## An Unfavorable Cost Variance Occurs When Budgeted Cost At Actual Volumes Exceeds Actual Cost

The difference between actual costs for variable overhead and budgeted costs based on the standards. As shown in the following, the labor rate variance is \$ favorable, and the labor efficiency variance is \$234,000 unfavorable. The difference between actual costs for direct labor and budgeted costs based on the standards. The materials quantity variance calculation presented previously shows the actual quantity used in production of 399,000 pounds is lower than the expected quantity of 420,000 pounds. Clearly, this is favorable because the actual quantity used was lower than the expected quantity. The standard quantity of 420,000 pounds is the quantity of materials allowed given actual production.

Assume Spindle Company produced 70,000 units last quarter. Prepare a variance analysis using the format shown in Figure 10.11 “Variable Overhead Variance Analysis for Jerry’s Ice Cream Using Activity-Based Costing”. Assume Hillside Hats produced 15,000 units last month. The company purchased 45,000 yards of material during the month for \$5.30 per yard. Assuming a standard price of \$5 per yard, prepare a journal entry to record the purchase of raw materials for the month. Assume Mammoth Company produced 40,000 units last quarter. The company purchased 1,000 elements during the month for \$38 each.

An unfavorable cost variance occurs when budgeted cost at actual volumes exceeds actual cost. Because accountants have financial expertise, they are the only ones that are able to set standard costs for the production area. By so doing, the full \$719,000 actually spent is fully accounted for in the records of Blue Rail.

## Causes Of Unfavorable Variances

SQ and SP refer to the “standard” quantity and price that was anticipated. Variance analysis can be conducted for material, labor, and overhead. Sue Mays, the manager at Fast Sleds, Inc., reviewed the company’s variance analysis report for the month of January. The materials price variance of \$ was the most significant favorable variance for the month, and the materials quantity variance of \$15,000 was the most significant unfavorable variance.

The process of determining direct labor variance is the same as for determining the direct material variance. The total standard cost per unit is the sum of the standard costs of Direct Materials, Direct Labor and Manufacturing Overheads.

## Example Of Unfavorable Variance

In closing this discussion of standards and variances, be mindful that care should be taken in examining variances. If the original standards are not accurate and fair, the resulting variance signals will themselves prove quite misleading. Blue Rail produces handrails, banisters, and similar welded products. The primary raw material is 40-foot long pieces of steel pipe. This pipe is custom cut and welded into rails like that shown in the accompanying picture.

• Production costs are incurred by a business when it manufactures a product or provides a service.
• Lastly, it will teach you about budgeting and standards.
• The shortfall could be due, in part, to an increase in variable costs, such as a price increase in the cost of raw materials, which go into producing the product.
• Notice that the raw materials inventory account contains the actual quantity of direct materials purchased at the standard price.
• Variable Production Cost Variance Analysis and Performance Evaluation.
• Figure 10.4 “Direct Materials Variance Analysis for Jerry’s Ice Cream” shows how to calculate the materials price and quantity variances given the actual results and standards information.

For example, if a small business spends an additional \$1,000 on marketing expenses, but generates only \$800 in additional revenue, the pretax profits would fall by \$200–\$1,000 minus \$800. The next illustration is the opposite scenario. When less is spent than applied, the balance represents the favorable overall variances. Favorable overhead variances are also known as “overapplied overhead” since more cost is applied to production than was actually incurred. Once again, debits reflect unfavorable variances, and vice versa.

## What Is An Example Of A Favorable Variance?

For Jerry’s Ice Cream, the standard quantity of materials per unit of production is 2 pounds per unit. Thus the standard quantity of 420,000 pounds is 2 pounds per unit × 210,000 units produced and sold. As we explain next, there are many approaches to establishing these six standards for direct materials, direct labor, and variable manufacturing overhead . Are costs that management expects to incur to provide a good or service. They serve as the “standard” by which performance will be evaluated. For example, fast-food restaurants have a standard for the length of time it should take to serve a drive-through-window customer. Phone directory operators have a standard length of time it should take to provide a phone number to a customer.

A Cost Variation is an indicate the work actually performed more cost or less than planned from earned value data. It is the mathematical difference between Budgeted Cost for Work Performed and Actual Cost of Work Performed .

## Difference Between A Favorable & Unfavorable Variance

A management team could analyze whether to bring in temporary workers to help boost sales efforts. Management could also offer target-based financial incentives to salespeople or create more robust marketing campaigns to generate buzz in the marketplace for their product or service. A budget is a forecast of revenue and expenses, including fixed costs as well as variable costs. Budgets are important to corporations because it helps them plan for the future by projecting how much revenue is expected to be generated from sales. As a result, companies can plan how much to spend on various projects or investments in the company. Normally standard costs should be revised when labor rates change to incorporate new union contracts.

The example shows that it is important to know both the ideal costs and the actual costs. A food cost variance signifies ideal food cost is different from actual food cost. A food cost variance is expressed as a percentage from turnover in a specific period. In a perfect situation, the variance is zero. The standard cost provides the basis for determining variances from standards.

## What Is Cost Variance In Manufacturing Accounting?

The challenge for a good manager is to take the variance information, examine the root causes, and take necessary corrective measures to fine tune business operations. Review the following graphic and notice that more is spent on actual variable factory overhead than is applied based on standard rates. This scenario produces unfavorable variances (also known as “underapplied overhead” since not all that is spent is applied to production). As monies are spent on overhead (wages, utilization of supplies, etc.), the cost is transferred to the Factory Overhead account.

A total of 25,520 labor hours were worked during the month at a cost of \$313,896. Variable overhead costs totaled \$790,000 for the month. Company policy is to investigate all unfavorable variances above 5 percent of the flexible budget amount for direct materials, direct labor, and variable overhead.

Political and regulatory changes that were not accurately forecast are also included in this category. An unfavorable variance can occur due to changing economic conditions, such as lower economic growth, lower consumer spending, or a recession, which leads to higher unemployment.

The shortfall could be due, in part, to an increase in variable costs, such as a price increase in the cost of raw materials, which go into producing the product. The unfavorable variance could also be due, in part, to lower sales results versus the projected numbers.

## 7 Using Variance Analysis With Activity

A careful examination of this analysis indicates that the overhead volume variance relates solely to fixed costs. Thus, the volume variance measures the amount that fixed overhead costs are under -or over applied.

Because fixed overhead costs are not typically driven by activity, Jerry’s cannot attribute any part of this variance to the efficient use of labor. In fact, there is no efficiency variance for fixed overhead. Instead, an unfavorable cost variance occurs when budgeted cost at actual volumes exceeds actual cost. Jerry’s must review the detail of actual and budgeted costs to determine why the favorable variance occurred. For example, factory rent, supervisor salaries, or factory insurance may have been lower than anticipated.

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One can compute the values for the red, blue, and green balls and note the differences. Or, one can perform the algebraic calculations for the price and quantity variances. Note that unfavorable variances offset favorable variances. A total variance could be zero, resulting from favorable pricing that was wiped out by waste. A good manager would want to take corrective action, but would be unaware of the problem based on an overall budget versus actual comparison. The fixed overhead production volume variance is favorable because the company produced and sold more units than anticipated. For example, suppose the actual cost for direct materials is significantly higher than the budgeted cost.