1 Standard Costing & Variance Analysis Week 9

2 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

3 Standard Costs Most suitable in organisations With common or repetitive operations Where inputs required to produce outputs can be accurately measured

4 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.

5 What things can be Standard? All expected inputs to and outputs from the production process Direct Labour Direct Materials also Variable Overheads Fixed Overheads

6 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

7 Types of Standards Ideal Standard Usually this standard cannot be attained and leads to unfavourable variances as it assumes minimum prices for all costs optimal usage 100% manufacturing capacity Attainable Standard Can be met because it recognizes 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% capacity

8 Establishing Standards Variety of Methods: Past Experience Best Prices Available Current Wage Rates Anticipated Improvements Expected Market Variations Opportunity to re-evaluate production

9 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

10 Acme Wall Blocks Ltd Standard Costs Production run of batch of 1,200 wall blocks Standard Price of concrete25p per Kg Standard Use of concrete1,200 Kg Standard Cost of Labour£6.00 per hour Standard Time to make batch 60 hours

11 Acme Wall Blocks Ltd Actual Costs Actual Figures Actual Price of concrete30p per Kg Actual Use of concrete900 Kg Actual Cost of Labour£5.00 per hour Actual Time to make batch 68 hours of which 10 idle

12 Standard v Actual Cost of production Standard Cost of production Materials 1,200 X 25p300 Labour 60 X £ Total660 Actual Cost of production Materials 900 X 30p270 Labour 68 X £ Total610 Variance ( )50Favourable

13 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)

14 Materials Sub-Variances Price Variance (Std Price - Act Price) X Act Use = ( ) X 900 = 45 (A) Usage Variance (Std Use - Act Use) X Std Price = (1, ) X 0.25 = 75 (F) Summary Price Variance45 (A) Usage Variance75 (F) 30 (F)

15 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)

16 Labour Sub-Variances Wage Rate Variance (Std rate - Act Rate) X Act Hours = ( ) X 68 = 68 (F) Labour Efficiency Variance (Std Hours - Act Hours) X Std Rate = ( ) X 6.00 = 48 (A) Summary Wage Rate Variance68 (F) Labour Efficiency Variance48 (A) 20 (F)

17 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 = ( ) X 6.00 = 12 (F) Summary Idle Time Variance60 (A) Productive Efficiency Variance12 (F) 48 (A)

18 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

19 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 sub- variances Total variances can mask inefficiencies Materials variance may be favourable but Good purchasing may be ruined by Excessive waste

20 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?

21 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

22 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

23 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

24 The Schopenhauer An example Budgeted Output 600 units Actual Output 550 units [mention!!] Standards (PER UNIT) Material A 1.5 £2.00 per kg Material B 2.0 £5.00 per litres Labour 5 £8.50 per hour Calculate materials and labour variances

25 The Schopenhauer Actual Data Material A 1,100 kg costing £2,090 Material B litres costing £4, Labour 3,025 hours costing £24,200 KEY POINT Need to compare standards at ACTUAL levels of output

26 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 And find Actual Unit costs 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

27 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)

28 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) (F) = 440 (A)

29 Material B & Labour Variances Answers attached to handout

30 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

31 Variable Overhead Variances Total Variance Sub-Variances Expenditure Efficiency

32 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

33 Total Variance 400 units should incur (400 X £3)= 1,200 Actually incurred =1,230 Variance 30(A)

34 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

35 Sub Variances Expenditure Variance Productive hours = 820 – 60 = hours should cost (760 X 1.50) =1,140 Actually Cost1,230 Variance 90 (A)

36 Sub Variances Efficiency Variance (similar to labour efficiency) (Std hrs – Productive hrs) X Std OH rate Std hours = 400 units X 2 hrs each = 800 So (800 – 760) X 1.50 = 60 (F)

37 Sub Variances Summary of Variable Overhead Variances Expenditure90 (A) Efficiency60 (F) Total30 (A) Next Week Fixed OH variances

38 IMPORTANT Standard Costing & Variance Analysis is a KEY element of the course Do read Dyson Chapter 18 in 6 th Edition Chapter 16 in 5 th 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