1
Standard costing and
variance analysis
Chapter
5
1
Standard costing and
variance analysis
Chapter
5
2
5.1
Standard costing
A standard cost is a planned (budgeted) or forecast unit cost for a product or service, which
is assumed to hold good given ‘expected’ efficiency and cost levels within an organisation.
A standard cost normally represents the planned (budgeted) or forecast unit cost for material,
labour and overhead expected for a product or service.
Types of standard cost
Ideal standard e.g. a standard attained under the ‘most favourable’ operating
conditions, no allowance for any waste, scrap, idle time or production stoppage. This
type of standard is normally unrealistic or unattainable in reality; staff could be
demotivated because such targets set would rarely be achieved.
Attainable (or expected) standard e.g. a standard that could be achieved by staff,
given a reasonable (not perfect) level of effort from them. Some allowances would be
made for delays or inefficiencies that are expected to occur during production or
delivery of a service.
Current standard e.g. a standard based on current and existing operating conditions.
Management must continually attempt to improve cost and efficiency levels by the
continual introduction of attainable (or expected) standards (as explained above).
Loose standard e.g. a standard ‘loosely’ set and therefore easy to achieve by staff.
Basic standard e.g. the first standard ever used by the organisation, often used as a
yardstick to monitor trends for improvement made over time.
Historical standards e.g. any standard used historically in previous periods.
Practical advice for setting standards
1. Use challenging but realistic targets. Link higher financial reward to the higher
achievement of more challenging targets and perhaps moderate incentives for easier
targets to achieve.
2. Consult with and allow staff to participate when setting targets, this can help improve
their motivation, reduce frustration and increase job satisfaction.
3. Clear trust and communication must be developed between management and staff,
management must avoid be over critical if very challenging targets have not been
achieved.
4. Good planning is essential to ensure whatever standards or targets that are used, they
are realistic and achievable. Frequent periodic reviews of standards or targets are
required to ensure they are attainable.
Example 5.1
Wood Plc makes wooden tables and chairs from natural timber. To make one unit of product
consisting of one table and four chairs, it consumes 60kg of timber; after an expected 20%
wastage due to wood shavings and scrap in the cutting process. 100kg of timber currently
costs Wood Plc £50.
What is the standard cost of material to make one unit of product?
3
Information for a standard (budgeted) cost e.g. for a product or service.
Standard material price
Supplier contracts, quotations and
estimates.
Previous supplier invoices and cost
trends.
Websites
of
material/component
suppliers.
Discounts
available
for
bulk
purchases.
Seasonality/volatility
of
material
prices.
Differences
in
quality
of
material/components and therefore
differences in price.
Inflation
rates
expected
for
material/component prices.
Standard material usage
The quality of material e.g. levels of
wastage and scrap maybe higher for
more inferior material/components
and vice versa.
Specification and design of the
product or service e.g. determines
directly the material usage.
Normal wastage levels expected
during delivery of a service or
manufacturing of a product.
Estimations based upon previous
consumption of material/components
e.g. quality of litres, kilos etc issued
from stores to production ÷ volume
of products made = average material
consumption.
Standard labour rate
Market rates for different skills and
grades of staff.
Wage inflation rates expected.
Existing internal rates from payroll
records e.g. bonus schemes, overtime
or piece work rates currently in use.
The standard (budgeted) wage rate per hour
normally incorporates any level of bonus or
overtime expected for a period, based upon
forecast output.
Standard labour efficiency
Idle
time
expected
e.g.
non-
productive time during processes.
Time and motion studies.
Time sheets e.g. total hours worked
÷ volume of products made = the
average time per unit.
Skill and expertise of staff e.g.
skilled staff work quicker or more
efficiently.
The learning curve or learning rate
expected when untrained staff or new
processes are introduced.
Motivation and morale of staff often
creates quicker performance.
Standard overhead rate
A variable or fixed overhead rate per unit can be obtained by dividing the total
forecast (budgeted) overhead for a period, by a forecast (budgeted) level of activity
e.g. labour hours worked, machine hours run or products and services made (output).
Review and monitor variable overhead rates used in past periods and consider
expected inflation rates.
Cost relationships can be found by using techniques such as the high-low method or a
scatter graph as a way of separating variable and fixed cost.
4
Standard costing can be used for
Preparation of budgets e.g. more accurate planning and forecasting.
Controlling performance of an organisation by ‘exception reporting’ e.g. standard or
budgeted costs and revenues, compared with actual results and any differences
highlighted for investigation.
Inventory valuation e.g. raw material, work-in-progress and finished goods
inventory valued at standard cost for simplicity.
Simplifying cost bookkeeping e.g. the flow of entries from expense accounts to
work-in-progress or cost of sales can take place at standard rather than actual cost,
this integrates both financial and management accounting systems together.
Motivating and rewarding staff e.g. standards can be used as goals or targets for
staff achieve, financial reward can be linked measurably to achieving standards set.
Staff bonuses can be linked to efficiency, productivity or cost savings made by staff.
Criticisms of standard costing
Sometimes it can be hard to define a ‘current’ or ‘attainable standard’ especially with
the complexity and diversity of modern manufacturing. Traditionally manufacturers
produced a small range of products using mass production techniques. Nowadays
products have shorter lifecycles and different batches of many different products can
be produced.
With more automation of manufacturing operations today and less human
intervention, labour standards are becoming less valuable as management
information. Automation produces greater uniformity and consistency of products
made, with less likelihood of material and labour variances actually occurring.
Standard costing is an internal not external control measure e.g. too internally focused
on maximising efficiency and minimising cost. Organisations need to consider other
external factors such as competition, customers and other global environmental
factors, not just internal cost and efficiency levels. Quality, innovation and customer
satisfaction have become far more important to survive as an organisation today.
Even when variances are identified there could be uncontrollability of any exceptions
highlighted e.g. discounts lost due to a reduction in the quantity of material ordered or
seasonal price fluctuations within the financial period. In these cases very little
control action (if any) can be taken by management and care must also be taken to
avoid blame. Often the reason or causes of variances even when found are sometimes
overlooked or not investigated at all.
The revision to standards may be too infrequent to guide or improve performance
over time e.g. the life cycle of products are much shorter in a modern manufacturing
environment and the environment more dynamic. Standards quickly become out of
date due to frequent and continuous change.
Modern manufacturing techniques such as TQM and quality circles mean as
manufacturers aim for near perfection, the frequency and materiality of variances
should not occur so often. Today focus is more on quality and customer satisfaction
not the minimisation of cost.
5
5.2
Variance analysis
Variance analysis is a budgetary control technique, which compares planned (budgeted) or
forecast costs and revenues to actual financial results, it measures the differences between
standard (budgeted) and actual performance. Variance analysis is used to improve
operational performance through control action by management e.g. investigation of any
variance causes and correction of them to prevent in future any further deviations from plan.
Reasons why variances occur
Inaccurate data used to compile standards, inaccurate compilation of the budget or
inaccurate compilation of actual financial results.
Standard used either not realistic or out of date.
Efficiency of how operations were undertaken and performed by staff during the
period e.g. mistakes made, poor decisions made, lack of effort etc can all lead to
actual results be worse than expected.
Random or chance events occurring e.g. sudden economic down turn such as the
credit crunch, volatility of exchange rates, weather and commodity prices.
The budgetary planning process involves the production of budgets or forecasts using the
most realistic standards for cost and efficiency levels. The budgetary control process
identifies areas of responsibility for management and staff and then frequently compares
actual results against the budget or standards used. The original budget would have normally
forecast a different number of units produced and sold, compared with the actual number of
units produced and sold, a ‘flexed budget’ is therefore prepared e.g. the original budget
‘flexed’, (redrafted based on actual units produced and sold), to compare with actual costs
and revenues. When a flexed budget is compared with actual results this is on a like for like
basis and therefore a meaningful yardstick to calculate variances. Variances can be
subdivided and analysed further to help management determine where control action is
needed.
A variance is the difference between planned, budgeted or standard cost and the actual cost
incurred. The same comparisons may be made for revenues.
(CIMA)
There are many variance proforma calculations that need to be learned and applied as part of
your studies. These proforma are essential to learn and practice in order to truly understand
and interpret what variances mean. Once variances have been calculated either ‘F’ or ‘A’ is
used as terminology to indicate favourable or adverse differences between actual and
standard performance. Favourable means that actual results were better than standard.
Adverse means that actual results were worse than standard. Remember variances are just
reconcilable differences between a budget (standard) and actual results so in the case of an
adverse variance this would mean that actual cost will be higher or profit lower when
compared to the budget, and vice versa if a variance was favourable.
6
Sales variance proforma
Sales price
variance
Sales volume
(contribution)
variance
Sales volume
profit
variance
Sales volume
(revenue)
variance
£
Did sell (actual quantity sold x actual selling price) X
Should sell (actual quantity sold x standard selling price) (X)
Sales price variance
X
This measures the impact on profit when actual units sold were at a lower
or higher price than the standard (budgeted) price.
Units
Did sell (actual quantity sold)
X
Should sell (original budgeted quantity sold) (X)
X
x Standard Contribution per unit
Sales volume (contribution) variance
X
.
The sales volume (contribution) variance measures the difference between
the original and flexed budgeted contribution. It measures the impact on
contribution, when actual sale of units is more or less than the original
budgeted sale of units. This method of calculation would be applied when
marginal costing is used by the organisation.
Units
Did sell (actual quantity sold)
X
Should sell (original budget quantity sold) (X)
X
x Standard Profit per unit
Sales volume (profit) variance
X
The sales volume (profit) variance measures the difference between the
original and flexed budgeted profit. It measures the impact on profit, when
actual sale of units is more or less than the original budgeted sale of units.
This method of calculation would be applied when absorption costing is
used by the organisation.
Units
Did sell (actual quantity sold)
X
Should sell (original budget quantity sold) (X)
X
x Standard Price
Sales volume (revenue) variance
X
The above proforma would be the same regardless of whether marginal or
absorption costing principles are applied.
7
Cost variance proforma
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
The material price variance measures the impact on contribution or profit
when the actual quantity of material purchased was at a lower or higher
price than the standard price. This variance calculation always uses the
quantity of material purchased never material used if there is a difference
between material purchased and used in a question.
Material
usage
variance
kg/litres/units
Actual production did use
X
Actual production should use
(actual production x standard usage) (X)
X
x Standard Price
Material usage variance
X
The material usage variance measures the impact on contribution or profit
when the actual quantity of material used was a lower or higher amount
than standard usage. This variance calculation always uses the quantity of
material used never material purchased if there is a difference between
material purchased and used in a question.
.
Total material variance
equals material price variance
+/- material usage variance
8
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
The labour rate variance measures the impact on contribution or profit
when the actual hourly rate paid, was at a lower or higher rate than the
standard rate. This variance calculation always uses actual hours paid
never hours worked if there is a difference between hours paid and
worked in 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 per hour
Labour efficiency variance
X
The labour efficiency variance measures the impact on contribution or
profit when the actual quantity of labour hours worked was at a lower or
higher amount than standard efficiency. This variance calculation always
uses actual hours worked never hours paid if there is a difference between
hours paid and worked in a question.
.
Labour idle
time
variance
Hours
Actual hours paid
X
Actual hours worked (X)
Idle time
X
x Standard Rate per hour
Labour idle time variance
X
The idle time variance measures the impact on contribution or profit when
labour hours paid is different to labour hours worked. Tip: The idle time
variance in your exam will always be adverse.
Total labour variance
equals labour rate variance
+/- labour efficiency variance
+/- labour idle time variance
9
Variable
overhead
expenditure
variance
£
Did spend (actual hours worked x actual variable overhead rate) X
Should spend (actual hours worked x standard variable overhead rate) (X)
Variable overhead expenditure variance
X
The variable overhead rate variance measures the impact on contribution
or profit when the actual rate paid, was at a lower or higher rate than the
standard rate. This variance calculation always uses actual hours worked
never hours paid if there is a difference between hours paid and worked in
a question. It is assumed that no variable overhead would be incurred
during any periods of idle time.
Variable
overhead
efficiency
variance
Hours
Actual production did take
X
Actual production should take
(actual production x standard hours) (X)
X
x Standard Rate per hour
Variable overhead efficiency variance
X
The variable overhead efficiency variance measures the impact on
contribution or profit when the actual quantity of labour hours worked
was at a lower or higher amount than standard efficiency. This variance
calculation always uses actual hours worked never hours paid if there is a
difference between hours paid and worked in a question. Tip: Similar
proforma to the labour efficiency variance e.g. if staff work more
efficiently when compared to standard, labour cost and variable overhead
can be saved due to the saving in staff time.
Total variable overhead variance
equals variable overhead expenditure variance
+/- variable overhead efficiency variance
10
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 uses
absorption costing. When marginal costing an organisation does not use
the process of absorbing fixed overhead and therefore doers not use an
overhead absorption rate for fixed overhead.
Total fixed overhead variance
equals fixed overhead expenditure variance
+/- fixed overhead volume variance
11
Example 5.2
Ramsey Oliver Restaurants is a local restaurant renowned for good quality food. One dish on
the menu which is sold throughout the week has been of major concern for management, the
‘all week chicken roast’. The standard cost and price of the ‘all week chicken roast’ 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
0.50
Fixed overhead 15 mins @ £20.00/hr
5.00
8.75
Standard profit
3.20
Selling price
11.95
The budget each week aims to produce and sell 500 meals. Fixed budgeted overhead for each
week is £2,500. For week 43 the following actual information was obtained.
The number of meals actually produced was 476.
The number of meals actually sold were 460, earning revenue of only £4,600 due to a
promotional offer on the menu reducing each meal sold to £10.00 rather than £11.95
as offered on the menu.
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
Standard costing is used to value any material inventory at the end of a period.
Prepare an operating statement for week 43 applying both absorption and marginal
costing principles, which reconciles any differences between actual and budgeted
results?
12
5.3
Working backwards with variances
Some exam questions rather than the requirement being to calculate variances, it could
instead require you to work out actual information or even standard or budgeted information,
the question will provide variances and normally further information to help. The following
example provides an operating statement prepared using absorption costing principles. You
have to use the budgeted information and variances provided to work out actual results.
Whether the question asks for actual or standard (budgeted) information the approach is the
same each time, use your variance proforma, include all the numbers you do know, then work
backwards to derive the answer you need.
Example 5.3 – Working backwards
Ramsey Oliver Restaurants had a problem with their accountant during period 46; he left in a
fume and took all the actual accounts information with him as revenge. You have been called
in from a temping agency to sort out the mess. The following information has been provided
to you.
Operating statement for week 43
Budget profit
1,600
Sales volume variance
128 (A)
Flexed budget profit
1,472
Sales price variance
897 (A)
575
Cost variances
F
A
Chicken price variance
45
Chicken usage variance
55
Vegetable price variance
15
Vegetable usage variance
9
Labour rate variance
120
Labour efficiency variance
45
Idle time variance
54
Variable overhead expenditure variance
78
Variable overhead efficiency variance
10
Fixed overhead expenditure variance
250
Fixed overhead volume variance
120
187
614 = 427 (A)
Actual profit
148
13
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
0.50
Fixed overhead 15 mins @ £20.00/hr
5.00
8.75
Standard profit
3.20
Standard selling price
11.95
Additional information
Budgeted fixed overhead was £2,500
Actual hours paid were 6 more than worked due to an electrical fault with the ovens
Closing inventory for Chicken and vegetables rose during this period by 15kg and
30kg respectively.
Closing inventory for meals prepared rose during this period by 16 meals. There was
no opening inventory of meals for the period.
You are required to
1. Calculate the actual sale of meals during the period
2. Calculate the actual production of meals during the period
3. Calculate actual hours worked by the chefs during the period
4. Calculate the actual quantity of chicken purchased during the period
5. Calculate the actual price paid for chicken during the period
6. Calculate the actual variable overhead expenditure during the period
7. Calculate the actual fixed overhead expenditure during the period
Tip: The standard cost information above includes fixed overhead in the unit cost of each
meal therefore absorption costing not marginal costing principles need to be applied.
14
5.4
Material mix and yield (productivity) variances
When different types of materials can be used as substitutes for each other, a standard mix
can usually be determined to ensure a quality product at the lowest possible cost. If the actual
material mix varies from the standard mix, both quality and cost may be affected. A material
usage variance can be subdivided into a mix and yield (productivity) variance when there
exists two or more ingredients that can be substituted for one another e.g. to provide a service
or manufacture a product. The sum of the material mix and yield variances will be equal the
material usage variance.
The material mix variance can be calculated by using two different methods, the ‘individual
valuation bases’ which is the easiest to apply and the ‘average valuation bases’. If the
examiner does not specify which method to use, the individual valuation bases is the easiest
method to apply, both methods give the same answer as a total mix variance, but the
individual values for each material which make up the mix variance will be different
depending on each method used.
The merit of using the mix variance calculations is that we can see exactly how much money
has been saved or wasted by understanding the overall composite (mix) of how materials
were used together. For example if making steak and kidney pies, the budget may aim to mix
steak and kidney in the ratio of 80% steak and 20% kidney per pie and the budget would
reflect this. If more kidney which is the assumed cheaper ingredient is substituted to replace
steak which is the assumed more expensive ingredient, then the mix would change and an
adverse total mix variance would be the result of spending too much money overall for all
ingredients together.
Yield (or productivity) variances measure the amount of output (unit of product or service)
from a given amount of input (total materials mixed). Producing more output than expected
from a given amount of material input, indicates greater efficiency of production, the
variance would be favourable, indicating that money has been saved by using material more
efficiently. Producing less output than expected from a given amount of material input,
indicates lower efficiency of production, the variance would be adverse, indicating that
money has been wasted by using material less efficiently.
15
Relationship for material variance calculations
Significance of mix and yield variances
If mix or yield variances occur this not only has an impact on cost, but also can have an
impact on the quality of the final product. For the example if making steak and kidney pies,
substituting more kidney for less steak would normally produce a favorable mix variance,
because kidney is cheaper, but now consider the quality of the pies made? Will customers
complain? A favorable yield variance indicates greater efficiency of how all material was
used altogether e.g. more output (pies) from the input of steak and kidney, however this could
mean that the pies are going out to less than the weight specified, which again may save cost
but may compromise on quality.
Proforma for material mix and yield variances
Yield (productivity) variance
Output
(units)
Actual material used (never purchased if there is a difference) did produce X
Actual material used should produce
(total material input ÷ standard usage per unit of output for all material) X
Over/(under) yield (production)
X
x standard cost of material for one unit of output*
x £x
£X (A)/(F)
Over yielded (produced) = (F) Under yielded (produced) = (A)
*Weighted average standard price of material for one unit of output. This is found by taking
the total standard material cost ÷ the total number of units (output) that would be budgeted
to be made.
Total
Material
Variance
Material
Price
Variance
Material
Usage
Variance
Material
Mix
Variance
Material
Yield
Variance
16
Individual valuation bases
Actual output Did Mix Should Mix Standard Price Variance
(1)
(2)
(3)
Material A
X
X
x £x = £x (A)
Material B
X
X
x £x = £x (F)
Material C
X
X
x £x = £x (A)
X
X
£x (A)
Approach
1. (1) Record the actual quantity of material used (never purchased if this is different to
the quantity used). Add this up e.g. total litres, units, kg etc for all material together.
2. (2) Take the actual quantity of material as a total from column (1) recalculate for
each material how much you should have used according to the standard (budgeted)
mix. Column (1) total should be equal to column (2) total.
3. Deduct (1) – (2) then multiply by the standard price (3) for each material to get the
variance for each material. The sum of the variances individually is the total mix
variance.
Interpretation
If you use a quantity of material which is more than the standard mix there would be
an adverse variance.
If you use a quantity of material which is less than the standard mix there would be a
favourable variance.
17
Average valuation bases
Actual output Did Mix Should Mix Standard Price WA Standard Variance
Price
(1)
(2)
(3) (4)
Material A
X
X
x (£x - £x) = £x (A)
Material B
X
X
x (£x - £x) = £x (F)
Material C
X
X
x (£x
- £x) = £x (A)
X
X
£x (A)
Approach
1. (1) Record the actual quantity of material used (never purchased if this is different to
the quantity used). Add this up e.g. total litres, units, kg etc for all material together.
2. (2) Take the actual quantity of material as a total from column (1) recalculate for
each material how much you should have used according to the standard (budgeted)
mix. Column (1) total should be equal to column (2) total.
Note: Up to this point this is an identical approach to the individual valuation bases.
3. (4) Calculate the weighted average standard price of one kg, litre, unit etc for all
material ‘together’ by using the standard cost information provided e.g. standard
total material cost ÷ standard units of material consumed for this cost = the weighted
average standard price of material.
4. Deduct (1) – (2) then multiply by the standard price (3) for each material less the
weighted average standard price (4) for all material together, this will find the
variance individually for each material. The sum of these variances individually is
the total mix variance
Interpretation
If you use more of a more expensive ingredient when compared to the standard mix
the variance will be adverse.
If you use more of a less expensive ingredient when compared to the standard mix
the variance will be favourable.
If you use less of a more expensive ingredient when compared to the standard mix
the variance will be favourable. This is because less expensive ingredients will be
used in substitute therefore saving cost.
If you use less of a less expensive ingredient when compared to the standard mix the
variance will be adverse. This is because more expensive ingredients will be used in
substitute therefore increasing cost.
18
Example 5.4 – Material mix and yield
Ramsey Oliver Restaurants also does a ‘deep pan cheese and tomato pizza’ on its menu, the
standard or budgeted cost and usage of topping ingredients for one pizza are as follows
Standard cost information for one pizza
£
0.5kg Tomatoes @ £1.40 a kg
0.70
0.6kg Cheese @ £7.50 a kg
4.50
5.20
1.1kg of cheese and tomato ingredients should produce a 1kg pizza (0.1kg of weight is lost
due to evaporation in the cooking process). In the previous week 60 pizzas were cooked (to
the weight specified of 1.0kg) and the following ingredients were used during this process.
Tomatoes
28 kg
£45.00
Cheese
40 kg
£270.00
Calculate the material usage, mix and yield variances for Ramsey Oliver Restaurants
for this day?
Note: two methods exist for the calculation of mix variances, the individual valuation and
average valuation bases. Make sure you are familiar with both types of calculation.
19
Example 5.5 – (CIMA past exam question)
A company has a process in which the standard mix for producing 9 litres of output is as
follows:
$
4·0 litres of D at $9 per litre
36·00
3·5 litres of E at $5 per litre
17·50
2·5 litres of F at $2 per litre
5·00
58·50
A standard loss of 10% of inputs is expected to occur. The actual inputs for the latest period
were:
$
4,300 litres of D at $9·00 per litre
38,700
3,600 litres of E at $5·50 per litre
19,800
2,100 litres of F at $2·20 per litre
4,620
63,120
Actual output for this period was 9,100 litres.
You are required to calculate
(a) the total materials mix variance
(b) the total materials yield variance
20
Example 5.6 – (CIMA past exam question)
X Ltd uses an automated manufacturing process to produce an industrial chemical, Product P.
X Ltd operates a standard marginal costing system. The standard cost data for Product P is as
follows:
Standard cost per unit of Product P
Materials
A 10 kgs
@ £15 per kilo
£150
B
8 kgs
@ £8 per kilo
£64
C
5 kgs
@ £4 per kilo
£20
23 kgs
Total standard marginal cost
£234
Budgeted fixed production overheads £350,000
In order to arrive at the budgeted selling price for Product P the company adds 80% mark-up
to the standard marginal cost. The company budgeted to produce and sell 5,000 units of
Product P in the period. There were no budgeted inventories of Product P.
The actual results for the period were as follows:
Actual production and sales
5,450 units
Actual sales price
£445 per unit
Material usage and cost
A
43,000 kgs
£688,000
B
37,000 kgs
£277,500
C
23,500 kgs
£99,875
103,500 kgs
Fixed production overheads
£385,000
Required:
(a) Prepare an operating statement which reconciles the budgeted profit to the actual profit for
the period. (The statement should include the material mix and material yield variances)?
(b) The Production Manager of X Ltd is new to the job and has very little experience of
management information. Write a brief report to the Production Manager of X Ltd that
(i)
interprets the material price, mix and yield variances?
(ii)
discusses the merits, or otherwise, of calculating the materials mix and yield
variances for X Ltd?
21
Labour mix and yield (productivity) variances
When different types of labour e.g. different grades or skills, can be used as substitutes for
each other, the labour efficiency variance can be subdivided into a mix and yield
(productivity) variance when there exists two or more types of labour that can be substituted
for one another e.g. to provide a service or manufacture a product. The sum of the labour mix
and yield variances will be equal the labour efficiency variance.
The labour mix variance can be calculated by using the same two different methods that can
be applied to material mix and yield variances, the ‘individual valuation bases’ which is the
easiest to apply and the ‘average valuation bases’. If the examiner does not specify which
method to use, the individual valuation bases is the easiest method to apply, both methods
give the same answer as a total mix variance, but the individual values for each type of labour
which makes up the mix variance will be different depending on each method used.
The yield variance for labour is also an identical calculation when compared to material
yield. For labour mix and yield follow the same guidance as for material mix and yield but
use labour hours and labour rates rather than material usage and material prices.
Relationship for labour variance calculations
There can be an interdependent relationship (both connected to each other), between a mix
and yield variance, for example a higher skill of labour used in substitute for a lower skill of
labour would normally give an adverse mix variance, (higher skills normally demand a higher
labour rate), but at the same time perhaps a favourable yield variance, due to the greater
experience and efficiency of the higher skill of labour substituted.
Total
Labour
Variance
Labour
Rate
Variance
Labour
Idle Time
Variance
Labour
Efficiency
Variance
Labour
Mix
Variance
Labour
Yield
Variance
22
A word of caution, favourable variances, especially when dealing with mix and yield do not
necessarily mean you have improved an organisations cost effectiveness or quality of the
product. Mixing more water and less concentrated flavor to make a drink can certainly create
a favorable mix variance (water is cheaper) but it can have an effect on the quality of the end
product as well, in this case the taste of the drink may change. In the case of favorable yield
variance more output from a certain amount of input could mean you are short changing the
customer e.g. producing soft drinks in 500ml bottles but increasing efficiency by only
bottling an average of 480ml in each bottle. Mix or yield variances can have a damaging
impact on the organisations brand image and reputation, in turn leading to a loss of customers
and sales. Mix and yield variances must therefore be interpreted and used very carefully,
ideally if the standard information is correct then expect no planning errors or variances at all.
23
Example 5.7
Mr Chumney-Warner, the accountant that left Ramsey Oliver Restaurants due to personal
grievances against the organisation and has now set up an audit practice, providing work to
local business within the area. Even though being a service organisation, Mr Chumney-
Warner recognises that labour mix and yield variances can also be applied to service
organisations. He has created a standard cost for one audit, which normally takes a partner,
semi-senior and junior together a total of 20 hours to perform.
Standard cost details for one 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 month of February, time sheets recorded the below information. In total 90 hours
were recorded and logged as audit work, this time was for completion of five audits during
the period. The new junior that had been recruited was under allot of pressure and did not
cope well. This meant the semi-senior had to be involved more in the compliance work to
improve the quality of the 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 worked and paid for five audits:
Partner
12 hours
Semi-senior
40 hours
Junior
38 hours
90 hours
The standard rates per hour paid to staff were the same as budget.
Produce the labour mix and yield variances for the above period?
24
5.5
Sales mix and quantity variances
The sales volume variance can be further subdivided into a mix and a quantity variance.
The sales mix variance shows the change in the different product lines being sold and the
impact it has on profit or contribution.
The sales quantity variance shows the change in the different total amount of units being
sold and the impact it has on profit or contribution.
The sales mix variances can be calculated by using two different methods, the ‘individual
valuation bases’ which is the easiest to apply and the ‘average valuation bases’. If the
examiner does not specify which method to use, the individual valuation bases is the easiest
method to apply, both methods give the same answer as a total mix variance, but the
individual values for each sales line which make up the mix variance will be different
depending on each method used.
Sales mix variance (individual valuation bases)
Actual output Did Mix Should Mix Standard Profit Variance
(1)
(2)
(3)
Product A
X
X
x £x = £x (A)
Product B
X
X
x £x = £x (F)
Product C
X
X
x £x = £x (A)
X
X
£x (A)
Approach
1. (1) Record the actual quantity of units sold and add this up.
2. (2) Take the actual quantity of units sold as a total from column (1) recalculate for
each product how much you should have sold according to the standard (budgeted)
mix. Column (1) total should be equal to column (2) total.
3. Deduct (1) – (2) then multiply by the standard profit (3) for each product to get the
variance for each product. The sum of the variances individually is the total mix
variance.
Interpretation
If you sell a quantity of product which is more than the standard mix there would be
a favourable variance.
If you sell a quantity of product which is less than the standard mix there would be
an adverse variance.
25
Sales mix variance (average valuation bases)
Actual output Did Mix Should Mix Standard Price WA Standard Variance
Profit
(1)
(2)
(3) (4)
Product A
X
X
x (£x - £x) = £x (A)
Product B
X
X
x (£x - £x) = £x (F)
Product C
X
X
x (£x
- £x) = £x (A)
X
X
£x (A)
Approach
1. (1) Record the actual quantity of units sold and add this up.
2. (2) Take the actual quantity of units sold as a total from column (1) recalculate for
each product how much you should have sold according to the standard (budgeted)
mix. Column (1) total should be equal to column (2) total.
Note: Up to this point this is an identical approach to the individual valuation bases.
1. (4) Calculate the weighted average standard profit of one unit for all products
‘together’ by using the standard cost information provided e.g. standard total product
profit ÷ standard units of products sold = the weighted average standard profit of a
unit.
2. Deduct (2) from (1) then multiply by the standard profit (3) for each product less the
weighted average standard profit (4) for all products together, this will find the
variance individually for each product. The sum of these variances individually is
the total mix variance
Interpretation
If you sell more of a more profitable product when compared to the standard mix
the variance will be favourable.
If you sell more of a less profitable product when compared to the standard mix the
variance will be adverse.
If you sell less of a more profitable product when compared to the standard mix the
variance will be adverse. This is because less profitable products will be sold in
substitute therefore decreasing profits.
If you sell less of a less profitable product when compared to the standard mix the
variance will be favourable. This is because more profitable products will be sold in
substitute therefore increasing profits.
26
Sales quantity variance
Actual output Should Mix Budget Mix Standard Profit Variance
(1)
(2)
(3)
Product A
X
X
x £x = £x (A)
Product B
X
X
x £x = £x (F)
Product C
X
X
x £x = £x (A)
X
X
£x (A)
Approach
1. (1) Take the actual quantity of units sold as a total recalculate for each product how
much you should have sold according to the standard (budgeted) mix.
2. (2) Record the budgeted quantity of units sold and add this up.
3. Deduct (2) from (1) then multiply by the standard profit (3) for each product to get
the variance for each product. The sum of the variances individually is the total mix
variance.
27
Example 5.8 - Worked example on sales mix and quantity variances
Tasty Meals Ltd makes and sells 2 meals, camel dansak and pigeon vindaloo. The budgeted
sales and profit are as follows:
Sales (units)
Profit (£)
Profit per unit (£)
Camel dansak
400
4,000
10
Pigeon vindaloo
300
1,800
6
5,800
Actual sales were 140 units of camel dansak and 315 units of pigeon vindaloo.
Calculate the sales mix and quantity variances.
Sales mix variance
Actual
sales
quantity
Actual
sales at
budget mix
(W1)
Difference
Contribution
Variance
Camel dansak
140
260
120 (A)
£10
£1,200 (A)
Pigeon vindaloo
315
195
120 (F)
£6
£720 (F)
455
455
£480 (A)
Sales quantity variance
Actual
sales at
budget mix
(W1)
Budget
sales
quantity
Difference Contribution
Variance
Camel dansak
260
400
140 (A)
£10
£1,400 (A)
Pigeon vindaloo
195
300
105 (A)
£6
£630 (A)
455
700
245 (A)
£2,030 (A)
Workings
W1 – Actual sales at budget mix
Camel dansak = 400 / 700 x 455 = 260
Pigeon vindaloo = 300 / 700 x 455 = 195
28
Example 5.9 – (CIMA past exam question)
A company produces trays of pre-prepared meals that are sold to restaurants and food
retailers. Three varieties of meals are sold: economy, premium and deluxe.
Extracts from the budget for last year are given below:
Economy
Premium
Deluxe
Sales quantity (units)
180,000
360,000
260,000
Selling price per tray
$2.80
$3.20
$4.49
Total sales revenue
$504,000
$1,152,000
$1,167,400
Direct material cost per tray
$1.00
$1.60
$2.20
Total direct material cost
$180,000
$576,000
$572,000
Direct labour cost per tray
$0.50
$0.50
$0.50
Total direct labour cost
$90,000
$180,000
$130,000
Variable overheads per tray
$0.65
$0.65
$0.65
Actual results for the last year were as follows:
Economy
Premium
Deluxe
Sales quantity (units)
186,000
396,000
278,000
Selling price per tray
$2.82
$3.21
$4.50
Total sales revenue
$524,520
$1,271,160
$1,251,000
Direct material cost per tray
$1.10
$1.50
$2.10
Total direct material cost
$204,600
$594,000
$583,800
Direct labour cost per tray
$0.52
$0.54
$0.48
Total direct labour cost
$96,720
$213,840
$133,440
Variable overheads per tray
$0.64
$0.66
$0.63
Actual fixed overheads were $546,000.
Calculate the sales quantity contribution variance and the sales mix contribution
variance.
29
5.6
Interpretation of variance calculations
In your exam you could be asked to interpret the variances you have calculated or interpret
from variances already provided to you in a question. The examiner may require you to
explain some possible reasons why a favourable or adverse variance has occurred. It is
important to give an answer that is practical and relates to the scenario or organisation, also to
apply consistent explanations with your answer e.g. if an adverse variance then give possible
reasons for the cause of an adverse not favourable variance. Possible causes or reasons for
variances have been included in the table below.
Sales price
variance
Unplanned price increases for the product or service sold.
Unplanned price reductions e.g. attracting additional business by
offering discounts or price promotions.
Interdependence (sales price and volume (demand) are both connected to each other) e.g. a
lower price for the product or service sold would normally cause an adverse sales price
variance, however the effect of lowering price is normally to sell more, so the sales volume
variance would be expected to be favourable, and vice versa.
Sales volume
variance
Seasonal changes in demand for the final product or service sold.
Economic (business) recession or boom.
Material price
variance
Different sources of supply may cost more or less.
Unexpected general price increases or decreases.
Alteration in quantity discounts.
Alteration in exchange rates for imported materials or components.
Substitution of a different grade of material which is cheaper or
more expensive.
Standard set at mid-year price, due to seasonal fluctuations and price
volatility, so one would expect a favourable price variance for part
of the year and an adverse variance for the rest of the year.
Interdependence (material price and usage both connected to each other) e.g. a lower price
for material obtained would give a favourable material price variance, but if an inferior
quality it could cause more wastage and therefore an adverse material usage variance, and
vice versa.
Material usage
variance
Higher or lower incidence of scrap, wastage, evaporation etc.
Alterations to product design e.g. product now consumes more or
less material.
Substitution of a different grade of material e.g. cheaper and more
inferior material can create more wastage.
30
Labour rate
variance
Unexpected national wage increases.
Overtime and bonus payments different from the standard ‘average’
plan.
Substitution of a different grade of labour which is cheaper or more
expensive.
Interdependence (labour rate and efficiency both connected to each other) e.g. a lower rate
for labour skills obtained would give a favourable labour rate variance, but if these staff are
inexperienced and face a steep learning curve, this could cause less efficiency and therefore
an adverse labour efficiency variance, and vice versa.
Labour
efficiency
variance
Improvement in the efficiency of working methods or conditions e.g.
through training or new technology.
Introduction of new incentive schemes e.g. higher productivity or
efficiency bonuses could make staff work more quickly.
Substitution of a different grade of labour e.g. less skilled staff
normally means they are less efficient.
Variable
overhead rate
variance
Unexpected price changes for variable overhead items.
Seasonal effects e.g. heat and 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.).
Variable
overhead
efficacy
variance
This variance is interdependent on the labour efficiency variance
therefore see reasons for labour efficiency variances.
Fixed overhead
expenditure
variance
Changes in prices relating to fixed overhead items e.g. rent increase.
Fixed overhead
volume
variance
Change in production volume due to changes in sales demand or
alterations to inventory holding policy. Production lost through
strike, idle time etc.
31
Example 5.10 – (CIMA past exam question)
Marshall Limited operates a business that sells advanced photocopying machines and offers
on-site servicing. There is a separate department that provides servicing. The standard cost
for one service is shown below along with the operating statements for the Service
Department for the six months to 30 September 2003. Each service is very similar and
involves the replacement of two sets of materials and parts.
Marshall Limited’s budgets for 5,000 services per month.
Standard cost for one service
£
Materials – 2 sets @ £20 per set
40
Labour – 3 hours @ £11 per hour
33
Variable overheads – 3 hours @ £5 per hour
15
Fixed overheads – 3 hours @ £8 per hour
24
Total standard cost
112
Operating statements for six months ending 30 September 2003
Months
1 2 3 4 5 6 Total
Number of
services per
month
5,000 5,200 5,400 4,800 4,700 4,500
29,600
£ £ £ £ £ £ £
Flexible budget
Costs
560,000 582,400 604,800 537,600 526,400 504,000 3,315,200
Less: variances:
Materials
Price
5,150F 3,090F 1,100F -2,040A -5,700A -2,700A -1,100A
Usage
-6,000A 2,000F -4,000A -12,000A -2,000A 0 -22,000A
Labour
Rate
26,100F 25,725F 27,331F 18,600F 17,400F 15,515F 130,671F
Efficiency
5,500F 9,900F 12,100F -12,100A -4,400A -11,000A 0
Variable overheads:
Spending
-3,500A -3,500A -2,500A -4,500A 500F 2,500F -11,000A
Efficiency
2,500F 4,500F 5,500F -5,500A -2,000A -5,000A 0
Fixed overheads:
Expenditure
-3,000A -5,000A -5,000A -15,000A 5,000F 5,000F -18,000A
Volume
0 4,800F 9,600F - 4,800A -7,200A -12,000A 9,600A
Actual costs
533,250 540,885 560,669 574,940 524,800 511,685 3,246,229
Note: “A” = adverse variance; “F” = favourable variance
32
Required:
(a) Prepare a summary financial statement showing the overall performance of the Service
Department for the six months to 30 September 2003.
(b) Write a report to the Operations Director of Marshall Limited commenting on the
performance of the Service Department for the six months to 30 September 2003. Suggest
possible causes for the features you have included in your report and state the further
information that would be helpful in assessing the performance of the department.
5.7
Investigating the cause of variances
Factors to consider before investigation or control action is taken
1. Consider the size or ‘materiality’ of the variance e.g. the variance relatively or
absolutely could be adverse but small in value, therefore not considered a problem.
2. The general trend of the variance e.g. control charts could indicate the variance trend
is persistent (not random) and therefore should be investigated.
3. Consider the type of standard used e.g. ideal standard unrealistic or planning errors
exist in the budget, knowing this could save wasting time investigating variances with
no operational faults.
4. Interdependence with other variances e.g. poor quality of material already explained
by the favourable price variance, variable overhead efficiency variance explained by
the labour efficiency variance etc.
5. The likelihood of identifying the cause of the variance if it were investigated e.g. if
unlikely a cause can be found then there maybe no value obtained from investigating.
6. The likelihood that if the cause of a variance is found, the cause or reason is
controllable and therefore can be rectified.
7. The cost of investigation and correction must be compared to the benefits e.g. cost
savings or improvements in quality, if correction is applied. The cost of investigating
and correcting or rectifying variances can be very expensive.
33
Statistical methods for interpretation
Variances can be expressed relatively rather than absolutely, the variance always expressed
as a percentage of standard (never actual) cost. These percentages can be plotted on a graph
over time to provide trend analysis for variances.
Advantages of relative statistical analysis
Graphical presentation of percentages over time will allow easier interpretation and
clearer understanding for any persistent deviations or exceptions.
By working in percentages (variance ÷ standard cost) it removes any distortion for
changes in the monetary size of variances caused by the activity (output) level
changing for each period.
Example of a percentage variance chart
%
Favourable
0
JAN FEB MAR APR
Adverse
Note: Each line represents two different variances monitored over the four months.
34
5.8
Planning and operational variances
Operational variances are the normal variance calculations as learned and applied earlier
within this chapter.
Planning variances are caused by the budget (standard) at the planning stage being wrong
e.g. budgeting errors or poor planning when the budget was prepared. The budget
(standard) used would need revising if operational variance calculations are to be more
realistic. Planning variances help ensure that all planning errors within the budget
(standard) are adjusted for or removed; the standard used for operational variances would
therefore be more realistic.
Process of calculating planning variances
1. Calculate the planning variance. This adjusts the flexed budget (a budget based on
actual sales or production volume) by comparing the ex ante standard (beforehand) to
an ex post (revised or realised) standard. All planning variances follow a similar
proforma because they all adjust the flexed budget up or down due to the revision of a
standard. Just like operational variances planning variances can be favourable or
adverse.
2. Now that the budget (standard) has been adjusted calculate operational variances in
the normal way but now using the new (revised) standard.
The effect is to sub-divide variances into two components
1. The planning variance which is beyond the operational control of management and
staff e.g. errors due to poor planning.
2. The operational variance which is normally within the control of staff and now more
realistic as a yardstick because calculations would include any revisions to standard.
Advantages of calculating planning variances
Helps highlight variances between those which are controllable and those which are
uncontrollable.
Helps motivate managers and staff e.g. avoids staff being blamed for faulty planning
and gives a fairer reflection of any operational variances calculated when assessing
any operational efficiencies or inefficiencies. Management and staff would be
appraised more fairly for any favourable or adverse deviations that are within their
control.
Use of realistic standards in order to measure performance gives better management
information for control purposes.
Limitations of calculating planning variances
Determining a ‘realistic standard’ in the first place, often management or staff could
politically place more emphasis on ‘bad planning’ rather than ‘bad management’
when it comes to exception reporting.
Further analysis of variances can be more time consuming and costly than the
conventional approach.
35
Example 5.11
Using the information contained within Example 4.2, demonstrate how Ramsey Oliver
Restaurants would deal with the variance calculations if you were told the following?
Note: Treat each example below as a separate consideration.
a) A pay rise was given to kitchen staff as from the beginning of last month.
The new labour rate payable to chefs being £11.25 rather than as budgeted
£9.00 a hour, this had been overlooked and was not reflected in the budget.
b) Expected labour efficiency of 15 minutes (0.25 hours) per meal served has
always been considered by management as too generous, the budget was
supposed to be updated last week using only 12 minutes (0.2 hours) per meal
but was overlooked during the planning process.
c) Due to a salmonella scare across the country the price of chicken had fallen
to £2 per kg at the beginning of the week. According to management this
should be reflected in the budget.
d) Due to more skin and bone on the poultry purchased for the month, it was
considered more realistic by management that 0.35kg of chicken should have
been served for each meal rather than currently 0.3kg of chicken.
36
5.9
Machine expenditure and efficiency variances
Machine variances would use the same method of calculation as labour rate and efficiency
variances e.g. machines have a rate of overhead per hour, they can also make more or less
product than standard efficiency targets which have been set.
Example 5.12
In the bar at Ramsey Oliver Restaurants 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 this machine?
What if you were told that the machine had been replaced at the beginning of the
period with a machine that is 20% faster than the previous model, but this had not
been reflected in the budget?
37
5.10
Benchmarking
“A 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.”
(Michael Spendolini)
Four types of benchmarking
A hospital is used to illustrate the following types of benchmarking
1. Internal. Compare an internal function to ‘the best internally’ within the same
organisation e.g. different methods of cleaning used by hospital wards within the
same hospital.
2. Best practice or functional. Compare an internal function to ‘the best’ but not
necessarily an organisation in the same industry e.g. compare administration activities
or cleaning methods to other hospitals or other organisations other than a hospital not
involved in healthcare.
3. Competitive. Hospital or healthcare services are compared to that of rival
‘competition’ in the same industry e.g. methods of patient care and levels of service
compared and contrasted with other hospitals.
4. Strategic. Comparison in terms of an organisations ‘strategic choices’ made to the
most successful market leader e.g. review organisational structure, culture, mission
statement and goals of other hospitals higher in ‘quality league tables’. Strategic
choices could include outsourcing or decisions about the closure of expensive wards
even though unpopular.
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
Encourage staff, manage knowledge, ideas and innovate to exceed
38
A process for benchmarking
1. Gain senior management commitment to establish benchmarking as a process within
the organisation and educate staff and stakeholders about the benefits. Participate and
consult with staff and stakeholders.
2. Consider the benefits against the cost for each activity to be benchmarked to ensure
economic or financial justification.
3. Assign responsibilities to a team of staff e.g. set goals; establish BM processes and
systems, checklists and documentation.
4. Identify potential partners and known leaders.
5. Undertake the process of benchmarking e.g. test, measure, observe, experiment or
investigate.
6. Gather, analyse and summarise information collected and documented.
7. Gap analysis undertaken for deficiencies identified e.g. standard v actual.
8. Implement improvement e.g. new programmes, processes and procedures. Education
and participation encouraged by those affected, avoid being over critical for
weaknesses identified. Set objectives and manage change.
9. Monitor and repeat regularly to discourage complacency, follow up improvements
implemented to ensure the expected benefits are realised.
Benefits of benchmarking
Better understanding of the business, competition and customers.
Improves business performance and discourages complacency.
Good way of comparing competitive strategies to reposition products.
You can learn from other organisations mistakes.
You don’t need to ‘re-invent the wheel’ for innovation and creativity e.g. learn from
other organisations and a source of new ideas.
Advance warning for deteriorating competitive performance e.g. faster awareness of
industry innovation and other competitor decisions.
Fewer complaints, product returns, and warranty claims e.g. quality improves.
Leaner and more cost efficient organisation.
Customer satisfaction and brand loyalty increases.
Sales and profitability will improve in the long-term.
Drawbacks of benchmarking
Benchmarking systems and programmes can be costly and time consuming
The diversity and complexity of information can ’overload’ management e.g. so much
information; management cannot see the wood through the trees.
Obtaining information to actually undertake a BM exercise can be a problem e.g.
absent, historical or out of date.
Confidential information could be leaked or compromised when shared
Deciding who the ‘best in a class’ is?
Keeping staff motivated e.g. staff can be criticised and once they exceed standards the
standard is normally raised
39
5.11
McDonaldization
Modern manufacturing, questions the thought to whether standard costing still plays a
valuable part when considering information for control purposes.
Characteristics of modern manufacturing
Dynamic environments, customisation and differentiation of products.
Shorter product life-cycles and high levels of automation.
Higher concern for quality and customer satisfaction.
George Ritver in his book ‘The McDonaldization of Society’ listed the advantages of
producing standard (homogenous or identical) 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, especially large corporations
e.g. Audi or V/W Group incorporating hundreds of the same standard components within
their different ranges of cars they manufacture. Although surely you would understand such
an idea better through the use of a ‘Big Mac’ right? Food already pre-prepared before
cooking e.g. cheese sliced, salads prepared, sauces all pre-packed and easy to open and serve.
Standardisation of machinery, uniforms and packaging e.g. standard product, sachets,
drinking cups and paper bags. Automation of dispensers, cooking processes and staff… even
a standardised departure e.g. have a nice day!
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 were 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 because of uniformity of product
specification and processes, easier to manage, organise, train and control workers.
Efficiency e.g. combined with specialisation it is the most efficient way of working
within large organisations.
Predictability e.g. customer always knows what they are buying to give reassurance
and support brand recognition.
Calculability e.g. quantitative so easier to interpret expected results.
Proficiency of staff performance can be assessed more effectively due to consistent
standards applied.
Example 5.13 – (CIMA past exam question)
UV Limited is a catering company that provides meals for large events. It has a range of
standard meals at fixed prices. It also provides meals to meet the exact requirements of a
customer and prices for this service are negotiated individually with each customer.
Discuss how a ‘McDonaldisation’ approach to service delivery would impact on budget
preparation and control within UV Limited?
40
5.12
Diagnostic related or reference groups (DRG) ‘can applied to a Big Mac’
Standard costing can be applied to service organisations such as the health services,
accountancy practices, fast food outlets etc. The diagnostic reference group or healthcare
resource group is a system of classifying hundreds of different medical treatments within the
healthcare sector. It applies standardisation by recognising that similar medical illnesses
require essentially similar treatments and care. There are around 800 DRG classifications
that exist within the healthcare industry sector.
DRG applied to health care services
Standardise resources e.g. beds/wards/consultancy time/medication etc.
Standardise patient treatment e.g. specifications of how treatments are applied.
Standardised codes for insurance companies or payments to the NHS (or other private
health care providers) based on standard prices used.
Government can benchmark performance and provide league tables for hospitals.
Such a system is not without its critics, arguing that surely it is the qualitative factors in
patient treatment that is more important than the quantitative measures when it comes to
patient care, and not every operation or treatment can be dealt with in a single best way. If
payments are made to hospitals based on a standard price for each DRG, this could mean
overzealous treatment of a patients in order to save cost, but at the same time compromising
the quality of patient care.
The characteristics of services
Intangibility e.g. no material substance or physical existence of the service contrasted
to a tangible good, difficult to tell in advance what you will be getting.
Legal ownership e.g. little physical evidence exists for its performance, so you can
never return it if it is faulty.
Instant perishability e.g. unlike physical goods, services cannot be stored, unused
capacity cannot be stored for future use.
Heterogeneity (not perfectly identical or variable) e.g. each time the service is
performed even to the same customer it is different each time, physical goods tend to
be homogenous (perfectly identical) when produced.
Inseparability e.g. the service cannot be separated from the person who provides it
and it is normally produced at the same time the customer requires it.
41
Example 5.14 – (CIMA past exam question)
The standard cost schedule for hospital care for a minor surgical procedure is shown below.
Standard Cost of hospital care for a minor surgical procedure
Staff: patient ratio is 0·75:1
£
Nursing costs: 2 days x 0·75 x £320 per day
480
Space and food costs: 2 days x £175 per day
350
Drugs and specific materials
115
Hospital overheads: 2 days x £110 per day
220
Total standard cost
1,165
The actual data for the hospital care for one patient having the minor surgical procedure
showed that the patient stayed in hospital for three days. The cost of the drugs and specific
materials for this patient was £320. There were 0·9 nurses per patient on duty during the time
that the patient was in hospital. The daily rates for nursing pay, space and food, and hospital
overheads were as expected.
Prepare a statement that reconciles the standard cost with the actual costs of hospital
care for this patient. The statement should contain five variances that will give useful
information to the manager who is reviewing the cost of hospital care for minor surgical
procedures?
42
5.13
Further question practice
Example 4.15
MCQ 1.1
X Plc uses a standard absorption costing system. Details for the month were as follows
Budget
Actual
Sales units
7,300
6,780
Selling price per unit
£13.00
£13.80
Profit per unit
£5.00
£5.20
The sales price and volume variance for the month was?
Volume
Price
a)
£2,600 (A)
£5,424 (F)
b)
£2,600 (A)
£5,424 (A)
c)
£2,600 (F)
£4,480 (A)
d)
£2,600 (F)
£4,480 (F)
The following data is to be used for MCQ 1.2 and 1.3
Z Plc sells garden gnomes that it purchases from a local distributor. Its budget shows for the
four-week period that it plans to sell 800 gnomes at a unit price of £30, which would give a
contribution to sales ration of 40%. Actual sales were 770 gnomes at an average selling price
of £27.50, the actual contribution to sales ratio averaged 27%
MCQ 1.2
The sales price variance was?
a) £2,000 (A)
b) £1,925 (F)
c) £1,925 (A)
d) £2,000 (F)
MCQ 1.3
The sales volume variance was?
a) £360 (A)
b) £360 (F)
c) £223 (A)
d) £223 (F)
43
The following data is to be used for MCQ 1.4 and 1.5
Meat and Veg Ltd manufactures steak and kidney pies, the standard cost of a 1kg pie being as
follows:
£
0.6kg Steak
@
£5.60 per kg 3.36
0.6kg Kidney @
£1.40 per kg 0.84
4.20
Actual data for the month was as follows:
1kg pies produced
1,350
Raw material used:
Steak Kidney
Quantity (Kg)
852 990
Cost (£)
5,106 1,287
MCQ 1.4
The total material mix variance (to the nearest £) using the weighted average approach
for both ingredients would be?
a) £145 (A)
b) £145 (F)
c) £290 (A)
d) £290 (F)
MCQ 1.5
The total material yield variance would be?
a) £1,134 (A)
b) £1,134 (F)
c) £777 (A)
d) £648 (F)
44
MCQ 1.6
The following data has been extracted from the budget of XL Plc:
Activity
Overhead cost
(Machine hours) £
10,000
£25,000
12,000
£29,000
18,000
£41,000
In May 2002, the actual activity was 12,750 machine hours and the actual overhead cost
incurred was £32,560.
The overhead expenditure variance was?
a) £2,060 (A)
b) £2,060 (F)
c) £1,748 (A)
d) £1,748 (F)
MCQ 1.7
BB Plc standard cost of labour time per unit was as follows:
4 Hrs @ £5.60
£22.40
The budgeted and actual number of units produced for this period was 4,000 and 4,260 units
respectively, giving an adverse labour efficiency variance of £2,386 (A).
The actual labour hours worked for the period was?
a) 17,466
b) 16,614
c) 16,426
d) 15,574
45
MCQ 1.8
ABC Ltd standard cost of material X which is used to assemble their final product is as
follows
2kg @ £6.50 = £13.00
3,000 units were produced for the period. This gave a material usage variance of £4,875
adverse, with material stock for the period rising by 800kg.
The quantity of material purchased for this period was?
a) 6,750kg
b) 6,000kg
c) 5,250kg
d) 7,550kg
MCQ 1.9
A budget has been prepared which includes the standard cost of material per unit of £50 (4kg
of material P at £12.50 per kg). Budgeted production was 1,000 units. There was a shortage
of material P during this month and the price per kg fluctuated to £13.00 per kg. During this
period 950 units were manufactured at a material cost of £50,160 for 3,800kg of material P.
What was the material price operational and planning variance for this period?
Operational
Planning
a)
£760(A)
£1,900(A)
b) £760(A)
£1,900(F)
c)
£760(F)
£2,000(F)
d) £760(A)
£2,000(A)
46
The following information is to be used for MCQ 1.10, MCQ 1.11 and MCQ 1.12
A unit takes two types of labour to complete, unskilled and skilled.
£
0.5hrs @ £1.40 an hour (unskilled)
0.70
0.6hrs @ £7.50 an hour (skilled)
4.50
5.20
On a Wednesday afternoon 60 units were manufactured, incurring the following actual
expenses:
Unskilled 28 hours £45.00
Skilled 40 hours £270.00
MCQ 1.10
The labour yield variance for the above period (to the nearest £1) was?
a) £9(A)
b) £9(F)
c) £6(A)
d) £9(F)
MCQ 1.11
It was found during the period that the labour rate per hour for skilled labour was
estimated as too high; it should have been £5.50 an hour rather than the £7.50 an hour
used within the standard cost. What was the operational and planning variance for the
labour rate variance for skilled labour?
Operational Planning
a) £50(A)
£80(A)
b) £50(F)
£72(A)
c) £50(A)
£80(F)
d) £50(F)
£72(F)
MCQ 1.12
Using the new revised standard of £5.50 an hour for skilled labour, what would be the
planning and operational efficiency variance for skilled labour if the budget was wrong
and it should have been 0.5 hours per unit rather than the 0.6 hours as planned above?
Operational Planning
a) £55(A)
£33(F)
b) £55(F)
£33(A)
c) £55(A)
£45(A)
d) £55(F)
£45(A)
47
MCQ 1.13
Moogle Plc uses 3kg of raw material Alpha into the production process to produce one unit of
output, but have calculated that this would be after 25% wastage of the raw material. The
cost of 1kg of Alpha is £25.
What would be the standard usage of material Alpha, per unit of output, if Moogle Plc
wanted to include the level of wastage within this standard?
a) 3 kg
b) 4 kg
c) 5 kg
d) 6 kg
MCQ 1.14
F Ltd uses an absorption costing system in which labour hours are used as the basis of
recovering overhead costs. Its accounting year is divided into 13 four-week periods, with
fixed production overhead costs budgeted to be incurred at a constant rate of £300,000 per
four-week period. Budgeted labour hours per four-week period were 40,000 hours. In the
accounting period of quarter 2, actual hours worked were 37,576 and the output was 39,000
standard hours.
Given that actual fixed overhead expenditure was £315,000, what would have been the
fixed overhead expenditure and volume variance for the above period?
Fixed overhead expenditure
Fixed overhead volume
a) £15,000 Adverse
£7,500 Adverse
b) £15,000 Favourable
£9,500 Favourable
c) £15,000 Adverse
£10,680 Adverse
d) £15,000 Favourable
£18,180 Adverse
MCQ 1.15
The following data is for XYZ plc.
Budget Actual
Material
Average price
£5.00
£5.60
Average usage per unit
3.5kg
3.3kg
Units produced
2,000
2,300
The material usage variance is?
a) £2,240 favourable
b) £2,000 adverse
c) £2,000 favourable
d) £2,300 favourable
48
MCQ 1.16
The following data is for ABC plc.
Budget Actual
Material
Average price
£7.00
£7.60
Units produced
2,000
2,300
Material purchased
6,500kg
6,700kg
The material price variance is?
a) £3,900 adverse
b) £4,020 adverse
c) £7,590 adverse
d) £9,300 adverse
MCQ 1.17
BB Plc standard cost of labour time per unit was as follows:
8 Hrs @ £7.60
£60.80
The budgeted and actual number of units produced for this period was 4,000 and 4,260 units
respectively, to meet production for the period 32,450 hours were worked.
The labour efficiency variance for the period was?
a) £12,388 favourable
b) £3,420 adverse
c) £12,388 adverse
d) £3,420 favourable
49
5.14
ABC and variance analysis.
These variances are appropriate for controlling the costs of unit-level activities and can
provide meaningful information for controlling those costs that are fixed in the short-term but
variable in the longer-term (provided suitable cost drivers can be established).
Illustration:
T Ltd uses activity-based costing to allocate its overheads. One of its main overheads is
machine set-up costs. The following information was available in relation to set-up costs for
the last accounting period:
Budget
Actual
Total number of units produced 264,000 Total number of units produced 320,000
Total number of set ups 330
Total number of set ups 360
Total set-up costs $52,800
Total set-up costs $60,000
The following activity-based variances in relation to the set-up overhead costs can be
established:
(i) The expenditure variance
(ii) The efficiency variance.
(i) The expenditure variance
Cost driver rate = $52,800 / 330 = $160
Expected cost therefore = 360 x $160
$57,600
Actual cost
$60,000
––––––––
Variance
$2,400 A
––––––––
(ii) The efficiency variance
Expected no. of units per set up = 264,000 / 330 = 800
Therefore expected no. of set ups for 320,000 = 320,000 / 800
=
400
Actual number of set ups
=
360
–––––––
Difference
40 F
–––––––
x standard rate per set up $160 Variance
$6,400 F
–––––––
50
Key summary of chapter
A standard cost is a planned (budgeted) or forecast unit cost for a product or service, which
is assumed to hold good given ‘expected’ efficiency and cost levels within an organisation.
A standard cost normally represents the planned (budgeted) or forecast unit cost for material,
labour and overhead expected for a product or service.
Types of standard cost
Ideal standard
Attainable (or expected) standard
Current standard
Loose Standard
Basic Standard
Historical Standards
Practical advice for setting standards
1. Use challenging but realistic targets.
2. Consult with and allow staff to participate when setting targets.
3. Clear trust and communication between management and staff.
4. Standards or targets used must be realistic and achievable.
Standard costing can be used for
Preparation of budgets
Controlling performance
Inventory valuation
Simplifying cost bookkeeping
Motivating and rewarding staff
Criticisms of standard costing
Sometimes it can be hard to define a ‘current’ or ‘attainable standard’.
Less human intervention means labour standards are becoming less valuable.
Automation produces greater uniformity and consistency of product therefore less
likelihood of material and labour variances actually occurring.
Standard costing is an internal not external control measure.
Uncontrollability of any exceptions highlighted.
Revision to standards too infrequent to guide or improve performance over time.
Modern manufacturing techniques such as TQM and quality circles means the
frequency and materiality of variances should not occur so often.
51
Variance analysis
Variance analysis is a budgetary control technique, which compares planned (budgeted) or
forecast costs and revenues to actual financial results, it measures the differences between
standard (budgeted) and actual performance. Variance analysis is used to improve
operational performance through control action by management e.g. investigation of any
variance causes and correction of them to prevent in future any further deviations from plan.
A variance is the difference between planned, budgeted or standard cost and the actual
cost incurred. The same comparisons may be made for revenues.
(CIMA)
Reasons why variances occur
Inaccurate data used to compile standards.
Standard used either not realistic or out of date.
Efficiency of how operations were undertaken and performed by staff.
Random or chance events occurring.
There are many variance proforma calculations that need to be learned and applied as part of
your studies. These proforma are essential to learn and practice in order to truly understand
and interpret what variances mean. Once variances have been calculated either ‘F’ or ‘A’ is
used as terminology to indicate favourable or adverse differences between actual and
standard performance. Favourable means that actual results were better than standard.
Adverse means that actual results were worse than standard. Remember variances are just
reconcilable differences between a budget (standard) and actual results so in the case of an
adverse variance this would mean that actual cost will be higher or profit lower when
compared to the budget, and vice versa if a variance was favourable.
Interpretation of variance calculations
In your exam you could be asked to interpret the variances you have calculated or interpret
from variances already provided to you in a question. The examiner may require you to
explain some possible reasons why a favourable or adverse variance has occurred. It is
important to give an answer that is practical and relates to the scenario or organisation, also
to apply consistent explanations with your answer e.g. if an adverse variance then give
possible reasons for the cause of an adverse not favourable variance. Possible causes or
reasons for variances have been included in the table below.
.
52
Material mix and yield (productivity) variances
When different types of materials can be used as substitutes for each other, a standard mix
can usually be determined to ensure a quality product at the lowest possible cost. If the actual
material mix varies from the standard mix, both quality and cost may be affected. The sum
of the material mix and yield variances will be equal the material usage variance.
The material mix variance can be calculated by using two different methods, the ‘individual
valuation bases’ which is the easiest to apply and the ‘average valuation bases’. If the
examiner does not specify which method to use, the individual valuation bases is the easiest
method to apply, both methods give the same answer as a total mix variance, but the
individual values for each material which make up the mix variance will be different
depending on each method used.
Yield (or productivity) variances measure the amount of output (unit of product or service)
from a given amount of input (total materials mixed). Producing more output than expected
from a given amount of material input, indicates greater efficiency of production, the
variance would be favourable, indicating that money has been saved by using material more
efficiently. Producing less output than expected from a given amount of material input,
indicates lower efficiency of production, the variance would be adverse, indicating that
money has been wasted by using material less efficiently.
.
Relationship for material variance calculations
Total
Material
Variance
Material
Price
Variance
Material
Usage
Variance
Material
Mix
Variance
Material
Yield
Variance
53
Labour mix and yield (productivity) variances
When different types of labour e.g. different grades or skills, can be used as substitutes for
each other, the labour efficiency variance can be subdivided into a mix and yield
(productivity) variance when there exists two or more types of labour that can be substituted
for one another e.g. to provide a service or manufacture a product. The sum of the labour mix
and yield variances will be equal the labour efficiency variance.
The labour mix variance can be calculated by using the same two different methods that can
be applied to material mix and yield variances, the ‘individual valuation bases’ which is the
easiest to apply and the ‘average valuation bases’. If the examiner does not specify which
method to use, the individual valuation bases is the easiest method to apply, both methods
give the same answer as a total mix variance, but the individual values for each type of
labour which makes up the mix variance will be different depending on each method used.
The yield variance for labour is also an identical calculation when compared to material
yield. For labour mix and yield follow the same guidance as for material mix and yield but
use labour hours and labour rates rather than material usage and material prices.
.
Relationship for labour variance calculations
There can be an interdependent relationship (both connected to each other), between a mix
and yield variance, for example a higher skill of labour used in substitute for a lower skill of
labour would normally give an adverse mix variance, (higher skills normally demand a
higher labour rate), but at the same time perhaps a favourable yield variance, due to the
greater experience and efficiency of the higher skill of labour substituted.
Total
Labour
Variance
Labour
Rate
Variance
Labour
Idle Time
Variance
Labour
Efficiency
Variance
Labour
Mix
Variance
Labour
Yield
Variance
54
Sales mix and quantity variances
The sales volume variance can be further subdivided into a mix and a quantity variance.
The sales mix variance shows the change in the different product lines being sold and the
impact it has on profit or contribution.
The sales quantity variance shows the change in a different total amount of units being
sold and the impact it has on profit or contribution.
Planning and operational variances
Planning variances are caused by the budget (standard) at the planning stage being wrong
e.g. budgeting errors or poor planning when the budget was prepared. The budget (standard)
used would need revising if operational variance calculations are to be more realistic.
Planning variances help ensure that all planning errors within the budget (standard) are
adjusted for or removed; the standard used for operational variances would therefore be more
realistic.
Operational variances are the normal variance calculations as learned and applied earlier
within this chapter.
Process of calculating planning variances
1. All planning variances follow a similar proforma because they all adjust the flexed
budget up or down due to the revision of a standard. Just like operational variances
planning variances can be favourable or adverse.
2. When the planning variance is calculated and the budget (standard) adjusted,
operational variances would then be calculated using any new (revised) standards.
The effect is to sub-divide variances into two components
1. The planning variance which is beyond the operational control of management and
staff e.g. errors due to poor planning.
2. The operational variance which is normally within the control of staff and now more
realistic as a yardstick because calculations would include any revisions to standard.
Advantages of calculating planning variances
Highlights variances between controllable and uncontrollable.
Helps motivate managers and staff.
Better management information for control purposes.
Limitations of calculating planning variances
Determining ‘bad planning’ or ‘bad management’ can sometimes be a thin line.
Time consuming and costly than the conventional approach.
55
Factors to consider before investigation or control action is taken
1. Size or ‘materiality’ of the variance.
2. The general trend of the variance.
3. Consideration of the type of standard used.
4. Interdependence with other variances.
5. The likelihood of identifying the cause of the variance if it were investigated.
6. The likelihood that if the cause is controllable and can be rectified.
7. The cost of investigation and correction compared to the benefits e.g. cost savings.
Statistical methods for interpretation
Variances can be expressed relatively rather than absolutely, the variance always expressed
as a percentage of standard (never actual) cost. These percentages can be plotted on a graph
over time to provide trend analysis for variances.
Example of a percentage variance chart
%
Favourable
0
JAN FEB MAR APR
Adverse
Note: Each line represents two different variances monitored over the four months.
56
Benchmarking
“A 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.”
(Michael Spendolini)
Types of benchmarking
Internal
Best practice or functional
Competitive
Strategic
The process
Selecting what you want to benchmark
Consider benefits against the cost of doing it
Assign responsibilities to a team
Identify potential partners/known leaders
Breakdown processes to complete
Test and measure e.g. observation, experimentation or investigation/interview
Gather information
Gap analysis
Implement changes/programmes/communicate
Monitor and control
Repeat regularly
57
The characteristics of services
Intangibility e.g. no material substance or physical existence
Legal ownership e.g. difficult to return if faulty
Instant perishability e.g. cannot be stored for future use
Heterogeneity e.g. performed different each time
Inseparability e.g. cannot be separated from the person who provides it
McDonaldization
George Ritver in his book ‘The McDonaldization of Society’ listed the advantages of
producing standard (homogenous or identical) products, the pinnacle comparison being
McDonalds, with its fast food strategy of uniformity of operations and delivery on a global
basis.
Advantages of McDonaldization
Standardisation reduces cost and improves efficiency.
Control
Efficiency
Predictability
Calculability
Proficiency
Diagnostic related or reference groups (DRG) ‘can applied to a Big Mac’
Standard costing can be applied to service organisations such as the health services,
accountancy practices, fast food outlets etc. The diagnostic reference group or healthcare
resource group is a system of classifying hundreds of different medical treatments within the
healthcare sector. It applies standardisation by recognising that similar medical illnesses
require essentially similar treatments and care. There are around 800 DRG classifications
that exist within the healthcare industry sector.
DRG applied to health care services
Standardise resources e.g. beds/wards/consultancy time/medication etc.
Standardise patient treatment e.g. specifications of how treatments are applied.
Standardised codes for insurance companies or payments to the NHS (or other
private health care providers) based on standard prices used.
Government can benchmark performance and provide league tables for hospitals.
58
Solutions to lecture examples
59
Chapter 5
Example 5.1
Wood Plc makes wooden tables and chairs from natural timber. To make one unit of product
consisting of one table and four chairs, it consumes 60kg of timber; after an expected 20%
wastage due to wood shavings and scrap in the cutting process. 100kg of timber currently
costs Wood Plc £50.
What is the standard cost of material to make one unit of product?
Solution
The standard usage of material is 60kg of timber to make one unit of product, but this is only
80% of material usage, given that 20% of timber is expected to be scrapped in the process.
Therefore the total material used to make one unit of product would be 60kg (80% before
wastage) x (100% ÷ 80%) = 75kg.
Standard cost of material to make one unit of product:
(75kg ÷ 100kg) x £50 (per 100kg) = £37.50 per unit of product.
60
Example 5.2 - Absorption costing principles
Operating statement for week 43
Budget profit (500 x £3.20)
1,600
Sales volume variance (460 - 500) x £3.20 (W1)
128 (A)
Flexed budget profit for 460 meals
1,472
Sales price variance 460 x (£10.00 - £11.95) (W2)
897 (A)
575
Cost variances
F
A
Chicken price variance 180kg x (£2.25 - £2.50) (W3) 45
Chicken usage variance (143kg - 165kg) x £2.50(W4)
55
Vegetable price variance 250kg x (£0.50 - £0.56) (W5) 15
Vegetable usage variance (238kg - 220kg) x £0.50 (W6) 9
Labour rate variance 120hrs x (£9-£10) (W7)
120
Labour efficiency variance (119hrs-114hrs) x £9 (W8) 45
Idle time variance (6hrs x £9) (W9)
54
Variable overhead expenditure variance
114hrs x (£2 - £1.32) (W10)
78
Variable overhead efficiency variance
(119hrs – 114hrs) x £2 (W11)
10
Fixed overhead expenditure variance
(£2,500 - £2,750) (W12)
250
Fixed overhead volume variance
(476 units - 500 units) x £5 (W13)
120
187
614 = 427 (A)
Actual profit
148
Calculation of actual profit
Sales
4,600
Chicken
405
Closing stock (15kg x £2.50) (38)
Vegetables
140
Closing stock (30kg x 50p) (15)
Labour
1,200
V/OH Exp
150
F/OH Exp
2,750
Closing stock of meals
(476 produced – 460 sold) =
16 meals valued at £8.75 Std Cost (140)
(4,452)
Profit for the period
148
Note: The above assumes that any material and finished good inventory can be stored.
61
Example 5.2 - Absorption costing principles - continued
WORKINGS
W1 Sales volume variance
meals
Did sell
460
Should sell (as per original budget)
500
40
x Standard profit per meal sold x £3.20
128 (A)
W2 Sales price variance
£
460 did sell for
4,600
460 meals should sell for (x £11.95)
5,497
897 (A)
W3 Chicken price variance
£
180kg did cost
405
180kg should cost (180kg x £2.50)
450
45 (F)
W4 Chicken usage variance
kg
476 meals did use
165
476 meals should use (x 0.3kg)
143
22
x Standard Price x £2.50
55 (A)
W5 Vegetable price variance
£
250kg did cost
140
250kg should cost (250kg x £0.50)
125
15 (A)
W6 Vegetable usage variance
kg
476 meals did use
220
476 meals should use (x 0.5kg)
238
18
x Standard Price x £0.50
9 (F)
W7 Labour rate variance
120 hours paid did cost
1,200
120 hours paid should cost (120 hours x £9)
1,080
120 (A)
62
Example 5.2 - Absorption costing principles - continued
W8 Labour efficiency variance
hours
476 meals did take (hours worked)
114
476 meals should take (x 0.25 hours)
119
5
x Standard Rate x £9.00
45 (F)
W9 Labour idle time variance
hours
Hours paid
120
Hours worked
114
6
x Standard Rate x £9.00
54 (A)
W10Variable overhead expenditure variance
£
114 hours worked did cost
150
114 hours worked should cost (114 hours x £2)
228
78 (F)
W11Variable overhead efficiency variance
hours
476 meals did take (hours worked)
114
476 meals should take (x 0.25 hours)
119
5
x Standard Rate x £2.00
10 (F)
W12 Fixed overhead expenditure variance
£
Actual fixed overhead expenditure
2,750
Original budgeted fixed overhead expenditure
2,500
250 (A)
W13 Fixed overhead volume variance
meals
Did produce
476
Should have produced
500
24
x Fixed overhead absorption rate per meal (O.A.R) x £5.00 O.A.R
120 (A)
63
Example 5.2 - Absorption costing principles - continued
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
In this case the overhead absorption rate has already been calculated e.g. £2,500 budgeted
fixed overhead ÷ 500 meals expected to be produced = £5.00 per meal.
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 charged would
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. In this case the under absorption is £370 (A) which consists
of the expenditure and volume variance added together, £250 (A) expenditure variance +
£120 (A) volume variance = £370 (A) under absorption.
The difference between absorption and marginal costing organisations is that the marginal
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 (units of meals)
x O.A.R = charge or absorption of
fixed overhead to income statement
(£5 x 476 meals) = absorbed 2,380
Under absorption for the period
(£2,750 - £2,380) = 370
2,750
Production fixed overhead control account
Actual production overhead 2,750
f
2,750
64
Example 5.2 - Marginal costing principles
Operating statement for week 43 £
Budget contribution (500 x £8.20)
4,100
Sales volume variance (460-500) x £8.20 W14
328 (A)
Flexed budget contribution for 460 meals
3,772
Sales price variance 460 x (£10.00-£11.95)
897 (A)
2,875
Cost variances
F
A
£ £
Chicken price variance 180kg x (£2.25-£2.50)
45
Chicken usage variance (165kg -143kg) x £2.50
55
Vegetable price variance 250kg x (£0.50-£0.56)
15
Vegetable usage variance (220kg-238kg) x £0.50
9
Labour efficiency variance (114hrs-119hrs) x £9
45
Labour rate variance 120hrs x (£10-£9)
120
Idle time variance (6hrs x £9)
54
V/OH efficiency variance (114-119hrs) x £2
10
V/OH overhead expenditure var 114hrs x (£1.32-£2) 78
7
187
244 = 57 (A)
Actual contribution 2,818
Less budgeted fixed overhead 2,500
Fixed overhead expenditure variance (£2500-£2750)
250 (A)
Actual profit
68
Calculation of actual profit
£ £
Sales
4,600
Chicken
405
Closing stock (15kg x £2.50)
(38)
Vegetables
140
Closing stock (30kg x 50p)
(15)
Labour
1,200
V/OH Exp
150
Closing stock of meals (476 produced – 460 sold) =
16 meals valued at £3.75 Variable Std Cost
(60)
Variable cost of sales
(1,782)
Contribution for the period
2,818
Less Fixed overhead
(2,750)
Profit for the period
68
Note: The above assumes that any material and finished good inventory can be stored.
65
Example 5.2 - Marginal costing principles - continued
WORKINGS
The variances calculated would be identical under both costing methods with the exception of
the sales volume and fixed overhead volume variance.
W14 Sales volume variance
meals
Did sell
460
Should sell (as per original budget)
500
40
x Standard contribution per meal sold x £8.20
328 (A)
The fundamental differences between marginal and absorption costing
Marginal costing uses a different format for its profit calculation, it deducts variable
cost first from sales in order to arrive at contribution, then deducts fixed overhead to
arrive a profit.
The sales volume variance when marginal costing would be calculated slightly
different to when using absorption costing. Because the marginal costing format uses
contribution, then the standard contribution must be used for the calculation of the
sales volume effect, rather than standard profit, which would be used if absorption
costing.
The fixed overhead volume variance would not exist when marginal costing, this is
because when marginal costing there is no calculation of fixed overhead absorption
rates and absorption of fixed overhead. Any fixed overhead is treated as period not
product cost and would be charged as incurred rather than absorbed.
Note: A profit difference exists under both statements prepared, the only reason why profits
would be different is because of the way each method values finished goods inventory. An
absorption costing approach would value finished goods inventory at full standard production
cost (£8.75 a meal), the marginal costing approach would value finished goods inventory at
variable standard production cost only (£3.75 a meal).
Reconciliation of profit
Profit under absorption costing
148
Increase in closing inventory carries forward £5 of fixed overhead each meal
To the next accounting period under absorption costing
(16 meals x £5 Fixed overhead per unit)
(80)
Profit under marginal costing
68
66
Example 5.3 – Using absorption costing principles
1. Calculate the actual sale of meals
meals
Did sell
460 (balance figure)
Should sell
500 (£1,600 original budget profit ÷ £3.20 Std Profit)
40
Standard profit per meal
x £3.20 Std Profit per unit
128 (A) Given
2. Calculate the actual production of meals
meals
Did produce
476 (balance figure)
Should have produced (£2,500 budgeted F/OH ÷ £5 O.A.R) 500
24
x Fixed overhead absorption rate per meal (O.A.R) x £5.00 O.A.R
120 (A) Given
Alternatively the additional information included that closing inventory of meals rose by 16
meals for the period. Therefore if you derive actual sales which was 460 meals + 16 meals
rise in closing inventory would equal 476 actual meals produced.
3. Calculate actual hours worked for the chefs
476 meals did take
114 (balance figure)
476 meals should take (476 x 0.25 hrs)
119
5
Standard rate per hour
x £9.00 Std Rate per hour
45 (F) Given
Hours paid would have been 114 hours worked (as above) plus 6 hours idle time = 120 hours
4. Calculate the actual quantity of chicken purchased
476 meals did use
165 kg (balance figure)
476 meals should have used (x 0.3kg)
143 kg
22 kg
Standard price per kg
x £2.50 Std price per Kg
55 (A) Given
67
Example 5.3 – Using absorption costing principles – continued
5. Calculate the actual price paid for chicken
165kg used (as above) + 15kg rise in closing inventory levels = 180kg purchased.
180kg did cost
405 (balance figure)
180kg should cost (x £2.50 kg)
450
45 (F)
6. 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) Given
7. Calculate the actual fixed overhead expenditure
Actual fixed overhead
2,750 (balance figure)
Budget fixed overhead
2,500
250(A) Given
68
Example 5.4
Material 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)
68kg
66kg
£27.20 (A)
Mix variances can be calculated using two methods
First method (individual valuation basis)
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) The total of 68kg of ingredients actually mixed
(68kg x (0.5kg/1.1kg)) = 31kg of standard mix for tomatoes.
(68kg x (0.6kg/1.1kg)) = 37kg of standard mix for cheese.
The total of 68kg in both columns should be equal because you are taking the actual
total of all material actually used and recalculating how much material you should
have used if the standard mix had been applied.
Interpretation of individual valuation basis
For tomato a lower quantity of material was used compared to the standard mix
therefore a favourable variance.
For cheese a greater quantity of material was used compared to the standard mix
therefore an adverse variance.
Overall the budget is worse when compared with actual cost; this is because more
expensive cheese has been substituted for less expensive tomato.
69
Example 5.4 - continued
Second method (average valuation basis)
60kg pizza
Did use Should use Average price (W2) Variance
less standard price
Tomato
28kg
31kg = 3kg x (£4.73-£1.40) = £10.00 (A)
Cheese
40kg
37kg = 3kg x (£4.73-£7.50) = £8.30 (A)
68kg
68kg
£18.30(A)
(W2) £5.20 is the standard (budgeted) cost of one pizza which uses 1.1kg of ingredients,
therefore £5.20 ÷ 1.1kg = £4.73 average price of one kg of input (cheese and tomato). Or an
alternative working (0.5kg/1.1kg) x £1.40 + (0.6kg/1.1kg) x £7.50 = £4.73 average price for
one kg of input. The fractions used are the same as what was used to rearrange the actual mix
in order to find the standard mix.
Interpretation of average valuation basis
]
For tomato a lower quantity of material was used compared to the standard mix but
the material is less expensive relative to the average cost for all material (its standard
price of £1.40 is less than the average price of all ingredients £4.73). This is an
adverse variance, no cost saving is obtained by using less of a less expensive
ingredient when compared to the weighted average standard price of £4.73.
For cheese a greater quantity of material was used compared to the standard mix and
the material is more expensive relative to the average cost of all material (its standard
price of £7.50 is more than the average price of all ingredients £4.73). This is an
adverse variance, no cost saving is obtained by using more of a more expensive
ingredient when compared to the weighted average standard price of £4.73.
70
Example 5.4 - continued
Yield (productivity) variance
Units of
pizza
(output)
68kg of cheese and tomato did yield
60.0
68kg of cheese and tomato input should yield (68kg/1.1kg input per pizza) 61.8
Under produced (yielded)
1.8
x Standard cost for one unit of pizza (output cost of material) x £5.20 (given)
£9.37 (A)
The amount of cheese and tomatoes actually used should have yielded 1.8 pizza more than
what was expected, which suggests more wastage of ingredients than what was necessary.
Perhaps staff are putting too much topping on the pizza?
Operating statement (to reconcile budget to actual cost)
Flexed budgeted cost (60 pizzas x £5.20)
312.00
Material price - tomatoes
28kg did cost
45.00
28kg should cost (28kg x £1.40 per kg)
39.20
6.00 (A)
Material price - cheese
40kg did cost
270.00
40kg should cost (40kg x £7.50 per kg)
300.00
30.00 (F)
Material mix
18.00 (A)
Material yield
9.00 (A)
Actual cost (£45 + £270)
315.00
Note: The material usage variance can be subdivided into a material mix and yield variance.
The mix and yield variances calculated above were £18.30 (A) + £9.37 (A) = £27.67 (A)
(give or take pennies this is the material usage variance).
71
Example 5.5
Individual valuation basis
Based on actual production of 9,100 litres
Did use Should use Standard price Variance
(litres) (litres)
$
D
4,300
4,000 W1 x $9 =
2,700 (A)
E
3,600
3,500 W2
x $5 =
500 (A)
F
2,100 2,500 W3 x $2 = 800 (F)
10,000 10,000
2,400 (A)
W1 10,000 litres x 4 ÷ (4 + 3.5 + 2.5) =
4,000 litres
W2 10,000 litres x 3.5 ÷ (4 + 3.5 + 2.5) = 3,500 litres
W3 10,000 litres x 2.5 ÷ (4 + 3.5 + 2.5) = 2,500 litres
Tip: Yield or productivity variance (proforma)
Actual material used did produce
X
Actual material used should produce
X
Over/(under) produced
X
x standard cost of one unit of output
x £x
£X (F)/(A)
Over produced = (F) Under produced = (A)
Yield variance
Litres of output
10,000 litres input did yield
9,100
10,000 litres input should yield (10,000 x 0.9)
9,000
Over produced
100
x standard cost of one litre (W1)
x $6.50
$650 (F)
W1 The standard cost of 9 litres of output is $58.50 therefore the standard cost of one litre of
output is $58.50 ÷ 9 litres = $6.50.
72
Example 5.6 – part (a)
Operating statement
£
£
£
Budgeted profit (W1)
586,000
Sales volume variance (W2)
84,240 (F)
Flexed budget
670,240
Sales price variance (W3)
129,710 (F)
799,950
Cost variances
Fav
Adv
Material price variance (W4)
Material A
43,000
Material B
18,500
Material C
5,875
Material mix variance (W5)
18,000
Material yield variance (W6)
222,300
Fixed overhead variance
Expenditure variance (£385,000 - £350,000)
35,000
Total
258,800
83,875
174,925 (F)
Actual profit
974,875
Working 1
Budgeted profit
Standard marginal cost
= £234 per unit
Budgeted mark – up at 80%
= £187.20 per unit
Budgeted units
= 5,000 units
Budgeted total mark –up (5,000 x £187.20) = £936,000
Budgeted fixed costs
= £350,000
Budgeted profit (£936,000 – 350,000)
= £586,000
Working 2
Sales volume variance
Did sell (actual quantity sold)
5,450
Should sell (budget quantity sold)
5,000
Variance in units
450 (F)
x standard contribution per unit
£187.20
Sales volume contribution variance
£84,240 (F)
73
Example 5.6 – part (a) continued
Working 3
Sales price variance
£
Did sell (actual quantity sold x actual price) 5,450 x £445
2,425,250
Should sell (actual quantity sold x standard price) 5,450 x £421.20
2,295,540
Sales price variance
129,710(F)
Working 4
Material price variance
A
B
C
Did spend (actual quantity purchased x actual price)
688,000
277,500
99,875
Should spend
645,000
296,000
94,000
Material price variance
43,000(A)
18,500(F)
5,875(A)
Should spend (actual quantity purchased x standard price)
£
Material A – 43,000 x £15
645,000
Material B – 37,000 x £8
296,000
Material C – 23,500 x £4
94,000
Alternative working can be based on price per unit
For example
Material A
Budget price per unit
£15 per kilo
Actual price per unit (£688,000 / 43,000kg) £16 per kilo
Price variance per kilo
£ 1 (A) per kilo
X actual quantity purchased
43,000 kgs
Material price variance in £
£43,000 (A)
74
Example 5.6 – part (a) continued
Working 5
Material mix variance
Standard mix
Material A
10 / 23
Material B
8 / 23
Material C
5 / 23
Standard mix of actual usage = fraction x 103,500 kg
Did use
Should use
Variance
in kilo
Standard
price
Variance £
Material A
43,000
45,000
2,000 (F)
£15
£30,000(F)
Material B
37,000
36,000
1,000 (A)
£8
£8,000(A)
Material C
23,500
22,500
1,000(A)
£4
£4,000 (A)
103,500
103,500
£18,000 (F)
Working 6
Material yield variance
Tip: Yield or productivity variance (proforma)
Actual material used did produce
X
Actual material used should produce
X
Over/(under) produced
X
x standard cost of one unit of output
x £x
£X (A)/(F)
Units
Actual material used did produce
5,450
Actual material used should produce (103,500kg / 23kg)
4,500
Over produced
950
x standard cost of one unit of output
x £234
Yield variance
£222,300 (F)
75
Example 5.6 part (b)
REPORT
To:
Production Manager
From:
Accountant
Date:
November 2006
Subject:
Variances
This report will firstly interpret the material price, mix and yield variances that have occurred
during the period. This report will also discuss the merits and drawbacks of calculating
material mix and yield variances.
1.1
Interpretation of material price, mix and yield variance
Material price variance
This variance looks at the difference between the budgeted cost of the material purchased and
the actual cost. For materials A and C the price variance is adverse. Material A is adverse by
£43,000 and material C is adverse by £5,875. This could be due to increase in the general
prices of material A and C or it could be due to a change of supplier. The price variance for
material B is favourable by £18,500. The total material price variance is adverse by £30,375.
This is bad news for X Ltd suggesting problems with the purchasing department and
therefore requires thorough investigation.
Material mix and yield variance
The material mix variance is £18,000 favourable because overall less expensive materials
(material B and C) have been used in place of a more expensive material (material A). The
material input or usage to produce product P has also resulted in a favourable yield variance
of £222,300 e.g. greater productivity from the material consumed. The total of the mix and
yield variance gives the material usage variance which is £191,925 favourable. This is a
huge variance and could indicate that the original budget is incorrect e.g. it could due to poor
planning. I would recommend prior periods should be investigated to see the overall trend of
these material variances.
76
Example 5.6 – part (b) continued
1.2
Merits and drawbacks of calculating material mix and yield variances
As mentioned before the material usage variance can be subdivided into a mix and yield
variance where there exist 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. X Ltd manufactures a product which uses three materials which are inter-
changeable. For this period X Ltd has been able to use cheaper materials (B & C) relative to
a more expensive material (A) to improve their situation e.g. lowering cost and therefore
increasing profit. The merit of using the mix calculation is that we can see exactly how much
money has been saved for each material as well as understanding the overall composite of
how materials were mixed together, something a material usage variance in isolation would
not have told us.
However the quality of the product does require careful inspection and it would be interesting
to see if there are any complaints from customers about the quality of the product. For
example mixing more water and less concentrated flavour to make a drink can certainly give
a favourable mix variance (water is cheaper) but it can have an effect on the quality of the
end product, in this case the taste of it. The chemical produced in the case of X Ltd could be
poorer quality or ineffective because of a deviation in mix. The same problem can be applied
to the yield, a favourable yield variance indicates you are short changing the customer e.g. X
plc may not be delivering exactly 23 kg of chemical for every unit of product P (ignoring
evaporation in the process) customers are getting less product for their money.
These problems in turn could have a damaging impact on the X Ltd brand image and
reputation, in turn leading to loss of customers and lower sales. Therefore the mix and yield
variances must be interpreted and used very carefully, ideally if the standard information is
correct you should have no variances at all. A short term favourable variance could result in
a poorer quality product and long term decline in sales.
I hope you find this information useful.
Signed: Accountant
77
Example 5.7
Labour Mix calculation - individual valuation bases
Actual Mix
Standard Mix
Standard hours
Standard rate
Partner
12
3 / 20 x 90
=
13.5
1.5
£100
150.00 (F)
Semi-senior
40
5 / 20 x 90
=
22.5
-17.5
£70
-1,225.00 (A)
Junior
38
12 / 20 x 90 =
54.0
16
£30
480.00 (F)
90
90.0
0.0
-595.00 (A)
Labour Mix calculation - average valuation bases
Actual Mix
Standard Mix
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
(W1)
-595.00 (A)
W1 Weighted average standard rate
(3/20 x £100) + (5/20 x £70) + (12/20 x £30) = £50.50
or £1,010 Std cost ÷ 20 Std hours = £50.50
Labour yield (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 (12 hours x £100) + (40 hours x £70) + (38 hours x £30) = £5 ,140
Note: the actual rates paid to all staff were the same as the standard rate
78
Example 5.9 – (CIMA past exam question)
Sales quantity contribution variance
Economy
Premium
Deluxe
Selling price
$2.80
$3.20
$4.49
Direct labour
($0.50)
($0.50)
($0.50)
Direct material
($1.00)
($1.60)
($2.20)
Variable overheads
($0.65)
($0.65)
($0.65)
Contribution
$0.65
$0.45
$1.14
Actual
sales at
budget mix
(W1)
Budget
sales
quantity
Difference Contribution
Variance
Economy
193,500
180,000
13,500 (F)
$0.65
$8,775 (F)
Premium
387,000
360,000
27,000 (F)
$0.45
$12,150 (F)
Deluxe
279,500
260,000
19,500 (F)
$1.14
$22,230 (F)
860,000
800,000
60,000 (F)
$43,155 (F)
Sales mix contribution variance
Actual
sales
quantity
Actual sales
at budget
mix (W1)
Difference Contribution
Variance
Economy
186,000
193,500
7,500 (A)
$0.65
$4,875 (A)
Premium
396,000
387,000
9,000 (F)
$0.45
$4,050 (F)
Deluxe
278,000
279,500
1,500 (A)
$1.14
$1,710 (A)
860,000
860,000
$2,535 (A)
Workings
W1 – Actual sales at budget mix
Economy = 180 / 800 x 860,000 = 193,500
Premium = 360 / 800 x 860,000 = 387,000
Deluxe = 260 / 800 x 860,000 = 279,500
79
Example 5.10 Part (a)
Tip: It is important that all workings are clearly shown to support your financial
statement. Make sure also your layout is clear and easy to follow. Other formats of
presenting the information below would have been acceptable.
For actual costs you can derive these using the flexed budgeted cost (based on 29,600
services) and the total of the favourable or adverse variances given. Note that the
30,000 original budget for services would be irrelevant. It is always actual not
budgeted production volume that drives a cost variance.
Actual costs incurred for the six months ended
£
Flexed budgeted material cost (W1)
1,184,000
Material price variance
1,100 (A)
Material usage variance
22,000 (A)
Actual material cost
1,207,100
Flexed budgeted labour cost (W1)
976,800
Labour rate variance
130,671 (F)
Actual labour cost
846,129
Flexed budgeted variable overhead (W1)
444,000
Variable overhead expenditure variance
11,000 (A)
Actual variable overhead
455,000
Flexed budgeted fixed overhead (W1)
710,400
Fixed overhead expenditure variance
18,000 (A)
Fixed overhead volume variance
9,600 (A)
Actual fixed overhead
738,000
Summary financial statement for the six months ended 30 September 2003
Actual material cost
1,207,100
Actual labour cost
846,129
Actual variable overhead
455,000
Actual fixed overhead
738,000
3,246,229
80
Example 5.10 Part (a) - continued
W1 Flexed budgeted cost based on 29,600 services
£
Material (£40 x 29,600)
1,184,000
Labour (£33 x 29,600)
976,800
Variable overhead (£15 x 29,600)
444,000
Fixed overhead (£24 x 29,600)
710,400
3,315,200
Example 5.10 Part (b)
Tip: A good report format will make your report well presented. A good approach
here would be to consider each cost and associated variances one by one, thinking of
good reasons that can support an adverse or favourable variance given, as well
discussion of possible interrelationships between the variances that you discuss.
REPORT
To: Operations Director of Marshall Ltd
From: Management Accountant
Date: DD/MM/YY
Subject: Performance of the service department
1.0 Introduction
The purpose of this report is to comment on the performance of the service department for the
six months to 30 September 2003. To suggest possible causes of such performance and also
state any further information that would be helpful in assessing the performance of this
department.
2.0 Sales volume
The sales volume achieved for the six month period was 29600 services. This is 400 short of
the budgeted sales volume of 30000. Even though 400 services do not seem to be materially
significant, the overall trend from month 4 to 6 is downwards and therefore this should be
investigated.
This downward spiral could be due to the following factors
A decline in business due to more intense competition
The business of servicing photocopiers is seasonal
A decline within the industry or market for photocopying servicing
81
Example 5.10 Part (b) - continued
If business is not seasonal further information should be obtained about the competition and
marketing methods they maybe using. As well as industry data which could be available e.g.
from financial statements of competitors or trade associations. This would allow a better
understanding of why sales maybe falling.
2.1 Material
The material price variance was favourable month 1 to 3 and now has become adverse over
months 4 to 6. This could be due to
The increasing cost of parts and components required for photocopying servicing
within the industry
The purchasing department not negotiating the procurement of parts or components
at very good prices
Further investigation will be required as well as perhaps information about other possible
suppliers in order to find cheaper components should this trend continue.
The material usage variance overall is significant for the six month period at £22,000 adverse.
It also has been adverse for 4 out of the 6 months of performance.
This could be due to
Greater wastage of components or parts by photocopying engineers
Poor quality components or parts and therefore the inability to use them due to
damage or obsolescence
Theft of components or parts
The adverse price variance does seem to suggest that wastage is perhaps not due to poor
quality components. Although if prices are rising within the industry, perhaps poorer quality
components are being purchased as a way of reducing cost. More investigation will be
needed.
More surprisingly is the favourable variance in month 2, this would mean less than the
required ‘2 sets’ of materials are being used per service in this month. This could mean
customers are perhaps being short changed by inadequate servicing e.g. parts are not being
replaced. If this affects the quality of service Marshalls provide it could mean significant
business in the future could be lost.
2.2 Labour
The labour rate variance of £130,671 favourable is the most material of all variances. This
could be due to reduced overtime payments e.g. the average per hour falls, or cheaper and
perhaps less skilled labour is being used. The efficiency variance in month 4 to 6 has been
adverse which could suggest an interrelationship here. Less skilled but cheaper labour could
mean each service is taking longer than the average of 3 hours expected.
82
Example 5.10 Part (b) - continued
Perhaps because Marshalls are paying less per hour than £11, key staff maybe leaving and
being replaced with cheaper trainees or staff are taking longer because of lower job
satisfaction. Both reasons can have an adverse impact on efficiency. Further information on
the composite of staff e.g. those fully, semi and untrained, as well as staff turnover rates need
to be investigated to find out if this is the case. Also Marshalls need to compare £11 an hour
to the general rate paid within this industry e.g. information from recruitment media or
agencies.
Given the significance of a £130,671 difference in budget there is also the possibility that the
standard of £11 per hour is wrong. This difference perhaps explained by a planning rather
than operating variance.
2.3 Variable overhead
The variable overhead efficiency variance is directly linked to the labour efficiency variance
e.g. if staff take longer then this drives more variable overhead being incurred. The variable
overhead rate variance has shifted from adverse to favourable in month 5 onwards. This
could indicate that less ‘consumables’ are being used for each service, which again could be
due to the customer being short changed. It could also indicate advancements in the
techniques used when servicing photocopiers.
2.4 Fixed overhead
The fixed overhead volume variance is caused by under or over absorption of production
volume for each period e.g. services performed. It therefore does not give a great deal of
information for control purposes. However the expenditure variance does give a great deal of
concern because it is overall £18,000 worse than budget for the period, although has got
better from month 5 onwards.
Perhaps the expenditure variance is due to unexpected rises in the fixed cost of running the
department e.g. rent increases or more administration or support staff employed. This
therefore needs to be investigated by obtaining more recent data to analyse what costs have in
fact risen. It could be due to poor planning e.g. a rent increase not reflected in the budget in
which case this is more a planning rather than operating variance.
3.0 Conclusion
Given the sum of all expenditure variances together are £68,971 favourable this represents
(£68,971 ÷ £3,315,200 flexed budgeted cost) 2% below budgeted cost for 29,600 services.
Due to however the significance of the variances for materials usage, labour rate and fixed
overhead expenditure, these I advise should be investigated further as a priority and further
information sought as to what has caused these to be incurred for the period.
Signed
Management Accountant
83
Example 5.11 (a)
A pay rise was given to kitchen staff as from the beginning of last month. The new labour
rate payable to chefs being £11.25 rather than as budgeted £9.00 an hour, this had been
overlooked and was not reflected in the budget.
Flexed budget (based on 476 meals) 476 x 0.25hrs @ £9 per hr
1,071
Planning rate variance
(476 meals x 0.25hrs) x £11.25 (revised standard rate) - £9.00 (old standard rate)
268 (A)
Operational rate variance
120 hrs paid did cost
1200
120 hrs paid should cost (revised standard rate) £11.25 per hr
1350
150 (F)
Operational efficiency variance
Hrs
476 meals did take (hours worked)
114
476 meals should take (x 0.25hrs per meal)
119
= 5hrs x (revised standard rate) £11.25 per hr
56 (F)
Operational idle time variance
Hours paid (120hrs) - Hours worked (114hrs) x (revised standard rate) £11.25/hr
68 (A)
Actual cost of labour charged during the period
1,200
Note: Before planning variances were introduced the operational labour rate variance was
£120 adverse but now as above £150 favourable. No one should get the blame now for
overpaying staff.
84
Example 5.11 (b)
Expected labour efficiency of 15 minutes (0.25 hours) per meal served has always been
considered by management as too generous, the budget was supposed to be updated last week
using only 12 minutes (0.2 hours) per meal but was overlooked during the planning process.
Flexed budget (based on 476 meals) 476 x 0.25hrs @ £9 per hr
1,071
Planning efficiency variance
(476 meals x £9.00) x 0.2hrs (revised standard) - 0.25hrs (old standard)
214 (F)
Operational efficiency variance
Hrs
476 meals did take (hours worked)
114
476 meals should take x 0.2 hrs per meal (revised standard)
95
= 19hrs x £9.00 Std rate per hr
171 (A)
Operational rate variance
120 hrs paid did cost
1200
120 hrs paid should cost £9.00 Std rate per hr
1080
120 (A)
Operational idle time variance
Hours paid (120hrs) - Hours worked (114hrs) x £9.00 Std rate per hr
54 (A)
Actual cost of labour charged during the period
1,200
Note: Before planning variances were introduced the operational labour efficiency variance
was £45 favourable but now as above £171 adverse. It seems chefs have not been as efficient
as you would expect.
85
Example 5.11 (c)
Due to a salmonella scare across the country the price of chicken had fallen to £2 per kg at
the beginning of the week. According to management this should be reflected in the budget.
Flexed budget (based on 476 meals) 476 x 0.3kg @ £2.50 per kg
357
Planning price variance
(476 meals x 0.3kg) x £2.00 (revised standard) - £2.50 (old standard)
71 (F)
Operational price variance
180 Kg purchased did cost
405
180 Kg purchased should cost (revised standard) £2.00 per Kg
360
45 (A)
Operational usage variance
Kg
476 meals did use
165
476 meals should use (x 0.3kg per meal)
143
= 22 Kg x (revised standard) £2.00 per Kg
44 (A)
180kg chicken did cost
405
Less 15kg closing stock valued at standard cost (revised standard) £2.00 a Kg
30
Actual cost of chicken charged during the period
375
Note: Before planning variances were introduced the operational price variance was £45
favourable but now as above £45 adverse. It seems that staff responsible for purchasing the
chicken have not been as efficient as you would expect when it came to getting a good price.
86
Example 5.11 (d)
Due to more skin and bone on the poultry purchased for the month, it was considered more
realistic by management that 0.35kg of chicken should have been served for each meal rather
than currently 0.3kg of chicken.
Flexed budget (based on 476 meals) 476 x 0.3kg @ £2.50 per kg
357
Planning usage variance
(476 meals x £2.50 per kg) x 0.3kg (old standard) - 0.35kg (revised standard)
60 (A)
Operational usage variance
Kg
476 meals did use
165
476 meals should use x 0.35kg per meal (revised standard)
167
2 Kg x £2.50 per Kg
5 (F)
Operational price variance
180 Kg purchased did cost
405
180 Kg purchased should cost £2.50 per Kg
450
45 (F)
180kg chicken did cost
405
Less 15kg closing stock valued at standard cost £2.50 per Kg
38
Actual cost of chicken charged during the period
368
Note: Before planning variances were introduced the operational usage variance was £55
adverse but now as above £5 favourable. It seems that staff responsible for serving the
chicken have been more lean when putting food on the customers plate.
87
Example 5.12
Machine expenditure and efficiency variances
Standard cost of 25 pints £40 x 0.6 hrs = £24 per 25 pints.
Expenditure
42 hrs did cost
1,880
42 hrs should cost (42 x £40)
1,680
200 (A)
Efficiency
1,900 pints did take
42.0 hrs
1,900 pints should take (1,900/25 x 0.6 hrs) 45.6 hrs
3.6 hrs
Standard cost per machine hour
x £40
144 (F)
Operating statement
Flexed budget based on actual output achieved Budget 1,900/25 x £24 = 1,824
Efficiency
144 (F)
Expenditure
200 (A)
Actual cost
1,880
88
Example 5.12 - continued
What if you were told that the machine had been replaced at the beginning of the period
with a machine that 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!!) = 0.48 hours new standard efficiency.
Planning machine efficiency variance
1,900 pints should have taken according to old std (÷ 25 pints x 0.6 hours)
46 hrs
1,900 pints should have taken according to new std (÷ 25 pints x 0.48 hours)
36 hrs
10 hrs
x £40
Planning machine efficiency variance 400 (F)
No change in machine expenditure operational variance
Operational efficiency variance (revised due to the new standard time)
Did take
36 hrs
Should take (1,900 ÷ 25 pints) x (0.6 hrs x 0.8)
42 hrs
6 hrs
x £40
240 (A)
Operating statement
Flexed budget based on actual output achieved (1,900 ÷ 25) x (0.6 x £40) = 1,824
Planning (machine efficiency)
400 (F)
Operational efficiency variance
240 (A)
Operational expenditure variance
200 (A)
Actual cost
1,880
89
Example 5.13
George Ritver within his book ‘The McDonaldisation 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 standardised delivery on a global
basis. Standardisation reduces cost and improves efficiency within organisations.
By the introduction of a McDonaldisation approach to service delivery, the likely impact
upon budgeting preparation and control for UV Ltd would be as follows.
Easier to create a pre-defined standard because of greater uniformity within the
specification of meals produced. Pricing would be easier and less time consuming
because of this.
Budget preparation would be easier, more accurate and less time consuming.
Greater predictability, UV Ltd always will have a uniform standard to compare to
actual cost to calculate any variances e.g. easier flexed budgeting and exception
reporting.
Easier to manage, organise, train and control catering staff because of the greater
uniformity of meals they produce. The proficiency of staff can be assessed more
effectively.
90
Example 5.14
Tip: Try not to get too confused here. The variances are no different to the normal
variances that you encounter in your studies. A clear layout, displaying the standard
cost and the calculation of just three variances would have passed this question.
The nursing efficiency variances are similar to a labour efficiency variance. It
took 1 day longer at standard rate to deliver care for one patient. Also 0.9 staff
was used as a ratio to the patient rather than 0.75. Both indicate greater
inefficiency.
One day extra created more space and food consumed which is similar to a
material usage variance.
Drugs and specific material is similar to an expenditure variance.
£
Standard cost of one procedure
1,165
Variances:
Nursing efficiency (1 day x 0.75 nurse x £320 per day)
240 (A)
Nursing efficiency (0.9 - 0.75 nurse) x 3 days x £320
144 (A)
Space and food (1 day x £175)
175 (A)
Drugs and specific materials (£320 - £115)
205 (A)
Overhead (1 day x £110)
110 (A)
874
Actual cost
2,039
Actual cost
£
Nursing (3 days x 0.9 nurse x £320)
864
Space and food (3 days x £175)
525
Drugs and specific materials (actual cost)
320
Overhead (3 days x £110 per day)
330
2,039
91
Example 5.15
MCQ 1.1 Answer A
(7300-6780) x 5.00 = sales volume variance £2,600 (A)
6780 x (13.00-13.80) = sales price variance £5,424 (F)
MCQ 1.2 Answer C
(27.50-30.00) x 770 = £1,925 (A)
MCQ 1.3 Answer A
(0.4 x £30.00) x (770-800) = £360 (A)
MCQ 1.4 Answer D
Actual mix
Standard mix Difference Price
£
Steak
852
921
-69
(3.50-5.60)
145 (F)
Kidney
990
921
+69
(3.50-1.40) 145 (F)
1,842 1,842 290 (F)
Weighted average standard price per kg (0.6/1.2 x £5.60) + (0.6/1.2 x £1.40) = £3.50
MCQ 1.5 Answer C
1842kg should yield (1,842/1.2kg) 1,535
1842kg did yield
1,350
185
x £4.20
777(A)
MCQ 1.6 Answer A
Using high/low method to separate fixed and variable cost
High 18,000
£41,000
Low 10,000
£25,000
8,000
£16,000
Variable cost £16,000/8,000 = £2.00
Therefore fixed cost (18,000 x 2 = 36,000) – 41,000 = 5,000
Therefore 12,750 hours should cost ((12,750 x 2) + 5,000)
30,500
12,750 hours did cost
32,560
2,060 (A)
92
Example 5.15 - continued
MCQ 1.7 Answer A
2,386/5.60 = 426 variance in labour hours
Should take 4hrs x 4,260 units = 17,040 hours therefore if adverse it took 426 hrs longer than
expected.
17,040 + 426 = 17,466 hours
MCQ 1.8 Answer D
Adverse variance £4,875/6.50 = 750kg variance in usage.
Should have used 3,000 units x 2kg = 6,000kg
Therefore actual usage 6,000kg + 750kg = 6,750kg
Closing stock rose by 800kg therefore must have purchased 6,750kg + 800kg = 7,550kg
MCQ 1.9 Answer A
Flexed budget 950 x 4kg x £12.50 =
£47,500
Revised budget 950 x 4kg x £13.00 =
(£49,400)
Planning price variance
£1,900(A)
3,800kg of material P did cost =
£50,160
3,800kg of material P should cost
(3,800kg x revised standard £13.00) =
(£49,400)
£760(A)
MCQ 1.10 Answer A
68 hours did produce
60.0 units
68 should produce (68/1.1hrs)
61.8 units
1.8
x £5.20
£9.36 (A)
93
Example 5.15 - continued
MCQ 1.11 Answer C
Planning rate variance
40 hours x £7.50 (original standard)
£300
40 hours x £5.50 (revised standard)
£220
£80(F)
Operational rate variance
40 hours x £5.50 (revised standard) should cost
£220
40 hours did cost
£270
£50(A)
MCQ 1.12 Answer A
Planning
60 x 0.6 (old standard) x £5.50 an hour
£198
60 x 0.5 (new standard) x £5.50 an hour
£165
£33(F)
Operational
60 units did take
40 hours
60 units should take (x 0.5)
30 hours
10 hours
x £5.50
£55(A)
MCQ 1.13 Answer B
% of one unit of output
Kg
3 kg after wastage
3
75%
1 kg of wastage
1
25% or 25%/75% x 3kg
Standard usage per unit of output
4
100%
3 kg (after wastage of 25%) x 100%/75% (after wastage) = 4 kg
4 kg = 100% before wastage
94
Example 5.15 - continued
MCQ 1.14 Answer A
OAR = £300,000/40,000 = £7.50
Standard hours would be the standard labour time per unit x the number of units actually
produced, therefore the company would have absorbed fixed overhead for the period of
39,000 x £7.50 = £292,500
Fixed overhead expenditure variance
Budgeted expenditure
£300,000
Actual expenditure
(£315,000)
£15,000 (A)
Fixed overhead volume variance
Budgeted expenditure to be absorbed (£7.50 x 40,000 hours) = £300,000
Actual expenditure absorbed for the period (£7.50 x 39,000) =
£292,500
£7,500 (A)
or
40,000 – 39,000 x £7.50 = £7,500 (A)
MCQ 1.15 Answer D
Did use
2,300 x 3.3 kg =
7,590
Should use
2,300 x 3.5 kg =
8,050
460
x
x Standard price
£5.00
Material usage variance
£2,300.00 (F)
or 2,300 x (3.3 kg - 3.5 kg) x £5.00 =
£2,300.00 (F)
MCQ 1.16 Answer B
Did purchase
6,700 kg x (£7.60 - £ 7.00) =
£4,020 (A)
95
Example 5.15 - continued
MCQ 1.17 Answer A
Did work
32,450
Should work
4,260 x 8 hours =
34,080
1,630
x
x Standard price
£7.60
Material usage variance
£12,388 (F)