Question

Blueprint Problem: Using Variances for Control-Investigating Variances and Control Limits

When to Investigate Variances

Calculating the variances is just a preliminary step. The important question is what do we do next? There are two possibilities - ignore the variance or investigate it. Relatively small variances are expected and managers do not need to look into them. For example, suppose that a factory bought $5,000 of raw materials and the standard cost was $4,990, resulting in a $10 unfavorable variance. Is $10 important? Probably not. The company expects raw materials to vary in price a little bit from month to month. Similarly, suppose $4,980 had been spent, resulting in a $10 favorable variance. Again, the $10 variance is probably not worth worrying about. However, suppose the factory paid $5,500 for the raw materials? Now the variance is $510 unfavorable and is more than 10% different from the standard cost of $4,990. This may well prompt an investigation.

There is no accounting rule on when to investigate variances. Instead, each company follows its own guidelines. These guidelines may involve an absolute dollar amount, such that any variance that is more than $600, for example, is investigated. Or, the guideline may be based on a percentage of standard, such that any variance that is more than 5% different from standard, for example, is investigated. Finally, there may be a two-part guideline, e.g., investigate all variances that are more than $500 or 10% different from standard.

Example: Batten Company provided data on product cost variances for the past month. Fill in the variance amount and direction (Favorable, Unfavorable or Not applicable):

Enter all amounts as positive numbers.

Type of Variance	Actual		Standard		Variance
Materials price variance	$24,600		$23,400		$
Materials usage variance	35,000		35,900
Labor rate variance	15,000		15,000
Labor efficiency variance	15,300		14,500
Variable overhead variance	5,950		5,800
Fixed overhead variance	5,800		6,200

Batten's policy is to investigate all variances that are either more than $1,000 or 5% more than standard. Which variances should be investigated and why? Select "Yes" if the variance is "more than $1,000" or "5% more than standard" else select "No" to explains why Batten would investigate.

Type of Variance	more than $1,000	more than 5% of standard
Materials price variance
Materials usage variance
Labor rate variance
Labor efficiency variance
Variable overhead variance
Fixed overhead variance

Which of the following statements is true?

Answer 1

Part 1

Type of Variance	Actual	Standard	Unfavorable (Favorable) Variance	Divided by: Standard	Divided by: Standard
Materials price variance	24,600	23,400	1,200	23,400	5.1%
Materials usage variance	35,000	35,900	(900)	35,900	-2.5%
Labor rate variance	15,000	15,000	-	15,000	0.0%
Labor efficiency variance	15,300	14,500	800	14,500	5.5%
Variable overhead variance	5,950	5,800	150	5,800	2.6%
Fixed overhead variance	5,800	6,200	(400)	6,200	-6.5%

Part 2

Type of Variance	more than $1000	more than 5% of standard
Materials price variance	Yes	Yes
Materials usage variance	No	No
Labor rate variance	No	No
Labor efficiency variance	No	Yes
Variable overhead variance	No	No
Fixed overhead variance	No	Yes

Which variances should be investigated and why?

Materials price variance	This variance is more than $1000 and more than 5% of standard.
Labor efficiency variance	This variance is more than 5% of standard.
Fixed overhead variance	This variance is more than 5% of standard.