All credit for this text goes to...
Garrison, R. H., Webb, A., & Libby, T. (2024). Managerial Accounting (13th Canadian ed.). McGraw-Hill Ryerson.
Study Session Meta (delete when complete)
LO Coverage & Mastery
LO Title Status Mastery Notes Section 1 Setting standard costs (materials, labour, variable MOH) ✅ Complete 🔶 Understood §1 2 Direct materials price and quantity variances ✅ Complete 🔶 Understood §2 3 Direct labour rate and efficiency variances ✅ Complete 🔶 Understood §2 4 Variable MOH spending and efficiency variances ✅ Complete 🔶 Understood §2 5 Denominator activity and POHR ✅ Complete 🔶 Understood §3 6 Fixed overhead budget and volume variances ✅ Complete 🔶 Understood §3 7 Performance reports, variance investigation, capacity analysis ✅ Complete 🔶 Understood §4 Vocabulary Tracker
Term Tier Location Standard T1 §1 Glossary Standard cost record T1 §1 Glossary Ideal standard T1 §1 Glossary Practical standard T2 §1 Vocab Standard quantity allowed T2 §2 Vocab Management by exception T2 §1 Vocab Materials price variance T1 §2 Rosetta Stone Materials quantity variance T1 §2 Rosetta Stone Labour rate variance T1 §2 Rosetta Stone Labour efficiency variance T1 §2 Rosetta Stone Variable overhead spending variance T1 §2 Rosetta Stone Variable overhead efficiency variance T1 §2 Rosetta Stone Current Position
LO: 6 (complete) Concept: Four overhead variances → under/overapplied connection Last Micro-Test: Sum four OH variances, determine over/underapplied — passed with label support Last Lens Used: Inversion (fixed vs variable cost behaviour)
Parking Lot (Later LOs)
- What is denominator activity and why does it matter? (LO5)
- What is the volume variance and why does it feel different from other variances? (LO6)
- How do the four overhead variances connect to under/overapplied overhead from Ch5? (LO6)
- How do managers decide which variances to investigate? (LO7)
- Capacity analysis — connect to personal productivity and opportunity cost (LO7)
- Connect variance analysis to Ceteris Paribus note (post-session)
Mastery Gaps (Review Before Exam)
- LO2-4: Hesitated on which multiplier to use for price-type variance (actual vs standard). Decision rule is understood but not yet automatic. Drill before exam.
- LO2-4: Vocabulary mapping (six names, two formulas) — understood conceptually but needs drill on correct name per input type.
- Pre-mortem flag: Under/overapplied overhead from Ch5. Struggled on Midterm 1. Must nail LO6 connection.
- LO5 V1 failure (input error): Asked “if company produces more than planned, is OH underapplied or overapplied?” — answered underapplied (wrong). Root cause: treated fixed overhead as if it increases with production (variable cost thinking). The debit/credit framework from Ch5 was valid, but the INPUT was wrong — assumed “produced more → spent more” which is only true for variable costs. Fixed costs don’t change with volume; only the APPLIED side moves. Defence: Before tracing any overhead mechanism, stop and ask “Is this cost fixed or variable?” If fixed → actual spending doesn’t change. Same V1 pattern as ECON midterm prep (mechanism correct, initial reading wrong).
- LO7 Mastery check trap (partial): “Favourable volume variance = saved money on fixed overhead” — said volume has nothing to do with fixed overhead (wrong framing). The volume variance IS about volume. The error in the statement is “saved” — you can’t save on fixed costs by producing more. You APPLIED more, but spending is identical. Same fixed/variable thinking gap as the V1 error above. This is the recurring weak spot for this chapter — drill fixed cost behaviour.
Session Log
Date LOs Covered Mastery Results Key Clarifications 2026-03-21 LO1-LO4 All 🔶 Understood Standards are per-unit (not totals like budgets); practical standards used because ideal breaks exception detection; all variances = two questions (“did we pay too much?” / “did we use too much?”); six names for two formulas; multiplier is always the OTHER variable (price-type = actual qty, qty-type = standard price); ceteris paribus principle underlies variance splitting; favourable ≠ good (cheaper inputs can cause waste); sign rule: negative = F, positive = U 2026-03-22 LO5-LO7 All 🔶 Understood POHR exists to stabilize unit costs (prevent seasonal fluctuation); denominator activity = activity base = cost driver (same concept, different Ch10 name); POHR creates artificial “as if variable” treatment of fixed costs; budget variance = only variance with no multiplier (fixed OH not measured in units); volume variance measures capacity utilization not spending; V1 input error: treated fixed OH as variable when asked about over/underapplied; four OH variances sum to under/overapplied; favourable = overapplied, unfavourable = underapplied; variance investigation uses absolute + relative + trend; capacity analysis = financial impact of idle capacity; mastery check: explain pass, apply pass, trap partial (confused “used capacity better” with “saved on fixed costs” — same fixed/variable thinking gap)
Note on Organization
This chapter answers one core question: How do we break down cost differences into actionable pieces that tell managers WHERE the problem is and WHO is responsible?
These notes are organized as a teaching flow, not a textbook mirror:
Section What It Teaches Textbook LOs §1 What Standards Are and Why They Matter The measuring stick — what we compare against LO1 §2 The Variance Machine — One Pattern, Three Applications Two questions, two formulas, six names — applied to materials, labour, and variable overhead LO2 + LO3 + LO4 §3 The Fixed Overhead Problem Why fixed overhead needs different treatment — denominator activity, POHR, budget and volume variances LO5 + LO6 §4 Putting It All Together Performance reports, which variances to investigate, capacity analysis LO7 Exam intel: Under/overapplied overhead from Ch5 connects directly to the four overhead variances in this chapter. This was a weak area on Midterm 1.
What Changed from Chapter 9?
Ch9 introduced the flexible budget — comparing actual results to what SHOULD have happened at the actual volume. Ch10 goes deeper.
| Chapter | What it does | Limitation |
|---|---|---|
| Ch9 | Flexible budget variance = Actual − Flexible budget | Tells you the TOTAL gap but not WHERE the problem is |
| Ch10 | Breaks that variance into price + quantity components | Now you know whether you paid too much, used too much, or both |
Ch9 answered: “How far off are we?” Ch10 answers: “WHY are we off — is it a price problem or a quantity problem, and who is responsible?“
1. What Standards Are and Why They Matter (LO1)
What is a standard cost?
A standard cost is the expected cost per unit of output. A budget is a total amount. The standard is the building block; the budget multiplies it by volume.
Standard cost = Standard quantity × Standard price
Each standard has two components:
- Standard quantity — how much input SHOULD be used per unit of output
- Standard price — what we SHOULD pay per unit of input
Standards are set for three cost elements:
| Input | Standard Quantity | Standard Price/Rate |
|---|---|---|
| Direct materials | How much material per unit (includes waste/spoilage allowances) | What we should pay per unit of material (includes freight, handling, net of discounts) |
| Direct labour | How many hours per unit (includes breaks, cleanup, downtime) | What we should pay per hour (includes wages, benefits, employment taxes) |
| Variable MOH | How many hours per unit (same activity base as labour) | The variable portion of the predetermined overhead rate |
Standard quantity includes allowances for normal waste, spoilage, and rejects
The bill of materials says 2.7 kg per unit, but the standard is 3.0 kg because you expect some material to be wasted or rejected under normal operating conditions.
Why practical standards, not ideal?
Practical standards are used because ideal standards break the exception-detection system.
| Type | Definition | Problem |
|---|---|---|
| Ideal | Best possible performance — no breakdowns, no waste, peak effort always | Variance is ALWAYS unfavourable → can’t distinguish “normal” from “something went wrong” |
| Practical | Challenging but attainable — allows for normal inefficiencies | Variance signals an actual deviation → management by exception works |
Management by exception investigates unusual variances. If every period produces an unfavourable variance by definition (because ideal is unattainable), the signal is buried in noise.
Beyond the Textbook
Why not both? You could track practical standards for daily exception management AND track the delta-from-ideal as a trend line for continuous improvement. Practical catches “something went wrong THIS period.” Ideal-delta catches “are we getting better over TIME?” Different questions, different time horizons. The textbook mentions some companies are moving toward continuous improvement targets — essentially this two-layer approach. For exam purposes: practical standards, not ideal.
Key Vocabulary (LO1)
Management by Exception
Definition: Investigating only the variances that fall significantly outside the standard — focusing attention on problems, not on things going right. Example: A 5,000 variance triggers an investigation. Trap: Ideal standards break this system because every period’s variance is unfavourable by definition — you can’t tell signal from noise. Connects to: Ceteris Paribus, responsibility accounting
Practical Standard
Definition: A standard that is challenging but attainable under normal operating conditions — allows for normal machine downtime, employee rest, and reasonable waste. Example: Standard labour time of 2.5 hours per unit includes 0.1 hours for breaks and 0.3 hours for cleanup/downtime. Trap: Don’t confuse with ideal standards. Practical = what a competent worker can achieve with reasonable effort. Ideal = best case, no interruptions, ever. Connects to: Management by exception
Glossary (LO1)
Standard — a benchmark or norm for measuring performance; specifies expected quantity and cost of inputs per unit of output Standard cost record — a document showing the standard quantities and costs of all inputs required to produce one unit of a specific product Ideal standard — a standard attainable only under the best circumstances; no waste, no downtime, peak effort always Bill of materials — details the type and quantity of each raw material required for a product (before waste/spoilage allowances)
2. The Variance Machine — One Pattern, Three Applications (LO2, LO3, LO4)
What is a variance and why do we split it?
A variance is the difference between what actually happened and what the standard said should happen. We split it into a price piece and a quantity piece because different managers are responsible for each.
The total variance tells you HOW MUCH you’re off. The split tells you WHERE the problem is:
- Price variance → Did we pay too much per unit of input? → Purchasing manager’s responsibility
- Quantity variance → Did we use too much input? → Production manager’s responsibility
Why split? Same principle as Ceteris Paribus — isolate one variable at a time so you can see its effect clearly. If you lump price and quantity together, you can’t tell which manager needs to act.
The two questions that drive everything
Every variance in this chapter answers one of two questions: "Did we pay too much?" or "Did we use too much?" Six different names, two formulas, two questions.
Formula 1 — “Did we pay too much?”
Formula 2 — “Did we use too much?”
Both formulas follow the same skeleton: (Actual − Standard) × multiplier. The multiplier is always the OTHER variable — and its version (actual vs standard) is determined by responsibility accounting:
| You’re measuring… | The multiplier is… | Version | Why |
|---|---|---|---|
| Price difference (AP − SP) | The OTHER variable (quantity) | Actual | That’s the real transaction size — how much was actually bought |
| Quantity difference (AQ − SQ) | The OTHER variable (price) | Standard | Shield the production manager from price fluctuations they don’t control |
The multiplier is always INVERTED to what you're measuring
Price variance uses actual QUANTITY. Quantity variance uses standard PRICE. This is ceteris paribus at work — hold everything else at a fixed benchmark so you can isolate the effect of one variable.
Why people mix up the multiplier
The temptation is to think “price variance = something about prices, so I multiply by the price.” Wrong. The DIFFERENCE is about prices. The MULTIPLIER is the other variable. The same logic applies to quantity variance — the difference is about quantities, but the multiplier is the price (at standard).
The Rosetta Stone — six names, two formulas
The textbook uses different names for the same two formulas depending on which input you’re analyzing:
| What it measures | Materials | Labour | Variable Overhead |
|---|---|---|---|
| ”Did we pay too much?” | Materials Price Variance | Labour Rate Variance | Variable Overhead Spending Variance |
| ”Did we use too much?” | Materials Quantity Variance | Labour Efficiency Variance | Variable Overhead Efficiency Variance |
The names change because the unit of measurement changes (kg vs hours vs overhead-hours). The math is identical.
Sign rule: Because the formula is always (Actual − Standard):
- Negative = Favourable (F) — actual was less than standard
- Positive = Unfavourable (U) — actual was more than standard
The three-column model
The textbook presents variance analysis using three columns. The middle column is the ceteris paribus pivot point:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| AQ × AP | AQ × SP | SQ × SP |
| What actually happened | Actual quantity at standard price | Standard quantity at standard price |
| (Actual costs) | (The pivot column) | (Flexible budget) |
- Column 1 vs Column 2 = Price variance (price changes, quantity held at actual)
- Column 2 vs Column 3 = Quantity variance (quantity changes, price held at standard)
The middle column creates the clean split by holding price at standard — isolating the two effects so each can be attributed to the responsible manager.
Favourable does NOT mean good
A favourable price variance (paid less) might mean lower-quality inputs were purchased — causing an unfavourable quantity variance (more waste). The purchasing manager looks good while creating problems for production. Always ask: are the price and quantity variances causally linked?
Beyond the Textbook
The price-quantity trade-off frontier. Cheaper inputs save on price but cost on quantity (waste). Expensive inputs cost on price but save on quantity (less waste). The optimal point is an equilibrium — similar to supply and demand. In a service business: the cheaper freelancer takes longer and needs more revisions; the expensive one nails it first try. Total cost depends on where you sit on this curve. (Research needed — does cost accounting literature formalize this trade-off?)
How to: Price and quantity variances computed for any variable cost input
Use when: Given actual and standard data for materials, labour, or variable overhead and asked to compute variances.
Given: Identify these from the problem before starting:
- Actual quantity (AQ) and actual price/rate (AP/AR)
- Standard quantity per unit (SQ per unit) and standard price/rate (SP/SR)
- Actual output (units produced)
Step Result Formula/Action 1 Standard quantity allowed (SQ) determined SQ = Actual output × Standard quantity per unit 2 Price-type variance computed AQ × (AP − SP). Negative = F, Positive = U 3 Quantity-type variance computed SP × (AQ − SQ). Negative = F, Positive = U 4 Net variance verified Price variance + Quantity variance should equal total variance (AQ × AP − SQ × SP) Sanity checks:
- Did I use ACTUAL quantity as the multiplier for the price variance?
- Did I use STANDARD price as the multiplier for the quantity variance?
- Do the two variances sum to the total flexible budget variance?
Final answer looks like: “X,XXX U” for each variance, with the correct name for the input type (price/rate/spending for price-type; quantity/efficiency for quantity-type).
Watch for: Use the correct name from the Rosetta Stone for the specific input you’re analyzing.
Why people get the multiplier wrong
The instinct is “price variance = multiply by price.” But the DIFFERENCE is about prices — the MULTIPLIER is the other variable (quantity), at ACTUAL. For quantity variance, the DIFFERENCE is about quantities — the MULTIPLIER is price, at STANDARD. The multiplier is always inverted to what you’re measuring, and its version (actual vs standard) follows from responsibility accounting.
Quick Reference: Variable Cost Variances (LO2-4)
Trigger: Given actual and standard data, compute variances for materials, labour, or variable overhead.
- SQ = Output × Std qty per unit
- Price-type = AQ × (AP − SP) → name: Price / Rate / Spending
- Quantity-type = SP × (AQ − SQ) → name: Quantity / Efficiency / Efficiency
Watch for: Multiplier inverted to what you’re measuring. Price-type = actual qty. Qty-type = standard price. Sign rule: Negative = F, Positive = U
Key Vocabulary (LO2-4)
Standard Quantity Allowed (SQ)
Definition: The amount of input that SHOULD have been used to produce the actual output — computed as actual output × standard quantity per unit. Example: Produced 2,000 units with a standard of 3 kg/unit → SQ = 6,000 kg. Even if you actually used 6,500 kg, the standard allows 6,000. Trap: This is NOT the standard for planned output. It’s the standard for ACTUAL output. If you planned to make 2,500 units but only made 2,000, SQ is based on 2,000. Connects to: Flexible budget (Ch9) — the flexible budget adjusts for actual volume, and SQ does the same thing at the input level.
Glossary (LO2-4)
Variance — the difference between actual results and what the standard said should happen Favourable (F) — actual cost was less than standard cost (negative result in the formula) Unfavourable (U) — actual cost was more than standard cost (positive result in the formula) Variance analysis cycle — prepare performance reports → identify significant variances → investigate root causes → take corrective action → repeat
3. The Fixed Overhead Problem (LO5, LO6)
Why does fixed overhead need different treatment?
Fixed overhead can't be split into "did we pay too much per unit?" and "did we use too much?" because it isn't purchased in measurable units. It's a lump sum — rent, depreciation, supervisory salaries.
Variable costs have a rate × quantity structure: 12. You can decompose any gap into a price piece and a quantity piece.
Fixed costs don’t work this way. You can’t say “we bought 12 units of rent at $X per unit.” So the variance analysis takes a different form — only two variances instead of the usual price/quantity split.
Why no efficiency variance for fixed overhead? Because using more or fewer hours doesn’t change fixed costs. If workers take 5,400 hours instead of 5,000, fixed overhead is still $300,000. Extra hours cause more variable overhead cost (more lubricants, more power) but zero additional fixed overhead. Efficiency variances only exist for costs that CHANGE when activity changes.
What is the POHR and why does it exist?
The predetermined overhead rate (POHR) exists to stabilize product costs by spreading fixed overhead evenly across units all year, rather than letting per-unit costs fluctuate with monthly production volume.
The problem it solves: Without the POHR, the same product gets different unit costs depending on which month it’s produced:
| Month | Fixed OH | Units | Cost per unit |
|---|---|---|---|
| January | $25,000 | 1,000 | $25.00 |
| February | $25,000 | 1,500 | $16.67 |
| March | $25,000 | 800 | $31.25 |
The POHR picks ONE rate at the start of the year and holds it constant. Every unit gets the same fixed overhead charge regardless of when it’s produced.
The trade-off: Stability in unit costs, but we’re treating fixed costs as if they were variable — 6 of fixed overhead. It doesn’t. This artificial treatment is what creates the volume variance.
What is denominator activity?
Denominator activity is the number on the bottom of the POHR formula — the estimated level of activity (DLH, machine-hours) planned for the year. It's the same thing as "activity base" (Ch5), "allocation base," and "cost driver" — just renamed to emphasize its role in variance analysis.
| Chapter | What they call it | What it actually is |
|---|---|---|
| Ch5 | Activity base, allocation base | The denominator of POHR |
| Ch7 | Cost driver | Same — what causes overhead to be incurred |
| Ch10 | Denominator activity | Same — now emphasizing that the PLANNED level matters for variance analysis |
The POHR can be broken into variable and fixed components:
| Component | Amount | ÷ Denominator Activity | Rate per DLH |
|---|---|---|---|
| Variable overhead | $150,000 | ÷ 50,000 DLH | $3.00 |
| Fixed overhead | $300,000 | ÷ 50,000 DLH | $6.00 |
| Total | $450,000 | $9.00 |
What are the two fixed overhead variances?
Budget variance — did we spend what we planned?
The budget variance is straight subtraction. No multiplier. The only variance in this chapter that works this way — because fixed overhead isn't measured in units.
The mental model rule: If it’s measured in units → it has a multiplier. If it’s NOT measured in units → no multiplier, just subtraction. The budget variance is the only one in this chapter not measured in units.
Volume variance — did we use our capacity as planned?
The volume variance measures whether we produced at the activity level we planned. It converts the gap between planned and actual capacity utilization into dollars.
| Term | What it is | NOT the same as |
|---|---|---|
| Denominator hours | What we PLANNED to operate at | Actual hours worked |
| Standard hours allowed | What actual production EARNED | Actual hours worked |
Neither number in the volume variance is actual hours. It compares the plan to what production earned.
- Produced more than planned → applied more fixed OH than budgeted → favourable
- Produced less than planned → applied less fixed OH than budgeted → unfavourable
This connects directly to operating leverage: producing more units spreads the same fixed costs thinner, driving down per-unit cost.
The volume variance measures capacity utilization, NOT overspending
A company incurs the same fixed costs regardless of activity level. The volume variance exists because we TREAT fixed costs as if they were variable (through the POHR). It’s the error created by that artificial treatment.
How do the four overhead variances connect to under/overapplied overhead?
The four overhead variances (two variable + two fixed) break down the total under/overapplied overhead into pieces that explain WHY overhead was under or overapplied.
| Variance | Amount | F/U | What it tells management |
|---|---|---|---|
| Variable spending | $810 | F | Saved on variable OH prices |
| Variable efficiency | $1,200 | U | Wasted variable OH through inefficient hours |
| Fixed budget | $2,500 | U | Spent more on fixed OH than budgeted |
| Fixed volume | $5,000 | F | Produced more than planned — better capacity utilization |
| Total | $2,110 | F | Overhead is overapplied by $2,110 |
The mapping:
- Favourable total → Overapplied (applied more to products than we actually spent — we over-collected)
- Unfavourable total → Underapplied (spent more than we applied to products — we under-collected)
Instead of just knowing “overhead was overapplied by $2,110,” the four variances tell the full story of where the money went.
Confusion Flag — Fixed vs Variable Input Error (V1 pattern)
What happened: Asked “if company produces more than planned, is OH underapplied or overapplied?” Answered underapplied (wrong).
The broken input: Treated fixed overhead as if it increases with production — applied variable cost thinking to a fixed cost. The debit/credit framework from Ch5 was valid, but the INPUT assumed “produced more → spent more,” which is only true for variable costs.
What landed: The two-bucket model. Bucket 1 (actual fixed OH) doesn’t move. Bucket 2 (applied) grows with production. More production → applied > actual → overapplied.
Defence: Before tracing any overhead mechanism, stop and ask: “Is this cost fixed or variable?” If fixed → actual spending doesn’t change with volume. Only the applied side moves. Same V1 pattern as ECON midterm prep — mechanism correct, initial reading wrong.
How to: Fixed overhead budget and volume variances computed
Use when: Given actual and budgeted fixed overhead data with denominator activity and actual output.
Given: Identify these from the problem before starting:
- Actual fixed overhead cost
- Budgeted fixed overhead cost
- Denominator activity (hours) — may need to convert from annual to monthly (÷ 12)
- Standard hours allowed for actual output (= actual units × standard hours per unit)
- Fixed portion of POHR
Step Result Formula/Action 1 Budget variance computed Actual fixed OH − Budgeted fixed OH. No multiplier. 2 Volume variance computed Fixed POHR × (Denominator hours − Standard hours allowed) 3 F/U labels applied Negative = F, Positive = U Sanity checks:
- Budget variance: did I use JUST subtraction? (No multiplier — only variance in this chapter without one)
- Volume variance: did I use denominator hours and standard hours allowed (NOT actual hours)?
- Is this cost FIXED? (If yes → actual spending doesn’t change with volume)
Final answer looks like: “X,XXX U” for each variance.
Watch for: Ask “fixed or variable?” BEFORE calculating. Fixed costs don’t change with activity.
Why people apply variable cost thinking to fixed overhead 6/hour), which reinforces the wrong instinct. When you see a per-unit fixed rate, remember: it's an artificial construct for product costing, not a real cost behaviour.
The instinct is “more production → more cost.” True for variable costs, false for fixed costs. Fixed overhead is the same
Quick Reference: Fixed Overhead Variances (LO5-6)
Trigger: Given fixed overhead data, compute budget and volume variances.
- Budget = Actual FOH − Budgeted FOH (no multiplier — just subtraction)
- Volume = Fixed POHR × (Denominator hrs − Standard hrs allowed)
- Negative = F, Positive = U
Watch for: “Is this fixed or variable?” before calculating. Neither number in volume variance is actual hours. Connection: Four OH variances sum to total under/overapplied. Favourable = overapplied. Unfavourable = underapplied.
Key Vocabulary (LO5-6)
Denominator Activity
Definition: The estimated level of activity (DLH, machine-hours) used as the denominator when computing the POHR at the start of the year. Same concept as activity base, allocation base, and cost driver — renamed to emphasize its role in variance analysis. Example: Heirloom Pewter plans 50,000 DLH for the year → denominator activity = 50,000 DLH. Monthly: 50,000 ÷ 12 = 4,167 DLH. Trap: This is the PLANNED level, not actual. It stays fixed all year even if actual activity differs — that’s the whole point (stability in unit costs). Connects to: POHR as Methodology Choice, FMGT-2294 Chapter 5 - Notes from the Textbook
Volume Variance
Definition: Measures whether production utilized plant capacity as planned — the gap between denominator hours (planned) and standard hours allowed (earned by actual production), converted to dollars by the fixed POHR. Example: Planned 4,167 DLH, earned 5,000 DLH through production → produced more than planned → 4,998 F. Trap: This is NOT about spending. Fixed costs are the same regardless. It’s about whether you captured the operating leverage of spreading fixed costs over more units. Also: neither number is actual hours worked. Connects to: Operating leverage, Variable vs Fixed Costs
Budget Variance (Fixed OH)
Definition: The difference between actual fixed overhead spent and the budgeted amount. Simple subtraction — no multiplier — because fixed overhead isn’t purchased in measurable units. Example: Actual fixed OH 25,000 = $2,500 U. Supervisory salaries were higher than planned. Trap: Don’t try to apply the (Actual − Standard) × multiplier pattern here. This is the ONE variance in Ch10 that’s just subtraction. Connects to: Flexible budget (Ch9)
Glossary (LO5-6)
POHR (Predetermined Overhead Rate) — estimated overhead cost per unit of activity base, computed at start of year to stabilize product costs; denominator = denominator activity Normal cost system — applies overhead using actual hours × POHR (Ch5 approach) Standard cost system — applies overhead using standard hours allowed × POHR (Ch10 approach) Overapplied overhead — applied more overhead to products than actually incurred; total overhead variance is favourable Underapplied overhead — applied less overhead to products than actually incurred; total overhead variance is unfavourable
4. Putting It All Together (LO7)
What is a performance report?
A performance report breaks down each overhead item individually and shows the spending/efficiency variances for each line item — so managers can see WHICH specific overhead item caused the problem, not just the total.
The performance report takes the aggregated variances we computed in §2 and §3 and decomposes them further by line item:
| Line Item | Actual | Budget (Actual Hours) | Budget (Standard Hours) | Spending Variance | Efficiency Variance |
|---|---|---|---|---|---|
| Indirect labour | $7,830 | $8,100 | $7,500 | $270 F | — |
| Lubricants | $5,022 | $5,400 | $5,000 | $378 F | — |
| Power | $2,538 | $2,700 | $2,500 | $162 F | — |
| Depreciation | $10,000 | $10,000 | $10,000 | $0 | — |
| Supervisory salaries | $14,000 | $12,000 | $12,000 | $2,000 U | — |
Fixed overhead items have NO efficiency variance
Notice depreciation and supervisory salaries show the same budget amount in both the “actual hours” and “standard hours” columns. Fixed costs don’t change with activity — so there’s no efficiency effect to measure. Only the budget (spending) variance applies.
How do managers decide which variances to investigate?
Two dimensions — absolute and relative — plus trend over time. Not every variance is worth investigating.
| Criterion | What it measures | Frame |
|---|---|---|
| Dollar amount | Is the variance large enough to matter? | Absolute — the raw number |
| Percentage of spending | Is the variance large relative to the spending category? | Relative — 5,000 item (10%) matters more than 500,000 item (0.1%) |
| Trend over time | Is the variance growing period over period? | Pattern — five consecutive 2,500 drift, even if no single variance triggers investigation |
Investigate to understand, not to blame
The textbook explicitly states: “Variance analysis should not be used to assign blame. The goal is to improve operations.” The question is “what happened and why?” not “whose fault is it?”
Favourable variances can be worth investigating too
A favourable materials quantity variance (used less material) could mean products are being made with less material than the standard calls for — resulting in lower quality. Harvey’s putting less meat in a burger is “favourable” on paper but terrible for the business.
What is capacity analysis?
Capacity analysis evaluates the financial impact of NOT fully using available productive capacity — it puts a dollar value on idle capacity.
Three levels of capacity, mapping directly to the ideal/practical distinction from LO1:
| Level | Definition | Analogy to Standards |
|---|---|---|
| Theoretical capacity | 24/7/365, no downtime whatsoever | Ideal standard — unattainable baseline |
| Practical capacity | Theoretical minus unavoidable downtime (maintenance, setup) | Practical standard — achievable benchmark |
| Denominator activity | What was actually planned for the period | The specific operating plan |
The analysis computes operating income at each level to show the opportunity cost of operating below capacity. The gap between practical capacity and actual output represents capacity you’re paying for but not using.
Beyond the Textbook
Capacity analysis for personal productivity. The same framework applies to any fixed-cost resource: your time, your tools, your subscriptions. A Claude Max subscription at $200/month has a fixed cost regardless of usage. Days when you don’t use it are idle capacity — the fixed cost depreciates whether you use it or not. Capacity analysis asks: what’s the financial impact of that idle time, and can you fill it with background work? This connects to operating leverage — spreading fixed costs over more output drives down per-unit cost, whether the “factory” is a pewter workshop or a solo consulting practice.
Glossary (LO7)
Performance report — detailed report showing actual vs budget for each individual overhead item, with spending and efficiency variances per line item Theoretical capacity — maximum possible output with no downtime, 24/7/365; analogous to ideal standards Practical capacity — theoretical capacity minus unavoidable downtime; analogous to practical standards Capacity analysis — evaluating the financial impact of operating below full capacity; measures opportunity cost of idle resources