Part Four:

Information for planning, control and performance

Chapter Eighteen:
Standard costing and variance analysis 2: further
aspects

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Direct Material Mix Variance

• Material ‘mix’ – refers to the quantity of each material

that is used to make the product i.e. we are referring to
material inputs.
• A direct material mix variance arises when the actual
mix differs from the pre-determined standard mix.
• In industries, particularly where the product being
made undergoes a chemical process, it may be
possible to change the composition of the material
mixture to make the same product.
• This, may result in differing yields, depending on the
mix of materials that has been used.
• ‘Yield’ refers to how much of our product is produced,
i.e. the product output.
• The optimum mix of materials will be the one that
balances the cost of each of the materials with the
Use with Management and Cost Accounting 10e
yield that they generate.by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Direct Material Mix Variance (Activity 1)
• Chemical C uses both chemicals A and B to make it.
Chemical A Chemical B
Standard cost per kg $20 $25

• Research has shown that various combinations of chemicals A and B can be

used to make C, which has a standard selling price of $30 per kg.
• The best two of these combinations have been established as:
Mixture 1 10 kg of A and 10 kg of B will yield 18 kg of C
Mixture 2 8 kg of A and 12 kg of B will yield 19 kg of C

• The optimum mix of materials A and B can be decided by looking at the cost
of materials A and B relative to the yield of C

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Direct Material Mix Variance (Activity 1)
1. Determine the throughput margin of Mixture 1 and 2

2. The standard cost of material per unit of C:

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Activity 2

Standard mix to produce 9 litres of output:

5 litres of X at £7 per litre = £35
3 litres of Y at £5 per litre = £15
2 litres of Z at £2 per litre = £ 4
£54

Standard loss =10% of input. Actual output = 92 700 litres

Actual inputs: £
53 000 litres of X at £7 = 371 000
28 000 litres of Y at £5.30 = 148 400
19 000 litres of Z at £2.20 = 41 800
100 000 561 200

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Direct Material Mix Variance (Activity 2a)
Compute the direct material mix variance
Direct Material Mix Variance = (AQ in standard mix – AQ) × SP

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Direct Material Mix Variance
Note:
• Standard prices are used to calculate the mix variance to ensure
that the price effects are removed from the calculation
• A – substituting more expensive higher quality materials for cheaper
materials.
• F - substituting cheaper materials for more expensive higher quality
materials

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Direct Material Yield Variance

• The use of a less expensive mix of inputs could

mean the production of fewer units of output than
standard.
• To analyse the effect of changes in quantity of
outputs from a given mix of inputs, a yield variance
can be calculated
• Arises because there is a difference between the
standard output for a given level of inputs and the
actual output attained.

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Direct Material Yield Variance (Activity 2(b))
Yield variance is the difference between the standard output for a given level of
inputs and the actual output:

= (Actual yield –Standard yield from actual input) × SC per unit of output

Mix and yield variances are interrelated and should not be interpreted in isolation.

Total variance

£
Direct Material Price Variance
Direct Material Mix Variance
Direct Material Yield Variance
Total Variance

Comments (Activity 2 (c))

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Total Material Variance
Use with Management and Cost Accounting 10e
by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Summary of Material Variances
Total Material Variance
(AC –SC)

Material Price Variance Material Usage Variance

[(APpurch –SP) x AQ] [(AQused – SQ) x SP]

Material Mix Variance Material Yield Variance

[(AQused in standard mix – AQ) × SP]
[(AY –SY) × SCO]
Legend:
AC = Actual material cost for the actual volume of output produced
AP= Actual purchase price per unit of material
AQpurch. = Actual quantity of material purchased
AQused = Actual quantity of material used in production
AY= Actual yield
SC = Standard material cost for the actual volume of output produced
SCO= Standard cost per unit of output
SP= Standard purchase price per unit of material Use with Management and Cost Accounting 10e
SQ = Standard quantity required for actual production by Colin Drury ISBN 9781473748873
(Actual production x Standard quantity required for 1 unit of Output)
© 2018 Colin Drury
 Summary of Labour Variances
Total Labour Variance
(AC –SC)

Labour Rate Variance Labour Efficiency Variance

[(AR –SR) x AH]
[(AH – SH) x SR]
Legend:
AC = Actual labour cost incurred
AR= Actual rate per hour of labour
AH. = Actual labour hours used
AY = Actual yield
SC = Standard labour cost for the actual
volume of output produced
SCO = Standard cost per unit of output
SH = Standard labour hours required for
actual production Labour Mix Variance Labour Yield Variance
(Actual production x Standard labour
[(AH in standard mix – AH) × SR] [(AY –SY) × SCO]
hour required for 1 unit of Output)
SR= Standard rate per hour of labour
SY = Standard yield

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Sales mix and quantity variances

• When a company sells several different products that

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

• Can be measured either using contribution margin or

profit margin

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Sales mix and quantity variances (Activity 3)
Budgeted sales
£
X = 8 000 units at £20 contribution = 160 000
Y = 7 000 units at £12 contribution = 84 000
Z = 5 000 units at £9 contribution = 45 000
20 000 289 000

Actual sales
£
X = 6 000 units at £20 contribution = 120 000
Y = 7 000 units at £12 contribution = 84 000
Z = 9 000 units at £9 contribution = 81 000
22 000 285 000

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Activity 3
a) Compute the sales margin volume variance

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
b) Sales Mix Contribution Variance Activity 3
= (ASV – ASV in budgeted proportions) × Standard margin

c) Sales Quantity Contribution Variance

= (ASV in budgeted proportions- BSV) × Standard margin

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 (BSV

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Comment (Activity 3(d)

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Summary of Sales Margin Variances
Total Sales Margin Variance
[(ASV x AM) –(BSV x SM)]

Sales Margin Price Variance Sales Margin Volume Variance

[(ASP-SSP) x ASV]
[(ASV-BSV) x SM]

Sales Margin Mix Variance

Legend: [(ASV – ASV in budgeted proportions) × SM]
ASP = Actual selling price
ASV = Actual sales volume Sales Margin Qtty Variance
BSV = Budgeted sales volume
SM= Standard margin [(ASV in budgeted proportions- BSV) × SM]
SSP = Standard selling price

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Planning and operating variances
• A major criticism is that actual performance is compared with a
standard based on the environment that was anticipated when
the standard was set.

• It is argued that an ex post variance analysis approach should

be adopted that distinguishes between planning and operating
variances.

• Three perspective:
A The original standard
B Ex post standard given the benefit of hindsight
C Actual outcome

Planning variance = A – B
Operating variance = B – C

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Activity 4

Standard Price = £5 per unit

Market price per unit at time of purchase = £5.20
Actual purchases =10 000 units at £5.18 per unit

a) Conventional price variance :

b) Ex post analysis:

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Activity 4 (c)
Comments:

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 18.7c

Activity 5

Assume:
Budgeted sales =10% market share (10% × 1m units)
Actual sales = 110 000 units
Actual industry sales volume = 1.2m units
Budgeted and actual contribution = £100
Ex post standard =120 000 units (10% × 1.2m units)

a) Conventional sales variance

b) Ex post analysis:

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 Activity 5 (c)
Comments:

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Investigation of variances
1. Variance investigation models can be classified into the following categories:
 Simple rule of thumb models.
 Statistical models that do not incorporate costs and benefits of investigation.
 Statistical decision models that take into account the cost and benefits of
investigation.

2. Reasons for variances

 Measurement errors.
 Out-of-date standards.
 Out-of-control operations.
 Random or uncontrollable factors.

3. Investigation will indicate that variance is due to:

 Random uncontrollable factors when the operation is under control.
 Assignable causes, but the cost of investigation exceeds benefits.
 Assignable causes, but the benefits of investigation exceed the cost.

Note : The aim is to investigate only those variances in the final category.

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Statistical investigation models not incorporating cost and benefits

1. Assume actual observations when under control indicate a mean usage of 10 kg

per unit with a SD of 1 kg (normally distributed).

2. Actual usage is 12 000 kg for an output of 1 000 units.

Therefore, average usage = 12 kg per unit.

3. Z = Actual usage (12 kg) – Expected usage (10 kg) = 2.0

SD (1 kg)

4. Normal distribution table indicates that an observation 2 SDs from the mean has a
probability of 2.275%.

5. Thus the probability of actual average material usage per unit of output being 12 kg
or more when the operation is under control is 2.275%.It is very unlikely that
material usage comes from ‘in control distribution’.

6. Statistical control charts, which rely on the above principles, can be used to monitor
resources usage and the probability that operations are out of control. (See figure
on Exhibit 18.10)
Use with Management and Cost Accounting 10e
by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
 18.10

Statistical quality control charts

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Variance investigation decision models

1. Bierman et al. model assumes two mutually exclusive states exist:

(i) System in control and variance due to random factors.
(ii) System out of control and corrective action can be taken
to remedy the situation.
2. If the process is out of control there is a benefit (B) associated with
returning it to its in-control state (i.e. cost savings from avoiding
variances in future periods). Assume B = £400.
3. Let C = cost of investigation (assume C = £100).
Let P = probability that the process is out of control.
4. Expected benefit = PB
5. Investigate if PB > C, or P > C/B
6. P >100 /400 =0.25
7. P (Process is in control) = 0.02275 (see sheet 19.9)
8. P (Process out of control) =1 – 0.02275 = 0.97725
9. Decision = Investigate the variance
10. Note the difficulty in estimating C and B.

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
Criticisms of standard costing

The usefulness of standard costing has been questioned, and its

demise predicted, because of the following:

1. The changing cost structure

2. Inconsistency with modern management approaches

3. Over-emphasis on the importance of direct labour

4. Delay in feedback reporting

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
The future role of standard costing

•Standard costs and variance analysis required for many other purposes
besides cost control and performance evaluation: (e.g. tracking costs for
inventory valuation and maintaining a database for decision-making)

•Variance analysis adapted to report on items that are company specific.

•Shift from treating the variances as the foundations for cost control and
performance evaluation to being one among a broader set of measures.

•Empirical evidence suggests that practitioners still regard variance analysis

as being important for cost control.

•Can still play a useful role within ABC systems particularly in relation to
controlling unit-level and batch-level activities.

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
The future role of standard costing (cont.)

• ABC and variance analysis:

1. Most appropriate for controlling the costs of unit-level

activities.

2. Can also 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.

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
ABC Variance Analysis
Example
Costs of set-up activity:

Budget Actual
Activity level (1 600 set-ups) Total FC (£70 000)
Practical capacity supplied (2 000 set-ups) Total VC (£39 000)
Total fixed costs (£80 000)
Total variable costs (£40 000)
Cost driver rates:
Variable (£25 per set-up)
Fixed (£40 per set-up)

Variance analysis for fixed set-up expenses:

£
Set-up expenses charged to products (1 500 × £40) 60 000
Budgeted unused capacity variance (400 × £40) 16 000 A
Capacity utilization variance (100 × £40) 4 000 A
Expenditure variance 10 000 F
Total actual expenses 70 000
Use with Management and Cost Accounting 10e
by Colin Drury ISBN 9781473748873
© 2018 Colin Drury
The future role of standard costing (contd.)

• ABC and variance analysis:

Variance analysis for variable set-up expenses:
£
Variable set-up expenses charged to product
(1 500 × £25) 37 500
Variable overhead variance (Flexed budget —
Actual cost) 1 500 A
Total actual expenses 39 000

Use with Management and Cost Accounting 10e

by Colin Drury ISBN 9781473748873
© 2018 Colin Drury