MA – Management Accounting

Contents
Standard Costing Systems ......................................................................................................... 2
SETTING STANDARD COSTS ..................................................................................................... 2
WHY SET STANDARD COSTS? .................................................................................................. 3
MARGINAL COSTING VS. ABSORPTION COSTING .................................................................... 4
EXAMPLE - STANDARD COST ................................................................................................... 5
Sales Variances ............................................................................................................................ 6
Materials Variances ..................................................................................................................... 8
Labour Variances ....................................................................................................................... 10
Variable Overhead Variances .................................................................................................... 12
Fixed Overhead Expenditure and Volume Variances ................................................................ 14
Fixed Overhead Capacity and Efficiency Ratios ........................................................................ 16
Reconciling Budgeted and Actual Profit.................................................................................... 18
Reconciliation statement under absorption costing: ............................................................ 18
Illustration 1 - Reconciliation statement under absorption costing: .................................... 20
Reconciliation statement under marginal costing: ............................................................... 22
Budgetary Control Reports and Variance Analysis ................................................................... 26
PURPOSE: ............................................................................................................................... 26
ROLE OF VARIANCES: ............................................................................................................. 26
REPORTING: ........................................................................................................................... 26

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Standard Costing Systems
Standard costing is used in planning and controlling business costs with budgeting and variance
analysis.

A standard cost is the planned unit cost of a product or service. They are the ‘target’ costs
which is why they are important for planning, control , and motivation.

Standard costs are set for activities, which are then periodically analysed against the actual
costs incurred by the firm.

Standard costing is best suited in organisations:

− That have repetitive actions and input into products or services; and

− Where the product inputs and their costs can be accurately measured and attributed to
a cost or responsibility centre.

A standard costing system involves the following steps:

1. The standard costs for actual output are recorded for each step of the process.

2. The actual costs for each operation are attributed to their responsibility centre.

3. The standard and actual costs are compared for variances.

4. Variances are investigated and corrective action is taken when appropriate.

5. The standards are monitored and adjusted for changes in usage and price.

SETTING STANDARD COSTS

Standard costs can be set using:

1. Past experience; and

2. By using engineering reports which are very detailed, outlining exactly what quantities
of labour and materials should be used under very efficient conditions.

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 The four main standards when setting standard costs are:

1. Basic Standards: These standards remain unchanged in the long term. They show
trends in price and efficiency over time. They are the least useful standard and used the
least.

2. Ideal Standards: These standards are based on perfect operating conditions where
there is no wastage, scrap, stoppages or idle time. Ideal standards are almost impossible to
achieve, so can be demotivating.

3. Attainable Standards: These standards are set using efficient but not perfect
conditions. These standards should be set so they are achievable with hard work; and
allow for breakdowns, fatigue, and normal material wastage.

4. Current Standards: These are based on the current efficiency levels and allow for
current levels of wastage and breakdowns. It is important to know the current standard
as a base point, but there is no incentive to improve on standard costs as they have
already been achieved.

WHY SET STANDARD COSTS?

Standard costing systems enable companies:

1. To predict future costs leading to better decision-making;

2. To provide targets to motivate the team;

3. To have reliable data for budget preparation;

4. To control costs by highlighting activities that are not going to plan; and

5. To easily measure the profit and inventory value of a product.

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MARGINAL COSTING VS. ABSORPTION COSTING

− Marginal costing takes only the variable costs attributable to a product and
deducts them from the sales price. The difference is the contribution to the fixed costs.
Under marginal costing, fixed costs must be incurred regardless, so are not included in
the costing.

− Absorption costing includes all the fixed and variable costs of production. The fixed cost
is apportioned to each unit produced by a suitable cost driver. To find out more about this
please see the ABC costing section.

− Standard costing values the units produced based on the standard labour and
material costs and usage set before production. Simply put, standard costing sets the cost
rates.

− Since standard costing sets the standard cost of materials and usage, both absorption
and marginal costing can be used with standard costing.

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EXAMPLE - STANDARD COST

The information about the standard cost and price of a product is presented in the table below.

Product A

Sales Price $30.00

Direct labour - 10 minutes $5.00

Direct Materials $5.00

Variable overheads $5.00

Total Variable costs $15.00

Monthly Fixed Overhead $ 10,000

Monthly budgeted production 1,500 units

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Sales Variances
Types of Sales Variances

There are two types of sales variances:

− Sales price variance

− Sales volume variance

Sales price variance:

The sales price variance arises when there is a change in the selling price of a product in a
budget period. The sales price variances occur, for example, when discounts are given and the
sales price is lower than budgeted or when prices are increased because the demand for a
product has increased and customers are willing to pay a high price for something.

Sales price Actual sales in

= (Actual price per unit - Standard price per unit) x
variance units

Sales volume variance:

The sales volume variance arises when the number of units of a product sold in a budget period
is different from the number of units budgeted to be sold in the original fixed budget. Sales
volume variances arise when demand for a product increases, for example, when there is a sale
or when production levels are lower than expected during a budget period. Sales volume
variances can also occur when there is a downturn in the economy and there is less demand for
goods which are considered to be luxury items.

Absorption costing Marginal costing

Sales volume profit variance Sales volume contribution variance

(Actual sales in units - Standard (Actual sales in units - Standard

x profit per x contribution
Standard sales in unit) unit Standard sales in unit) per unit

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Example 1:

An entity planned to sell 12,000 units at a price of $12 per unit. The entity actually sold 10,000
units at a price of $11 per unit. Calculate the sales price variance.

Solution 1:

Sales price variance = ($11 - $12) x 10,000

Sales price variance = $10,000

Since the actual price is lower than the standard price, the variance is adverse.

Example 2:

An entity planned to sell 10,000. The entity actually sold 12,000 units. The standard profit is $6
per unit. Calculate the sales volume variance.

Solution 2:

Sales volume variance = (12,000 - 10,000) x $6

Sales volume variance = $12,000

Since the actual volume is greater than the standard volume, the variance is favourable.

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Materials Variances
Materials total variance = Materials price variance + Materials usage variance

(Actual price per unit of

Materials price variance = material - Standard price x Actual usage
per unit of material)

Company spent more than

Adverse
expected

Company spent less than expected Favourable

(Actual quantity of material

Standard cost per unit of
Materials usage variance = used - Standard quantity of x
material
material)

Company spent more than Adverse

expected

Company spent less than expected Favourable

Reasons of Changes in Price Variance:

− Availability of bulk discounts.

− Change of suppliers.

− Change in material quality and rate.

− General price increase.

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Reasons for Changes in Usage Variance:

− Wastage levels are lower than budgeted due to more efficient employees.

− Wastage levels are higher than budgeted to inefficient employees.

− Superior quality materials.

− Poor quality materials.

Example 1:

ABC Co planned to produce 2,000 units in a given month. Each unit required 5 kg of materials
and, therefore, the total planned material consumption was 10,000 kg. The standard purchase
price of material was $15 per kg.

The business actually produced 2,000 units and consumed 8,000 kg of materials. The total
expense incurred on the material was $160,000.

Calculate the material price and material usage variance.

Solution:

Material price variance = 8,000 x ($15 - $160,000/8,000)

Material price variance = $40,000 Adverse

Material usage variance = $15 x (10,000 - 8,000)

Material usage variance = $30,000 Favourable

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Labour Variances
Labour total variance equals the difference between the expected labour cost and the actual
labour cost. It is calculated as follows:

Labour total variance = (Standard hours x Standard rate) - (Actual hours x Actual rate)

The labour total variance can be split into the labour rate variance and the labour efficiency
variance:

Labour rate variance = Actual hours x (Standard rate - Actual rate)

The labour rate variances occur because the actual rate of pay of labour is different from the
budgeted rate of pay. Reasons for changes to the labour rate include:

− Workers were paid a higher rate than planned, perhaps due to an unforeseen minimum
wage rate being set;

− Use of more highly-skilled labour than planned, thus leading to a higher rate of pay;

− Use of more low-skilled labour than planned, thus leading to a lower rate of pay;

− Payment of overtime and bonuses during the budget period that were unforeseen or
unplanned when the budget was set.

The labour efficiency variance is an indication of the efficiency with which an organisation’s
employees have worked during a budget period.

Labour efficiency variance = Standard rate x (Standard hours - Actual hours)

Labour efficiency variances occur when more or fewer hours are spent making products than
was expected. Reasons why labour efficiency variances sometimes occur include:

− Use of more highly-skilled labour than planned, thus leading to more efficient
productivity;

− Use of more low-skilled labour than planned, thus leading to less efficient productivity;

− Provision of training for workers during the budget period, thus leading to more
efficient methods of working;

− Introduction of bonus schemes, thus leading to more efficient productivity;

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 − Recruitment of new, inexperienced workers who will work less efficiently until they have
gained experience.

Note: Sometimes the labour rate and efficiency variances might be interrelated.

Example 1:

ABC Co planned to produce 2,000 units in a given month. Each unit takes 5 labour hours and,
therefore, the total planned labour hours were 10,000. The business is estimated to pay $15
per hour for the labour.

The business actually produced 2,000 units in 8,000 hours. The total expense incurred on the
labour was $160,000.

Calculate the labour rate variance and the labour efficiency variance.

Solution:

Labour rate variance = 8,000 x ($15 - $160,000/8,000)

Labour rate variance = $40,000 Adverse

Labour efficiency variance = $15 x (10,000 - 8,000)

Labour efficiency variance = $30,000 Favourable

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Variable Overhead Variances
There are two types of overhead variances: variable overhead variances and fixed overhead
variances.

The variable overhead total variance is the difference between the actual cost of
manufacturing a number of units and the budgeted cost of manufacturing the units, in terms of
the variable production overheads. It is calculated as follows:

Variable overhead Actual variable overheads expenditure -

=
total variance (Standard hours x Standard variable overhead rate per hour)

The variable overhead total variance can be split into the variable overhead expenditure
variance and the variable overhead efficiency variance.

Variable overhead Actual variable overhead expenditure -

=
expenditure variance (Actual hours x Standard variable overhead rate per hour)

Variable overhead Standard variable overhead rate per hour x

=
efficiency variance (Actual hours - Standard hours)

Note: The variable overhead efficiency variance can also be calculated relatively easily if you
have already calculated a labour efficiency variance for an organisation for the same budget
period. To do this, we multiply the labour efficiency variance in hours by the standard variable
overhead rate per labour hour.

Key reasons:

1) When more or fewer hours were worked than expected. This may occur due to:

− The use of more highly-skilled labour than planned;

− The use of more low-skilled labour than planned;

− The provision of training for workers during the budget period;

− The introduction of bonus schemes;

− The recruitment of new, inexperienced workers.

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 2) When the actual variable cost per hour worked was different from the standard variable
overhead cost per hour, which may occur if the fixed budget set prior to the budget
period turned out to be different from the actual results that were achieved.

Example 1:

At the start of a given period, a business budgeted to produce 1,950 units of a product. Each
unit takes 2 hours to produce and the variable overhead absorption rate per labour hour is $1.
At the end of the period, the business actually produced 1,950 units in 3,412.50 hours. The total
actual cost turned out to be $4,095. Calculate the variable overhead expenditure variance and
variable overhead efficiency variance.

Solution:

Variable overhead expenditure variance = Actual expenditure - (Actual hours x Standard OAR)

Variable overhead expenditure variance = $4,095 - (3,412.50 x $1)

Variable overhead expenditure variance = 682.50 - Adverse

Variable overhead efficiency variance = Standard OAR x (Actual hours - Standard hours)

Variable overhead efficiency variance = $1 x (3,412.50 - 1,950 x 2)

Variable overhead efficiency variance = $487.50 - Favourable

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Fixed Overhead Expenditure and Volume Variances
Remember: Fixed overhead variances will vary depending on whether an organisation uses
marginal or absorption costing (unlike the cost variances for materials, labour and variable
overheads).

In an organisation that uses absorption costing, the fixed overhead total variance is the
amount of any under or over absorbed overheads in a budget period. Over absorption is
favourable, whereas under absorption is adverse. The variance is calculated as follows:

Actual fixed overheads -

Fixed overhead total variance =
(Actual output x Fixed overhead absorption rate)

The fixed overhead total variance can be split into the fixed overheads expenditure variance
and the fixed overhead volume variance. The fixed overhead expenditure variance is the
difference between the budgeted fixed overheads and the actual fixed overheads:

Actual fixed overheads -

Fixed overhead expenditure variance =
Budgeted fixed overheads

Note: Budgeted fixed overheads = Budgeted output x Fixed overhead absorption rate.

Remember:

1) Organisations that use marginal costing have only one fixed overhead variance, which is
the fixed overhead expenditure variance;

2) The fixed overhead total variance for an organisation that uses marginal costing will be
equal to the fixed overhead expenditure variance.

The fixed overhead volume variance is only calculated for organisations that use absorption
costing systems. It is therefore the difference between the actual fixed overheads absorbed and
the budgeted fixed overheads:

(Actual output - Budgeted output)

Fixed overhead volume variance =
x Fixed overhead absorption rate

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Note: The fixed overhead volume variance can be further subdivided into the fixed overhead
capacity variance and the fixed overhead efficiency variance.

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Fixed Overhead Capacity and Efficiency Ratios
The fixed overhead volume variance explains the amount of the fixed overhead total variance
that is due to the number of units that were actually produced being different from the number
of units that were budgeted to be produced (calculated for organisations that use absorption
costing).

It can be further subdivided into the fixed overhead capacity variance and the fixed overhead
efficiency variance.

The fixed overhead capacity variance compares the original fixed budget in terms of labour
hours with the actual labour hours worked:

Fixed overhead (Budgeted production hours - Actual production hours)

=
capacity variance x Fixed overhead absorption rate

Fewer hours worked compared to budget Adverse variance

More hours worked compared to budget Favourable variance

The fixed overhead efficiency variance compares the variation in absorbed fixed production
overheads attributable to the change in the number of manufacturing hours (labour hours or
machine hours) as compared to the budget.

Fixed overhead (Actual production hours - Standard production hours)

=
efficiency variance x Fixed overhead absorption rate

Example 1:

An organisation budgeted to produce 2,000 units, with each requiring 2 labour hours. The
standard fixed overhead absorption rate is $3. The actual labour hours worked were 3,500
hours. Calculate the fixed overhead capacity variance.

Solution:

Fixed overhead capacity variance = (4,000 - 3,500) x $3

Fixed overhead capacity variance = $1,500

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Since the number of hours worked was lower than planned, the business did not utilise the
available capacity. The variance is, therefore, adverse.

Example 2:

An organisation budgeted to produce 1,000 units, with each requiring 3 labour hours. The
standard fixed overhead absorption rate is $4. The actual labour hours worked were 2,500
hours and 800 units were produced. Calculate the fixed overhead capacity variance.

Solution:

Fixed overhead efficiency variance = (2,500 - 800 x 3) x $4

Fixed overhead efficiency variance = $400

The business was supposed to take 2,400 hours in making 800 units. However, it did take 2,500
hours. Therefore, the variance is adverse.

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Reconciling Budgeted and Actual Profit
Reconciliation statement under absorption costing:

Description Comments $ $ $

Budgeted sales in units x Standard profit

Standard profit on budgeted sales X
per unit

Sales volume profit variance F / (A) X / (X)

Actual sales in units x Standard profit per

Standard profit on actual sales X / (X)
unit

Sales price F / (A) x (x)

Materials price F / (A) x (x)

Materials usage F / (A) x (x)

Labour rate F / (A) x (x)

Labour efficiency F / (A) x (x)

Variable overheads expenditure F / (A) x (x)

Variable overheads efficiency F / (A) x (x)

Fixed overheads expenditure F / (A) x (x)

Fixed overheads efficiency F / (A) x (x)

Fixed overheads capacity F / (A) x (x)

Total variances Total F - Total A X (X) X / (X)

Standard profit on actual sales + Total

Actual gross profit X / (X)
variances

Non-production overheads X / (X)

Actual net profit X / (X)

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Standard profit per Standard selling Standard total
= -
unit price per unit absorption cost

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Illustration 1 - Reconciliation statement under absorption costing:

Description Comments $ $ $

Standard profit on budgeted Budgeted sales in units x Standard

56,000
sales profit per unit

Sales volume profit variance F / (A) 6,400

Actual sales in units x Standard profit

Standard profit on actual sales 62,400
per unit

Sales price F / (A) -17,550

Materials price F / (A) -11,700

Materials usage F / (A) 19,500

Labour rate F / (A) -6,825

Labour efficiency F / (A) 2,925

Variable overheads expenditure F / (A) -682

Variable overheads efficiency F / (A) 487

Fixed overheads expenditure F / (A) -280

Fixed overheads efficiency F / (A) -375

Fixed overheads capacity F / (A) 975

- -
Total variances Total F - Total A 23,887
374,122 13,525

Standard profit on actual sales + Total -

Actual gross profit
variances 48,875

-
Non-production overheads
14,800

Actual net profit 34,075

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Standard profit per Standard selling Standard total
= -
unit price per unit absorption cost

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Reconciliation statement under marginal costing:

Description Comments $ $ $

Standard contribution on budgeted Budgeted sales in units x Standard X

sales contribution per unit

Sales volume contribution variance F / (A) X / (X)

Standard contribution on actual Actual sales in units x Standard contribution X / (X)

sales per unit

Sales price F / (A) x (x)

Materials price F / (A) x (x)

Materials usage F / (A) x (x)

Labour rate F / (A) x (x)

Labour efficiency F / (A) x (x)

Variable overheads expenditure F / (A) x (x)

Variable overheads efficiency F / (A) x (x)

Total variances Total F - Total A X (X) X / (X)

Actual gross profit Standard profit on actual sales + Total X / (X)

variances

Fixed overheads X / (X)

Non-production overheads X / (X)

Actual net profit X / (X)

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Standard contribution Standard selling price
= - Standard marginal cost
per unit per unit

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Illustration 2 - Reconciliation statement under marginal costing:

Description Comments $ $ $

Standard contribution on budgeted Budgeted sales in units x 63,000

sales Standard contribution per unit

Sales volume contribution variance F / (A) 6,400

Standard contribution on actual Actual sales in units x Standard 70,200

sales contribution per unit

Sales price F / (A) (17,550)

Materials price F / (A) (11,700)

Materials usage F / (A) 19,500

Labour rate F / (A) (6,825)

Labour efficiency F / (A) 2,925

Variable overheads expenditure F / (A) (682)

Variable overheads efficiency F / (A) 487

Total variances Total F - Total A 22,912 (36,757) (13,845))

Actual gross profit Standard profit on actual sales 56,355)

+ Total variances

Fixed overheads (7,480

Non-production overheads (14,800)

Actual net profit 34,075

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Standard contribution Standard selling price
= - Standard marginal cost
per unit per unit

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Budgetary Control Reports and Variance Analysis
PURPOSE:

The purpose of the control stage of the planning and control cycle is to compare the actual
results achieved in a budget period with the results which were expected for that period in
order to calculate variances.

ROLE OF VARIANCES:

Variances are then listed in a budgetary control report so that they can be brought to the
attention of management. There are a number of factors that should be considered before
investigating variances further:

1) We need to think about whether the variance is significant or not. One way of doing this
is to calculate the variance as a percentage of the flexed budget.

2) We need to consider whether the variance is controllable or not;

3) We need to think about any possibility of eliminating the variance;

4) We need to consider whether the costs of investigating it outweigh any benefits of the
investigation.

REPORTING:

A report is a way in which you can present information, for example, a budgetary control
report. It is important that a report is structured properly so that the contents are clear to its
users. Here is a checklist of things that you should think about including in a report:

a) Title;

b) Introduction - provides information about who has written the report and what the
report is aiming to do;

c) Content - the body of the report which includes the main findings;

d) Conclusions;

e) Recommendations;

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 f) Appendix - used when there is any supplementary information available that might be
useful to the readers of the report.

EXAMPLE:

A Company has calculated the following variances for its recent period:

Flexed budget Actual results Variance $

1,950 units 1,950 units

$ $

Sales revenue 175,500 157,950 17,550 (A)

Materials 78,000 70,200 7,800 (F)

Labour 23,400 27,300 3,900 (A)

Variable overheads 3,900 4,095 195 (A)

Fixed overheads 7,200 7,480 280 (A)

The company has a policy of investigating all variances that are equal to or greater than 10% of
the flexed budget. Identify the variances that require further investigation.

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Solution:

% of Variance

Sales revenue (17,550 / 175,500) x 100 = 10%

Materials (7,800 / 78,000) x 100 = 10%

Labour (3,900 / 23,400) x 100 = 16.7%

Variable overheads (195 / 3,900) x 100 = 5%

Fixed overheads (280 / 7,200) x 100 = 3.9%

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