1. MANAGEMENT AND COST ACCOUNTING
SIXTH EDITION
COLIN DRURY

2. Information for planning, control and performance Chapter Nineteen:
Part Four:
Information for planning, control and performance
Chapter Nineteen:
Standard costing and variance analysis 2- further aspects
© 2000 Colin Drury

3. 19.1a
Mix variance
1. A mix variance arises when the actual mix differs from the predetermined standard mix.
Example
Standard mix to produce 9 litres of output:
5 litres of X at £7 per litre = £35
3 litres of Y at £5 per litre = £15
2 litres of Z at £2 per litre = £ 4
£54
Standard loss =10% of input. Actual output = litres
Actual inputs: £
litres of X at £7 =
litres of Y at £ =
litres of Z at £ =
© 2000 Colin Drury

4. 19.1b 2. Mix variance = (AQ in standard mix – AQ) × SP
AQ in standard mix ×SP £ AQ ×SP £
X = × 5/10 × £ × £
Y = × 3/10 × £ × £
Z = × 2/10 × £ × £
Mix variance = £9 000 A
© 2000 Colin Drury

5. 19.2
Yield variance
1. Yield variance is the difference between the standard output for a given level of inputs and the actual output:
= (Actual yield –Standard yield from actual input)
× SC per unit of output
= ( – )× £54/9 =£ F
2. Possible causes
3. Mix and yield variances are interrelated and should not be
interpreted in isolation.
Summary
Total variance = SC ( ×£6) – AC (£ ) = £5 000 A
Price variances £ A
+ Mix variance £ A
+ Yield variance £ F
£ A
© 2000 Colin Drury

6. Sales mix and quantity variances
1. Where a company sells several different products that have
different profit margins, it is possible to divide the sales volume variance into a quantity and mix variance.
Example
Budgeted sales
X = units at £20 contribution =
Y = units at £12 contribution =
Z = units at £9 contribution =
Actual sales
X = units at £20 contribution =
Y = units at £12 contribution =
Z = units at £9 contribution =
© 2000 Colin Drury

7. 19.3b Sales mix and quantity variances (contd.)
2 .Mix variance = (AQ – AQ in budgeted proportions) × Standard margin
AQ – AQ in budgeted proportions Standard margin
X – (40%) × £20 = £ A
Y – (35%) × £12 = £ A
Z – (25%) × £9 = £ F
£ A
© 2000 Colin Drury

8. 19.4 Sales mix and quantity variances (contd.)
3. Quantity variance = (AQ in budgeted
proportions – BQ) × SM
X = ( – 8 000) × £20 = £ F
Y = ( – 7 000) × £12 = £ F
Z = ( – 5 000) × £9 = £ F
£ F
4. If planned mix had been achieved the sales volume variance would
have been £ F.
© 2000 Colin Drury

9. Recording standards costs in the accounts
1. Purchase of materials (Material A)
Dr Stores ledger control account (AQ × SP)
Dr Materials price variance
Cr Creditors control
2. Issue of materials (Material A)
Dr Work in progress (SQ ×SP)
Dr Material usage variance
Cr Stores ledger control account (AQ × SP)
© 2000 Colin Drury

10. 19.5b 3. Recording of wages due
Dr Wages control account (actual cost)
Cr Wages accrued account
The wages control account is cleared as follows:
Dr Work in Progress (SQ ×SP)
Cr Wages control account
Dr Wage rate variance
Dr Labour efficiency variance
Cr Wages control account
© 2000 Colin Drury

11. 19.6a 4. Manufacturing overhead cost incurred
Dr Factory variable overhead control
account
Dr Factory fixed overhead control account
Cr Expense creditors
5. Absorption of fixed manufacturing overhead
Dr Work in progress (SQ ×SP)
Dr Volume variance
Cr Factory fixed overhead control
account
Dr Factory fixed overhead control account
Cr Fixed overhead expenditure variance
© 2000 Colin Drury

12. 19.6b 6.Variable manufacturing overhead
Dr Work in progress (SQ ×SP)
Dr Variable overhead efficiency variance
Cr Factory variable overhead control
account
Dr Factory variable overhead control
account
Cr Variable overhead expenditure
variance account
7. Completion of production
Dr Finished stock account
Cr Work in progress
Note that the variances are transferred to the profit and loss account at the end of the period.
© 2000 Colin Drury

13. Ex post variance analysis
1. A major criticism is that actual performance is compared with a standard based on the environment that was anticipated when the standard was set.
2. It is argued that an ex post variance analysis approach should be adopted that distinguishes between planning and operating variances.
3. A Original standard
B Ex post standard given the benefit of hindsight
C Actual outcome
Planning variance = A – B
Operating variance = B – C
© 2000 Colin Drury

14. 19.7b
4. Example
SP = £5 per unit, market price at time of purchase = £5.20
Actual purchases = units at £5.18
Conventional variance analysis = × £0.18 = £1 800 A
Ex post analysis:
Purchase planning variance = (£5 –£5.20) × = £2 000 A
Purchase efficiency variance = (£5.20 –£5.18) × = £200 F
£1 800 A
© 2000 Colin Drury

15. 19.7c 5. Sales variances Assume:
Budgeted sales =10% market share (10% × 1m units)
Actual sales = units
Actual industry sales volume = 1.2m units
Budgeted and actual contribution = £100
Ex post standard = units (10% × 1.2m)
Conventional sales variance = £1m favourable ( × £100)
Ex post analysis: Planning variance = 2m favourable ( × £100)
Appraisal variance = £1m adverse ( × £100)
© 2000 Colin Drury

16. Investigation of variances
19.8
Investigation of variances
1. Variance investigation models can be classified into the following categories:
• Simple rule of thumb models.
• Statistical models that do not incorporate costs and benefits of investigation.
• Statistical decision models that take into account the cost and benefits of
investigation.
2. Reasons for variances
• Measurement errors.
• Out-of-date standards.
• Out-of-control operations.
• Random or uncontrollable factors.
3. Investigation will indicate that variance is due to:
• Random uncontrollable factors when the operation is under control.
• Assignable causes, but the cost of investigation exceeds benefits.
• Assignable causes, but the benefits of investigation exceed the cost.
Note : The aim is to investigate only those variances in the final category.
© 2000 Colin Drury

17. 19.9a
Statistical investigation models not incorporating cost and benefits
1. Assume actual observations when under control indicate a mean usage of 10 kg per unit with a SD of 1 kg (normally distributed).
Actual usage is kg for an output of units. Therefore,average usage = 12 kg per unit.
Z = Actual usage (12 kg)– Expected usage (10 kg) = SD (1 kg)
© 2000 Colin Drury

18. 19.9b
Normal distribution table indicates that an observation 2 SDs from the mean has a probability of 2.275%.
Thus the probability of actual average material usage per unit of output being 12 kg or more when the operation is under control is 2.275%.It is very unlikely that material usage comes from ‘in control distribution ’.
Statistical control charts,which rely on the above principles,can be used to monitor resources usage and the probability that operations are out of control.(See figure on sheet )
© 2000 Colin Drury

19. 19.10
Statistical quality control charts
© 2000 Colin Drury

20. 19.11 Variance investigation decision models
1. Bierman et al model assumes two mutually exclusive states exist:
(i) System in control and variance due to random factors.
(ii) System out of control and corrective action can be taken
to remedy the situation.
2. If the process is out of control there is a benefit (B) associated with
returning it to its in - control state (i.e.cost savings from avoiding
variances in future periods). Assume B = £400.
3. Let C = cost of investigation (assume C = £100).
Let P = probability that the process is out of control.
4. Expected benefit = PB
5. Investigate if PB > C, or P > C/B
6. P >100 /400 =0.25
7. P (Process is in control) = (see sheet 19.9)
8. P (Process out of control) =1 – =
9. Decision = Investigate the variance
10. Note the difficulty in estimating C and B.
© 2000 Colin Drury

21. Criticisms of standard costing
• The usefulness of standard costing has been questioned, and its demise predicted, because of the following:
The changing cost structure
Inconsistency with modern management approaches
Over-emphasis on the importance of direct labour
Delay in feedback reporting
© 2000 Colin Drury

22. The future role of standard costing
19.12b
The future role of standard costing
• Standard costs and variance analysis required for many other purposes
besides cost control and performance evaluation: (e.g. tracking costs for
inventory valuation and maintaining a database for decision-making)
• Variance analysis adapted to report on items that are company specific.
• Shift from treating the variances as the foundations for cost control and
performance evaluation to being one among a broader set of measures.
• Empirical evidence suggests that practitioners still regard variance
analysis as being important for cost control.
• Can still play a useful role within ABC systems particularly in relation to
controlling unit-level and batch-level activities.
© 2000 Colin Drury

23. 19.13a The future role of standard costing (cont.)
• ABC and variance analysis:
Most appropriate for controlling the costs of unit-level activities.
Can also provide meaningful information for controlling those costs that are fixed in the short-term but variable in the longer-term provided suitable cost drivers can be established.
© 2000 Colin Drury

24. 19.13b Example Costs of set-up activity: Budget Actual
Activity level (1 600 set-ups) Total FC (£70 000)
Practical capacity supplied (2 000 set-ups) Total VC (£39 000)
Total fixed costs (£80 000)
Total variable costs (£40 000)
Cost driver rates:
Variable (£25 per set-up)
Fixed (£40 per set-up)
Variance analysis for fixed set-up expenses:
Set-up expenses charged to products (1 500 × £40)
Budgeted unused capacity variance (400 × £40) A
Capacity utilization variance (100 × £40) A
Expenditure variance F
Total actual expenses
© 2000 Colin Drury

25. 19.14 The future role of standard costing (contd.)
• ABC and variance analysis:
Variance analysis for variable set-up expenses:
Variable set-up expenses charged to products
(1 500 ×£25)
Variable overhead variance (Flexed budget —
Actual cost) A
Total actual expenses
© 2000 Colin Drury