F5 Performance Management

2 Section D: Standard Costing And Variance Analysis Designed to give you knowledge and application of: D1. Budgeting and standard costing D2. Basic variances and operating statements D3. Material mix and yield variances D4. Sales mix and quantity variances D5. Planning and operational variances D6. Behavioural aspects of standard costing D1. Budgeting and standard costing D2. Basic variances and operating statements D3. Material mix and yield variances D4. Sales mix and quantity variances D5. Planning and operational variances D6. Behavioural aspects of standard costing

3 D2: Basic variances and operating statements Learning outcomes  Calculate & identify the cause of, and interpret basic variances: [1] Sales price and volume Materials total, price and usage Labour total, rate and efficiency Variable overhead total, expenditure and efficiency Fixed overhead total, expenditure and, where appropriate, volume, capacity and efficiency  Explain the effect on labour variances where the learning curve has been used in the budget process. [2]  Produce full operating statements in both a marginal cost and full absorption costing environment, reconciling actual profit to budgeted profit. [2]  Calculate the effect of idle time and waste on variances including where idle time has been budgeted for. [2]  Explain the possible causes of idle time and waste, and suggest methods of control. [2]  Calculate, using a simple situation, ABC-based variances. [3]  Explain the different methods available for deciding whether or not to investigate a variance cause. [2]

4 Favourable if Actual sales revenue > Standard sales revenue Variances Cost related variances Revenue related variances (sales variance) Favourable if Actual cost < Standard cost Basic variances Causes of variances  Inaccurate recording of actual costs and revenues  Random events  Operating efficiency  Setting inappropriate standard Variances can be split into two types:  Price difference: compare the actual price with the standard price for actual quantity  Volume difference: compare the actual quantity with the standard quantity for standard price

5 Sales variances & Material variances Total sales value variance = Actual sales – Budgeted (Standard) sales Sales price variance = Actual quantity (Actual selling price – Standard selling price) Sales volume variance = Standard price (Actual quantity – Standard quantity) Direct material cost variance = Standard material cost for actual production – Actual material cost Direct material price variance = Actual quantity (Standard price – Actual price) Direct material usage variance = Standard price (Standard quantity for actual production – Actual quantity)

6 Labour variances Direct labour cost variance = Standard direct wages for production - Actual direct wages paid = (Standard labour hours for actual production x Standard wages rate per hour) - (Actual labour hours x Actual wages rate per hour) Direct labour rate variance = (Standard wages rate per hour - Actual wages rate per hour) x Actual labour hours Direct labour efficiency variance = (Standard labour hours for actual production – Actual labour hours worked) x Standard wages rate per hour Idle time variance = Hours lost x Standard wage rate per hour = (Hours paid - Hours worked) x Standard wage rate per hour

7 Variable overhead total, expenditure and efficiency variances Variable overhead total variance = Variable overhead absorbed - Actual variable overhead = (Variable overhead absorption rate per hour x Standard hours for actual production) - Actual variable overhead Variable overhead expenditure variance = (Standard variable overhead rate– Actual variable overhead rate) x Actual hours worked = Standard variable overhead for actual hours - Actual variable overhead Where, Standard variable overhead rate =Variable overhead absorption rate Variable overhead efficiency variance = (Variable overhead absorbed – Standard Variable overhead) = (Standard hours for actual production - Actual hours) x Standard variable overhead rate per hour

8 Fixed overhead total variance = (Standard hours for actual production x Fixed overhead absorption rate) - Actual expenditure on fixed overheads Fixed overhead expenditure variance = Budgeted fixed overhead - Actual expenditure on fixed overhead Fixed Overhead Volume Variances (FOVV) = Budgeted fixed overheads - (Fixed overhead absorption rate per hour x Standard hours for actual production) = (Budgeted hours - Standard hours require for actual production) x Fixed overhead absorption rate per hour Fixed overhead efficiency variance (FOEV)= (Standard hours for actual production - Actual hours worked) x Fixed overhead absorption rate Fixed overhead capacity variance = Budgeted fixed overheads - (Actual hours x Fixed overhead absorption rate) = (Budgeted hours – Actual hours) x Fixed overhead absorption rate Fixed overhead variances

9  Learning curve is the mathematical expression of the phenomenon that, when complex and labour intensive procedures are repeated, unit labour times tend to decrease at a constant rate.  The learning curve mathematically models this reduction in unit production time.  Effect of learning curve must be considered when setting the standard labour hours. The effect on labour variances where the learning curve has been used in the budget process Refer to example on page 335

10  Operating income under absorption costing is a function of both sales volume and production volume (i.e. changes in either of these volumes will affect operating income).  Since fixed costs are considered to be period costs in a marginal costing environment, this cost does not change with a change in volume. Produce full operating statements in both a marginal cost and a full absorption costing environment, reconciling actual profit to budgeted profit

11 Format of absorption costing operating statement $ Budgeted profitX Sales volume varianceX Flexed budget profitX Sales price varianceX Adjusted profitX Cost varianceFA - MaterialX(X)X - LabourX(X)X - Overheads (Both Fixed & Variable)X(X)X Actual profitX Add favourable variances & deduct adverse variances

12 Format of marginal costing operating statement $ Budgeted contributionX Sales contribution volume varianceX Flexed budget contributionX Sales contribution price varianceX Adjusted profitX Variable Cost variancesFA - MaterialX(X)X - LabourX(X)X - Variable OverheadsX(X)X Actual contributionX Budgeted fixed overheads(X) Fixed overheads expenditure varianceX-X Actual profitX Add favourable variances & deduct adverse variances Refer to example on page 337

13 The effect of idle time and waste on variances including where idle time has been budgeted for Idle time:  If idle time is included in standard cost: Idle time variance =(Standard idle time – Actual idle time) x Standard labour rate  If idle time is not included in standard cost: Idle time variance = Actual Idle hours x Standard labour rate Waste:  The material waste variance will get reflected in the yield variance whether the actual waste is more or less than the standard.

14 Variance analysis for variable set-up overhead cost Total variance for variable set-up overhead costs Variable setup overhead spending variance Variable overhead (of an activity) efficiency variance Actual costs incurred – flexible budget costs Actual variable cost/unit of allocation base – budgeted variable unit of allocation base (Actual quantity allocation base – budgeted QTY of allocation base) x budgeted VOH/allocation base ABC based variances Continued…

15 Methods of investigating Setting pre- determined criteria Statistical decision models Determining statistical probability to chart out in-control and out of control distribution Variance analysis for variable set-up overhead cost Fixed overhead (w.r.t an activity) variance or fixed overhead (w.r.t an activity) spending variance Production volume variance for FOH costs (w.r.t an activity) Actual costs incurred – flexible budget costs Budgeted FOH costs – FOH allocated with budgeted input allocated for actual output units produced Refer to Example on page 340 and Self Examination Question 3 on 349 Continued…

16 RECAP  Calculate & identify the cause of, and interpret basic variances: [1] Sales price and volume Materials total, price and usage Labour total, rate and efficiency Variable overhead total, expenditure and efficiency Fixed overhead total, expenditure and, where appropriate, volume, capacity and efficiency  Explain the effect on labour variances where the learning curve has been used in the budget process. [2]  Produce full operating statements in both a marginal cost and full absorption costing environment, reconciling actual profit to budgeted profit. [2]  Calculate the effect of idle time and waste on variances including where idle time has been budgeted for. [2]  Explain the possible causes of idle time and waste, and suggest methods of control. [2]  Calculate, using a simple situation, ABC-based variances. [3]  Explain the different methods available for deciding whether or not to investigate a variance cause. [2]