Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Standard costing and variance analysis CHAPTER 15 Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.1a 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. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.1b 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). Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.1c Operation of a standard costing system (cont.) 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. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.2 An overview of a standard costing system Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.3a 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. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.3b 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) = If actual DLH are less than the department will be efficient, whereas if hours exceed the department will be inefficient. Note: Different activity measures and other factors (besides activity)will influence cost behaviour. Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.4 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 2 Standard costs for inventory valuation and profit measurement Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.5a Direct material variances 1. Can be analysed by price and quantity. 2. Material price variance (SP AP) AQ (10 11) x = 19 000A (Material A) (15 14) x = 10 100F (Material B) Possible causes Should AQ be quantity purchased or quantity used? Example Price variance = units purchased in period 1 at 1 over SP 2000 units per period used. Should variance be reported in period 1 or 2 000 per period? Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.5b 3. Material usage variance (SQ AQ) SP (9 000 x 2 kg = ) x 10 = 10 000A (Mat.A) (9 000 x 1 kg = ) 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 price variance and that (SP AP) (AQ SQ) is reported as a joint price/usage variance. 5. Total material variance = SC AC Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.6a 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 = 17 100A Possible causes 3. Labour efficiency variance (SH AH) SR (9 000 x 3 hours = SHP AH ) x 9 = A Possible causes Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.6b Direct labour and overhead variances (cont.) 4. Variable overhead expenditure variance Flexed budget allowance (AH SR) Actual cost ( x 2 = 57 000) 52 00 = 5 000F Possible causes 5. Variable overhead efficiency variance (SH AH) SR (9 000 x 3 hours = SHP AH) x 2 = 3 000A Possible causes (note similarity to labour efficiency) 6. Fixed overhead expenditure (spending) variance BFO AFO ( /12 = ) = 4000F Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.7a Sales variances 1. Variances should be computed in terms of contribution profit margins rather than sales revenues. 2. Example Budgeted sales = units 11 = Standard and actual cost per unit = 7 Actual sales = units 10 = Variance in terms of sales value = 10 000F Variance in terms of contribution margin = 4 000A (Budgeted contribution margin = 4 = Actual contribution margin = 3 = 36 000) Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.7b 3. Objective is to maximize profits (not sales value). 4. Total sales margin variance Example Actual sales (9 000 90)= Standard VC of sales (9 000 68)= Budgeted contribution margin: 20 Variance = 2 000 A Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.8 Sales variances (cont.) 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) = F Sales margin volume = (9 000 ) 20 = A 2 000 A Reconciliation of budgeted and actual profit (see slide 9). Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.9 Reconciliation of budgeted and actual profit Budgeted net profit Sales variances: Sales margin price F Sales margin volume A A Direct cost variances: Material: Price A Usage A A Labour: Rate A Efficiency A A Manufacturing overhead variances: Fixed overhead expenditure F Variable overhead expenditure F Variable overhead efficiency A F A Actual profit Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 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 ( units) or / 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 = units or SHP Budgeted production = units or SHP Volume variance = units 12 or (3 000 SHP 4) = 12 000A Volume variance = (AP BP) SR 15.10a Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 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 = (B) Actual hours of input = (C) Actual hours of output = Volume variance = A C = hours (12 000) Capacity variance= A B = hours (6 000) Efficiency variance = B C = hours (6 000) 15.10b Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 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 units 8 = a Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.11b Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 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 Issue of materials (Material A) Dr Work in progress (SQ SP) Dr Material usage variance Cr Stores ledger control account (AQ SP) a Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.12b 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 Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.12c 4. Manufacturing overhead cost incurred Dr Factory variable overhead control account Dr Factory fixed overhead control account Cr Expense creditors 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 4 000 Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN 2011 Cengage Learning EMEA 15.12d 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 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.