Standard Costing & Variance Analysis

Week 9

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
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Standard Costs

Most suitable in organisations With common or repetitive operations Where inputs required to produce outputs can be accurately measured
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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.
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What things can be Standard?

All expected inputs to and outputs from the production process Direct Labour Direct Materials also Variable Overheads Fixed Overheads
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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
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Types of Standards

Ideal Standard Usually this standard cannot be attained and leads to unfavourable variances as it assumes

Attainable Standard Can be met because it recognizes

minimum prices for all costs optimal usage 100% manufacturing capacity

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% capacity7

Establishing Standards

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

Opportunity to re-evaluate production

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
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Acme Wall Blocks Ltd Standard 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
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Acme Wall Blocks Ltd Actual Costs

Actual Figures Actual Price of concrete 30p per Kg

Actual Use of concrete 900 Kg Actual Cost of Labour 5.00 per hour Actual Time to make batch 68 hours of which 10 idle
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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

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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)

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

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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)

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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 Labour Efficiency Variance 68 (F) 48 (A) 20 (F)

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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 Productive Efficiency Variance 60 (A) 12 (F) 48 (A)
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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
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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 subvariances Total variances can mask inefficiencies Materials variance may be favourable but Good purchasing may be ruined by Excessive waste
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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?
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Analysis of Acme Wall Blocks Labour

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
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Materials Variances Summary

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
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Labour Variances Summary

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
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The Schopenhauer An 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
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The Schopenhauer Actual 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

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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 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
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And find Actual Unit costs

The Schopenhauer Answer (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)

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The Schopenhauer Answer (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)
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Material B & Labour Variances

Answers attached to handout

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Overhead Variances Fixed & 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
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Variable Overhead Variances

Total Variance Sub-Variances Expenditure Efficiency

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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 Ohead = 1,230
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Total Variance

Total Variance 400 units should incur (400 X 3)= Actually incurred = Variance

1,200 1,230 30(A)

Sub Variances

Expenditure Variance Difference between amount of variable ohead which Should have been incurred in the hours productively worked (ie total hours idle hours) and Actual amount of variable overhead incurred
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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)
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Sub Variances

Efficiency Variance (similar to labour efficiency)

So (800 760) X 1.50 = 60 (F)

Sub Variances

Summary of Variable Overhead Variances Expenditure 90 (A) Efficiency 60 (F) Total 30 (A) Next Week Fixed OH variances
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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 38