Exercise 9-1 Prepare a Flexible Budget

Gator Divers is a company that provides diving services such as underwater ship prepare to clients
in Tampa Bay area. The company's planning budget for March appears below

Gator Divers
Planning Budget
For the Moth Ended March 31

Budgeted diving-hours (q) 200

Revenue ($380.00q) $76,000
Expenses:
Wages and Salaries ($12,000 + $130.00q) 38,000
Supplies ($5.00q) 1,000
Equipment rental ($2,500 + $26.00q) 7,700
Insurance ($4,200) 4,200
Miscellaneous ($540 + $1.5q) 840
Total expense 51,740
Net Operating Income $76,000 - 51,740 $24,260

During March, the Company's activity was actually 190 diving hours. Prepare a flexible budget for that level

Gator Divers
Planning Budget
For the Moth Ended March 31

Actual diving-hours 190

Revenue ($380.00q) $72,200
Expenses:
Wages and Salaries ($12,000 + $130.00q) 36,700
Supplies ($5.00q) 950
Equipment rental ($2,500 + $26.00q) 7,440
Insurance ($4,200) 4,200
Miscellaneous ($540 + $1.5q) 825
Total expense 50,112
Net Operating Income $76,000 - 51,740 $22,085
budget for that level activity.
Exercise 10–3 Variable Overhead Variances

Order Up, Inc., provides order fulfillment services for dot.com merchants. The company maintains
warehouses that stock items carried by its dot.com clients. When a client receives an order from a
customer the order is forwarded to Order Up, which pulls the item from storage, packs it, and ships it
to the customer. The company uses a predetermined variable overhead rate based on direct labor-hours.

In the most recent month, 140,000 items were shipped to customers using 5,800 direct labor-hours.
The company incurred a total of $15,950 in variable overhead costs.

According to the company’s standards, 0.04 direct labor-hours are required to fulfill an order
for one item and the variable overhead rate is $2.80 per direct labor-hour.

1. According to the standards, what variable overhead cost should have been incurred to fill the orders
for the 140,000 items? How much does this differ from the actual variable overhead cost?

Number of items shipped 140,000

Standard direct labor-hours per item x 0.04
Total direct labor-hours allowed 5,600
Standard varbale overhead cost per hour x $2.80
Total Standard varibale overhead cost $15,680
Actual variable overhead cost incurred $15,950
Total standard variable overhead cost (above) 15,680
Spending variance $270 unfavorable

2. Break down the difference computed in (1) above into a variable overhead rate variance and a variable
overhead efficiency variance.

Standard Hours Allowed

For Actual Output, at Actual Hours of Input Actual Hours of Imput
Standard Rate at Standard Rate at Actual Rate
(SH x SR) (AH x SR) (AH x AR)
5,600 hours x $2.80 per hours 5,800 hours x $2.80 per hour 5,800 hours x $2.75 per hour
= $15,680 = $16,240 = $15,950

Variabel overhead Variable overhead

efficiency variance rate variance
= $560U = $290F
Spending variance = $270 U

Alternatively, the variances can be computed using the formulas:

Variable overhead efficiency varinace = SR(AH- SH)
= $280 per hour (5,800 hours - 5,600 hours
= $560 U
abor-hours.

rect labor-hours.

to fill the orders

nce and a variable

urs of Imput

rs x $2.75 per hour

Exercise 10–8 Material and Labor Variances 

Topper Toys has developed a new toy called the Brainbuster. The company has a standard cost system
to help control costs and has established the following standards for the Brainbuster toy:

Direct Materials: 8 diobes per toy at $0.30 oer diobe

Direct labor: 0.6 hours per toy at $14.00 per hour

During August, the company produced 5,000 Brainbuster toys. Production data on the toy for August follows:

Direct Materials 70,000 diobes were purchased at a cost of $0.28 per diobe. 20,000 of these
diobes were still in inventory at the end of the month

Direct labor: 3,200 direct labor-hours were worked at a cost of $48,000

1. Compute the following variance for August

a. Notice in the solution below that the materials price variance is computed on the entire amount of materials
purchased, whereas the materials quantity variance is computed only on the amount of materials used in production

Standard Quantity Allowed Actual Quantity Actual Quantity

for Actual Output of Input, at of Input at
at Standard Price Standard Price Actual Price
(SQ x SP) (AQ x SP) (AQ x AP)
40,000 diodes x $0.30 per diode 50,000 diodes x $0.30 per diode 70,000 diodes x $0.28
= $12,000 = $15,000 = $19,600

Materials quantity
variance = $3,000 U
70,000 diodes x $0.30 per diode
= $21,000

Materials price variance

= $1,400 F

*5,000 toys × 8 diodes per toy = 40,000 diodes

Alternatively, the variances can be computed using the formulas:
= $030 per diode (50,000 diodes - 40,000 diodes
= $3,000 U
Materials price variance = AQ (AP - SP)
= 70,000 diodes ($0.28 per diode - $0.30 per diode)
= $1,400 F
2. A variance usually has many possible explanations. In particular, we should always keep
in mind that the standards themselves may be incorrect. Some of the other possible
explanations for the variances observed at Topper Toys appear below:

Materials Price Variance Since this variance is favorable, the actual price paid per unit
for the materialswas less than the standard price. This could occur for a variety of reasons
including the purchase of a lower grade material at a discount, buying in an unusually large
quantity to take advantage of quantity discounts, a change in the market price of the material,
and particularly sharp bargaining by the purchasing department.

Materials Quantity Variance Since this variance is unfavorable, more materials were

used to produce the actual output than were called for by the standard. This could
also occur for a variety of reasons. Some of the possibilities include poorly trained or
supervised workers, improperly adjusted machines, and defective materials.

Labor Rate Variance Since this variance is unfavorable, the actual average wage
rate was higher than the standard wage rate. Some of the possible explanations
include an increase in wages that has not been reflected in the standards, unanticipated
overtime, and a shift toward more highly paid workers.

Labor Efficiency Variance Since this variance is unfavorable, the actual number

of labor hours was greater than the standard labor hours allowed for the actual
output. As with the other variances, this variance could have been caused by any
of a number of factors. Some of the possible explanations include poor supervision,
poorly trained workers, low-quality materials requiring more labor time to process,
and machine breakdowns. In addition, if the direct labor force is essentially fixed,
an unfavorable labor efficiency variance could be caused by a reduction in output
due to decreased demand for the company’s products.
ost system

August follows:

unt of materials
als used in production.

Actual Quantity
of Input at
Actual Price
(AQ x AP)
70,000 diodes x $0.28 per diode
= $19,600
Problem 10–9 Comprehensive Variance Analysis

Portland Company’s Ironton Plant produces precast ingots for industrial use. Carlos Santiago, who
was recently appointed general manager of the Ironton Plant, has just been handed the plant's contibution
format income statement for Ocotber. The statement is shown below:

Budgeted
Sales (5,000 ingots) $250,000
Variable expenses:
Variable cost of goods sold* 80,000
Variable selling expenses 20,000
Total variable expenses 100,000
Contribution margin 150,000
Fixed expenses:
Manufacturing overhead 60,000
Selling and administrative 75,000
Total fixed expenses 135,000
Net operating income (loss) $15,000

Mr. Santiago was shocked to see the loss for the month, particularly because sales were exactly
as budgeted. He stated, "I sure hope the plant has a standard cost system in operation. If it doesn't
I won't have the slightest idea of where to start looking for the problem." The plant does use a
standard cost system, with the following standard varibale cot per ignod:

Standard
Quantaty of
Hours
Direct Materials 4.0 pounds
Direct Labor 0.6 hours
Variable manufacturing overhead 0.3 hours*
Total standard varibale cost

During October the plant produces 5,000 ingots and incurred the following costs:

a. Purchased 25,000 pounds of material at a cost of $2.95 per pound. There were o raw materials in
inventory at the beginning of the month.

b. Used 19,800 pounds of materials in production. (Finished goods and work in process inventories
are insignificant and can be ignored.)

c. Worked 3,600 direct labor-hours at a cost of $8.70 per hour.

d. Incureed a total variable manufacturing overhead cost of $4,320 for the month. A total of 1,800
machine hours was recorded. It is the company's policy to close all variances to cost of goods sold
on a mnthly basis.
1. Compute the following variance for October:
a. Direct materials price and quantity variance.

Standard Quantity Allowed

for Actual Output
at Standard Price
(SQ x SP)
20,000 pounds * X $2.50 per pound
= $50,000

Material quantity
variance - $500 F

*5,000 ingots x 4.0 pounds per ingot = $20,000 pounds

Alternatively, the variances canbe computed using the formulas:

Materials quantity vanraince = SP (AQ - SQ)
= $2.50 per pounds (19,800 pounds - $20,000 pounds
= $500 F

Mateials price variance = AQ (AP - SP)

= 25,000 pounds ($2.95 per pound - $2.50 per pound)
= $11,250 U

b. Direct labor rate and efficiency variances.

Standard Hours Allowed

for Actual Output
at Standard Rate
(SH x SR)
3,000 hours * X $9.00 per hour
= $27,000

Labor Efficiency variance

= $5,400 U
Spending Varia
 *5,000 ingots x 0.6 hours per ingot = $20,000 hours

Alternatively, the variances canbe computed using the formulas:

Labor Efficiency variance = SR (AH - SH)
= $9.00 per hour (3,600 hours - 3,000 hours
= $5,400 U

Labor Rate variance = AH (AR - SR)

= 3,600 hours ($8.70 per hour - $9.00 per hour)
= $1,080 F

c. Variable overhead rate and efficiency variances.

Standard Hours Allowed

for Actual Output
at Standard Rate
(SH x SR)
1,500 hours * X $2.00 per hour
= $3,000

Variable overhead
Efficiency variance
= $600 U
Spending Varia

*5,000 ingots x 0.3 hours per ingot = $1,500 hours

Alternatively, the variances can be computed using the formulas:

Variable overhead Efficiency variance = SR (AH - SH)
= $2.00 per hour (1,800 hours - 1,500 hours
= $600 U

Variable overhead rate variance = AH (AR - SR)

= 1,800 hours ($2.40 per hour* - $2.00per hour)
= $1,080 F
* $4,320/1,800 hours = $$2.40 per hour

2. Summarize the variances that you cpmputed in (1) above by showing the net overall favorable or
unfavorable variance for October. What impact did this figure have on the company's incoem statement?

Summary of Variances;
Material quantity variance
Material price variance
Labor efficiency variance
Labor rate variance
 Variable overhead efficiency variance
Variable overhead rate variance
Net variance

The net unfavorable variance of $16,390 for the month caused the plant's variable cost of goods
sold to increase from the budgeted level of $80,000 to $96,390

Budgeted cost of goods sold at $16 per ingot

Add the net unfavorable variance (as above)
Actual cost of goods sold

This $16,390 net unfavorable variance also accounts for the difference between the budgeted
net operating income and the actual net loss for the month.

Budgeted net operating income

Deduct the net unfavorable variance added
to cost of goods sold for the month
Net operating loss

3. Pick out two most significant variances that you computed in (1) above. Explain to Mr. Santiago possible
causes of these variances.

The two most significant variances are the materials price variance and the labor efficiency variance.
Possible causes of the variance include:

Material price variance: Outdated standards, uneconomical quantatiy

purchased, higher quality materials, high-cost
method of transport

Labor efficiency vairance: Poorly trained workers, poor quality mateirals,

faulty equipment, work interruptions, inaccurate
standards, insufficient demand.
ant's contibution

Actual
$250,000

96,390
20,000
116,390
133,610

60,000
75,000
135,000
($1,390)

Standard
Price or Standard
Rate Cost
$2.50 per pound $10.00
$9.00 per hour 5.40
$2.00 per hour 0.60
$16.00
 Actual Quantity Actual Quantity
of Input, at of Input at
Standard Price Actual Price
(AQ x SP) (AQ x AP)
19,800 pounds x $2.50 per pound 25,000 pounds X $2.95 per pound
= $49,500 = $73,750

25,000 pounds x
$2.50 per pound
= $62,500

Materials price variance

= $11,250 U

Actual Hours Actual Hours

of Input, at of Input at
Standard Rate Actual Rate
(AH x SR) (AH x AR)
3,600 hours x $9.00 per hour 3,600 hours X $8.70 per hour
= $32,400 = $31,320

Efficiency variance Labor rate variance

= $1,080 F
Spending Variance = $4,320 U
 Actual Hours Actual Hours
of Input, at of Input at
Standard Rate Actual Rate
(AH x SR) (AH x AR)
1,800 hours x $2.00 per hour
= $3,600 = $4,320

ble overhead Variable overhead

ency variance rate variance
= $720 U
Spending Variance = $1,320 U

all favorable or
s incoem statement?

$500 F
11,250 U
5,400 U
1,080 F
 600 U
720 U
$16,390 U

$80,000
16,390
$96,390

the budgeted

$15,000

16,390
($1,390)

o Mr. Santiago possible

y variance.
Problem 10–10 Variance Analysis in a Hospital 

“What’s going on in that lab?” asked Derek Warren, chief administrator for Cottonwood Hospital,
as he studied the prior month's reports. “Every month the lab teeters between a profit and a loss. Are
we going to have to increase our lab fees again?” "We cant," replied Lois Ankers, the controller.
We’re getting lots of complaints about the last increase, particularly from the insurance companies
and governmental health units. They’re now paying only about 80% of what we bill. I’m beginning
to think the problem is on the cost side.” To determine if lab costs are in line with other hospitals
Mr. Warren has asked you to evaluate the costs for the past month. Ms. Ankers has provided you
with the following information:

a. Two basic types of tests are performed in the lab—smears and blood tests. During the past month, 2,700
smears and 900 blood tests were performed in the lab.

b. Small glass plates are used in both types of tests. During the past month, the hospital purchased 16,000
plates at a cost of $38,400. This cost is net of a 4% purchase discount. A total of 2,000 of these plates were
unused at the end of the month; no plates were on hand at the beginning of the month.

c. During the past month, 1,800 hours of labor time were used in performing smears and blood tests. The
cost of this labor time was $18,450.

d. The lab’s variable overhead cost last month totaled $11,700.

Cottonwood Hospital has never used standard costs. By searching industry literature, however, you have determine
the following nationwide averages for hospital labs:

Plates:
Three plates are required per lab test. These plates cost $2.50 each and are disposed
of after the test is completed.

Labor:
Each smear should require 0.3 hours to complete, and each blood test should require 0.6
hours to complete. The average cost of this lab time is $12 per hour.

Overhead:
Overhead cost is based on direct labor-hours. The average rate of variable overhead is $6 per hour.

1. Compute the materials price variance for the plates purchased last month, and compute
a materials quantity variance for the plates used last month. Materials price variance: $1,600 F

The standard quantity of plates allowed for tests performed during the month would be:

Smears 2,700
Blood tests 900
Total 3,600
Plates per test x3
Standard quantity allowed 10,800

The variance analysis for plates would be:

Standard Quantity Allowed Actual Quantity
for Actual Output of Input, at
at Standard Price Standard Price
(SQ x SP) (AQ x SP)
10,800 pounds * X $2.50 per pound 14,000 pounds x $2.50 per pound
= $27,000 = $35,000

Material quantity
variance - $8,000 U
16,000 pounds x
$2.50 per pound
= $40,000

Materials price variance

= $1,600 F

Alternatively, the variances canbe computed using the formulas:

Materials quantity variance = SP (AQ - SQ)
= $2.50 per pounds (14,000 pounds - $10,800 pounds
= $8,000 U

Mateials price variance = AQ (AP - SP)

= 16,000 pounds ($2.40 per pound - $2.50 per pound)
= $1,600 U
*$38,400/16000 plates = $2.40 per plate

a. compute labor rate variance and a labor efficiency variance Labor efficiency variance: $5,400 U

The standard hours allowed for tests performed during the month would be:

Smears: 0.3 hours per test x 2,700 tests 810

Blood tests 0.6 hour per test x 900 tests 540
Total standard hours allowed 1,350

The Variance analysis of Labor would be:

Standard Hours Allowed Actual Hours

for Actual Output of Input, at
at Standard Rate Standard Rate
(SH x SR) (AH x SR)
1,350 hours * X $12.00 per hour 1,800 hours x $12 per hour
= $16,200 = $21,600

Labor Efficiency variance Labor rate variance

 = $5,400 U = $3,150 F
Spending Variance = $2,250 U

Alternatively, the variances can be computed using the formulas:

Labor Efficiency variance = SR (AH - SH)
= $12 per hour (1,800 hours -1,350 hours
= $5,400 U

Labor Rate variance = AH (AR - SR)

= 1,800 hours ($10.25 per hour - $12.00 per hour)
= $3,150 F
*$18,450/1,800 hours = $10.25 per hour

b. In most hospitals, three-fourths of the workers in the lab are certified technicians and one-fourt
are assistants. In an effort to reduce costs, Cottonwood Hospital employs only one-half certified te
and one-half assistants. Would you recommend that this policy be continued? Explain.

The policy probably should not be continued. Although the hospital is saving $1.75 per hour by employing
relative to the number of senior technicians than other hospitals, this savings is more than offset by other
Too much time is being taken in performing lab tests, as indicated by the large unfavorable labor efficienc
And, it seems likely that most (or all) of the hospital’s unfavorable quantity variance for plates is traceable
supervision of assistants in the lab.

3. Compute the variable overhead rate and efficiency variances. Is there any relation between the variable
overhead efficiency variance and the labor efficiency variance? Explain.

Standard Hours Allowed Actual Hours

for Actual Output of Input, at
at Standard Rate Standard Rate
(SH x SR) (AH x SR)
1,350 hours * X $6.00 per hour 1,800 hours x $6.00 per hour
= $8,100 = $10,800

Labor Efficiency variance Labor rate variance

= $2,700 U = $900 F
Spending Variance = $3,600 U

Alternatively, the variances can be computed using the formulas:

Variable overhead efficiency variance = SR (AH - SH)
= $6 per hour (1,800 hours -1,350 hours
= $2,700 U

Variable overhead rate variance = AH (AR - SR)

= 1,800 hours ($6.50 per hour - $6.00 per hour)
= $900 F
 *$11,700/1,800 hours = $6.50 per hour

the two variances are related. Both are computed by comparing actual labor time to the standard hours allowed for t
output of the period. Thus, if there is an unfavorable labor efficiency variance, there will also be an unfavorable
variable overhead efficiency variance.
d Hospital,
and a loss. Are

e companies
m beginning
r hospitals
provided you

the past month, 2,700

tal purchased 16,000

0 of these plates were

and blood tests. The

however, you have determined

e disposed

uld require 0.6

overhead is $6 per hour.

nd compute
iance: $1,600 F
 Actual Quantity
of Input at
Actual Price
(AQ x AP)
50 per pound
= $38,400

Materials price variance

= $1,600 F

fficiency variance: $5,400 U

Actual Hours
of Input at
Actual Rate
(AH x AR)

= $18,450

Labor rate variance

 = $3,150 F

ed technicians and one-fourth

loys only one-half certified technicians
ntinued? Explain.

g $1.75 per hour by employing more assistants

gs is more than offset by other factors.
rge unfavorable labor efficiency variance.
variance for plates is traceable to inadequate

ation between the variable

Actual Hours
of Input at
Actual Rate
(AH x AR)

= $11,700

Labor rate variance

= $900 F
he standard hours allowed for the
ill also be an unfavorable
Problem 10A–12 Comprehensive Standard Cost Variances

Dresser Company uses a standard cost system and sets predetermined overhead rates on the
basis of direct labor-hours. The following data are taken from the company’s budget for the current year:

Denominator activity (direct labor-hour

Variable manufacturing overhead cost at 9,000 direct labor-hours
Fixed manufacturing overhead cost

The standard cost for the Company's only product is given below:

Direct materials, 4 pounds at $2.60 per pound

Direct labor, 2 direct labor-hours at $9.00 per hour
Overhead, 2 direct labor-hours at $10.80 per hour
Standard cost per unit

During the year, the company produced 4,800 units of product ad incurred the following costs:

Materials purchased, 30,000 pounds at $2.50 per pound

Materials used in production (in pounds)
Direct labor cost incurred, 10,000 direct labor-hours at
$8.60 per direct labor-hour
Variable manufacturing overhead cost incurred
Fixed manufacturing overhead cost incurred

1. Redo the standard cost card in a clearer, more usable format by detailing the variable
overhead cost elements.

Standard
Quantity
Direct materials (pounds) 4
Direct labor (direct labor hours) 2
Variable overhead 2
Fixed Overhead 2
Standard cost per unit

2. Prepare an analysis of the variances for materials and labor for the year. Materials price variance: $3,000
DM Actual Costs
Aqp X Sp Aqp X Ap
30,000 X $2.60 30,000 X $2.50
$78,000 $75,000
$3000 Favorable Purchase price Variance
DM 19,200 Actual Costs
SQA X Sp Aqu X Sp Aqu X Ap
4,800 X 4 X $2.60 20,000 X $2.60 20,000 X $2.50
19,200 X $2.60
$49,920 $52,000 $50,000
($2080) Unfavorable $2000 Favorable
DM Quantity Variance DM Price Variance

DML 9,600 Actual Costs

SQA X Sp Aq X Sp Aq X Ap
4,800 X 2 X $9 10,000 X $9.00 10,000 X $8.60
9,600 X $9.00
$86,400 $90,000 $86,000
($3,600) Unfavorable $4,000 Favorable
DML Efficiency Variance DML Rate Variance

3. Prepare an analysis of the variances for variable and fixed overhead for the year.

VOH Applied
9,600 DL Hhrs SQA X Sp Aq X Sp
4,800 X 2 X $3.80 4,800 X 2 X $3.80
9,600 X $3.80 9,600 X $3.80 10,000 X $3.80
$36,480 $36,480 $38,000
$0 Always ($1,520)
VOH Unfavorable VOH
Volume Variance Efficiency Variance (Spending Variance

FOH Applied Flexible Budget Flexible Budget

9,600 DL Hrs 9,600 DL Hrs 10,000 DL Hrs
4,800 X 2 X $7.00
9,600 X $7.00
$67,200 $63,000 $63,000
$4,200 Favorable $ 0 Always ($1,800)
FMOH FMHO
Volume Variance Efficiency Variance Budget Variance)

Alternative Calculations Std. DL Hrs

FOH Volume Variance: Allowed Units
Actual production volume 9,600 4,800
Denominator Level 9,000 4,500
Difference 600 300
Fixed overhead rate $7.00 $14.00
 Volume variance $4,200 $4,200 Overapplied
Favorable Favorable

4. What effect, if any, does the choice of a denominator activity level have on standard unit costs?
Is the volume variance a controllable variance from a spending point of view? Explain.

Denominator = 9,600 Standard Standard

Quantity Price
Direct materials (pounds) 4 $2.60
Direct labor (direct labor hours) 2 $9
Variable overhead 2 $3.80
Fixed Overhead 2 $6.56
Standard cost per unit

Alternative Calculations Std. DL Hrs

FOH Volume Variance: Allowed Units
Denominator Level 9,600 4,800
Actual production volume 9,600 4,800
Difference 0 0
Fixed overhead rate $6.56 $13.13
Volume variance $0 $0
None None

The volume variance cannot be controlled by controlling spendinbg. Rather, the volume variance simply reflects
whether actual activity was greater or less than the denomiator activity. The volume varinace is controlled only
through controlling the activity.
he current year:

9,000
$34,200
$63,000

$10.40
18.00
21.60
$50.00

$75,000
20,000

$86,000
$35,900
$64,800

Standard Standard
Price Cost/Unit
$2.60 $10.40
$9.00 $18.00
$3.80 $7.60
$7.00 $14.00
$50.00

als price variance: $3,000 F

 ctual Costs
Aqu X Ap
,000 X $2.50

000 Favorable
Price Variance

ctual Costs

,000 X $8.60

000 Favorable
Rate Variance

Actual Costs
Aq X Ap

,000 X $3.80 10,000 X $3.59

$35,900
$2,100
VOH Rate
(Spending Variance)

xible Budget Actual Costs

0,000 DL Hrs Aq X Ap

$64,800
Unfavorable
FMOH
Budget Variance)
dard unit costs?

Standard
Cost
$10.40
$18.00
$7.60
$13.13
$49.13

variance simply reflects

ace is controlled only