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Chapter 12

Page 1

Variance Analysis

A variance is the difference between an actual result and an expected result. The process by which the total difference between standard and actual results is analysed is known as variance analysis. When actual results are better than the expected results, we have a favourable variance (F). If, on the other hand, actual results are worse than expected results, we have an adverse (A). I will use this example throughout this Exercise: Standard cost of Product A Materials (5kgs x $10 per kg) Labour (4hrs x $5 per hr) Variable o/hds (4 hrs x $2 per hr) Fixed o/hds (4 hrs x $6 per hr) Budgeted results Production: 1,200 units Sales: 1,000 units Selling price: $150 per unit

$ 50 20 8 24 102 1,000 units 900 units 4,850 kgs, $46,075 4,200 hrs, $21,210 $9,450 $25,000 $140 per unit

ACTUAL Results Production: Sales: Materials: Labour: Variable o/hds: Fixed o/hds: Selling price:

The direct material total variance is the difference between what the output actually cost and what it should have cost, in terms of material. From the example above the material total variance is given by: $ 50,000 46,075 3, 925 (F)

1,000 units should have cost (x $50) But did cost Direct material total variance It can be divided into two sub-variances

This is the difference between what the actual quantity of material used did cost and what it should have cost. $ Chapter 12 Page 2

4,850 kgs should have cost (x $10) But did cost Direct material price variance 48,500 46,075 2,425 (F)

This is the difference between how much material should have been used for the number of units actually produced and how much material was used, valued at standard cost 1,000 units should have used (x 5 kgs) 5,000 kgs But did use 4,850 kgs Variance in kgs 150 kgs (F) Valued at standard cost per kg x $10 Direct material usage variance in $ $1,500 (F) The direct material price variance is calculated on material purchases in the period if closing stocks of raw materials are valued at standard cost or material used if closing stocks of raw materials are valued at actual cost (FIFO).

The direct labour total variance is the difference between what the output should have cost and what it did cost, in terms of labour. $ 20,000 21,210 1,210 (A)

1,000 units should have cost (x $20) But did cost Direct material price variance

This is the difference between what the actual number of hours worked should have cost and what it did cost. 4200hrs should have cost (4200hrs x $5) But did cost Direct labour rate variance $21000 $21210 $210(A)

The is the difference between how many hours should have been worked for the number of units actually produced and how many hours were worked, valued at the standard rate per hour. $ 4,000 hrs 4,200 hrs 200 hrs Page 3

1,000 units should have taken (x 4 hrs) But did take Variance in hrs Chapter 12

Valued at standard rate per hour Direct labour efficiency variance x $5 $1,000 (A)

When idle time occurs the efficiency variance is based on hours actually worked (not hours paid for) and an idle time variance (hours of idle time x standard rate per hour) is calculated.

The variable production overhead total variance is the difference between what the output should have cost and what it did cost, in terms of variable production overhead. $ 8,000 9,450 1,450 (A)

1,000 units should have cost (x $8) But did cost Variable production o/hd expenditure variance

This is the difference between what the variable production overhead did cost and what it should have cost $ 8,400 9,450 1,050 (A)

4,200 hrs should have cost (x $2) But did cost Variable production o/hd expenditure variance

This is the same as the direct labour efficiency variance in hours, valued at the variable production overhead rate per hour. Labour efficiency variance in hours Valued @ standard rate per hour Variable production o/hd efficiency variance 200 hrs (A) x $2 $400 (A)

The total fixed production variance is an attempt to explain the under- or over-absorbed fixed production overhead. Remember that overhead absorption rate = Budgeted fixed production overhead Budgeted level of activity

If either the numerator or the denominator or both are incorrect then we will have under- or overabsorbed production overhead.

Chapter 12

If actual production / hours of activity budgeted production / hours of activity (denominator incorrect) volume variance. The workforce may have been working at a more or less efficient rate than standard to produce a given output volume efficiency variance (similar to the variable production overhead efficiency variance). Regardless of the level of efficiency, the total number of hours worked could have been more or less than was originally budgeted (employees may have worked a lot of overtime or there may have been a strike and so actual hours worked were less than budgeted) volume capacity variance.

4. The fixed production overhead variances are calculated as follows: Fixed production overhead variance

This is the difference between fixed production overhead incurred and fixed production overhead absorbed (= the under- or over-absorbed fixed production overhead) $ 25,000 24,000 1,000 (A)

This is the difference between the budgeted fixed production overhead expenditure and actual fixed production overhead expenditure $ 28,800 25,000 3,800 (F)

This is the difference between actual and budgeted production volume multiplied by the standard absorption rate per unit. $ 24,000 28,800 4,800 (A)

Actual production at std rate (1,000 x $24) Budgeted production at std rate (1,200 x $24)

This is the difference between the number of hours that actual production should have taken, and the number of hours actually worked (usually the labour efficiency variance), multiplied by the standard absorption rate per hour. Chapter 12 Page 5

Labour efficiency variance in hours Valued @ standard rate per hour Volume efficiency variance 200 hrs (A) x $6 $1,200 (A)

This is the difference between budgeted hours of work and the actual hours worked, multiplied by the standard absorption rate per hour Budgeted hours (1,200 x 4) Actual hours Variance in hrs x standard rate per hour 4,800 hrs 4,200 hrs 600 hrs (A) x $6 $3,600 (A)

KEY.

The fixed overhead volume capacity variance is unlike the other variances in that an excess of actual hours over budgeted hours results in a favourable variance and not an adverse variance as it does when considering labour efficiency, variable overhead efficiency and fixed overhead volume efficiency. Working more hours than budgeted produces an over absorption of fixed overheads, which is a favourable variance.

The selling price variance is a measure of the effect on expected profit of a different selling price to standard selling price. It is calculated as the difference between what the sales revenue should have been for the actual quantity sold, and what it was. $ 135,000 126,000 9,000 (A)

Revenue from 900 units should have been (x $150) But was (x $140) Selling price variance

The sales volume variance is the difference between the actual units sold and the budgeted quantity, valued at the standard profit per unit. In other words it measures the increase or decrease in standard profit as a result of the sales volume being higher or lower than budgeted. Budgeted sales volume Actual sales volume Variance in units x standard margin per unit (x $ (150 102) ) Sales volume variance Chapter 12 1,000 units 900 units 100 units (A) x $48 $4,800 (A) Page 6

KEY.

Dont forget to value the sales volume variance at standard contribution marginal costing is in use.

The most common presentation of the reconciliation between budgeted and actual profit is as follows.

$ Budgeted profit before sales and admin costs Sales variances - price - volume X Actual sales minus standard cost of sales X Cost variances (F) (A) Material price Material usage etc X X Sales and administration costs Actual profit X X $ X __ X X $ X X $ X

No fixed overhead volume variance Sales volume variances are valued at standard contribution margin (not standard profit margin)

(F) unforseen discounts received, greater care taken in purchasing, change in material standard (A) price increase, careless purchasing, change in material standard.

Material usage

(F) material used of higher quality than standard, more effective use made of material (A) defective material, excessive waste, theft, stricter quality control

Labour rate

Chapter 12 Page 7

(F) use of workers at rate of pay lower than standard (A) wage rate increase

Idle time

Labour efficiency

(F) output produced more quickly than expected because of work motivation, better quality of equipment or materials (A) lost time in excess of standard allowed, output lower than standard set because of deliberate restriction, lack of training, sub-standard material used.

Overhead expenditure

(F) savings in cost incurred, more economical use of services. (A) increase in cost of services used, excessive use of services, change in type of services used

Overhead volume

(F) production greater than budgeted (A) production less than budgeted

The cause of one (adverse) variance may be wholly or partly explained by the cause of another (favourable) variance.

Material price or material usage and labour efficiency Labour rate and material usage Sales price and sales volume

The decision as to whether or not a variance is so significant that it should be investigated should take a number of factors into account.

The type of standard being used Interdependence between variances Controllability Materiality

The materials usage variance can be subdivided into a materials mix variance and a materials yield variance if the proportion of materials in a mix is changeable and controllable. The mix variance indicates the effect on costs of changing the mix of material inputs. Chapter 12 Page 8

The yield variance indicates the effect on costs of material inputs yielding more or less than expected. Standard input to produce 1 unit of product X: $ 200 150 350

In period 3, 13 units of product X were produced from 250 kgs of material A and 350 kgs of material B. Solution 1: individual prices per kg as variance valuation cases

Mix Variance Standard mix of actual use: A: 2/5 x (250+350) B: 3/5 x (250+350) Kgs 240 360 600 === B 360 kgs 350 kgs 10 kgs (F) x $5 $50 (F) ===

Mix should have But was Mix variance in x standard cost Mix variance in

A 240 kgs 250 kgs 10 kgs (A) x $10 $100 (A) ===== 50 (A)

13 units of product X should have used but actual input in standard mix was Yield variance in kgs x standard cost per kg (F) ===== $350 (F) ==== ===== A 260 kgs 240 kgs 20 kgs (F) x $10 $200 (F) B 390 kgs 360 kgs 30 kgs (F) x $5 $150

Solution 2: budgeted weighted average price per unit of input as variance valuation base. Therefore, Budgeted weighted average price =$350/50 = $7 per kg

Mix variance A B 13 units of product X should have used but did use kgs

Chapter 12

Page 9

Usage variance in kgs x individual price per kg budgeted weighted average price per kg $ (10 7) $ (5 7) 10 kgs (F) 40 kgs (F)

x $3 ____ $30 (F) === $50 (A) === x ($2) $80 (A) ===

Yield variance A B Usage variance in kgs (F) x budgeted weighted average Price per kg

10 kg (F)

40 kg

$ 280 (F)

The sales volume variance can be subdivided into a mix variance if the proportions of products sold are controllable.

This variance indicates the effect on profit of changing the mix of actual sales from the standard mix. It can be calculated in one of two ways.

The difference between the actual total quantity sold in the standard mix and the actual quantities sold, valued at the standard margin per unit. The difference between actual sales and budgeted sales, valued at (standard profit per unit budgeted weighted average profit per unit)

This variance indicates the effect on profit of selling a different total quantity from the budgeted total quantity. It can be calculated in one of two ways.

The difference between actual sales volume in the standard mix and budgeted sales valued at the standard margin per unit. The difference between actual sales volume and budgeted sales valued at the budgeted weighted average profit per unit.

KEY.

With all variance calculations, from the most basic (such as variable cost variances) to the more complex (such as mix and yield / mix and quantity variances), it is vital that you do not simply learn formulae. You must Chapter 12 Page 10

understand what your calculations are supposed are supposed to show.

Standard Cost for Product RBT 80 30 40 45 195

Materials (10kg x 8 per kg) Labour (5hrs x 6 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr)

Budgeted Results

Production Sales Selling Price 10000 units 7500 units 300 per unit 8000 units 6000 units 85000 kg Cost 700000 36000 hrs Cost 330900 400000 500000 260 per unit

Actual Results

Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price Calculate a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 2

Standard Cost for Product TUH Materials (10kg x 8 per kg) 80 Labour (5hrs x 6 per hr) 30 Variable O/Hds (5hrs x 8 per hr) 40 Chapter 12 Page 11

Fixed O/Hds (5hrs x 9 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 45 195

11000 units 7500 units 300 per unit 9000 units 7000 units 85000 kg Cost 700000 36000 hrs Cost 330900 410000 520000 260 per unit

Calculate

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 3

Standard Cost for Product TD Materials (10kg x 5 per kg) Labour (5hrs x 6 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Chapter 12 50 30 40 45 165

8000 units 7500 units 300 per unit 11000 units 10000 units 85000 kg Cost 700000 36000 hrs Cost 330900 Page 12

Variable O/Hds Fixed O/Hds Selling Price 400000 500000 320 per unit

Calculate

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 4

Standard Cost for Product WXYZ Materials (4kg x 8 per kg) Labour (5hrs x 10 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 6 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price Calculate a. b. c. d. e. f. g. Chapter 12 Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Page 13 32 50 40 30 152

10000 units 7500 units 300 per unit 8000 units 6000 units 85000 kg Cost 700000 36000 hrs Cost 330900 400000 500000 260 per unit

h. Fixed Production overhead total Variance and all sub-variances i. Selling price variance j. Sales volume variance

Question 5

Standard Cost for Product RTY Materials (10kg x 8 per kg) Labour (5hrs x 6 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 80 30 40 45 195

13000 units 10000 units 300 per unit 12000 units 9000 units 90000 kg Cost 750000 40000 hrs Cost 350000 500000 600000 350 per unit

Calculate

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 6

Standard Cost for Product RED Materials (10kg x 7 per kg) Labour (5hrs x 6 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr) 70 30 40 45 185 Page 14

Chapter 12

Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 10500 units 7800 units 310 per unit 8500 units 6200 units 87000 kg Cost 700000 36000 hrs Cost 330900 400000 550000 270 per unit

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 7

Standard Cost for Product BUZZ Materials (3kg x 8 per kg) Labour (5hrs x 10 per hr) Variable O/Hds (5hrs x 9 per hr) Fixed O/Hds (5hrs x 10 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Chapter 12 24 50 45 50 169

10000 units 7500 units 300 per unit 8000 units 6000 units 85000 kg Cost 700000 36000 hrs Cost 330900 400000 500000 Page 15

Selling Price 260 per unit

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 8

Standard Cost for Product RST Materials (10kg x 20per kg) Labour (5hrs x 16 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 200 80 40 45 365

1000 units 7500 units 800 per unit 8000 units 6000 units 85000 kg Cost 700000 36000 hrs Cost 330900 400000 500000 260 per unit

Calculate

a. b. c. d. e. f. g. h. i. j. Chapter 12 Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance Page 16

Question 9

Standard Cost for Product FGT Materials (10kg x 8 per kg) Labour (5hrs x 6 per hr) Variable O/Hds (5hrs x 8 per hr) Fixed O/Hds (5hrs x 9 per hr) Budgeted Results Production Sales Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 80 30 40 45 195

10000 units 7500 units 300 per unit 13000 units 6000 units 85000 kg Cost 700000 36000 hrs Cost 330900 400000 500000 260 per unit

a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Question 10

Standard Cost for Product White Diamond Materials (7kg x 9 per kg) Labour (6hrs x 9 per hr) Variable O/Hds (6hrs x 6 per hr) Fixed O/Hds (6hrs x 7 per hr) Budgeted Results Production Sales Chapter 12 63 54 36 42 195

Selling Price Actual Results Production Sales Materials Labour Variable O/Hds Fixed O/Hds Selling Price 500 per unit 15000 units 8000 units 8750 kg Cost 85000 5200hrs Cost 52900 25500 84000 600 per unit a. b. c. d. e. f. g. h. i. j. Material total variance Material price variance Material usage variance Labour total variance Labour rate variance Labour efficiency variance Variable overhead total variance and all sub- variances Fixed Production overhead total Variance and all sub-variances Selling price variance Sales volume variance

Chapter 12

Page 18

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