Chapter 8

Evaluating Performance
The Use of Variance Analysis
 A STANDARD COST IS ………

 a predetermined cost of manufacturing, servicing, or marketing an item during a

given future period
Standards are set at the beginning of the period. They may be in physical and
dollar terms. Standards assist in the measurement of both effectiveness and
efficiency.
Variance analysis compares standards with actual performance It can be done
by division, department, program, product, territory, or any other responsibility
unit.
Variances may be as detailed as necessary, considering the cost-benefit
relationship.
Evaluation of variances may be done yearly, quarterly, monthly, daily, or hourly,
depending on the importance of identifying a problem quickly.
 Advantages of Standards and Variances
 Aid in inventory costing; Assist in decision making.
 Sell price formulation based on what costs should be.
 Aid in coordinating by having all departments focus on common goals.
 Set and evaluate divisional objectives.
 Allow cost control and performance evaluation by comparing actual to budgeted figures. The
objective of cost control is to produce an item at the lowest possible cost according to
predetermined quality standards.
 Highlight problem areas through the management-by-exception principle.
 Pinpoint responsibility for undesirable performance so that corrective action may be taken.
Motivate employees to accomplish predetermined goals.
 Facilitate communication within the organization, such as between top management and
supervisors.
 Assist in planning by forecasting needs (e.g., cash requirements).
 Establish bid prices on contracts.
 Types of Standards
1. Basic  not changed from period to period and are used in the same way as an index number.
2. Maximum efficiency  perfect standards assuming ideal, optimal conditions, allowing for no losses of any
kind, even those considered unavoidable. They will always result in unfavorable variances.
3. Currently attainable (practical)  refer to the volume of output possible if a facility operated continuously,
after allowing for normal and unavoidable losses such as vacations, holidays, and repairs.
 Currently attainable standards are based on efficient activity.
 Possible but difficult to achieve.
 Practical standards should be set high enough to motivate employees and low enough to permit normal interruptions.
 Attainable standards typically are used in practice.
4. Expected  expected figures based on foreseeable operating conditions and costs. They come very close to
actual figures.
 Standards should be set at a realistic level.
 When reasonable standards exist, employees typically become cost conscious and try to accomplish the best results
at the least cost.
 Standards that are too tight discourage employee performance.
 Standards that are too loose result in inefficient operations.
 Types of Variance (Sales Variance)
2. Sales Variance 
 Sales standards may be established to control and measure the effectiveness of the marketing operations, as
well as for other relevant purposes such as stimulating sales, reallocating sales, resources, and providing
incentive awards.
 The usual standard set for a salesperson, branch, or territory is a sales quota. Although the sales quota typically
is expressed in dollars, it may also be expressed in volume. Other types of standards that may be set to
evaluate sales efforts are number of calls, order size, gross profit obtained, new customers obtained, and
number of regular customers retained.
 The marketing manager is responsible for sales variances and must explain any deviations to upper
management.
Cost Variance
3. Cost Variance  When a product is made or a service is performed, three measures have to be
determined:
 Actual cost = Actual price X Actual quantity, where
actual quantity = Actual quantity per unit of work X Actual units of work produced
 Standard cost = Standard price X Standard quantity, where
standard quantity = Standard quantity per unit of work X Actual units of work produced
 Total (control) variance = Actual cost - Standard cost

Total (control) variance has these elements:

 Price (rate, cost) variance: (Standard price versus Actual price) X Actual quantity
 Quantity (usage, efficiency) variance: (Standard quantity versus Actual quantity) X Standard price

Price and quantity variances are computed for both material and labor. A variance is unfavorable when actual cost
is higher than standard cost
Material Variance
4. MaterialVariance  Material price standards are set by the
purchasing manager, who has knowledge of price data and market
conditions.
 The standard price should reflect the total cost of buying the material,
which includes the basic price less discounts plus freight, receiving, and
handling.
 The standard quantity should be based on the most economical size and
quality of product
 Physical standards for materials are based on determination of kind and
quality specifications, quantity specifications, and assembly
specifications.
Labor Variance
 LaborVariance Standard labor rates may be computed based on
the current rates adjusted for future changes in such variables as:
 Union contracts
 Changes in operating conditions
 Changes in the mix of skilled versus unskilled labor
 The average experience of workers.

 Thebasic rates are (1) daily or hourly, (2) straight piece rate, and
(3) multiple piece rates or bonus systems.
Labor Variance
Overhead Variance
 Overhead variances may be determined by department and by cost center.
 Fixed and variable overhead variances should be analyzed independently.
Fixed Overhead Variance
Total Overhead Variance
 One-way, two-way, and three-way analysis may be used for total overhead.
Total Overhead Variance
 One-way, two-way, and three-way analysis may be used for total overhead.
Total Overhead Variance
 One-way, two-way, and three-way analysis may be used for total overhead.