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Diagnostic Tests ACCA Paper F5 Performance Management

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ACCA Paper F5: PERFORMANCE MANAGEMENTDiagnostic Tests - Questions and Answers

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Main PageCopyright statementEnvironmental noticeFor the ladies onlyOur results speak for themselves …Test your knowledge now!Formulae sheetContents

Syllabus Study GuideThe structure of the syllabus A Specialist cost and management accounting techniquesIntellectual levels B Decision-making techniquesLearning hours C BudgetingGuide to exam structure D Standard costing and variance analysisGuide to examination assessment E Performance measurement and controlAimMain capabilitiesRelational diagram of main capabilitiesRationaleDetailed syllabusApproach to examining the syllabus

Diagnostic Test Topics1: Activity Based Costing (ABC) 8: Make or Buy and Other Short-Term Decisions2: Target Costing 9: Dealing with Risk and Uncertainty3: Life-Cycle Costing (LCC) 10: Budgetary Systems and Types of Budgets4: Backflush Accounting 11: Quantitative Analysis in Budgeting5: Throughput Accounting 12: Standard Costing and Variance Analysis6: Multi-limiting Factors and the Use of Linear Programming 13: Planning and Operational Variances7: Pricing Decisions 14: The Scope of Performance Measurement

ACCA Paper F5

Performance Management (PM)Diagnostic Test – Practice Questions & Answers

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ONLY TOPIC 12 IN THIS SAMPLE: Standard Costing and Variance AnalysisFor full version, go to www.tonysurridge.co.uk










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Diagnostic TestStandard Costing and

Variance AnalysisQuestions

ACCA Paper F5Performance Management









Question 1C Company uses a standard costing system. The standard cost card for one of its products shows thatthe product should use 4 kg of material B per finished unit and that the standard price per kg is $4.50. CCompany values its inventory of materials at standard prices.

During April when the budgeted production level was 1,000 units, 1,040 units were made. The actualmaterial quantity of material B used was 4,100 kg and material B inventories were reduced by 300 kg.

The cost of the material B which was purchased was $14,400.

The material price and usage variances for April were

Price Usage$ $

A 2,700 F 450 AB 2,700 F 270 FC 4,050 F 270 FD 2,700 F 1,620 F (3 marks)

Question 2S Company has extracted the following details from the standard cost card of one of its products.

Direct Labour 4.5 hours @ $6.40 per hour

During March, S Company produced 2,300 units of the product and incurred direct wages costs of$64,150. The actual hours worked were 11,700.

The direct labour rate and efficiency variances were

Rate Efficiency$ $

A 2,090 F 7,402 AB 2,090 F 8,640 AC 10,730 F 7,402 AD 10,730 F 8,640 A (2 marks)

Question 3The following details relate to product T, which has a selling price of $44.00.

$/unitDirect materials 15.00Direct labour (3 hours) 12.00Variable overhead 6.00Fixed overhead 4.00

37.00

During April, the actual production of T was 800 units, which was 100 units fewer than budgeted. Thebudget shows an annual production target of 10,800, with fixed costs accruing at a constant ratethroughout the year.

A

A


A








A

Actual overhead expenditure totaled $8,500 for April.

The overhead variances for April were

VolumeExpenditure variance

$ $

A 367 A 1,000 AB 500 A 400 AC 100 A 1,000 AD 100 A 400 A (2 marks)

Question 4Z Company uses a standard costing system and has the following labour cost standard in relation to oneof its products.

4 hours skilled labour @ $6.00 per hour $24.00

During October, 3,350 of these products were made which was 150 units less than budgeted. Thelabour cost incurred was $79,893 and the number of direct labour hours worked was 13,450.

The direct labour variances for the month were

Rate EfficiencyA $804 (F) $300 (A)B $804 (F) $300 (F)C $807 (F) $300 (A)D $840 (F) $3,300 (F) (2 marks)

Question 5J Company uses a standard costing system and has the following data relating to one of its products.

$ $Selling price 9.00Variable costs 4.00Fixed costs 3.00 7.00Profit per unit 2.00

Its budgeted sales for October were 800 units, but actual sales were 850 units. The revenue earnedfrom these sales was $7,480.

If a profit reconciliation statement were to be drawn up using marginal costing principles, the salesvariances would be

Price VolumeA $160 (A) $100 (F)B $160 (A) $250 (F)C $170 (A) $250 (F)D $170 (A) $100 (F) (2 marks)

A

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AQuestion 6T Company uses a standard costing system, with its material inventory account being maintained atstandard costs. The following details have been extracted from the standard cost card in respect of directmaterials.

8 kg @ $0.80/kg = $6.40 per unitBudgeted production in April was 850 units.

The following details relate to actual materials purchased and issued to production during April whenactual production was 870 units.

Materials purchased 8,200 kg costing $6,888Materials issued to production 7,150 kg

Which of the following correctly states the material price and usage variances to be reported?

Price UsageA $286 (A) $152 (A)

B $286 (A) $280 (A)C $286 (A) $294 (A)D $328 (A) $152 (A) (2 marks)

Question 7PG Company operates a standard costing system for its only product. The standard cost card is asfollows.

Direct materials (4 kg @ $2/kg) $ 8.00Direct labour (4 hours @ $4/hour) $16.00

Variable overhead (4 hours @ $3/hour) $12.00Fixed overhead (4 hours @ $5/hour) $20.00

Fixed overheads are absorbed on the basis of labour hours. Fixed overhead costs are budgetedat $120,000 per annum arising at a constant rate during the year.

Activity in period 3 is budgeted to be 10% of total activity for the year. Actual production during period 3was 500 units, with actual fixed overhead costs incurred being $9,800 and actual hours worked being1,970.

The fixed overhead expenditure variance for period 3 was

A $2,200 (F)B $200 (F)C $50 (F)D $200 (A) (2 marks)

A









AQuestion 8F Company has the following budget and actual data.

Budgeted fixed overhead cost $100,000Budgeted production (units) 20,000Actual fixed overhead cost $110,000Actual production (units) 19,500

The fixed overhead volume variance

A is $500 adverseB is $2,500 adverseC is $10,000 adverseD is $17,500 adverse (2 marks)

Question 9J Company operates a standard cost accounting system. The following information has been extracted

from its standard cost card and budgets.

Budgeted sales volume 5,000 unitsBudgeted selling price $10.00 per unitStandard variable cost $5.60 per unitStandard total cost $7.50 per unit

If it used a standard marginal cost accounting system and its actual sales were 4,500 units at a sellingprice of $12.00, its sales volume variance would be

A $1,250 adverse

B $2,200 adverseC $2,250 adverseD $3,200 adverse (2 marks)

Question 10Which of the following is likely to be a consequence of switching from labour intensive to automatedproduction systems in manufacturing industries?

A Ideal and attainable standards should now be the same.B Any reported variances are likely to be due to uncontrollable causes.

C The significance of any direct labour cost variances will be reduced.D It will not be possible to establish standard costing systems properly. (2 marks)

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A

The following data refers to Questions 11 - 13

Armenia Sling Company manufactures and sells a single product. Shown below is a summary of thebudget for the year and actual results.

Budget Actual

$ $ $ $Sales 500,000 600,000Direct materials costs 200,000 300,000Other costs (all fixed) 250,000 250,000

450,000 550,000Profit 50,000 50,000

Fanny Bone, the company's owner, made two decisions on 1 January (1st day of the year).

(1) She reduced the sales price of the product by 25% for all units sold in the year.

(2) She switched to a different supplier for direct materials, purchasing a lower qualitymaterial but obtaining a 20% reduction on the budgeted price. There were no inventoriesof direct materials, work in progress or finished goods on either 1 January or 31 December.

It is to be assumed that the original budget shown above was an accurate estimate of the likely results forthe year before these two decisions were made.

The original budget is to be taken as a basis for comparison with actual results, for budgetary controlpurposes.

Question 11Contribution is the difference between sales price and variable cost. What were the sales volumecontribution variance and the sales price variance in the year, in $'000?

Sales volume Sales price variance variance

A $ 60 (F) $150 (A)B $150 (F) $200 (A)C $180 (F) $150 (A)D $180 (F) $200 (A) (3 marks)

Question 12What was the direct materials price variance in the year in $'000?

A $20 (F)B $50 (F)C $60 (F)D $75 (F) (2 marks)

A









A

A

Question 13The direct materials usage variance in the year (in $'000) was

A $60 (A)B $55 (A)C $25 (A)D $20 (F) (3 marks)

The following data refers to Questions 14 - 15

The budgeted sales of Product X in August were 2,400 units. Bruce Chinn Company, the company thatmanufactures Product X, uses a standard costing system, and the standard cost per unit of Product X is$21. The company recorded the following variances for the month.

Sales price variance $ 300 (A)Sales volume profit variance $1,200 (F)

During August 2,700 units of Product X were actually sold.

Question 14What was the budgeted profit for Product X in August?

A $6,300B $7,200C $9,600D $10,800 (2 marks)

Question 15What was the actual sales revenue for Product X in August?

A $57,600B $67,200C $67,500D $68,400 (2 marks)

Question 16

A cleaning detergent, D5, is manufactured by mixing three materials. Standard cost details of the productare as follows:

Cost per batch of 15 litres of D5:$

Material X 9 litres at $4.50 per litre 40.50Material Y 4.5 litres at $1.50 per litre 6.75Material Z 1.5 litres at $7.50 per litre 11.25

58.50

A

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A

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AIn October, the actual mix used was 300 litres of X, 112.5 litres of Y and 37.5 litres of Z. Theoutput achieved was 420 litres of detergent D5.

The material mix variance for each material was:

Material X Material Y Material ZA $135 (F) $42.85 (A) $52.50 (A)

B $130 (F) $42.85 (F) $56.25 (A)C $135 (A) $33.75 (F) $56.25 (F)D $130 (A) $33.75 (A) $52.50 (F) (2 marks)

Question 17Compare and contrast standard costing with the calculation of variances through budget flexing.

(4 marks)

Question 18Describe briefly five purposes of a system of standard costing. (5 marks)

Question 19Explain three different levels of performance which may be incorporated into a system of standardcosting. (3 marks)

Question 20Comment on whether standard costing applies in both manufacturing and service businesses and howit may be affected by modern initiatives of continuous improvement and cost reduction. (4 marks)

Question 21Discuss the problems associated with the use of traditional standard costing and variance analysis.

(8 marks)

Question 22Comment on the meaning of the material mix variance and the yield variance. (3 marks)

Question 23"A high rate of inflation tends to make standard costing and variance analysis a waste of time" said theproduction manager to her managing director.

You are required, as the management accountant, to draft a brief memorandum to the productionmanager in reply to her statement. (5 marks)

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Question 24Briefly outline 4 advantages of flexed budgets over fixed (or static) budgets (4 marks)

Question 25

Briefly outline 8 ways that the level of efficiency of labour could be improved. (8 marks)

Question 26Define ‘Manufacturing idle time’. (1 mark)

Question 27Briefly outline 5 causes for manufacturing idle time. (5 marks)

Question 28Briefly outline the implications of material mix variances (3 marks)

Question 29Briefly discuss the Interrelationships between material price, mix and yield variances (3 marks)

Question 30Briefly discuss 2 reasons for a favourable sales price variance. (2 marks)

Question 31Briefly discuss 2 reasons for an adverse sales price variance. (2 marks)

Question 32Briefly discuss 2 reasons for a favourable sales volume variance. (2 marks)

Question 33Briefly discuss 2 reasons for an adverse sales volume variance. (2 marks)

Question 34Briefly discuss 3 reasons for a favourable material price variance. (3 marks)

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Question 35Briefly discuss 3 reasons for an adverse material price variance. (3 marks)

Question 36Briefly discuss 3 reasons for a favourable material usage variance. (3 marks)

Question 37Briefly discuss 5 reasons for an adverse material usage variance. (5 marks)

Question 38Briefly discuss 1 reason for a favourable labour rate variance. (1 mark)

Question 39

Briefly discuss 1 reason for an adverse labour rate variance. (1 mark)

Question 40Briefly discuss 2 reasons for an favourable labour efficiency variance. (2 marks)

Question 41Briefly discuss 6 reasons for an adverse labour efficiency variance. (6 marks)

Question 42Briefly discuss 2 reasons for a favourable production overhead expenditure variance.

(2 marks)

Question 43Briefly discuss 2 reasons for an adverse production overhead expenditure variance.

(2 marks)

Question 44

Joel Demski categorised the general causes of variances in five groups. What are they? (5 marks)

Question 45Managers with responsibilities in a standard costing system are likely to receive control reports foreach reporting period, itemising variances for every resource item in their area of responsibility forwhich standard usage and/or cost has been set. What should an effective manager do after receivinga control report? Should he/she investigate the cause and consequence of every deviation?

Managers have limited time, and to interrupt work flow is expensive. The manager faces a difficultdecision. To investigate every reported variance will be costly and, probably without commensuratebenefits, but if reported variances are not investigated or followed up, then the control function ofthe standard costing system becomes non-functional.

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Between the two extremes of investigating every variance that is reported and of investigating none ofthem, lies the optimal policy. However decision models specifying exactly which variances toinvestigate cannot deal with all aspects of the problem and in practice the decision becomes asubjective one, and is often left to the manager using discretion within the framework of general rules.

Briefly outline five investigation decision-rule models that could be used to help resolve the problemsidentified above. (5 marks)

Question 46Briefly discuss the weakness of using the ‘monetary size of the variance investigation model’.

(6 marks)

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END








END OF THE

DIAGNOSTIC TEST FORSTANDARD COSTINGAND VARIANCE ANALYSIS









Diagnostic TestStandard Costing and

Variance AnalysisAnswer Guides

ACCA Paper F5Performance Management









Q

Answer to Question 1 B

Price variance $

3,800 kg should cost (x $4.50) 17,100but did cost 14,400Material price variance 2,700 (F)

Note

Units purchased = Units used + Closing inventory - Opening inventory= 4,100 - 300= 3,800 kg

Usage variance

1,040 units should use (x 4 kg) 4,160 kgbut did use 4,100 kg

Variance in kg 60 kg (F)x standard cost per kg $4.50Material usage variance $270 (F)

Answer to Question 2 D

$11,700 hrs should cost (x $6.40) 74,880but did cost 64,150Labour rate variance 10,730 (F)

2,300 units should take (x 4.5 hrs) 10,350 hrsbut did take 11,700hrsVariance in hrs 1,350 hrs (A)x standard rate per hr x $6.40Labour efficiency variance $8,640 (A)


Overhead expenditure should have been $((800 x $6) + ((10,800 x $4)/12) 8,400

but was 8,500Overhead expenditure variance 100 (A)

$Budgeted production at standard rate of absorptionof fixed overheads ([10,800/12] x 4) 3,600Actual production at standard rate (800 x 4) 3,200Overhead volume variance 400 (A)

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QAnswer to Question 4 C

$13,450 hours should have cost (x $6) 80,700but did cost 79,893Direct labour rate variance 807 (F)

3,350 units should have taken (x 4 hrs) 13,400 hrs

but did take 13,450 hrsVariance in hrs 50 hrs (A)x standard rate per hour x $6Direct labour efficiency variance $ 300 (A)

Answer to Question 5 C

Actual sales 850 unitsBudgeted sales 800 unitsVariance in units 50 units (F)

x standard contribution per unit ($(9 - 4)) x $5Sales contribution volume variance $250 (F)

$Revenue for 850 units should have been (x $9) 7,650but was 7,480Selling price variance 170 (A)


If material inventory is valued at standard cost, the price variance is based on actual purchases, i.e.

the whole variance is eliminated as soon as the material is purchased.

Price variance $8,200 kg should have cost (x $0.80) 6,560but did cost 6,888

328 (A)Usage variance 870 units should have used (x 8 kg) 6,960 kgbut did use 7,150 kgUsage variance in kg 190 kg (A)x standard cost per kg x $0.80

$ 152 (A)


Assumption. There are twelve equal periods in one year.

$Budgeted fixed overhead cost per period ($120,000 ÷ 12) 10,000Actual fixed overhead cost 9,800Fixed overhead expenditure variance 200 (F)

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Standard fixed overhead cost per unit = $100,000/20,000 = $5 per unit

$Actual production at standard rate (19,500 x $5) 97,500Budgeted production at standard rate (20,000 x $5) 100,000

Fixed overhead volume variance 2,500 (A)


Since J Company uses a standard marginal costing system, the sales volume variance will be valued atthe standard contribution of $4.40 per unit ($10.00 - $5.60).

Budgeted sales volume 5,000 unitsActual sales volume 4,500 unitsSales volume variance in units 500 units (A)x standard contribution per unit x $4.40

Sales contribution volume variance in $ $2,200 (A)


Standard costing systems can be established in an automated manufacturing system. Variancesmight identify controllable causes (such as inefficient maintenance) and automation does not mean thatideal and attainable standards are the same. However, direct labour costs will become a much smallerproportion of total costs, and so the significance of any direct labour cost variances will be much lessthan in non-automated systems or systems with a bigger labour element.

Answer to Question 11 D Remove the price increase from the actual sales revenue: $600,000/0.75 = $800,000 (at budgetprices).

Actual sales (at same price level as budget) increased by $300,000 ($800,000 - $500,000.)

The contribution in the budget is $500,000 - $200,000 = $300,000, or 60c per $1 of sales.

Sales contribution volume variance = 60% of $300,000 (F)= $180,000 (F)

Actual sales in the year = $600,000Sales price actually charged = 75% of original budgeted sales priceActual sales at original budgeted price = $800,000Sales price variance ($800,000 - $600,000) = $200,000 (A)


Actual direct materials costs in the year = $300,000. This is 80% of the original budgeted price.Actual purchase quantities at original budget price = $300,000 ÷ 0.80 = $375,000.

Material price variance = $375,000 - $300,000

= $75,000 (F)

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Actual production and sales = 160% of original budgeted quantity. ($800,000/$500,000)

$160% of original budget quantity should use

(x 1.6) ($200,000 x 1.6) 320,000 of materials at budget pricebut did use ($300,000/0.8) 375,000 of materials at budget price

Usage variance 55,000 (A)

Note $ $

Budgeted profit 50,000Sales price variance 200,000 (A)Sales volume variance 180,000 (F)Materials price variance 75,000 (F)Materials usage variance 55,000 (A)Total variances 0Actual profit (given in question) 50,000


Budgeted sales 2,400 unitsActual sales 2,700 unitsSales volume variance in units 300 units (F)x standard profit per unit X (unknown!)Sales volume variance in $ $1,200 (F)Thus, standard profit per unit (1,200 ÷ 300) $4 (thus, X = $4.)Budgeted profit in the month (2,400 units x $4) $9,600


$Standard profit per unit 4Standard cost per unit 21Standard selling price per unit 25

$2,700 units should sell for (x 25) 67,500Sales price variance 300 (A)2,700 units did sell for 67,200

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QAnswer to Question 16 C

Workings:

Weighted average standard price (WASP) per litre = $58.50/15 litres = $3.90.

Actual usage Standard mix Mix variance Rate Mix variancelitres litres litres $ $

Material X 300 (9/15) 270 30 (A) 4.50 135 (A)Material Y 112.5 (4.5/15) 135 22.5 (F) 1.50 33.75 (F)Material Z 37.5 (1.5/15) 45 7.5 (F) 7.50 56.25 (F)

450 450 45 (A)

Answer to Question 17 The calculation of variances through budget flexing is achieved by adjusting the budget for the period toproduce a realistic budget cost allowance for the actual level of activity achieved. The variance is thedifference between the actual cost or revenue and the budgeted cost or revenue for the actual level ofactivity.

The analysis of variances in a standard costing system is achieved by the comparison of the cost incurredwith the standard cost that should have been incurred for the actual level of activity.

There are therefore similarities between variance analysis with flexible budgets and standard costs. Bothapproaches compare the actual costs for a given level of activity with the expected costs for that volumeof activity.

However, there are differences between the two approaches.

- With standard costing, variances are analysed in detail, reporting for example direct material

price and direct material usage variances. With flexible budgeting, the reported costvariances are more likely to be total cost variances, e.g. total direct material cost variance.

- All products or services are valued at standard cost in a standard costing system. Withflexible budgeting there is not necessarily a standard costing system. Output is costed usingnormal costing methods.

- With standard costing, all products or services have a standard selling price. With flexiblebudgeting, standard selling prices are unlikely to be used.

Answer to Question 18 A standard costing system supports management in a number of ways. For example:

(i) It can assist in the planning of budgets. Standards are the building blocks of periodic budgets.

(ii) Standards are used for control purposes. They are used as performance indicators and thevariances that are derived from the system reveal activities which are different from plans. Thisinforms management of the need to take action to take advantage of any circumstances whichhave produced favourable variances or reduce or mitigate the effects of any adverse variances.

(iii) If the prerequisites of a standard costing system are observed, the existence of appropriately setstandards can act as targets and become a source of employee motivation.

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Q(iv) Standards are estimated costs which can be used to support decision making - such as pricingdecisions.

(v) Standard costs are often used for the valuation of inventory - raw materials, work-in-progress,finished goods.

Answer to Question 19

Three different levels of performance are as follows:

(a) Ideal standards An ideal standard is one which can be attained under the most favourable conditionspossible (using maximum capacity) in the forthcoming period. The ideal standard will berevised period by period in the light of developments in technology, etc. Ideal standardswill be used where management believe that they will provide the best type of standardneeded for motivation and cost control. In some cases it will be reasonable to expect thatno wastage of material will occur. However, in terms of labour efficiency, ideal standards,which would assume no inefficiency, no extra breaks, no loss of efficiency due to fatigue,may be no more than a pipe-dream.

(b) Attainable standards A currently attainable standard will show the cost to be incurred under normal efficientoperating conditions (the use of practical capacity). Allowances are made for normalwastage of materials, machine breakdowns, and loss of efficiency from fatigue.However although a currently attainable standard should be possible to achieve, it shouldalso represent a high standard of performance. Standard costs determined in this way canbe used for a variety of purposes, for example for budget preparation, for cost control bymeans of variance analysis, for product costing and for motivation.

(c) Budget standard

The budget standard is the standard set for the budget period and is normally based on thesales volume, and thus production volume, budgeted for the period concerned.

Answer to Question 20 Relevant for mass production Standard costing is most suited to organisations whose activities consist of a series of common or repetitive operations. Typically, mass production systems are indicative of its main area of application.

Use in service provision businesses It is possible to envisage the operation of standard costing and variance analysis systems within the

service sector, though standards might not be set with the same degree of accuracy which apply inmanufacturing due to the heterogeneous and intangible nature of services. For example, banks willhave common processes for dealing with customer transactions, processing cheques etc, transportcompanies will have standard routes and vehicles, hotels and restaurants often use standard recipes forfood preparation, and so on.

Standards used in modern industry In modern industry, which includes both the manufacturing and service sectors, continuous improvementand cost reduction can be key issues which render standard costing difficult to apply. In order to remaincompetitive, it is essential that businesses address the cost levels of their various operations. But thecontinuous quest to reduce costs may mean that standards become transient and soon out of date. Insuch a situation, an alternative to the use of standard costing is to compare actual costs with those of aprevious period, or to benchmark actual costs against industrial norms.

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QQManagers must decide

It is for management to judge the pros and cons of employing standard costing, and consequentlywhether such a system is appropriate for their needs.


Traditional standard costing systems are widely used though they present weaknesses. Examples are:

E Emphasis on monetary values. The monetary values are used at the exclusion of important

non-monetary measures and indicators.

N No encouragement for managers to exceed the standard set. The cybernetic control

system does not respond when standards are achieved.

D Difficulty in setting accurate standards. Even the use of different policy levels of standard

('ideal', 'attainable' and 'budgeted') does not resolve the difficulties of setting accurate standards.

B Batch related management reporting. The system is normally periodical (say monthly or four-

weekly) and relates to batches. This long delay in reporting is unacceptable to operationalmanagers working in modern factories.

A Aggregated financial figures are often used. Reported figures are aggregates, and thus lose

management value. What is the 'knowledge and understanding' difference between a reportedvariance of, say, $10,000 (A) and $12,000 (A)?

S Surrogate financial figures are often used. The system places financial surrogate values on

events which may cause inaccuracies, misunderstanding and subjectivity. Furthermore, the actof evaluating events in financial values tends to slow the reporting cycle.

I Includes variances which might not be helpful for management. For example. conventional

variances relating to material price, material usage, labour efficiency are not helpful in modern 'JIT'orientated factories.

S Standards often include costs that are not relevant. Standard costs are often used for cost-

based decisions. Standards do not relate to 'relevant costs' and may not be appropriate for short-run decisions.

Tutorial comment: Remember our mnemonic 'END BASIS‘

Answer to Question 22 The material mix variance shows the increase (or reduction) in costs caused by the substitution ofexpensive materials for more cheaper (or cheaper materials for more expensive).

It is not clear that a favourable mix variance represents an improvement for the firm. A short-termsaving in costs may lead to a reduction in product quality with consequent quality costs. The standard isset with an appropriate mix. A deviation from this standard might represent a reduction in customersatisfaction (consider increasing the cheaper materials in a cake mix) with subsequent losses of sales in

the future.

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QAn adverse yield variance represents an over-usage of materials in respect of the output actuallyachieved. A favourable yield variance represents a savings of normal loss. If a normal loss is notbudgeted it is difficult to envisage a favourable yield variance, unless again, there has been a loss ofquality.

The mix and yield variance add to the total of the usage variances of the different materials incorporatedin the mix, and in this respect are related. For example, a change in the mix could result in an increase

in defective units (and thus an increase in the material usage).

In the same way as for a usage variance, the usage variance could be due to a number of factors notrelated to the mix, such as machine malfunctioning, poor quality labour, and so on.

Answer to Question 23 MEMORANDUM

To: Production managerFrom: Management accountant

10th September

Subject: Standard costing and variance analysis under inflationary conditions

I have been requested by the managing director to respond to your comment on standard costing andvariance analysis in time of inflation.

Standard costs are made up of two elements:

(i) a quantity of resource required per unit, and

(ii) an estimated price per unit of the resource.

When setting a value for the price element two possibil ities exist:

(i) to use a price prevailing at the start of the year; or(ii) to estimate an average price to be paid during the year ahead.

Both methods cause difficulties. Method (i) will cause adverse (often uncontrollable) price variances asinflation causes prices to rise. Method (ii) would (in theory) cause favourable variances in the earlyperiods of a year and adverse variances in the later periods of a year which will (if the estimated price isaccurate) total to a nil variance for the year. Either of these techniques will allow an analysis of the trendsof costs to be recognised.

A further alternative is to revise the price element of the standard cost each accounting period, but thismakes trend analysis very difficult.

Variances arising from the use of Method (i), which involves retaining the standard price (unchanged) forthe year can be improved and made more meaningful by the use of planning and operational variances.Using this approach the inflationary element might be treated as a planning variance, which isuncontrollable as far as operational management are concerned, with operational variances, thecontrollable element of the activity, highlighted for management attention.

Thus the two price related variances may be of use under inflationary conditions.

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Answer to Question 28 A favourable mix variance would result from substituting cheaper materials for more expensivematerials but this may not always be in a firm's best interests as the quality of the product may suffer oroutput may be reduced.

An adverse mix variance would have the opposite effect of substituting expensive materials in the placeof cheaper materials. There are two main reasons why this may occur:

(i) a stock-out of the cheaper material occurs and it is economical to use expensive materials andmaintain throughput; or

(ii) there is a fault in the process, probably in the mixing machinery (most mixing is done by machine,like petrol and air is mixed in a car engine).

Answer to Question 29 Generally, the use of a less expensive mix of material input will mean the production of fewer outputthan standard. This may be because of an increase in rejects due to imperfections in the lower quality

inputs, or other similar factors. The overall result may be:

- favourable material price variance - because less expensive materials are purchased- favourable mix variance - because some of these less expensive materials have been substituted

for more expensive materials- adverse yield variance because the inferior materials have resulted in more defects and waste.

Answer to Question 30 Possible causes of a favourable sales price variance are:

Increase of sales price to take advantage of market price elasticity.

A reduction in discounts planned. (Discounts effectively reduce the sales price.)

Answer to Question 31Possible causes of a averse sales price variance are:

Reduction of sale price to take advantage of market price elasticity. The unplanned discounts given to customers.

Answer to Question 32 Possible causes of a favourable sales volume variance are:

A reduction in the sales price has resulted in an increase in sales volume (demand). An increase in the firm’s share of market due to marketing activities such as advertising, product

positioning, etc.

Answer to Question 33 Possible causes of a averse sales volume variance are:

An increase in the sales price has resulted in a fall in sales volume (demand).

Loss of share of market due to ineffective marketing activities and offensive actions of competitors.

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Answer to Question 34 Possible causes of a favourable material price variance are:

Unforeseen discounts received. Greater effectiveness in purchasing. Change in material prices.

Answer to Question 35 Possible causes of a averse material price variance are:

Price increases. Ineffective purchasing. Change in supplier’s discount policy.

Answer to Question 36 Possible causes of a favourable material usage variance are:

Material used of higher quality than standard. More effective use made of material. Errors in allocating materials to jobs (mix of materials).

Answer to Question 37 Possible causes of a averse material usage variance are:

Defective material Excessive waste. Theft. Stricter quality control (more rejects) Errors in allocating material to jobs. (mix of materials).

Answer to Question 38 The main possible cause of a favourable labour rate variance is the use of apprentices or other workersat a rate of pay lower than standard.


The main possible cause of a averse labour rate variance results from unplanned wage rate increases.

Answer to Question 40 Possible causes of a favourable labour efficiency variance are:

Output produced more quickly than expected, i.e. actual output in excess of standard output set forthe same number of hours because of staff motivation, effective supervision, better quality ofequipment or materials, etc.

Errors in allocating time to jobs.

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Answer to Question 41Possible causes of a averse labour efficiency variance are:

Idle time in excess of standard allowed. Machine breakdown(s). Non-availability of materials (stock outs). Absence or injury of workers.

Output lower than standard because of deliberate labour ‘go slow’, lack of training, or sub-qualitymaterial used.

Errors in allocating time to jobs.

Answer to Question 42 Possible causes of a favourable production overhead expenditure variance are:

Savings in costs incurred. More economical use of services.

Answer to Question 43 Possible causes of a averse production overhead expenditure variance are:

Increase in cost of services used. Change in type of services used.

Answer to Question 44 Joel Demski categorised the causes of variances in five groups:

(i) Implementation deviation caused by a human or mechanical failure to achieve attainable

standard, e.g. an over-usage of material due to ineffective supervision in the factory.

(ii) Prediction deviation caused from errors in specifying the standard costs or other parametervalues in a decision model, e.g. in determining the labour cost standard affected by a learningrate, ex ante predictions must be made, inter alia , of the future level of activity and the extent oflearning. If the predictions are incorrect the labour standard will be wrong and variances will occur.

(iii) Measurement deviation caused as a result of error in measuring the actual outcome, e.g. anadverse material variance reported in one process with a favourable usage variance for the samematerial in another process, caused by incorrect postings by the storekeeper.

(iv) Model deviation which results from an error in the formulation of a decision model, e.g. informulating a model to determine the rate of pay of workers involved in a group incentive bonusscheme, the treatment of allowances (such as contingency, relaxation and process allowances)incorporated in the basic standard hour may be incorrectly specified or dealt with.

(v) Random deviations due to chance fluctuations of a cost or other parameter for which no causecan be identified, e.g. a small adverse labour efficiency variance for a period in which climatictemperature was particularly warm, a factor which may, or may not, have caused the variance. Bydefinition a random variance per se calls for no control action affecting the current process.

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Answer to Question 45 The investigation decision-rule models that can be identified are:

(i) Monetary significance of the variance modelA variance is investigated if it exceeds a certain monetary size - say $500.

(ii) Fixed percentage significance of standard modelAnother simple rule is to choose a fixed percentage, say 10 per cent and investigate all variancesthat exceed the standard by this amount. Using, for example, a material 'NN' used in amanufacturing process with a standard usage of 2.1 kilograms per standard hour. With a 10 percent significance the upper and lower control limits are 2.31 (2.1. x 1.1) and 1.89 (2.1 x 0.9)kilograms respectively. If the average usage of material for a control period was reported as 2.25kilograms it would not be highlighted for attention.

The model is easy to implement, once the manager on the basis of the historical results, orcomparisons with other work aided by experience and judgement, specifies the appropriatepercentage to use.

(iii) Statistical significance modelThe model requires that a measure of expected dispersion be specified for each account item.Using for example, a material ‘NN’ with a standard usage of 2.1 kilograms per standard hour,obtained from records of the average usage of the material in the process over the previous fifteenmonths and when production levels were approximately equal in each of the months sampled sothat each observation can be weighed equally, and the data used to calculate a standard deviation,of say 0.056 kilos.

The data could be used to set control limits based on:

- say a confidence level of 95% (which is 1.96 standard deviation from the average)- the assumption of normally distributed deviations (say, +/- 0.11 kilos).

If variance is over 2.21 kgm (2.1 + 0.11) or under 1.99 (2.1 - 0.11) the manager could accept that thedeviation is unusual, because probability of it occurring is less than 0.05 (5 chances in 100).

(iv) Decision with costs and benefits of investigation modelA simple decision theory model, based on cost-benefit analysis, using prior-period resultanalysis (i.e. probabilities of events based on previous periods).

(v) The use of rule of thumb policyManagers take subjective judgement based on the situation, their experience, intuition and needs.

Usually this means that the bigger the variance the more chance there is that it will be investigated.Hunch plays a part in the decision process. However, in practice, the size of a variance and itssignificance may not correlate. Such an informal approach to the investigation of variances wouldprobably lead to unproductive investigative work.


The weaknesses of the monetary size of the variance include the following:

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(i) the choice of the monetary size, $500, $1,000, $1,500, or whatever, is likely to be subjective;(ii) it ignores the cost of investigating a variance;(iii) it does not consider type and probable cause of the variance;(iv) it does not reflect that some accounts are more important than others, in terms of interrelationships,

trade off, etc.;(v) it will not signal when an important account that historically has been controlled very closely,

suddenly departs from its historical pattern but with a variance that is still within the presentmonetary values;

(vi) it will trigger investigation into accounts where sizable fluctuation is normally experienced fromperiod to period.

The model can be improved by the use of cost-benefit analysis based on statistical probabilities. Withthis approach probabilities (based on historical analysis of variances) that a variance of a certain size islikely to be controllable are measured. The net benefits from control action, the costs of investigationand the costs of control are incorporated in the decision-rule model.

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Score sheet:Diagnostic Test: Standard Costing and Variance Analysis

Questionnumber

Marksavailable

Score

1 3

2 2

3 2

4 2

5 2

6 2

7 2

8 2

9 2

10 2

11 3

12 2

13 3

14 2

15 2

16 2

17 4

18 5

19 3

20 4

21 8

22 3

23 5

24 4

Total score c/fwd

Questionnumber

Marksavailable

Score

Total score b/fwd

25 8

26 1

27 5

28 3

29 3

30 2

31 2

32 2

33 2

34 3

35 3

36 3

37 5

38 1

39 1

40 2

41 6

42 2

43 2

44 5

45 5

46 6

Totalscore

143

Percentage (%)

111 – 143 marks 73 – 110 marks 0 – 72 marks








+Add VanceACCA F5 Diagnostic Tests

Contents

Tutorial Syllabus classificationScreen

Questions Answers

Tutorial 1 Activity Based Costing (ABC) 19 25

Tutorial 2 Target Costing 36 40

Tutorial 3 Life-Cycle Costing (LCC) 84 51

Tutorial 4 Throughput Accounting (TA)

57 66Tutorial 5 Environmental Accounting 77 81

Tutorial 6 Cost behaviour and break-even analysis 88 104

Tutorial 7 Multi-limiting factors and the use of linearprogramming

124 130

Tutorial 8 Pricing Decisions 136 143

Tutorial 9 Make-or-Buy and other short-term decisions 157 168

Tutorial 10 Dealing with risk and uncertainty 186 197

Tutorial 11 Budgetary systems and types of budgets 218 227

Tutorial 12 Quantitative analysis in budgeting 261 271

Tutorial 13 Standard costing and variance analysis(This test is activated for this free sample)

291 304

Tutorial 14 Planning and operational variances 324 328

Tutorial 15 The scope of performance measurement 334 344

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