Cost-Volume-Profit (CVP) Analysis, Standard and Variance Analysis

Formula for Contribution margin and Gross Profit

Sale xx

VC (xx)

CM xx

FC (xx)

GP xx

Inherent Simplifying Assumptions of CVP Analysis

1. All costs are classifiable as either variable or fixed

2. Cost and revenue relationships are predictable and linear over a relevant range of activity and a specified period of time

3. Total variable costs change directly with the cost driver, but variable costs per unit are constant over the relevant range

4. Total fixed costs are constant over the relevant range, but fixed costs per unit vary inversely with the cost driver

5. Selling prices per unit and market conditions remain unchanged

6. Production equal sales, there is no change in inventory

7. If the company sells multiple products, sales mix is constant.

8. Technology, as well as productive efficiency, is constant

9. The time value of money is ignored.

It is the point in peso sales volume where the peso profits of the two companies are equal to the peso volume where total cost are equal

Indifference Point

It is a measure of acceptable performance established by management as a guide in making economic decisions.

Standard

It indicates the quantity of raw materials or labor time required to produce a unit of product or to provide services.

Quantity Standard

It indicates what the cost of the quantity standards should be

Cost Standard

Users of Standard Costs

1. Manufacturing Firms

2. Service Firms

3. Non-profit Organizations

A standard cost system may be used in both job order and process costing systems (T/F)

True

Advantages of using standard costs

1. It serves as a key element in the application of management by exception, management by objectives, and responsibility accounting

2. It promotes economy and efficiency among employees

3. It simplifies bookkeeping and costing procedures

It is the difference between the actual costs and standard costs

Variance

When actual cost is less than standard cost (credit balance)

Favorable

When actual cost is greater than standard cost (debit balance)

Unfavorable

Standard Costing Control Loop

1. Establish standards

2. Measure actual performance

3. Compare actual performance with standard

4. Analyze the variances

5. Investigate the variances that are material or significant in amount

6. Take corrective action when needed. This may include revision of standards.

Only those variances that are material or significant in amount, whether favorable or unfavorable, should be investigated.

Management by exception

Two types of standards

1. Ideal Standards

2. Practical Standards (Attainable Standards)

It is only attainable only under the best circumstances. Also called Theoretical or Maximum-Efficiency Standards, they require perfect performance: no allowance for machine breakdown, work interruption, wastages, etc., 100% of the time

Ideal Standards

It is tight, but attainable standards. They allow for normal machine downtime and employee rest-periods, normal wastages, and work interruptions. These standards are attainable under normal though highly efficient operating conditions.

It is also the standards that normally used for product costing and cash budgeting purposes.

Practical Standards

It should reflect the final, delivered cost of materials, net of any discount and inclusive of allowances for handling costs

Standard Price per Unit

It should reflect the units of materials required to produce each unit of product, including allowances for unavoidable wastages, spoilage, as well as other normal inefficiencies.

Standard Quantity per Unit

It is a systematically pre-determined costs established by the management to be used as a basis for comparison with actual cost.

Standard cost

When standard costs are used for inventory valuation, and variances are immaterial/insignificant, the treatment for this is

written-off to cost of goods sold

When standard costs are used for inventory valuation, and variances are material/significant, the treatment for this is

It is allocated to ending Work-in-Progress, Finished goods, and COGS