Chapter 6:
Standard costing and variance analysis
Standard Costing & Variance Analysis
• Management Accounting Control System
broad approach to control systems
. financial and non-financial controls
this chapter: examines detailed financial controls
& revenue centres profit & investment centres
(this chp.) (chp 5 & 6)
Standard Costing & Variance Analysis
• Financial control systems operated in std. cost centres
std. costing system (Variance analysis)
enables any deviations from budgets to be analysed in detail
able to measure output & input required to produce each unit of output, and
hence control cost more effectively especially for manufacturing activities
• Std. cost: predetermined costs on per unit basis
• Budgeted cost: predetermined cost on entire activity
..: Budgeted outputs = 10,000 units
Std. cost is £3 p/unit
Hence, budgeted cost is = £3 x 10,000 units = £30,000
1)Standard Costing System
• Std. Costing System
suitable for manufacturing organisations
- because activities are repetitive & series of common operations
- because output can be measured with input being specified to produce p/unit
output
- applied to organisations that produce large product range with few number of
operations
Standard Costing System
An overview of a
standard costing
system
Standard Costing System
• In establishing variances, comparison is made between total std. cost & total
actual cost per operation cost
hence, variances are allocated to responsibility centres (operations) and so
managers are responsible for variances in own responsibility centres.
Effective control
• Cannot compare std. product cost with actual product cost
as each product may involve combination of different operations
so which manager is responsible for variance and how can control be achieved
effectively?
Once variances are allocated to responsibility centres, managers
analyse according to Price & Quantity
Investigation is done as to why variance occurred so that corrective
actions can be taken
Eg.: Maybe excessive usage of DM, and if so why?
Standard Costing System: Example
Operation of a standard costing system
Comparison is made between total std cost & total actual cost to establish
variances according to operations / responsibility centres
2) Std. Cost
Direct Material Std. Direct Labour Std. Std.
Std. Qty (of input) x / Hours
Std. Price (of input) x Std. Wage Rate
Flexible O/H Fixed O/H
Produced -largely
x Hourly O/H Rate independent of
changes in
produced activity
= actual output (units) -remains constant
x / time p/unit produced over a wide range
of activities in
short term
- std. hours produced is an output measure
- flexible budget allowances are based on
std. hours produced
3) Purposes of Std Costing System
(a) Provides prediction of future costs that can be used for decision making
(b) Provides a challenging target for individuals to achieve
clearly defined target increases motivation increases performance
these challenging targets are quantitative and motivates higher performance
than non-quantitative targets
(c) Assist in budget setting and evaluating managerial performance
(d) Act as control device
when std. is compared to actual variances are highlighted, analysed,
investigated corrective actions are taken to adjust std. performance
(e) Helps managers to control costs at own responsibility centres & to be
more accountable as variances are allocated to responsibility centres
4) Variance Analysis
Std Variable / Marginal Costing System Std Absorption Costing System
Profit Variance (diff. bet. Budgeted & actual profit)
Selling & var. Total production cost var. Total sales margin var.
Sales margin Sales
price var. margin
. volume var.
Total DM Var. Total DL Var. Total Variable Fixed O/H Exp. Var.
O/H Var.
Material Price Wage / Labour Variable Variable Efficiency
var. rate var. Exp. var. var.
& &
Material Usage Labour Efficiency
var. var.
(a) Material Price Variance
Refer to . (pg 426)
(Std Price – Actual Price) x Actual Quantity Purchased
(SP – AP) × AQP
Material A (£10 - £11) x 19 000kg = £19 000 Adverse (A)
Material B (£15 - £14) x 10 100kg = £10 100 Favourable (F)
Adverse: maybe because general price increase; external conditions in
market; failure to source for correct suppliers
Favourable: could also be source of supplies of inferior quality – hence
cheaper; general price decrease; manage to secure good but cheap
supplies
(b) Material Usage Variance
(Std Quantity for Actual Output – Actual Quantity for Actual Output) x Std Price
(SQ – AQ*) × SP
Material A [(2 kg x 9 000) - 19 000] x £10 = £10 000 A
Material B [(1 kg x 9 000) - 10 100] x £15 = £16 500 A
Adverse: careless handling of material by worker; wastage; purchase of
inferior material and therefore wastage; changes in methods of production.
Favourable: effective & efficient material handling; better production
methods to decrease wastage of materials etc.
* -So evaluation is done on budgeted figures but actual situation
- More comparable to actual results as condition is same
- Manager also evaluated on more valid / realistic results
(c) Total Material Variance
Std Material Cost for Actual Output – Actual Material Cost for Actual Output
SMC - AMC
Material A (£20 x 9 000 units) - £209 000 = £29 000 A
Material B (£15 x 9 000 units) - £141,400 = £6,400 A
or
Material Price Variance + Material Usage Variance
Material A = £19 000A + £10 000A =£29 000A
Material B = £10 100 F+ £16 500 A = £6 400 A
d) Labour / Wage Rate Variance
(Std Rate – Actual Rate) x Actual Hours Worked
(SR – AR) x AH
= (£9 - £) x 28 500 hrs = £17 100A
e) Labour Efficiency Variance
(Std Hours for Actual Output – Actual Hours for Actual Output) x Std Rate
(SH – AH) x SR
= [(3 hrs x 9 000) – 28 500] x £9 = 13 500A
Adverse: poor production scheduling; changes in quality control; changes
in production method / process; new equipment / tools; inferior material;
different grades of labour; improper usage of machinery
f) Total Labour Variance
Std Labour Cost for Actual Output – Actual Labour Cost for Actual Output
SLC - ALC
= (£27 x 9 000 units) - £273 600 = £30 600 A
or
Labour Rate Variance + Labour Efficiency Variance
= £17 100 A + £13 500 A = £30 600 A
g) Variable O/H Expenditure Variance
(Budgeted Flexed Variable O/H Rate for Actual Direct Labour Hours) –
(Actual Variable O/H Rate for Actual Direct Labour Hours)
BFVO – AVO
= (£2 x 28 500hrs) - £52 000 = £5 000F
h) Variable O/H Efficiency Variance
(Std Hours for Actual Output – Actual Hours for Actual Output)
x Std Variable O/H Rate
(SH – AH) x SR
= [(3 hours x 9 000) - 28 500] x £2 = £3 000A
i) Total Variable O/H Variance
Std Variable O/H Cost for Actual Output –
Actual Variable O/H Cost for Actual Output
SVOC – AVOC
= (£6 x 9 000 units) - £52 000 = £2 000 F
or
Variable O/H Expenditure Var. + Variable O/H Efficiency Var.
= £5 000 F + £3 000 A = £2 000 F
Variable O/H: indirect labour; indirect material; electricity; maintenance
variances due to change in these prices and how efficiently they are
used
variable o/h varies with direct labour hours, machine hours or output ut
j) Fixed O/H Expenditure
Budgeted Fixed O/H – Actual Fixed O/H
BFO - AFO
= £120 000 - £116 000 = £4 000 F
- Fixed O/H are fixed for the period in which it is incurred
hence, fixed o/h does not change towards changes in level of activity
over the short term
- BUT other causes of changes include changes in price such as
changes in salaries of supervisors / need to get additional supervisors
hence uncontrollable in short term
k) Sales Margin Price Variance
(Actual Contribution Margin p/unit – Std Contribution Margin)
x Actual Sales Volume
(AM* – SM) x AV
= (£22* - £20) x 9 000 units = £18 000 F
* (Actual sales price – Budgeted sales price) + Std Contribution Margin
= (£90 - £88) + £20 = £22
l) Sales Margin Volume Variance
(Actual Sales Volume – Budgeted Sales Volume) x Std Contribution Margin
(AV – BV) x SM
= (9 000 units – 10 000 units) x £20 = £20 000 A
- Based on contribution margin and not sales price
- Affected through competitors’ price and recession
m) Total Sales Margin Variance
Actual Contribution Margin – Budgeted Contribution Margin
ACM – BCM
= £198 000* - £200 000** = £2 000A
* Actual Sales Revenue – Std Variable Cost for Actual Sales Volume
(£90 x 9 000 units) – (£68 x 9 000 units) = £198 000
** Budgeted Sales Revenue – Budgeted Variable Cost
(£88 x 10 000 units) – (£68 x 10 000 units) = £200 000
or
Sales Margin Price Var. + Sales Margin Volume Var.
= £18 000 F + £20 000 A = £2 000A
6) Reconciling Budgeted Profit & Actual Profit through Std Variable /
Marginal Costing System
£ £ £
Budgeted net profit 80 000
Total Sales variances:
Sales margin price 18 000 F
Sales margin volume 20 000 A 2 000 A
Total Direct cost variances:
Material: Price 8 900 A
Usage 26 500 A 35 400 A
Labour: Rate 17 100 A
Efficiency 13 500 A 30 600 A
Total Manufacturing overhead variances:
Fixed overhead expenditure 4 000 F
Variable o/h expenditure 5 000 F
Variable o/h efficiency 3 000 A 6 000 F 62 000 A
Actual profit 18 000
Standard absorption costing
1. For financial accounting (stock valuation) fixed overheads must be allocated to
results in a volume variance.
2. Fixed overhead rate = budgeted fixed overhead = £12 per unit
budgeted activity (10 000 units)
or £120 000 /30 000 hours = £4 per standard hour = £12 per unit (3 ×£4).
3. If actual production is different from budgeted production, a volume variance will
arise:
Actual production = 9 000 units or 27 000 SHP
Budgeted production = 10 000 units or 30 000 SHP
Volume variance = 1 000 units × £12 or (3 000 SHP ×£4) = £12 000A
Volume variance = (AP – BP) × SR
4. Volume variances are not useful for cost control since FC are sunk costs.
5. Sometimes analysed into two sub-variances (capacity and efficiency):
(A) Budgeted hours of input and output = 30 000
(B) Actual hours of input = 28 500
(C) Actual hours of output = 27 000
Volume variance = A – C = 3 000 hours (£12 000)
Capacity variance = A – B = 1 500 hours (£6 000)
Efficiency variance = B – C = 1 500 hours (£6 000)
Reconciliation of budgeted and actual profit (absorption
costing)
To reconcile the budget and actual profit with an absorption costing
system,the sales volume margin variance is measured at the standard
profit margin (and not the contribution margin), 000 units × £8 = £8
000.
