oO) Cc = aD tandard co Ss > Chapter 38CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK A clean performance Faiza owns and runs a small business manufacturing and saling ap. She set ip trea years ago working fom home with some equipment, and supp ies of rw materials. She sells the soaps at local a stall, events and online. Wh: planning the busines, she approached her lozul bank fora bcsiness bank account and small loan, The bank’s business acsor ‘commended that she set budgets for the busines costs and revenves, Faiza found that comparing her arwel and expected performance was very usefl Intally,Faiza relied heavy on market escarch acl guesswork to estimate the cost of making each har of soap, the seling price and the amount she could make and cel n her fst year. When she compared her actual performance againt the budgeted figures, she found there were big cifferences between the two sets of results Faiza used the information w help her to focus on what changes she needed to make to prove the busines. At the end ofthe fist year, the changed supplier and negotiated a trade decount.Faza also Updated her bunigsted figures so that her budgets forthe secon year were moe realistic and achievable. At the ed of her second year of trading Faiza found that hor actual results were closer to her budgets than inthe frst yar Foiz til found the comparison helpful and resolved to continue re compare Figure 38.1: size owns and runs a small ectva, and budgeted figutes. business manufacturing and seling soap Discuss in a pair or a group: “© Why's it useful to compare actual escitz against budgeted figures? ‘+ Why are Faiza's budgeted figures fo: the second year likely tobe more realistic than forthe fist year? ‘+ Faiza is keen to continue comparing actual and budgeted figures. Are there any clisacvantages of making the comparisons? 38.1 What is standard costing? A standard cost is vsod by manufacturers when preparing realistic budgets. Standards can also be set for revenue, standard cost: the estimated or budgeted ‘cost of a unit of output ‘Standard costing compares actual costs against standard costs. The differences between for activity actual and standard costs and revenue are known as variances. standard costing: an accounting system that ‘compares actual costs against standard costs, ‘which helps managers to assess and control costs and take action where needed. variance: the diference between the standard ‘cost and actual cost ‘This comparison will help managers to assess and contro! costs and take action where needed Fo: example, a diference between the actual and budgeted cost of materials might show that the purchase price of the materials has increased since te budget was prepared, Possible ‘causes ofa significant variance would be investigated. Corrective action might be that the purchasing manager reviews current suppliers o: actively secks additional discounts. 38.2 Setting standards Standards must be realistic if they ave to be useful. Standards will need to be regularly reviewed and kept up to date if they are to be realistic, For example, if new machinery is purchased, direct labour tinxe for production will need to be updated. Copyright Material - Review Only ~ Not for Redistribution38. Standard costing A Level 4.2 There are various types of stausard that businesses might use. The main types of siandard and their practical use Ideal standards ae standards that can only be met under ideal conditions. In practice, conditions uncer which businesses work are rarely ideal, therefore hese standards are unrealistic and are unlikely to be attained. As a result, they can demotivate managers and cause them to perform less efficiently: Ideal standards should not be used. © Current standards ate based on present levels of performance. This may be inappropriate for the future. They do not offer management or workers any incentive to perform more efficiently. Current standards sluld only be used when present conditions are too uncertain to enable more appropriate standards to be so. = Attainable standards recognise that there is some wastage of materials and not all the hours worked are productive. Time spent unproductively by workers is called idle ‘ime and may occur when machinery breaks down or the machinery has to be set up" for a production run. The standards should take aecount of these factors and give the workers an incentive to use ‘hei time and materials efficiently. The standards Set should be attainable ones. Worked example 1 shows how sisadards are used to prepare budgets ‘Study Limited moos desks in three sizes: small, medium and large. In Apel, output is expected tobe as follows © 200ml desks, which take 30 minutes each to make +500 medium desks, which take 1 hour each to make + Oath age daa wih na f box ech nan "rnd snsstn ba sn inane gp? a eaad Fi ‘Study Limited has set its budgeted fixed overitads at $5000 per month, which are absorbed ‘on the basis of direct labour hours ‘The standard selling prices per unit for each product are Small desks s100 Medium desks 5150 Lange desks 3200 Required 8 Calculate the standard costs to be charged to production for i labour materials bCaleulate the fixed overheads absorption rate. | & Pep Stay Limite budge profit statement for Api as) Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK rit wil be: er) rs fo} 200 small desks, which take 30 minutes 100 1500 teach to make 300 medium desks, which take 1 hour 300 4500 teach to make @ 600 9000 400 large desks, which tae 15 hours each to make ‘otal standard hours and wages cost of 1000 prochiction Note: [1] The total standard wage cost foreach type of desk isthe tora standard hours x15 The standard material cost of production areas follows: 200 small desks, which each take 2 nites 400 8000 ff wood to make 300 medium desks, which each take 3 900 18000 ‘metres of wood to make 400 large desks, which 2 cof wood to make ‘Total standard quantity and cost of ‘material for production takedmeves 1600 Note: [1] The total standard material cos for each typeof dest isthe total standard suetres of material X $20. bb Study Limited has set its budgeted fixed overheads at $5000. It is absorbed on the basis of direct labour hours: therefore, the standard overhead absorption rate is $$0 (850000 + 1000 hours) Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 ‘€ Study Limited's budgeted profit statement is as follows: Study Limited Cee eet er a $s s s $ kovenue 20000 45000-80000 145000 Direct materials (e000, (18000) (32000) (58000) Direct labour (1500) (4500) (9000) (15000) Fixed overhead at $50 per direct (5000) (15000) labour hour a Budgeted profit 5500 ©7500 Note: [1] Iris nota budgeted siatement of profit or loss as not all expenses hav= teen included, This is acceptable ait is for management use and not for publication. The information to prepare the budgeted profit statement has been built up from the standard da‘a prepared; hence standard costing isthe foundation for budgeting and budgetary control | Amanufacturing company uses standard costing er its products: curtains and sheets. Both use the same materials and are made in the same factory Estimated production and sales volumes for the next three months are 10000 sets of curtains and 8000 packs of sheets Standard costing information forthe products is a8 follows: | Selling price 3 $40, Direct materials ‘Smetres of cotton at $4 permetre ‘2 metres of cotton at $4 per metre Direct labour ‘2 hours at $12 per hour ‘hour at 12 per hour Requirsd Copyright Material - Review Only - Not for Redistribution Total budyeted fixed overheads for the three-month period fs $266000. Fixed ‘overheacts are absorbed on the basis of direct labour hours are the budgeted profit statement forthe nest three-month period a>CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK 38.3 The advantages and disadvantages of standard costing Standard costing isan important management tool. It provides a beschmark against Which actuai performance can be measured, ‘There are both advantages and disadvantages to using a standard costing system. When used properly the advantages of standard costing will ou-weigh the disadvantages and impuove the future performance of the business The preparation of budgets is made easier Te takes time to collect the data needed to prepare the based on standard costs, and the budgets ae likely tobe | standard cost of a product. more realistic Differences between actual and badgated results (variances) | The standards need to be continually monitored and are easier to identiy f standard covts are used, Updated if they are to be useful ‘ave highlighted Te does not explain the cause of the variances. Further investigation s needed ifimprovemnents are to be made. The activities that causa vara Calculated standards "elp the preparation of estates for | There may bs factors outside the control ofthe business the costs of new products and quotations for orders. which cause the variance. For example, the business may ‘expect material prices to increase by 2%, but inflation may lead to a 4% price increase ‘Although ctaridard costing is associated with manufacturing, it can be used in other businesses, inclucing services, 38.4 The flexible budget ‘The actual volume of goods produced and sold is not the same asthe expected volume on Which a budget has been based. Once accurate figures are known, sensible comparisons ean bbe made if “like is compared with like’ und the budget is based on the actual volume of output. Ths is done by flexing the budget after the aetual produetion level is knows = When flexing the budget, the bndgeted sales volume is adjusted to the actual sales voiume nA and the variable expenses in the budget is adjusted to take account of the actuz! volume of | flexible budget: a goods produced, ‘budget that changes It is important to flex the budget for the following reasons: ‘a match the actual + Iallows comparison of ke with ihe Comparing actual cos nd revenue against | OMe 0 fren Sse btget ncn tht we ty conparng pure based cate ame Ice eutput Ped ows do nt vary wih output but seme and variable cents do Thortre ny varios calculated sing Hawes ura eile Duet wil be one ‘+ Flexing the budget helps management to take beiter corrective action and control the business. Fixed budgets are prepared before production and flexible budgets are prepared after actual production is known, Copyright Material - Review Only ~ Not for Redistribution38. Standard costing A Level 4.2 Weneleuuaes: In May, Liu Limited produced the following budget forthe production and sas of 20000 units for Reverwe 500000 Vorabie expenses: Direc materials ($0000) Direct labour (100000) Variable production overheads (40000) Variable selling and distribution (19000) (200000) Fined expenses (230000) Total cost 1639000) Budgeted profit 70000 ‘ier December i was found that the atual output and sales forthe six swnths ended 31 December was 25 000 units Required Prepare Liu Limited's flexible budgeted profit statement for tse aext six-month period ine lexble budget forthe pero is as follows The budget is exible by mliplying When ealuating thereveme variances, th frst thing you must doi ex the budgeted (or standard) information provided 28000 and variable expenses by Revenue 760000 Variable expenses: Direct materials, 70009) Direct labour 249000) Production overheads (56000) Selling and distribution (14000) (280000) Fixed expenses 730000) fotal cost (610000) 190000 Budgeted profit Note: the revenue and variable costs hav® all changed asa result of flexing the budget. ‘The fixed expenses have not changes. Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK Worked example 2 applied fexible budgeting to variable and fixed costs The varis ble costs, were adjusted but the fixed costs remained the same. In Section 35.1 we fooked at semi-variable costs and stepped costs, A semi-variable cost contains an elemeat of both a variable and fixed cost. Therefore, to fle a semi-variable cost, separate its xed element from its variable element. The fixed element stays the same While the variable costs flexed ~ for example, if Liu Limited has a budgeted telephone ‘expense of $500 that consists of $100 fixed rental and $400 of calls that vary with the level of activity of the business. ‘The flexed budget telephone expense will be: (28000) (20000) AA stepped! cost is fixed only within a certain fim that limit is reached. si00+ % $400 = $660 and will increase toa higher level when For example, if Liu Limited had a budgeted labour cost for staff supervision of $300 for the first 9000 units then another $300 for every 9 000 units of production. ‘The cost of 0 to 9000 units = $300: the cost of 9001 to 18000 wits = $600 ($300 x 2) ete. ‘Therefore, the original bude: for 20000 units would have a budgeted staff supervision of $900 ($300 x 3) because it falls between 18001 and 27000 units ‘The flexed budget stu? supervision cost is then $1200 ($300 x 4) because it falls between 27001 and 36000 waits 38.5 Variances Aas thecifcra: toons dard cot el Sata onto tte Cuiyaed nic and saa re os With all of the variance caleulations, a positive ‘number indicates a Variances ean be calculated for: favourable variance and anegatve answer indicates an © direct materials adverse variance # direct labour Variances are useful for helping management to spo% activities that may need intervention if the budgeted profit isto be achieved orto lunit any adverse effect on profi + sales © variable and fixed ove These variances can be further analysed into sub-variances. LS ausit very variance must be desorbed as ther faourable variance (Foran averse variance | favourable variance a (A), A alesse wl be faoumble ister higher han Budgeted. A cont | vance where reverse ‘variance will be favourable if actual figures are lower than budgeted. is higher: ier oxpactect ‘Once the varianes he eon clue eile budge satement can be prepared costs ae lower than ‘This shows the budgeted and actual results along wih the variances. A exible budget statement isa useful report for management who can use it to help them decide which s variances need investigation, Siaace qian ros fr costs are higher than expected, adverse variance: a Copyright Material - Review Only ~ Not for Redistribution38. Standard costing A Level 4.2 Maan Anya Limited makes one type of product. The budget for September is based wo the following Standard cost: Number 2 rit produced and sole: 18000 Per unit Selling price per unit $32 irect materials (ka) 125 | Cost of material per ka sa Direct labour (inutes) 30 Labour rate per hour si Budgeted fixed overheads forthe month 360000 Required Prepare the budgeted staersent of profit or loss for Anya Limited Additional information ‘The actual data for September was as follows: Number of init produced and sold 20000 Seling pce por unit $30.60 Direct -naterials (ka per unit 1:10 Costof direct materials per ky $415 Remember to flex Cirect labour (sinutes) % tre budoet bafors | Direct labour rate perhour sn caleuating the Fixed overheads $370000 variances. The mos ict ‘aleulate the variance bby comparing the ‘actual cata with the 1 flexible budget September fixed budget Prepare the following statements actual profit statement for September. ‘¢Prepare the flexible bud data and showing the ot statement for September showing t ference (variance) between the two, budgeted an setual Answer The budgeted siatement of profit or loss eee Revenue (18000 x $32) 576000 Direct materials (18000 » 1.25 kg * $4) (90000) Direct labour (18000 %[30 minutes + 60] x $12) (108000) (198000) Contribution 378000 Fixed overheads (360000) Budgeted profit 18000 DP wy Copyright Material - Review Only ~ Not for RedistributionCAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK toes the budget to reflect the and sales ‘This isin eifect, the new budgeted profit statement for the moot ‘The fexble budget for the 20000 units produced and so 9 as panera $ $ Revenue (20000 x $32) 40000 Direct materials (20000 x 1.25ka + $4) (100000) Direct labour (20000 x {30 minstes + 60] x $12) (120000) Contribution Fixed overheads Flexible budgeted prnit Note that only the variable costs are exible to the actual level of out! and sles i The actual r-ults SS eens $ $ evens 20000» $3040 aoe eet eater, OM ay Diet sour 20000 » 36 mints 60} $11) 132000) (223300) Contribution 388700 Fixed overheads[1] (370000) Actual profit 18700 Note: [U] The fixed costs are higher than the budget. However, these are the acta! results and so the fixed costs for the budget may have been seta a clllerent ad ahsosption rate or an unexpected invoice was received Variances are shown ‘either without brackets if they are favourable, cor in brackets they Units 20000 sre adverse Ris Revenue () 612000 (28000) Adverse also important to Direct materials () (71300, (100000) 8700 Favourable dearly abel cham as Direct labour (8) (132006) (120000) (12000) Adverse Contribution (8) 358700 4200001300) Adverse Fed overheads (§) (870000) 60000) (10000) Adverse Variances are shown Profit) 78700 _ 60000 (41300) Adverse ether without brackets if they ate favourable ‘or in brackets ifthey S are adverse. Copyright Material - Review Only ~ Not for Redistribution38. Standard costing A Level 4.2 Understanding the data The exible budget epot is an important part of management contol or esinss. Tt ases flexible igures rather than the master budget data, Some companies may also show the ined budget die as part of thei report, but he comparison bese the actual results andthe eile Suge the most important thing, Variance give management an indication of wher to lok fore problems Varanees Jo no tell managers what has enused the variances this eure Further vestigation, 4 Baqi Limited makes one type of product. The flowing information is available about the standard and actual results for six montis to 30 June: Nuber of units produce and sold 12000 15600_| | Per uit Sling pice per 2 Direct materials) 2 10) Cost of material per s $3 Drect labour nutes) 0 30 Labour a pe hoor a a Budgeted fred overheads fora onte Siren | 115000 eased Fropare the flexible budgeted profit statement for tho si months to 30 June. Show the | Sudgeted and actual data and variances, A jes variances 38.6 How to calculate sa Actual sales revenue differs from budgeted sales revenue because the aetual selling price i different from the standard selling price and/or because the actual volume sold is diflerent. Sales variances highlight the exient of any volume or price differences, fad “The total sales variance isthe difference between actual and budgeted sales revenue. This — is caused by the sales voiume variance (selling more or less than the budget), or the sales price variance (selling the goods ata different price than was budgete). This can be shown diagrammatically as in Figure 38.2. ‘The variances are calculated as follows: 2 Toval sales variance isthe difference between the bud Figure 38. Sales variance sd sales revenue and the actual ‘The total sales variance Formula for total sales price variance: al sales vara is equal tothe sl actual sales ~ (fixed) budgeted sales volume variance plus b Sales volume variance is the difference bovveen the total sale in the original budget sales price variance ‘and the total sales in the flexible bude. Knowing this allows you to check whether the Formula for sales volume variance: Siceaetea sae (actual units sold ~ fixed budgeted units sold) x standard price volume variances have bbeen calculated correctly 623 > Copyright Material - Review Only ~ Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK © Sales price varian standard selling and the aetual si covnpaces the aetual selling price per unit of the units sold with the ie pet unit, Is the difference between the flexible budgeted sales Formula for sales price variance {actual price ~ standard price) actual units sold Ge ea ‘Contued from Worked example 3 Required CCaleulate for Anya Limited for September: athe sles volume variance the sales price variance © the total sues variance Anya Limited’ sales volume variance is ‘56400000 ~$576100 = $64000 vourable, ‘This could clso have been calculated using the formula: (actual sales volume ~ original budgeted sales volume) x standard price (20000 units ~ 18000 units) x $32 = $64000 favourable The variance is favourable because actual sales were more than the original ‘amount budgeted b Anya Limited’ sales price variance is: ‘Actual sales ~ flexible budgeted sales ‘3612000 ~ $640000 = $2800 adverse ‘This could also have been calculaisd using the formula: (actual price - standard price) x actual units (832 ~ $30.60) « 20000 units = $28000 adverse © Anya Limited's tote! sales ‘actual sales butgoted sales = (612000 ~ 576000) = $36000 favours Alternatively, can be shown as: sales voume variance + sales price variance = $64000 + (528000) = $36000 favourable Notice ere that we are using the sales figures from the orignal (xed) budget wer actual selling price has al esc is higher than expected Calculating the variances has identified that having a increased the sales revenue Limited sold. The ov ime Any Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 38.7 How to ci As with sales the variance on the direct materials cost can be due to two things: using more or less material than vas budgeted and/or purchasing materials ata hier or lower price than was set in the budget late direct materials cost variances This ean be chown diagrammatically as in Figure 38.3, igure 38,2: Direct materisis cast variance ‘The total direet materials variance is the difference between actual an budgeted materials, This is caused by te direct materials usage (volume) variance (using more or less material than budgeted), or the direct materials price variance (purchasing the materials ata diferent price than was budgeted). ‘The variances are calculated as follows: 8 Total direct materials variance is the difference between the flexible budgeted direct ‘materials cost and the actual direct materials cost b Direct materials usage variance is the differeace between the actual quantity of direct ‘materials used and the quantity of direct materials that should have been used to produce the actual output. The difforeace between the two figures is multiplied by the standard cost per kg (or other iveasure of the quantity), that is: (exible budget quantity of material - actual quantity of material) x standard cos: per_—_| When ealeulating unit of material ‘material and labour variances, always start © Dircet materials price variance isthe diference between the actual price pid and the budgeted price forthe actual quantity used wah the standard and deduct the ‘actual tre in kg then the formula is: This is opposite to the sales variance. I the materia price per kg actual price per kg) * actual quantity in ke Calculate for Anya Limited for September: the dirvet materials usage variance bb the dirvet materials price varionce © the total direct materials variance, a ws) Copyright Material - Review Only ~ Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK Answer ‘4 Anya Limited's total direct materials usage variance is (exible budget quantity of material ~ actual quantity of material) x standard cost per unit of material ‘The actual quantity produced and sold was 20000 unis. The flexible budget quantity of materials is 20000 x 125k 2000 ks, 25000ke. ‘The actual usage was 20000 x 11 ‘The standard cost per kg was $4 The caleulation i, therfore: (25000 kg ~ 22000 kg) « $4 = 512000 favourable Anya Limited’s total direct materials price variance i (standard price per kg —actoal price per kg) * actual quantity in kg “The act 1 price pee ky was $8.15, ‘The budgeted, or stand, price per kg was S4 ‘The caleulation is therefore: (84.00 - $4.15) « 22000kg = $3300 adverse © Anya Limited’ total direct materials variance is Alecible budget direct materials ~ actual direct materials = (91 300 ~ 100000) = $8700 favourable Alternatively, it can be shown as: '$12000 + (3300) = $8700 favourable Anya Limited has been more efiient in use the material, or perhaps it was of better ‘quality, as the business has had to pay mos fort 38.8 How to calculate direct labour variances ‘The calculations of the direct labour variances ate similar to those required to caleulate the rect materials variances. The only difference i in their names. For direct labour, a direet labour effcieney variance isthe same thing asa direct materials usage variance. Both measure the efficiency with which the company used the resources. Similarly, a direc: iabour rate variance measures the price the company paid for labour — the wage rate, This is the same as the direct materials price variance. ‘This can be shown diagrammatically as in Figure 38.4. Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 The variances are calculated as follows: 8 Total direct labour var inne i the difference between the flexible budget direct labour ‘cost and the acta direct labour cost. Formula for total direct labour variance (lexibl+ budget labour hours ~ actual labour hours) « standard wage rate b Direct labour efficiency variance is the difference between the actual direct labour hours \worked and the direct labour hours that should have been worked to produce the aetual ‘output. The difference between the two figure is maltiplied by the standard wage rate Formula for direct labour ficiency variance: (flexible budget labour hours ~ actual labour hours) x standard wage rate Direct labour rate variance isthe difercoce between the actual direct labour wage rate and the budgeted direet labour wage rae for the actual hours worked. Formula for direct labour rate (standard wage rate ~ actual wage rate) x actual hours worked. Continued from Worle example S Required Calculate for Anya Limited for September: the dirwet labour efficiency variance bw direct labour rate variance © the total direct labour variance. Answer Anya Limited's direct labour effciney variance is (exible budget labour hours ~ actual labour hours) x standard wage rate The actual quantity produced an sold was 20000 units. The flexible budgeted labour hours is 20000 x (30 + 0) = 10000 direct labour hours “The actual usage was 20000 x (36-+ 60)= 12000 direet labour hours, The standard wage rate i $12 The calculation is therefore: (10000 hours ~ 12000hours) x $12 = $24000 adverse bo Anya (standard wa (ed's direct labour rate variance i rate actual wage rate) x actual hours worked. ‘The actual direct labour hour rate was Sper ho The budgeted, or standard, direct labour hour rate was S12 per hour. The caleulation is therefore: (S12— 11) x 12000 =$12000 favourable PS ° a> Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK © Anya Limited’ total direct labour variance is Alexis budget direct labour cost actual direct labour eost 000 adverse = (8120000. Alter tively it can be shown as ($2400) + $12000 = $12000 adverse as identifi inthe exible budget ‘Anyat Limited may have used cheaper labour but workers have not been as efficent as predicted ‘Action Limited makes one type ct product. The following budgeted information is ‘available for January ‘Number of units prosiacad and sold 0000 Per unit Selling price per unit $8 Direct materials (ites) 1 Cost of material per litre $s Direct labour (minutes) 10 Labour rate perhour $10 The following actual information is available far September: ‘sales were 9000 units at $10 each, + 9900 litres of materials were used at a total cost of $4450. 2250 direct labour hours wars used at $11 per hour, Required For Action Limited for January 2 caleulate the sales volume variance b calculate the sales price variance © caleulate the direct materials usage variance calculate the direct material price variance © calculate the direct labour efficiency variance £caleulate the direct labour rate variance When answering Activity 38.3, how dic you know how to calculate each variance? Did you learn a formula for each or are thore other ways to remember how to calculate ‘each variance? Discuss with anotie: learner how you can best learn how to calculate teach variance and recognise it az favourable or adverse. Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 38.9 Calculation of fixed overhead variances “The aim of setting standard costs for fixed overheads is to absorb the amount of fixed overheads into the overall cost of output. Actual eosts and levels of production will vary from the standards or budgets set, Thus, there will bean under(shortfall) o over= ‘Only the budgeted (surplus) absorption of overheads. This will be caleulated by means of the variances shown | fxedl overhead diagrammatically in Figure 38.5, absorption rate is used in variance calculations Never calculate an ‘actual overhead absorption ate Figure 38.5: Fixed overhead variance. [Notice from Figure 38.5 thatthe fixed overhead volume variance is made up of two other variances: + the fixed overhead capacity variance Note that the budgeted fixed overhead + the fixed overhead efcieney variance. Sbesppuc ste wl The fixed overhead variances are caleutsted as follows need tobe calculated forthe fixed overhead 2 Fived overhead expenditure variance, whic is the difference between the actual fed ‘overheads incurred and the budgeted fixed overheads. b Fixed overhead volume variance isthe difference between the standard hours for actual ‘output and the budgeted hours. This diference in hours is then multiplied ty the budgeted fixed overinead absorption rate (OAR). Assuming the fixed overheads are absorbed based on direet labour hours, the formula is (standard hours forthe actual output ~ budgeted houss) x budgeted OAR I the fixed overheads are absorbed based on direct movesiuls then the formula will neal to be adapied, ‘Note: the budgeted fixed OAR willbe needed to calculate this variance. The OAR. will also be needed for the fixed overhead capacity variance and the fixed overhead cffciency variance. ¢ Fived overhead capacity variance isa sub-division of the volume variance, where actual direct abour hours for actual output differ from the budgeted direct labour hours. Again, this difference in hours i woltiplied by the budgeted fixed OAR, Assuming the fixed overheads are absorbed based on direct labour hours, then the formula is: {actual direct labour hours budgeted direct labour hours) * OAR a 0 a > volume, capacty and cffciency variances, Copyright Material - Review Only ~ Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK Fixed overhead efficiency vuriance, again, isa sub-division of the volume vaviance, ‘where the actual direct labour hours for the actual output differ from the standard direct labour hows for the actual output. This difference is multiplied by the budgeted fixed OAR, Assuming she fixed overheads are absorbed based on direct labour hours, then the Formla (standard hours for the actual output — actual direct labour hours) x OAR ‘Continued from Worked example 6 Anya Limited uses budgeted direct labour hours to absorb fixed overheads Required Calculate for Anya Limited for September: 4 the fixed overhead expenditure variance b the fixed overhead volume variance © the fixed overhead cxpacity variance 4 the fixed overhesd efficiency variance Answer 2 Anya Litited’s fixed overhead expenditure variance is: ‘budgeted fixed overheads ~ actual fixed overheads ($3600000 ~ $370000) = $1000 adverse 1b The fixed overhead volume variance is: ‘As the OAR is based on direct labour hours the formula is (standard hours for the actual output ~ budgeted hours) x budgeted OAR “The budgeted fixed overhead absorption rate per labour hous ‘budgeted overhead 360000 budgeted direct labour hours 9000 hours Actual output 20000 urits should have taken (20000 » [30 + 60 labour hours. Budgeted output {S000 units should have taken (18000 [30 60)) = 9600 direct labour hours. ‘40 per direct labour hour 10000 direct ‘The caleulatian is, therefore: (10000 hours — 9000 hours) x $40 = $40000 favourable © Thefixed overhead capacity variance is (actual direct labour hours ~ budgeted direct labour hours) x OAR Where actual direct labour hours worked = labour hours. ‘budgeted direct labour hours =9000 direct labour hours, ‘The calculation i, therefore: (12000 hours — 9000 hours) x $40 1000 units > (36 + 60) = 12000 direct 12000 favourable Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 ‘4 Thefixed overhend eficiency variance is (standard hours for the actual output ~ actual direct labour hows) x OAR Where: actual direct labour hours worked 2000, standard direct labour hours for actual production = 10000. The calculation i, therefore: (10000 hours — 12000 direct labour hours) x $40 80000 adverse tis now posible to prepare a summary of from the calculations made: ‘the fixed overhead expenditure variances s Expenditure variance (10000) Volume variance Total fixed overheed expenditure variance The volume variance is sub-divided into: $ Copacity variance 120000 F Eficiency variance (2000) Volume variance The total fixed overhead variance is positive for Anya Limited. Favourable here means that fixed overheads have heen over-tbsorbeu int production asa result of more units being produced and sold than was budgets The otal fixed overhead variance isthe diflerence between the fixed overheads absorbed into production (10000 direct labour ours x $40 per hout) minus the fied overheads ‘actually paid, However, the sation is not altogether satisfactory as, despite higher production, the time it took i9 make the product was in excess of the budgeted time allowed. This has resulted ia an adverse fixed overhead efficiency variance 38.10 Reconciling standard cost and actual cost After the variances have been calculated, a statement can be prepared reconciling the standard cost of the actual units produced with the actual cost ofthe units produced. To do this, first i is necessary to calculate the standard cost of prodvesion and sales. | Cootinaed from Worked example 7 Required Prepare a statement reconciling te flexible nsdgeted cost of production with the actual cost of production for Anya Limited DP a) Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK ons Answer step 1 Calculate the standard (or budgeted) cost per unit of the product: Dist materials (1.25kg per unit « $4) Civect labour (30 min « $12 per hour) Fixed overheads (30 min x $40 per hour Standard cost per unit IS$1Baoaue ‘Step? Calculate the total standard cost of ectual produetion and sales: 20000 units x $31 per unit =$620000, Step 3 Prepare the statement roconciling the standard cost of actual production with te actual cost: C 4) Oa ee re tndard cost of actual production 620000111 eee eee 12600 Direct materials price variance (3300) Direct labour ffcioncy variance (24000) Direct labour rat variance 12000 Fixed overhead expenciture vansnce (10000) ee eerie teeter 40000121 64000 (27300) eee Actual cost of produictisal2] Notes: [I] The standard cost of actual produetion is preater than the figure in the flexible budget by ‘S400 ($620000 ~ $S80000 [direct materials $100000 © diet labour S120000 + fixed ‘overheads $360000)) This is due to the over-absorption of fxed overheads by the extra production and sales of 2000 units x$20 per unit =$40000 [1 Actual cost of production i the direct materils cust ($91 300) + direct labour cost (5132000) + actual fixed overheads ($370000) = $593300. [3] ‘The statement could have shown the fixed overhead capacity variance of $120000 favourable and the fixed overhead eficiency variance of $80000 adverse, rather than the total volume variance of $40000 favourable, but not all three variances. Ifthe capacity vurianceis shown this su trve measure of fixed overheads overabsorbed, Copyright Material - Review Only - Not for Redistribution38. Standard costing A Level 4.2 38.11 Reconciling the actual profit with the flexible budget profit tis now posible io prepare a statement reconciling the flexible budgsted profit for the year with the actual profit forthe year. This shows the link between the profit calculated based fon standard cost and the actual profit achieved, inved from Worked example 8 eee Peper stent conclig th Bag (GPtd pot oth ox wi te acon prod forthe year for Anya Limite. ine Read ee eee Flexible buciget profit for the year 60000 Soles price variance: (28000) DDitect materials usage variance 12069 Direct materials price variance: (2300) Direct labour efficiency variance: (24000) Direct labour rate variance 12000 Fixed overhead expenditure variance (10000) 24000 (65300) (an3n0y Actual profit for the year Note: only the variances tsi are reflected inthe comparison between the Mexible budget and ‘the actual esuls ave included inthis statement 38.12 Causes of variances and their interrelationships Variances highlight where actual figures differ from stands, Variances do not explain the causes of the differences but do show management wieve further investigation is required. ‘Once management understands the cause(s) of a variance, they can consider whether there 's corrective action that can be taken, Is important management understands that exch variance does not operate in isolation. action is taken to correct one variance, there can be an effect on another variance. For example, if'a business buys cheaper direct inaterials than the standard, this will result in favourable direct materials variance. However, if these cheaper materials are of a pore 4quality, this might lead to materials being wasted or employees having more work to produce the good to be sold. As a result, the favourable direct materials variance may lead to adverse materials usage snd adverse labour efficiency variances a 0 a ws) Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK We now consider what causes variances to be favourable or adverse and their relationships with other variances. Sales variances Sales voiume variance A sales volume variance means that the actual amount sold was more or less than budgeted. A faxourable sales volume variance means that the acta! amount sold was more than expected. Causes of favourable variances ‘© increase in customer demand, for examp'e through improved promotion of the product creating popularity ‘© selling price has been reduced to increase volume ‘© seasonal sales have increased voluine © competition from other businesses has reduced or disappeared ‘+ more special discounts have been given to selected customers to increase orders. ‘An adverse sales volume variance means that the actual amount sold was less than expected. ‘Causes of adverse variances. © decrease in customer demand, for example due to the goods becoming unfashionable or obsolete © selling price has been increased to pass increased costs orto customers ‘© seasonal sales have decreased volume ‘© competition from other businesses has increased ‘+ fewer special discounts have been given to selected customers ‘customers have heard that new, improved products will be available soon and are waiting for those. Other variances that affect sales volume ‘There is a close relationship between seiling price and sales volume, Management decides the selling price and knows that this will affect the volume sold. An increase in selliug price leads to lower sales volume. Theretore, a favourable sales price variance can lead toa". adverse sales volume variance Sales price variance A sales price variance means that the actual sling price was more of xs than budgeted A favourable sates price variance means that the actual selling pris the standard, © was higher than Causes of favourable variances + prizes have been increased, for example due to ineseosed costs oF inflation + Fewer discounts have been allowed to customers + improved products have allowed prices to be ‘An adverse sales price variance means that tue actual selling price was Jower than the standard eased, et) Copyright Material -Reviow Only - Not for Redistribution38. Standard costing A Level 4.2 Causes of adverse variances ‘© prices have been reduced, for example to increase sales volume ‘© some customers nave been given price concessions to inerease the volume of oners ‘© competition has necessitated a price reduction ‘© selling prices inave been reduced in seasonal sales. Other variances that affect sales price ‘An increase in either direct materials price or direct labour wuts may lead to a management decision to increase the selling price, Therefore, an adve:se direct material price variance or ‘an adverse direct labour rate variance can lead to a favourable sales price variance, Direct materials variances Materials usage variance A materials usage variance means thatthe actual amount of material used in production was more or less than expected. A favourable material usage variaace means that the actual amount of material used in production was less than in (he tlexible budget Causes of favourable variances ‘© actual materials used were higher quality than the standard, resulting in materials that are easier to ‘work with ‘© actual labour was more highly skilled than the standard skill; which may lead to less wastage of the materials, ‘An adverse material sage variance means that the amonst of material used in production was inore than in the flexible budget Causes of adverse variances ‘© actual materials used were lover quality than the standard resulting in materials that are harder to work with ‘© actual labour was /ower skilled than the standard ski wastage of the materials, Other variances that affect materials usage Purchasing higher quality macesials can lead to an adverse direct materials price vaviance but a favourable direct materials usage variance and vice versa Using more highly skilled labour than the standard can lead to an adverse direct labour rate variance but a favourable direct materials usage variance and vice vers. which may lead to more Materials price variance [A materials price variance means that the actual price of the terial bought was more ot Jess than expected. A fexourable material price variance means thatthe actial purchase price of material was tess than inthe flexible budget. Causes of favourable variances ‘© actual materials price falls because the supplier(s) offers new trade or bulk discounts ‘© actual materials price falls because materials bought are of a lower quality ‘An adverse material price variance means that the actual price of materials purchased was ‘more than inthe Mlexible budget. ws) Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK Causes of adverse variances ‘actual materials price rises because the suppliers) passes on their own ire-ease in costs ‘sometimes due to inflation © actual materials price rises because materials bought are of a heer quality Direct labour variances Labour efficiency variance A abou efficiency variance means that the actual labour hours were more or ess than expsted A favourable labour effcieney vatiance means thatthe actual labour time used was less than the standard time allowed. Causes of favourable variances ‘© better skilled workers were employed who work more efficiently than the standant # highty motivated stat © goad quality materials sadior machinery for staff to work with ‘An adverse labour effcieres vaciance means that the actual labour time usc the standard time allowed. ‘was more than Causes of adverse variances less skilled workers were employed who work less efficiently than the standard © low motivation of stall * poor quality materials and/or machinery breakdowns Labour rate variance ‘A labour rate variance means thatthe actual wage rate was more or less than the standard wage rate, {A favourable labour rate variance means thatthe actual wage rate was fess than the standard wage rate Causes of favourable variances * actual labour employed wi 1 lower grade than standard, [An adverse labour rave variance means thatthe actual wage rate Was more than the standard wage rte Causes of adverse varionces ployed was of a higher grade than standard ‘© a wage inerease has been given to staf (the standard should be -evised). © actual labour Fixed overhead variances + A favourable faxed overhead expenditure variance will arse from the actual fixed ‘overhead spend being lower than the budgeted overhead spend, for example because of cost savings made after the budget was set. # Anadverse fixed overhead expenditure variasve will arise when more has been paid for fixed overheads than was budgeted, for example because of an unexpected cost or a supplier increasing costs mote than budgeted. As an example, rent may be increased by «higher figure than was expected when the budget was set. * A favourable fixed overhead volume variance will arise if hours actually worked by direct labour are greater than the direct labour hours budgeted in the master bdget 636) Copyright Material -Reviow Only - Not for Redistribution38. Standard costing A Level 4.2 ‘A new order could have bevu received that requires extra labour to be employed and therefore extra hours are worked. © An adverse fixed overhead volume variance will rise when the opposite occurs, Fewer Copyright Material - Review Only - Not for Redistribution) CAMBRIDGE INTERNATIONAL AS & A LEVEL ACCOUNTING: COURSEBOOK Whether the standard wage rate Uneypecced events may affect production, for example needs to be changed, machine break-down, or adverse weather may affect outside activities, ‘Whether the business needs to increase or decrease the amount ‘he availabilty of appropiate sis in the economy. of staff it employs, ‘Whether the right balance of sills is available and whether further staff taining ie needed, ‘Whether there should be 3 change in the use of overtime hours and/or ratas Where one variance has an impact on another variance, itis important that departinent managers do not make decisions in isolation but discuss them aeross departments to agree the best decision for the business as a whole. Not all variances need corrective action. Managers focus their attention on te most significant variances Significant variances are the largest variances, particularly where they are adverse. This is because large variances have the biggest imps on business performance and adverse variances lead to lower than expected prot. The investigation of all variances in a business can be very time consuming, therefore ‘managers should prioritise variances by taking the following steps: Step 1 Decide which variances are significant Step 2 Determine the causes of each significant variance ‘Step3 If the cause of the variance can be controlled, then take corrective action Note: not all variances can be controlled by « business manager. For example, a supplier ‘ay increase the price of materials becaus® of inflation. This may make it difficult to find an alternative, cheaper supplier. In this cae, it isthe standard that will ned to be updated for future budgets and variance analysis Planning and control: Variance analysis is an important accounting tool fer the control of costs, Managers should carefully consider variances that arise and the causes Underlying thes Managers can then make supported decisions ‘0 improve business performance and improve the accuracy of future standards and budgets. Copyright Material - Review Only ~ Not for Redistribution