CHAPTER TEN - Standard Costing and Variance Analysis

Variance analysis is

a quantitive investigation of the difference between actual and planned behaviour

A fixed budget is one

that is prepared for the expected level of production and not adjusted for actual production or output.

A flexible budget recognises

different cost behaviour patterns and can change as the volume of activity changes.

Cost behaviour refers to

how costs change in relation to changes in business activity levels

• fixed, variable, or semi-variable

Behaviour of Total Costs as Activity levels rise:

VC - Increases

FC - Remains Constant

SV - Increases

Behaviour of Cost/Unit as Activity Level Increases:

VC - same per unit

FC - reduces (spread over more units)

SV - reduces

Favourable Variances occur when

actual performance is better than budgeted

Adverse Variances happen when

actual performance is worse

Standard Costing is

the budgeted cost per unit

The predetermined estimate cost of a product is the

standard cost

The standard costs can be

compared to the actual costs

Standard Costs on a cost card are based on

the expected costs per unit:

• usage of resources

• price per unit of resources

Standard Costing can be used to:

• produce budgets/forecasts

• compare actual performance to budgeted performance

Advantages of Standard Costing

• aids more accurate budgeting

• provides a benchmark where actual costs can be measured

• set efficiency targets for staff

• creating a cost conscious mindset

• allows variance analysis to take place

• can simplify bookkeeping

• motivate staff

Disadvantages of Standard Costing

• hard to apply in service industries that are labour delivered

• harder to standardise the service provided

Budget Flexing is when

the total difference between standard and actual results is analysed

Flexed Budgets should be compared with

what actually happened

Fixed Budgets should

not be used to compare with actuals

Fixed Costs should

not get flexed, as they stay the same.

Sales Price Variance is

(budgeted selling price - actual selling price) x actual units sold

Adverse Materials Variance can be caused by:

• materials costing more

• using more materials per unit

Favourable Labour Variance can be caused by:

• working faster per unit

• cheaper labour per hour

Material Variances are

actual cost of materials used - standard cost expected for actual production level (flexed)

Labour variances are

actual costs incurred - standard labour costs expected for actual production level

Material Variances can be broken down into:

• price variance

• usage variance

The production levels are always at

actual level

The Materials Usage Variance focuses on

the amount of material used

The Materials Price Variance focuses on

the price paid for the materials

Materials Usage Variance is the difference between

standard quantity of materials/unit and the actual quantity of materials/unit, valued at the standard price of material

Materials Price Variance is the difference between

standard cost and the actual cost, at the actual quantity of materials used/purchased

Whether the price variance is calculated on actual materials used/ actual materials purchased depends on

the valuation of closing inventory

If closing inventories are valued at standard cost,

price variance should be calculated at actual materials purchased

If closing inventories are valued at actual cost,

price variance should be calculated at actual materials used

Total Material Variance =

(Actual Units Produced x Budgeted Materials Cost/Unit) - Actual Total Materials Cost

Materials Usage Variance

(Actual Units produced x Budgeted materials cost/unit) - (Actual Total Material Quantity x Budgeted Material price/kg)

Material Price Variance

(actual total material quantity x budgeted material cost per kg) - actual total materials price

The materials total variance is

the materials usage variance + materials price variance

When working out the materials usage variance,

work out difference in materials (kg/l) and then multiply by standard cost

The Total Labour variance measures

the difference between standard labour cost of output and the actual labour cost incurred

Labour Variance is driven by:

• labour efficiency variance

• labour rate variance

Labour efficiency variance focuses on

number of hours worked

• similar to materials usage

Labour Rate Variance focuses on

the rate paid per hour

Labour Efficiency Variance is the

(budgeted hours - actual hours) x standard rate/hour

Labour Rate Hour is the

(Actual total labour hours x Budgeted labour cost/hour) - Actual Total Labour cost

Variable Overheads Variance are similar to

labour variances

Variable Overheads are split into:

• variable overhead efficiency variance (numbers of hours worked)

• variable overhead expenditure variance (overhead cost charged)

Variable Overhead efficiency is similar to

labour usage calculation

Variable Overhead expenditure is similar to

labour price

Variable overhead efficiency is

(how many hours should have been worked - how many hours were worked) x standard variable charge

Variable overhead expenditure is

what they should have cost - what the hours worked cost

All Variable Cost Variances have:

• total variance

• price/rate variance

• efficiency rate

Total Variances

• Use actual number of units

• compare standard cost and actual cost

Price/Rate Variance

• material - KGs, Litres

• Use actual usage

• compare standard cost/material and the actual cost/material

Efficiency Rate

• the actual units

• compared with standard and the actual

When there is variance analysis,

an operating statement is likely to be completed

An operating statement is

a schedule that reconciles the actual profit to the original profit

In an Operating Statement, the adverse figures

are not presented as negative

Causes of a Favourable Sales Volume

• efficient sales force

• successful advertising campaign

• potential market was larger than expected

• original budgeted sales were very conservative

Causes of an Adverse Sales Volume

• demotivated sales force

• competitor increased advertising effort

• budgeted sales are too optimistic

Causes of a Favourable Sales Price

• supply shortages - customers have to pay a higher price

• quantity discounts given to customers were lower than expected

• original standard selling price was set too low

Causes of an Adverse Sales Price

• supply surplus - customers wanted to pay less

• quantity discounts given to customers were higher than expected

• original standard selling price was set too high

Causes of Favourable Materials Usage

• materials is a higher quality

• more effective use made of material

• incorrect budgeting

Cause of Adverse Materials Usage

• defective material

• excessive waste

• theft

• stricter quality control

• errors in allocating material to jobs

Causes of a Favourable Materials Price

• unforeseen discounts received

• more care taken in purchasing

• material standard price is set too high

Causes of Adverse Materials Price

• price increase in the market

• careless purchasing

• material standard price has been set too low

Causes of a Favourable Labour Efficiency

• output produced more quickly because of motivation, better quality of equipment, or better methods

• errors in allocating time to jobs

Causes of Adverse Labour Efficiency

• Lost time in excess of standard allowed

• Output is lower than standard set

• lack of training

• substandard material used

• errors in allocating time to jobs

Causes of a Favourable Labour Rate

• using apprentices or lower paid staff

Causes of a Adverse Labour Rate

• pay rise

• better quality of staff

Inter-relationship with variances

where variances can be interrelated with another

• e.g. buying a lower quality of material - worse to work with/produce

Data bias can also apply to

variance analysis

If the favourable variances exceed adverse variances

this may suggest that the budget was deliberately misstated

• slack