Standard Costing Slides 2015

1

Standard Costing

& Variance Analysis

Drury: Chapter 17 and 18

Standard costing and variance analysis

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Objectives • Revision of standard costing:

– Conventional production and sales variances • Rate variances

• Usage variances

• Sales volume variance

• Sales price variance

– Raw materials mix and yield variances

– Sales quantity and mix variances

• Extension of standard costing (new*) – Market share and size variances

– Ex post variances (Planning and operating variances)

• Integration with other topics

3

Standard costing When do we use a standard costing system? • Common or repetitive operations (Often used in a manufacturing firm)

What is standard costing? • A financial control system that enables:

– deviations from budget to be analysed in detail, – costs to be controlled more effectively. – good planning, as we have detailed knowledge on how costs are driven.

• Of paramount importance is the flexible budget: – the master budget adjusted to the actual level of volume NB Flex your budget – Standard costing compares the flexed budgeted costs to the actual costs.

What are standard costs? • Pre-determined target costs that can be incurred under efficient operating conditions. • Standard costs are given on a per unit basis, i.e. the cost expectation per unit • Budgeted costs relate to the anticipated costs for an entire activity or operation

Standard Cost Card (always per unit)

Cost item Details Amount

Direct materials 1 meter @R10 R 10

Direct labour 0.1 hrs @ R20 R 2

Fixed overhead 0.1 hrs @R10 R 1

R 13

Include normal losses/ normal wastage:

Take 9 hours @ 75% efficiency = effectively taking

12 hours (3 hours= normal loss which needs to be included in std)

4

Remember: • Always value inventory at the standard (AQ*SR)

• Raw materials T account: Opening balance at standard rate (AQ*SR)

Add: Actual purchases

Add: favourable variances (income)

Less: unfavourable variances (expense)

Less: closing balance at standard rate (AQ*SR)

= Balance transferred to WIP representing amount used

Rate variances Usage variances

Given [AQ of DM purchased/AQ of labour hours used]; how much should I have spent and how much did I spend?

Given actual units produced, how many kg’s

or hours should I have used and how many did I use?

5

What variances usually arise under a standard costing system?

• Material variances (price, usage, mix & yield)

• Labour variances (expenditure, usage & mix)

• Variable overhead variances (expenditure & usage)

• Fixed overhead variances (expenditure, volume, capacity

& efficiency)

• Sales variances – Price and volume (mix and quantity)

– Market size and share variances (new!)

Production

What levels of activity are important when calculating variances?

• Budgeted Quantity: Only use to calculate budgeted profit /income statement

• Actual Production Quantity: Use to calculate your production variances

• Actual Sales Quantity: Use to calculate your sales variances

On a traditional costing basis, or on an ABC basis

Not recognised in

acc records!

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7

Raw materials variances

Total Raw Materials Variance

= Standard Cost – Actual Cost

= (SQ x SP) – (AQ x AP)

= RM Price Variance + RM Usage Variance

(SQ – AQ) x SP (SP – AP) x AQ

Raw Materials actually used

Raw Materials Purchased

Mix Variance Yield Variance

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Raw materials Mix and Yield Variances

• 3 Things before you can have a mix and yield variance: – More than one raw material input – There is an optimal mix of raw materials that minimises cost while still meeting the

quality standards – A change in mix affects the yield (normal loss).

Only arises when you use different amounts of the inputs compared to budget • Mix variance = inputs A mix variance arises when the actual mix differs from the predetermined standard mix.

(AQ in budgeted proportions - AQ) SP for each unit of input

• Yield variance = outputs A yield variance arises when the actual output differs from what should have come out the

process, based on what we put in.

(Actual production - What should have come out the process) SP for each unit of output (actual yield - Actual quantity*standard yield )*SP (where SP is the budgeted average

cost per unit of output) Example: expect a 15% loss, if produce 1 000 000l, expect output of 850 000l

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• Standard ingredient of 1kg of product FDN is: – 0.65kg of F @ R4.00

– 0.3kg of D @ R6.00

– 0.2kg of N @ R2.50

1.15kg

• Budgeted production of product X is 4000 kg

• Actual production is 4200kg

• Actual material costs: – 2840kg of F

– 1210kg of D and Total used: 4910kg

– 860kg of N

– Total cost R20380.00

Standard proportions:

F = 56.5% D = 26.1% N = 17.4%

10

Raw materials Mix and Yield Variances: Example

Mix variance

A mix variance arises when the actual mix differs from the predetermined standard mix.

(AQ in budgeted proportions - AQ ) SP for each unit of input

Yield variance

A yield variance arises when the actual output differs from what should have come out the process, based on what we put in.

(Actual production - What should have come out the process) SP

( – ) x =

(AQ in budg prop - AQ)SP

F ( - 2840 ) £ 4.00

D ( - 1210 ) £ 6.00

N ( - 860 ) £ 2.50

4910 £ 150.87 F

2775.22

1280.87

853.91

4910

£ 259.13

£ 425.22

£ 15.22

F

A

A

£4.9 4200 4910kg x 1/1.15 = 4270kg

R340.87 A

£4*0.65kg+ £6*0.3kg+ £2.5*0.2kg

11

Raw materials Mix and Yield Variances Material Usage Variance:

Usage Variance (Mix and Yield)

(The amount of raw materials I should have used at my actual level of production – AQ)SP

My actual level of production is 4 200 units of FDN

My input at this level of production should have been 4 200 * 1.15 kg = 4 830 kg

(in other words, 4830kg should have been used to produce 4200kg based on budget)

F ( - 2840 ) £ 4.00

D ( - 1210 ) £ 6.00

N ( - 860 ) £ 2.50

190 A

4830 x( 0.65/1.15) =2730

4830 x (0.3/1.15)=1260

4830 x (0.2/1.15)=840

£ 440

£ 300

£ 50

F

A

A

(SQ – AQ) x SP

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Sales Variances

• Total Sales Variance =

– Budgeted Contribution – Actual Contribution

– (BV x SM) – (AV x AM)

Sales Margin Volume Variance + Sales Margin Price Variance

(SM – AM) x AV or

(SSP – ASP) x AV

(BV – AV) x SM

13

Variable vs Absorption Costing

– Variable Costing - The standard/actual margin is a contribution margin:

• Standard margin:

(Standard SP – Standard VC)

• Actual margin

(Actual SP – Standard VC)

– Absorption Costing –The standard/actual margin is the profit margin:

• Standard margin

Standard SP– (std VC + std FC)

• Actual margin

Actual SP – (std VC + std FC)

Sales price variance:

(SM – AM) x AV

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Sales mix and quantity variances Where a company sells several different products that have different profit

margins, it is possible to divide the sales volume variance into a quantity and mix

variance.

Example:

Budgeted sales R

A = 8 000 units at R20 contribution = 160 000

B = 7 000 units at R12 contribution = 84 000

C = 5 000 units at R9 contribution = 45 000

20 000 289 000

Actual sales R

A = 6 000 units at R20 contribution = 120 000

B = 7 000 units at R12 contribution = 84 000

C = 9 000 units at R9 contribution = 81 000

22 000 285 000

Therefore, AQ*std %= A: 40% = 8 800 B: 35% = 7 700 C: 25% = 5 500

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Sales Margin Price Variance

(SM – AM) x AV

Sales Margin Volume Variance

(BV – AV) x SM

Mix Variance

(Actual Volume in budgeted proportions

- Actual Volume ) Std Margin

Quantity Variance

(Budgeted Volume - Actual Volume in

budgeted proportions ) x Std Margin

Total Sales Variance

BV AV X SM

Actual volume in budgeted

proportions

A 6 000

B 7 000

C 9 000

22 000

A 8 000

B 7 000

C 5 000

20 000

5500

40%

35%

25%

7700

8800

22000

A R20

B R12

C R9

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Sales Variances

Sales Volume Variance: (BV – AV )SM

A (8000 – 6000) 20 = 40 000A

B (7000 – 7000) 12 = 0

C (5000 – 9000) 9 = 36 000F

4 000A

Sales Mix Variance: = (AQ in budgeted proportions - AQ) × Standard margin

A (8 800 – 6 000 ) × R20 = R56 000 A

B (7 700 – 7 000 ) × R12 = R 8 400 A

C (5 500 – 9 000 ) × R9 = R31 500 F

22 000 22 000 R32 900 A

Quantity variance: = (BQ - AQ in budgeted proportions ) × SM

A (8 000 – 8 800) × R20 = R16 000 F

B (7 000 – 7 700) × R12 = R 8 400 F

C (5 000 – 5 500) × R9 = R 4 500 F

R28 900 F

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Sales Margin Price Variance

(SM – AM) x AV

Sales Margin Volume Variance

(BV – AV) x SM

Mix Variance (Actual Volume in budgeted proportions

- Actual Volume ) Std Margin

Quantity Variance (Budgeted Volume - Actual Volume in

budgeted proportions ) x Std Margin

Total Sales Variance

Market

size

variance

Market

share

variance

Where published industry sales statistics are readily available, it is possible to divide the sales quantity variance into a component due to changes in

market size and component due to changes in market share.

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Market size and share variances

Budgeted

market

share

percentage

Market

size

variance

Actual

industry

sales

volume in

units

Budgeted

industry

sales

volume in

units

Budgeted

average

contribution

per unit X X = -

Budgeted

market

share

percentage

Market

share

variance

Actual

industry

sales

volume in

units

Budgeted

average

contribution

per unit X X = -

Actual

market

share

percentage

How much of industry am I

supposed to get?

What sales volume should I get due to change in market

share?

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Previous example continued

Assuming that the budgeted industry sales volume for a company was

200 000 units and the actual industry sales volume was 275 000 units

• Calculate the market size and market share variances

Budgeted

market

share

percentage

Actual

industry

sales

volume in

units

Budgeted

average

contribution

per unit X X = -

Actual

market

share

percentage

Market

share

variance

Budgeted

market

share

percentage

Market

size

variance

Actual

industry

sales

volume in

units

Budgeted

industry

sales

volume in

units

Budgeted

average

contribution

per unit X X = -

R14.45

Budgeted sales Actual sales A = 8 000 units at R20 contribution A = 6 000 units at R20 contribution

B = 7 000 units at R12 contribution B = 7 000 units at R12 contribution

C = 5 000 units at R9 contribution C = 9 000 units at R9 contribution

Total 20 000 Total 22 000

R14.45

200 000

20 000/200 000

275 000

20 000/200 000

= 10%

22 000 / 275 000

= 8%

275 000

A: 40% B: 35% C: 25%

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Solution

Market

size

variance

= R108 375 F

Market

share

variance = R79 475 A

The market size variance indicates that an additional contribution of

R108 375 was expected, given that the market expanded from

200 000 to 275 000 units.

However, the company did not attain the predicted market share of

10%. Instead, a market share of only 8% was attained, and the 2%

decline in market share resulted in a failure to obtain a contribution of

R79 475.

Sales quantity variance

= 28 900 F

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Ex post variance analysis

A major criticism is that actual performance is compared with a standard based on

the environment that was anticipated when the standard was set.

Standard Revised standard Actual

1. Planning variance: • Variances that have arisen due to unforeseen, or uncontrollable events, and therefore

management should not be evaluated on these variances as they are outside their control.

• Planning variances can indicate how successful management is at forecasting.

Raw Materials planning variance:

(Budgeted production x SQ x SP - Budgeted production x revised SQ x revised SP)

2. Operating variance: • The variance calculations are exactly the same as before, except one uses revised

standards as opposed to the original standards in the calculations:

a) Raw Materials usage variance b) Raw Materials price variance:

(Revised SQ – AQ) Revised SP (Revised SP – AP) AQ

Planning Operational

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Ex post variance analysis example

The original budget for August 2011 is as follows:

Sales (R20 x 50 units ) R1 000

Raw materials cost (2kg @ R5 per kg) x 50 units R 500

The budgeted profit R 500

A shortage of raw materials in the market caused the market price for 1kg to

increase to R5.18 per kg for August 2011 only. These raw materials were of a

slightly lower quality, therefore 2.2kg were expected to be used. The actual

production and sales for August 2011 was 55 units, and the profit statement is

found below:

Actual Profit Statement for August 2011:

Sales (R20 x 55 units ) R1 100.00

Raw materials cost (2.1kg @ R5.2 per kg) x 55 units R 600.60

Actual profit R 499.40

You are required:

1. Reconcile the budgeted and actual profit using conventional variance analysis.

2. Reconcile the budgeted and actual profit using ex post variance analysis.

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Raw Materials usage variance

(SQ – AQ) SP

=(2kg-2.1kg)*55 units*R5

=R 27.50 Adverse

Raw Materials price variance:

(SP – AP) AQ

=(R5.00-R5.20)*(55 units*2.1kg)

=R 23.10 Adverse

Sales Volume variance before:

(BV - AV) SM

=(R20-R10)*(55 - 50 units)

=R50 Favourable

Reconciliation

Budgeted profit = 50 units (R20 - R10) R 500.00

Raw materials price variance


Sales Volume variance

Actual Profit R 499.40

1) Conventional Variance Analysis

Raw Materials usage variance (SQ – AQ) SP

Raw Materials price variance: (SP – AP) AQ

Sales Volume variance before: (BV - AV) SM

Reconciliation Budgeted profit = 50 units (R20 - R10) R 500.00

Raw materials price variance -R 23.10

Raw Materials usage variance -R 27.50

Sales Volume variance R 50.00


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2) Ex post Variance Analysis

-R69.8


(revised SQ – AQ) Revised SP

Raw Materials price variance:

(Revised SP – AP) AQ


(BV - AV) x revised SM

Reconciliation

Budgeted profit R 500.00

Planning variance

Operating variances

Raw materials price variance




(R20 - 2.2kg x R5.18) = R8.604

b) Operating variances

a) Planning variance

Raw Materials planning variance:

(Budgeted production x SQ x SP - Budgeted production x revised SQ x revised SP)

=50*2*5 – 50*2.2*5.18

[(55*2.2) – (55*2.1)]5.18

R28.49

Adverse

(5.18 – 5.20) 115.5

R-2.31

(50units - 55units ) R8.604 per unit

R 43.02

Revised std margin

(revised Std selling price - revised variable costs)

Favourable

Reconciliation


Planning variance -R 69.80

Operating variances


Raw Materials usage variance R 28.49



Favourable

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Conventional Variance Reconciliation



Standard profit at actual level of sales R 550.00

Variances


Raw Materials usage variance -R 27.50


Ex post Variance Reconciliation


Planning variance -R 69.80

Revised budgeted profit R 430.20


Standard profit at actual level of sales R 473.22

Operating variances


Raw Materials usage variance R 28.49


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Investigation of variances

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Investigation of variances

1. Reasons for variances • Measurement errors e.g. Number of labour hours is incorrectly added or assigned.

• Out-of-date standards. Frequent technological changes

Standard fails to take into account learning curve effects

• Inefficient operations: Failure to follow prescribed procedures, faulty machinery or human errors

pin point cause of inefficiency and implement corrective action.

• Random or uncontrollable factors.

2. Investigation will indicate that variance is due to: • Random uncontrollable factors when the operation is under control.

• Assignable causes, but the cost of investigation exceeds benefits.

• Assignable causes, but the benefits of investigation exceed the cost.

A good

investigation

model would

only

investigate

these

variances Incorrect standard?

Corrective action needed?

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• Under traditional costing, there is one lot of fixed (assumed to be indirect) costs that are allocated over a budgeted allocation base to units (usually budgeted production or labour hours).

• Under ABC, the indirect costs are split into activities, and for each activity, variances can be performed:

– Expenditure variance

– Usage/efficiency variance

– Note: under ABC, costs and variances may also be performed per batch, not just per unit. However, calculations remain the same

Integration with ABC (VOH and FOH)

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Fixed Overhead Variances

Allocated FMC

Budgeted FMC

Actual FMC

SR = Budgeted FMC Budgeted allocation base

AP x SR BP x SR Expenditure Volume

Volume Efficiency

Variance

(SH- AH) x SR

Volume Capacity

Variance

(AH – BH) x SR

AH SH BH

SR = Budgeted FMC BP

(AP-BP) x SR

SR = Budgeted FMC Budgeted labour hours

F when absorb more than actual

F when actual exceeds budgeted,

otherwise indication failed to

use capacity

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ABC Variance Analysis Example

Information relating to the production set-up function:

Budget Actual

Activity level (1 600 set-ups) Activity level (1 400 set-ups)

Practical capacity supplied (2 000 set-ups) Total VC (R39 000)

Total indirect fixed costs (R80 000) Total FC (R70 000)

Total indirect variable costs (R40 000)

Cost driver rates:

Variable

Fixed

Assume that production takes place in batches of 100 units, and that the machine

needs to be set up before every batch. Actual production in units for the period is

150 000 units. Fixed costs are allocated based on practical capacity

R40 000/1600 = R25 per set up

R80 000/2000 = R40 per set up

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Variable Overhead Variances

• Total Variable Overhead Variance

– Standard Cost – Actual Costs

– (SH x SR) – (AH x AR)

– Ovhd Expenditure Variance + Ovhd Efficiency Variance

(SR – AR) x AH (SH – AH) x SR

32

Variable Set-up Variances

• Total Variable Set-up Variance

– Standard set-up costs – Actual set-up costs – (Std number of set-ups x SR per set up) – (Actual number of set-ups x AR per set up)

– Set-up Expenditure Variance + Set-up Efficiency Variance

(SR per set up – AR per set up ) x A SU’s (Std SU’s – Act SU’s) x SR per set up

(R25 – R39 000/1 400) x 1 400

=R4 000 A

(150 000/100 – 1 400) x R25

= 2 500 F

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Fixed Set-up Variances

Allocated set-up costs

Budgeted set-up costs

Actual set-up costs

SR = Budgeted fixed set-up costs Practical no. of set ups

E.g. Now use practical capacity, as trying to

isolate cost of not planning to use capacity.

Expenditure Volume

(Budgeted set-up costs – Actual set up costs)

(R80 000 – R70 000) =R10 000F

SR = R80 000 = R40 per set up 2 000 set ups

(1 400 – 1 600) x R40

= R8 000A

(1 600 – 2 000) x R40

=R16 000 A

(1 500 – 1 400) x R40

= 4 000 F

Volume Efficiency

Variance

(Ssu’s- Asu’s) x

SR per su

Volume Capacity

Variance

(Asu’s – Bsu’s) x

SR per su

Budgeted Unused

Capacity Variance

(Bsu’s – PBsu’s) x

SR per su

ASU BSU SSU PSU

1500 1400 1600 2000

34

ABC and variance analysis:

Variance analysis for variable set-up expenses:

R

Variable set-up expenses charged to products (1 500 ×R25) 37 500

Variable set-up efficiency variance 2 500 F

Variable set-up expenditure variance 4 000 A

Total actual expenses 39 000

Variance analysis for variable set-up expenses: R

Set-up expenses charged to products (1 500 × R40) 60 000

Budgeted unused capacity variance (400 × R40) 16 000 A

Capacity utilization variance (200 × R40) 8 000 A

Volume Efficiency variance (100 × R40) 4 000 F

Expenditure variance 10 000 F

Total actual expenses 70 000

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MANAGEMENT ACCOUNTING IV

- Job Costing/Process Costing - CVP - Standard Costing - Strategy

- Joint & By-product Costing - Decisions under uncertainty - Divisional performance - Sustainability reporting

- Variable Costing (decision trees) - Performance evaluation - ABM/ TQM

- Absorption Costing - Relevant Costing - Just-in-time

- Pricing Decisions - Balanced Scorecard

- ABC

Traditional ABC - Capital investment decisions

Production Cost

Cost Classification Period Cost Inventory Valuation

Fixed Cost

Variable Cost Relevant Costing/Planning and Controlling Costs/ Inventory Valuation/CVP

Direct Costs Trace to products

Indirect Costs Allocate to products Traditional Approach

ABC

Fixed Component

How costs behave Variable Component Decision Making / Relevant Costing/Planning and Controlling Costs/ Inventory Valuation/CVP/Cost Estimation

Inventory Valuation

Decision Making Planning, Control &

Performance Measurements

Strategic

Management

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INTEGRATION with Cost Estimation Principles

• NB Linear Regression:

– May need to split mixed costs into their fixed and variable components before you can do your variance calculations.

• NB Learning Curve:

– Seldom linked, because the standard has been set over time. However if temporary staff need to be employed, you may need to incorporate learning curve into the variances. This would be very clear (a learning curve percentage would be given).

INTEGRATION with Inventory Valuation Principles

• NB Production v period costs

Only production costs can be included in the value of the inventory. These will be included in the inventory at standard.

• NB Absorption and variable costing - Affects your:

– Fixed overhead variances (no volume, capacity and efficiency variances)

– Sales variances (use the standard contribution margin and not the gross profit margin).

37

INTEGRATION with Cost Classification Principles

• NB Cost Behaviour

– Need to identify whether costs are fixed or variable. This will determine how the variances will be calculated.

• With variable costs you flex the standard (standard quantity)

• With fixed costs you compared budgeted to actual to absorbed (as these costs do not vary with production)

INTEGRATION with Decision-Making tools • Not really linked to the decision making tools.

INTEGRATION with Performance Evaluation (often linked)

• NB Responsibility centres

– The person who was responsibility for the decision that resulted in the variance should be evaluated on the variance.

– E.g. Purchasing department purchase inferior quality raw materials, therefore more was used by the production department. This usage variance should be attributed to the purchasing department. NB: You should only be evaluated on what you have control over.

• NB Planning and operating variances

– Will have an important link here

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What are the reasons for using a standard costing system?

• To help set budgets. • To predict future costs needed for decision making purposes. • To evaluate managers performance:

• Variances must be allocated to the correct responsibility centres in order to ensure control and accountability

• To control costs: • Reasons for variances must be identified and investigated • Remedial action should be undertaken

• To value inventory. Standard costing can be used for financial accounting purposes as long as standard costs approximate actual costs. IAS 2

Documents

Standard Costing Slides 2015