1

Standard Costing & Variance Analysis

Week 9

2

Managing Production

Control of Costs within manufacturing is vital

To keep product costs to a minimum

To monitor the production process To gauge efficiency To provide a basis for

improvement

3

Standard Costs

Most suitable in organisations

With common or repetitive operations

Where inputs required to produce outputs can be accurately measured

4

What are “Standard Costs”?

All costs attached to products are based on standard or predetermined amounts

Standard Costs are established before production begins

Provides management with goals to attain (planning) basis for comparison with actual results

(control) Standard Costs are costs per unit Standard Costs are also known as planned

costs, predicted costs and scheduled costs.

5

What things can be “Standard”?

All expected inputs to and outputs from the production process

Direct Labour Direct Materials also Variable Overheads Fixed Overheads

6

Cost Control Assists management in production of a unit of usable

product at the lowest possible cost at predetermined quality standards

making periodic comparisons of actual costs with standard costs to

measure performance correct inefficiencies

7

Types of Standards Ideal Standard Usually this standard cannot be attained and

leads to unfavourable variances as it assumes

minimum prices for all costs optimal usage 100% manufacturing capacity

Attainable Standard Can be met because it recognizes

good overall price but not necessarily the lowest price for all costs

direct labour is not 100% efficient normal spoilage will occur manufacturers do not operate at 100% capacity

8

Establishing Standards

Variety of Methods: Past Experience Best Prices Available Current Wage Rates Anticipated Improvements Expected Market Variations

Opportunity to re-evaluate production

9

So what do you do, then?

Establish inputs for planned output

Attach standards to all inputs Start Production Monitor Actual Outcomes Compare Standards to Actuals

(Variance Analysis) Take corrective action if necessary

10

Acme Wall Blocks LtdStandard Costs

Production run of batch of 1,200 wall blocks

Standard Price of concrete 25p per Kg

Standard Use of concrete 1,200 Kg Standard Cost of Labour £6.00 per

hour Standard Time to make batch 60

hours

11

Acme Wall Blocks LtdActual Costs

Actual Figures

Actual Price of concrete 30p per Kg Actual Use of concrete900 Kg Actual Cost of Labour £5.00 per hour Actual Time to make batch 68 hours of

which 10 idle

12

Standard v Actual Cost of production

Standard Cost of production Materials 1,200 X 25p 300 Labour 60 X £6.00 360 Total 660

Actual Cost of production Materials 900 X 30p 270 Labour 68 X £5.00 340 Total 610

Variance (660 - 610) 50 Favourable

13

Materials Variances

Total Materials Variance

(Standard Price X Standard Use) - (Actual Price X Actual Use) =

(0.25 X 1,200) X (0.30 X 900) = 30(F)

14

Materials Sub-Variances Price Variance

(Std Price - Act Price) X Act Use = (0.25 - 0.30) X 900 = 45 (A)

Usage Variance

(Std Use - Act Use) X Std Price = (1,200 - 900) X 0.25 = 75 (F)

Summary Price Variance 45 (A) Usage Variance 75 (F) 30 (F)

15

Labour Variances

Total Labour Variance

(Standard Rate X Standard Hours) - (Actual Rate X Actual Hours) =

(6.00 X 60) - (5.00 X 68) = 20 (F)

16

Labour Sub-Variances Wage Rate Variance

(Std rate - Act Rate) X Act Hours = (6.00 - 5.00) X 68 = 68 (F)

Labour Efficiency Variance

(Std Hours - Act Hours) X Std Rate = (60 - 68) X 6.00 = 48 (A)

Summary Wage Rate Variance 68 (F) Labour Efficiency Variance 48 (A) 20 (F)

17

Labour Efficiency Sub - Variances

Idle Time Variance (Idle Hours X Std Rate) = 10 X 6 = 60 (A)

Productive Efficiency Variance (Std Hours - Productive Hours) X Std Rate = (60 - 58) X 6.00 = 12 (F)

Summary Idle Time Variance 60 (A)

Productive Efficiency Variance 12 (F) 48 (A)

18

Point to Note Variances are hierarchical Total Product Variance is sum of Primary sub-variances

Labour, materials, etc Each of these variances can be

reduced to sub-variances The sum of sub-variances of any

given variance = that variance

19

Very Nice, but what does it tell us?

We can compare what we expect with what actually happens

We can investigate “below the surface” A “total” variance is constructed of

sub-variances Total variances can mask inefficiencies Materials variance may be favourable

but Good purchasing may be ruined by Excessive waste

20

Analysis of Acme Wall Blocks

Materials Materials Prices have risen –

why? Less waste in Usage – why? Has better quality material been

purchased creating less wastage? Is workforce being more careful? Were standards wrong? Can we get similar quality

materials elsewhere cheaper?

21

Analysis of Acme Wall BlocksLabour

Labour is being paid less – why? Hired less skilled workers? If so, would expect decline in efficiency Certainly efficiency is down, but Re-analyse and find “productive”

efficiency has improved Decline due to enforced idle time. Why idle time – stock problems,

machine break down, production bottlenecks?

Investigate and correct

22

Materials VariancesSummary

Total Variance (Std Use X Std Price) – (Act Use X

Act Price) Sub Variances Price Variance (Std Price – Act Price) X Act Use Usage Variance (Std Use – Act Use) X Std Price

23

Labour VariancesSummary

Total Variance (Std Hrs X Std Rate) – (Act Hrs X Act Rate) Sub Variances Wage Rate (Std Rate – Act Rate) X Act Hours Efficiency (Std Hrs – Act Hrs) X Std Rate Efficiency Sub Variances Idle Time (Idle Hrs X Std Rate) note always adverse Productive Efficiency (Std Hrs – (Act Hrs – Idle Hrs)) X Std Rate

24

The SchopenhauerAn example

Budgeted Output 600 units Actual Output 550 units [mention!!] Standards (PER UNIT) Material A 1.5 kg @ £2.00 per kg Material B 2.0 litres @ £5.00 per litres Labour 5 hours @ £8.50 per hour

Calculate materials and labour variances

25

The SchopenhauerActual Data

Material A 1,100 kg costing £2,090 Material B 962.5 litres costing

£4,812.50 Labour 3,025 hours costing

£24,200 KEY POINT Need to compare standards at ACTUAL levels of output

26

Therefore… Standard use and hours at output

level of 550 units

Material A 1.5 X 550 = 825 kgs Material B 2.0 X 550 = 1,110 litres Labour 5 X 550 = 2,750 hours

And find Actual Unit costs Material A 2,090/1,100 = £1.90 per kg Material B 4,812.5/962.5 = £5.00 per litre Labour 24,200/3025 = £8.00 per hour

27

The SchopenhauerAnswer (a)

Material A Total Variance (Std Use X Std Price) – (Act Use

X Act Price) (825 X 2.00) – (1,100 X 1.90) =

440 (A)

28

The SchopenhauerAnswer (b)

Material A Sub Variances Usage Variance (Std Use – Act Use) X Std Price = (825 – 1,100) X 2.00 = 550 (A) Price Variance (Std Price – Act Price) X Act Use = (2.00 – 1.90) X 1,100 = 110 (F) So, 550 (A) + 110 (F) = 440 (A)

29

Material B & Labour Variances

Answers attached to handout

30

Overhead VariancesFixed & Variable

We saw from Absorption costing that Overhead Absorption Rates are calculated in advance

As estimates on materials and labour can be wrong

So can the amount of overhead absorbed

31

Variable Overhead Variances

Total Variance Sub-Variances

Expenditure Efficiency

32

Scenario Product “X” has a Variable

Overhead Cost of 2 hours X £1.50 = £3.00 per unit

Actual Results = Labour 820 hours of which 60

were idle 400 units made Actual Variable O’head = £1,230

33

Total Variance

Total Variance

400 units should incur (400 X £3)= 1,200 Actually incurred = 1,230 Variance

30(A)

34

Sub Variances Expenditure Variance Difference between amount of

variable o’head which Should have been incurred in

the hours “productively” worked (ie total hours – idle hours) and

Actual amount of variable overhead incurred

35

Sub Variances

Expenditure Variance Productive hours = 820 – 60 =

760 760 hours should cost (760 X 1.50) = 1,140 Actually Cost 1,230 Variance 90 (A)

36

Sub Variances

Efficiency Variance (similar to labour efficiency) (Std hrs – Productive hrs) X Std

O’H rate Std hours = 400 units X 2 hrs each

= 800 So (800 – 760) X 1.50 = 60 (F)

37

Sub Variances

Summary of Variable Overhead Variances

Expenditure 90 (A) Efficiency 60 (F) Total 30 (A)

Next Week Fixed O’H variances

38

IMPORTANT Standard Costing & Variance Analysis is a

KEY element of the course Do read Dyson Chapter 18 in 6th Edition Chapter 16 in 5th Edition Also recommended Colin Drury any of Cost & Management Accounting Cost & Management Accounting (an

introduction) Management Accounting for Business

Decisions All on Level 5 ref 657