Standard Costs and Variance Analysis Principles of Managerial Accounting

Inefficient use of the cost driver used to apply variable manufacturing overhead typically results in additional overhead costs. The completed top section of the template contains all the numbers needed to compute the direct labor efficiency (quantity) and direct labor rate (price) variances. The direct labor efficiency and rate variances are used to determine if the overall direct labor variance is an efficiency issue, rate issue, or both. Job order costing requires the assignment of direct materials, direct labor, and overhead to each production unit.

• Using the standard and actual data given for Lastlock and the direct labor variance template, compute the direct labor variances.
• Although the new fabricator was less experienced, her pay rate per hour was lower.
• As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things.
• Fortunately, the accounting system keeps track of the manufacturing overhead, which is then applied to each individual job in the overhead allocation process.

Video Illustration 8-3: Computing direct labor variances

These two factors are accounted for by isolating two variances for materials—a price variance and a usage variance. While many types of production processes could be demonstrated, let’s consider an example in which a contractor is building a home for a client. The accounting system will track direct materials, such as lumber, and direct labor, such as the wages paid to the carpenters constructing the home. Along with these direct materials and labor, the project will incur manufacturing overhead costs, such as indirect materials, indirect labor, and other miscellaneous overhead costs. To illustrate standard costs variance analysis for direct labor, refer to the data for NoTuggins in Exhibit 8-1 above.

Indirect Labor

The requisition is recorded on the job cost sheet along with the cost of the materials transferred. The costs assigned to job MAC001 are $300 in vinyl, $100 in black ink, $60 in red ink, and $60 in gold ink. During the finishing stages, $120 in grommets and $60 in wood are requisitioned and put into work in process inventory. The costs are tracked from the materials requisition form to the work in process inventory and noted specifically as part of Job MAC001 on the preceding job order cost sheet. The same calculation is shown using the outcomes of the direct materials price and quantity variances. Using the standard and actual data given for Lastlock and the direct labor variance template, compute the direct labor variances.

Total Direct Materials Cost Variance

At the end of the current operating cycle, Brad determined that the actual variable manufacturing costs incurred to produce 150,000 units of NoTuggins were $181,500 more than the standard costs projected. A summary of the direct materials, direct labor, and variable manufacturing overhead variances is provided in Exhibit 8-12. This standard costs variance analysis report is the starting point for further investigation and corrective action if appropriate.

The direct material standards for one unit of NoTuggins are 4.2 feet of flat nylon cord that costs $0.50 per foot for a total direct material cost per unit of $2.10. During the period, 600,000 feet of flat nylon cord costing $330,000 were purchased and used. In order to set an appropriate sales price for a product, companies need to know how much it costs to produce an item. Just as a company provides financial statement information to external stakeholders for decision-making, they must provide costing information to internal managerial decision makers. To account for these and inform managers making decisions, the costs are tracked in a cost accounting system.

Examples of typical overhead costs are production facility electricity, warehouse rent, and depreciation of equipment. The actual quantity used can differ from the standard quantity because of improved efficiencies in production, carelessness or inefficiencies in production, actual quantity is the actual direct material or direct labor used to manufacture the or poor estimation when creating the standard usage. Since both the rate and efficiency variances are unfavorable, we would add them together to get the TOTAL labor variance. If we had one favorable and one unfavorable variance, we would subtract the numbers.

Variable manufacturing overhead costs are applied to the product based on direct labor hours. The standard variable manufacturing overhead rate is $3 per direct labor hour. Each unit should require 0.25 direct labor hours for total variable manufacturing overhead costs per unit of $0.75. It is important to note that cost standards are established before the work is started.

If, however, the actual quantity of materials used is greater than the standard quantity used at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more materials than anticipated to make the actual number of production units. With either of these formulas, the actual quantity used refers to the actual amount of materials used at the actual production output. The standard quantity is the expected amount of materials used at the actual production output. If there is no difference between the actual quantity used and the standard quantity, the outcome will be zero, and no variance exists.

Refer to the total variable manufacturing overhead variance in the top section of the template. The standard variable manufacturing overhead rate per direct labor hour was established as $3. Total variable manufacturing overhead costs per the standard amounts allowed are calculated as the total standard quantity of 37,500 times the standard rate per hour of $3 equals $112,500. During the period, Brad projected he should pay $112,500 for variable manufacturing overhead to produce 150,000 units. Once the top section is complete, the amounts from the top section can be plugged into the formulas to compute the variable manufacturing overhead efficiency (quantity) and rate (price) variances.

Each of these variances are discussed in detail in the following sections. The standard materials cost of any product is simply the standard quantity of materials that should be used multiplied by the standard price that should be paid for those materials. Actual costs may differ from standard costs for materials because the price paid for the materials and/or the quantity of materials used varied from the standard amounts management had set.