Management Accounting Fundamentals [MA1]

Module 7: Standard costs for materials, labour,

and variable overhead
Required reading

Chapter 10, pages 434-471

Overview

The focus of this module is standard cost analysis, a technique used by management to monitor and control
the input costs and quantities of materials, labour, and variable overhead. After the initial definition of terms,
the required textbook reading presents the concepts and computations related to standard costs for each of
these inputs. A general model of variance analysis is developed and examples provided. Computer
illustration 7-1 shows you how to use a spreadsheet program to do an analysis of direct material variances.

Learning objectives

7.1 Explain the term management by exception and how it relates to standard costs. (Level 2)

7.2 Explain how direct materials standards and direct labour standards are set.(Level 1)

7.3 Compute the following variances and explain their significance: (Level 1)

direct materials price and quantity variances

mix and yield variances

direct labour rate and efficiency variances

variable overhead spending and efficiency variances

7.4 Prepare journal entries to record standard costs and variances. (Level 2)

7.5 Explain how managers would determine whether a variance constituted an "exception" that would
require their attention. (Level 2)

7.6 List the advantages and disadvantages of using standard costs.(Level 1)

7.7 List some operating performance measures and explain how they are used. (Level 1)

7.8 Compute the delivery cycle time, the throughput time, and the manufacturing cycle efficiency.
(Level 1)

7.9 Construct a worksheet to calculate the various components of the material variance. (Level 2)

Module 7: Standard costs for materials, labour, and variable overhead - Content Links

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Required reading

Chapter 10, pages 434-471

7.1 Standard costs — Management by exception

LEVEL 2

In all illustrations of this topic, two standard amounts are specified, even though one may be used without
the other in practice. Thus, you are dealing with usage standards (for example, unit time for labour or
quantity per production unit for material) and the associated cost standards (for example, labour rate per
hour or material price per kilogram). The standard total cost for production during a period is simply
production multiplied by standard usage multiplied by standard cost. For example, the standard total cost for
raw materials in a given situation might be 3,000 units of production multiplied by 2 kilograms per unit
multiplied by $4 per kilogram, equalling $24,000 for the standard total cost of the raw materials.

Note that the term management by exception relates to standard costs and variance analysis.

A wide range of businesses and various types of organizations use standard costs. The organization must
have some capacity to forecast requirements, and there must be enough stability in the operation to justify
the prediction being made. Without stability, standard costs can easily become irrelevant for management
and accounting purposes.

7.2 Setting standard costs

LEVEL 1

Setting standards is difficult. First, it is necessary to define the nature of the standard desired: ideal or
practical. Ideal standards are sometimes used for management planning purposes such as evaluating present
operations or assessing the potential of the competition. Practical standards are used for normal situations,
and they are generally the standards referred to in this module. Practical standards provide reasonable costs
for inventory valuation; they are suitable for control and some planning decisions. The textbook reading
deals with material, labour, and variable overhead standards, in that order.

Direct material standards

These standards are specified on a bill of materials. This information is usually presented to the accountant
by design or production staff. For practical standards, the amounts contain an allowance for normal waste
and rejects.

Direct labour standards

Standard hours are the most difficult standard to set. Sometimes industrial engineers can determine the

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standard hours by time and motion studies or work study investigations. Motivation and labour relations
issues arise here. For office workers, the standard time is often determined by work sampling techniques.

The labour rate can include fringe benefits costs, if these are treated as direct labour rather than overhead.
Review Chapter 2 for an elaboration on this point. In practice, because wage rates are often set by the labour
contract, the actual rate per hour could be used.

Variable overhead standards

The concept of a predetermined overhead rate was introduced in Module 2 and is briefly explained on pages
95-96 of the textbook. The predetermined overhead rate for variable overhead represents the standard. Notice
that to become a standard cost per unit, the variable overhead rate has to be multiplied by the activity base
per production unit. In some textbook examples, this multiplication has already been done, in which case it is
called the standard variable overhead per unit of inventory (technically, per production unit).

7.3 A general model for variance analysis

LEVEL 1

Variance calculations are an important part of this module. It is important to note the timing of the material
variance calculation and the order of calculation of price and quantity variances.

The complex part of the calculation is the standard quantity allowed for the actual output produced. The
difference between the actual output and the planned (or predicted) output is made by using actual
production, specified in units, multiplied by the standard quantity per production unit. Actual production is
always measured in FIFO equivalent units. Refer to Chapter 4 of the textbook, if necessary, for a review of
this calculation. In a standard process costing system, the equivalent units are also measured using the FIFO
method. That is, the standard quantities for materials, labour, and overhead are based on the related number
of equivalent units.

Example 7-1 is based on Exercise 10-5.

Example 7-1

The following activity was recorded during the most recent month:

a. Twenty litres of material were purchased at a cost of $2.40 per millilitre (mL). (There are 1,000 mLs in
a litre.)

b. All of the material purchased was used to produce 2,500 bottles of the perfume Whim.

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c. 900 hours of direct labour time were recorded at a total labour cost of $10,800.

Required

1. Compute the direct materials price and quantity variances for the month.

2. Compute the direct labour rate and efficiency variances for the month.

To calculate the direct materials price and quantity variances for the month, you can use either the general
variance model or the equations. You will look first at the model and then at the equations.

Part a

i) General variance model graphically

ii) Unfactored equations

Using the equations, you need to solve for [(AQ x AP) – (AQ x SP)], the materials price variance, and for
[(AQ x SP) – (SQ x SP)], the materials quantity variance, as follows:

iii) Factored equation

As demonstrated in the textbook, these formulas can be further reduced as follows:

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Regardless of which approach you use, the answer is the same. The total material variance is $3,000
unfavourable. This is made up of a $2,000 favourable price variance and a $5,000 unfavourable quantity
variance. It is hard to determine the cause of a total variance without the individual components of the
variance. Taking appropriate management action depends on the details.

To continue with this exercise, look at the labour variances. The components of a labour variance are the
labour rate (or price) variance and the efficiency variance. Begin with the more graphic general variance
model and then calculate the variances using the equations.

Part b

i) General variance model graphically

ii) Unfactored equations

Using the equations, you need to solve for [(AH x AR) – (AH x SR)], the labour rate variance, and for [(AH
x SR) – (SH x SR)], the labour efficiency variance, as follows:

iii) Factored equation

As demonstrated in the textbook, these formulas can be further reduced as follows:

Each of these approaches to the variance analysis gives the same result, but you may find one approach

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easier to work with than the others. In the factored equation approach, there are only two computations,
whereas there are four computations in the unfactored equation approach and three in the general variance
model. To see the difference, review the calculation of the materials variances in each approach. In the
unfactored equation approach, (AQ x SP) is calculated twice — once for the price variance and once for the
quantity variance. In the general variance model, however, this computation is done just once. The general
variance model is set up so that this computation is available to use for both the price and the quantity
variance. In calculating the price variance, (AQ x SP) is the subtrahend — that is, it is subtracted from the
actual quantity at the actual price. In calculating the quantity variance, (AQ x SP) is the minuend — that is,
the standard quantity at the standard price is subtracted from it. The two variances are readily calculated by
computing (AQ x SP) just once. Work with each of these approaches and find one that you prefer.

Activity 7-1 Basic direct materials and direct labour variance analysis

This activity reinforces your understanding of the calculation of material and labour variances.

Part c

Mix and yield variances

To illustrate mix and yield variances, suppose that two materials, A and B, are required to make a product.
Assume their standard unit prices are SPA and SPB, and that the materials can be mixed in different
proportions when producing the product. The following is one popular method for computing mix and yield
variances:

where:

AQA and AQB are the actual quantities of A and B used in production.

SQA and SQB are the standard quantities of A and B for the units produced, using their standard
proportions.

(AQA – SQA) and (AQB – SQB) are the typical material quantity differences (before multiplying
by their respective standard prices) discussed in the text.

MA and MB are the actual total quantity of material used, in the proportions specified by the
standard mix; that is, what should have been used of A and B had the standard mix been
followed for the total quantity of material actually used.

Review the example on pages 448-449, which suggests that material A was overused in the mix of materials
A and B compared to the standard ($45 U). Material B was underused in the mix ($75 F). The shift in

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material mix seems to have caused an increased use of materials A and B, which, in turn, is reflected in the
two unfavourable yield variances.

While the literature contains other specific approaches to calculating mix and yield variances, the method
outlined here is acceptable and the easiest to understand. Because of fluctuations in actual prices for
materials, the actual unit prices for materials may be used in practice, rather than predetermined standard
prices.

7.4 Journal entries to record standard costs and variances

LEVEL 2

Follow through the examples for direct material, direct labour, and variable overhead variances.

Responsibility for the variance may be difficult to assess accurately. Blame has to be very carefully assessed
if organizational and behavioural problems are to be avoided. If a person feels wronged, avoidance and
revenge are very common reactions that have negative implications for the firm.

Appendix 10A details the journal entries to record direct material, direct labour, and variable manufacturing
overhead variances.

7.5 Variance analysis and management by exception

LEVEL 2

The structure of performance reports is described on page 455. Notice how the flow of information in
Exhibit 10-9 reflects the flow up the organizational chart. Also, notice the aggregation of the numbers in the
reports. This aggregation causes information to be lost (a topic addressed in Module 1). It also reduces the
amount of information that must be dealt with by the manager, which is a benefit. This tradeoff is an
important one for systems designers and report users.

What is an exception? In other words, when should a variance be investigated? These questions are difficult
to answer. They are the equivalent of asking in financial accounting: what is a material amount? There is
always a tradeoff between the cost of investigating the variance and the cost of running the system "out of
control." In statistics, the tradeoff question is studied in the topic of Type I and Type II errors in hypothesis
testing.

The statistical control chart (Exhibit 10-10) illustrates the concept of variance. However, on closer
inspection, the obvious problem with the chart is that it represents a small sample. This number of
observations is far too low to construct a meaningful chart. At least 30 to 50 observations are required.
Nevertheless, the idea in the chart about what is normal and what is significant presents a way to explain
significance.

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7.6 Advantages and disadvantages of standard costs

LEVEL 1

The advantages and disadvantages of standard costs are important for systems design work. They help to
determine whether a standard cost system is appropriate.

Many of the problems around using standard costs focus on their design. Care must be taken in the creation
of standard costs to ensure that variance analysis provides meaningful information. The variance analysis
needs to identify controllable issues. It is also essential that the analysis identify the base problem if the
variances can underscore a problem when they have been attained at the expense of quality. Note the caution
about dwelling on the negative aspects of performance.

7.7 Balanced scorecard

LEVEL 1

Increased automation is changing the traditional standard cost variance analysis. In an automated
environment, direct labour is a small component of many processes and the quality of the output is
emphasized. These changes mean that direct labour variances and materials price variances are less relevant
in today’s business environment.
New performance measures are being developed. Study Exhibit 10-12, and notice that many of these new
measures are not measured by financial statement results. Other examples of new performance measures are
repeat business, new customers, number of referrals, and reduction in employee absenteeism.

Quality control measures have always existed in successful companies. The textbook states that the
difference in today’s manufacturing environment is that companies are responding faster to customer
complaints. In fact, many companies that were slow to respond or that ignored customers are not in business
today.

Material control measures have changed because of increased control over the amount of scrap produced.
Scrap is an inevitable result of many processes. Scrap performance measures encourage the reduction and
eventual elimination of scrap. These measures also encourage recycling scrap material in the various
production processes.

You might think that in a JIT system, inventory control measures are unnecessary. In fact, it is the emphasis
on reduction and eventual elimination of inventory that makes these measures important. The inventory
turnover ratio is monitored closely to ensure that this objective is being met.

The lower the inventory, the higher the turnover.

Machine performance measures are another example of non-financial measures. The objective is to derive a
balance between constant production and production of required amounts. Another factor in this measure is
to ensure that the other areas of production (for example, raw materials preparation or finished goods
assembly) are coordinated with machine use.

A goal of flexible manufacturing systems (FMS) is to reduce non-value-added time such as waiting time.

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When non value-added time increases, it may mean that the company has too many machines for the desired
level of output. It may also mean that the other processes need more personnel or machines to speed
production.

Activity 7-2 The Balanced Scorecard

This activity reinforces your understanding of the necessity and importance of nonfinancial measures.

7.8 Other performance measures

LEVEL 1

Delivery performance measures monitor the entire process from receipt of the order to shipment (the
delivery cycle time). Manufacturing cycle efficiency is a measure that deals with the time between initial
handling of the raw materials and the delivery of the finished product (the throughput time). It is the
percentage of the value-added or productive time to the total manufacturing time. The higher the percentage,
the more efficient the process. The company has to be careful that a high percentage does not mean that
goods are being processed too quickly, with insufficient inspection or quality control.

Study the example on pages 466-467. The manufacturing cycle efficiency is 25%. Therefore, this company
has considerable non-value-added time. The throughput time is 8 days. The delivery cycle time is 25 days.
This is a company that needs to examine its customer service and manufacturing processes. The information
indicates that the company may be operating inefficiently and may not be serving its customers quickly
enough.

The performance measures listed in Exhibit 10-12 are also relevant for a nonautomated environment. The
measures are used to monitor excellence in operating efficiency and customer service. These are important
factors for any type of organization.

Online chapter summary

This topic marks the end of the textbook coverage of standard costs and balanced scorecard measures. To
ensure you understand this material and the corresponding terminology, read the summary on page 468,
work through the review problem on pages 468-470, and go to the Online Learning Centre, click Contents,
choose Chapter 10, select Chapter Summary and review the material thoroughly. If you are unclear on how
to access or use this site, refer to the Online Learning Centre (OLC) Guide in the course navigation pane.

7.9 Computer illustration 7-1: Mix and yield variances

LEVEL 2

Chapter 10 of the textbook describes how managers control costs through the use of standard costs and
variance analysis. In controlling costs, three types of standard costs are generally used — direct material
costs, direct labour costs, and variable overhead costs.

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This illustration demonstrates the derivation of standard direct material costs and the analysis of direct
material variances using the extended model Exhibit 10-6.

Material provided

A partially completed worksheet M7P1

A completed solution worksheet M7P1S

Description

This illustration is based on Problem 10-21 (pages 485-486). Read this problem now.

Required

Answer Requirement 1 by completing the worksheet M7P1. Answer Requirement 2 manually.

Procedure

Requirement 1

1. Open the file MA1M7P1.

2. Click the sheet tab M7P1 and study the layout of the worksheet. Rows 5 to 14 contain the data
provided in the problem statement. Rows 16 to 49 contain a template that you will complete by
entering the necessary formulas.

3. Following the extended model given in Exhibit 10-5, enter the required formulas to calculate the price
variance in cells B19 to B21, D19 to D21, and E19 to E21. For example, cell B19 should contain the
actual total material cost of product Alpha. This is found in cell E9. So enter +E9 in this cell. The
formulas in row 22 have been pre-entered for you. Study the formula in cell E22, which uses the IF
function to cross check the price variance calculations.

4. Enter in cell B25 the formula for the total standard amount of litres of input. In other words, given the
standard quantity of materials required to produce one litre of Omega, calculate the total number of
litres of inputs that should have been used to produce 175,000 litres of Omega.

5. Enter the necessary formulas in cells B29 to B31, D29 to D31, and E29 to E31 to calculate the total
usage variance. The usage variance compares the standard cost of the actual quantity of inputs with the
standard cost of the standard quantity of inputs. As an example of the latter, the formula in cell D29
should calculate the proportion of Alpha to total inputs required to produce one litre of Omega (the
standard mix) multiplied by the total standard litres of inputs required to produce 175,000 litres of
Omega (calculated in cell B25). This is the standard usage at standard mix. Multiply the result by the
standard cost per litre for Alpha. This formula can then be copied to cells D30 and D31, assuming you
used the appropriate absolute cell references.

6. Enter in cells B38 to B40 the cell references for the actual quantities and in cells C38 to C40 the
formulas to calculate the actual quantity at the standard mix. In other words, you are comparing the
proportion of each input used in producing 175,000 litres of Omega with the proportion of each input
that should have been used (given the standard).

7. Calculate the yield variance by entering appropriate formulas in row 48. In cell C48, calculate the

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quantity of output that should have been produced given the quantity of inputs used (using the standard
as a base).

8. Save your completed worksheet.

9. Print a copy of the completed worksheet and compare it with the solution worksheet M7P1S.

10. If you do not obtain the same results as in the worksheet M7P1S, print a copy of the formulas from
your worksheet. Compare the formulas you entered with those in the solution worksheet. Correct any
discrepancies.

Conclusion

Note that all variances in brackets reference unfavourable variances. Similarly, all variances that are positive
are favourable variances.

The usage variance is $39,000 Favourable. This usage variance is made up of a favourable mix variance and
an unfavourable yield variance.

The detail of the usage variance gives management better insight into the situation. These variances should
be carefully examined to determine why they occurred. This deviation from the standard mix appears to have
negatively affected the yield variance.

Requirement 2

Labour efficiency variance:

Part of actual labour hours were used to transform the materials that became part of the output yield loss.
That amount is equal to:

1/2 hour × 8,333 litres × $15 = $62,500 U

Therefore, the production foreman is correct in arguing that his workers are operating better than standard.

Audio lectures
Audio lectures are available for this module. System requirements and instructions on how to access the
online lectures are included.

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Module 7 summary
Module 7 paves the way to management control and performance evaluation which require a benchmark for
actual achievements.

Topic 7.1 deals with the need for standards in various activities and introduces the concept of management
by exception. This concept consists of investigating and possibly taking action when the actual results vary
significantly from these standards.

Topic 7.2 discusses the standard setting for the three components of a product cost — direct materials, direct
labour, and variable overhead — and Topic 7.3 proceeds with variance analysis pertaining thereto.

Topic 7.4 elaborates on tracking the cost flows and brings out these variances.

Not all variances require management's attention. Topic 7.5 deals with those variances that are material and
therefore require action while Topic 7.6 evaluates the usage of standard cost.

For control and performance evaluation purposes, Topic 7.7 extends the use of new performance metrics
derived from the balanced scorecard, which include metrics other than cost and financial measures.

Since the advent of dramatic progress in manufacturing system as witnessed by the flexible manufacturing
system, time has become a key factor for success. Topic 7.8 highlights time-based performance indicators.

Finally, Topic 7.9 accounts for direct material mix and yield variances and relates the analysis to
performance evaluation.

Module 7 self-test
Question 1

Multiple choice

a. Which of the following is true about standard costs?

1. They are the actual costs for delivering a product or service under normal conditions.
2. They are predetermined costs for delivering a product or service under normal conditions.
3. They are the actual costs for producing a product under normal conditions.
4. They are predetermined costs for delivering a product or service under normal and abnormal
conditions.

b. Which of the following is true?

1. Standard costs are predetermined rates for materials and labour only.
2. Standard costs are predetermined rates for materials only.
3. Standard costs are based on actual activity at the end of the period.
4. Standard costs are predetermined rates for materials, labour, and overhead.

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c. Which of the following is often the cause of differences between actual and standard costs of materials
and labour?

1. Price changes for materials

2. Excessive labour hours
3. Excessive use of materials
4. All of the above

d. Which of the following can be used to calculate the materials price variance?

1. (AQ – SQ) x SP
2. (AP – SP) x AQ
3. (AP – SP) x SQ
4. (AQ – SQ) x AP

e. Which of the following is the difference between actual and standard cost of material caused by the
actual quantity of material used exceeding the standard quantity of material allowed?

1. Price variance
2. Mix variance
3. Quantity variance
4. Yield variance

f. Which of the following departments is most likely responsible for a price variance in direct materials?

1. Warehousing
2. Receiving
3. Purchasing
4. Production

g. The overhead variance is caused by the difference between which of the following?

1. Actual overhead and standard overhead applied

2. Actual overhead and overhead budgeted at the actual operating level
3. Standard overhead applied and budgeted overhead
4. Budgeted overhead and overhead applied

h. When are the overhead variances recorded in a standard costing system?

1. When the cost of goods sold is recorded

2. When the factory overhead is applied to work-in-process
3. When the goods are transferred out of work-in-process
4. When direct labour is recorded

i. Which of the following is true when recording variances in a standard costing system?

1. All unfavourable variances are debited.

2. Only unfavourable material variances are credited.
3. Only unfavourable material variances are debited.
4. Only unfavourable variances are credited.

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j. Which of the following operating measures would a manager want to see decreasing over time?

1. Merchandise inventory turnover

2. Total quality cost
3. Percentage of on-time deliveries
4. Finished goods inventory turnover

Solution

Question 2

Multiple choice

a. Benson Company makes and sells a single product. Last period the company’s labour rate variance
was $11,690 favourable. During the period, the total actual direct labour cost was $295,590. The
standard labour rate for the product was $9.20 per hour. What was the actual labour rate for the
product in dollars per hour? Round your answer to the nearest whole cent.

1. $ 8.85
2. $ 8.94
3. $ 9.56
4. $ 9.58

b. Parker Inc. uses a standard cost system. The following information pertains to direct labour for product
B for the month of March:

Actual rate paid $14.25 per hour

Standard rate $13.50 per hour
Standard hours allowed for actual production 3,300 hours
Labour efficiency variance $2,700 unfavourable

What were the actual hours worked during March?

1. 3,100
2. 3,111
3. 3,489
4. 3,500

c. Benson Inc. showed actual material usage of 12,500 units at $4.60 for 12,000 units of finished product.
If budgeted materials were 12,000 units at $5 per unit for 12,000 units of finished product, what is the
total direct materials variance?

1. $2,400 favourable
2. $2,400 unfavourable
3. $2,500 favourable
4. $2,500 unfavourable

d. CGA Manufacturing Inc. experienced actual variable overhead of $41,000 for 32,000 units of
production that used 8,500 direct labour hours. If budgeted volume was 36,000 units at 9,000 direct
labour hours, at a standard rate of $5 per direct labour hour, what is the variable overhead efficiency

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and spending variances?

1. $2,000 unfavourable efficiency variance; $1,500 unfavourable spending variance

2. $2,500 favourable efficiency variance; $1,500 unfavourable spending variance
3. $2,500 unfavourable efficiency variance; $2,000 favourable spending variance
4. $2,500 unfavourable efficiency variance; $1,500 favourable spending variance

e. Borgonovo Inc.’s labour rate variance was $80 unfavourable, and its efficiency variance was $30
favourable. It reports a standard cost per unit of product of 2 hours of direct labour at $7.50 per hour.
Assuming 250 units were produced, what were the actual direct labour hours?

1. 450
2. 496
3. 500
4. 504

f. What are the material price and quantity variances and direct labour rate and efficiency variances
given the following information?

Actual cost per unit of direct material $6.20

Standard cost per unit of direct material $6.00
Actual direct materials used for production 40,000 units
Standard quantity of direct materials for actual production 42,000 units
Actual cost per direct labour-hour $15
Standard cost per direct labour-hour $14
Actual direct labour-hours 48,000
Standard director labour hours for actual production 46,000

Direct materials Direct labour

Price variance Quantity variance Rate variance Efficiency variance
1. $8,000 unfav. $12,000 fav. $48,000 unfav. $28,000 unfav.
2. $8,000 fav. $12,000 unfav. $48,000 unfav. $28,000 unfav.
3. $8,000 fav. $12,000 fav. $30,000 unfav. $28,000 unfav.
4. $8,000 unfav. $12,000 unfav. $48,000 unfav. $30,000 unfav.

g. Jamara Corp. uses a standard costing system and showed an unfavourable materials quantity variance
of $500 and a favourable materials price variance of $1,620. Work in process was debited for $43,120
during the period, and 42,000 units of product were completed. What was the per unit price of the
actual materials used?

1. $0.01
2. $0.10
3. $0.10267
4. $1.00

h. Bella Inc. recorded a $1,200 unfavourable direct labour rate variance and a favourable direct labour
efficiency variance of $3,000. The actual cost of direct labour for the period was $48,500. What will
the debit to Work in process be, assuming the variances are recorded at the time payroll is recorded?

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1. $46,700
2. $47,300
3. $50,300
4. $51,500

i. The actual materials price was $3.50, the actual quantity of material was 5,100 units, and the total
materials price variance was $1,275 unfavourable. What was the standard materials price?

1. $3.00
2. $3.25
3. $3.30
4. $3.75

Solution

Question 3

Textbook, Problem 10-21, pages 484-486.

Solution

Question 4

Textbook, Question 10-1, page 474.

Solution

Question 5

Textbook, Problem 10-17, pages 483.

Solution

Question 6

Textbook, Problem 10-29, page 491.

Solution

Question 7

Textbook, Case 10-33, pages 493-494.

Solution

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Self-test - Content Links

Solution 1

Multiple choice

a. 2)

Standard costs are the predetermined costs for delivering a product or service under normal conditions.

b. 4)

Standard costs are predetermined rates for materials, labour, and overhead.

c. 4)

Price changes for materials, excessive labour hours, and excessive use of materials are often the causes
of differences between actual and standard costs of materials and labour.

d. 2)

To calculate the materials price variance, the actual price is subtracted from the standard price, and the
result is then multiplied by the actual quantity to arrive at the materials price variance.

e. 3)

The quantity variance is the difference between actual and standard cost of material caused by the
actual quantity of material used exceeding the standard quantity of material allowed.

f. 3)

Since material price variances are caused by paying more or less than the standard price, the
responsibility for material price variances lies with the purchasing department.

g. 1)

The difference between actual overhead and standard overhead applied equals the overhead variance.

h. 2)

In a standard costing system, overhead variances are recorded when the factory overhead is applied to
work-in-process.

i. 1)

When recording variances in a standard costing system, all unfavourable variances are debited.

j. 2)

A manager would want to see the total quality cost decreasing over time with increasing merchandise

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inventory turnover, percentage of on-time deliveries, and finished goods inventory turnover.

Solution 2

Multiple choice

a. 1)

($295,590 + $11,690) ÷ $9.20 = 33,400 hours; $295,590 ÷ 33,400 = $8.85 per hour

b. 4)

(2,700 ÷ $13.50) = 200 hours; 3,300 + 200 = 3,500 hours

c. 3)

(12,000 × $5) – (12,500 × $4.60) = $2,500 favourable

d. 4)

(8,500 × $5) – (8,000 × $5) = $2,500 unfavourable efficiency variance; [$41,000 – (8,500 × $5)] =
$1,500 favourable spending variance

e. 2)

$30 ÷ $7.50 = 4 hours; 2 × 250 = 500 hours; 500 – 4 = 496 hours.

f. 1)

($6.20 – $6.00) × 40,000 = $8,000 unfavourable material price variance;

(40,000 – 42,000) × $6.00 = $12,000 favourable materials quantity variance;
($15 – $14) × 48,000 = $48,000 unfavourable labour rate variance;
(48,000 – 46,000) × $14 = $28,000 unfavourable labour efficiency variance

g. 4)

($43,120 + $500 – $1,620) ÷ 42,000 = $1.00

h. 3)

The complete journal entry would be:

Account titles and explanation Debit Credit

Work in process 50,300
Direct labour rate variance 1,200
Direct labour efficiency variance 3,000
Factory payroll 48,500

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i. 2)

$1,275 ÷ 5,100 = $0.25; $3.50 – $0.25 = $3.25

Solution 3

Problem 10-21

a. i.

Material Actual Cost Standard Price

Cost Variances
Alpha $325,565 $2 × 159,000 $5,565 U
Beta 290,102 $4 × 72,000 2,102 U
Gamma 435,000 $10 × 44,000 5,000 F
$2,667 U

ii.

Actual Production (litres) 175,000

X Standard input per litre (150 ÷ 100) 1.5
Total standard litres of input 262,500

*Standard usage at standard mix:

Alpha 80 ÷ 150 x 262,000 = 140,000
Beta 40 ÷ 150 x 262,500 = 70,000
Gamma 30 ÷ 150 x 262,500 = 52,500

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 Management Accounting Fundamentals [MA1]

iii.

iv.

Actual yield (litres) 175,000.00

Standard yield 183,333.33
(275,000 litres × 100 ÷ 150)
Difference (8,333.33)
× Cost per litre of output* $6.20
Yield variance $51,666.65 U

*(80 × $2) + (40 × $4) + (30 × $10)

= $6.20 / litre
100

Check: Mix variance $90,666 F

Yield variance 51,666 U
Usage variance $39,000 F

b. Labour efficiency variance:

[91,000 hrs - (50 hours ÷ 100 litres × 175,000)] × $15.00 = $52,500U

Part of actual labour hours were used to transform the material that became part of the output yield
loss. That amount is equal to:

½ hr. × (8,333 litres × $15 = $62,500 U )

Therefore, the production foreman is correct in arguing that his workers are operating better than
standard.

Source: Ray H. Garrison, Eric W. Noreen, G.R. Chesley, and Raymond F. Carroll, Solutions Manual to
accompany Managerial Accounting, Sixth Canadian Edition. Copyright © 2004, by McGraw-Hill Ryerson
Limited. Reproduced with permission.

Solution 4

Question 10-1

A quantity standard indicates how much of an input should be used to make a unit of output. The quantity

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 Management Accounting Fundamentals [MA1]

might be measured either in terms of units of direct materials or hours of direct labour time. A price standard
indicates what the cost of the input should be.

Source: Ray H. Garrison, Eric W. Noreen, G.R. Chesley, and Raymond F. Carroll, Solutions Manual to
accompany Managerial Accounting, Sixth Canadian Edition. Copyright © 2004, by McGraw-Hill Ryerson
Limited. Reproduced with permission.

Solution 5

Problem 10-17

Requirement 1

1. a. Materials price variance = AQ (AP – SP)

6,000 kilograms ($2.75 per kilogram* SP) = $1,500 F**
$16,500 – 6,000 kilograms × SP = $1,500***
6,000 kilograms × SP = $18,000
SP = $3 per kilogram

* $16,500 ÷ 6,000 kilograms = $2.75 per kilogram

** $1,200 U + ? = $300 F; $1,200 U + $1,500 F = $300 F.
*** When used with the formula, unfavourable variances are positive and favourable variances are
negative.

b. Materials quantity variance = SP (AQ – SQ)

$3 per kilogram (6,000 kilograms – SQ) = $1,200 U
$18,000 – $3 per kilogram × SQ = $1,200*
$3 per kilogram × SQ = $16,800
SQ = 5,600 kilograms

* When used with the formula, unfavourable variances are positive and favourable variances are
negative.

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Alternative approach to parts (a) and (b):

*Given

c. 5,600 kilograms ÷ 1,400 units = 4 kilograms per unit.

Requirement 2

2. a. Labour efficiency variance = SR (AH - SH)

$9 per hour (AH – 3,500 hours*) = $4,500 F
$9 per hour × AH – $31,500 = – $4,500**
$9 per hour × AH = $27,000
AH = 3,000 hours

* 1,400 units × 2.5 hours per unit = 3,500 hours

When used with the formula, unfavourable variances are positive and favourable variances are
** negative.

b. Labour rate variance = AH (AR – SR)

Actual $ Direct labour

AR =
Actual hours

$28,500
=
3,000 H

= $9.50

3,000 hours ($9.50 per hour* – $9.00 per hour) = $1,500 U

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 Management Accounting Fundamentals [MA1]

Alternative approach to parts (a) and (b):

* $28,500 total labour cost ÷ 3,000 hours = $9.50 per hour

** Given
*** 1,400 units × 2.5 hours per unit = 3,500 hours

Solution 6

Problem 10-29

1.

* $18.20 ÷ 2.8 metres = $6.50 per metre.

** 2,000 units × 2.8 metres per unit = 5,600 metres

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 Management Accounting Fundamentals [MA1]

Alternative Solution:
Materials Price Variance = AQ (AP - SP)
6,000 metres ($6.00 per metre* – $6.50 per metre) = $3,000 F
*$36,000 ÷ 6,000 metres = $6.00 per metre

Materials Quantity Variance = SP (AQ – SQ)

$6.50 per metre (6,000 metres – 5,600 metres) = $2,600 U

2. Many students will miss parts 2 and 3 because they will try to use product costs as if they were hourly
costs. Pay particular attention to the computation of the standard direct labour time per unit and the
standard direct labour rate per hour.

* 780 standard hours ÷ 1,950 robes = 0.4 standard hour per robe.
$3.60 standard cost per robe ÷ 0.4 standard hours = $9 standard
rate per hour.
** 2,000 robes × 0.4 standard hour per robe = 800 standard hours.

Alternative Solution:

Labour Rate Variance = AH (AR – SR)

760 hours ($10 per hour* – $9 per hour) = $760 U
*$7,600 ÷ 760 hours = $10 per hour

Labour Efficiency Variance = SR (AH – SH)

$9 per hour (760 hours – 800 hours) = $360 F

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 Management Accounting Fundamentals [MA1]

3.

* $1.20 standard cost per robe ÷ 0.4 standard hours = $3 standard rate per hour.

Alternative Solution:

Variable Overhead Spending Variance = AH (AR – SR)

760 hours ($5 per hour* – $3 per hour) = $1,520 U
*$3,800 ÷ 760 hours = $5 per hour

Variable Overhead Efficiency Variance = SR (AH – SH)

$3 per hour (760 hours – 800 hours) = $120 F

Source: Ray H. Garrison, Eric W. Noreen, G.R. Chesley, and Raymond F. Carroll, Solutions Manual to
accompany Managerial Accounting, Sixth Canadian Edition. Copyright © 2004, by McGraw-Hill Ryerson
Limited. Reproduced with permission.

Solution 7

Case 10-33
Note: There is not just one correct answer for this case.

This case, which is based on an actual situation, may be difficult for some students to grasp since it requires
looking at standard costs from an entirely different perspective. In this case, standard costs have been
inappropriately used as a means to manipulate reported earnings rather than as a way to control costs.

Requirement 1

Lansing has evidently set very loose standards in which the standard prices and standard quantities are far
too high. This will guarantee that favourable variances will ordinarily result from operations. If the standard
costs are set artificially high, the standard cost of goods sold will be artificially high and thus the division’s
net income will be depressed until the favourable variances are recognized. If Lansing saves the favourable
variances, he can release just enough in the second and third quarters to show some improvement and then he

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 Management Accounting Fundamentals [MA1]

can release all of the rest in the last quarter, creating the annual “Christmas present.”

Requirement 2

There are a number of reasons why Lansing should not be permitted to continue this practice. First, it distorts
the quarterly earnings for both the division and the company. The distortions of the division’s quarterly
earnings are troubling because the manipulations may mask real signs of trouble. The distortions of the
company’s quarterly earnings are troubling because they may mislead external users of the financial
statements. Second, Lansing should not be rewarded for manipulating earnings. This sets a moral tone in the
company that is likely to lead to even deeper trouble. Indeed, the permissive attitude of top management
toward manipulation of earnings may indicate that there are other, even more serious, ethical problems in the
company. Third, a clear message should be sent to division managers like Lansing that their job is to manage
their operations, not their earnings. If they keep on top of operations and manage well, the earnings should
take care of themselves.

Requirement 3

Stacy Cummins does not have any easy alternatives available. She has already taken the problem to the
president, who was not interested. If she goes around the president to the board of directors, she will be
putting herself in a politically difficult position with little likelihood that it will do much good if, in fact, the
board of directors already knows what is going on.

On the other hand, if she simply goes along, she will be violating the “Objectivity” standard of ethical
conduct for management accountants. The Home Security Division’s manipulation of quarterly earnings
does distort the entire company’s quarterly reports. The Objectivity standard clearly stipulates that
“management accountants have a responsibility to disclose fully all relevant information that could
reasonably be expected to influence an intended user’s understanding of the reports, comments, and
recommendations presented.” Apart from the ethical issue, there is also a very practical consideration. If
Merced Home Products becomes embroiled in controversy concerning questionable accounting practices,
Stacy Cummins will be viewed as a responsible party by outsiders, and her career is likely to suffer
dramatically.

There is no obvious best course of action for Stacy to take. One suggestion is that she quietly, in a
nonconfrontational manner, bring the problem to the attention of the audit committee of the board of
directors, carefully laying out the problems created by Lansing’s practice of manipulating earnings. If the
president and the board of directors are still not interested in dealing with the problem, she may reasonably
conclude that the best alternative is to start looking for another job.

Source: Ray H. Garrison, Eric W. Noreen, G.R. Chesley, and Raymond F. Carroll, Solutions Manual to
accompany Managerial Accounting, Sixth Canadian Edition. Copyright © 2004, by McGraw-Hill Ryerson
Limited. Adapted with permission.

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