Standard Costing by Acca

8/7/2019 Standard Costing by Acca

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Standard costing andvariance analysis

Chapter

1

Syllabus Content

B - Standard Costing 25%

Manufacturing standards for material, labour, variable overhead and fixed overhead.

Fixed overhead expenditure and volume variances. (Note: the subdivision of fixed overhead

volume variance into capacity and efficiency elements will not be examined.)

Price/rate and usage/efficiency variances for materials, labour and variable overhead. Further

subdivision of total usage/efficiency variances into mix and yield components. (Note: The

calculation of mix variances on both individual and average valuation bases is required.)

Planning and operational variances.

Sales price and sales revenue/margin volume variances (calculation of the latter on a unit basis

related to revenue, gross margin and contribution margin). Application of these variances to allsectors, including professional services and retail analysis.

Standards and variances in service industries, (including the phenomenon of "McDonaldization"),

public services (e.g. Health), (including the use of "diagnostic related" or "reference" groups), and

the professions (e.g. labour mix variances in audit work). Criticisms of standard costing in general

and in advanced manufacturing environments in particular.

Interpretation of variances: interrelationship, significance.

Benchmarking.


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1.1Introduction to standard costingA standard cost is a planned or forecast unit cost for a product or service, which is assumed

to hold good given expected efficiency and cost levels within an organisation. It represents a

target cost and is useful for planning, controlling and motivating within an organisation.

Variance analysis is a budgetary control process, which compares standard or budgeted costs

and revenues with the actual results of an organisation, in order to obtain information

regarding any exceptions from budget, this information is also used to improve performance

through control action e.g. correcting problems.

Standard costing can be used for

Budget preparation e.g. planning Control through exception reporting e.g. performance measurement Stock valuation Cost bookkeeping. Motivating staff

Under a standard costing system an organisation can value stock at standard cost,

incorporating this within the ledger or cost accounts of the organisation, the budget or

forecasts being a memorandum kept outside the ledger accounts.

Types of standard

Ideal Standard e.g. attained under the most favourable conditions with no allowancefor any waste, scrap, idle time or downtime

Attainable or Expected Standard e.g. what should be achieved with a reasonablelevel of effort given current efficiency and cost levels

Loose Standard e.g. loosely set and easy to achieve Basic Standard e.g. first standard ever used by the organisation and used as a basis or

yardstick for comparing current standards or monitoring trends over time

Historical Standards e.g. standards used historically in previous accounting periodsCritism of standard costing

Sometimes hard to define an attainable standard

Uncontrollability of performance within operations e.g. discounts lost due to thereduction in the quantity ordered or seasonal price fluctuations within the period of

appraisal

With more automation within operations, they become less valuable as information

Feedback not feed forward control e.g. out of date information

Revisions to standards may be too frequent to guide performance over time

Standard costing is an internal not external control measure e.g. improvement also

needs to consider competition and customers

Performance measurement would be inadequate as a process if the standard is wrong

The reason or cause of the variance are sometimes overlooked or not investigated


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How to create a standard cost

Standard material price Supplier quotations and estimates Previous invoices/trends Internet/websites of suppliers Discounts for bulk purchases Price seasonality Cost to manufacture internally Differences between the quality of

different material

Standard material usage Time/motion studies Quality of material e.g. natural

wastage

Specification of standard productmanufactured

Operational wastage expected

Standard labour rate Market rate for grade/type of labour Internal rates from HR department Bonus schemes/piece work rates incurrent use

Standard labour efficiency Idle time expected during operations Time/motion studies Skill/expertise of staff Learning curve Motivation of staff Remuneration systems in place

Standard overhead rate Overhead absorption rates obtainedby dividing forecast overhead with an

expected level of activity

Review overhead Understand fixed and variable

relationship with output, labour hours,

machine hours or % of cost


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1.2 Methods for planning and control

A fixed budget is a budget prepared on the basis of an single estimated production and sales

volume. It does not mean it is never revised or changed, just fixed at a certain level of

output sold and produced. This tends to be a form of budgeting for a service organisation

where a high proportion of total cost is fixed, and therefore does not vary significantly, withthe volume or activity of the service performed. Such a form of budgeting would be little use

for control purposes, when comparing to actual results, if significant variable cost exists. A

fixed budget provides details of costs, revenues or resource requirements for a single

level of activity.

Flexible budgets are prepared for many different sales and production quantities and can be

used to plan more effectively for an organisation e.g. useful at the planning stage for what

if? analysis. Flexible budgeting recognises different cost behaviour patterns, that may rise or

fall with the volume of production or sales and is a better system for control purposes. A

flexible budgeting system based upon its budget set at the beginning of the period can be

flexed to correspond to the actual activity volume of results for a period. When a budget isflexed it would give an appropriate level of revenue and costs as a yardstick to compare like

for like to actual results, at the same activity level, meaningful variances can then be reported

to the managers responsible for control purposes.

Flexible budgeting

1. Useful at the planning stage (what if analysis)2. Can be flexed retrospectively and compared to actual results for control purposes


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Example 1.1

Butliness is a business that offers packaged holiday deals in 3 locations in the UK and as part

of this service has a restaurant that serves many different meals and puddings through out the

day to guests staying over in chalets on the holiday park. One such serving counter has been

a major concern for the management, the All week Sunday lunch counter, as it is expensiveto run.

The stand uses 2 staff on different shifts to cook and serve meals at the counter, the standard

cost and price of the Hungry man roast of the day is as follows:

Standard cost information for 1 meal

Per meal

Chicken 0.3kg @ 2.50 per kg 0.75

Vegetables 0.5kg @ 0.50 per kg 0.25

Labour 15 mins @ 9.00/hr 2.25

Variable overhead 15 mins @ 2.00/hr 0.50Fixed overhead 15 mins @ 20.00/hr 5.00

8.75

Standard profit 3.20

Selling price (included in packaged price) 11.95

The counter works on a 6-day shift (all week except Sunday) and the budget aims to sell 500

meals within week 43 the following actual information was obtained.

Meals actually sold were 476 the revenue earned 5,688.

Ingredients purchased

Chicken Vegetables

Purchased 180kg (405) 250kg (140)

Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (wages paid 1,200)

Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead 150

Fixed overhead 2,750

Produce the original budget, flexed budget based upon actual sales volume, and

compare this to actual results in order to calculate any variances?


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Answer to Example 1.1

Budgets prepared for an organisation using absorption costing principles

Original Flexed Actual Variances

Production and sales 500 476 476

Sales 5,975 5,688 5,688 -

Chicken 375 357 368 11(A)

Veg 125 119 125 6 (A)

Labour 1,125 1,071 1,200 129(A)

Variable overhead 250 238 150 88(F)

Fixed overhead 2,500 2,380 2,750 370(A)

4,375 4,165 4,593 428(A)Profit 1,600 1,523 1,095 428(A)

Budgets prepared for an organisation using marginal costing principles

Original Flexed Actual Variances

Production and sales 500 476 476

Sales 5,975 5,688 5,688 -

Chicken 375 357 368 11(A)

Veg 125 119 125 6 (A)

Labour 1,125 1,071 1,200 129(A)

Variable overhead 250 238 150 88(F)

1,875 1,785 1,843 58(A)

Contribution 4,100 3,903 3,845 58(A)

Fixed overhead 2,500 2,500 2,750 250(A)

Profit 1,600 1,403 1,095 308(A)

Notes

The 368 actual charge for Chicken is the actual cost less standard cost of closingstock e.g. (405 less (15kg x 2.50))

The 125 actual charge for Vegetables is the actual cost less standard cost of closingstock e.g. (140 less (30kg x 0.50))

The absorption costing company charges fixed overhead to the profit and loss accounton the basis of 5.00 for every meal produced e.g. 476 meals x 5.00 per meal =

2,380, for this reason, when a budget is flexed, we prorate the budgeted fixed

overhead, but never for marginal costing organisations, they do not charge or absorb

fixed overhead in this manner.


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1.3 Variance analysis

By comparing a flexed budget, which has been prepared using standard cost information to

actual results, total variances can be calculated. These reconcilable differences between the

two statements can then be sub-divided further, calculated, interpreted and used to correctproblems within the organisation to stay on target through control action by management or

employees.

Variances can occur for the following reasons

Inaccurate data when creating standards, producing the budget or compiling actualresults

A standard used which is either not realistic or perhaps out of date Efficiency of how operations were undertaken by management or employees during

the period of assessment

Random or chanceBudgetary planning involves the production of budgets or forecasts using realistic standards

for cost and efficiency levels. Budgetary control identifies areas of responsibility for

management and is the process of regularly comparing actual results against budget or

standards. Because the original budget would have forecast a different number of units

produced or sold, when compared to actual units produced or sold, a flexed budget would

be prepared in order to compare costs and revenues on a like with like basis.


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Variance calculations

Sales pricevariance

Did sell (actual quantity sold x actual price) X

Should sell (actual quantity sold x standard price) (X)Sales price variance X

Sales volume

profit

variance

units

Did sell (actual quantity sold) X

Should sell (budget quantity sold) (X)

X

x standard profit per unit*

Sales volume profit variance X

* Standard profit would be used if the organisation uses absorption

costing methods, when using marginal costing methods, the standard

contribution volume variance, rather than standard volume profit

variance would be used. The proforma above would be the same

however the difference in units above would be multiplied by the

standard contribution per unit rather than standard profit per unit.

There is also the calculation of the sales volume revenue variance

unitsDid sell (actual quantity sold) X

Should sell (budget quantity sold) (X)

X

x standard price

Sales volume revenue variance X

This would be a calculation considered in isolation from an operating

statement e.g. if an organisation wants to reconcile the difference

between the original sales budget revenue and actual sales revenue

achieved rather than profit or contribution.

Material

price

variance

Did spend (actual quantity purchased x actual price) X

Should spend (actual quantity purchased x standard price) (X)

Material price variance X

This variance calculation always uses the quantity of material actually

purchased never used, if there is a difference between the two within a

question.


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Material

usage

variance

Kg/litres

Actual production did use X

Actual production should use (actual production x standard usage) (X)

X

x standard priceMaterial usage variance X

This variance calculation always uses the quantity of material actually

used never purchased, if there is a difference between the two within a

question.

Labour rate

variance

Did spend (actual hours paid x actual rate) X

Should spend (actual hours paid x standard rate) (X)

Labour rate variance X

This variance calculation always uses the actual hours paid for never

hours worked if there is a difference between the two within a question.

Labour

efficiency

variance

Hours

Actual production did take X

Actual production should take (actual production x standard hours) (X)

X

x standard rate

Labour efficiency variance X

This variance calculation always uses the actual hours worked never

hours paid if there is a difference between the two within a question.

Labour idle

time

variance

Hours

Actual hours paid for X

Actual hours worked (X)

Idle time X

x standard rate

Labour idle time variance X

Only applicable if there is idle time e.g. a difference between labour

hours paid and worked.


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Variable

overhead

expenditurevariance

Did spend (actual hours worked x actual OH rate) X

Should spend (actual hours worked x standard OH rate) (X)

Variable overhead expenditure variance X

Variable overhead expenditure within a question will be assumed to bedriven by labour hours worked never paid if there is a difference

between the two e.g. if production stops and staff are idle then no

variable overhead should be incurred.

Variable

overhead

efficiency

variance

Hours

Actual production did take X

Actual production should take (actual production x standard hours) (X)

X

x standard overhead rate

Variable overhead efficiency variance X

This variance calculation always uses the actual hours worked never

hours paid if there is a difference between the two within a question;

notice the proforma is similar to the labour efficiency variance.

Fixed

overhead

expenditure

variance

Actual fixed overhead expenditure X

Budgeted fixed overhead expenditure (X)

Fixed overhead expenditure variance X

Fixed

overhead

volume

variance

units

Did produce (actual quantity produced) X

Should produce (budget quantity produced) (X)

X

x overhead absorption rate (O.A.R)

Fixed overhead volume variance X

This variance calculation is only applicable if the organisation usesabsorption costing, never when marginal costing, and is to do with the

way the organisation charges the profit and loss account within the

production fixed overhead control account.


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1.4 Fixed overhead variances further explained

Traditional absorption costing takes the total budgeted fixed overhead for a period and

divides by a budgeted (or normal) activity level e.g. units, in order to find the overhead

absorption rate. This is a simple method of charging fixed overhead and allows fixed

overhead to be allocated to products, jobs or work-in-progress

Overhead absorption rate (OAR) = Budgeted production overhead

Normal/budget level of activity

At the end of the period, the overhead absorbed or charged to production is compared to the

actual production overhead incurred for the period. Any shortfall in overhead chargedwould be an under absorption of production overhead (DR profit and loss account CR

Production overhead control account). Any over charge to the profit and loss account

during a period would be an over absorption of production overhead (CR profit and loss

account DR Production overhead control account).

The sum of the fixed overhead expenditure and volume variance would be equal to the under

or over absorption, when sub-divided, explaining the two different causes as to how this

occurred during a period e.g. under or over spent and/or under or over produced when

compared to the original budget.

The difference between absorption costing and marginal costing organisations, is that themarginal costing organisation makes no attempt to absorb or charge production overhead into

a cost unit or the profit and loss account. It treats production overhead as a period cost only

and does not absorb overhead, but rather charges it entirely to the profit and loss account for

each period. With marginal costing organisations only the fixed overhead expenditure never

the fixed overhead volume variance would be applicable within a question.

Actual production overheadActual production (units) x O.A.R

= Charge to W.I.P during the period

Production fixed overhead control account

XX


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Stock valuation under absorption and marginal costing systems

It is also important to remember that marginal costing organisations would also value stock

at variable production cost only never full production cost, when contrasted to an

absorption costing company.

Standard cost per unit:

Direct costs of production

Direct labour X

Direct material X

Direct variable production overhead X

Total direct variable cost or total prime cost X Marginal costing stock valuation

Indirect production overhead absorbed X

Full production cost X Absorption costing stock valuation


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Example 1.2

Butliness is a business that offers packaged holiday deals in 3 locations in the UK and

as part of this service has a restaurant that serves many different meals and puddings

through out the day to guests staying over in chalets on the holiday park. One suchserving counter has been a major concern for the management, the All week Sunday

lunch counter, as it is expensive to run.

The stand uses 2 staff on different shifts to cook and serve meals at the counter, the

standard cost and price of the Hungry man roast of the day is as follows:

Standard cost information for 1 meal

Per meal



Labour 15 mins @ 9.00/hr 2.25Variable overhead 15 mins @ 2.00/hr 0.50

Fixed overhead 15 mins @ 20.00/hr 5.00

8.75



The counter works on a 6-day shift (all week except Sunday) and the budget aims to

sell 500 meals every week. During week 43 the following actual information was

obtained.

Meals actually sold were 476 the revenue earned 5,688.

Ingredients purchased

Chicken Vegetables

Purchased 180kg (405) 250kg (140)

Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (Wages paid 1,200)

Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead 150

Fixed overhead 2,750

Prepare an operating statement for week 43 for both an absorption and marginal

costing organisation, which reconciles any differences between actual results and

budget?


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Additional information known

Budgeted fixed overhead was 2,500 Actual hours paid were 6 more than worked due to an electrical fault with the ovens Closing stock for chicken and vegetables rose during this period by 15kg and 30kg

respectively.

Sales were the same as production during the weekYou are required to

1. Calculate the actual production and sale of meals2. Calculate actual hours worked for the chefs3. Calculate the actual quantity of chicken purchased4. Calculate the actual price paid for chicken5. Calculate the actual variable overhead expenditure6. Calculate the actual fixed overhead expenditure

Note: an alternative form of question would have been to provide you with actual

information and the variances, asking you to calculate budgeted or standard cost information

instead. The principle would be exactly the same as within this example.


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1.5 Mix and yield (or productivity) variances

A material usage variance can be subdivided into a mix and yield variance where there

exists two or more ingredients that can be substituted for one another. The sum of the

material mix and yield variances will total the sum of the material usage variance. The same

concept can also be applied to labour mix and yield variances, when one grade or skill oflabour can be substituted for another, when making a particular product or completing a job.

The labour efficiency variance in this case reanalysed further into the mix and yield

variances, exactly in the same way as the material usage variance.

Interpreting mix variances individual valuation basis

Actual output did use should use standard price variance

(at std mix)

Material/Labour A X kg/Hrs X kg/Hrs x x = x (F)

Material/Labour B X kg/Hrs X kg/Hrs x x = x (A)X kg/Hrs X kg/Hrs x (A)

If you use a quantity of material which is more than standard mix there would be anadverse variance

If you use a quantity of material which is less than standard mix there would be afavourable variance

Interpreting mix variances average valuation basis

Actual output did use should use standard price variance

(at std mix) less average price

Material/Labour A X kg/Hrs X kg/Hrs x x = x (F)

Material/Labour B X kg/Hrs X kg/Hrs x x = x (A)

X kg/Hrs X kg/Hrs x (A)

If you use a quantity of material which is more than standard mix and the material ismore expensive than the average cost, there would be an adverse variance

If you use a quantity of material which is more than standard mix and the material isless expensive than the average cost, there would be a favourable variance If you use a quantity of material which is less than standard mix and the material is

more expensive than the average cost, there would be a favourable variance

If you use a quantity of material which is less than standard mix and the material isless expensive than the average cost, there would be an adverse variance

Both totals of the individual and average valuation bases give the same answer; it is the

analysis which makes up the total, where you would find the differences between the two

methods.


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Interpreting yield (or productivity) variances

Yield

Actual material used or labour time did produce X

Actual material used or labour time should produce XOver/(under) produced X

x standard cost of one unit of output x x

X (A)/(F)

The sum of the material mix/labour mix and material/labour yield variances will be equal to

the material usage/labour efficiency variance respectively. It is also worth noting that there

can be an interdependent relationship between a mix and yield variance e.g. a higher skill mix

of labour in substitute of a lower skill mix, would cause an adverse mix variance, but may

also cause at the same time a favourable yield variance, due to greater experience and

therefore efficiency by that type of labour. Lastly a word of caution favourable variances,

especially when dealing with mix and yield do not necessarily mean you have improved theorganisation e.g. more water and less flavouring would improve both mix and yield when

making soft drinks, but do little to improve the quality of the drink being made.


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Example 1.4

Butliness also does a deep pan cheesy and tomato pizza on one of its counters, the

standard or budget cost and usage of the topping ingredients for one pizza are as

follows

0.5kg Tomatoes @ 1.40 a kg 0.70

0.6kg Cheese @ 7.50 a kg 4.50

5.20

1.1kg ingredients will produce or yield a 1kg pizza (due to evaporation in the cooking

process). On a Wednesday afternoon 60 pizzas were cooked (to the weight specified

of 1.0 kg) and the following ingredients were used during the process;

Tomatoes 28 kg 45.00Cheese 40kg 270.00

Calculate the material usage, mix and yield variances for Butliness for this day?

Note: two methods exist for calculation of the mix variance, the individual valuation

and average valuation bases. Make sure you are familiar with both types of

calculation.


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1.6 Investigating variances

Statistical methods for interpretation

Variances can be expressed relatively rather than absolutely, the variance is normally

expressed as a percentage against the standard cost. In a past exam (old syllabus theexaminer asked students to express material mix and yield variances, the deviations in weight

rather than values, as a percentage of the standardised weight for the product being produced.

From the answer of example 1.4 above this would have been calculated as

Tomato ingredient mix 3kg/31kg = 9.7% (F)

Cheese ingredient mix 3kg/37kg = 8.1% (A)

Yield 1.8kg/61.8kg = 2.9% (A)

These percentages could be plotted on a graph from one period to the next, which would

provide managers with the following advantages.

Graphical presentation or percentages analysed over time allows easier interpretationand clearer understanding by managers

Presenting variances over time allows trends to be identified easier By working out percentages expressed against standard, it removes changes in

monetary size of the variance caused by changing activity levels, improving trend

analysis

Example of a variance chart

%

Favourable

0JAN FEB MAR APR

Adverse


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Factors to consider before investigation

1. The size of it (materiality)2.

The general trend of it e.g. use of control charts for this3. The type of standard that was used

4. Interdependence with other variances5. The likelihood of identifying the cause of it6. The likelihood that if a cause is found then it is controllable7. The cost and benefits of correcting the cause8. The cost of the investigation


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Example 1.5

Mr Chumney-Warner, the accountant that left Butliness, due to personal grievances against

the organisation and has set up an audit practice, providing work to local business within the

area. Even though being a service organisation, Mr Chumney-Warner recognises thatvariances can also be applied to such organisations. He has created a standard cost of an

average audit, which normally takes a partner, semi-senior and junior together, 20 hours.

Details of one standard audit

Partner 3 hours @ 100 per hour 300

Semi-senior 5 hours @ 70 per hour 350

Junior 12 hours @ 30 per hour 360

1,010

During the period of February, time sheets recorded the following information. In total, 90

hours was logged as audit work, completing 5 audits during this period. The new junior that

had been recruited was under allot of pressure, and did not cope well. This had meant the

semi-senior had to be involved more in compliance work to improve the quality of audit files.

Mr Chumney-Warner was pleased however that his time as a partner was used less because

of the final quality of the audit files, due to more involvement from the semi-senior.

Actual time recorded on audit work

Partner 12 hours

Semi-senior 40 hours

Junior 38 hours

90 hours

You have again been recruited from an agency as a temp, your first job apart from idle

chit chat about working conditions at Butliness, is to produce labour mix and yield

calculations for Mr Chumney-Warner, within an operating statement, for the period of

February above. Your mix calculations to use both the average and individual bases of

valuation.


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1.7 Planning and operational variances

Planning variances are caused by the budget or standard at the planning stage being wrong.The budget and standard used would therefore need revising if your operational variances are

to be more realistic.

Operational variances are your normal variance calculations as learned earlier within this

chapter, that is, assuming all planning errors within the budget have been adjusted for or

removed and your standard used is realistic.

Process of calculating planning variances

1. Calculate the planning variance and adjust the original budget within the operatingstatement for this, before any operational variances are calculated

2. Adjust the standard cost used in the budget from ex ante to ex post (revised) standard3. Now that the original budget and standard cost has been adjusted, the operational

variances that would be effected by the adjustment, will give a more realisticstandard.

The effect is to sub-divide a variance into 2 parts

1. The planning variance which is beyond the control of staff e.g. planning errors2. The operational variances which may be within the control of staff

This allows better management information for control purposes

Planning and operational variances are not alternatives to the conventional approach; they

just produce a more detailed analysis. Further analysis of variances into groups e.g. planning

which are to do with poor planning or inadequate standards used compared with actual true

favourable or adverse operational variances, allow managers to be appraised truly on

deviations they can control not those variances which are beyond their control.

Advantages of planning variances

Highlight between variances which are controllable and uncontrollable Help motivate managers and staff Help use more realistic standards

Give a fairer reflection of operational variances

However critism includes still the question of determining a realistic standard in the first

place and putting too much emphasis on bad planning rather than bad management and

the analysis can be more time consuming and costly than the conventional approach.


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Example 1.6

Using the information from Example 1.2, how should Butliness deal with the variance

calculations if you were told the following; due to salmonella scare across the country

the price of chicken had fallen to 2 a kg this should have been reflected in the budgetwhen it was completed, but was overlooked.

Adjust standard cost

Revised Standard cost information for 1 meal

Per meal



Labour 15 mins @ 9.00/hr 2.25Variable overhead 15 mins @ 2.00/hr 0.50

Fixed overhead 15 mins @ 20.00/hr 5.00

8.60



Chicken price planning variance

500 meals should have cost (x 0.3kg x 2.00) according to new standard 300

500 meals should have cost (x 0.3kg x 2.50) according to old standard 375

75(F)

Revise operational variances now because standard has changed

180kg did cost 405

180kg should cost (x revised standard 2 per kg) 360

45(A)

476 meals did use 165kg

476 meals should use (0.3kg per meal) 143kg

22kg

Revised standard price x 2 per kg

44 (A)

Notice the biggest effect of this analysis is that the operational price variance changes

from 45 favourable to 45 adverse. This highlights that the purchasing of the

chicken is not as keener price as it should have been e.g. better control information.

The planning variance will be offset against the original budget, just before the offset

of the sales volume variance within the operating statement.


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1.8Machine expenditure and efficiency variancesSuch variances use the same method as labour rate, efficiency and idle time variances so do

not be afraid when it comes to rate, efficiency and idle time variances for machines.

Example 1.7

In the bar at Butliness they produce a banana extravaganza by using a machine

blender (it has proved to be very popular).

Standard processing time for every 50 half-pint glasses is 0.6 hours at 40 variable

overhead per hour.

During one hot summer week there was 42 hours of processing time at a total cost that

week of 1,880, 1,900 pints were produced.

Calculate the machine expenditure and efficiency variances for the machine?

What if you were told that the machine has been replaced with a machine, which is

20% faster than the previous model, but this had not been reflected in the budget?


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1.9 Causes of variances

Possible causes of the individual variances are:

Different sources of supply. Unexpected general price increase. Alteration in quantity discounts. Alteration in exchange rates (imported

goods)

Substitution of a different grade ofmaterial

Material price variance

Standard set at mid-year price so onewould expect a favourable price variance

for part of the year and an adversevariance for the rest of the year.

Higher/lower incidence of scrap. Alteration to product design.

Material usage variance

Substitution of a different grade ofmaterial.

Unexpected national wage award. Overtime/bonus payments different from

plan.

Wages rate variance

Substitution of a different grade oflabour.

Improvement in methods or workingconditions.

Variations in unavoidable idle time. Introduction of incentive scheme.

Labour efficiency variance

Substitution of a different grade oflabour.


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Unexpected price changes for overheaditems.

Variable overhead variance Labour efficiency variances (see above). Changes in prices relating to fixed

overhead items e.g. rent increase.

Fixed overhead expenditure variance Seasonal effects e.g. heat/light in winter.

(This arises where the annual budget is

divided into four equal quarters of

thirteen equal four-weekly periods

without allowances for seasonal factors.

Over a whole year the seasonal effects

would cancel out.)

Change in production volume due tochange in demand or alterations to

stockholding policy.

Changes in productivity of labour ormachinery.

Fixed overhead volume

Production lost through strikes etc. Unplanned price increase.Operating profit variance due to selling

prices Unplanned price reduction e.g. to try and

attract additional business.


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1.10 Benchmarking

Continuous, systematic process for evaluating the products, services and work processes

of an organisation that are recognised as representing best practice, for the purpose of

organisational improvement.

World-class organisations strive to obtain competitive advantage. This can be achieved by

using benchmarking. This is the process of comparing your performance with that of another

organisation considered to be the best in its class.

Benchmarking

1. Internal. Compare an internal function to the best found elsewhere internally withinthe same organisation.

2. Best practice or functional. Compare an internal function to that of the best, notnecessarily an organisation in the same industry.

3. Competitive. Product/service features compared to that of firms/competition in thesame industry.

4. Strategic. Compare yourself in terms of organisational structure and culture, missionstatement and strategic choices made to the most successful market leader.

Performance dimensions to gain competitive advantage

Quality e.g. aesthetics (imperative to organisations like Dior or Cartier), features,courtesy and friendliness of staff involved within the purchase stages within the

organisation, accuracy of administration

Speed/flexibility e.g. AA/RAC 24/7, parcel force overnight, Concorde gave fasttransatlantic flights

Cost e.g. if the organisation pursues cost leadership Differentiation e.g. brand recognition for certain product features such as image,

reliability or functional

Companies to be the very best must establish where customers perceive differences, set the

very best standards to exceed, establish what the competition is doing and encourage, manage

knowledge and ideas of staff to exceed standards set.

The process would involve

1. Select what you want to benchmark/set objectives2. Consider benefits against the cost of doing it3. Assign responsibilities to a team4. Identify potential partners/known leaders5. Breakdown of processes to complete6. Test and measure (observation, experimentation or investigation/interview)7. Gather information8. Gap analysis9. Implement changes/programmes/communicate10.Monitor and control11.Repeat regularly


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Benefits of benchmarking

Better understanding of competition and customers needs Discourages complacency/improves business awareness of managers You learn from other organisations mistakes Dont need to re-invent the wheel Source of new ideas/faster awareness of innovation Fewer complaints and warranty claims Leaner more efficient organisation in terms of waste and reworks Customer satisfaction and brand loyalty in the long-term Efficiency and effectiveness of functions or processes improved within the

organisation

Sales and profitability improvedDrawbacks of benchmarking

Deciding and documenting what needs to be benchmarked is time consuming

Getting the information to actually do it maybe a problem

Confidential information could be leaked

Damn lies and statistics

Deciding who is the best in their class

Keeping employees motivated, as standards once exceeded, will normally be raised


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1.11 McDonaldization

Modern manufacturing questions the thought of whether standard costing still plays a

valuable part when considering information for control purposes.

Dynamic environments Customisation/differentiation not homogenous products Shorter product life-cycles Automation Higher concern for quality rather than efficiency

George Ritver within his book The McDonaldization of Society listed the advantages of

producing standard or homogenous products, the pinnacle comparison being McDonalds,

with its fast food strategy of uniformity of operations and delivery on a global basis. A

concept you will find within thousands of companies in the world, especially the larger

corporations e.g. Audi or V/W Group incorporating hundreds of components, including the

engine, within a large range of cars manufactured. Although surely you would understand

such an idea better through the use of a Big Mac right? Standardisation of machinery,

uniforms and packaging e.g. sachets, drinking cups and paper bags. Automation of

dispensers, cooking processes and staff have a nice day! Food already pre-prepared before

cooking e.g. cheese sliced, salads prepared, sauces all pre-packed and easy to open and serve.

This is uniformity or standardisation.

Some facts about McDonalds

Started as a hot dog stand in 1939 by 2 brothers (Richard and Maurice McDonald)

30,000 outlets in 119 countries One of the first to end waiter service Cut their menus down to a few standard and homogenous dishes for simplicity Plates replaced with cardboard containers to save on washing up

Advantages of McDonaldization standardisation reduces cost and improves efficiency

Control e.g. easier to create a pre-defined standard as there is such uniformity withinthe specification of the products produced, also easier to manage, organise, train and

control workers

Efficiency e.g. combined with specialisation it is the most efficient way of workingwithin large organisations Predictability e.g. customer always knows what they are buying, giving reassuranceand brand recognition

Calculability e.g. quantitative not qualitative information so easier to interpret Proficiency of staff can be assessed more effectively

Such a philosophy and its advantages are similar to the classical school of management, but

can have its disadvantages

Excessive specialisation of tasks e.g. work dull and boring

Removes initiative of workers e.g. reduces innovation and creativity

Boredom, frustration and de-motivation of workers


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1.12 Diagnostic related or reference groups (DRG) can applied to a Big Mac

Standard costing is and can be applied to service organisations such as the health service,

accountancy practice or even retail. The diagnostic reference group or healthcare resource

group is a system of classifying hundreds of different medical conditions within the healthsector, as a basis of recognising that similar medical illnesses require essentially similar

treatment or care. There are around 800 DRGs existing within the health service.

This enables health service management to

Standardise resources e.g. beds/wards/consultancy/medication Standardise patient treatment e.g. specifications of how treatment applied Standardise codes for insurance companies or standardise payments to the NHS or

other private health providers for payment or charges made

Such standards can also be used by government to benchmark the performance and create

league tables of those hospitals that complete treatments within standard times and costs and

those that do not. The DRG approach also used to remunerate hospitals for each standard

treatment they perform.

Such a system is not without its critics, arguing that surely it is the qualitative factors in

patient treatment more than the quantitative measures that are more important when it comes

to patient care, and not every operation or treatment can be cured in a single best way. If

payments are made to hospitals based on a standard amount or price, this could mean

overzealous treatment of a patient causing overspending; this in itself could affect the level of

patient care given.

Characteristics of services

Intangibility e.g. no material substance or physical existence of it when compared toa tangible good

Legal ownership e.g. no physical evidence often exists, so you can never return it if itwas faulty

Instant perishability e.g. unlike goods, services cannot be stored Heterogeneity e.g. each time the service is performed even to the same customer it

can be different each time, goods generally are homogenous

Inseparability e.g. cannot be separated from the person who provides itIt is for the above reasons, as well as the human influence in the quality and effectiveness of

the service performed, when compared to manufacturing a product, that makes standard

costing more difficult to apply within the service sector.


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Solutions to lecture examples


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Example 1.2- absorption costing organisation

Operating statement for week 43

Budget (500 x 3.20) 1,600Sales volume variance (476-500 x 3.20) 77(A)

Flexed budget for 476 meals 1,523

Sales price variance (476 x (11.95-11.95) 0

1,523

Cost variances F A

Chicken price variance (180kg x 2.25-2.50) 45

Chicken usage variance (143-165 x 2.50) 55

Vegetable price variance (250kg x 0.50-0.56) 15Vegetable usage variance (238kg-220kg x 0.50) 9

Labour efficiency variance (119-114 x 9) 45

Labour rate variance (120 x 10-9) 120

Idle time variance (6 x 9) 54

Variable overhead efficiency variance

(119-114 x 2) 10

Variable overhead expenditure variance

(114 x 2-1.32) 78

Fixed overhead expenditure variance

(2500-2750) 250

Fixed overhead volume variance

(476-500 x 5) 120

187 614 = 427(A)

Actual profit* 1,096

* Proof

Sales 5,688

Chicken 405

Closing stock (15kg x 2.50) (38)

Vegetables 140

Closing stock (30kg x 50p) (15)

Labour 1,200

V/OH 150

F/OH 2,750 (4,592)

1,096


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Example 1.2- marginal costing organisation

Operating statement for week 43

Budget (500 x 8.20) 4,100Sales volume variance (476-500 x 8.20) 197(A)

Flexed budget for 476 meals 3,903

Sales price variance (476 x (11.95-11.95) 0

3,903

Cost variances F A

Chicken price variance (180kg x 2.25-2.50) 45

Chicken usage variance (143-165 x 2.50) 55

Vegetable price variance (250kg x 0.50-0.56) 15Vegetable usage variance (238kg-220kg x 0.50) 9

Labour efficiency variance (119-114 x 9) 45

Labour rate variance (120 x 10-9) 120

Idle time variance (6 x 9) 54

Variable overhead efficiency variance

(119-114 x 2) 10

Variable overhead expenditure variance

(114 x 2-1.32) 78

187 244 = 57(A)

Actual contribution 3,846

Budgeted fixed overhead 2,500

Fixed overhead expenditure variance (2500-2750) 250(A)

Actual profit* 1,096

* Proof

Sales 5,688

Chicken 405Closing stock (15kg x 2.50) (38)

Vegetables 140

Closing stock (30kg x 50p) (15)

Labour 1,200

V/OH 150

(1,842)

Contribution 3,846

F/OH (2,750)

1,096


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Example 1.3

Calculate the actual production and sale of meals

Did sell 476 (balance figure)Should sell 500 (2500 Budget F/OH divided by 5 F/OH)

24

Standard profit per meal x 3.20

77(A)

Calculate actual hours worked for the chefs

476 meals did take 114 (balance figure)

476 meals should take (476 x 0.25 hrs) 119

5Standard rate per hour x 9.00 per hour

45(F)

Hours paid for would have been 114 worked plus 6 hours idle time = 120 hours

Calculate the actual quantity of chicken purchased

476 meals did use 165 kg (balance figure)

476 meals should have used (x0.3kg) 143 kg

22 kg

Standard price per kg x 2.50

55 (A)

Calculate the actual price paid for chicken

165kg used as above + 15kg rise in closing stock levels = 180kg purchased.

180kg did cost 405 (balance figure)

180kg should cost (x 2.50 kg) 450

45(F)

Calculate the actual variable overhead expenditure

114 hrs worked did cost 150 (balance figure)

114 hrs should have cost (x 2 per hour) 228

78(F)

Calculate the actual fixed overhead expenditure

Actual fixed overhead 2,750 (balance figure)

Budget fixed overhead 2,500

250(A)


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Example 1.4

Usage variance

60kg pizza did use should use standard price variance

Tomato 28kg 30kg x 1.40 = 2.80 (F)

Cheese 40kg 36kg x 7.50 = 30.00 (A)

27.20 (A)

Mix can be calculated by one of two ways

First method (individual valuation bases)

60kg pizza did use should use standard price variance

(W1)

Tomato 28kg 31kg x 1.40 = 4.20 (F)Cheese 40kg 37kg x 7.50 = 22.50 (A)

68kg 68kg 18.30 (A)

(W1)

68kg ingredients x 0.5kg/1.1kg = 31kg of tomatoes you would have used had you kept to the

mix

68kg ingredients x 0.6kg/1.1kg = 37kg of cheese you would have used had you kept to the

mix

Second method (average valuation bases)

Weighted average cost of one Kg of ingredients

(0.5kg/1.1kg x 1.40) + (0.6kg/1.1kg x 7.50) = 4.73

Within the mix

(did use less should use) x (average standard cost less standard cost) = variance

Thus if an actual mixed quantity is greater than the standard quantity mixed for thismaterial, but this material costs less than average, then a favourable variance will

result, as also would using less of a relatively more expensive ingredient, when

compared to the average cost.

Tomatoes 28kg-31kg= 3kg x 4.73-1.40 = 10.00 (A)

Cheese 40kg-37kg= 3kg x 4.73-7.50 = 8.31 (A)

18.31 (A)

For tomatoes 3kg used less than you should of but this costs less than the average cost,

adverse. For cheese 3 kg used more than you should of which costs more than the average

cost, adverse. Butliness have substituted a relatively less expensive ingredient for a moreexpensive one, hence both variances adverse.


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Example 1.4 continued.

Yield

68kg of cheese and tomato should yield (68kg/1.1kg per pizza) 61.8

68kg of cheese and tomato did yield 60.0Under produced 1.8

x standard cost of one pizza average cost per kg 4.73 x 1.1kg/1.0kg x 5.20*

9.37 (A)

*1.1KG INGREDIANT = 1.0KG OUTPUT THEREFORE THE COST OF ONE PIZZA

SHOULD BE 1.1/1.0 X 4.73 AVERAGE COST PER KG.


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Example 1.5

Labour Mix calculation - individual valuation basis

Actual hours Standard mix Standard hours Standard rate

Partner 12 3 / 20 13.5 1.5 100 150.00 (F)

Semi-senior 40 5 / 20 22.5 -17.5 70 -1225.00 (A)

Junior 38 12 / 20 54.0 16 30 480.00 (F)

90 20 / 20 90.0 0.0 -595.00 (A)

Labour Mix calculation - average valuation basis

Actual hours Standard hours Standard rate - Average rate

Partner 12 13.5 1.5 100 50.50 -49.50 74.25 (F)

Semi-senior 40 22.5 -17.5 70 50.50 -19.50 -341.25 (A)

Junior 38 54.0 16 30 50.50 20.50 -328.00 (A)

90 90.0 0.0 -595.00 (A)

W1 Average rate

(3/20 x 100) + (5/20 x 70) + (12/20 x 30) = 50.50

Labour yield or productivity variance

90 hours did yield 5.0 audits

90 audits should yield (90 hours/20 hours an audit) 4.5 audits

0.5 audits

x standard cost of an audit (1,010)

505(F)

Operating statement

5 audits should cost (based on standard mix of labour) 5 x 1,010 = 5,050

Labour mix variance 595 (A)

Labour yield variance 505 (F)

5 audits did cost (assuming standard rates were correct e.g. no rate variance)

(12 hours x 100) + (40 hours x 70) + (38 hours x 30) = 5,140

Worse off by 90, the semi-senior improving productivity, due to higher quality of work, however this cost

the organisation 90 (adverse) labour efficiency variance due to the higher cost of using the semi-senior, shown

within the mix variance.


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Example 1.7

Machine expenditure and efficiency variances

Standard cost of 25 pints 40 x 0.6 hrs = 24 per 25 pints.

Efficiency

1900 pints did take 42.0 hrs

1900 pints should take (1900/25 x 0.6 hrs) 45.6 hrs

3.6 hrs

Standard cost per machine hour x 40

144(F)

Expenditure

42 hrs did cost 1,880

42 hrs should cost (42 x 40) 1,680

200 (A)

Operating statement

Flexed budget based on actual output achieved

Budget 1900/25 x 24 = 1,824

Efficiency 144(F)

Expenditure 200(A)

Actual 1,880


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Example 1.7 - continued

What if you were told that the machine has been replaced with a machine, which is 20%

faster than the previous model, but this had not been reflected in the budget?

Revise standard 0.6hrs x 0.8(20% faster time!!) x 40

Planning variance

1900 pints should have taken according to old standard 46hrs

1900 pints should have taken according to new standard 36hrs

10 hrs

x 40

400(F)

Operational expenditure variance no change

Operational efficiency variance (revised)

1900/25 x 0.6 hrs x 0.8 should take 36 hrs

Did take 42 hrs

6 hrs

x 40

240 (A)

Operating statement

Flexed budget based on actual output achieved

Budget 1900/25 x 24 = 1824

Planning 400(F)

Efficiency 240(A)

Expenditure 200(A)

Actual 1880

About 14 rounding difference above.

Documents

Standard Costing by Acca