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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 Costing The 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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Financial Management and Decision Making Chapters 11 and 12 should be seen as providing examples of product costing in simplified situations, yet the principles are sound and generalisable as long as they are applied with care and thought to fit the actual production environment.
Introduction Earlier 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 principles of 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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as whether they should in fact be doing the jobs that they are doing. This has led to a 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 Organisation The 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 unfavourable variances 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 Standards We 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
Exhibit 11.2
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 with materials variances, a negative figure indicates an unfavourable (U) variance and a positive figure indicates a favourable (F) variance.
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Overhead Standards
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:
Exhibit 11.3
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Fixed overheads include items such as rent and rates as well as supervisory salaries. 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.
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 the characteristics 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 Company The 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 Direct labour Overhead incurred
1,050 metres @ $2.10 per metre 108 hours @ $7.50 per hour $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 Direct labour Variable overheads Fixed overheads
4.8 metres @ $2 per metre 0.5 hours @ $7.80 per hour $7.50 per labour hour $1,000
Materials Variance Actual Materials Used at Actual Cost
Actual Materials Used at Standard Cost
Standard Materials to achieve Actual Output at Standard Cost
1,050 x 2.10 = 2,205
1,050 x 2 2,100
200 x 4.8 x 2 1,920
Price Variance $105 U
Usage Variance $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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Chapter 11: Standard Costing Labour Variance Actual Labour Hours Worked at Actual Labour Hour Rate
Actual Labour Hours Worked at Standard Labour Hour Rate
Standard Labour Hours for Actual Output at Standard Labour Hour Rate
108 x 7.50 = 810.08
108 x 7.80 42.40
200 x 0.5 x 7.80 780.0
Labour Rate Variance $32.40 F
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Labour Efficiency Variance $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 Overhead Costs Variable Overhead Incurred Rate on the Actual Hours
Variable Overhead Applied (Flexible Budget Overhead Rate on the Standard Hours)
1,400 = 1,400
7.50 x 200 x 0.5 750
7.50 x 108 810 Spending Variance $590 U
Efficiency Variance $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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Financial Management and Decision Making Fixed Overhead Variance Fixed Overhead Budgeted Costs Incurred Fixed Overhead
Fixed Overhead Applied
= 950
200 x 5.55 1,111
1,000 Fixed Overhead Budget Variance $50 F
Fixed Overhead Volume Variance $111 F
Fixed Overhead Variance $161 F The spending variance is the difference between the incurred or actual expenditure and 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 its learning 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 Consumption Up 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 considered separate 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 Standards remain the same: Direct Materials Materials Variance Actual Materials Purchased at Actual Cost 2,000 @ 2.10 = 4,200
2,000 metres @ $2.10 per metre 4.8 metres @ $2 per metre
Actual Materials Purchased at Standard Cost 2,000 @ 2.0 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 Variances The 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
Summary The 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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Financial Management and Decision Making behaviour of the staff then it is likely to have quite significant negative impacts on the 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.
Selected Readings
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 Standard direct labour hours per briefcase Standard rate for direct labour Standard cost for one piece of leather Standard allowance per briefcase Actual Results for July: 250 briefcases produced Labour cost Leather used Cost of leather used
200 briefcases 2 hrs $9 per hour $30 2 pieces of leather
$5,200 for 600 hrs 420 pieces $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? allowances be if production were 180 units?
What would the
11.4 Distinguish 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:
Indirect labour Maintenance Lubricants Electricity Results for September are as follows: Units produced Direct labour hours Variable overhead costs incurred: Indirect labour Maintenance Lubricants Electricity
Expected Cost per DLH .80 .10 .05 .07 1.02 20,000 42,000
32,000 5,000 3,000 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 Direct labour Variable overhead Fixed overhead
4 metres @ $7.50 2 hours @ $10.00 2 hours @ $2.50 2 hours @ $1.75
30.00 20.00 5.00 3.50 $58.50
In March 500 bookcases were constructed. Costs for March are shown below. Direct materials Direct labour Variable overhead Fixed overhead
1,800 metres @ $7.75 1,250 hours @ $9.80
13,950 12,250 3,200 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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11.14 Henderson 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:
Repairs Supervision Cleaning Power Freight
Standard Cost per DLH .50 .30 .35 1.37 .85 $3.37
Costs Incurred 860 595 630 2,850 1,700 $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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11.18 The 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 Indirect materials Fixed Overhead: Electricity Depreciation Administrative Expenses
$50,000 $26,000 $3,000 $53,000 $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 Indirect materials Electricity Depreciation Administrative expenses
$49,300 $24,000 $2,800 $53,000 $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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11.21 The management accountant of a manufacturing concern has calculated the following variances: Labour rate variance Labour efficiency variance Materials price variance Materials usage variance Fixed overhead denominator variance Fixed overhead spending (budget) variance Variable overhead efficiency variance Variable overhead spending variance
$800 favourable $1,000 unfavourable $380 unfavourable $500 favourable $3,000 unfavourable $220 favourable $390 unfavourable $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, using 18,000 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:
Indirect labour Maintenance Electricity Indirect materials Lubricants
Budget formula per standard direct labour hour 2.50 .50 1.10 1.00 .60 $5.70
Actual Costs June
Required: Prepare a detailed performance report showing variable overhead variances.
46,000 8,750 20,050 17,500 9,460 $101,760
