Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Standard costing and variance analysis

CHAPTER 15

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.1a

Definition

• Standard costs are target costs for each operation that can be built up to produce a product standard cost.

• A budget relates to the cost for the total activity, whereas standard relates to a cost per unit of activity.

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.1b

Operation of a standard costing system1. Most suited to a series of common or repetitive organizations (this can result in the production of many different products).

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.1c

Operation of a standard costing system (cont.)

2. Variances are traced to responsibility centres (not products).

3. Actual product costs are not required.

4. Comparisons after the event provide information for corrective action or highlight the need to revise the standards.

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.2

An overview of a standard costing system

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.3a

Establishing cost standards

1. Two approaches: (i) past historical records (ii) engineering studies

2. Engineering studies A detailed study of each operation is undertaken: • direct material standards (standard quantity × standard prices) • direct labour standards (standard quantity × standard prices) • overhead standards:• cannot be directly observed and studied and traced to units of output;

• analysed into fixed and variable elements;• fixed tend not to be controllable in the short term.

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.3b

Standard hours produced

1. Used to measure output where more than one product is produced.

ExampleStandard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hoursOutput = 100 units of X, 200 units of Y, 300 units of ZStandard hours produced = (100 × 5 hours) + (200 ×2 hours) +(300 ×3 hours) = 1 800

2. If actual DLH are less than 1 800 the department will be efficient, whereas if hours exceed 1 800 the department will be inefficient.

Note: Different activity measures and other factors (besides activity)will influence cost behaviour.

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.4

Purposes of standard costing1. To provide a prediction of future

costs that can be used for decision-making.

2. To provide a challenging target that individuals are motivated to achieve.

3. To assist in setting budgets and evaluating performance.

4. To act as a control device by highlighting those activities that do not conform to plan.

5. To simplify the task of tracing costs to products for inventory valuation.

Figure 2 Standard costs for inventory valuation and profit measurement

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.5a

Direct material variances

1. Can be analysed by price and quantity.2. Material price variance• (SP – AP) × AQ (£10 – £11) x 19 000 = £19 000A (Material A) (£15 – £14) x 10 100 = £10 100F (Material B)• Possible causes• Should AQ be quantity purchased or quantity used?

ExamplePrice variance = 10 000 units purchased in period 1 at £1 over SP 2000 units per period used.Should £10 000 variance be reported in period 1 or £2 000 per period?

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.5b

3. Material usage variance• (SQ – AQ) × SP (9 000 x 2 kg = 18 000 - 19 000) x £10 = £10 000A (Mat.A) (9 000 x 1 kg = 9 000 - 10 000) x £15 = £16 500A (Mat.B)• Possible causes• Speedy reporting required

4. Joint price/usage variance• It could be argued that SQ used to compute price variance and that

(SP – AP) × (AQ – SQ) is reported as a joint price/usage variance.

5. Total material variance = SC – AC

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.6a

Direct labour and overhead variances

1. Can also be analysed into price and quantity.

2. Wage rate variance • (SR – AR) × AH (£9 – £9.60) x 28 500 = £17 100A • Possible causes

3. Labour efficiency variance • (SH – AH) × SR (9 000 x 3 hours = 27 000SHP - 28 500AH ) x £9 = 13 500A • Possible causes

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.6b

Direct labour and overhead variances (cont.)

4. Variable overhead expenditure variance • Flexed budget allowance (AH × SR) – Actual cost (28 500 x £2 = £57 000) – £52 00 = £5 000F • Possible causes

5. Variable overhead efficiency variance • (SH – AH) × SR (9 000 x 3 hours = 27 000SHP – 28 500AH) x £2 = £3 000A • Possible causes (note similarity to labour efficiency)

6. Fixed overhead expenditure (spending) variance • BFO – AFO (£1 440 000/12 = £120 000) – £116 000 = £4000F

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.7a

Sales variances

1. Variances should be computed in terms of contribution profit margins rather than sales revenues.

2. Example

Budgeted sales = 10 000 units × £11 = £110 000 Standard and actual cost

per unit = £7 Actual sales = 12 000 units ×£10 = £120 000 Variance in terms of sales value = £10 000F Variance in terms of contribution margin = £4 000A (Budgeted contribution margin = 10 000 × £4 = £40 000 Actual contribution margin = 12 000 × £3 = £36 000)

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.7b

3. Objective is to maximize profits (not sales value).

4. Total sales margin variance

Example Actual sales (9 000 × £90) = £810 000Standard VC of sales (9 000 × £68) = £612 000

£198 000

Budgeted contribution margin: 10 000 × £20 £200 000

Variance = £2 000 A

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.8

Sales variances (cont.)

5. Total sales contribution variance can be analysed further:

Sales margin price = (AP – BP) × AQ or (AM – BM) × AQSales margin volume = (AQ – BQ) × SM

Therefore,Sales margin price = (£90 – £88) × 9 000 = £18 000 FSales margin volume = (9 000 – 10 000)× £20 = £20 000 A

£2 000 A

Reconciliation of budgeted and actual profit (see slide 9).

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.9

Reconciliation of budgeted and actual profit

£ £ £Budgeted net profit 80 000Sales variances:Sales margin price 18 000 FSales margin volume 20 000 A 2 000 ADirect cost variances:Material: Price 8 900 A Usage 26 500 A 35 400 ALabour: Rate 17 100 AEfficiency 13 500 A 30 600 AManufacturing overhead variances:Fixed overhead expenditure 4 000 FVariable overhead expenditure 5 000 FVariable overhead efficiency 3 000 A 6 000 F 62 000 A

Actual profit 18 000

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Standard absorption costing

1. For financial accounting (stock valuation) fixed overheads must be allocated to products. This results in a volume variance.

2. Fixed overhead rate = budgeted fixed overhead = £12 per unitbudgeted activity (10 000 units)

or £120 000 /30 000 hours = £4 per standard hour = £12 per unit (3 ×£4).

3. If actual production is different from budgeted production, a volume variance will arise:

Actual production = 9 000 units or 27 000 SHP Budgeted production = 10 000 units or 30 000 SHP Volume variance = 1 000 units × £12 or (3 000 SHP ×£4) = £12 000A Volume variance = (AP – BP) × SR

15.10a

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

4. Volume variances are not useful for cost control since FC are sunk costs.

5. Sometimes analysed into two sub-variances (capacity and efficiency):

(A) Budgeted hours of input and output = 30 000(B) Actual hours of input = 28 500(C) Actual hours of output = 27 000

Volume variance = A – C = 3 000 hours (£12 000)Capacity variance = A – B = 1 500 hours (£6 000)Efficiency variance = B – C = 1 500 hours (£6 000)

15.10b

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Reconciliation of budgeted and actual profit (absorption costing)

To reconcile the budget and actual profit with an absorption costing system, the sales volume margin variance is measured at the standard profit margin (and not the contribution margin), i.e.1 000 units × £8 = £8 000.

15.11a

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

£ £ £ £Budgeted net profit 80 000Sales variances

Sales margin price 18 000 FSales margin volume 8 000 A 10 000 F

Direct cost varianceMaterial Price: Material A 19 000 A

Material B 10 100 F 8 900 AUsage: Material A 10 000 A

Material B 16 500 A 26 500 A 35 400 ALabour Rate 17 100 A

Efficiency 13 500 A 30 600 AManufacturingin overhead variancesFixed Expenditure 4 000 F

Volume capacity 6 000 AVolume efficiency 6 000 A 8 000 A

Variable Expenditure 5 000 FEfficiency 3 000 A 2 000 F 6 000 A 62 000 A

Actual profit 18 000

15.11b

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Recording standards costs in the accounts

1. Purchase of materials (Material A)Dr Stores ledger control account (AQ × SP) 190 000Dr Materials price variance 19 000

Cr Creditors control 209 000

2. Issue of materials (Material A)Dr Work in progress (SQ ×SP) 180 000Dr Material usage variance 10 000

Cr Stores ledger control account (AQ × SP) 190 000

15.12a

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.12b

3. Recording of wages due

Dr Wages control account (actual cost) 273 600Cr Wages accrued account 273 600

The wages control account is cleared as follows:

Dr Work in Progress (SQ ×SP) 243 000Cr Wages control account 243 000

Dr Wage rate variance 17 100Dr Labour efficiency variance 13 500

Cr Wages control account 30 600

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.12c

4. Manufacturing overhead cost incurred

Dr Factory variable overhead control account 52 000Dr Factory fixed overhead control account 116 000

Cr Expense creditors 168 000

5. Absorption of fixed manufacturing overheadDr Work in progress (SQ ×SP) 108 000Dr Volume variance 12 000

Cr Factory fixed overhead control account 120 000

Dr Factory fixed overhead control account 4 000Cr Fixed overhead expenditure variance 4 000

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

Cost and Management Accounting: An Introduction, 7th editionColin Drury

ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA

15.12d

6.Variable manufacturing overhead

Dr Work in progress (SQ ×SP) 54 000Dr 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 productionDr 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.