Management Accounting & Decisions II N12401

Lecture 3

Standard Costing: Additional Variances

by Hung Woan-Ting

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Learning Objectives

1. To understand and be able to quantify the analysis for fixed overhead costs

2. To appreciate different costing principles within a standard costing environment

3. To appreciate how changes in anticipated environment should be reflected in variances analysis

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0.0 Revisiting the concept

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0.0 Revisiting the concept

• Chicken roll (P*Q)

• Egg (P*Q)

• Cheese (P*Q)

• McMuffin (P*Q)

• …

Standard Cost Card

• Meal (P*Q)

• Laundry (P*Q)

• Care time (P*Q)

• Lab test (P*Q)

• Medicine (P*Q)

• …

Standard Cost Card

• Engine (P*Q)

• Valve (P*Q)

• Fuel Tank (P*Q)

• Brake (P*Q)

• Headlamp (P*Q)

• Wheel (P*Q)

• Audio (P*Q)

• …

Standard Cost Card

•Manufacturing costs •Cost competiveness • Assembly line defect rate •…

Effective cost control Price & Quantity

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0.1 Revisiting Cost Classifications

Total Costs

Material Costs

Labour Costs

Other Manufacturing Costs

Non-manufacturing costs

PRODUCT

Purpose: Cost analysis for better management

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0.2 Cost Analysis for Management

Reflecting cost behaviour in cost analysis The flexible budgeting approach

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0.3 Cost Analysis for Management

VARIABLE COSTS

ANALYSIS

DIRECT MATERIAL

COST

DIRECT LABOUR COST

VARIABLE OH

FIXED COSTS

ANALYSIS

FIXED OH

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1.0 Determining Fixed MOH Variances

Example

• Budgeted output 1000 units

• Budgeted Fixed MOH ₤3500

• All OHs allocated on direct labour hour basis

• Std direct labour hour = 7

• Actual output 900 units. Actual Fixed MOH ₤2800

• Actual hours worked 6100

Std Rate

= ₤__ per hr

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1.1 Expenditure Variance

• Expected to be constant within the relevant range of activities and in the short term

• What happens when spending differs from plan?

• Fixed MOH Expenditure Variance

Budgeted Fixed MOH – Actual Fixed MOH

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1.1 Expenditure Variance

Fixed MOH Expenditure Variance

= Budgeted Fixed MOH – Actual Fixed MOH

= ₤3500 - ₤2800

= ₤700 ( )

Managerial implications ??

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1.2 Volume Variance

• Fixed MOH may be allocated (absorbed) into products (external financial reporting regulation; pricing; etc.)

• Standard costing system records (absorbs) budgeted fixed MOH via pre-determined rate (budgeted labour

hours; machine hours; etc.)

• What happens when actual volume differs from plan?

• Fixed MOH Volume Variance

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1.2 Volume Variances

Fixed MOH Volume variance

= (Actual Vol.–Budgeted Vol.) @ Std Rate

= (Actual Vol.*Std Rate)–(Budgeted Vol.*Std Rate)

= Absorbed Fixed MOH – Budgeted Fixed MOH

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[Refer Slide #8]

Fixed MOH Volume variance

= Absorbed Fixed MOH – Budgeted Fixed MOH

= 900units*7h*₤0.5p.h. – 1000units*7h*₤0.5p.h.

= ₤3150 – ₤3500

= ₤350 ( )

1.2 Volume Variances

Managerial implications ??

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2.0 Different Costing Principles – revisit

Variable Costing vs. Absorption Costing

Pro

duct

Cost

Pro

duct

Cost

• Purposes (internal vs. external)

• Stock valuation • Timing of release of Fixed MOH

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2.1 Standard Variable Costing System

• Stock @ Standard Variable Manufacturing Costs

• Budgeted Fixed MOH expensed off as incurred

• Analysis of cost variances – reflect cost structure

Pro

duct

Cost

Direct Material

Direct Labour

Variable MOH

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2.2 Standard Absorption Costing System

• Stock @ Standard Total Manufacturing Costs

• Budgeted Fixed MOH allocated to products

• Analysis of cost variances – reflect cost structure

Pro

duct

Cost

Direct Material

Direct Labour

Variable MOH

Fixed MOH

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2.3 Volume Variance [up close]

Making more sense out of Volume Variance for better business management?

Example:

How is the current use of capacity?

Any idle capacity?

$¢ ?

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2.3 Volume Variance [up close]

Static Budget

Flexible Budget

Actual Results

BV AV AV

*SH *AH * SH

@ SR @ SR @ SR

Variance due to capacity usage

(Actual hours – Budget hour) *Std Rate = (6100 – 1000*7h) *₤0.5p.h. = ₤450 ( )

= Volume Capacity Variance

Managerial implications ??

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2.3 Volume Variance [up close]

Static Budget

Flexible Budget

Actual Results

BV AV AV

*SH *AH * SH

@ SR @ SR @ SR

Variance due to labour efficiency

(Allowed hours – Actual hour)*Std Rate = (900*7h – 6100)* ₤0.5p.h. = ₤100 ( )

= Volume Efficiency Variance

Managerial implications ??

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3.0 Changes in Anticipated Environment

Actual performances compared with planned performance (standard set based on anticipated environment)

Total Variances

Ex-post analysis approach ~ reflect changes in anticipated

environment (Demski, 1977)

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3.1 Changes in Anticipated Environment

Ex-post analysis approach

Original standard

Actual outcome

Planning Variance

Operating Variance

Ex-post standard (given the benefit of hindsight)

Managerial implications ??

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Planning variances

Operational variances

3.2 Ex-post Variance Analysis - Example

Budgeted output from production 1,000 units.

Std cost for Material A: 3kg @ ₤2/kg.

After the budget was set, the local government announced a sharp increase in fuel price and the cost of Mat A was raised to ₤2.30/kg for the near foreseeable future.

Actual output 900 units.

Cost of Mat A actually incurred: ₤2.20/kg for 2,800kg.

Mat Price Variance = (₤__- ₤__)*2800kg = ₤__ (_) Mat Usage Variance = (3kg*900units – 2800kg)* ₤ __ = ₤ __ (_)

Material Price Planning variance = (₤__- ₤ __)*3kg*1000units = ₤__ (_)

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– GNBCY Ch12

– D Ch17, Ch18

– Cheatham & Cheatham (1996) ‘Re-designing Cost Systems: Is Standard Costing Obsolete?’, Accounting Horizons, Dec, Vol 10(4): 23-31

– Johnsen & Sopariwala (2000) “Standard Costing is Alive and Well at Parker Brass”, Management Accounting Quarterly, Winter, Vol 1(2): 1-9.

– KPMG (2010) Standard costing: Insights from leading companies, in association with CIMA.

End of Lecture

Readings

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Seminar 1 preparation

Attempt the Questions Set (at the back of this handout)

Indicative solutions in Moodle.

Please refer before attending seminar

Seminar starts next week!

(Details in Module Outline Document, p6)

Remember to go by your registered grouping

Exe.