TARGET PROFESSIONAL TRAINING CENTER

(COMPILED BY FREDERICK GBLI WRITTEN AS TARGET)

Standard costing and variance analysis

A standard cost is a predetermined estimated unit cost, used for inventory valuation and control.

The building blocks of standard costing are standard costs and so before we look at standard costing in any detail you really need to
know what a standard cost is.
Notice how the total standard cost is built up from standards for each cost element: standard quantities of materials at standard prices,
standard quantities of labour time at standard rates and so on. It is therefore determined by management's estimates of the following.

 The expected prices of materials, labour and expenses

 Efficiency levels in the use of materials and labour
 Budgeted overhead costs and budgeted volumes of activity

But why should management want to prepare standard costs? Obviously to assist with standard costing, but what is the point of
standard costing?

The uses of standard costing

Standard costing has a variety of uses but its two principal ones are as follows.
(a) To value inventories and cost production for cost accounting purposes
(b) To act as a control device by establishing standards (planned costs), highlighting (via variance analysis which we will cover in the
next chapter) activities that are not conforming to plan and thus alerting management to areas which may be out of control and in need
of corrective action

EXAMPLE 1
Bloggs makes one product, the joe. Two types of labour are involved in the preparation of a joe, skilled and semi-skilled. Skilled labour is
paid $10 per hour and semi-skilled $5 per hour. Twice as many skilled labour hours as semi-skilled labour hours are needed to produce a
joe, four semi-skilled labour hours being needed.
A joe is made up of three different direct materials. Seven kilograms of direct material A, four litres of direct material B and three
metres of direct material C are needed. Direct material A costs $1 per kilogram, direct material B $2 per litre and direct material C $3
per metre.
Variable production overheads are incurred at Bloggs Co at the rate of $2.50 per direct labour (skilled) hour.
A system of absorption costing is in operation at Bloggs Co. The basis of absorption is direct labour (skilled) hours. For the forthcoming
accounting period, budgeted fixed production overheads are $250,000 and budgeted production of the joe is 5,000 units.
Administration, selling and distribution overheads are added to products at the rate of $10 per unit.
A mark-up of 25% is made on the joe.
Required
Using the above information, draw up a standard cost card for the joe.

EXAMPLE 2

What would a standard cost card for product joe show under a marginal system?

Standard cost setting process

Standard costing therefore involves the following.
The establishment of predetermined estimates of the costs of products or services
The collection of actual costs
The comparison of the actual costs with the predetermined estimates
The predetermined costs are known as standard costs and the difference between standard and actual cost is known as a
variance. The process by which the total difference between standard and actual results is analysed is known as variance
analysis.

Although standard costing can be used in a variety of costing situations (batch and mass production, process manufacture,
jobbing manufacture (where there is standardisation of parts) and service industries (if a realistic cost unit can be

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established)), the greatest benefit from its use can be gained if there is a degree of repetition in the production process. It is
therefore most suited to mass production and repetitive assembly work.

Introduction
Standard costs may be used in both absorption costing and in marginal costing systems. We shall, however, confine our
description to standard costs in absorption costing systems.
As we noted earlier, the standard cost of a product (or service) is made up of a number of different standards, one for each
cost element, each of which has to be set by management. We have divided this section into two: the first part looks at
setting the monetary part of each standard, whereas the second part looks at setting the resources requirement part of each
standard.

Types of performance standard

Performance standards are used to set efficiency targets. There are four types: ideal, attainable, current and basic.
The setting of standards raises the problem of how demanding the standard should be. Should the standard represent a
perfect performance or an easily attainable performance? The type of performance standard used can have behavioural
implications. There are four types of standard.

Ideal standard These are based on perfect operating

conditions: no wastage, no spoilage, no
inefficiencies, no idle time, no breakdowns.
Variances from ideal standards are useful for
pinpointing areas where a close examination may
result in large savings in order to
maximise efficiency and minimise waste. However,
ideal standards are likely to have an unfavourable
motivational impact because reported variances will
always be adverse. Employees will often feel that
the goals are unattainable and not work so hard.
Attainable These are based on the hope that a standard
amount of work will be carried out efficiently,
machines properly operated or materials properly
used. Some allowance is made for wastage and
inefficiencies. If well set, they provide a useful
psychological incentive by giving employees a
realistic but challenging target of efficiency. The
consent and co-operation of employees involved in
improving the standard are required.
Current These are based on current working conditions
(current wastage, current inefficiencies).
The disadvantage of current standards is that they
do not attempt to improve on current levels of
efficiency.
Basic These are kept unaltered over a long period of
time, and may be out of date. They are used to
show changes in efficiency or performance over a
long period of time. Basic standards are perhaps
the least useful and least common type of standard
in use.

COST VARIANCES
Direct Material Variance
The direct material total variance can be subdivided into the direct material price variance and the direct material usage
variance.

 The direct material total variance is the difference between what the output actually cost and what it should have
cost, in terms of material.

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  The direct material price variance is the difference between the standard cost and the actual cost for the
actual quantity of material used or purchased. In other words, it is the difference between what the material did
cost and what it should have cost

 The direct material usage variance is the difference between the standard quantity of materials that should
have been used for the number of units actually produced, and the actual quantity of materials used, valued
at the standard cost per unit of material. In other words, it is the difference between how much material should
have been used and how much material was used, valued at standard cost.

Example Direct material variances

Product X has a standard direct material cost as follows.
10 kilograms of material Y at $10 per kilogram = $100 per unit of X.
During period 4, 1,000 units of X were manufactured, using 11,700 kilograms of material Y which cost $98,600.
Required
Calculate the following variances.
(a) The direct material total variance
(b) The direct material price variance
(c) The direct material usage variance

Direct Labour variance

The direct labour total variance can be subdivided into the direct labour rate variance and the direct
labour efficiency variance.

 The direct labour total variance is the difference between what the output should have cost and what it did cost, in
terms of labour.
 The direct labour rate variance is similar to the direct material price variance. It is the difference between the
standard cost and the actual cost for the actual number of hours paid for. In other words, it is the difference
between what the labour did cost and what it should have cost.
 The direct labour efficiency variance is similar to the direct material usage variance. It is the difference between
the hours that should have been worked for the number of units actually produced, and the actual number of
hours worked, valued at the standard rate per hour. In other words, it is the difference between how many hours
should have been worked and how many hours were worked, valued at the standard rate per hour.

The calculation of direct labour variances is very similar to the calculation of direct material variances.
Example4: Direct labour variances
The standard direct labour cost of product X is as follows.
2 hours of grade Z labour at $5 per hour = $10 per unit of product X.
During period 4, 1,000 units of product X were made, and the direct labour cost of grade Z labour was $8,900 for 2,300 hours of
work.
Required
Calculate the following variances.
(a) The direct labour total variance
(b) The direct labour rate variance
(c) The direct labour efficiency (productivity) variance

Variable production overhead variances

The variable production overhead total variance can be subdivided into the variable production overhead expenditure
variance and the variable production overhead efficiency variance (based on actual hours).

Example 5: Variable production overhead variances

Suppose that the variable production overhead cost of product X is as follows.
2 hours at $1.50 = $3 per unit
During period 6, 1,000 units of product X were made. The labour force worked 2,020 hours, of which
60 hours were recorded as idle time. The variable overhead cost was $3,075.
Calculate the following variances.
(a) The variable overhead total variance
(b) The variable production overhead expenditure variance
(c) The variable production overhead efficiency variance

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Fixed Production Overhead Variance

The fixed production overhead total variance can be subdivided into an expenditure variance and a volume variance. The
fixed production overhead volume variance can be further subdivided into an efficiency and capacity variance.

The fixed production overhead total variance (ie the under- or over-absorbed fixed production overhead) may be broken
down into two parts as usual.
An expenditure variance
A volume variance. This in turn may be split into two parts.
– A volume efficiency variance
– A volume capacity variance

The fixed overhead expenditure variance

The fixed overhead expenditure variance occurs if the numerator is incorrect. It measures the under- or over-absorbed
overhead caused by the actual total overhead being different from the budgeted total overhead.
Therefore, fixed overhead expenditure variance = Budgeted (planned) expenditure – Actual expenditure.

The fixed overhead volume variance

As we have already stated, the fixed overhead volume variance is made up of the following subvariances.
Fixed overhead efficiency variance
Fixed overhead capacity variance
These variances arise if the denominator (ie the budgeted activity level) is incorrect.
The fixed overhead efficiency and capacity variances measure the under- or over-absorbed overhead caused by the actual
activity level being different from the budgeted activity level used in calculating the absorption rate.
There are two reasons why the actual activity level may be different from the budgeted activity level used in calculating
the absorption rate.

(a) The workforce may have worked more or less efficiently than the standard set. This deviation is measured by the fixed
overhead efficiency variance.

(b) The hours worked by the workforce could have been different to the budgeted hours (regardless of the level of efficiency
of the workforce) because of overtime and strikes etc. This deviation from the standard is measured by the fixed overhead
capacity variance.

How to calculate the variances

In order to clarify the overhead variances which we have encountered in this section, consider the following definitions which
are expressed in terms of how each overhead variance should be calculated.
 Fixed overhead total variance is the difference between fixed overhead incurred and fixed overhead absorbed. In
other words, it is the under- or over-absorbed fixed overhead.

 Fixed overhead expenditure variance is the difference between the budgeted fixed overhead expenditure and
actual fixed overhead expenditure.

 Fixed overhead volume variance is the difference between actual and budgeted (planned) volume multiplied by the
standard absorption rate per unit.

 Fixed overhead volume efficiency variance is the difference between the number of hours that actual production
should have taken, and the number of hours actually taken (that is, worked) multiplied by the standard absorption
rate per hour.

 Fixed overhead volume capacity variance is the difference between budgeted (planned) hours of work and the
actual hours worked, multiplied by the standard absorption rate per hour.

Suppose that a company plans to produce 1,000 units of product E during August 20X3. The expected time to produce a unit of E is
five hours, and the budgeted fixed overhead is $20,000.

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The standard fixed overhead cost per unit of product E will therefore be as follows.
5 hours at $4 per hour = $20 per unit
Actual fixed overhead expenditure in August 20X3 turns out to be $20,450. The labour force manages to produce 1,100 units of
product E in 5,400 hours of work.
required
Calculate the following variances.
(a) The fixed overhead total variance
(b) The fixed overhead expenditure variance
(c) The fixed overhead volume variance
(d) The fixed overhead volume efficiency variance
(e) The fixed overhead volume capacity variance

Example 6: A manufacturing company operates a standard absorption costing system. Last month 25,000
production hours were budgeted and the budgeted fixed production overhead cost was $125,000. Last
month the actual hours worked were 24,000 and the standard hours for actual production were
27,000.
What was the fixed production overhead capacity variance for last month?

General causes of variances

There are four general causes of variances.
(a) Inappropriate standard. Incorrect or out of date standards could have been used which will not reflect current conditions. For
example, a material price standard may have been wrong if an old price was used or the wrong type of material was priced.
(b) Inaccurate recording of actual costs. For example, if timesheets are filled in incorrectly, this may lead to variances.
(c) Random events. Examples include unusual adverse weather conditions and a flu epidemic. These may cause additional
unforeseen costs.
(d) Operating inefficiency. If the variance is not caused by inappropriate standards, inaccurate recording or random events, then it
must be due to operating efficiency. The operating efficiency may be due to controllable or uncontrollable factors.

Specific causes of variances

Favorable Adverse
(a) Material price Unforeseen discounts received Price increase
More care taken in purchasing Careless purchasing
Change in material standard Change in material standard
(b) Material usage Material used of higher quality than Defective material
standard Excessive waste
More effective use made of material Theft
Errors in allocating material to jobs Stricter quality control
Errors in allocating material to jobs
(c) Labour rate Use of apprentices or other workers at a Wage rate increase
rate of pay lower than standard Use of higher grade labour
(d) Labour efficiency Output produced more quickly than Lost time in excess of standard
expected because of work motivation, allowed
better quality of equipment or materials, Output lower than standard set
or better methods because of deliberate restriction, lack
Errors in allocating time to jobs of training or substandard material
used
Errors in allocating time to jobs
(e) Overhead expenditure Savings in costs incurred Increase in cost of services used
More economical use of services Excessive use of services
Change in type of services used
(f) Overhead volume efficiency Labour force working more efficiently Labour force working less efficiently
(favourable labour efficiency variance) (adverse labour efficiency variance)
(g) Overhead volume capacity Labour force working overtime Machine breakdown, strikes, labour
shortages

The significant of cost variance

Materiality, controllability, the type of standard being used, the interdependence of variances and the cost of an investigation should
be taken into account when deciding whether to investigate reported variances.

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Once variances have been calculated, management have to decide whether or not to investigate their causes. It would be
extremely time consuming and expensive to investigate every variance, therefore managers have to decide which variances are
worthy of investigation.
There are a number of factors which can be taken into account when deciding whether or not a variance should be investigated.
(a) Materiality. A standard cost is really only an average expected cost and is not a rigid specification. Small variations either side
of this average are therefore bound to occur. The problem is to decide whether a variation from standard should be considered
significant and worthy of investigation. Tolerance limits can be set and only variances which exceed such limits would require
investigating.
(b) Controllability. Some types of variance may not be controllable even once their cause is discovered. For example, if there is a
general worldwide increase in the price of a raw material, there is nothing that can be done internally to control the effect of this. If a
central decision is made to award all employees a 10% increase in salary, staff costs in division A will increase by this amount and
the variance is not controllable by division A's manager. Uncontrollable variances call for a change in the plan, not an investigation
into the past.
(c) The type of standard being used
(i) The efficiency variance reported in any control period, whether for materials or labour, will depend on the efficiency level set. If,
for example, an ideal standard is used, variances will always be adverse.
(ii) A similar problem arises if average price levels are used as standards. If inflation exists, favourable price variances are likely to
be reported at the beginning of a period, to be offset by adverse price variances later in the period as inflation pushes prices up.
(d) Interdependence between variances. Quite possibly, individual variances should not be looked at in isolation. One variance
might be interrelated with another, and much of it might have occurred only because the other, interrelated variance occurred too.
We will investigate this issue further in a moment.
(e) Costs of investigation. The costs of an investigation should be weighed against the benefits of correcting the cause of a
variance.

Interdependence between variances

When two variances are interdependent (interrelated) one will usually be adverse and the other one favourable.

Interdependence – materials price and usage variances

It may be decided to purchase cheaper materials for a job in order to obtain a favourable price variance.
This may lead to higher materials wastage than expected and therefore adverse usage variances occur.
If the cheaper materials are more difficult to handle, there might be some adverse labour efficiency variance too.
If a decision is made to purchase more expensive materials, which perhaps have a longer service life, the price variance will be
adverse but the usage variance might be favourable.

Interdependence – labour rate and efficiency variances

If employees in a workforce are paid higher rates for experience and skill, using a highly skilled team should incur an
adverse rate variance at the same time as a favourable efficiency variance. In contrast, a favourable rate variance
might indicate a high proportion of inexperienced workers in the workforce, which could result in an adverse labour
efficiency variance and possibly an adverse materials usage variance (due to high rates of rejects).

Sales variances
(a) Selling price variance
The selling price variance is a measure of the effect on expected profit of a different selling price to standard selling price.
It is calculated as the difference between what the sales revenue should have been for the actual quantity sold, and what it
was.
Example: Suppose that the standard selling price of product X is $15. Actual sales in 20X3 were 2,000 units at $15.30 per unit.
The selling price variance is calculated as ?
(b) Sales volume profit variance
The sales volume profit variance is the difference between the actual units sold and the budgeted (planned) quantity, valued at
the standard profit per unit. In other words, it measures the increase or decrease in standard profit as a result of the sales volume
being higher or lower than budgeted (planned).

Example: Sales volume profit variance

Suppose that a company budgets to sell 8,000 units of product J for $12 per unit. The standard full cost per unit is $7. Actual sales
were 7,700 units, at $12.50 per unit.

The significance of sales variances

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The possible interdependence between sales price and sales volume variances should be obvious to you. A reduction in the sales
price might stimulate greater sales demand, so that an adverse sales price variance might be counterbalanced by a favourable
sales volume variance. Similarly, a price rise would give a favourable price variance, but possibly at the cost of a fall in demand and
an adverse sales volume variance. It is therefore important in analysing an unfavourable sales variance that the overall
consequence should be considered; that is, has there been a counterbalancing favourable variance as a direct result of the
unfavourable one?

Operating statement
Operating statements show how the combination of variances reconcile budgeted profit and actual profit. So far, we have
considered how variances are calculated without considering how they combine to reconcile the difference between budgeted profit
and actual profit during a period. This reconciliation is usually presented as a report to senior management at the end of each
control period. The report is called an operating statement or statement of variances.
An operating statement is a regular report for management of actual costs and revenues, usually showing variances from budget.

EXAMPLE Variances and operating statements

Sydney manufactures one product, and the entire product is sold as soon as it is produced. There are no opening or closing
inventories and work in progress is negligible. The company operates a standard costing system and analysis of variances is
made every month. The standard cost card for the product, a boomerang, is as follows.
STANDARD COST CARD – BOOMERANG
GHS
Direct materials 0.5 kilos at GHS4 per kilo 2.00
Direct wages 2 hours at GHS2.00 per hour 4.00
Variable overheads 2 hours at GHS0.30 per hour 0.60
Fixed overhead 2 hours at GHS3.70 per hour 7.40
Standard cost 14.00
Standard profit 6.00
Standing selling price 20.00

Selling and administration expenses are not included in the standard cost, and are deducted from profit as a period charge.

Budgeted (planned) output for the month of June 20X7 was 5,100 units. Actual results for June 20X7 were as follows.
Production of 4,850 units was sold for GHS95,600.
Materials consumed in production amounted to 2,300 kg at a total cost of GHS9,800.
Labour hours paid for amounted to 8,500 hours at a cost of GHS16,800.
Actual operating hours amounted to 8,000 hours.
Variable overheads amounted to GHS2,600.
Fixed overheads amounted to GHS42,300.
Selling and administration expenses amounted to GHS18,000.
Required
Calculate all variances and prepare an operating statement for the month ended 30 June 20X7.

Absorption costing system

Solution
(a) GHS
2,300 kg of material should cost (GHS4) 9,200
but did cost 9,800
Material price variance 600 (A)

(b) 4,850 boomerangs should use (0.5 kg) 2,425 kg

but did use 2,300 kg
Material usage variance in kg 125 kg (F)
standard cost per kg × GHS4
Material usage variance in GHS GHS 500 (F)

(c) GHS
8,500 hours of labour should cost (GHS2) 17,000
but did cost 16,800

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Labour rate variance 200 (F)

(d) 4,850 boomerangs should take (2 hrs) 9,700 hrs

but did take (active hours) 8,000 hrs
Labour efficiency variance in hours 1,700 hrs (F)
standard cost per hour × GHS2
Labour efficiency variance in GHS GHS3,400 (F)

(e) Idle time variance 500 hours (A) GHS2 GHS1,000 (A)

(f) GHS
8,000 hours incurring variable o/hd expenditure should cost (GHS0.30) 2,400
but did cost 2,600
Variable overhead expenditure variance 200 (A)

(g) Variable overhead efficiency variance in hours is the same as the

labour efficiency variance:
1,700 hours (F) GHS0.30 per hour GHS 510 (F)

(h) GHS
Budgeted fixed overhead (5,100 units 2 hrs GHS3.70) 37,740
Actual fixed overhead 42,300
Fixed overhead expenditure variance 4,560 (A)

(i)
4,850 boomerangs should take (2 hrs) 9,700 hrs
but did take (active hours) 8,000 hrs
Fixed overhead volume efficiency variance in hrs 1,700 hrs (F)
standard fixed overhead absorption rate per hour GHS3.70
Fixed overhead volume efficiency variance in GHS 6,290 (F)

(j) GHS
Budgeted hours of work (5,100 2 hrs) 10,200 hrs
Actual hours of work 8,000 hrs
Fixed overhead volume capacity variance in hrs 2,200 hrs (A)
standard fixed overhead absorption rate per hour GHS3.70
Fixed overhead volume capacity variance in GHS 8,140 (A)

(k) GHS
Revenue from 4,850 boomerangs should be (GHS20) 97,000
but was 95,600
Selling price variance 1,400 (A)

(l) Budgeted sales volume 5,100 units

Actual sales volume 4,850 units
Sales volume profit variance in units 250 units (A)
standard profit per unit × GHS6
Sales volume profit variance in GHS GHS1,500 (A)

SYDNEY – OPERATING STATEMENT JUNE 20X7

GHS GHS
Budgeted (planned) profit before sales and administration costs 30,600
Sales variances: price 1,400 (A)
Volume 1,500 (A)
2,900 (A)
Actual sales minus the standard cost of sales 27,700
(F) (A)
Cost variances GHS GHS
Material price 600

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Material usage 500
Labour rate 200
Labour efficiency 3,400
Labour idle time 1,000
Variable overhead expenditure 200
Variable overhead efficiency 510
Fixed overhead expenditure 4,560
Fixed overhead volume efficiency 6,290
Fixed overhead volume capacity 8,140
10,900 14,500 3,600 (A)
Actual profit before sales and
administration costs 24,100
Sales and administration costs 18,000
Actual profit, June 20X7 6,100

Check GHS GHS

Sales 95,600
Materials 9,800
Labour 16,800
Variable overhead 2,600
Fixed overhead 42,300
Sales and administration 18,000
89,500
Actual profit 6,100

Variances in a standard marginal costing system

There are two main differences between the variances calculated in an absorption costing system and the variances
calculated in a marginal costing system.
In the marginal costing system the only fixed overhead variance is an expenditure variance.
The sales volume variance is valued at standard contribution margin, not standard profit margin.

Returning once again to the example of Sydney, the variances in a system of standard marginal costing would be as follows.
(a) There is no fixed overhead volume variance (and therefore no fixed overhead volume efficiency and volume capacity
variances).

(b) The standard contribution per unit of boomerang is GHS(20 – 6.60) = GHS13.40, therefore the sales volume
contribution variance of 250 units (A) is valued at (GHS13.40) = GHS3,350 (A).

The other variances are unchanged. However, this operating statement differs from an absorption costing operating
statement in the following ways.
(a) It begins with the budgeted contribution (GHS30,600 + budgeted fixed production costs
GHS37,740 = GHS68,340).

(b) The subtotal before the analysis of cost variances is actual sales (GHS95,600) less the standard variable cost of sales
(GHS4,850 GHS6.60) = GHS63,590.

(c) Actual contribution is highlighted in the statement.

(d) Budgeted (planned) fixed production overhead is adjusted by the fixed overhead expenditure variance to show the actual
fixed production overhead expenditure.
Therefore a marginal costing operating statement might look like this.

SYDNEY – OPERATING STATEMENT JUNE 20X7

GHS GHS GHS

Budgeted (planned) contribution 68,340

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Sales variances: volume 3,350 (A)
Price 1,400 (A)
4,750 (A)
Actual sales minus the standard variable cost of sales 63,590
(F) (A)
Variable cost variances
Material price 600
Material usage 500
Labour rate 200
Labour efficiency 3,400
Labour idle time 1,000
Variable overhead expenditure 200
Variable overhead efficiency 510
4,610 1,800
2,810 (F)
Actual contribution 66,400
Budgeted (planned) fixed production overhead 37,740
Expenditure variance 4,560 (A)
Actual fixed production overhead 42,300
Actual profit before sales and administration costs 24,100
Sales and administration costs 18,000
Actual profit 6,100

Notice that the actual profit is the same as the profit calculated by standard absorption costing because there were no
changes in inventory levels. Absorption costing and marginal costing do not always produce an identical profit figure.

Deriving actual data from standard cost details and variances

Variances can be used to derive actual data from standard cost details.
Rather than being given actual data and asked to calculate the variances, you may be given the variances and required to
calculate the actual data on which they were based. See if you can do these two questions.
Question Rate of pay
XYZ uses standard costing. The following data relates to labour grade ll.
Actual hours worked 10,400 hours
Standard allowance for actual production 8,320 hours
Standard rate per hour GHS5
Rate variance (adverse) GHS416
What was the actual rate of pay per hour?

The standard material content of one unit of product A is 10kg of material X which should cost GHS10 per kilogram. In June
20X4, 5,750 units of product A were produced and there was an adverse material usage variance of GHS1,500.
Required
Calculate the quantity of material X used in June 20X4.

Materials mix and yield variances

The materials usage variance can be sub-divided into a materials mix variance and a materials yield variance when more
than one material is used in the product.
However, calculating a mix and yield variance is only meaningful for control purposes when management is in a position to
control the mix of materials used in production.

Calculating mix and yield variances

The mix variance is calculated as follows.
a) Take the total actual quantity of materials used.
b) Divide this total quantity of materials into the standard mix or standard proportions of the different materials used in
the mix.

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 c) For each item of materials, the difference between the actual quantity used and the quantity in the standard mix is a
mix variance.
d) Convert the mix variance for each item of material into a money value by applying the standard price per unit for
the material.
e) The total of the mix variance for each of the materials in the mix is the total materials mix variance.

The yield variance is calculated as follows.

(a) For the actual number of units of product manufactured, calculate the total quantity of materials that should have
been used (a single total for all the materials in the mix).
(b) Compare this standard quantity of materials that should have been used with the actual total quantity of materials
that was used.
(c) The difference is the yield variance in material quantities.
(d) Convert this into a money value by applying the weighted average cost per unit of material.

An alternative method of calculating the yield variance produces the same result.
(a) Take the actual total quantity of materials used and calculate how many units of output should have been produced with
this quantity of materials. (This is the total quantity of materials actually used divided by the total quantity of materials in one
standard unit of product.)
(b) Compare this with the actual number of units produced. The difference is the yield variance in units of finished product.
(c) Convert this into a money value by applying the standard material cost per unit of product.

Example: Materials usage, mix and yield variances

A company manufactures a chemical, Dynamite, using two compounds Flash and Bang. The standard materials usage and
cost of one unit of Dynamite are as follows.
GHS
Flash 5 kg at GHS2 per kg 10
Bang 10 kg at GHS3 per kg 30
40
In a particular period, 80 units of Dynamite were produced from 600 kg of Flash and 750 kg of Bang.
Required
Calculate the materials usage, mix and yield variances.

Solution
(a) Usage variance
If we do not calculate a mix and yield variance, we would calculate a usage variance separately for each material.

Std usage for Actual Standard

actual output of 80 units usage Variance cost per kg Variance
kg kg kg GHS GHS
Flash 400 600 200 (A) 2 400 (A)
Bang 800 750 50 (F) 3 150 (F)
1,200 1,350 250 (A)
The total usage variance of GHS250 (A) can be analysed into a mix variance and a yield variance and these may be reported
instead of the usage variance.

(b) Mix variance

To calculate the mix variance, it is first necessary to decide how the total quantity of materials used (600 kg + 750 kg) should
have been divided between Flash and Bang. In other words, we need to calculate the standard mix of the actual quantity
of materials used.
Actual usage Actual total usage in
standard mix (5:10 or 1:2) Mix variance
kg kg kg
Flash 600 450 150 (A)
Bang 750 900 150 (F)
1,350 1,350 0
The mix variance in total quantities is always 0. This must always be the case since the expected mix is based on the total
quantity actually used and hence the difference between the total expected and total actual is zero.

11
However the actual mix uses:

(a) More of the cheaper material Flash (= adverse variance, because actual usage of Flash in the mix is more than the
standard usage; therefore the cost for Flash is more), but
Less of the more expensive material Bang (= favourable variance, because actual usage of Bang in the mix is less than the
standard usage; therefore the cost for Bang is lower).
Taking both materials together, the actual mix of materials is cheaper than the standard mix, and this will produce a
favourable mix variance overall.
The mix variances in quantities are converted into a money value at the standard price of the materials.
Actual Standard Mix Standard Mix
usage/mix mix variance price variance
kg kg kg GHS per kg GHS
Flash 600 450 150 (A) 2 300 (A)
Bang 750 900 150 (F) 3 450 (F)
1,350 1,350 0 150 (F)
The total mix variance is GHS150 (F).

(c) Yield variance

The yield variance can be calculated in total or for each individual material input.
Method 1
The weighted average cost per kilogram of materials = GHS40/15 kg = GHS2.67 per kg.
Kg
80 units of product should use in total (15 kg) 1,200
They did use (600 + 750) 1,350
Yield variance in kg 150 (A)
Weighted average price per kg GHS2.67
Yield variance in GHS GHS400 (A)
Method 2
units
1,350 kg of material should produce (15) 90
They did produce 80
Yield variance in units of output 10 (A)
Standard material cost per unit GHS40
Yield variance in GHS GHS400 (A)
The mix variance GHS150 (F) plus the yield variance GHS400 (A) together add up to the usage variance GHS250 (A).

Inter-relationship between mix and yield variance

A favourable mix variance occurs when the actual mix of materials is cheaper than the standard mix.

As a consequence of using a cheaper mix of materials, it is possible that the output/yield will be less than the standard
output. In other words, a favourable mix variance may result in an adverse yield variance.
In the previous example, it is possible that by using a bigger proportion of Flash in the production mix, the actual yield of
finished products (= 80 units) was less than it should have been (= 90 units).

For similar reasons, when there is an adverse mix variance because the actual mix of materials is more expensive than the
standard mix, there may possibly be an inter-related favourable yield variance

Example 2 mix and yield estion Mix and yield variances

The standard materials cost of product D456 is as follows.
GHS
Material X 3 kg at GHS2.00 per kg 6
Material Y 5 kg at GHS3.60 per kg 18
24

During period 2, 2,000 kg of material X (costing GHS4,100) and 2,400 kg of material Y (costing GHS9,600) were used to
produce 500 units of D456.
Required
Calculate the following variances.
(a) Price variance
12
(b) Mix variance
(c) Yield variances – in total and for each individual material

Sales mix and quantity variances

The sales volume variance can be analysed further into a sales mix variance and a sales quantity variance. This may be
useful for control purposes where management is in a position to control the sales mix, for example through the allocation of
spending on advertising and sales promotion.

The sales mix variance occurs when the proportions of the various products sold are different from those in the budget.
The sales quantity variance shows the difference in contribution/profit because of a volume from the budgeted volume of
sales.

The units method of calculation

The sales mix variance is calculated in a similar way to the materials mix variance.
(a) Take the total actual quantity of units sold, for all the products combined.
(b) Divide this total quantity of sales units into the budgeted standard mix or budgeted proportions of the different products
in the mix.
(c) For each product, the difference between the actual quantity sold and the sales quantity in the budgeted standard mix is a
mix variance.
(d) Convert the mix variance for each product into a money value by applying the standard profit per unit (or standard
contribution pr unit, where standard marginal costing is used).
(e) The total of the mix variance for each of the products in the sales mix is the total sales mix variance.
The sales quantity variance is calculated in a similar way to the materials yield variance, as follows.
(a) Calculate the weighted average standard profit per unit (or weighted average standard contribution per unit). This is
calculated from the budget, as the budgeted total profit divided by the budgeted total units of sale.
(b) Calculate the difference between the actual total sales units and the budgeted total sales units. This difference is the
sales quantity variance in units.
(c) Convert this variance in sales units into a money value by applying the weighted average standard profit (or standard
contribution) per unit of sale.
The sales mix variance plus the sales quantity variance equals the total sales volume variance for all the products.
Example: Sales mix and quantity variances
Just Desserts Limited makes and sells two products, Chocolate Crunch and Strawberry Sundae.
The budgeted sales and profit are as follows.
Sales Revenue Costs Profit Profit per unit
Units GHS GHS GHS GHS
Chocolate Crunch (CC) 400 8,000 6,000 2,000 5
Strawberry Sundae (SS) 300 12,000 11,100 900 3
2,900
Actual sales were 280 units of Chocolate Crunch and 630 units of Strawberry Sundae. The company management is able to
control the relative sales of each product through the allocation of sales effort, advertising and sales promotion expenses.
Required
Calculate the sales volume variance, the sales mix variance and the sales quantity variance.

Solution
(a) Sales volume variance
CC SS
Budgeted sales 400 units 300 units
Actual sales 280 units 630 units
Sales volume variance in units 120 units (A) 330 units (F)
standard profit per unit × GHS5 × GHS3
Sales volume variance in GHS GHS600 (A) GHS990 (F)
Total sales volume variance GHS390 (F)
The favourable sales volume variance indicates that profit was better than budget because on balance more units were sold
than budgeted. However the favourable variance may be due to selling a larger proportion of the more profitable product
(sales mix variance) or selling more units in total (sales quantity variance).
Now we will see how to analyse this favourable volume variance into its mix and quantity elements.
(b) Sales mix variance

13
This is calculated in a similar way to the materials mix variance. Start with the total quantity of products sold and calculate
what sales of each product would have been if they had been sold in the budgeted proportions.

Actual sales Standard Sales mix Standard profit Sales mix

Mix sales mix variance variance
(4:3)

units units units GHS per unit GHS

CC 280 520 240 (A) 5 1,200 (A)
SS 630 390 240 (F) 3 720 (F)
910 910 0 480 (A)
The total sales mix variance is GHS480 (A).

(c) Sales quantity variance

The standard weighted average profit per unit of sale, taken from the budget, is
GHS2,900/700 = GHS29/7
units
Budgeted sales in total 700
Actual sales in total 910
Sales quantity variance in units 210 (F)
Standard weighted average profit per unit GHS29/7
Sales quantity variance in GHS GHS870 (F)

Sales mix variance GHS480 (A) + Sales quantity variance GHS870 (F) = Sales volume variance GHS390 (F).

The overall favourable sales volume variance was achieved by selling products in a cheaper sales mix, but achieving a
higher total quantity of sales units than budgeted.

Planning and operation variance

Revising a budget or standard cost
Occasionally, it may be appropriate to revise a budget or standard cost. When this happens, variances should be reported
in a way that distinguishes between variances caused by the revision to the budget and variances that are the responsibility
of operational management.
A planning and operational approach to variance analysis divides the total variance into those variances which have arisen
because of inaccurate planning or faulty standards (planning variances) and those variances which have been caused by
adverse or favourable operational performance, compared with a standard which has been revised in hindsight (operational
variances).
Reasons for revising a budget or standard cost
When variances are reported in a system of budgetary control, it is usually assumed that:
(a) The original budget or standard cost is fairly accurate or reliable
(b) So any differences between actual results and the budget or standard, measured as variances, are attributable to the
manager who is responsible for that aspect of performance.

The manager responsible will be expected to explain the reasons for any significant variances, and where appropriate take
measures to rectify problems causing an adverse variance.

Occasionally however, circumstances may occur that make the original budget or standard cost invalid or inappropriate.
(a) The sales budget may have been based on expectations of the total size of the market for the organisation’s product.
However due to an unexpected change in economic conditions, or an unexpected technological change, or a radical change
in customer attitudes, or unexpected new regulations affecting the marketability of a product, the market size may be much
larger or much smaller than assumed when the sales budget was prepared.

(b) The standard cost of materials for a product may have been based on an assumption about what the market price for the
materials should be. However due to a major change in the market, the available market price for the materials may become
much higher or much lower than originally expected when the standard cost was prepared.

(c) The standard quantity of materials for a product may be significantly altered due to an unexpected change in the product
specification, requiring much more or much less of the material in the product content.

14
(d) The standard labour rate may become unrealistic due to an unexpected increase in pay rates for employees.

(e) The standard time to produce a unit of product may also change for unexpected reasons.
If the budget or standard cost is not revised in these circumstances, variances reported to operational managers will be
unrealistic. A large part of the variances will be due to changes that are outside the control of the operational
managers.
In these circumstances, it may be appropriate to revise the budget or revise the standard cost.
Calculating a revised budget
The syllabus requires you to be able to calculate a revised budget, which could involve revising standards for sales, materials
and/or labour so that only operational variances are highlighted when actual results are compared to the revised budget.

Factors to consider when preparing flexible budgets

The mechanics of flexible budgeting are, in theory, fairly straightforward. In practice, however, there are
a number of points that must be considered before figures are flexed.
(a) The separation of costs into their fixed and variable elements is not always straightforward.
(b) Fixed costs may behave in a step-line fashion as activity levels increase/decrease.
(c) Account must be taken of the assumptions on which the original fixed budget was based. Such assumptions might include the
constraint posed by limiting factors, the rate of inflation, judgements about future uncertainty and the demand for the organisation's
products.

Example 1: Revised budget

A company produces Widgets and Splodgets which are fairly standardised products. The following information relates to
period 1.

The standard selling price of Widgets is GHS50 each and Splodgets GHS100 each. In period 1, there was a special
promotion on Splodgets with a 5% discount being offered. All units produced are sold and no inventory is held.

To produce a Widget they use 5 kg of X and in period 1, their plans were based on a cost of X of GHS3 per kg. Due to
market movements the actual price changed and if they had purchased efficiently the cost would have been GHS4.50 per kg.
Production of Widgets was 2,000 units.

A Splodget uses raw material Z but again the price of this can change rapidly. It was thought that
Z would cost GHS30 per tonne but in fact they only paid GHS25 per tonne and if they had purchased correctly the cost would
have been less as it was freely available at only GHS23 per tonne. It usually takes 1.5 tonnes of Z to produce 1 Splodget and
500 Splodgets are usually produced.

Each Widget takes 3 hours to produce and each Splodget 2 hours. Labour is paid GHS5 per hour.
At the start of period 1, management negotiated a job security package with the workforce in exchange for a promised 5%
increase in efficiency – that is, that the workers would increase output per hour by 5%.
Fixed overheads are usually GHS12,000 every period and variable overheads are GHS3 per labour hour.
Required
Produce the original budget and a revised budget allowing for controllable factors in a suitable format.
Solution
Original budget for Period 1
GHS
Sales revenue ((2,000 × GHS50) + (500 × GHS100)) 150,000
Material costs X (2,000 × 5kg × GHS3) 30,000
Material costs Z (500 × GHS30 × 1.5) 22,500
Labour costs ((2,000 × 3 × GHS5) + ( 500 × 2 × GHS5)) 35,000
Variable overheads ((2,000 × 3 × GHS3) + ( 500 × 2 × GHS3)) 21,000
Fixed overheads 12,000
Profit 29,500

Revised budget for Period 1

GHS
Sales revenue ((2,000 × GHS50) + (500 × GHS100)) 150,000
Material costs X (2,000 × 5kg × GHS4.5) 45,000
Material costs Z (500 × GHS23 × 1.5) 17,250
15
Labour costs ((2,000 × 3 × GHS5 ) + ( 500 × 2 × GHS5)) × 0.95 33,250
Variable overheads ((2,000 × 3 × GHS3) + ( 500 × 2 × GHS3)) × 0.95 19,950
Fixed overheads 12,000
Profit 22,550
Example 2
(a) Prepare a budget for 20X6 for the direct labour costs and overhead expenses of a production
department at the activity levels of 80%, 90% and 100%, using the information listed below.

(i) The direct labour hourly rate is expected to be $3.75.

(ii) 100% activity represents 60,000 direct labour hours.
(iii) Variable costs
Indirect labour $0.75 per direct labour hour
Consumable supplies $0.375 per direct labour hour
Canteen and other welfare services 6% of direct and indirect labour costs
PART C: BUDGETING
(iv) Semi-variable costs are expected to relate to the direct labour hours in the same manner as for the
last five years.
Direct Semi
Labour variable
Year hours costs
$
20X1 64,000 20,800
20X2 59,000 19,800
20X3 53,000 18,600
20X4 49,000 17,800
20X5 (estimate) 40,000 16,000

(v) Fixed overhead per labour hour at 100% activity

$
Depreciation 0.30
Maintenance 0.20
Insurance 0.10
Rates 0.25
Management salaries 0.40

(vi) Inflation is to be ignored.

(b) Calculate the budget cost allowance (ie expected expenditure) for 20X6 assuming that 57,000
direct labour hours are worked.

Solution
(a) 80% level 90% level 100% level
48,000 hrs 54,000 hrs 60,000 hrs
$'000 $'000 $'000
Direct labour 180.00 202.50 225.0
Other variable costs
Indirect labour 36.00 40.50 45.0
Consumable supplies 18.00 20.25 22.5
Canteen etc 12.96 14.58 16.2
Total variable costs ($5.145 per hour W1) 246.96 277.83 308.7

16
Semi-variable costs (W2) 17.60 18.80 20.0
Fixed costs
Depreciation (60 $0.3) 18.00 18.00 18.0
Maintenance (60 $0.2) 12.00 12.00 12.0
Insurance (60 $0.1) 6.00 6.00 6.0
Rates (60 $0.25) 15.00 15.00 15.0
Management salaries (60 $0.4) 24.00 24.00 24.0
Budgeted costs 339.56 371.63 403.7

Workings
1 Total variable cost = direct labour + indirect labour + canteen + consumables
= $4.50 + $0.27 + $0.375 = $5.145
2 Using the high-low method:
$
Total cost of 64,000 hours 20,800
Total cost of 40,000 hours 16,000
Variable cost of 24,000 hours 4,800
Variable cost per hour ($4,800/24,000) $0.20

$
Total cost of 64,000 hours 20,800
Variable cost of 64,000 hours ($0.20) 12,800
Fixed costs 8,000

Semi-variable costs are calculated as follows.

$
60,000 hours (60,000 $0.20) + $8,000 = 20,000
54,000 hours (54,000 $0.20) + $8,000 = 18,800
48,000 hours (48,000 $0.20) + $8,000 = 17,600
(b) The budget cost allowance for 57,000 direct labour hours of work would be as follows.
$
Variable costs (57,000 $5.145) 293,265
Semi-variable costs ($8,000 + (57,000 $0.20)) 19,400
Fixed costs 75,000
384,665
Note that in each case the fixed costs remain the same when the level of activity changes and are not flexed.

Example 3 The budgeted and actual results of Crunch for September were as follows. The company uses a marginal costing
system. There were no opening or closing inventories.
Fixed budget Actual
Sales and production 1,000 unit’s 700 units
$ $ $ $
Sales 20,000 14,200
Variable cost of sales
Direct materials 8,000 5,200
Direct labour 4,000 3,100
Variable overhead 2,000 1,500
14,000 9,800
Contribution 6,000 4,400
Fixed costs 5,000 5,400
Profit/(loss) 1,000 (1,000)

Required
Prepare a budget that will be useful for management control purposes.
When should budget revisions be allowed?
A budget revision should be allowed if something has happened which is beyond the control of the organisation or
individual manager and which makes the original budget unsuitable for use in performance management.

17
Any adjustment should be approved by senior management who should look at the issues involved objectively and
independently. Operational issues are the issues that a budget is attempting to control so they should not be subject to
revision. However, it can be very difficult to establish what is due to operational problems (controllable) and what is due to
planning (uncontrollable).
The nature of planning and operational variances
When a budget or standard cost is revised, variances are still reported as a comparison between actual results and the
original budget or standard cost.
However, the variances should be reported that make a clear distinction between:
(a) Variances that have been caused by the revision in the budget or standard cost, for which operational managers should
not be made responsible: these are called planning variances
(b) Variances that are caused by differences between actual performance and the revised budget or standard. For which
operational managers should be made responsible and accountable. These are called operational variances.
Planning variances are calculated by comparing the original budget/standard cost with the revised budget/standard cost.
Operational variances are calculated in the same way as ‘normal’ basic variances, except that they are based on a
comparison between actual results and the revised budget/standard cost.

Planning and operational variances for sales: market size and market share variances
A sales budget may be revised when it is recognised that the original sales budget was based on
expectations of the total market size that in retrospect are seen to be inappropriate and unrealistic.

When the sales budget is revised, a sales volume planning variance may be reported. This is the
difference in profit caused by the difference between the original sales budget and the revised sales
budget. This planning variance is called a market size variance. When the sales budget is revised, a
sales volume operational variance may be reported, for which operational sales managers should be
held responsible. This is the difference in profit caused by the difference between actual sales volume
and the sales volume in the revised sales budget. This operational variance is called a market share
variance.

When the sales budget is revised it may be assumed that:

(a) The revision to the sales budget was due to a re-assessment of the total market size for the
organisation’s product, but

(b) Sales management should still be expected to win the same market share (as a proportion of the
total market size) as in the original budget.
On the basis of this assumption, the sales volume variance can be reported as:
(a) A sales volume planning variance, or market size variance, which is caused by the difference
between the sales volume in the original budget and the sales volume in the revised budget, and

(b) A sales volume operational variance, or market share variance, which is caused by the
difference between actual sales volume and the sales volume in the revised budget.
As there has been no change in the budgeted sales price or standard cost of products, these two
variances can be converted from units into a money value by multiplying the variance is units by the
standard profit (or standard contribution) per unit.
Example: market size and market share variance
Dimsek budgeted to make and sell 400 units of its product, the Role, in the four-week period no 8, as follows.
GHS
Budgeted sales (100 units per week) 40,000
Variable costs (400 units GHS60) 24,000
Contribution 16,000
Fixed costs 10,000
Profit 6,000

18
At the beginning of the second week, production came to a halt because inventories of raw materials ran out, and
a new supply was not received until the beginning of week 3. As a consequence, the company lost one week's
production and sales. Actual results in period 8 were as follows.
GHS
Sales (320 units) 32,000
Variable costs (320 units GHS60) 19,200
Contribution 12,800
Fixed costs 10,000
Actual profit 2,800
In retrospect, it is decided that the optimum budget, given the loss of production facilities in thethird
week, would have been to sell only 300 units in the period.
Required
Calculate appropriate planning and operational variances for sales volume.
Solution
The sales volume planning variance compares the revised budget with the original budget. It may
be called a market size variance.
Revised sales volume, given materials shortage 300 units
Original budgeted sales volume 400 units
Sales volume planning variance in units of sales 100 units (A)
standard contribution per unit × GHS40
Sales volume planning variance in GHS GHS4,000 (A)

Arguably, running out of raw materials is an operational error and so the loss of sales volume and
contribution from the materials shortage is an opportunity cost that could have been avoided with better
purchasing arrangements. The operational variances are variances calculated in the usual way, except
that actual results are compared with the revised standard or budget. There is a sales volume variance
which is an operational variance, as follows.
operational variances
Actual sales volume 320 units
Revised sales volume 300 units
Operational sales volume variance in units 20 units (F)
(possibly due to production efficiency or marketing efficiency)
standard contribution per unit × GHS40
Operational sales volume variance in GHS contribution GHS800 (F)

The operational variance for sales volume may be called a market share variance. These planning and
operational variances for sales volume can be used as control information to reconcile budgeted and
actual profit.
GHS GHS
Operating statement, period 8
Budgeted profit 6,000
Planning variance: sales volume 4,000 (A)
Operational variance: sales volume 800 (F)
3,200 (A)
Actual profit in period 8 2,800
You may have noticed that in this example sales volume variances were valued at contribution
forgone. This is because it is assumed that a marginal costing system applies.
Question Sales volumes

19
PG budgeted sales for 20X8 were 5,000 units. The standard contribution is GHS9.60 per unit. A
recession in 20X8 meant that the market for PG's products declined by 5%. PG's market share also fell
by 3%. Actual sales were 4,500 units.
Required
Calculate planning and operational variances for sales volume.
Answer
Planning variance
Units
Original budgeted sales 5,000
Revised budget sales (–5%) 4,750
250 A
@ Contribution per unit of GHS9.60 GHS2,400

Operational variance
Units
Revised budget sales 4,750
Actual sales 4,500
250 A
@ Contribution per unit of GHS9.60 GHS2,400

The fall in market size is uncontrollable by the management of PG and therefore results in a planning
variance. The fall in market share is controllable and forms part of the operational variance.

Planning and operational variances for sales price

There may be a situation where a revision is made to the budgeted or standard selling price for a
product. When this happens, a sales price planning variance and a sales price operational variance can
be calculated.
The planning variance is generally outside the control of sales management, but the operational sales
price variance is a sales management responsibility.

exampleQuestion Planning and operational sales variances

KSO budgeted to sell 10,000 units of a new product during 20X0. The budgeted sales price was
GHS10 per unit, and the variable cost GHS3 per unit.
Actual sales in 20X0 were 12,000 units and variable costs of sales were GHS30,000, but sales revenue
was only GHS5 per unit. With the benefit of hindsight, it is realised that the budgeted sales price of
GHS10 was hopelessly optimistic, and a price of GHS4.50 per unit would have been much more
realistic.
Required
Calculate planning and operational variances for sales price.
Answer
The only variances are selling price variances.
Planning (selling price) variance
GHS per unit
Original budgeted sales price 10.00
Revised budgeted sales price 4.50
Sales price planning variance 5.50 (A)
The planning variance is adverse because the revised sales price is lower than the sales price in the
original budget. As a result, actual profit will not achieve the budgeted profit level.

20
The total sales price planning variance is obtained by multiplying the planning variance per unit
by the actual number of units sold (not the budgeted number of units sold).
Sales price planning variance = GHS5.50 per unit (A) × 12,000 units sold
= GHS66,000 (A).

Operational (selling price) variance

The sales price operational variance is calculated in the same way as a ‘normal’ sales price variance,
except that the sales price in the revised budget is used, not the original budget.
GHS
12,000 units should sold for (12,000 GHS5) 60,000
They should have sold for (GHS4.5) 54,000
Operational (selling price) variance 6,000 (F)

Planning and operational variances for materials

Planning and operational variances can be reported for direct materials, when the standard cost is
revised for the material price, material usage per unit, or both.
The same basic principles can be applied to calculating planning and operational variances for
materials, when the standard material cost per unit is changed.
However:
Operational variances are reported as a materials price and a materials usage variance.
Should these variances be calculated using the original standard cost or the revised standard cost?
The planning variance for materials is the difference between the original standard and the revised
standard. But should they be converted into a total money value using actual material quantities or
standard material quantities?

An additional problem, and one that you may be expected to deal with in your exam, is that the revised
standard for materials may contain a revision to both the material price and the material quantity per
unit.
The calculation of planning and operational variances for materials will be explained with two examples.
The first example revises just one aspect of the standard material cost. The second example revises
both the standard unit price of materials and the standard material usage per unit of product.

Example 1: Planning price and usage variances

Product X had a standard direct material cost in the budget of:
4 kg of Material M at GHS5 per kg = GHS20 per unit.
Due to disruption of supply of materials to the market, the average market price for Material M during the
period was GHS5.50 per kg, and it was decided to revise the material standard cost to allow for this.
During the period, 6,000 units of Product X were manufactured. They required 26,300 kg of
Material M, which cost GHS139,390.

Required
Calculate:
(a) The material price planning variance
(b) The material price operational variance
(c) The material usage (operational) variance

Solution
The original standard cost was 4kg × GHS5 = GHS20. The revised standard cost is 4kg ×

21
GHS5.50 = GHS22.
Material price planning variance
This is the difference between the original standard price for Material M and the revised standard price.
GHS per kg
Original standard price 5.00
Revised standard price 5.50
Material price planning variance 0.50 (A)
The planning variance is adverse because the change in the standard price increases the material cost
and this will result in lower profit.
The material price planning variance is converted into a total money amount by multiplying the planning
variance per kg of material by the actual quantity of materials used.
Material price planning variance = 26,300 kg × GHS0.50 (A) = GHS13,150 (A).

Material price operational variance

This compares the actual price per kg of material with the revised standard price. It is calculated using
the actual quantity of materials used.
GHS
26,300 kg of Material M should cost (revised standard GHS5.50) 144,650
They did cost 139,390
Material price operational variance 5,260 (F)

Material usage operational variance

This variance is calculated by comparing the actual material usage with the standard usage in the
revised standard, but it is then converted into a money value by applying the original standard
price for the materials, not the revised standard price. This is an important rule.
kg of M
6,000 units of Product X should use (4 kg) 24,000
They did use 26,300
Material usage (operational) variance in kg of M 2,300 (A)
Original standard price per kg of Material M GHS5
Material usage (operational) variance in GHS GHS11,500 (A)

The variances may be summarised as follows

GHS GHS
6,000 units of Product X at original std cost (GHS20) 120,000
Actual material cost 139,390
Total material cost variance 19,390 (A)
Material price planning variance 13,150 (A)
Material price operational variance 5,260 (F)
Material usage operational variance 11,500 (A)
Total of variances 19,390 (A)
Example 2: Planning price and usage variances
The standard materials cost of a product is 5 kg GHS7.50 per kg = GHS37.50. Actual production of
10,000 units used 54,400 kg at a cost of GHS410,000.

In retrospect it was realised that the standard materials cost should have been 5.3 kg per unit at a cost
of GHS8 per kg. The standard cost was revised to this amount.

Required

22
Calculate the materials planning and operational variances in as much detail as possible.

Solution
Original standard cost: 5 kg GHS7.50 per kg = GHS37.50 per unit of product

Revised standard cost: 5.3 kg GHS8 per kg = GHS42.40 per unit of product

In this example, both the material price and the material usage per unit have been revised. There are
planning variances for both material price and material usage.

Material price planning variance

This is the difference between the original standard price and the revised standard price.
GHS per kg
Original standard price 7.50
Revised standard price 8.00
Material price planning variance 0.50 (A)

The planning variance is adverse. The variance is converted into a total money amount by multiplying
the planning variance per kg of material by the actual quantity of materials used.
Material price planning variance = 54,400 kg GHS0.50 (A) = GHS27,200 (A).
Material usage planning variance
This is the difference between the original standard usage and the revised standard usage for the
quantity of units produced. The usage planning variance is converted into a total money value by
applying the original standard price for the material, not the revised standard price.
kg
10,000 units of product X should use: original standard 50,000
10,000 units of product X should use: revised standard 53,000
Material usage planning variance in kg of material 3,000 (A)
Original standard price per kg of material GHS7.50
Material usage planning variance in GHS GHS22,500 (A)

The planning variance is adverse because the revised standard is for a higher usage quantity (so higher
cost and lower profit).

Material price operational variance

This is calculated using the actual quantity of materials used.
GHS
54,400 kg of material should cost (revised standard GHS8) 435,200
They did cost 410,000
Material price operational variance 25,200 (F)

Material usage operational variance

This variance is calculated by comparing the actual material usage with the standard usage in the
revised standard, and is then converted into a money value by applying the original standard price
for the materials.
kg
10,000 units of product X should use (5.3 kg) 53,000
They did use 54,400
Material usage (operational) variance in kg of material 1,400 (A)

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Original standard price per kg of Material M GHS7.50
Material usage (operational) variance in GHS GHS10,500 (A)
The variances may be summarised as follows
GHS GHS
10,000 units of product at original std cost (GHS37.50) 375,000
Actual material cost 410,000
Total material cost variance 35,000 (A)
Material price planning variance 27,200 (A)
Material usage planning variance 22,500 (A)
Material price operational variance 25,200 (F)
Material usage operational variance 10,500 (A)
Total of variances 35,000 (A)

Planning and operational variances for labour

Planning and operational variances can be reported for direct labour, when the standard cost is revised
for the labour rate per hour, the standard labour time per unit, or both.
Precisely the same argument applies to the calculation of operational variances for labour, and the
examples already given should be sufficient to enable you to do the next question. If you are not sure,
check the solution carefully
Example Question Planning and operational labour variances
A company makes a single product. At the beginning of the budget year, the standard labour cost was
established as GHS8 per unit, and each unit should take 0.5 hours to make.

However during the year the standard labour cost was revised. A new quality control procedure was
introduced to the production process, adding 20% to the expected time to complete a unit. In addition,
due to severe financial difficulties facing the company, the work force reluctantly agreed to reduce the
rate of pay to GHS15 per hour.

In the first month after revision of the standard cost, budgeted production was 15,000 units but only
14,000 units were actually produced. These took 8,700 hours of labour time, which cost GHS130,500.
Required
Calculate the labour planning and operational variances in as much detail as possible.

Answer
Original standard cost = 0.5 hours GHS16 per hour = GHS8 per unit

Revised standard = 0.6 hours GHS15 per hour = GHS9 per unit

Planning and operational variances for labour are calculated in a similar way to planning and operational
variances for materials. We need to look at planning and operational variances for labour rate and
labour efficiency.

Labour rate planning variance

This is the difference between the original standard rate per hour and the revised standard rate per hour.
GHS per hour
Original standard rate 16
Revised standard rate 15
Labour rate planning variance 1 (F)

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The planning variance for labour rate is favourable, because the revised hourly rate is lower than in the
original standard. The variance is converted into a total money amount by multiplying the planning
variance per hour by the actual number of hours worked.
Labour rate planning variance = 8,700 hours GHS1 (F) = GHS8,700 (F).

Labour efficiency planning variance

This is the difference between the original standard time per unit and the revised standard time, for the
quantity of units produced. The efficiency planning variance is converted into a total money value
by applying the original standard rate per hour, not the revised standard rate.
hours
14,000 units of product should take: original standard (× 0.5) 7,000
14,000 units of product should take: revised standard (× 0.6) 8,400
Labour efficiency planning variance in hours 1,400 (A)
Original standard rate per hour GHS16
Labour efficiency planning variance in GHS GHS22,400 (A)

The planning variance is adverse because the revised standard is for a longer time per unit (so higher
cost and lower profit).

Labour rate operational variance

This is calculated using the actual number of hours worked and paid for.
GHS
8,700 hours should cost (revised standard GHS15) 130,500
They did cost 130,500
Labour rate operational variance 0

In this example, the work force was paid exactly the revised rate of pay per hour.
Labour efficiency operational variance
This variance is calculated by comparing the actual time to make the output units with the standard time
in the revised standard. It is then converted into a money value by applying the original standard
rate per hour.

hours
14,000 units of product should take (0.6 hours) 8,400
They did take 8,700
Labour efficiency (operational variance in hours) 300 (A)
Original standard rate per hour GHS16
Labour efficiency (operational variance in GHS) GHS4,800 (A)

The variances may be summarised as follows.

GHS GHS
14,000 units of product at original standard cost (GHS8) 112,000
Actual material cost 130,500
Total material cost variance 18,500 (A)
Labour rate planning variance 8,700 (F)
Labour efficiency planning variance 22,400 (A)
Labour rate operational variance 0
Labour efficiency operational variance 4,800 (A)
Total of variances 18,500 (A)

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TUTORIAL QUESTIONS (GOOD FOR YOUR HEALTH) (WATCH OUT)
QUESTION 1
a) Jungle Twist Ltd manufactures quality blocks for the housing industry in Ghana. It operates a standard marginal
costing system. The following standard costs, volume and revenue data for the quarter ending 31 October, 2015 are
change in sales provided:
Standard cost card:
Selling price GH¢18 per block
Costs:
Direct material P 3 kg at GH¢2.60 per kg
Q 2 kg at GH¢2.50 per kg
Direct labour 2 hours at GH¢0.60 per hour
Budgeted sales for the quarter: 62,500 blocks
Variable overheads are absorbed at the rate of GH¢0.50 per direct labour hour.
Fixed production overheard for the quarter are estimated to be GH¢78,500

The following actual results were recorded for the quarter just ended 31 October, 2015: Production : 60,000 blocks
Sales : 58,000 blocks
Price : GH¢17.00 per block
Direct material P 150,000 kg were bought and used at GH¢360,000
Q 109,000 kg were bought and used at GH¢327,000
Direct labour 108,000 hours were worked for at a cost of
GH¢90,400
Variable overheads GH¢82,000
Fixed production overheads GH¢80,000
Required:
Calculate the following variances for the quarter just ended 30 September, 2015 the:
i) Sales volume and sales price variances; (3 marks)
ii) Price and usage variances for each material; (3 marks)
iii) Mix and yield variance for each material; (3 marks)
iv) Labour rate, labour efficiency and idle time variances; and (3 marks)
v) Variable overheads expenditure and variable overheads efficiency variances. 3 Marks

QUESTION 2
SK Limited makes and sells a single product ‘Jay’ for which the standard cost is as follows:
£ per unit
Direct materials 4 kilograms at £12.00 per kg 48.00
Direct labour 5 hours at £7.00 per hour 35.00
Variable production overhead 5 hours at £2.00 per hour 10.00
Fixed production overhead 5 hours at £10.00 per hour 50.00
143.00

The variable production overhead is deemed to vary with the hours worked.
Overhead is absorbed into production on the basis of standard hours of production and the normal volume of
production for the period just ended was 20 000 units (100 000 standard hours of production).

For the period under consideration, the actual results were:

18 000
units
Production of ‘Jay’ (£)

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Direct material used – 76 000 kg at a cost of 836 000
Direct labour cost incurred – for 84 000 hours worked 604 800
Variable production overhead incurred 172 000
Fixed production overhead incurred 1 030 000
You are required
(a) to calculate and show, by element of cost, the standard cost for the output for the period; (2 marks)
(b) to calculate and list the relevant variances in a way which reconciles the standard cost with the actual cost
(Note: Fixed production overhead sub-variances of capacity and volume efficiency (productivity) are not required);
(9 marks)
(c) to comment briefly on the usefulness to management of statements such asthat given in your answer to (b)
above. (4 marks)
(Total 15 marks)
QUESTION 3
JK plc operates a chain of fast-food restaurants. The company uses a standard marginal costing system to monitor
the costs incurred in its outlets. The standard cost of one of its most popular meals is as follows:
£ per meal
Ingredients (1.08 units) 1.18
Labour (1.5 minutes) 0.15
Variable conversion costs (1.5 minutes) 0.06
The standard selling price of this meal is 1.99

In one of its outlets, which has budgeted sales and production activity level of 50 000 such meals, the number of
such meals that were produced and sold during April 2003 was 49 700. The actual cost data was as follows:
£
Ingredients (55 000 units) 58 450
Labour (1 200 hours) 6 800
Variable conversion costs (1 200 hours) 3 250
The actual revenue from the sale of the meals was 96 480
Required:
(a) Calculate
(i) the total budgeted contribution for April 2003;
(ii) the total actual contribution for April 2003. (3 marks)

(b) Present a statement that reconciles the budgeted and actual contribution for
April 2003. Show all variances to the nearest £1 and in as much detail as possible. (17 marks)
(c) Explain why a marginal costing approach to variance analysis is more appropriate in environments such as that
of JK plc, where there are a number of different items being produced and sold. (5 marks)
(Total 25 marks)
QUESTION 4
A company manufactures two components in one of its factories. Material A is one of several materials used in the
manufacture of both components.
The standard direct labour hours per unit of production and budgeted production quantities for a 13-week period
were:
Standard Budgeted
direct labour production
hour quantities
Component X 0.40 hours 36 000 units
Component Y 0.56 hours 22 000 units
The standard wage rate for all direct workers was £5.00 per hour.
Throughout the 13-week period 53 direct workers were employed, working a standard 40-hour week.
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The following actual information for the 13-week period is available:

Production:
Component X, 35 000 units
Component Y, 25 000 units
Direct wages paid, £138 500
Material A purchases, 47 000 kilos costing £85 110
Material A price variance, £430 F
Material A usage (component X), 33 426 kilos
Material A usage variance (component X), £320.32 A

Required:
(a) Calculate the direct labour variances for the period; (5 marks)
(b) Calculate the standard purchase price for material A for the period and the standard usage of material A per
unit of production of component X. (8 marks)
(c) Describe the steps, and information, required to establish the material purchase quantity budget for material A
for a period. (7 marks)
(Total 20 marks)

QUESTION 5
You have been provided with the following data for S plc for September:
Accounting method: Absorption Marginal
Variances: (£) (£)
Selling price 1900 (A) 1900 (A)
Sales volume 4500 (A) 7500 (A)
Fixed overhead expenditure 2500 (F) 2500 (F)
Fixed overhead volume 1800 (A) n/a
During September production and sales volumes were as follows:

Sales Production
Budget 10 000 10 000
Actual 9 500 9 700

Required:
(a) Calculate:
(i) the standard contribution per unit;
(ii) the standard profit per unit;
(iii) the actual fixed overhead cost total. (9 marks)

(b) Using the information presented above, explain why different variances are calculated depending upon the
choice of marginal or absorption costing. (8 marks)
(c) Explain the meaning of the fixed overhead volume variance and its usefulness to management. (5 marks)

(d) Fixed overhead absorption rates are often calculated using a single measure of activity. It is suggested that
fixed overhead costs should be attributed to cost units using multiple measures of activity (activity-based costing).
Explain ‘activity-based costing’ and how it may provide useful information to managers.
(Your answer should refer to both the setting of cost driver rates and subsequent overhead cost control.) (8 marks)
(Total 30 marks)

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QUESTION 6
JC Limited produces and sells one product only, Product J, the standard cost for which is as follows for one unit.
(£)
Direct material X – 10 kilograms at £20 200
Direct material Y – 5 litres at £6 30
Direct wages – 5 hours at £6 30
Fixed production overhead 50
Total standard cost 310
Standard gross profit 90
Standard selling price 400

The fixed production overhead is based on an expected annual output of 10 800 units produced at an even flow
throughout the year; assume each calendar month is equal. Fixed production overhead is absorbed on direct labour
hours.

During April, the first month of the financial year, the following were the actual results for an actual production of
800 units.
(£)
Sales on credit: 320 000
800 units at £400
Direct materials:
X 7800 kilogrammes 159 900
Y 4300 litres 23 650
Direct wages: 4200 hours 24 150
Fixed production overhead 47 000
254 700
Gross profit 65 300
The material price variance is extracted at the time of receipt and the raw materials stores control is maintained at
standard prices. The purchases, bought on credit, during the month of April were:

X 9000 kilograms at £20.50 per kg from K Limited

Y 5000 litres at £5.50 per litre from C plc.

Assume no opening stocks.

Wages owing for March brought forward were £6000.
Wages paid during April (net) £20 150.
Deductions from wages owing to the Inland Revenue for PAYE and NI were
£5000 and the wages accrued for April were £5000.

The fixed production overhead of £47 000 was made up of expense creditors of
£33 000, none of which was paid in April, and depreciation of £14 000.
The company operates an integrated accounting system.

You are required to

(a) (i) calculate price and usage variances for each material,
(ii) calculate labour rate and efficiency variances,
(iii) calculate fixed production overhead expenditure, efficiency and volume variances; (9 marks)

(b) show all the accounting entries in T accounts for the month of April – the work-in-progress account should be
maintained at standard cost and each balance on the separate variance accounts is to be transferred to a Profit and
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Loss Account which you are also required to show; (18 marks)
(c) explain the reason for the difference between the actual gross profit given in the question and the profit shown
in your profit and loss account. (3 marks) (Total 30 marks)

QUESTION 7
You are the Management Accountant computer printout shows details of ABS Limited. The following relating to
June 2017.

Actual Budget
Sales volume 4,900 units 5,000 units
Selling price per unit GH¢11.00 GH¢10.00
Production volume 5,400 units 5,000 units

Direct materials
Quantity 10,600kg 10,000kg
price per kg GH¢0.60 GH¢0.50

Direct labour
hours per unit 0.55 0.50
rate per hour GH¢3.80 GH¢4.00

Fixed overhead
Production GH¢10,300 GH¢10,000
Administration GH¢3,100 GH¢3,000

ABS Limited uses a standard absorption costing system. There was no opening or closing work-in-progress
Required
Prepare a statement which reconciles the budgeted profit with the actual profit for June 2017, showing individual
variances in much detail. (15 marks) ICAG MAY 2017 Q5

a) The following information relates to product Jupiter, produced by Bfield Ltd during January. This represents the
information that remains after a fire in the premises destroyed most of the accounting records.
Variances GH¢
Selling price 50,000 A
Materials price 28,500 F
Materials usage 7,500 A
Labour rate 18,700 F
Labour efficiency 20,400 A

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Actual data
Sales (25,000 units at GH¢10) 250,000
Materials costs (112,500 kg at GH¢1.20) 135,000
Labour costs (75,000 hrs. at GH¢1.9 142,500

There was no opening or closing inventories

Required:
Calculate the following;
i) Standard selling price per unit; (3 marks)
ii) Standard cost of material per kilogram; (3 marks)
iii) Standard kilograms of materials required per unit; (2 marks)
iv) Standard labour rate per hour; (2 marks)
v) Standard hours of labour required per unit. (2 marks)

b) Prepare the standard cost card per unit of product Jupiter. (3 marks)

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