Variable Cost Variance Analysis

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Introduction to Accounting

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Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.

1. A standard cost sheet includes the following types of costs:

a. direct labor
b. direct material
c. manufacturing overhead
d. all of the above

Answer
D. All of the above are product costs. Management uses the cost sheet to determine the total cost to make the product. It includes all product costs.
2. The purpose of using standard costs is to

a. simplify manufacturing procedures
b. eliminate the need to track actual costs
c. allow the company to skip the budgeting process
d. allow management to compare estimated costs to actual costs

Answer
D. A standard cost is an estimate. Management estimates at the beginning of the year so that they can compare actual costs to the original estimate and control costs. Standard costs do not impact manufacturing procedures. The company must track actual costs and report actual costs on the financial statements as cost of goods sold and inventory, even if they do not have standard costs. Normally, developing standard costs is part of the budgeting process.
3. Management determines a predetermined overhead rate for the purpose of

a. allocating overhead costs to the product
b. estimating total overhead costs for the year
c. estimating how many labor hours will be used during the year
d. calculating actual costs incurred to make a product

Answer
A. The predetermined overhead rate is calculated using total estimated overhead costs and an estimated activity (labor) for the year. As these are included in the formula, the rate is not calculated for this purpose, they are part of it. (b. & c.) The pre-determined rate is based on budget and has nothing to do with actual costs. (d.) Overhead costs are generally paid in total for a period of time and are not direct to the product. It is difficult to tell exactly how much overhead it takes to make one product. Therefore, a rate per activity that occurs is used to determine the amount of cost it takes to make a particular product or job.
4. In order for management to determine a cost standard, they must

a. estimated the quantity used and the cost for one quantity
b. know exactly how much will be used and what it will cost
c. know exactly how many employees will be working for them
d. consider total actual manufacturing overhead

Answer
A. A cost standard is an estimate, so they will not know exactly what will occur (b. & c.) Since it is an estimate, you do not use actual amounts. (d.) Total cost is equal to quantity multiplied by cost and both must be estimated.
Do you understand the terms and definitions?
1. A “variance” is the difference between

a. budgeted and estimated costs
b. estimated and actual costs
c. definite and actual costs
d. this year’s actual costs and last years actual costs

Answer
B. Budgeted and estimated mean the same thing, so there is no difference. (a.) Definite is not a term that is used (c.) A variance is the difference between what actually happens and what was expected to happen, so it can not be the difference between two actual costs. (d.)
2. A quantity standard is an estimate of

a. how much it will cost to purchase material for the product
b. the amount direct labor will be paid per hour
c. how much will be used to make the product
d. how much overhead is expected to cost

Answer
C. Quantity refers to how much of something is used. a.b.&d. refer to how much something will cost which are related to price standards
3. A price standard is an estimate of

a. how many direct labor hours will be used to make a product
b. how much is expected to be paid for one
c. exactly how much will be paid for one
d. how much is expected to be used to make one product

Answer
B. Price refers to paying for something. a.&d. are related to how much is used and would be related to a quantity standard. A standard is an estimate and would not be an exact amount (c.).
4. An unfavorable variance means that:

a. the company’s income will be lower than expected
b. the company’s income will be higher than expected
c. the company used less than was expected
d. the company paid less than was expected

Answer
A. An unfavorable variance means that the company incurred more costs than was estimated. More costs will lead to lower income. To incur more costs, the company would either pay more or use more than was expected, not less (c.d.)
5. A predetermined overhead rate is the

a. total amount of overhead that the company expects to incur
b. estimated cost of overhead incurred each time an activity happens
c. actual cost of overhead incurred each time an activity happens
d. estimated total number of times the activity occurred this year

Answer
B. Both a. and d. are included in the formula to calculate a predetermined overhead rate. (a. is divided by d.) Predetermined means it is a budgeted amount and it will not be actual (c.)
Do you understand the formulas?
1. A material price variance is caused by

a. the difference in standard and actual material used
b. the difference in the standard and actual price paid
c. the difference in the standard price and actual amount used
d. the difference in the standard usage and the actual price paid

Answer
B. Material price variance is the difference between the actual price paid for what was purchased and what was expected to be paid for what was purchased. The quantity purchased is constant and the difference is due to the difference between the standard and actual price for one. This variance focuses on material quantity purchased and does not have anything to do with material used. (a.c.d.)
2. A labor efficiency variance is caused by

a. the difference in standard and actual labor hours used
b. the difference in the standard and actual price paid per hour
c. the difference in the standard cost per hour and actual hours used
d. the difference in the standard hours used and the actual price paid

Answer
A. Labor efficiency variance is the difference between the actual labor hours worked and the amount of labor hours that should have been worked to produce the actual quantity of products made. The standard rate per hour used is the same for both actual and estimated hours (b.). The efficiency variance tells management how efficient the labor was when making the product. Efficiency means: did they use more or less hours than they should have to make the products they made. The cost per hour is held constant at standard price to show how much the difference in labor hours cost/saved the company(b). Variance calculations are set up to compare standard price to actual price or compare standard usage to actual usage. Price and usage are never compared to each other as they are very different things (c.d.)
3. A company will have an unfavorable labor rate variance when

a. employees are paid less per hour than expected and work more hours
b. employees work more hours than expected and are paid less per hour
c. employees work less hours than expected
d. employees are paid more per hour than expected

Answer
D. A labor rate variance shows the difference it costs the company because they paid the employees more or less than the standard rate per hour. The quantity of actual hours worked is held constant so that is not a factor in the variance. Unfavorable means the company paid more than was expected.
4. A company will have a favorable materials quantity variance when

a. materials are purchased for less cost than expected
b. materials are purchased for more than expected
c. less materials are used than expected to make the products
d. more materials are used than expected to make the products

Answer
C. A materials quantity variance shows the difference in how much material was actually used to make the products and how much material was estimated to be used to make the products. The price paid for materials is held constant at the standard price, so price paid is not a factor in the quantity variance (a.b.). Favorable means the company used less than was expected
5. A company will have an unfavorable variable manufacturing overhead efficiency variance when

a. less labor hours than expected were used to make the products
b. less dollars were actually spent for total variable manufacturing overhead than expected
c. manufacturing overhead per unit was higher than expected
d. more labor hours than expected were used to make the products

Answer
D. The variable manufacturing overhead variance is related to how many times the activity base actually occurred compared to the quantity that was estimated to occur to make the actual number of products that were made. The predetermined overhead rate is held constant and is not a factor in this variance (c.) The dollars actually spent are a factor in the spending variance and not the efficiency variance (b.) Unfavorable means the company activity was more than expected and more activity costs more.
6. A company will have a favorable variable manufacturing overhead spending variance when

a. less labor hours than expected were used to make the products
b. less dollars were spent for total variable manufacturing overhead than expected
c. manufacturing overhead per unit was higher than expected
d. more labor hours than expected were used to make the products

Answer
B. The variable manufacturing overhead spending variance is related to how much was actually spent compared to how much was expected to be spent for the actual amount of activity that occurred. Actual activity is the same for both so labor hours is not a factor in the spending variance (a.&d.). Favorable means the company paid less than was expected and the rate would not be higher if the company paid less with the same activity (c.).
7. A predetermined overhead rate is calculated by

a. actual manufacturing overhead dollars divided by estimated activity
b. estimated manufacturing overhead dollars divided by estimated activity
c. estimated activity divided by total estimated dollars
d. actual activity divided by total actual dollars

Answer
B Predetermined means it is budgeted and therefore actual data is not used. (a. & d.) It is a cost per unit; therefore, units must be the denominator. (c.)
8. A predetermined overhead rate tells management

a. how much overhead in total will actually be incurred
b. the expected overhead cost that will be incurred every time an activity occurs
c. how many total direct labor hours will be used
d. exactly how much overhead will be incurred every time an activity occurs

Answer
B. A predetermined overhead rate is an estimate for the year. It is not actual. (a. & d.) Direct labor hours can be the activity, but the rate does directly tell c.
9. The formulas for calculating variable cost variances have three columns that are laid out as follows:

a. actual, standard for actual units made, standard for estimated units to be made
b. actual, estimated cost of the actual quantity, estimated cost of actual units made
c. estimated cost for actual, actual, estimated cost for actual units made
d. estimated, standard cost for actual units made, actual

Answer
B. Going from left to right, the format starts with actual dollars spent and works to the right which is what should have been spent for what was actually produced. In the middle is a mixture of actual quantity at standard price, which makes it an estimated cost for the actual quantity.

 AQ x AP		       AQ x SP			            SQ x SP
Actual $ spent	    The actual		          The actual units
			 quantity was expected        produced were expected
			 to cost                                             to cost

Do You Know the Formulas?

1. Write the formula for calculating a predetermined overhead rate.
Answer
Total estimated annual overhead dollars
    Total estimated annual activity
2. Write the formulas/format for calculating variable cost variances.
Answer
 AQ    X    AP                 AQ   X   SP          SQ   X   SP

	        Price		   Quantity
	        Rate		       Efficiency
	        Spending	       Efficiency