CHAPTER 15 Standard costing and variance analysis Cost

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CHAPTER 15 Standard costing and variance analysis Cost and Management Accounting: An Introduction, 7

CHAPTER 15 Standard costing and variance analysis Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 1 a Definition • Standard costs are target costs for each operation that

15. 1 a Definition • Standard costs are target costs for each operation that can be built up to produce a product standard cost. • A budget relates to the cost for the total activity, whereas standard relates to a cost per unit of activity. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 1 b Operation of a standard costing system 1. Most suited to a

15. 1 b Operation of a standard costing system 1. Most suited to a series of common or repetitive organizations (this can result in the production of many different products). Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 1 c Operation of a standard costing system (cont. ) 2. Variances are

15. 1 c Operation of a standard costing system (cont. ) 2. Variances are traced to responsibility centres (not products). 3. Actual product costs are not required. 4. Comparisons after the event provide information for corrective action or highlight the need to revise the standards. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 2 An overview of a standard costing system Cost and Management Accounting: An

15. 2 An overview of a standard costing system Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 3 a Establishing cost standards 1. Two approaches: (i) past historical records (ii)

15. 3 a Establishing cost standards 1. Two approaches: (i) past historical records (ii) engineering studies 2. Engineering studies A detailed study of each operation is undertaken: • direct material standards (standard quantity × standard prices) • direct labour standards (standard quantity × standard prices) • overhead standards: • cannot be directly observed and studied and traced to units of output; • analysed into fixed and variable elements; • fixed tend not to be controllable in the short term. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 3 b Standard hours produced 1. Used to measure output where more than

15. 3 b Standard hours produced 1. Used to measure output where more than one product is produced. Example Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours Output = 100 units of X, 200 units of Y, 300 units of Z Standard hours produced = (100 × 5 hours) + (200 × 2 hours) + (300 × 3 hours) = 1 800 2. If actual DLH are less than 1 800 the department will be efficient, whereas if hours exceed 1 800 the department will be inefficient. Note: Different activity measures and other factors (besides activity)will influence cost behaviour. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 4 Purposes of standard costing 1. To provide a prediction of future costs

15. 4 Purposes of standard costing 1. To provide a prediction of future costs that can be used for decision-making. 2. To provide a challenging target that individuals are motivated to achieve. 3. To assist in setting budgets and evaluating performance. 4. To act as a control device by highlighting those activities that do not conform to plan. 5. To simplify the task of tracing costs to products for inventory valuation. Figure 2 Standard costs for inventory valuation and profit measurement Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 5 a Direct material variances 1. Can be analysed by price and quantity.

15. 5 a Direct material variances 1. Can be analysed by price and quantity. 2. Material price variance • (SP – AP) × AQ (£ 10 – £ 11) x 19 000 = £ 19 000 A (Material A) (£ 15 – £ 14) x 10 100 = £ 10 100 F (Material B) • Possible causes • Should AQ be quantity purchased or quantity used? Example Price variance = 10 000 units purchased in period 1 at £ 1 over SP 2000 units period used. Should £ 10 000 variance be reported in period 1 or £ 2 000 period? Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 5 b 3. Material usage variance • (SQ – AQ) × SP (9

15. 5 b 3. Material usage variance • (SQ – AQ) × SP (9 000 x 2 kg = 18 000 - 19 000) x £ 10 = £ 10 000 A (Mat. A) (9 000 x 1 kg = 9 000 - 10 000) x £ 15 = £ 16 500 A (Mat. B) • Possible causes • Speedy reporting required 4. Joint price/usage variance • It could be argued that SQ used to compute price variance and that (SP – AP) × (AQ – SQ) is reported as a joint price/usage variance. 5. Total material variance = SC – AC Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 6 a Direct labour and overhead variances 1. Can also be analysed into

15. 6 a Direct labour and overhead variances 1. Can also be analysed into price and quantity. 2. Wage rate variance • (SR – AR) × AH (£ 9 – £ 9. 60) x 28 500 = £ 17 100 A • Possible causes 3. Labour efficiency variance • (SH – AH) × SR (9 000 x 3 hours = 27 000 SHP - 28 500 AH ) x £ 9 = 13 500 A • Possible causes Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 6 b Direct labour and overhead variances (cont. ) 4. Variable overhead expenditure

15. 6 b Direct labour and overhead variances (cont. ) 4. Variable overhead expenditure variance • Flexed budget allowance (AH × SR) – Actual cost (28 500 x £ 2 = £ 57 000) – £ 52 00 = £ 5 000 F • Possible causes 5. Variable overhead efficiency variance • (SH – AH) × SR (9 000 x 3 hours = 27 000 SHP – 28 500 AH) x £ 2 = £ 3 000 A • Possible causes (note similarity to labour efficiency) 6. Fixed overhead expenditure (spending) variance • BFO – AFO (£ 1 440 000/12 = £ 120 000) – £ 116 000 = £ 4000 F Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 7 a Sales variances 1. Variances should be computed in terms of contribution

15. 7 a Sales variances 1. Variances should be computed in terms of contribution profit margins rather than sales revenues. 2. Example Budgeted sales = 10 000 units × £ 11 Standard and actual cost per unit Actual sales = 12 000 units ×£ 10 Variance in terms of sales value Variance in terms of contribution margin (Budgeted contribution margin = 10 000 × £ 4 = £ 40 000 Actual contribution margin = 12 000 × £ 3 = £ 36 000) Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA = £ 110 000 = £ 7 = £ 120 000 = £ 10 000 F = £ 4 000 A

15. 7 b 3. Objective is to maximize profits (not sales value). 4. Total

15. 7 b 3. Objective is to maximize profits (not sales value). 4. Total sales margin variance Example Actual sales (9 000 × £ 90) Standard VC of sales (9 000 × £ 68) = £ 810 000 = £ 612 000 £ 198 000 Budgeted contribution margin: 10 000 × £ 20 Variance £ 200 000 = Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA £ 2 000 A

15. 8 Sales variances (cont. ) 5. Total sales contribution variance can be analysed

15. 8 Sales variances (cont. ) 5. Total sales contribution variance can be analysed further: Sales margin price or Sales margin volume Therefore, Sales margin price Sales margin volume = (AP – BP) × AQ (AM – BM) × AQ = (AQ – BQ) × SM = (£ 90 – £ 88) × 9 000 = £ 18 000 F = (9 000 – 10 000)× £ 20 = £ 20 000 A £ 2 000 A Reconciliation of budgeted and actual profit (see slide 9). Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 9 Reconciliation of budgeted and actual profit Budgeted net profit Sales variances: Sales

15. 9 Reconciliation of budgeted and actual profit Budgeted net profit Sales variances: Sales margin price Sales margin volume Direct cost variances: Material: Price Usage Labour: Rate Efficiency Manufacturing overhead variances: Fixed overhead expenditure Variable overhead efficiency £ £ 18 000 F 20 000 A 2 000 A 8 900 A 26 500 A 17 100 A 13 500 A £ 80 000 35 400 A 30 600 A 4 000 F 5 000 F 3 000 A 6 000 F Actual profit 62 000 A 18 000 Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 10 a Standard absorption costing 1. For financial accounting (stock valuation) fixed overheads

15. 10 a Standard absorption costing 1. For financial accounting (stock valuation) fixed overheads must be allocated to products. This results in a volume variance. 2. Fixed overhead rate = budgeted fixed overhead budgeted activity (10 000 units) = £ 12 per unit or £ 120 000 /30 000 hours = £ 4 per standard hour = £ 12 per unit (3 ×£ 4). 3. If actual production is different from budgeted production, a volume variance will arise: Actual production = 9 000 units or 27 000 SHP Budgeted production = 10 000 units or 30 000 SHP Volume variance = 1 000 units × £ 12 or (3 000 SHP ×£ 4) = £ 12 000 A Volume variance = (AP – BP) × SR Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 10 b 4. Volume variances are not useful for cost control since FC

15. 10 b 4. Volume variances are not useful for cost control since FC are sunk costs. 5. Sometimes analysed into two sub-variances (capacity and efficiency): (A) Budgeted hours of input and output (B) Actual hours of input (C) Actual hours of output Volume variance (£ 12 000) Capacity variance Efficiency variance = 30 000 = 28 500 = 27 000 =A–C =A–B =B–C = 3 000 hours = 1 500 hours (£ 6 000) Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 11 a Reconciliation of budgeted and actual profit (absorption costing) To reconcile the

15. 11 a Reconciliation of budgeted and actual profit (absorption costing) To reconcile the budget and actual profit with an absorption costing system, the sales volume margin variance is measured at the standard profit margin (and not the contribution margin), i. e. 1 000 units × £ 8 = £ 8 000. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 11 b Cost and Management Accounting: An Introduction, 7 th edition Colin Drury

15. 11 b Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA

15. 12 a Recording standards costs in the accounts 1. Purchase of materials (Material

15. 12 a Recording standards costs in the accounts 1. Purchase of materials (Material A) Dr Stores ledger control account (AQ × SP) Dr Materials price variance Cr Creditors control 190 000 19 000 2. Issue of materials (Material A) Dr Work in progress (SQ ×SP) 180 000 Dr Material usage variance 10 000 Cr Stores ledger control account (AQ × SP) Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA 209 000 190 000

15. 12 b 3. Recording of wages due Dr Wages control account (actual cost)

15. 12 b 3. Recording of wages due Dr Wages control account (actual cost) Cr Wages accrued account 273 600 The wages control account is cleared as follows: Dr Work in Progress (SQ ×SP) Cr Wages control account Dr Wage rate variance Dr Labour efficiency variance Cr Wages control account Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA 243 000 17 100 13 500 30 600

15. 12 c 4. Manufacturing overhead cost incurred Dr Factory variable overhead control account

15. 12 c 4. Manufacturing overhead cost incurred Dr Factory variable overhead control account Dr Factory fixed overhead control account Cr Expense creditors 5. Absorption of fixed manufacturing overhead Dr Work in progress (SQ ×SP) 108 000 Dr Volume variance Cr Factory fixed overhead control account Dr Factory fixed overhead control account Cr Fixed overhead expenditure variance Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA 52 000 116 000 168 000 120 000 4 000

15. 12 d 6. Variable manufacturing overhead Dr Work in progress (SQ ×SP) Dr

15. 12 d 6. Variable manufacturing overhead Dr Work in progress (SQ ×SP) Dr Variable overhead efficiency variance Cr Factory variable overhead control account Dr Factory variable overhead control account Cr Variable overhead expenditure variance account 54 000 7. Completion of production Dr Finished stock account Cr Work in progress 3 000 57 000 5 000 720 000 Note that the variances are transferred to the profit and loss account at the end of the period. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 978 -1 -40803 -213 -9 © 2011 Cengage Learning EMEA