topic 34 standard costing + variance analysis

• Standard costing is the setting of pre determined levels of costs and revenues that ought to be achievable with efficient working practices and reasonable levels of performance when manufacturing a product
• Standard costing is an example of management by exception and is used when setting budgets
• A variance is the difference between budgeted (standard) revenue and costs and actual revenue and costs
• Adverse variance is when actual costs>budgeted costs or actual revenue<budgeted revenue
• Favourable variance is when actual costs<budgeted costs or actual revenue>budgeted revenue
• Cost variances: (standard quantity x standard price) - (actual quantity x actual price)
• Revenue variances: (actual quantity x actual price) - (standard quantity x standard price)
• Usage variance: (standard usage - actual usage) x standard price
• Price varaince: (standard price - actual price) x actual usage
• Total direct materials variance: (standard usage x standard price) - (actual usage x actual price)
• Efficiency variance: (standard hours - actual hours) x standard wage
• Rate variance: (standard wage - actual wage) x actual hours
• Total direct labour variance: (standard hours x standard wage) - (actual hours x actual wage)
• Direct material usage sub variance causes:

  Favourable:

  -better quality materials

  -better skilled workers

  -'state of the art' capital equipment

  Adverse:

  -poorer quality materials

  -less skilled workers

  -poor capital equipment/breakdowns

  -theft or deterioration of materials
• Direct material price sub variance causes:

  Favourable:

  -deflation

  -supplier reducing price

  -poorer quality materials

  -larger quantity/eos/trade discount

  -appreciation of currency

  Adverse:

  -inflation

  -supplier increasing price

  -better quality materials

  -smaller quantity/dos/loss of discount

  -depreciation of currency
• Direct labour efficiency sub variance causes:

  Favourable:

  -higher skilled labour - quicker

  -better machinery

  -high morale/motivation/conditions

  Adverse:

  -unskilled labour - slower

  -poor machinery

  -poor morale/motivation/conditions
• Direct labour rate sub variance causes:

  Favourable:

  -less skilled workers - lower pay

  -deflation

  -reduction in overtime

  Adverse:

  -skilled workers - higher pay

  -inflation

  -increase in overtime
• Positive correlation between some variances:

  -an adverse material usage variance might be due to inexperienced staff and this would be accompanied by an adverse labour efficiency variance

  -an adverse labour efficiency sub variance could be due to inexperienced staff, taking longer to do work so firm has to pay for overtime
• Negative correlation between some variances:

  -higher skilled labour will be more productive but paid a higher wage

  -higher skilled labour will waste less materials so favourable material usage sub variance but an adverse labour rate sub variance
• Volume variance: (actual volume - standard volume) x standard price
• Price variance: (actual price - standard price) x actual volume
• Reconciliation of variances to revised profit:

  • budgeted profit will be based on budgeted revenue minus budgeted costs
  • actual profit will be based on actual revenue minus actual costs
  • difference between the two figures can be reconciled to the variances

  *Budgeted profit + Favourable variances - Adverse variances = Actual profit
• Sales volume sub variance causes:

  Favourable:

  -less competition

  -more aggressive marketing strategy

  -quality product

  Adverse:

  -more competition

  -less aggressive marketing strategy

  -defective product

  Also in general, change in customer tastes and seasonal variations in sales
• Sales price sub variance causes:

  Favourable:

  -increase in price to cover higher costs

  -increase in price after short term reduction

  Adverse:

  Reduction in price as marketing tool
• Positive correlation for sales sub variances:

  -high quality materials will mean a favourable materials usage sub variance and a higher quality product so a favourable sales volume sub variance
• Negative correlation for sales sub variances:

  -demand theory shows an inverse relationship between price and quantity demanded (PED)

  -buying better quality materials will lead to less wastage so favourable material usage sub variance but a higher price so an adverse sales volume sub variance

  -better quality materials mean an adverse materials price sub variance but a higher price will be charged so a favourable sales price sub variance
• Benefits of using a standard costing system:

  • minimises wastage by detecting adverse variances allowing correction to be done
  • draws management attention to areas not performing
  • provides a yardstick for performance evaluation
  • provides the basis for incentive schemes (motivation)
  • acts as an effective tool for business planning/budgeting
• Flexed budget

  When actual output is different to planned output, there will be a difference in material usage and labour hours which is not necessarily an adverse or favourable variance
• Calculating the standard cost of the actual output

  1. Multiply the standard volume per unit by the actual output

  2. To calculate the standard cost of the actual output (materials usage and labour efficiency only)