Management and Cost Accounting, 6

th
edition, ISBN 1-84480-028-8
2004 Colin Drury
MANAGEMENT
AND COST
ACCOUNTING
SIXTH EDITION

COLIN DRURY
Management and Cost Accounting, 6
th
edition, ISBN 1-84480-028-8
2004 Colin Drury
2000 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
2000 Colin Drury
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
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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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.1c
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.2
2000 Colin Drury
An overview of a
standard costing
system
Management and Cost Accounting, 6
th
edition, ISBN 1-84480-028-8
2004 Colin Drury
18.3a
2000 Colin Drury
Establishing cost standards

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

2. 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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.3b
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.4
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.5a
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.5b
2000 Colin Drury
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 - 10 000) 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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.6a
2000 Colin Drury
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 - 28 500AH ) x 9 = 13 500A
Possible causes
Management and Cost Accounting, 6
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.6b
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.7a
2000 Colin Drury
Sales variances

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

2. Example

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

(Budgeted contribution margin =10 000 4 = 40 000
Actual contribution margin =12 000 3 = 36 000)
Management and Cost Accounting, 6
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18.7b
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3. Objective is to maximize profits (not sales value).

4. Total sales margin variance

Example 18.1
Actual contribution
Actual sales (9 000 90) = 810 000
Standard VC of sales (9 000 68) = 612 000
198 000

Budgeted contribution margin: 10 000 20 200 000

Variance = 2 000 A
Management and Cost Accounting, 6
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.8
2000 Colin Drury
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
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.9
2000 Colin Drury
Reconciliation of budgeted and actual profit


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

Actual profit 18 000
Management and Cost Accounting, 6
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.10a
2000 Colin Drury
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 = 12 per unit
budgeted activity (10 000 units)

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 = 9 000 units or 27 000 SHP
Budgeted production = 10 000 units or 30 000 SHP
Volume variance = 1 000 units 12 or (3 000 SHP 4) = 12 000A
Volume variance = (AP BP) SR

Management and Cost Accounting, 6
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edition, ISBN 1-84480-028-8
2004 Colin Drury
18.10b
2000 Colin Drury
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 = 30 000
(B) Actual hours of input = 28 500
(C) Actual hours of output = 27 000

Volume variance = A C = 3 000 hours (12 000)
Capacity variance = A B = 1 500 hours (6 000)
Efficiency variance = B C = 1 500 hours (6 000)
Management and Cost Accounting, 6
th
edition, ISBN 1-84480-028-8
2004 Colin Drury
18.11a
2000 Colin Drury
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
2000 Colin Drury

Budgeted net profit 80 000
Sales variances
Sales margin price 18 000 F
Sales margin volume 8 000 A 10 000 F
Direct cost variance
Material Price: Material A 19 000 A
Material B 10 100 F 8 900 A
Usage: Material A 10 000 A
Material B 16 500 A 26 500 A 35 400 A
Labour Rate 17 100 A
Efficiency 13 500 A 30 600 A
Manufacturingin overhead variances
Fixed Expenditure 4 000 F
Volume capacity 6 000 A
Volume efficiency 6 000 A 8 000 A
Variable Expenditure 5 000 F
Efficiency 3 000 A 2 000 F 6 000 A 62 000 A
Actual profit 18 000