MANAGEMENT AND COST ACCOUNTING

SIXTH EDITION

COLIN DRURY

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

Part Four: Information for planning, control and performance Chapter Eighteen: Standard costing and variance analysis 1

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.1a

• •

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.

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.1b

Operation of a standard costing system

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

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.1c

Operation of a standard costing system (contd.)

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.

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.2

An overview of a standard costing system

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.3a

Establishing cost standards

1.

2.

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

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.3b

Standard hours produced

1.

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

Example

Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours Output = 100 units of X, 200 units of Y, 300 units of Z Standard 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.

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.4

Purposes of standard costing

1.

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 18.2 Standard costs for inventory valuation and profit measurement

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.5a

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?

Example

Price 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 £2000 per period?

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.5b

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 0 00) 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 pricevariance and that (SP – AP) × (AQ – SQ) is reported as a joint price/usage variance.

5. Total material variance = SC – AC

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.6a

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 • Possible causes 28 500AH ) x £9 = 13 500A

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.6b

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

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.7a

Sales variances

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

2.

Example

Budgeted sales Standard and actual cost per unit Actual sales Variance in terms of sales = 10 000 units = 12 000 units value Variance in terms of contribution margin × £11 ×£10 (Budgeted contribution margin =10 000 × £4 = £40 000 Actual contribution margin =12 000 × £3 = £36 000) = £110 000 = £7 = £120 000 = £10 000F = £4 000A

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.7b

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

4. Total sales margin variance

Example 18.1

Actual contribution Actual sales (9 000 × £90) Standard VC of sales (9 000 × £68) Budgeted contribution margin: 10 000 × £20 Variance = £810 000 = £612 000 £198 000 £200 000 = £2 000 A

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.8

Sales variances (contd.)

5. Total sales contribution variance can be analysed further: Sales margin price = (AP – BP) × AQ or (AM – BM) × AQ Sales margin volume = (AQ – BQ) × SM Therefore, Sales margin price = (£90 – £88) × 9 000 = £18 000 F Sales margin volume = (9 000 – 10 000)× £20 = £20 000 A £2 000 A Reconciliation of budgeted and actual profit (see slide 18.9).

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.9

Reconciliation of budgeted and actual profit

£ £ Budgeted net profit Sales variances: Sales margin price Sales margin volume Direct cost variances: Material: Price Usage Labour: Rate Efficiency Manufacturing overhead variances: Fixed overhead expenditure Variable overhead expenditure Variable overhead efficiency 18 000 F 20 000 A 8 900 A 26 500 A 17 100 A 13 500 A 4 000 F 5 000 F 3 000 A Actual profit 2 000 A 35 400 A 30 600 A 6 000 F £ 80 000 62 000 A 18 000

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.10a

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

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.10b

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 (B) Actual hours of input (C) Actual hours of output Volume variance Capacity variance Efficiency variance = A – C = A – B = B – C = 30 000 = 28 500 = 27 000 = 3 000 hours (£12 000) = 1 500 hours (£6 000) = 1 500 hours (£6 000)

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.11a

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.

Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury

18.11b

Budgeted net profit Sales variances Sales margin price Sales margin volume Direct cost variance Material Price: Usage: Labour Rate Efficiency Manufacturingin overhead variances Fixed Expenditure Variable Volume capacity Volume efficiency Expenditure Efficiency Actual profit Material A Material B Material A Material B £ £ £ £ 80 000 18 000 F 8 000 A 10 000 F 19 000 A 10 100 F 10 000 A 16 500 A 8 900 A 26 500 A 17 100 A 13 500 A 35 400 A 30 600 A 4 000 F 6 000 A 6 000 A 5 000 F 3 000 A 8 000 A 2 000 F 6 000 A 62 000 A 18 000 Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury