Chapter

10 Standard costing and

variance analysis

Page 1
10.1 Introduction to standard costing

A standard cost is a planned (budgeted) or forecast unit cost for a product or service,
which is assumed to hold good given ‘expected’ efficiency and cost levels within an
organisation. A standard cost normally represents the planned (budgeted) or forecast
unit cost for material, labour and overhead expected for a product or service.

Variance analysis is part of a budgetary control process, whereby a budget (or

standard) for costs and revenues, is compared to the actual results of the organisation
e.g. financial analysis of the differences between standard and actual costs. This
information can be used to improve operational performance through control action
then taken by management.

Standard costing is useful for

· The preparation of budgets e.g. more accurate planning or forecasting.

· Controlling the organisation through ‘exception reporting’ e.g. standard or
budgeted costs and revenues, compared with actual results. Any differences
that do not conform to expectations is investigated.
· Inventory valuation e.g. accounting convention ‘IAS 2 inventory’, allows
manufacturing organisations to use standard costing as an external accounting
method to value raw materials, work-in-progress and finished goods
inventory.
· Standard costing can also simplifying cost bookkeeping (see chapter 11).
· Motivating and rewarding staff e.g. by the use of standards as goals or targets,
and often financial incentives to motivate staff.

Types of standard cost

· Ideal standard e.g. a standard attained under the ‘most favourable’ operating
conditions, no allowance for any waste, scrap, idle time or production
stoppage. This type of standard is normally unrealistic or unattainable in
reality; staff could be demotivated because such targets set would rarely be
achieved.
· Attainable (or expected) standard e.g. a standard that could be achieved by
staff, given a reasonable (not perfect) level of effort from them. Some
allowances would be made for delays or inefficiencies that are expected to
occur during production or delivery of a service.
· Current standard e.g. a standard based on current and existing operating
conditions. Management must continually attempt to improve cost and
efficiency levels by the continual introduction of attainable (or expected)
standards (as explained above).
· Loose standard e.g. a standard ‘loosely’ set and therefore easy to achieve by
staff.
· Basic standard e.g. the first standard ever used by the organisation, often
used as a yardstick to monitor trends for improvement made over time.
· Historical standards e.g. any standard used historically in previous periods.

Page 2
10.2 Limitations (critisms) of standard costing

Sometimes it can be hard to define a ‘current’ or ‘attainable standard’

especially with the complexity and diversity of modern manufacturing.
Traditionally manufacturers produced a small range of products using mass
production techniques. Nowadays products have shorter lifecycles and
different batches of many different products can be produced.
With more automation of manufacturing operations today and less human
intervention, labour standards are becoming less valuable as management
information. Automation produces greater uniformity and consistency of
products made, with less likelihood of material and labour variances actually
occurring.
Standard costing is an internal not external control measure e.g. too internally
focused on maximising efficiency and minimising cost. Organisations need to
consider other external factors such as competition, customers and other
global environmental factors, not just internal cost and efficiency levels.
Quality, innovation and customer satisfaction have become far more important
to survive as an organisation today.
Even when variances are identified there could be uncontrollability of any
exceptions highlighted e.g. discounts lost due to a reduction in the quantity of
material ordered or seasonal price fluctuations within the financial period. In
these cases very little control action (if any) can be taken by management and
care must also be taken to avoid blame. Often the reason or causes of
variances even when found are sometimes overlooked or not investigated at
all.
The revision to standards may be too infrequent to guide or improve
performance over time e.g. the life cycle of products are much shorter in a
modern manufacturing environment and the environment more dynamic.
Standards quickly become out of date due to frequent and continuous change.
Modern manufacturing techniques such as TQM and quality circles mean as
manufacturers aim for near perfection, the frequency and materiality of
variances should not occur so often. Today focus is more on quality and
customer satisfaction not the minimisation of cost.
Practical advice for setting standards
1. Use challenging but realistic targets. Link higher financial reward to the
higher achievement of more challenging targets and perhaps moderate
incentives for easier targets to achieve.
2. Consult with and allow staff to participate when setting targets, this can help
improve their motivation, reduce frustration and increase job satisfaction.
3. Clear trust and communication must be developed between management and
staff, management must avoid be over critical if very challenging targets have
not been achieved.
4. Good planning is essential to ensure whatever standards or targets that are
used, they are realistic and achievable. Frequent periodic reviews of standards
or targets are required to ensure they are attainable.

Page 3
10.3 Information to help create a standard cost

Information for a standard (budgeted) cost e.g. for a product or service.

Standard material price Standard material usage

· Supplier contracts, quotations and · The quality of material e.g.

estimates. levels of wastage and scrap
· Previous supplier invoices and maybe higher for more inferior
cost trends. material/components and vice
· Websites of material/component versa.
suppliers. · Specification and design of the
· Discounts available for bulk product or service e.g.
purchases. determines directly the material
· Seasonality/volatility of material usage.
prices. · Normal wastage levels expected
· Differences in quality of during delivery of a service or
material/components and therefore manufacturing of a product.
differences in price. · Estimations based upon previous
· Inflation rates expected for consumption of
material/component prices. material/components e.g. quality
of litres, kilos etc issued from
stores to production ÷ volume of
products made = average
material consumption.

Standard labour rate Standard labour efficiency

· Market rates for different skills · Idle time expected e.g. non-
and grades of staff. productive time during
· Wage inflation rates expected. processes.
· Existing internal rates from payroll · Time and motion studies.
records e.g. bonus schemes, · Time sheets e.g. total hours
overtime or piece work rates worked ÷ volume of products
currently in use. made = the average time per
unit.
The standard (budgeted) wage rate per · Skill and expertise of staff e.g.
hour normally incorporates any level of skilled staff work quicker or
bonus or overtime expected for a period, more efficiently.
based upon forecast output. · The learning curve or learning
rate expected when untrained
staff or new processes are
introduced.
· Motivation and morale of staff
often creates quicker
performance.

Page 4
Standard overhead rate

· A variable or fixed overhead rate per unit can be obtained by dividing the total
forecast (budgeted) overhead for a period, by a forecast (budgeted) level of
activity e.g. labour hours worked, machine hours run or products and services
made (output).
· Review and monitor variable overhead rates used in past periods and consider
expected inflation rates.
· Cost relationships can be found by using techniques such as the high-low
method or a scatter graph as a way of separating variable and fixed cost.

Example 10.1

Wood Plc makes wooden tables and chairs from natural timber. To make one unit of
product consisting of one table and four chairs, it consumes 60Kg of timber; but this
is before accounting for an expected 20% wastage of timber, due to wood shavings
and scrap in the cutting process. 100Kg of timber costs Wood Plc £50.

What is the standard cost of material to make one unit of product?

Page 5
10.4 Fixed and flexible budgeting

Fixed budget

A budget set prior to the control period and not subsequently changed in response to
changes in activity, costs or revenue.
(CIMA)

A fixed budget provides details of costs, revenues or resource requirements for a

single level of activity. A fixed budget is normally not changed once it has been
prepared. For budgetary control purposes, the actual results are compared at the end
of the financial period, but no account is taken, if the actual activity level is different
from the budgeted activity level. An example of a fixed budget is a master budget.
Fixed budgets are a more useful form of budgeting for service organisations, where
often a high proportion of budgeted total cost is fixed. Fixed cost remains constant or
does not vary significantly with an activity level, therefore even if the actual activity
level is different from the budgeted activity level, you still have a good yardstick to
compare the two, due to fixed cost not expected to change.
Flexible budget

A ‘flexed budget’ is a budget that has been revised or adjusted using the actual level
of sales or output achieved as its activity level.
Flexing variable costs from original budgeted levels to the allowances permitted for
actual volume achieved while maintaining fixed costs at original budget levels.
(CIMA)

A flexible budgeting system often produces many budgets projecting costs and
revenues over different ranges of production or sales volumes. Flexible budgets are
also amended (flexed) if the actual level of activity turns out to be different from the
budgeted level of activity. A flexible budget is therefore flexed to correspond to the
actual activity level for a period. When a budget is flexed it would give an
appropriate level of revenue and cost as a yardstick to compare on a like for like basis
to actual results, meaningful variances or exceptions to the budget, can then be
highlighted for management attention.
Flexible budgeting recognises different cost behaviour patterns e.g. costs will rise or
fall with the volume of sales or output achieved, this is a better system for control
purposes. They are useful at the planning stage for ‘what if?’ analysis e.g. what if
sales volume falls by 20%, what would be the effect on revenue, cost or contribution?
Benefits of flexible budgets

1. Useful at the planning stage for ‘what if?’ analysis.

2. Can be ‘flexed’ at the end of a period to correspond and be compared to actual

results achieved, giving better information for control purposes.

Page 6
Example 10.2
Butliness is a business that offers packaged holiday deals in three locations within the
UK. In each location the business operates a restaurant that serves many different
meals and puddings through out the day to guests staying over in chalets, on the
holiday parks. One such serving counter has been of major concern for management,
the ‘all week Sunday lunch’ counter, as it is expensive to run.
The stand uses two staff on different shifts to cook and serve meals at the counter, the
standard cost and price of the ‘hungry man roast of the day’ is as follows:

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
3.75
Standard contribution 8.20
Selling price (included in packaged price) 11.95

The budget each week aims to sell 500 meals. Fixed budgeted overhead for each week
is £2,500. For week 43 the following actual information was obtained.

Meals actually sold were 476 and the revenue earned £5,688.

Ingredients purchased
Chicken Vegetables
Purchased 180kg (£405) 250kg (£140)
Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (wages paid £1,200)
Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead £150

Fixed overhead £2,750

Standard costing is used to value any material inventory at the end of a period.

Produce the original budget, a flexed budget based upon actual sales volume
achieved and compare this to actual results in order to calculate any budget
variances?

Page 7
10.5 Variance analysis

Variance analysis is a budgetary control technique, which compares planned

(budgeted) or forecast costs and revenues to actual financial results, it measures the
differences between standard (budgeted) and actual performance. Variance analysis
is used to improve operational performance through control action by management
e.g. investigation of any variance causes and correction of them to prevent in future
any further deviations from plan.

Reasons why variances occur

· Inaccurate data used to compile standards, inaccurate compilation of the
budget or inaccurate compilation of actual financial results.
· Standard used either not realistic or out of date.
· Efficiency of how operations were undertaken and performed by staff during
the period e.g. mistakes made, poor decisions made, lack of effort etc can all
lead to actual results be worse than expected.
· Random or chance events occurring e.g. sudden economic down turn such as
the credit crunch, volatility of exchange rates, weather and commodity prices.
The budgetary planning process involves the production of budgets or forecasts using
the most realistic standards for cost and efficiency levels. The budgetary control
process identifies areas of responsibility for management and staff and then frequently
compares actual results against the budget or standards used. The original budget
would have normally forecast a different number of units produced and sold,
compared with the actual number of units produced and sold, a ‘flexed budget’ is
therefore prepared e.g. the original budget ‘flexed’, (redrafted based on actual units
produced and sold), to compare with actual costs and revenues. When a flexed budget
is compared with actual results this is on a like for like basis and therefore a
meaningful yardstick to calculate variances. Variances can be subdivided and
analysed further to help management determine where control action is needed.

A variance is the difference between planned, budgeted or standard cost and the actual
cost incurred. The same comparisons may be made for revenues.
(CIMA)

There are many variance proforma calculations that need to be learned and applied as
part of your studies. These proforma are essential to learn and practice in order to
truly understand and interpret what variances mean. Once variances have been
calculated either ‘F’ or ‘A’ is used as terminology to indicate favourable or adverse
differences between actual and standard performance. Favourable means that actual
results were better than standard. Adverse means that actual results were worse than
standard. Remember variances are just reconcilable differences between a budget
(standard) and actual results so in the case of an adverse variance this would mean
that actual cost will be higher or profit lower when compared to the budget, and vice
versa if a variance was favourable.

Page 8
Within example 10.2 the following budget variances were calculated

· The total material variance for chicken £11 (A) and vegetables £6 (A)
· The total labour variance £129 (A)
· The total variable overhead variance £88 (F)
· The total fixed overhead variance £370(A)

(A) = Adverse
Indicates the organisation performed worse than expected in comparison to budget.

(F) = Favourable
Indicates the organisation performed better than expected in comparison to budget.

Note: These total (budget) variances above can be sub-divided further to provide
more effective management information for control purposes. Your syllabus does
not require you to understand fixed overhead variances and therefore no further
discussion will take place regarding this.

Page 9
10.6 Variances ‘calculations (proforma) to learn’

Sales variance proforma

£
Did sell (actual quantity sold x actual selling price) X
Sales price Should sell (actual quantity sold x standard selling price) (X)
variance Sales price variance X

This measures the impact on profit when actual units sold were at a
lower or higher price than the standard (budgeted) price.

Units
Sales volume Did sell (actual quantity sold) X
(contribution) Should sell (original budgeted quantity sold) (X)
variance X
x Standard Contribution per unit
Sales volume (contribution) variance X
.
The sales volume (contribution) variance measures the difference
between the original and flexed budgeted contribution. It measures
the impact on contribution, when actual sale of units is more or less
than the original budgeted sale of units. This method of calculation
would be applied when marginal costing is used by the organisation.

Page 10
Cost variance proforma

£
Did spend (actual quantity purchased x actual price) X
Should spend (actual quantity purchased x standard price) (X)
Material price variance X
Material
price The material price variance measures the impact on contribution or profit
variance when the actual quantity of material purchased was at a lower or higher
price than the standard price. This variance calculation always uses the
quantity of material purchased never material used if there is a difference
between material purchased and used in a question.

kg/litres/units
Actual production did use X
Actual production should use
(actual production x standard usage) (X)
X
Material x Standard Price
usage Material usage variance X
variance
The material usage variance measures the impact on contribution or profit
when the actual quantity of material used was a lower or higher amount
than standard usage. This variance calculation always uses the quantity of
material used never material purchased if there is a difference between
material purchased and used in a question.

Total material variance

equals material price variance
+/- material usage variance

£
Did spend (actual hours paid x actual rate) X
Labour rate Should spend (actual hours paid x standard rate) (X)
variance Labour rate variance X

The labour rate variance measures the impact on contribution or profit

when the actual hourly rate paid, was at a lower or higher rate than the
standard rate. This variance calculation always uses actual hours paid
never hours worked if there is a difference between hours paid and
worked in a question.

Page 11
 Hours
Actual production did take X
Actual production should take
(actual production x standard hours) (X)
X
Labour x Standard Rate per hour
efficiency Labour efficiency variance X
variance

The labour efficiency variance measures the impact on contribution or

profit when the actual quantity of labour hours worked was at a lower or
higher amount than standard efficiency. This variance calculation always
uses actual hours worked never hours paid if there is a difference between
hours paid and worked in a question.
.

Hours
Labour idle Actual hours paid X
time Actual hours worked (X)
variance Idle time X
x Standard Rate per hour
Labour idle time variance X

The idle time variance measures the impact on contribution or profit when
labour hours paid is different to labour hours worked. Tip: The idle time
variance in your exam will always be adverse.

Total labour variance

equals labour rate variance
+/- labour efficiency variance
+/- labour idle time variance

£
Did spend (actual hours worked x actual variable overhead rate) X
Should spend (actual hours worked x standard variable overhead rate) (X)
Variable Variable overhead expenditure variance X
overhead
expenditure The variable overhead rate variance measures the impact on contribution
variance or profit when the actual rate paid, was at a lower or higher rate than the
standard rate. This variance calculation always uses actual hours worked
never hours paid if there is a difference between hours paid and worked in
a question. It is assumed that no variable overhead would be incurred
during any periods of idle time.

Page 12
 Hours
Actual production did take X
Actual production should take
(actual production x standard hours) (X)
X
Variable x Standard Rate per hour
overhead Variable overhead efficiency variance X
efficiency
variance
The variable overhead efficiency variance measures the impact on
contribution or profit when the actual quantity of labour hours worked
was at a lower or higher amount than standard efficiency. This variance
calculation always uses actual hours worked never hours paid if there is a
difference between hours paid and worked in a question. Tip: Similar
proforma to the labour efficiency variance e.g. if staff work more
efficiently when compared to standard, labour cost and variable overhead
can be saved due to the saving in staff time.

Total variable overhead variance

equals variable overhead expenditure variance
+/- variable overhead efficiency variance

Other relevant cost variances (fixed overhead)

Fixed Actual fixed overhead expenditure X

overhead Budgeted fixed overhead expenditure (X)
expenditure Fixed overhead expenditure variance X
variance

Page 13
Example 10.3
Butliness is a business that offers packaged holiday deals in three locations within the
UK. In each location the business operates a restaurant that serves many different
meals and puddings through out the day to guests staying over in chalets, on the
holiday parks. One such serving counter has been of major concern for management,
the ‘all week Sunday lunch’ counter, as it is expensive to run.
The stand uses two staff on different shifts to cook and serve meals at the counter, the
standard cost and price of the ‘hungry man roast of the day’ is as follows:

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
3.75
Standard contribution 8.20
Selling price (included in packaged price) 11.95

The budget each week aims to sell 500 meals. Fixed budgeted overhead for each week
is £2,500. For week 43 the following actual information was obtained.

Meals actually sold were 476 and the revenue earned £5,688.

Ingredients purchased
Chicken Vegetables
Purchased 180kg (£405) 250kg (£140)
Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (wages paid £1,200)
Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead £150

Standard costing is used to value any material inventory at the end of a period.

Prepare an operating statement for week 43 which reconciles the difference

between the budgeted and actual contribution?

Page 14
10.7 Reasons why variances occur
· Inaccurate data used to compile standards, inaccurate compilation of the
budget or inaccurate compilation of actual financial results.
· Standard used either not realistic or out of date.
· Efficiency of how operations were undertaken and performed by staff during
the period e.g. mistakes made, poor decisions made, lack of effort etc can all
lead to actual results be worse than expected.
· Random or chance events occurring e.g. sudden economic down turn such as
the credit crunch, volatility of exchange rates, weather and commodity prices.
10.8 Possible operational causes of sales variances

Possible causes or reasons for variances have been included in the table below.

· Unplanned price increases for the product or service sold.

Sales price
variance · Unplanned price reductions e.g. attracting additional business by
offering discounts or price promotions.
Interdependence (sales price and volume (demand) are both connected to each other) e.g. a
lower price for the product or service sold would normally cause an adverse sales price
variance, however the effect of lowering price is normally to sell more, so the sales volume
variance would be expected to be favourable, and vice versa.
Sales volume · Seasonal changes in demand for the final product or service sold.
variance · Economic (business) recession or boom.

Page 15
10.9 Possible operational causes of cost variances

· Different sources of supply may cost more or less.

· Unexpected general price increases or decreases.
· Alteration in quantity discounts.
Material price · Alteration in exchange rates for imported materials or components.
variance · Substitution of a different grade of material which is cheaper or
more expensive.
· Standard set at mid-year price, due to seasonal fluctuations and price
volatility, so one would expect a favourable price variance for part
of the year and an adverse variance for the rest of the year.
Interdependence (material price and usage both connected to each other) e.g. a lower price
for material obtained would give a favourable material price variance, but if an inferior
quality it could cause more wastage and therefore an adverse material usage variance, and
vice versa.
· Higher or lower incidence of scrap, wastage, evaporation etc.
· Alterations to product design e.g. product now consumes more or
Material usage
less material.
variance
· Substitution of a different grade of material e.g. cheaper and more
inferior material can create more wastage.

· Unexpected national wage increases.

· Overtime and bonus payments different from the standard ‘average’
Labour rate
plan.
variance
· Substitution of a different grade of labour which is cheaper or more
expensive.
Interdependence (labour rate and efficiency both connected to each other) e.g. a lower rate
for labour skills obtained would give a favourable labour rate variance, but if these staff are
inexperienced and face a steep learning curve, this could cause less efficiency and therefore
an adverse labour efficiency variance, and vice versa.
· Improvement in the efficiency of working methods or conditions e.g.
through training or new technology.
Labour
· Introduction of new incentive schemes e.g. higher productivity or
efficiency
efficiency bonuses could make staff work more quickly.
variance
· Substitution of a different grade of labour e.g. less skilled staff
normally means they are less efficient.

Page 16
 · Unexpected price changes for variable overhead items.
Variable
overhead rate
· Seasonal effects e.g. heat and light in winter. (This arises where the
variance
annual budget is divided into four equal quarters of thirteen equal
four-weekly periods without allowances for seasonal factors. Over a
whole year the seasonal effects would cancel out.).

Variable
overhead · This variance is interdependent on the labour efficiency variance
efficacy therefore see reasons for labour efficiency variances.
variance

Fixed overhead
expenditure · Changes in prices relating to fixed overhead items e.g. rent increase.
variance

10.10 Interdependent (interrelated) relationships between variances

Sometimes two variances together can be explained by the same reason.

· When the sales volume contribution variance is adverse, the sales price
variance is normally favourable, vice versa. As an example if the business
were to reduce selling price (adverse sales price variance) this could
stimulate more demand for the product because of the cheaper selling price
(favourable volume variance).
· When the material usage variance is adverse, the material price variance is
normally favourable, vice versa. As an example if the business purchases a
higher quality grade of material used, there maybe less wastage (favourable
usage variance) but higher quality material will normally cost more (adverse
price variance).
· When the labour efficiency variance is adverse, the labour rate variance is
normally favourable, vice versa. As an example if the business takes on more
apprentices rather than skilled labour there maybe less efficiency (adverse
efficiency variance) but apprentices or less skilled labour will normally cost
less (favourable rate variance).
· The same causes of the labour efficiency variance will explain the variable
overhead efficiency variance. When one is adverse the other will also be
adverse and vice versa.
· There can be many other interdependent reasons e.g. higher quality material
and more experienced labour will both cost more (adverse price and rate
variances) but if this helps create a better quality of product, the sales volume
may increase (favourable sales volume variance).

Page 17
10.11 Working backwards with variances

Actual financial data can be found from standard or budgeted financial data by using
the same variance proforma given earlier within this chapter.

Example 10.4

Butliness had a problem with the accountant; he left in a fume and took all the actual
financial accounting information with him as revenge. You have been called in from
a temping agency to sort out the mess. The following information has been provided
to you.

Operating statement for week 43

Budget 4,100
Sales volume variance 197(A)
Flexed budget 3,903
Sales price variance nil
3,903

Cost variances F A

Chicken price variance 45

Chicken usage variance 55
Vegetable price variance 15
Vegetable usage variance 9
Labour efficiency variance 45
Labour rate variance 120
Idle time variance 54
V/OH efficiency variance 10
V/OH overhead expenditure variance 78
187 244 = 57(A)
Actual contribution 3,846

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
3.75
Standard contribution 8.20
Selling price (included in packaged price) 11.95

Page 18
Additional information known

· Actual hours paid were 6 more than worked due to an electrical fault with the
ovens.
· Closing stock for chicken and vegetables rose during this period by 15kg and
30kg respectively.

You are required to

· Calculate the actual sale of meals
· Calculate the actual hours worked by the chefs
· Calculate the actual quantity of chicken purchased
· Calculate the actual price paid per Kg for chicken
· Calculate the actual variable overhead expenditure

Page 19
Key summary of chapter

A standard cost is a planned (budgeted) or forecast unit cost for a product or service,
which is assumed to hold good given ‘expected’ efficiency and cost levels within an
organisation. A standard cost normally represents the planned (budgeted) or forecast
unit cost for material, labour and overhead expected for a product or service.

Types of standard cost

· Ideal standard
· Attainable (or expected) standard
· Current standard
· Loose Standard
· Basic Standard
· Historical Standards

Practical advice for setting standards

1. Use challenging but realistic targets.
2. Consult with and allow staff to participate when setting targets.
3. Clear trust and communication between management and staff.
4. Standards or targets used must be realistic and achievable.

Standard costing can be used for

· Preparation of budgets
· Controlling performance
· Inventory valuation
· Simplifying cost bookkeeping
· Motivating and rewarding staff

Criticisms of standard costing

Sometimes it can be hard to define a ‘current’ or ‘attainable standard’.
Less human intervention means labour standards are becoming less valuable.
Automation produces greater uniformity and consistency of product therefore
less likelihood of material and labour variances actually occurring.
Standard costing is an internal not external control measure.
Uncontrollability of any exceptions highlighted.
Revision to standards too infrequent to guide or improve performance over
time.
Modern manufacturing techniques such as TQM and quality circles means the
frequency and materiality of variances should not occur so often.

Page 20
Fixed budget

A budget set prior to the control period and not subsequently changed in response to
changes in activity, costs or revenue.
(CIMA)

Flexible budget

A ‘flexed budget’ is a budget that has been revised or adjusted using the actual level
of sales or output achieved as its activity level.
Flexing variable costs from original budgeted levels to the allowances permitted for
actual volume achieved while maintaining fixed costs at original budget levels.
(CIMA)

Variance analysis

Variance analysis is a budgetary control technique, which compares planned

(budgeted) or forecast costs and revenues to actual financial results, it measures the
differences between standard (budgeted) and actual performance. Variance analysis
is used to improve operational performance through control action by management
e.g. investigation of any variance causes and correction of them to prevent in future
any further deviations from plan.

A variance is the difference between planned, budgeted or standard cost and the
actual cost incurred. The same comparisons may be made for revenues.
(CIMA)

Reasons why variances occur

· Inaccurate data used to compile standards.
· Standard used either not realistic or out of date.
· Efficiency of how operations were undertaken and performed by staff.
· Random or chance events occurring.
There are many variance proforma calculations that need to be learned and applied as
part of your studies. These proforma are essential to learn and practice in order to
truly understand and interpret what variances mean. Once variances have been
calculated either ‘F’ or ‘A’ is used as terminology to indicate favourable or adverse
differences between actual and standard performance. Favourable means that actual
results were better than standard. Adverse means that actual results were worse than
standard. Remember variances are just reconcilable differences between a budget
(standard) and actual results.

Page 21
Variances proforma to learn

£
Sales price Did sell (actual quantity sold x actual selling price) X
variance Should sell (actual quantity sold x standard selling price) (X)
Sales price variance X

This measures the impact on profit when actual units sold were at a
lower or higher price than the standard (budgeted) price.

Units
Sales volume Did sell (actual quantity sold) X
(contribution) Should sell (original budgeted quantity sold) (X)
variance X
x Standard Contribution per unit
Sales volume (contribution) variance X
.
The sales volume (contribution) variance measures the difference
between the original and flexed budgeted contribution. It measures
the impact on contribution, when actual sale of units is more or less
than the original budgeted sale of units. This method of calculation
would be applied when marginal costing is used by the organisation.

Cost variance proforma

£
Material Did spend (actual quantity purchased x actual price) X
price Should spend (actual quantity purchased x standard price) (X)
variance Material price variance X

kg/litres/units
Material Actual production did use X
usage Actual production should use
variance (actual production x standard usage) (X)
X
x Standard Price
Material usage variance X

Total material variance

equals material price variance
+/- material usage variance

Page 22
 £
Labour rate Did spend (actual hours paid x actual rate) X
variance Should spend (actual hours paid x standard rate) (X)
Labour rate variance X

Hours
Labour Actual production did take X
efficiency Actual production should take
variance (actual production x standard hours) (X)
X
x Standard Rate per hour
Labour efficiency variance X

Hours
Labour idle Actual hours paid X
time Actual hours worked (X)
variance Idle time X
x Standard Rate per hour
Labour idle time variance X

Total labour variance

equals labour rate variance
+/- labour efficiency variance
+/- labour idle time variance

£
Variable Did spend (actual hours worked x actual variable overhead rate) X
overhead Should spend (actual hours worked x standard variable overhead rate) (X)
expenditure Variable overhead expenditure variance X
variance

Hours
Variable Actual production did take X
overhead Actual production should take
efficiency (actual production x standard hours) (X)
variance X
x Standard Rate per hour
Variable overhead efficiency variance X

Total variable overhead variance

equals variable overhead expenditure variance
+/- variable overhead efficiency variance

Page 23
Solutions to lecture examples

Page 24
Chapter 10

Example 10.1
Wood Plc makes wooden tables and chairs from natural timber. To make one unit of
product consisting of one table and four chairs, it consumes 60kg of timber; after an
expected 20% wastage due to wood shavings and scrap in the cutting process. 100kg
of timber currently costs Wood Plc £50.

What is the standard cost of material to make one unit of product?

Solution
The standard usage of material is 60kg of timber to make one unit of product, but this
is only 80% of material usage, given that 20% of timber is expected to be scrapped in
the process. Therefore the total material used to make one unit of product would be
60kg (80% before wastage) x (100% ÷ 80%) = 75kg.

Standard cost of material to make one unit of product:

(75kg ÷ 100kg) x £50 (per 100kg) = £37.50 per unit of product.

Page 25
Example 10.2

Original Flexed Actual Budget

Budget Budget Results Variances
Production and sales 500 476 476
£ £ £ £
Sales 5,975 5,688 5,688 nil

Chicken 375 357 368 11(A)

Vegetables 125 119 125 6 (A)
Labour 1,125 1,071 1,200 129(A)
Variable overhead 250 238 150 88(F)
1,875 1,785 1,843 58(A)
Contribution 4,100 3,903 3,845 58(A)

Fixed overhead 2,500 2,500 2,750 250(A)

Profit 1,600 1,403 1,095 308(A)

(A) = Adverse
Indicates the organisation performed worse than expected in comparison to budget.

(F) = Favourable
Indicates the organisation performed better than expected in comparison to budget.

Notes

· The £368 actual charge for chicken, is the actual cost of chicken less the
standard cost of closing inventory e.g. (£405 less (15kg x £2.50)). It is normal
practice for standard costing systems to value inventory using standard cost.
· The £125 actual charge for vegetables is the actual cost of vegetables less the
standard cost of closing inventory e.g. (£140 less (30kg x £0.50)). It is normal
practice for standard costing systems to value inventory using standard cost.
· The total budget variances are calculated by comparing actual revenue and
costs to the flexed budgeted revenue and costs. Actual revenue and costs
would never be compared to the original budgeted revenue and costs, this
would not provide a meaningful yardstick for comparison
· You might in a question, have to split a semi-variable or mixed cost into its
fixed and variable components in order to produce a flexible or flexed budget.

Page 26
Example 10.3
An operating statement reconciles budgeted to actual contribution earned for a period.
The variances will be the reconcilable items within the operating statement.
Note: The short hand form of calculating each variance has been demonstrated below,
this will help you save time in your exam. You are advised to practice the below
calculations also using the proforma variance calculations given within chapter 10.
Operating statement for week 43

Budget (500 x £8.20) 4,100

Sales volume variance (476-500) x £8.20 197(A)
Flexed budget for 476 meals 3,903
Sales price variance 476 x (£11.95-£11.95) nil
3,903

Cost variances F A

Chicken price variance 180kg x (£2.25-£2.50) 45

Chicken usage variance (165kg -143kg) x £2.50 55
Vegetable price variance 250kg x (£0.50-£0.56) 15
Vegetable usage variance (220kg-238kg) x £0.50 9
Labour efficiency variance (114hrs-119hrs) x £9 45
Labour rate variance 120hrs x (£10-£9) 120
Idle time variance (6hrs x £9) 54
V/OH efficiency variance (114-119hrs) x £2 10
V/OH overhead expenditure variance 114hrs x (£1.32-£2) 78
187 244 = 57(A)
Actual contribution 3,846
(A) = Adverse
Indicates the organisation performed worse than expected in comparison to budget.
(F) = Favourable
Indicates the organisation performed better than expected in comparison to budget.

* Proof
Sales 5,688
Chicken 405
Closing stock (15kg x £2.50) (38)
Vegetables 140
Closing stock (30kg x £0.50) (15)
Labour 1,200
V/OH 150
(1,842)
Contribution 3,846

Page 27
WORKINGS

Sales volume variance

meals
Did sell 476
Should sell (as per original budget) 500
24
x Standard profit per meal sold x £8.20
197 (A)
Chicken price variance
£
180kg did cost 405
180kg should cost (180kg x £2.50) 450
45 (F)
Chicken usage variance
kg
476 meals did use 165
476 meals should use (x 0.3kg) 143
22
x Standard Price x £2.50
55 (A)
Vegetable price variance
£
250kg did cost 140
250kg should cost (250kg x £0.50) 125
15 (A)
Vegetable usage variance
kg
476 meals did use 220
476 meals should use (x 0.5kg) 238
18
x Standard Price x £0.50
9 (F)
Labour rate variance

120 hours paid did cost 1,200

120 hours paid should cost (120 hours x £9) 1,080
120 (A)

Labour efficiency variance

hours
476 meals did take (hours worked) 114
476 meals should take (x 0.25 hours) 119
5
x Standard Rate x £9.00
45 (F)

Page 28
Labour efficiency variance
hours
476 meals did take (hours worked) 114
476 meals should take (x 0.25 hours) 119
5
x Standard Rate x £9.00
45 (F)
Labour idle time variance
hours
Hours paid 120
Hours worked 114
6
x Standard Rate x £9.00
54 (A)

Variable overhead expenditure variance

£
114 hours worked did cost 150
114 hours worked should cost (114 hours x £2) 228
78 (F)

Variable overhead efficiency variance

hours
476 meals did take (hours worked) 114
476 meals should take (x 0.25 hours) 119
5
x Standard Rate x £2.00
10 (F)

Fixed overhead expenditure variance

£
Actual fixed overhead expenditure 2,750
Original budgeted fixed overhead expenditure 2,500
250 (A)

Page 29
Example 10.4
Calculate the actual sale of meals

Did sell 476 (balancing figure)

Should sell 500 (£4,100 budget ÷ £8.20 Std Cont/Per unit)
24
Standard contribution per meal x £8.20 (Given)
Given 197 (A)

Calculate the actual hours worked by the chefs

476 meals did take 114 (balance figure)

476 meals should take (476 x 0.25 hrs) 119
5
Standard rate per hour x £9.00 per hour (given)
Given 45 (F)
Hours paid would have been 114 hours worked plus 6 hours idle time = 120 hours
Calculate the actual quantity of chicken purchased
476 meals did use 165 kg (balance figure)
476 meals should have used (x 0.3kg) 143 kg
22 kg
Standard price per kg x £2.50 (given)
Given 55 (A)
Calculate the actual price paid per Kg for chicken
165kg used above + a 15kg rise in closing inventory level = 180kg purchased.

180kg did cost 405 (balance figure)

180kg should cost (x £2.50 kg) 450
Given 45 (F)

£405 actual cost of chicken ÷ 180kg purchased = actual price £2.25 per kg.
Calculate the actual variable overhead expenditure
114 hrs worked did cost 150 (balance figure)
114 hrs should have cost (x £2 per hour) 228
Given 78 (F)
The 114 hours worked was obtained from the labour efficiency calculation above.

Page 30