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CPA BEC - STUDY UNIT 20Standard Costs and Variance Analysis:

Core Concepts

 A. Static and le!i"le B#d$etin$

1. Variance analysis is the foundation of any performance evaluation system based on a

budget. Variances are the calculated differences between the amounts budgeted and theamounts actually incurred (or, in the case of revenues, earned). When analyzing costs,

always subtract actual amounts from budgeted amounts. his results in favorable variances

being positive, and unfavorable variances being negative.

!. he starting point for variance analysis is the static% or &aster% "#d$et. he static budget

is management"s best estimate about sales, production levels, and costs for the upcoming

period. he static budget for a production input is the standard #uantity times the standard

price. he static "#d$et 'ariance is the total variance to be e$plained. %t e#uals the static

budget minus the actual results for the period.

&. Variance analysis becomes much more meaningful when the static budget variance is

separated into its t(o co&ponent 'ariances. %n order to do this, the fle$ible budget must

be prepared.a. he )le!i"le "#d$et consists of the costs that s*o#ld *a'e "een incurred given the

actual level of production achieved. he fle$ible budget e#uals the actual number of

outputs produced, times the standard inputs per unit of output, times the standard price

per unit of input. he product of the first two elements of this e#uation, that is the

actual number of outputs produced and the standard inputs per unit of output, yields

the +e!pected, #antity o) inp#ts.

'. he two component variances of the static budget variance can now be derived. he sales

'ol#&e 'ariance reveals how the number of inputs codified in the master budget before the

period began compares to the inputs that should have been used given the achieved level of

output (holding price constant). A more accurate name for this variance, therefore, would be

production volume variance. he )le!i"le "#d$et 'ariance reveals how both the price paidfor inputs and the #uantity of them consumed compares to the price and #uantity that should

have been paid and consumed, given the actual level of output. What was codified in the

master budget is not relevant to this side of the calculation. y definition, the sales volume

and fle$ible budget variances net to the static budget variance.

. Direct .aterials Variances

1. he )le!i"le "#d$et 'ariance portion of the total variance for any of the three variable

production inputs (direct materials, direct labor, and variable overhead) can be s#"di'ided

into two component variances. %n the case of direct materials, the two components are the

price variance and the #uantity variance (also called the efficiency or usage variance).

!. he &aterials price 'ariance is a pure measure of how much the actual price paid for

inputs deviated from the standard (holding #uantity constant). %t e#uals the actual #uantity

times the difference between the standard and actual prices. he &aterials #antity

'ariance, on the other hand, measures how efficiently direct materials were used given the

actual level of production (holding price constant). %t e#uals the difference between the

e$pected and actual #uantities times the standard price.

&. Variances cannot "e interpreted in isolation. o variance by itself is either *good+ or

*bad+ news.

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3. Direct /a"or Variances

1. As with direct materials, the )le!i"le "#d$et 'ariance portion of the total variance for direct

labor can be s#"di'ided into two component variances4 the rate variance and the efficiency

variance.

!. he la"or rate 'ariance e#uals the actual number of hours wor5ed times the difference

between the standard and actual wage rates. he la"or e))iciency 'ariance e#uals the

difference between the e$pected and actual number of hours wor5ed times the standardwage rate.

2. 'er*ead Variances

1. As with direct materials and direct labor, the static "#d$et 'ariance for variable overhead

can be s#"di'ided into two component variances.

!. he variable overhead )le!i"le "#d$et 'ariance reports how much actual variable overhead

costs deviated from what was e$pected given the actual level of production. %n other words,

the variable overhead fle$ible budget variance is the amount of over6 or underapplied

variable overhead. he variable overhead sales 'ol#&e 'ariance reports how much

variable overhead costs applied deviated (given the actual level of production) from what

was planned when the master budget was prepared.&. 7i5ewise, the )le!i"le "#d$et 'ariance for variable overhead can be s#"di'ided into two

component variances. he 'aria"le o'er*ead spendin$ 'ariance measures how much the

*actual+ overhead rate deviated from the standard (holding the driver level constant). %t

e#uals the actual driver level times the standard rate for the driver, minus the actual costs

incurred. he 'aria"le o'er*ead e))iciency 'ariance measures the *efficiency+ with which

the allocation base was used (holding the application rate constant). %t e#uals the difference

between the e$pected and actual driver levels, times the standard rate for the driver.

'. he )i!ed portion of the total overhead variance also has two components, but they are not

co&"ined. 8ust as with variable overhead, the )i!ed o'er*ead spendin$ 'ariance is

derived by comparing the actual costs incurred with the fle$ible budget. ote that )i!ed

o'er*ead has no e))iciency 'ariance, due to the fact that the fle$ible and static budgetamounts for fi$ed overhead are the same. %nstead, a production6volume variance, also

5nown as a denominator6level variance, is calculated. he production volume variance

e#uals the fi$ed overhead allocation minus the fle$iblestatic budget.

9. Inte$rated o'er*ead 'ariance analysis combines the variable and fi$ed portions of the

overhead variance to allow simplified scrutiny.

a. o#r-(ay:  V:; spending, <:; spending, V:; efficiency, <:; production6volume

b. T*ree-(ay:  =pending, V:; efficiency, <:; production6volume

c. T(o-(ay:  <le$ible budget, <:; production6volume

d. ne-(ay:  :verhead

>. 1e'ie( o) Variance Analysis1. irst le'el:

  =tatic budget variance ? (=@ × =0) (A@ × A0)

!. Second le'el:

  =ales volume variance ? (=@ >@) × =0

  <le$ible budget variance ? (>@ × =0) (A@ × A0)

&. T*ird le'el:Baterials price labor rate V:; spending variance ? A@ × (=0 A0)

Baterials #uantity labor efficiency V:; efficiency variance ? (>@ A@) × =0

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