BACT 302

MANAGEMENT ACCOUNTING
TOPIC:
BUDGETING,STANDARD COSTING,
VARIANCE ANALYSIS
 Learning Outcome

Students should be able to:

• Explain the purposes of budgeting and discuss the different

budgeting methods and their suitability to a particular scenario
• Prepare Functional and Master budgets for resource allocation;

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 Outline

• Definition of a Budget, budgeting and budgetary control

• Objectives of budgeting and budgetary control
• Approaches to budgeting
• Administration of budgets [budget manual, budget key factor, budget
committee, budget period]
• Types of budgets [fixed budgets, flexible budgets, incremental
budgets, zero based budget, rolling budgets, programme based
budgets, activity based budgets]
• Preparation and analysis of functional budgets
• Preparation and analysis of cash budget
• Preparation and analysis of master budget
• Behavioural aspects of budgeting

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 Definition of a Budget, budgeting and budgetary control

What is A Budget?

• “A budget is a formal quantitative expression of management plans” Charles T. Horngren

• “A Budget is a plan quantified in monetary terms, prepared and approved prior to a defined
period of time, usually showing planned income to be generated and/or expenditure to be
incurred during that period and the capital to be employed to attain a given objective.” CIMA
• ‘A budget is a quantified plan of action for a forthcoming accounting period’ ICAG

What is Budgeting?
• Budgeting is the process of preparing detailed projections of resources to be expended and
revenues to be earned in a specific time period.

What is Budgetary control?

• Monitoring performance by comparing actual outcomes with budgeted estimates and taking
steps to correct any variances.

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 Objectives of budgeting and budgetary control

Ensure the achievement of the organisation's objectives

Compels planning
To Communicate ideas and plans.
To Coordinate activities
Provide a framework for responsibility accounting
Control /Evaluation of performance
Establish a system of control

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 The Administration of Budgeting
• The process is also usually supervised by a budget committee
• Usually to guide everyone there is a budget manual
• Usually budget is first approved by the committee and
subsequently by the BOD.
• At the end of the process we have a Master Budget- the final
approved budget .
• The master budget is usually presented in the form of a
financial statement -so we have
• a budgeted income statement
• a budgeted statement of financial position
• a cashflow forecast and
• a capital budget for the coming year.

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 Stages in the budgeting process

• 1. Identify the principal budget factor(PBF)/limiting factor

• 2.Prepare functional budget for the PBF
• 3.Prepare all other functional budgets within the limits of the principal
budget factor- production resources budget- material usage, labour and
overhead budgets.
• 4. Submit the budgets to the budget committee for review and approval.
• 5.Prepare the master budget-
• 6. Submit master budget and supporting functional budgets to BOD for
approval
• 7. Communicate detailed budgets to managers responsiblefor
implementation
• 8.Control the process- continually monitor and compare actual
outcomes with budgeted figures , investigate and correct variances.

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 Methods of budgeting

 Incremental budgeting
• This approach uses prior period figures and adjusts them by an amount to cover inflation and any
other known changes.
• It is the most common approach, it is reasonably quick and for stable companies it tends to be fairly
accurate.
• However, one potential problem is that it can encourage errors and past inefficiencies to be carried
forward.
• Incremental planning does not encourage the company to consider new ways of operating the
business. Wasteful expenditure is not questioned each year because the budgeting process
incorporates and carries this forward to next period.
• For example, if we require a wages budget, we will probably ask the wages department to produce it
and they (using an incremental approach) will assume that our workers will continue to operate as
before. They will therefore simply adjust by any expected wage increases.
• As a result, the ‘plan’ for our workers stays the same as before. Nobody has been encouraged to
consider different ways of operating that may be more efficient.
 Zero-based budgeting (ZBB)
• With zero-based budgeting we do not build upon the prior period values. Instead, we consider each
activity on its own merits and draw up the costs and benefits of the different methods of achieving it
(and indeed whether or not the activity should continue). The management then decide on the most
effective way of performing each activity.

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 Methods of budgeting

• ZBB is bottom up by nature and aims to cut wasteful expenditure.

• Although this approach is in principle a much better approach to budgeting, it is time-
consuming and also requires high level of management expertise. For this reason, it is
sometimes restricted to just to a few activities each year in order that training and help
may be given to the people involved. The remaining activities may then be budgeted using
the incremental approach.
Activity Based Budgeting (ABB)
• The activity-based approach uses the principles and costing information obtained by an
ABC costing system.
• ABB budgets will use a number of different cost drivers e.g. number of orders , number of
machine set-ups, number of inspections etc – to calculate the budgeted overhead figures.
• Activity Based measures recognise that certain costs are a result of a demand for activities
rather than output driven (which is the assumption in our traditional budgeting model).
• The process will begin with the key budget factor (usually sales) in order to first determine
the volume driven costs and revenues – from here the various other overhead costs will
be calculated according to the expected level of support activities, which drive them.

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 Types of budgets
• Budgets can be categorised according to:
 Coverage/ functional area to which they relate:
• Sales
• Production
• Material usage, material purchases
• Labour
• Overhead
• Capital
• Cash
• Master
 Their flexibility
• - Fixed
• - Flexible
Time period they cover
• Short-term
• Long-term
• rolling

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PREPARATION
OF
BUDGETS
 Sales Budget

• A sales budget is a plan for the volume and value of sales for
the budget period
• Multiply for each product, the budgeted volume of sales by
price and add all to obtain sales budget .

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 Sales Budget-example
Prince Engineering produces a single product, the Stephenson. The forecast sales quantities for
the first five periods of 20X0 are as follows:

• Period 1 Period 2 Period 3 Period 4 Period 5

• 10,000 12,000 15,000 13,000 11,000
• The current selling price of the Stephenson is GHS40 although it is anticipated that there will be a
10% price increase in Period 4.
• The sales revenue budget can now be prepared.

• Forecast revenue GHS

• Period 1 (10,000 × GHS40) 400,000
• Period 2 (12,000 × GHS40) 480,000
• Period 3 (15,000 × GHS40) 600,000
• Period 4 (13,000 × GHS44) 572,000
• Period 5 (11,000 × GHS44) 484,000
2,536,000

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 Production Budget

• Units
• Sales budget in units S
• Minus: opening inventories of finished goods (OS)
• Plus: closing inventories of finished goods CS
• Production Budget PB

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 Production Budget-example

• A business has budgeted sales for the following period of 3,500

units of its product. The inventories at the start of the period
are 800 units and these are to be reduced to 600 units at the
end of the period. What is the production quantity for the
period (in units)?
• Units
• Sales 3,500
• Less opening inventories of finished goods (800)
• Add closing inventories of finished goods 600
• Production Budget (units) 3,300

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 Material usage Budget

It is a statement of direct material usage and their cost.

• A company makes and sells two products S & T. Its production
budget for the year is 40,000 units of S and 10,000 units of T.
• The materials required to make one unit of each and their cost
is as ff;
• Product S Product T Cost per kilo
• Material M1 2.0 3.0 $0.4
• Material M2 2.5 1.5 $0.6

• Prepare the material usage budget.

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 Material Usage Budget-example

• Material 1 Material 2 Total

• To make 40,000 S 80,000 100,000
• To make 10,000 T 30,000 15,000
• 110,000 115,000

• price per kilo $0.4 $0.6

• Total cost $44,000 $69,000 $ 113,000

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 Material Purchase Budget

• Units
• Material usage budget in units MU
• Minus: opening inventories (OS)
• Plus: closing inventories CS
• Material Purchase Budget MPB

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 Material Purchase Budget-Example

• A company makes and sells two products X &Y. Its production budget
for the year is 20,000 units of X and 15,000 units of Y.
• The materials required to make one unit of each and their cost is as ff;
• Product X Product Y Cost per kilo
• Material M4 0.5 1.5 $3
• Material M5 1.0 2.0 $4

• It expects opening inventory for each material to be 3000 and 2000

respectively
• Closing inventory are expected to be increased to 3500 and 1200
respectively.
• Prepare the material purchases budget.

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 Material Purchase Budget-Example

• Material 4 Material 5 Total

• To make 20,000 X 10,000 20,000
• To make 15,000 Y 22,500 30,000
• Material usage 32,500 50,000
• Plus:closing inventory 3,500 1,200
• Minus: opening inventory 3,000 2,000
• 33,000 49,200
• price per kilo $3 $4

• Total cost $99,000 $196,800 $ 295,800

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 Direct labour budget

• Direct labour budget shows budgeted no of hours required to produce

budgeted production quantities, multiplied by the cost of labour per hour.
• This is done for each grade of labour.
• A company makes and sells two products S & T. Its sales budget for the year
is 40,000 units of S and 10,000 units of T.
• It expects opening inventory for each good to be 500 and 1000 respectively
• And plans to double finished goods by the end of the year.

• The direct labour hours required to make one unit of each product and their
cost is as ff;
• Product S Product T Cost per hour
• Grade G1 labour 0.2 0.6 $20
• Grade G2 labour 0.3 0.8 $16

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 Direct labour budget-example

• Step1. Prepare production budget.

• Product S Product T
•
• Sales 40,000 10,000
• Minus: opening inventories (500) (1000)
• Plus: closing inventories 1,000 2,000
• Production Budget 40,500 11,000

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 Direct labour budget-example

• Step 2. Prepare direct labour budget

• Grade G1 Grade G2 Total
• hours hours
• To make 40,500 S 8,100 12,150
• To make 11,000 T 6,600 8,800
• Direct labour 14,700 20,950
• Rate per hour $20 $16

• Total cost $294,000 $335,200 $ 629,200

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 Overhead budget

• The overheads budget is the budget for indirect expenses of

the business
A company makes and sells one product-product Z.
• The production budget is to make and sell 5,000 units but
there is the possibility that sales demand might be less than
expected.
• Hence management have decided to prepare a budget for
4,000 units of production and sales.
• Production overhead costs are expected to be fixed costs of
$360,000 plus variable overheads of 1.5 per direct labour hour.
• Product Z take 2 hours to produce.

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 Overhead budget-example

• Production overhead budget

• 4,000 units 5,000 units
• Variable overheads
(2 X1.5= $3 per unit) 12,000 15,000
• Fixed overheads 360,000 360,000
• Total overheads 372,000 375,000
• Overhead cost per unit $93 $75

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 Cash Budget

• Shows planned cash receipts and payments.

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 Cash budget-example
• You are presented with the following forecasted cash flow data for your organisation for the period
November 20X1 to Mar 20X2.

• It has been extracted from functional flow forecasts that have already been prepared.
• NovX1 DecX1 JanX2 FebX2 MarX2
• $ $ $ $ $
• Sales 80,000 100,000 110,000 130,000 140,000
• Purchases 40,000 60,000 80,000 90,000 110,000
• Wages 10,000 12,000 16,000 20,000 24,000
• Overheads 10,000 10,000 15,000 15,000 15,000
• Dividends 20,000
• Capital expenditure 30,000

• You are also told the following.

• (a) Sales are 40% cash 60% credit. Credit sales are paid two months after the month of sale.
• (b) Purchases are paid the month following purchase.
• (c) 75% of wages are paid in the current month and 25% the following month.
• (d) Overheads are paid the month after they are incurred.
• (e) Dividends are paid three months after they are declared.
• (f) Capital expenditure is paid two months after it is incurred.
• (g) The opening cash balance is $15,000.
• Prepare a monthly cash budget for the three months from January to March 20X2.
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 Cash budget- example 2
• JAN FEB MAR
Cash receipts:
• Cash sales 44,000 52,000 56,000
• Credit sales 48,000 60,000 66,000
• Total receipts 92,000 112,000 122,000
Cash payments:
• Purchases 60,000 80,000 90,000
• Wages (25%) 3,000 4,000 5,000
• (75%) 12,000 15,000 18,000
• Overheads 10,000 15,000 15,000
• Dividends 20,000
• Capital expenditure 30,000
• Total payments 85,000 114,000 178,000
• Net cash flow 7,000 (2,000) (56,000)
• Opening balance 15,000 22,000 20,000
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Closing balance 22,000 20,000 (36,000) 28
 Fixed ,flexible &Flexed budgets

• Fixed budget is a budget for a specific volume and sales activity. It

is the original budget usually prepared at the beginning of the
year.
• Not useful for control purposes when activity levels have changed-
provides no basis for comparison.so variances can be misleading.
• Flexed budget shows the revenues and costs and profit that
should have been expected given the actual volume of sales.
• Prepared at the end of the year. Useful for control purposes. Tells
what was expected given actual volume of sale. Hence actual
performance can be compared with it.
• Flexible budget are prepared to show the results to expect at
different levels of activity -50%, 80%, 90% etc.

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 Fixed &Flexed budgets

• A company makes and sells a single product. Its budget for the
year was to make and sell 10,000 units.actual sales and
production were 15,000 units.
• fixed actual difference
• Sales 200,000 286,000 86,000
• Material 60,000 94,000 34,000
• Labour 70,000 97,000 27,000
• Variable o/head 20,000 23,000 3,000
• Fixed costs 30,000 34,000 4,000
• Total costs 180,000 248,000
• PROFIT 20,000 38,000
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 Fixed &Flexed budgets

• fixed flexed actual difference

• Sales 200,000 300,000 286,000 14,000 A
• Material 60,000 90,000 94,000 4,000 A
• Labour 70,000 105,000 97,000 8,000 F
• Variable o/h 20,000 30,000 23,000 7,000 F
• Fixed costs 30,000 30,000 34,000 4,000 A
• Total costs 80,000 255,000 248,000
• PROFIT 20,000 45,000 38,000

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 flexible budget

LEVEL OF ACTIVITY
100% 80% 85%
• Sales 200,000 160,000 170,000
• Material 60,000 48,000 51,000
• Labour 70,000 56,000 59,500
• Variable o/h 20,000 16,000 17,000
• Fixed costs 30,000 24,000 25,500
• Total costs 80,000 144,000 153,000
• PROFIT 20,000 16,000 17,000

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 BACT 302
MANAGEMENT ACCOUNTING
TOPIC:
STANDARD COSTING & VARIANCE
ANALYSIS
 Standard Costing
A Standard cost is an estimated unit cost.
 The standard cost for a product (or service) is determined in advance based
on expected resource usage using expected resource prices.
It is therefore determined by management's estimates of the following.
• The expected prices of materials, labour and expenses
• Efficiency levels in the use of materials and labour
• Budgeted overhead costs and budgeted volumes of activity
Standard costing is most suited to mass production and repetitive assembly
work, where large quantities of a standard product are manufactured.
Budgets and standards are very similar and interrelated, but a budget is an
overall plan and a standard cost is a unit cost.
 Standard costs may be used for budgeting.
The standard costs form the basis of budget totals, which can then be
compared to actuals as part of the performance management process.
Standard costs can be based on absorption or maginal costing.

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 STANDARD COST CARD

• Product: the Splodget, No 12345

• Cost Requirement
Direct materials GHS GHS
• A GHS2.00 per kg 6 kg 12.00
• B GHS3.00 per kg 2 kg 6.00
• C GHS4.00 per litre 1 litre 4.00
Others 2.00
• 24.00
Direct labour
• Grade I GHS4.00 per hour 3 hrs 12.00
• Grade II GHS5.40 per hour 5 hrs 27.00
39.00
Variable production
overheads GHS1.00 per hour 8 hrs 8.00
Fixed production
overheads GHS3.00 per hour 8 hrs 24.00
Standard full cost of production 95.00

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 Standard cost card for Product X

• $ per unit
• Sales price 100

• Materials (2 kg @ $20/kg ) 40
• Labour (1.5 hrs @ $2/hr ) 3
• Variable o/h (1.5 hrs @ $6/hr) 9
• Fixed o/h (1.5 hrs @ $10/hr) 15
• Standard cost of production 67

• Standard profit per unit 33

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 ESTABLISHING A STANDARD COST
• Astandard cost is established by building up the standard material labour and overhead
costs for each standard unit.
• ex. A company manufactures two products X &Y.
• In year 1 , it budgets to make 2,000 units of product X and 1,000 units of product Y.
• The standard quantity of resources per unit are as ffs:
• Product X Product Y
• Direct material per unit:
• Material A 2 15
• Material B 1 3
• Direct labour hours per unit 1.5 2
• Standard rates and prices are as follows:
• Material A $4
• Material B $3
• Direct labour $10
• Variable Production Overhead $2 Per direct labour hour
• Fixed production overhead are 60,000 for the year, and are absorbed per unit using
standard labour hours per unit.
• Calculate the standard full production cost per unit for products X and Y.

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 ESTABLISHING A STANDARD COST

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 Types of standards
• ๏ Ideal standard: 100% efficient 100% of the time. Calculated assuming perfect
operating conditions.
• Could form the basis for long-term aims, but not useful for variance analysis or
budgeting because unrealistic.
• ๏ Basic standard: This is a long-term standards which remain unchanged over many
years. Often they are determined at the inception of a product.
• It is only really of use to show trends or improvements over time. They are not
useful measures of current performance.
• ๏ Expected / Attainable standard: This is a standard expected to apply to a specific
budget period and is based on normal efficient operating conditions. It can
incorporate allowance for wastage and idle time. This is usually the basis for
variance analysis. However, standards may be too ‘easy’ to be used as targets.
• ๏ Current standard: This is the current attainable standard which reflects
conditions actually applying in the period under review.
• They are useful when operating under abnormal conditions – eg a period of hyper
inflation.
• They may reduce the drive for improvement because the standards reflect up-to-
date cost environment.

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 Use of standard costs

It is an alternative to FIFO and average cost as a method of inventory valuation.

To budget production costs. When a standard per unit of product as been established,
budgeting production costs becomes a fairly straightforward process
To act as a control device by establishing standards (expected costs) and comparing
actual costs with the expected costs. Variances between actual and standard cost
indicate aspects of operations which may be out of control.
To evaluate managerial performance.
To enable the principle of 'management by exception' to be practised, whereby
managers concentrate on those areas of the business that are performing below or
above expectations and ignore those that appear to be conforming to expectations.
A standard cost, when established, is an average expected unit cost. Because it is only
an average, actual results will vary to some extent above and below the average. Only
significant differences between actual and standard should be reported.
 To provide a prediction of future costs, for use in some decision-making situations.
 To motivate staff and management by providing challenging targets.
To provide guidance on possible ways of improving efficiency.

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 Limitations of standard costing

• ๏ Obtaining appropriate standards can be difficult

• ๏ Standards may be different depending on their purpose (see
next section)
• ๏ Less useful when environment does not involve mass
production of homogenous items.
• ๏ Standard costing can lead to an over-emphasis on quantitative
measures of performance at the expense of qualitative measures
(e.g. customer satisfaction; quality and employee morale)
• ๏ Traditional standards are based on company’s own costs – a
more modern approach is benchmarking, which considers best
practice of other organisations.

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 Variance analysis
Standard costs are usually compared with actual costs to
determine if there there are any differences- variances.
A variance is the difference between a planned, budgeted, or
standard cost and the actual cost incurred.
 The same comparisons may be made for revenues.
The process by which the total difference between standard
and actual results is analysed is known as variance analysis.
Variances can be divided into three main groups.
• Variable cost variances –direct
mat,directlab,variab.prod.o/head
• Sales variances
• Fixed production overhead variances.

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 Variable Cost Variances

DIRECT MATERIAL COST VARIANCES

• Direct material total variances
• Direct material usage variance
• Direct material price variance
DIRECT LABOUR COST VARIANCES
• Direct labour total variance
• Direct labour rate variance
• Direct labour efficiencyvariance
VARIABLE OVERHEAD COST VARIANCES
• Variable overhead total variance
• Variable overhead expenditure variance
• Variable overhead efficiency variance

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 Variance analysis

• A company manufactures a single product for which the standard variable cost is:
• £ per unit
• Direct material: 81 kg £7 per kg 567
• Direct labour: 97 hours £8 per hour 776
• Variable overhead: 97 hours £3 per hour 291
• 1,634
• During January, 530 units were produced and the costs incurred were as follows:
Direct material: 42,845 kg purchased and used; cost £308,484
• Direct labour: 51,380 hours worked; cost £400,764
• Variable overhead: cost £156,709
•
•
• You are required to calculate the variable cost variances for January.

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 DIRECT MATERIAL COST VARIANCES

Direct material total variances

£
530 units should cost ( £567) 300,510
But did cost 308,484
Total direct material cost variance 7,974 adverse

Direct material price variance

  £
42,845 kg purchased should have cost ( @ £7) 299,915
But did cost 308,484
Direct material price variance 8,569 adverse

Direct material quantity variance

kg
• 530 units produced should have used (@ 81kg) 42,930
• But did use 42,845
• Variance in kg 85kg @ (£7) favourable
Direct material usage variance £595 favourable
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 DIRECT MATERIAL COST VARIANCES

• However, when the amount of material purchased is different from what was used. There could be problems
calculating material price variance.- which quantity do we use- puchased or used?
• In that case the direct material price variance could be based either on the material purchased or on the
material used.
Based on purchases
• £
• Material purchased should have cost X
• But did cost X
• Direct material price variance X

Based usage
• £
• Material used should have cost X
• But did cost X
• Direct material price variance X

• If inventory is valued at standard cost, then method A is used. This will ensure that all of the variance is
eliminated as soon as purchases are made and the inventory will be held at standard cost.
• If inventory is valued at actual cost, then method B is used. This means that the vari- ance is calculated and
eliminated on each bit of inventory as it is used up. The remainder of the inventory will then be held at actual
price, with its price variance still attached , until it is used and the price variance is calculated.

•
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 DIRECT LABOUR COST VARIANCES

Direct labour total variance

£
 530 units should cost ( £776) 411,280
But did cost 400,764
Total direct labour cost variance 10,516 favourable

 Direct labour rate variance £

51,380 hours should have cost ( £8) 411,040
But did cost 400,764
Direct labour rate variance 10,276 favourable

Direct labour efficiency variance £

530 units produced should take ( 97 hours) 51,410

But did take 51,380
Variance in hours 30 favourable
standard labour rate per hour (£8)
Direct labour efficiency variance £240 favourable

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 VARIABLE OVERHEAD COST VARIANCES

 Variable overhead total variance £

530 units should cost ( £291) 154,230
But did cost 156,709
Total variable overhead cost variance 2,479 adverse

Variable overhead expenditure variance £

51,380 hours of variable overhead should cost ( £3) 154,140
But did cost 156,709
Variable overhead expenditure variance 2,569 adverse

Variable overhead efficiency variance £

Variance in hours (from labour efficiency variance) 30 hours
favourable standard variable overhead rate per hour (£3)
Variable overhead efficiency variance £90 favourable

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 SALES VARIANCES

sales price variance

sales volume contribution variance
reveals the contribution difference which is caused by selling a different quantity
from that budgeted.

EX.
Budget
• Sales and production volume 81,600 units
• Standard selling price £59 per unit
• Standard variable cost £24 per unit
Actual results
• Sales and production volume 82,400 units
• Actual selling price £57 per unit
• Actual variable cost £23 per unit

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 SALES VARIANCES

Sales price variance £

• 82,400 units should sell for ( £59) 4,861,600
• But did sell for (82,400 units £57) 4,696,800
• Sales price variance 164,800 adverse

sales volume contribution variance

• the calculation of the sales volume variance is based on the standard
contribution not on the actual contribution.
• Actual sales volume 82,400
• Budget sales volume 81,600
• Sales volume variance in units 800
• Standard contribution per unit (£59- £24) £35
• Sales volume contribution variance £28,000 favourable

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 FIXED PRODUCTION OVERHEAD VARIANCES
Fixed overhead total cost variance
• It is the amount of under or over absorped fixed overhead
• If under absorbed – adverse
• If over absorbed - favourabe
Overheads are absorbed at standard fixed costs per unit.
Fixed overhead expenditure variance
• Budgeted fixed prod.overhead exp X
• Actual fixed prod.overhead exp Y
• fixed prod.overhead exp variance X-Y
If actual exceeds budgeted it is adverse.
Fixed overhead volume variance
• Actual no. Of units produced X
• Budgeted prod. units Y
• volume variance in units X-Y
• @ Standard fixed overhead cost per unit P
• Fixed production volume variance (X-Y) x P

If actual exceeds budgeted it is adverse.

Instead of units the maesurement could be in stndard hours produced which is =actual units produced x
standard hours per unit.

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 FIXED PRODUCTION OVERHEAD VARIANCES
• ex. A company budgeted to make 5,00 units of a single standard
product in one year. Budgeted direct labour hours are 10,000
hours. Budgeted fixed production overhead is 40,000. actual
production was 5,200 and fixed production overhead was $40,500.
• Calculate the :
• Fixed overhead total cost variance
• Fixed overhead expenditure variance
• Fixed overhead volume variance
Fixed overhead total cost variance $
Fixed overhead absorbed:
5,200 x standard fixed cost per unit(40,000/5,000)$8 41,600
Actual fixed overhead expenditure 40,500
Fixed overhead total cost variance 1,100

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 FIXED PRODUCTION OVERHEAD VARIANCES

Fixed overhead expenditure variance $

Budgeted fixed prod. overhead expenditure 40,000
Actual fixed prod. Overhead expenditure 40,500
Fixed overhead expenditure variance 500 Adverse
Fixed overhead volume variance
Budgeted prod. Volume in units 5,000
Actual prod. Volume 5,200
200 favourable
Standard fixed overhead cost per unit $8
Fixed overhead volume variance $1,600 favourable

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 Fixed ,Flexed budget -example
• A company has prepared the following standard cost card:
• $ per unit
• Materials (4 kg at $4.50 per kg) 18
• Labour (5 hrs at $5 per hr) 25
• Variable overheads (5 hrs at $2 per hr) 10
• $53
• Budgeted selling price $75 per unit, and the budgeted fixed overheads are $130,500
• Budgeted production 8,700 units
• Budgeted sales 8,000 units
• There is no opening inventory.
The actual results are as follows:
• Sales: 8,400 units for $613,200
• Production: 8,900 units with the following costs:
• Materials (35,464 kg) 163,455
• Labour (45,400 hrs paid, 44,100 hrs worked) 224,515
• Variable overheads 87,348
• Fixed overheads 134,074

• Prepare a flexed budget and calculate the total variances.

• analyse the variances and use them to produce on Operating Statement reconciling the budgeted profit
with the actual profit.
• Note: the company currently uses marginal costing
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 Fixed ,Flexed budget -example
• fixed flexed Actual T. VAR
• Sales 600,000 630,000 613,200 16,800 (A)
(8,000 x$75)
Less cost of sales:
open. Stk 0 0
Plus prod.:
Material (8700 x$18) 156,600 160,200 163,455 3,255 (A)
Labour(8700x $25) 217,500 222,500 224,515 2,015 (A)
Variable overhead(8700 x $10) 87,000 89,000 87,348 1,652 (F)
Fixed o/head (8700 x$15) 130,500 133,500 134,074 574 (A)
Less closing stk.(700 x $68) 47,600 34,000 34,000 0
544,000 571,200 575,392
Profit 56,000 58,800 37,808 20,992(A)

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 Further variance analysis

Sales variance 16,800 (A)

sales price variance
• 8,400 units should sell for@$75 630,000
• But did sell for 613,200
• Sales price variance 16,800 (A)
sales volume variance
• Actual sales volume 8,400
• Budget sales volume 8,000
• Sales volume variance in units 400
• Standard profit per unit (£75- £68) £7
• Sales volume contribution variance £2,800 (F)
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 Further variance analysis

Total material variance 3,255 (A)

Material expenditure variance
• for 35464kg we spent 163,455
• shoud have spent for 35,465 @ $4,5 159,588
• 3867 (A)
Material usage variance
• For 8900 we used 35,464
• Shd have used 8,900 @4kg 35,600
• 136kg @ $4,5 612 (F)

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 Further variance analysis

Total labour variance 2,015 (A)

labour rate variance
• For 45,400hrs paid 224,515
• Shd have paid $5 x 45,400 227,000
• 2,485 (F)
IDLE time variance:
• Hours paid 45,400
• hours worked 44,100
• Idle time 1,300 @$5 6,500(A)
labour efficiency variance
• For 8,900 units used 44,100
• Shd have used 8,900 x5 44,500
• 400 (F) @ $5 2,000 (F)

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 Further variance analysis

Total variable overhead variance 1,652 (F)

Variable overhead expenditure variance

44,100hrs cost 87,348
Shd have cost 44,100 x $2 88,200 852 (F)
Variable overhead efficiency variance
• Actual hours worked 44,100
• Shd have worked (8,900units x5) 44,500
400@$2 800(F)

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 Further variance analysis

Fixed overhead total variance 574(A)

Fixed overhead expenditure variance
Did spend 134,074
Budget 130,500
3574(A)

Fixed overhead volume variance

• Actual prod 8,900
• Budgeted prod 8,700
• 200 X$ 15 = 3,000(F)
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 Reconciliation of variances

• Operating statement is prepared to reconcile actual and

budgeted profit

• when using marginal costing the focus is on contribution

(rather than profit) and the fact that we will not be absorbing
fixed overheads means that any fixed overhead volume
variance is not relevant.

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 Operating statement
• $
• Budgeted profit BP
• Sales price variance X (F) or (A)
• Sales volume variance X (F) or (A)
Actual sales minus standard X
Production cost of sales

• Cost variances: F A
• $ $
• Direct material price X
• Direct material usage X
• Direct labour rate X
• Direct labour efficiency X
• Variable prod.o/h expenditure var. X
• Variable prod. o/h efficiency var. X
• Fixed overhead expenditure var.
• Fixed overhead volume var. X
• Total cost variances X (F) or (A)
• Actual profit AP

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 Operating statement

• Budgeted profit 56,000

• Sales price variance 16,800 (A)
• Sales volume variance 2,500 (F)

• Direct material price 3,867 (A)

• Direct material usage 612 (F)

• Direct labour rate 2,485 (F)

• Direct labour efficiency 2,000 (F)
• Idle Time 612 (A)
• Variable prod.o/h expenditure var. 852 (F)
• Variable prod. o/h efficiency var. 800 (F)
• Fixed overhead expenditure var. 3,574 (A)
• Fixed overhead volume var. 3,000 (F)
• Actual profit 37,808

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 Interpretation of variances
Variance Favourable
Material price Unforeseen discounts received
More care taken in purchasing
Change in material standard
Material usage Material used of higher quality than
• (a) (c) Labour rate Use of apprentices or other workers at a
standard
More effective use made of material
rate of pay lower than standard Wage rate increase Use of
higher grade labour Use of apprentices or other workers at
Labour rate a rate of pay lower than standard
Output produced more quickly than
Labour efficiency expected because of work motivation,
better quality of equipment or
materials, or better methods. Errors in
allocating time to jobs
Savings in costs incurred More
economical use of services
Overhead expenditure
Labour force working more efficiently
(favourable labour efficiency variance)
Overhead volume efficiency Labour force working overtime
Overhead volume capacity
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adverse
• Price increase
• Careless purchasing
• Change in material standard
• Errors in allocating material to jobs
•
•
Defective material
Excessive waste
•
•
Theft
Stricter quality control
• Errors in allocating material to jobs
• Wage rate increase Use of higher
grade labour
• Lost time in excess of standard
allowed
• Output lower than standard set
because of deliberate restriction,
lack of training, or sub-standard
material used
• Errors in allocating time to jobs
• Increase in cost of services used
Excessive use of services Change in
type of services used
• Labour force working less efficiently
(favourable labour efficiency
variance)
• Machine breakdown, strikes, labour
shortages
64
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 TARGET COSTING

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