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After studying this chapter, you should
be able to:
1. Describe the types of standards and
how they are established for
businesses.
2. Explain and illustrate how standards
are used in budgeting.
3. Compute and interpret direct material
and direct labor variances.
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After studying this chapter, you should
be able to:
4. Compute and interpret factory
overhead controllable and volume
variances.
5. Journalize the entries for recording
standards in the accounts and prepare
an income statement that includes
variances from standard.
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After studying this chapter, you should
be able to:
6. Explain and provide examples of
nonfinancial performance measures.

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7-1
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Objective
Objective 11
Describe the types of
standards and how
they are established
for businesses.
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Standards

Standards are performance

goals. Manufacturers normally
use standard costs for each of
the three manufacturing costs:
 Direct materials
 Direct labor
 Factory overhead
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Accounting systems that use

standards for direct
materials, direct labor, and
factory overhead are called
standard costs systems.

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When actual costs are compared

with standard costs, only the
exceptions or variances are reported
for cost control (called reporting by
the principle of exceptions).

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Setting Standards

The standard-setting process normally requires the joint

efforts of accountants, engineers, and other management
personnel.

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Types of Standards

Unrealistic standards that can be

achieved only under perfect
operating conditions (such as no
idle time, no machine breakdowns,
no materials spoilage) are called
ideal standards or theoretical
standards.

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Currently attainable standards or
normal standards can be attained
with reasonable effort. Standards
set at this level allow for
disruptions, such as material
spoilage and machine breakdowns.

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Reviewing and Revising Standards

Standard costs should be

continuously reviewed and
should be revised when
they no longer reflect
operating conditions.

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Critics of Using Standards

Critics of standards believe the following:

• Standards limit operating improvements
by discouraging improvements beyond
the standard.
• Standards are too difficult to maintain in
a dynamic manufacturing environment,
resulting in “stale standards.”

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7-1
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Critics of Using Standards

• Standards can cause workers to lose

sight of the larger objectives of the
organization by focusing only on
efficiency improvements.
• Standards can cause workers to
unduly focus upon their own
operations to the possible harm of
other operations that rely on them.
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7-2
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Objective
Objective 22
Explain and
illustrate how
standards are used
in budgeting.
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Standard Cost for XL Jeans

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Budget Performance Report

The budget performance report

summarizes the actual costs, the
standard amounts for the actual
level of production achieved, and
the differences between the two
amounts (called cost variances).

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A favorable cost variance occurs
when the actual cost is less than the
standard cost (at actual volumes).
An unfavorable cost variance occurs
when the actual cost exceeds the
standard cost (at actual volumes).

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Budget Performance Report

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Relationship of Variances to the Total
Manufacturing Cost Variances

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7-3
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Objective
Objective 33
Compute and
interpret direct
material and direct
labor variances.
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7-3
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Direct Materials

Standard square yards per

pair of jeans 1.50 sq. yards
Actual units produced x 5,000 pairs of jeans
Standard square yards of
denim budgeted for
actual production 7,500 sq. yards
Standard price per sq. yd. x $5.00
Standard direct materials cost
at actual production $37,500

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7-3
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Direct Materials Price Variance

Actual price per unit $5.50 per sq. yd.

Standard price per unit 5.00 per sq. yd.
Price variance (unfavorable) $0.50 per sq. yd.

$0.50 times the actual quantity of 7,300 sq.

yds. = $3,650 unfavorable

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Direct Materials Quantity Variance

Actual quantity used 7,300 sq. yds.

Standard quantity at
actual production 7,500
Quantity variance (favorable) (200) sq. yds.

(200) square yards times the standard

price of $5.00 = ($1,000) favorable

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Direct Materials Variance
Relationships
Actual cost: Standard cost:
Standard
Actual quantity x Actual quantity x quantity x
Actual price Standard price Standard price
7,300 x $5.50 = 7,300 x $5.00 = 7,500 x $5.00 =
$40,150 $36,500 $37,500

Materials price Material quantity

variance variance
$3,650 U ($1,000) F
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Direct Materials Variance
Relationships
Actual cost: Standard cost:
Standard
Actual quantity x Actual quantity x quantity x
Actual price Standard price Standard price
7,300 x $5.50 = 7,300 x $5.00 = 7,500 x $5.00 =
$40,150 $36,500 $37,500

Total direct materials cost variance

$2,650 U
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7-3

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Example Exercise 7-1

Tip Top Corp. produces a product that requires

six standard pounds per unit. The standard
price is $4.50 per pound. If 3,000 units
required 18,500 pounds, which were purchased
at $4.35 per pound, what is the direct materials
(a) price variance, (b) quantity variance, and (c)
cost variance?

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Follow My Example 7-1
a. Direct materials price variance (favorable)
($2,775) [($4.35 – $4.50) x 18,500 pounds]
b. Direct materials quantity variance (unfavorable)
$2,250 [(18,500 pounds – 18,000 pounds) x
$4.50]
c. Direct materials cost variance (favorable)
($525) [($2,775) + $2,250] or[($4.35 x
18,500 pounds) – ($4.50 x 18,000 pounds)] = $80,475
– $81,000
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For Practice: PE7-1A, PE7-1B
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7-3
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Direct Labor Variances

Standard direct labor hours

per pair of XL jeans 0.80 direct labor hour
Actual units produced x 5,000 pairs of jeans
Standard direct labor hours
budgeted for actual
production 4,000 direct labor hours
Standard rate per DLH x $9.00
Standard direct labor cost
at actual production $36,000

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Direct Labor Rate Variance

Actual rate $10.00

Standard rate 9.00
Rate variance—unfavorable $ 1.00 per hour

$1.00 times the actual time of 3,850

hours = $3,850 unfavorable

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Direct Labor Time Variance

Actual hours 3,850 DLH

Standard hours at actual
production 4,000
Time variance—favorable (150) DLH

(150) Direct labor hours times the standard

rate of $9.00 = ($1,350) favorable

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4 Direct Labor Variance
Relationships

Actual cost: Standard cost:

Actual hours x Actual hours x Standard hours x
Actual rate Standard rate Standard rate
3,850 x $10 = 3,850 x $9.00 = 4,000 x $9.00 =
$38,500 $34,650 $36,000

Direct labor rate Direct labor time

variance variance

$3,850 U ($1,350) F
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4 Direct Labor Variance
Relationships

Actual cost: Standard cost:

Actual hours x Actual hours x Standard hours x
Actual rate Standard rate Standard rate
3,850 x $10 = 3,850 x $9.00 = 4,000 x $9.00 =
$38,500 $34,650 $36,000

Total direct labor cost variance

$2,500 U
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Example Exercise 7-2

Tip Top Corp. produces a product that requires

2.5 standard hours per unit at a standard hourly
rate of $12 per hour. If 3,000 units required
7,420 hours at an hourly rate of $12.30 per
hour, what is the direct labor (a) rate variance,
(b) time variance, and (c) cost variance?

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Follow My Example 7-2
a. Direct labor rate variance (unfavorable)
$2,226 [($12.30 – $12.00) x 7,420 hours]
b. Direct labor time variance (favorable)
($960) [7,420 hours – 7,500 hours) x $12.00]
c. Direct labor cost variance (favorable)
($1,266) [$2,226 + ($960)] or [($12.30 x
7,420 hours) – ($12.00 x 7,500 hours)] = $91,266 –
$90,000

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For Practice: PE7-2A, PE7-2B
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7-4
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Objective
Objective 44
Compute and
interpret factory
overhead controllable
and volume
variances.
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7-4
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Factory Overhead Cost
Budget Indicating Standard
Factory Overhead Rate

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The Factory Overhead Flexible Budget

Variances from standard for factory

overhead result from:
1. Actual variable factory overhead cost
greater or less than budgeted variable
factory overhead for actual production.
2. Actual production at a level above or
below 100% of normal capacity.
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Variable Factory Overhead
Controllable Variance

Actual variable factory overhead $ 10,400

Budgeted variable factory overhead
for actual amount produced
(4,000 hrs. x $3.60) 14,400
Controllable variance—
favorable $ (4,000) F

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Example Exercise 7-3

Tip Top Corp. produced 3,000 units of product

that required 2.5 standard hours per unit. The
standard variable overhead cost per unit is
$2.20 per hour. The actual variable factory
overhead was $16,850. Determine the variable
factory overhead controllable variance.

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Follow My Example 7-3

$350 unfavorable
$16,850 – [$2.20 x (3,000 units x 2.5
hours)]

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For Practice: PE7-3A, PE7-3B
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7-4
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Fixed Factory Overhead Volume
Variance

100% of normal capacity 5,000 direct labor hours

Standard hours at actual
production 4,000
Capacity not used 1,000 direct labor hours
Standard fixed overhead rate x $2.40
Volume variance—unfavorable $ 2,400 U

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Example Exercise 7-4

Tip Top Corp. produced 3,000 units of product

that required 2.5 standard hours per unit. The
standard fixed overhead cost per unit is $0.90
per hour at 8,000 hours, which is 100% of
normal capacity. Determine the fixed factory
overhead volume variance.

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Follow My Example 7-4

$450 unfavorable
$0.90 x [8,000 hours – (3,000 units x 2.5
hours)]

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For Practice: PE7-4A, PE7-4B
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7-4
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Reporting Factory Overhead Variances

Total actual factory overhead $22,400

Factory overhead applied (4,000
hours x $6.00 per hour) 24,000
Total factory overhead cost
variance—favorable $(1,600) F

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Variance
Factory Overhead Cost
Report

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7-4
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Factory Overhead Variances and the
Factory Overhead Account

Factory Overhead
Actual factory Applied factory
overhead 22,400 overhead 24,000

$10,400 + 4,000 hours

$12,000 x $6.00 per
hour
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Factory Overhead Variances and the
Factory Overhead Account

Factory Overhead
Actual factory Applied factory
overhead 22,400 overhead 24,000

Balance, June 30 1,600

Overapplied
factory overhead
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Factory Overhead
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Actual factory OH 22,400 Applied factory OH 24,000

Budgeted Factory
Overhead for
Actual Applied
Amount Produced
Factory Factory
Variable factory OH $14,000
Overhead Overhead
Fixed factory OH 12,000
$22,400 Total $26,400 $24,000

Controllable Volume
Variance Variance
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$(4,000) F $2,400 U
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Factory Overhead
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Actual factory OH 22,400 Applied factory OH 24,000

Budgeted Factory
Overhead for
Actual Applied
Amount Produced
Factory Factory
Variable factory OH $14,000
Overhead Overhead
Fixed factory OH 12,000
$22,400 Total $26,400 $24,000

$(1,600) F
Total Factory Overhead 51
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7-5
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Objective
Objective 55
Journalize the entries for
recording standards in the
accounts and prepare an income
statement that includes
variances from standard.
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Recording and Reporting Variances
from Standards

Western Rider Inc. purchased,

on account, the 7,300 square
yards of blue denim at $5.50
per square yard. The standard
price was $5.00.

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Western Rider Inc.’s Purchase of
Materials Entry

Materials (7,300 sq. yds. x $5.00) 36 500 00

Direct Materials Price Variance 3 650 00
Accounts Payable (7,300 sq. yds.
x $5.50)
40 150 00

$5.50 x 7,300 = $40,150

$3,650 U Direct materials
$5.00 x 7,300 = $36,500 price variance

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Western Rider Inc. used 7,300 square

yards of blue denim to produce 5,000
pairs of XL jeans, compared to the
standard of 7,500 square yards.

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Work in Process (7,500 sq. yds. x $5) 37 500 00
Direct Materials Quantity Variance 1 000 00
Materials (7,300 sq. yds. X $5)
36 500 00

Direct
$5.00 x 7,500 = $37,500 materials
$(1,000) F
$5.00 x 7,300 = $36,500 quantity
variance
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Example Exercise 7-5

Tip Top Corp. produced 3,000 units of product

that required six standard pounds per unit at
$4.50 standard price per pound. The company
actually used 18,500 pounds in production.
Journalize the entry to record the standard
direct materials used in production.

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Follow My Example 7-5

Work in Process 81,000

Direct Materials Quantity
Variance 2,250*
Materials 83,250

*(18,500 pounds – 18,000 pounds) x

$4.50, unfavorable debit

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For Practice: PE7-5A, PE7-5B
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7-5
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Variances from Standards in
Income Statement

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Example Exercise 7-6

Prepare an income statement for the year ended

December 31, 2008 through gross profit for Tip
Top Corp. using the variance data in Example
Exercise 7-1 through Example Exercise 7-4.
Assume Tip Top sold 3,000 units at $100 per unit.
Click for EE 7-1 Click for EE 7-3

Click for EE 7-2 Click for EE 7-4

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Follow My Example 7-6

TIP TOP CORP.

INCOME STATEMENT THROUGH GROSS PROFIT
For the Year Ended December 31, 2008
Sales (3,000 units x $100) $300,000
Cost of goods sold—at standard 194,250*
Gross profit—at standard $105,750

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Follow My Example 7-6 (continued)
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Gross profit—at standard (from Slide 61) $105,750
Favorable Unfavorable
Less variances from
standard cost:
Direct materials price $2,775
Direct materials quantity $2,250
Direct labor rate 2,226
Direct labor time 960
Factory overhead controllable 350
Factory overhead volume 450 1,541
Gross Profit $104,209
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For Practice: PE7-6A, PE7-6B
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7-6
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Objective
Objective 66
Explain and provide
examples of
nonfinancial
performance measures.
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Nonfinancial Performance Measures

A nonfinancial
performance measure is
a performance measure
expressed in units other
than dollars.

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Nonfinancial Performance Measures

 Inventory turnover
 Percent on-time delivery
 Elapsed time between a customer order and
product delivery
 Customer preference rankings compared to
competitors
 Response time to a service call
 Time to develop new products
 Employee satisfaction
 Number of customer complaints 64
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7-6
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Nonfinancial Performance Measures
for the Counter Service Activity of a
Fast Food Restaurant

Inputs
Inputs
Employee
Employeetraining
training Outputs
Outputs
Employee
Employeeexperience
experience Line
Linewait
wait
Number
Numberof ofnew
newmenu
menu Activity Percent
items Percentorder
order
items Counter accuracy
Number accuracy
Numberof ofemployees
employees service Friendly
Fryer Friendlyservice
service
Fryerreliability
reliability score
score
Fountain
Fountainsupply
supply
availability
availability
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Example Exercise 7-7

The following are inputs and outputs to the baggage

claim process of an airline.
Baggage handling training
Time customers wait for returned baggage
Maintenance of baggage handling equipment
Number of baggage handlers
Number of damaged bags
On-time flight performance
Identify whether each is an input or an output to the
baggage claim process. 67
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Follow My Example 7-7

Input Baggage handling training

Output Time customers wait for returned baggage
Input Maintenance of baggage handling equipment
Input Number of baggage handlers
Output Number of damaged bags
Input On-time flight performance

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For Practice: PE7-7A, PE7-7B