Variance Analysis 5.15

7/31/2019 Variance Analysis 5.15

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Prudent Business Limited manufactures a single product, which has astandard cost of N80 made up as follows:

NDirect Materials 15 square metres at N3/sq. mtr. 45Direct Labour 5 hours at N4/hour 20Variable Overheads 5 hours at N2/hour 10Fixed Overheads 5 hours at N1/per hour 5

80

The standard selling price of the product is N100 per unit.The monthly budget projects production and sales of 1,000 units.Actual figures for the month of April are as follows:

Sales 1,200 units at N102Production 1,400 unitsDirect materials 22,000 square metres at N4 per square metreDirect wages 6,800 hours at N5Variable Overheads N11,000Fixed Overheads N6,000

You are required to prepare a trading account reconciling actual andbudgeted profit and showing all appropriate variances.

This is simply the difference between the Actual fixed overheadincurred and the fixed overhead absorbed using thepredetermined absorption rate.

From the Illustration 9-3N

Actual Fixed Overhead incurred was 6,000Absorbed Fixed Overhead (based on actualproduction) was 1,400 units x N5 7,000

Therefore, F/ohd cost variance (over-absorptionof overhead) 1,000 F

TE TWAWEZATE TWAWEZA 2012


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Fixed Overhead Expenditure Variance is simply that part of fixedoverhead cost variance which was due to the failure to budget

the amount of fixed overhead correctly, that is:N

Budgeted Fixed Expenditure (1,000 units x N5) 5,000Actual Fixed Overhead Expenditure 6,000

(1000) A

This is that part of fixed overhead cost variance, which was dueto the failure to budget production volume correctly. The readerwill recall from the topic Overhead Absorption that the

Absorption rate was predetermined by estimating the amount ofoverhead and the estimated volume. Thus:

Budgeted production volume 1,000 unitsActual production volume 1,400 unitsDifference 400 unitsTherefore, fixed overhead would be over absorbed @ N5 in thesum of 400 X N5that is, N2,000 F. This is the Fixed overhead volume variance.

Investigating the volume variance further, it would bediscovered that two major factors could be responsible. First, isthe capacity budgeted to work. That is, based on a budget of1,000 units and a working period of 5 hours per unit, thecompany had planned to work for 5,000 hours.

If the workers fail to work for the 5,000 hours, that is, underutilization of available capacity they might not succeed in

producing the 1,000 units except if they worked above normalefficiency. Hence, the efficiency of the labour force could alsoaffect the production volume.

It should, however, be borne in mind that we are working interms of labour hours and so the fixed overhead rate will have tobe expressed in terms of labour hours to obtain the fixedoverhead capacity and the fixed overhead efficiency variances.

Thus, in the Illustration 9-3,



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Budget Capacity = 1,000 x 5 hours, that is, 5,000 hours

Actual Hours Worked 6,800 hoursTherefore, Fixed Overhead Capacity Variance= 1,800 hours

=1,800 x N1(FOAR per hr)

= N1,800 F

It is favourable, because more hours worked should result inincreased production volume.

The effect of the efficiency of labour on overhead absorption.Actual hours allowed for actual output = 1,400 unit x 5 hours

= 7,000 hoursActual hours worked = 6,800 hoursHours saved = 200 hours

Therefore, Fixed Overhead Efficiency Variance = 200 x N1(FOAR per hour)

= N200 F

Reconciling, Fixed overhead volume variance:

The same idea of Overhead absorption would also help simplify thecalculation of variable overhead variances. Variable overhead costvariance is simply the difference between the Actual variable overheadexpenditure incurred and the Variable overhead absorbed.

N2,000 F

Fixed OverheadCapacity Variance

N1,800 F

Fixed OverheadEfficiency Variance

N200 F



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From the Illustration 9-3,N

Actual Variable Overhead Expenditure was 11,000Absorbed Fixed Overhead would beActual production x the predetermined absorptionrate (VOAR) that is, 1,400 x N10 14,000Therefore, Variable Overhead Cost Variance = 3,000 FThe variance is favourable because there was an over-recovery of theoverhead.

There is no volume variance in the Variable overhead analysis. This isbecause, by the very nature of this expenditure it should change when

there is a change in volume. For this reason, some cost analysts stopthe calculation of the variable overhead variance at the level of thevariable overhead cost and call it variable overhead expenditurevariance.

However, many analysts also attempt to go further to see the effect ofthe labour on the overhead recovery. Then variable overhead isanalysed into expenditure and efficiency. The calculation at this stageis quite similar to the calculation of the fixed overhead capacity andefficiency variances in that they use labour hours and express the

absorption rates in terms of labour hours.

This is based on the assumption that variable overhead varies withactual labour hours worked. Therefore, variable overhead expenditureis the difference between the actual variable overhead expenditure andthe allowed variable overhead expenditure based on actual hoursworked.

Hint: You can first calculate the variable overhead absorption rate perlabour hour. In this question, this becomes.

Budgeted Variable Overhead = N10,000Budgeted Labour Hour 5,000

= N2 per hour

Actual Variable Overhead Expenditure = N11,000Allowed Variable Overhead



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(6,800 hours x N2) = N13,600N2,600 F

This is the difference between the allowed variable overhead and theabsorbed variable overhead. If the time-based bonus schemes ofremuneration in Labour Costing in Chapter 3 is brought to mind, thevariable overhead efficiency variance can be looked at as the labourefficiency indicated by the time saved, but now valued at the variableoverhead absorption rate (VOAR) per labour hour.

that is, Allowed Variable Overhead Expenditure N(1,400 units x 5 x N2) 14,000

Absorbed Variable Overhead

(6,800 hours x N2) 13,600N400 F

Alternatively,Time Allowed (1,400 x 5) = 7,000 hoursTime Taken = 6,800Time Saved 200 hours

Therefore, Variable Overhead Efficiency Variance(200 hours x N2) = N400 F

This is the difference between the Budgeted Margin and the ActualMargin attained. Actual Margin should be understood, to be the Actualsales revenue less the Standard cost of sales.

From Illustration 9-3:

Total Sales Margin VarianceN

Actual Sales Revenue = 1,200 x N102 122,400Standard Cost of Sales = 1,200 x N80 96,000Therefore, Actual Margin is 26,400Budgeted Margin 1,000 units X (100 80) 20,000Therefore, Total Sales Margin Variance 6,400 F



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This is the variance due to selling at a price different from the standardselling price. This is similar to the material price and the labour rate

variances.N

Actual Quantity Sold @ Actual Selling Price (1,200 x 102) = 122,400Less Actual Quantity Sold @ Standard Selling Price

(1,200 x 100) = 120,0002,400 F

This is Profit Variance due to a change in budgeted volume:Budgeted volume = 1,000 units

Actual volume = 1,200 unitsDifference 200 units @Standard Margin ofN20 = N4,000 F

Exception to the variances computed above is sales margin variancewhere more than one product is for sales, that is, where it is possible ornecessary to calculate the sales margin (mix and quantity) variances.We can now illustrate how the operating statement reconcilingbudgeted profit with actual profit is prepared.

You are requested to complete the other cost variances on your own,

that is, material price, material usage, labour rate and labourefficiency. The operating statement should start with the name of theorganisation, and the title of the statement including the relevantperiod.

Fav AdvN N N

Budgeted Profit 20,000

Price 2,400Volume 4,000 6,400

26,400

Materials - Price 22,000- Usage 3,000

Labour - Rate 6,800- Efficiency 800



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Variable Overhead- Expenditure 2,600- Efficiency 400

Fixed Overhead- Expenditure 1,000- Volume 2,000

5,800 32,800 (27,000)

The listing of the variances explains why the Budgeted Profit was notachieved.

The actual loss can be proved as follows:

N N

Sales 1,200 x N102 122,400

Materials 22,000 x N4 88,000Labour 6,800 x N5 34,000Variable Overhead 11,000Fixed Overhead 6,000

139,000less: Closing stock at standard cost

200 x N80 (16,000)(123,000)

Where more than one product is sold, it is possible to isolate the effectson profit of a change in the volume due to proportions in which theproducts were sold, that is, the mix, and the absolute quantitydifference. The sales margin volume variance can be analysed into

sales margin mix variance and sales margin quantity (or yield)variance.

Two approaches are possible the unit approach and the sales valueapproach. Though, the unit approach will be used in this illustration, itis warned that where the relative sales value of the products aresignificantly different, it will be advisable to use the sales valueapproach. This will be considered at the higher level of your study,that is, in the Management Accounting paper.


Variance Analysis 5.15

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