MANAGEMENT

AND COST
ACCOUNTING
SIXTH EDITION

COLIN DRURY

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2004 Colin Drury
 Part Four:
Information for planning, control and performance

Chapter Nineteen:
Standard costing and variance analysis 2- further aspects

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.1a

Mix variance
1. A mix variance arises when the actual mix differs from the predetermined
standard mix.

Example
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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.1b

2. Mix variance = (AQ in standard mix – AQ) × SP

AQ in standard mix ×SP £ AQ ×SP £

X =100 000 × 5/10 × £7 350 000 53 000 × £7 371 000
Y =100 000 × 3/10 × £5 150 000 28 000 × £5 140 000
Z =100 000 × 2/10 × £2 40 000 19 000 × £2 38 000
540 000 549 000

Mix variance = £9 000 A

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.2

Yield variance

1. 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

= (92 700 –90 000 )× £54/9 =£16 200 F

2. Possible causes

3. Mix and yield variances are interrelated and should not be

interpreted in isolation.

Summary
Total variance = SC (92 700 ×£6) – AC (£561 200) = £5 000 A

Price variances £12 200 A

+ Mix variance £ 9 000 A
+ Yield variance £16 200 F
£ 5 000 A

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.3a
Sales mix and quantity variances
1. Where 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.

Example
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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.3b

Sales mix and quantity variances (contd.)

2 .Mix variance = (AQ – AQ in budgeted proportions) × Standard margin

AQ – AQ in budgeted proportions Standard margin

X 6 000 – 8 800 (40%) × £20 = £56 000 A
Y 7 000 – 7 700 (35%) × £12 = £ 8 400 A
Z 9 000 – 5 500 (25%) × £9 = £31 500 F
22 000 £32 900 A

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.4

Sales mix and quantity variances (contd.)

3. Quantity variance = (AQ in budgeted

proportions – BQ) × SM
X = (8 800 – 8 000) × £20 = £16 000 F
Y = (7 700 – 7 000) × £12 = £ 8 400 F
Z = (5 500 – 5 000) × £9 = £ 4 500 F
£28 900 F

4. If planned mix had been achieved the sales volume variance would
have been £28 900 F.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.5a

Recording standards costs in the accounts

1. Purchase of materials (Material A)

Dr Stores ledger control account (AQ × SP) 190 000
Dr Materials price variance 19 000
Cr Creditors control 209 000

2. Issue of materials (Material A)

Dr Work in progress (SQ ×SP) 180 000
Dr Material usage variance 10 000
Cr Stores ledger control account (AQ × SP) 190 000

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.5b

3. Recording of wages due

Dr Wages control account (actual cost) 273 600

Cr Wages accrued account 273 600

The wages control account is cleared as follows:

Dr Work in Progress (SQ ×SP) 243 000

Cr Wages control account 243 000
Dr Wage rate variance 17 100
Dr Labour efficiency variance 13 500
Cr Wages control account 30 600

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
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19.6a

4. Manufacturing overhead cost incurred

Dr Factory variable overhead control

account 52 000
Dr Factory fixed overhead control account 116 000
Cr Expense creditors 168 000

5. Absorption of fixed manufacturing overhead

Dr Work in progress (SQ ×SP) 108 000
Dr Volume variance 12 000
Cr Factory fixed overhead control
account 120 000
Dr Factory fixed overhead control account 4 000
Cr Fixed overhead expenditure variance 4 000

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.6b

6.Variable manufacturing overhead

Dr Work in progress (SQ ×SP) 54 000

Dr Variable overhead efficiency variance 3 000
Cr Factory variable overhead control
account 57 000
Dr Factory variable overhead control
account 5 000
Cr Variable overhead expenditure
variance account 5 000

7. Completion of production
Dr Finished stock account 720 000
Cr Work in progress 720 000

Note that the variances are transferred to the profit and loss account at the end of
the period.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.7a

Ex post variance analysis

1. A major criticism is that actual performance is compared with a standard based
on the environment that was anticipated when the standard was set.

2. It is argued that an ex post variance analysis approach should be adopted that

distinguishes between planning and operating variances.

3. A Original standard
B Ex post standard given the benefit of hindsight
C Actual outcome

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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.7b

4. Example

SP = £5 per unit, market price at time of purchase = £5.20

Actual purchases =10 000 units at £5.18
Conventional variance analysis = 10 000 × £0.18 = £1 800 A

Ex post analysis:
Purchase planning variance = (£5 –£5.20) × 10 000 = £2 000 A
Purchase efficiency variance = (£5.20 –£5.18) × 10 000 = £200 F
£1 800 A

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.7c

5. Sales variances

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)

Conventional sales variance = £1m favourable (10 000 × £100)

Ex post analysis: Planning variance = 2m favourable (20 000 × £100)

Appraisal variance = £1m adverse (10 000 × £100)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.8
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.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
19.9a

Statistical investigation models not incorporating cost and benefits

1. 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)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.9b

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 sheet 19.10.)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.10

Statistical quality control charts

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.11
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.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.12a

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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.12b

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.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.13a

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.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.13b

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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
19.14

The future role of standard costing (contd.)

• ABC and variance analysis:

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

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury