Learning objectives

Chapter 11 After studying this presentation you should be able to:

11.1 identify variances for investigation
Variance analysis: 11.2 understand and calculate relevant profit- and
revenue-related variances
revenue and cost
11.3 calculate direct cost variances
11.4 understand how direct cost variance information is
analysed and used
11.5 calculate variable and fixed overhead variances

Learning objectives Identifying variances

After studying this presentation you should be able to: • Benny’s Purple Madness ice cream:
11.6 understand how overhead variance information is
analysed and used
11.7 close off manufacturing cost variances at the end
of the period.

Identifying variances Revenue and cost variance framework

• Benny’s Purple Madness ice cream: • Variances can be broken down into volume, price and
efficiency components to provide more insight into
profitability.
 Profit variance Profit- and revenue-related variances

• Revenue budget variance:

• The objective of isolating revenue variances is to
generate meaningful insights into the reasons that
budgeted revenue and actual revenue might differ.
• The revenue variance can be examined from both a
volume and price perspective.

Profit- and revenue-related variances Sales price and sales quantity variance

• Revenue variances are caused by a number of different • The sales price variance reflects the difference between
factors, including: standard and actual selling prices for the volume of
– changes in demand units actually sold.
– sales price Sales price variance = (Actual price – Standard price) x Actual volume
– discounting practices.
• Sales price variance is favourable if the actual selling
price exceeds the standard price, and it is unfavourable
if the reverse is true.

Sales price and sales quantity variance Sales volume and profit variance

• The sales quantity variance reflects the difference • The market size variance provides an indication of the
between the standard and actual quantity of units sold proportion of the sales volume variance that can be
at the standard selling price. attributed to unexpected changes in market size.

Sales quantity variance = (Actual volume – Budgeted volume) x Standard price

Market size variance = Change in market size x Budgeted market share
x Planned average contribution margin
• Sales quantity variance is favourable when actual sales
quantities exceed standard quantities, and it is
unfavourable if the reverse is true.
 Sales volume and profit variance Sales volume and profit variance

• The market share variance provides an indication of the • The product mix variance provides an indication of
proportion of the sales volume variance that can be changes in contribution margin caused by selling a
attributed to changes in the market share. different mix from the planned mix of products.

Market share variance = Actual market size x Change in market share Product mix variance =
x Planned average contribution margin Change in average standard contribution margin x Actual unit volume

Direct cost variances Direct cost variances

• The total variance for direct costs can be broken down • A direct materials price variance compares the actual
into the following two components: price for the amount of direct materials purchased with
– price variance the standard price for the direct materials.
– efficiency variance.
Direct materials price variance =
(Actual price – Standard price) x Quantity purchased

Direct cost variances Direct cost variances

• A direct materials efficiency variance compares the

actual amount of materials used to the standard
amount of materials allowed for the actual level of
output.

Actual Standard

( )
Direct
quantity quantity
materials
efficiency = used for
actual
– allowed for x Standard
price
actual
variance
output output
 Direct cost variances Direct cost variances

• Summary of direct material variances: • A direct labour price variance compares the actual
price for labour with the standard price.

Direct
labour
price
variance
= ( Actual
labour
price per
hour
–
Standard
labour
price per
hour
) x Actual hours
used

Direct cost variances Direct cost variances

• A direct labour efficiency variance compares the labour • Summary of direct labour variances
hours worked to produce the actual output to the
standard amount of labour hours allowed for the actual
output; it values this difference at the standard labour
price per hour.
Actual
Direct
labour
efficiency
variance
= (
hours
for
actual
output
–
Standard

actual
output
)
hours for
x Standard
price

Direct cost variances Direct cost variances

Journal entries for direct costs and variances: • Journal entries for direct costs and variances
– In a standard cost system for a manufacturer, inventory
accounting entries are recorded using standard costs.
Differences between actual and standard costs are
recorded in variance accounts.
 Direct cost variances Analysing direct cost variance information

• Journal entries for direct costs and variances • Identifying reasons for direct cost variances

Analysing direct cost variance information Overhead variances

• Identifying reasons for direct cost variances
• To monitor overhead costs, a standard overhead
allocation rate is created at the beginning of each
period.
• The standard variable overhead allocation rate is
determined by estimating the variable amount of
overhead cost per unit of an allocation base as follows:

Standard variable Estimated variable overhead cost

=
overhead allocation rate Estimated volume of an allocation base

Overhead variances Overhead variances

• Although fixed costs do not vary with volume, we need • At the end of the period, variances between standard
to develop an allocation rate to assign these costs to allocated overhead costs and actual costs are analysed.
inventory and cost of sales. • The variable overhead budget variance is the
• The standard fixed overhead allocation rate is difference between allocated variable overhead cost
determined as follows: and actual variable overhead cost.
• The fixed overhead budget variance is the difference
Estimated fixed overhead cost
between allocated fixed overhead cost and actual fixed
Standard fixed
overhead allocation
= overhead cost.
Estimated volume of an allocation base
rate
 Overhead cost variances Overhead variances

• The variable overhead spending variance is the

difference between the actual variable overhead costs
for the actual output compared with the total expected
variable overhead costs for the actual output.

Variable Actual Standard Actual

–
overhead variable variable volume of
spending = overhead overhead x allocation
variance cost allocation rate base

Overhead variances

• The variable overhead efficiency variance is the • The fixed overhead spending variance is the difference
difference between the standard amount of variable between actual fixed overhead costs and estimated
overhead for the actual volume of the allocation base fixed overhead costs (the static budget amount).
and the flexible budget for variable overhead cost.

Variable Standard Actual Standard

–
Fixed overhead Actual fixed Estimated fixed
overhead volume of volume of
x variable = –
efficiency = allocation base allocation overhead spending variance overhead cost overhead cost
variance for actual base allocation rate
output

Overhead variances Overhead variances

• The production volume variance is the difference • Summary of overhead variances:

between the standard amount of fixed overhead cost
allocated to products and the estimated fixed overhead
costs.

Standard Estimated Standard fixed

Production
volume = volume of
allocation base – volume of
allocation x overhead
allocation rate
variance
for actual base
output
 Overhead variances
• Journal entries for overhead costs and variances
Using overhead variance information
• Analysing overhead spending variances:
• accountants investigate spending variances to
pinpoint the specific fixed and variable overhead
costs that differ from expectations.
• Interpreting the variable overhead efficiency variance:
• overhead efficiency variance provides no new
information
• however, this variance must be calculated for
bookkeeping reasons.
Using overhead variance information
• Examples of reasons for overhead variances
Overhead variances
• Journal entries for overhead costs and variances
Using overhead variance information
• Interpreting the production volume variance:
• the production volume variance provides information
about capacity utilisation
• this may be monitored to achieve long-term goals of
operating at optimal capacity levels.
Cost variance adjustments in the general
ledger
• All of the production entries and variances are recorded
for an accounting period; an additional entry is made to
eliminate the variance accounts.
• The type of adjustment made typically depends on
whether the variances are material.
• AASB102 Inventories does not allow the variances
relating to over/underapplied overhead to be prorated
between cost of sales and inventory for external
reporting purposes.
 Summary

• Identify variances for investigation.

• Understand and calculate relevant profit- and revenue-
related variances.
• Calculate direct cost variances.
• Understand how direct cost variance information is
analysed and used.
• Calculate variable and fixed overhead variances.
• Understand how overhead variance information is
analysed and used.
• Close off manufacturing cost variances at the end of the
period.