pf Standard costing and variance analysis utcomes autre enctor this chapter students should be able to . ynderstand the use of a standard costing system » calculate material, labour and overheads variances * Calculate sales variances oncile budgeted to actual profit. + rec Chapter outline 141 Introduction 14.5 Production cost variances 142 Astandard costing system 145.1 Direct materials variances 1421 Advantages of standard 14.5.2. Direct labour variances costing 14.53. Variable manufacturing 1422 Disadvantages of stan- overheads variances | dard costing 14.5.4 Fixed manufacturing 143 Variance analysis overheads variances 144 Sales variances 144.1 Sales price variance 144.2 Sales quantity variance 14.1 Introduction In Chapter 13, you were introduced to budgeting as a means of planning, con- trolling and monitoring business activities. This chapter continues the theme of control by the use of standard costing and variance analysis. £ Ina manufacturing environment, it can be difficult to track down the causes t of variances unless a detailed analysis is carried out. These variances can be 4 identified and quantified by using a standard costing system. t 14.2 A standard costing system 253 } * Used to improve planning and control, and to facilitate product costing. ii * Forces planning, resulting in a more efficient operation with less waste, 2 climinating overspending, excessive inventory, wasted time, etc @n a & on ounTING FOR NON-ACE OUNTANTS rm for measurin, 8 Performance, enchmark or ano 1 two ca tegories: which allow for n° breakd « Astandard is 4 be standards fall int - Ideal standards, lowns or other work inte Ty ip. standards, which can be reacheg Unde, tions. thout extraordinary effort by pr Operly oI rently attainable g conditions wi ced employees. bes performance and minimum allowable ken down and costed. Perens ach ~ Practical or CU! efficient operatin: trained and experien! A standard cost prescl E Each element of cost of production is brol product a standard cost card is drawn up. Setting standards. Historical data provide a good starting point for der, mining standards for materials, labour and overheads. This data a be adapted for changes in technology, production methods, etc. Effecti st standard setting requires combined effort and the experience of all a cerned to predict future trends. These standards must be revised repulaly 14.2.1 Advantages of standard costing * Provides a good basis for cost comparisons, in particular with the use of flexible budgets. Enables managers to use management by exception whereby their atten- tion is focused only on those variances that are significant, thereby saving management time. Provides a basis for managerial performance evaluation and determining bonuses. Participation in settin, g standards and assigning re: bili S| motivational effects on employees. ee 14.2.2 Disadvantages of standard costing * Standard costii ing systems tend to focus too heavily on cost minimisation. May encourage c¢ ‘ost reduction, whi strategic importance. , Which can adversely affect other areas of Controlling one di \, ments partment's costs may increase costs in other depatt 7 : Too much emphasis is placed on the cost and efficiency of direct labour which can be insignific: € face o utom: be insi, the fe ignificant in ce of increasi ing automation. Standard costs becom: 20 i lutdated quickly due to short I orter product life cy“l@ ——————STA NDARD COSTING AND VARIANCE ANALYSIS 414. v riance analysis a * si a variance aS learnt in flexible budgets can be broken down in very 5 °° id entify the effects on the volume and price of resource inputs. aes arise when the actual quantity or price of a production compon- nce i es from the standard quantity or price. pt vy production component a have a price (rate, budget or spending) ‘ eranee anda quantity (efficiency or usage) variance. ts that should have been incurred at the actual level of activity accord- ” 4 the standard are compared with actual costs incurred. The differ- anceis the variance. \ favourable variance occurs when actual costs are less than the standard costs at actual volume. van unfavourable variance occurs when actual costs are more than the standard costs at actual volume. Operating profit variance | Seling and distribution cost variances | (not presented further) Total production cost variance Total sales variance | Total Total a Total variable fixed Sales Sales er direct || production || production } | Price volume materials, labour ethead || overhead variance variance variance || vanance earianice variance tee | Variable Fixed J Direct production Sales | materials overhead f | mx | price expenditure variance | variance variance Fixed i Direct | Direct \| production {materials | 14 labour overhead 255 usage efficiency volume variance variance variance 5 i ie o Figure 14.1 Diagrammatic illustration of variancesy ACCOUNTING FOR NON-ACC OUNTANTS 14.4 Sales variances joned previously, variance analysis is used by an enterprise , its costs. It is, however, just as important to contro] ae es a Janned profits ‘As mentit cise control ove to ensure that p! Sales variance: represent income an than the budgeted sal cover only two sales variance: are achieved. s are the opposite of production variances, becaus, d not costs. Therefore when the actual sales are © they Jes, the variance is favourable and vice versa, Beater s, namely sales price and sales quantity. © will 14.4.1 Sales price variance he difference between the standard price per y nit The sales price variance ist and the actual price per unit for the number of units sold in the period: (AP - SP) x AQ 14.4.2 Sales quantity variance ance is the difference between the budgeted number The sales quantity vari tual number sold valued at the standard gross profit of units sold and the act per unit. 7 Pre (AQ - SQ) x Standard gross profit per unit (Standard gross profit per unit = Standard selling price - Standard cost price) Explanation of abbreviations AP - actual price SP - standard price AQ - actual quantity SQ - standard quantity ILLUSTRATIVE EXAMPLE WG Ltd manufacture s produ to the two products: Products Widget and Gadget. The following information is releva"t Budgeted | Budgeted | Standard | Actual Actual (unin) we sales price | sales salesin | it ba (units) rands Widget : Unie) (R) | Gadget = = 20 4100 19800 —__| 800 a" is | Total p>————+ 5 1 i uss | 2000 Oo} 70 Be: ot 1.820 27720MARIAN © ania for e¢ vie (010 wing variances for each product and in total: ee tne variance gall af round off to two decimal places. $5! wr gto” ice variance sae op) x AQ yee ais — R20) x 1 100 units = R2200U ee (ait® ~ R10) x 720 units = RT20F ice variance = R1480U - we 38 .pig600*! 100 jqroa0 = 720U = AN yousold each unit of Widget for R2 less and you sold each unit of Gadget for R1 more 7 sales quantity variance (ag- $Q) x Standard gross profit per unit widget = (1 100-1 200) x (R20-R10) = 1 000U Gadget = (720 - 800) x (R10 - R5) = R400U Total sales quantity variance = R1400U ‘You sold fewer units than expected for both Widget and Gadget. 14.5 Production cost variances 145.1 Direct materials variances Price variance measures the effect on the cost of purchasing at a price that is different from standard. This variance can arise due to an unexpected price ‘ctease/decrease, inefficiency of purchasing department, quality of material purchased, quantity of material purchased, etc. The material price variance is the difference between t “=sctual unit price of raw material multiplied by the actual quantity ei he standard and of raw §-AR) AQ of using 2 different ntity that aterial ‘ with the standard qua! in production compared whis variance can ave been used fi 1 i - yroduction ol Bl ‘or the actual p ie io ent, qual Usa (quantity) yar: (quantity) variance measures the effect on the cost “tant of m sou se dy Yo ee the efficiency (or lack thereof) of a prodi Cnet The = machine breakdowns, skill of workers, ee re between “te acy ce variance is calculated by determining the diff ae have been Quantity of material used and the quantity that show on 1a258 € ACCOUNTANTS FOR NON OUNTING FO used for actual production, according to the standard, Multiplie by th dard price: (SQ- AQ) « SP | direct materials variance is the difference between on at and the budgeted total materials cost, or the t als 5 : sum of the price and usage variance: (AP x AQ) ~ (SP x SQ) Actual toys) i: Otal Variance ey Sy or Price variance + Usage variance 14.5.2. Direct labour variances Rate variance measures the effect on cost of Paying a different labouy compared with the standard. This variance is caused by an 5 Unexpecteg ip increase/decrease, incorrect standards established, skill of Worker; ployee 'S emy etc. : : : The direct labour rate variance is the difference be hourly rate and the actual hourly rate multiplied by the (GR- AR) x AH tween the stan, 7 dard actual time Used, Efficiency variance measures the effect on cos of direct labour hours, compared with the sta been used for the actual production output. skill of workers, quality of material, machi: workers, incorrect standards established, etc, The direct labour efficien ference between the act been worked to pi the standard rate (SH-AH) x sR The total labour variance is the difference between actual total labour cos and the budgeted total labour cos: t, or the total variance is the sum of ther" and efficiency variance: (AR x AH) - (SR x SH) : t of using a different Dumber indard hours that should have This variance is caused by the ine breakdowns, supervision of cy variance is calculated by determining the di ‘ual hours worked and the hours that should have roduce the output, according to the standard, multiplied by or Rate variance + Efficiency variance 14.5.3 Variable manufacturing overheads variances a s . act Spending (rate) variance is a measure Of the difference between the * ied variable overheads and the standard variable overheads rate ™u!0?ICE ANAL YS! js variance 1s caused by incorrect standards establ mse in the cost of variable overheads, efficient (or ine sat ads ites, ei, efficient) manufacturing overheads rate variance is the diffe : standard rate and the actual rate multiplied by the ¢ vantiy ye a 7 allocation basis, which can be labour hours, machine hoe ee jot tt 2 {0 Ugre used aS basis) yall ee variable gees! variance measures the difference between the actual activity and : dard activity allowed, given the actual output multiplied by the stan variable overhead rate. This variance is caused by efficient (or inefl- t)use of time, quality of material used, machine breakdowns, supervision s, incorrect standards established, etc. : ble manufacturing overhead efficiency variance is calculated by he difference between the actual hours worked and the hours been worked to produce the output, according to the stan- tandard rate (if the allocation base is time): worker’ the varial getermining should have dard, multiplied by the s' (SH- AH) x SR total variable manufacturing overhead variance is the difference between actual total manufacturing overheads and the budgeted total variable over- heads, or the total variance is the sum of the rate and efficiency variance: (AR x AH) - (SR x SH) or Spending variance + Efficiency variance 14.5.4 Fixed manufacturing overheads variances ed manufacturing overheads are not allocated to Only a fixed overhead expenditure Marginal costing system Fix .d by actual overhead costs being production, but written off as a period cost. variance is calculated. This variance is cause different from expected and can arise due to an increase/decrease 1n salaries paid to supervisors Or other fixed overheads, overbudgeting for some fixed expenses, etc. It is calculated as the difference between actual fixed overheads and budgeted fixed overheads: \_ AFO - BFO ture variance, a volume vari- lisation of available facilities is calculated. The andard hours allowed for actual output are ity level planned for the period. Absorption costing system Besides the expendi! ance which measures the util volume variance occurs when sti different from the budgeted (normal) activi (BH - SH) «SR or (actual units Budgeted units) x SR ——. . ™ 259 c)s FoR NON-ACCOUNTANT iG 260 Onan ACCOUNTIN ————__xAMPLE ILLUSTRATIVE ean = ig 7 Eee ee — —————_—_———_ ‘ted from the records of : following information has er Senayshia's Baa, oa for the month of March 20x": iy Standard cost card: R ; 1,40 kg @ R4,10/kg 5,74 Materials stole 0.90 hours @ R4,50/hour 4,05 Direct lat Variable overheads R2,20/hour @ 0,90 hours 1,98 iable Fixed overheads Senayshia’s Beautiful Baskets Performance report Original Flexible Actual Variance budget budget Volume 240 000 220.000 220.000 ee ee ee Sales 6000000 —-R5500000 —_-R5.060000 440000 u Less: Cost ofsales 4346400 R4 111000 R4.049 698 R61902F Direct materials 1377600 R1262800 1.252.240 R10 560 F Direct labour R972 000 R891 000 R857 648 R33352 F Variable overheads R475 200 R435 600 R438 570 2970 U Fixed overheads R1521600 1521600 RI 501 240 20360 F Profit Rt 653 600 Rt 389 000 R1 010302 Rg78.698 U erro Riotoso2 Raves Vanable overheads allocation is based on direct labour hours, while faced manufac"? Overheads are allocated ‘on the 1 based 'e basis of units produce stermined rates on budgeted costs and volumes Produced, all at prede' Actual production costs: Material 313 060 kg at R4 per kg Direct labour 194 920 hours at R4,40 per hour Required Prepare a complete variance analysis., te” pice variance 28 &/ / je usage variance al we material variance pect abOur rate variance pyect labour efficiency variance Joa! labour variance variable o/h expenditure variance Variable o/h efficiency variance Total variable overhead variance Fixed overheads volume variance Total fixed overhead variance Sales price variance Sales volume variance Fixed overheads expenditure variance = STANDARD co: OSTING AND vari ANCE ANALYSIS 14 =e iis an = [R4,10 - R4,00] x 3 = R31 306 (F) ise 818 080, = (SQ- AQ) x SP = (220 000 x 1,40) - 31 = R20 746 (U) ) = 313 060] x R4,10 = Material price + Material usage = 31306 (F) + 20 746 (U) H = R10 560 (F) = (SR-AR) x AH IR4,50 - R4, 40] x 194 920 = R19 492 (F) = (SH-AH) x SR = [220 000 x 0,90 194 920] x R4,50 = R13 860 (F) = Labour rate + Labour efficiency 19 492 (F) + 13 860 (F) = R33 352 (F) (SR - AR) x AH (R2,20 - R2,25) x 194 920 = R9746 (U) = (Standard hours - Actual hours) x Standard rate 1.98 000 - 194 920] x R2,20 = RG 776 (F) = (AH x AR) - (SH = SR) 494 920 x R2,25) - (220 000 x 0,90 x R2,20) 38 570 - 435 600 = R2970(U) = Budgeted cost - Actual cost 521 600 - 1501 240 = R20 360 (F) = (Actual units - Budget units) x Standard rate 220 000 - 240 000] x R6.34 = R126 800 (U) = Actual cost - (Actual units x SR) 501 240 - (220 000 x R6.34) 501 240 - 1394 800 = R106 440 (U) = (AP - SP) x AQ (R23 - R25) x 220 000 261 = R440 000 U = (AV - BV) x Standard profit i (220 000 - 240 000) x (R25 - R18,11) 8 = R137 800 (U)BASIC ACCOUNTING FOR NON-AC! 262 COUNTANTS Senayshia’s Beautiful Baskets Standard cost operating statement Budgeted net profit 1653 = ‘Add: Sales volume variances 1a, | standard profit (flexed budget profit) 15a, ‘Add/(less): Favourable/adverse variance 505, re : Sales price variance 440 000 (U) Material price 31-306 (F) Material usage 20746 (U) Labour rate 19492 (F) Labour efficiency 13 860 (F) Variable overhead rate 9746 (UY | Variable overhead efficiency 6776 (F) | Fixed overhead expenditure 20360 (F) | Fixed overhead volume 126 800 (U) | Actual profit 1010302 TUTORIAL EXERCISES Exercise 1 Multiple-choice questions 1.1 Standard costs include the quantity and price of inputs for each unit of product. These inputs include a. delivery costs b. marketing costs . accounting costs d. overhead costs 1.2 Variances indicate a. the cause of the variance b. who is responsible for the variance that actual performance is not going according to plan d. when the variance should be investigated 1,3 Price variances focus on the difference between a. actual price and standard actually produced nits Price for actual cuantity allowed for ¥