the areas of Material, Labour, Variable Overhead and

Fixed Overhead.

SelectedReadings

Chatham, C., ‘Updating Standard Cost Systems’, Journal of Accountancy,December 1990.

Foster, G. and Horngren, C.T, ‘JIT: Cost Accounting and Cost Management

Issues’, Management Accounting , June 1987.

Hayde, D., ‘Activity Based Costing - Putting Relevance Back into Cost

Accounting’, Accountants Journal , March 1991.

Howell, R.A., and Soucy, S.R., ‘Cost Accounting in the New Manufacturing

Environment’, Management Accounting , August 1987.

Kaplan, R.S., ‘Yesterday’s Accounting Undermines Production’, Harvard Business

Review, July-August 1984.

Linnegar, G., ‘An Investigation into the Management of Change in Cost Accounting

Information System Requirements during the Transition from Traditional

Manufacture to JIT Concepts’, Ann Arbor, Michigan University Mictrofilms

International, 1988.

Woods, M.D., ‘How We Changed our Accounting’, Management Accounting ,

February 1989.



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Questions

11.1

What is a variance? Distinguish between favourable and unfavourable variances.

11.2

Distinguish between a materials price variance and a materials usage variance.

11.3

Mark’s Manufacturing Company produces hand-made leather briefcases. Given below is information

relating to the production of briefcases:

Expected production for July 200 briefcases

Standard direct labour hours per briefcase 2 hrs

Standard rate for direct labour $9 per hour

Standard cost for one piece of leather $30

Standard allowance per briefcase 2 pieces of leather

Actual Results for July:

250 briefcases produced

Labour cost $5,200 for 600 hrsLeather used 420 pieces

Cost of leather used $13,650

Required:

a. Compute the raw materials price and usage variances.

b. Compute direct labour rate and efficiency variances.

c. What can you learn from the variances you have calculated?

d. What are the budget allowances for direct materials and direct labour? What would the

allowances be if production were 180 units?

11.4Distinguish between three different types of standards.

11.5

Why is a comparison of actual costs with standard costs more meaningful than a comparison of actual

costs with past data?

11.6

After analysing the actual and standard cost figures relating to raw materials, you discover an

unfavourable materials usage variance. What are the possible causes and what action would you take?



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11.7

What are the possible causes of an unfavourable labour rate variance?

11.8

At Fetch & Carry Company, budgeted production for September is 20,000 units. Records show that

the standard allowance for production of one unit is two direct labour hours. Variable overhead can

be broken down as follows:

Expected Cost

per DLH

Indirect labour .80Maintenance .10

Lubricants .05

Electricity .07

1.02

Results for September are as follows:

Units produced 20,000

Direct labour hours 42,000

Variable overhead costs incurred:

Indirect labour 32,000

Maintenance 5,000

Lubricants 3,000Electricity 2,500

42,500

Required:

Prepare a report detailing the overall budget variance, the spending variance and the efficiency

variance.

11.9

Fred’s Furniture Company uses standard costs for budgeting, based on an activity level of 800 direct

labour hours per month. The standard costs for one bookcase are shown below.

Direct materials 4 metres @ $7.50 30.00Direct labour 2 hours @ $10.00 20.00

Variable overhead 2 hours @ $2.50 5.00

Fixed overhead 2 hours @ $1.75 3.50

$58.50

In March 500 bookcases were constructed. Costs for March are shown below.

Direct materials 1,800 metres @ $7.75 13,950

Direct labour 1,250 hours @ $9.80 12,250

Variable overhead 3,200

Fixed overhead 2,500

$31,900



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Required:a. Calculate the materials price and usage variances.

b. Calculate the labour rate and efficiency variances.

c. Calculate the variable overhead variances.

d. Calculate the fixed overhead variances.

11.10

What determines whether an item of materials is included as direct materials or as a component of

overhead?

11.11

Mark Company budgets variable overhead based on direct labour hours. An analysis of overhead

variances reveals an unfavourable variable overhead efficiency variance. What does this mean?

11.12

Which of the following is not a possible cause of an unfavourable variable overhead spending

variance?

a. Price changes in variable overhead items.

b. Poor budget estimates for individual overhead items.

c. Inefficiency in the use of a particular overhead item.

d. Individual overhead items that do not vary closely with the particular base that has been chosen to

budget variable overhead.e. None of the above - all are possible causes of an unfavourable variable overhead spending

variance.

11.13

Match the following terms and definitions:

a. High-low method

b. Visual fit

c. Mixed costs

d. Committed fixed costs

e. Discretionary fixed costs

f. Flexible budget

g. Efficiency variance

1. Costs that have both fixed and variable components.

2. The difference between the flexible budget based on the actual number of inputs and the flexible

budget based on the standard inputs allowed for the outputs achieved.

3. Choosing two cost points and then fitting a straight line between them to determine the fixed and

variable portions of total costs.

4. Costs that are the result of top management policies.

5. A formula used to relate total costs to activity at any level of activity within the relevant range.

6. A method of determining fixed and variable portions of total cost by fitting a straight line to a

series of cost points on a scatter diagram.

7. Fixed costs that are associated with providing a basic organisation to enable business activity to

continue.



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11.14Henderson Company produces door handles. Scheduled production for February was 3,000 handles

using 1,800 hours of direct labour. Actual production figures show that 3,600 handles were produced

in February using 1,950 hours of direct labour. The variable overhead items are shown below:

Standard Cost Costs

per DLH Incurred

Repairs .50 860

Supervision .30 595

Cleaning .35 630

Power 1.37 2,850

Freight .85 1,700

$3.37 $6,635

What is the variable overhead efficiency variance for repairs?

a. $40 favourable

b. $115 favourable

c. $115 unfavourable

d. $75 unfavourable

e. $75 favourable

f. none of the above

11.15

Refer to Question 11.14. What is the variable overhead spending variance for freight?a. $42 favourable

b. $42 unfavourable

c. $170 unfavourable

d. $128 unfavourable

e. $128 favourable

11.16

Refer to Question 11.14. Which of the following is not a possible cause of an unfavourable efficiency

variance for freight?

a. An increase in the cost of petrol.

b. Freight may not be closely related to the number of direct labour hours worked.c. Inefficiency in the use of direct labour.

d. Poor estimates of the number of direct labour hours necessary to produce one door handle.

e. All of the above are possible causes of an unfavourable efficiency variance.

11.17

How is a fixed overhead application rate determined? What are the problems associated with

determining a fixed overhead application rate?



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11.18The management accountant has determined that Astral Company had an unfavourable volume

(denominator) variance for June. What does this indicate?

11.19

Carl Company budgeted the following overhead costs for August 1991:

Variable Overhead:

Indirect labour $50,000

Indirect materials $26,000

Fixed Overhead:

Electricity $3,000

Depreciation $53,000

Administrative Expenses $70,000

Expected production for August was 10,000 units. Both variable and fixed overhead are applied on

the basis of direct labour hours and expected direct labour hours for August were 20,000.

Actual production for August was 8,000 units and 17,000 direct labour hours were worked. Actual

costs for August were as follows:

Indirect labour $49,300

Indirect materials $24,000

Electricity $2,800Depreciation $53,000

Administrative expenses $72,000

Required:

a. Calculate the overhead application rates for variable and fixed overhead.

b. Calculate all overhead variances and prepare a report to the factory manager detailing your

findings.

11.20

Peter Piper operates a small business making hand-made skis. The nature of the business means that

large seasonal fluctuations are experienced. Budgeted overhead is $50,000 per month plus $5.60 per

direct labour hour (based on a denominator level of activity of 90 pairs of skis). Standard costs

provide for 4 direct labour hours per pair of skis at a cost of $11.50 per hour. During June 80 pairs of

skis were made which required 340 direct labour hours at a total labour cost of $3,800. Actual fixed

overhead for June was $45,000 and variable overhead was $1,900.

Required:

Calculate and comment on the following variances:

a. Variable overhead efficiency variance

b. Variable overhead spending variance

c. Labour efficiency variance

d. Fixed overhead volume/denominator variance

e. Fixed overhead spending (budget) variance



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11.21The management accountant of a manufacturing concern has calculated the following variances:

Labour rate variance $800 favourable

Labour efficiency variance $1,000 unfavourable

Materials price variance $380 unfavourable

Materials usage variance $500 favourable

Fixed overhead denominator variance $3,000 unfavourable

Fixed overhead spending (budget) variance $220 favourable

Variable overhead efficiency variance $390 unfavourable

Variable overhead spending variance $500 unfavourable

Required:

a. Explain each of the variances. b. Suggest possible causes of the variances.

11.22

What is a variable overhead efficiency variance and how does it arise?

11.23

The manufacturing department of Arco Industries produced 15,000 units of produce in June, using18,000 hours of direct labour. Variable overhead is applied on the basis of direct labour hours, with

one direct labour hour allowed per unit of output. The standard allowance for variable overhead items

and the actual costs incurred in June are as follows:

Budget formula per Actual Costs

standard direct June

labour hour

Indirect labour 2.50 46,000

Maintenance .50 8,750

Electricity 1.10 20,050

Indirect materials 1.00 17,500

Lubricants .60 9,460

$5.70 $101,760

Required:

Prepare a detailed performance report showing variable overhead variances.

Documents

chap11 standard costing