Financial Management 300

An overview of the standard costing system.

STANDARD cost of ACTUAL ACTUAL costs TRACED
output RECORDED for each to each responsibility
responsibility Centre Centre

Standard and actual costs

COMPARED and VARIANCES
ANALYSED and REPORTED

Variances INVESTIGATED and

CORRECTIVE ACTION taken

STANDARDS MONITORED and

ADJUSTED to reflect changes in
standard usage and / or prices
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 Working class example

Baby friend (Pty) Ltd (hereafter “BF”) manufactures and sells

rubber support chairs (called “Supportababy”) used for bathing new
born babies. You are the management accountant at BF and part
of your responsibility is to draw up BF’s annual budget as well as
provide management with information in order to assist them in
exercising control over their planned performance. You have just
compiled the following budgeted assumptions for the coming
financial year ending March 2023.

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 Working class example

Budgeted assumptions for the financial year ending March 2023

 
Production and sales volume provided by the sales manager and 100 000 units
agreed by the production manager

Selling price per Supportababy provided by the sales manager R 250 per unit

Kg material used per Supportababy provided by the production 2 kg

manager
Material cost per Kg provided by the purchase manager R 80

Labour hours per Supportababy” provided by the production 1.50 hours

manager
Labour cost per hour provided by the personnel manager R 30

Variable overheads per labour hour provided by the production R 15

manager

Action required: Prepare BF’s budgeted Income Statement

for the coming financial year ending March 2023.
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Working class example: Budgeted
Income Statement

Budgeted Income Statement of BF for the year ending March 2023

Sales (100 000 Units * R250 per unit) 25 000 000

Cost of Sales -22 750 000

Material (2kg * 100 000 units * R80/kg) 16 000 000

Labour (1.50 hrs * 100 000 units * R30 per hour) 4 500 000

Variable overheads (1.50 hrs *100 000 units * R15 per hour) 2 250 000

Gross Profit 2 250 000

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 Working class example

Actual information for the financial year ended March 2023

 

Production and sales volume 115 000 units

Selling price per Supportababy R 230 per unit
Kg material used per Supportababy 1.95kg
Material cost per Kg R 82
Labour hours per Supportababy 1.45 hours
Labour cost per hour R 32
Variable overheads per labour hour R 15.50

Action required: Prepare BF’s Actual Income Statement for

the coming financial year ending March 2023.

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 Working class example: Actual
Income Statement

Sales ( 115 000 units * R230 per unit) 26 450 000

Cost of Sales -26 309 125

Material (1.95 kg * 115 000 * R82) 18 388 500

Labour (1.45 hrs * 115 000 *R32) 5 336 000

Variable overheads (1.45 hrs * 115 000 * R15.50) 2 584 625

Gross Profit 140 875

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 Working class example

• The financial director prepared the following in order to assist him in

understanding why BF made a profit of R 140 875 compared to a
budgeted profit of R 2 250 000.
Budget Actual Difference

Sales 25 000 000 26 450 000 1 450 000

Cost of Sales -22 750 000 -26 309 125 -3 559 125
Material 16 000 000 18 388 500 -2 388 500

Labour 4 500 000 5 336 000 - 836 000

Variable overheads 2 250 000 2 584 625 -334 625

Gross Profit 2 250 000 140 875 -2 109 125

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Financial Management 300

“the production manager over spent R 3 559 125 on

production in this financial year - I’m afraid his job might be
on the line. We need detailed answers from him for over
spending on every single component of production cost”
 Is the above judgement fair? Can this be used for
measuring his performance?
 What can the financial director do to better compare the
budget to the actual?
 Prepare a “new” budget based on your answer from the
above question. The “new” budget is called a flexed budget.

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Financial Management 300

The difference between budget and actual without flexing.

Who is responsible for the differences between the Budget and the Actual. Is the Budget comparable
with the Actual? Is this comparison fair?
Budget (100 000 units) Actual (115 000 Difference(15 000
units) units)

Sales 25 000 000 26 450 000 1 450 000

Cost of Sales -22 750 000 -26 309 125 -3 559 125

Material 16 000 000 18 388 500 -2 388 500

Labour 4 500 000 5 336 000 - 836 000

Variable overheads 2 250 000 2 584 625 -334 625

Gross Profit 2 250 000 140 875 -2 109 125 9

Financial Management 300

Budgeted Income Statement of BF for the year ending March 2023

Sales (100 000 Units * R250 per unit) 25 000 000

Cost of Sales -22 750 000

Material (2kg * 100 000 units * R80/kg) 16 000 000

Labour (1.50 hrs * 100 000 units * R30 per hour) 4 500 000

Variable overheads (1.50 hrs *100 000 units * R15 per hour) 2 250 000

Gross Profit 2 250 000

New Budgeted Income Statement of BF for the year ending March 2023

Sales (115 000 Units * R250 per unit) 28 750 000

Cost of Sales -26 162 500

Material (2kg * 115 000 units * R80/kg) 18 400 000

Labour (1.50 hrs * 115 000 units * R30 per hour) 5 175 000

Variable overheads (1.50 hrs *115 000 units * R15 per hour) 2 587 500

Gross Profit 2 587 500 10

Financial Management 300

Consider the following performance analysis between

the ‘new budget’ prepared and the actual production
results:

‘New’ Budget Actual Difference/variance

Cost of Sales -26 162 500 -26 309 125 -146 625

Material 18 400 000 18 388 500 11 500

Labour 5 175 000 5 336 000 -161 000

Variable overheads 2 587 500 2 584 625 2 875

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Financial Management 300

What is a flexed budget and why do we need to flex ?

The ‘new ‘ budget is actually a flexed budget.

FLEXING =
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Financial Management 300

Now that the reason for over or under spending as a

result of production volume is eliminated, can you
break down the differences or variances in more
detail in order to better understand the actual
performance against budgeted performance? The
differences can now further be analysed into a price
and a volume variance.
The variances are calculated for all the input costs. In
this case we have material, labour and variable
overheads variances.
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Financial Management 300

Variance Calculations
• Material
Material price variance (80 - 82) x 115 000 x 1.95= (R 448 500)

Material volume variance (2 - 1.95) x 115 000 x 80= R 460 000

Total variance   11 500

• Labour
Price variance (32 -30) x 115 000 x 1.45 = - 333 500
Volume variance (1.45 – 1.5) x 115 000 x 30 = 172 500
Total variance   -161 000

• Variable
Price (15.50 – 15.00) x 115 000 x 1.45 = -83 375
Volume (1.45 – 1.5) x 115 000 x 15 = 86 250
Total variance   2 875
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Financial Management 300

We have now calculated production cost variances for

all production cost items. Surely we also need to
calculate sales variances in order to analyze
performance in its totality.

Sales variances
Sales variance

Sales price variance (230 - 250) x 115 000 = (R 2 300 000)

Sales volume variance (115 000 – 100 000) x 250 = R 3 750 000
Total variance 1 450 000

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Financial Management 300

Variances
•Cost determined by PRICE paid and QUANTITY used
•Therefore, ACTUAL cost can differ from STANDARD
cost because:
•Actual price paid differs from standard price you ‘should
have’ paid. This gives you a price or rate variance.
•Actual quantity used differs from standard quantity you
‘should have’ used. This gives you a usage or efficiency
variance.
•NB – Variances will always be favourable or adverse;
need to know which and state in your answer!
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Financial Management 300

Once all the variances have been calculated a reconciliation of the budgeted and actual profit can
be performed.
•A reconciliation is performed to show the bigger picture to top management with regards to the
performance of the company.
•In a reconciliation favorable variances are added and unfavorable variances subtracted.
Budgeted sales
Plus:
Sales volume variance (using SELLING price)
Equals:
Actual units sold at standard prices (i.e. FLEXED sales)
Less:
Standard cost of sales (i.e. actual units sold X standard cost of sales)
Equals:
Standard profit
Plus:
All other variances (sales price and all cost variances)
Equals:
Actual profit

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Financial Management 300

Contribution / profit approach:

Budgeted sales
Less:
Budgeted cost of sales (i.e. budgeted units sold X standard cost / unit)
Equals:
Budgeted profit
Plus:
Sales volume variance (based on PROFIT / CONTRIBUTION)
Equals:
Standard profit
Plus:
All other variances (sales price and all cost variances)
Equals:
Actual profit

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Financial Management 300

• Please refer to the following meaningful reconciliation

between the original budget and the actual results
based on all the variances calculated.

Reconciliation Responsible person

 
Original budgeted sales 25 000 000  
Sales volume variance 3 750 000 Sales Manager
Actual sales volume at budgeted price 28 750 000  
Cost of sales per 'new' budget -26 162 500  
Gross profit per 'new' budget 2 587 500  
Remainder of variances  
Sales price variance -2 300 000 Sales Manager
Material price variance -448 500 Purchase Manager
Material volume variance 460 000 Production Manager
Labour price variance -333 500 Personnel Manager
Labour volume variance 172 500 Production Manager
Variable overheads price variance -83 375 Production Manager
Variable overheads volume variance 86 250 Production Manager 19
Actual profit 140 875