Standard Costing

& Variance Analysis

Drury: Chapter 17 and 18
Standard costing and variance analysis

Objectives
Revision of standard costing:
Conventional production and sales variances

Rate variances
Usage variances
Sales volume variance
Sales price variance

Raw materials mix and yield variances

Sales quantity and mix variances

Extension of standard costing (new*)

Market share and size variances
Ex post variances (Planning and operating variances)

Integration with other topics

2

Standard costing
When do we use a standard costing system?

Common or repetitive operations (Often used in a manufacturing firm)

What is standard costing?

Include normal losses/

A financial control system that enables:
normal wastage:
deviations from budget to be analysed in detail,
Take 9 hours @ 75%
costs to be controlled more effectively.
efficiency = effectively taking
good planning, as we have detailed knowledge on how costs
driven.
12are
hours
Of paramount importance is the flexible budget:
(3 hours= normal loss which
the master budget adjusted to the actual level of volume
your in
budget
needs toNB
beFlex
included
std)
Standard costing compares the flexed budgeted costs to the actual costs.

What are standard costs?

Pre-determined target costs that can be incurred under efficient operating conditions.
Standard costs are given on a per unit basis, i.e. the cost expectation per unit
Budgeted costs relate to the anticipated costs for an entire activity or operation
Standard Cost Card (always per unit)
Cost item
Direct materials
Direct labour
Fixed overhead

Details
1 meter @R10
0.1 hrs @ R20
0.1 hrs @R10

Amount
R 10
R2
R1
R 13

Remember:
Always value inventory at the standard (AQ*SR)
Rate variances

Usage variances

Given [AQ of DM
purchased/AQ of labour
hours used]; how much
should I have spent and
how much did I spend?

Given actual units

produced, how many kgs
or hours should I have used
and how many did I use?

Raw materials T account:

Opening balance at standard rate (AQ*SR)
Add: Actual purchases
Add: favourable variances (income)
Less: unfavourable variances (expense)
Less: closing balance at standard rate (AQ*SR)
= Balance transferred to WIP representing amount used

What variances usually arise under a

standard costing system?

Material variances (price, usage, mix & yield)

Labour variances (expenditure, usage & mix)
Variable overhead variances (expenditure & usage)
Fixed overhead variances (expenditure, volume, capacity
& efficiency)

Production

On a traditional costing basis, or on an ABC basis

Sales variances
Price and volume (mix and quantity)
Market size and share variances (new!)

Not recognised in
acc records!

What levels of activity are important when calculating variances?

Budgeted Quantity: Only use to calculate budgeted profit /income statement
Actual Production Quantity: Use to calculate your production variances
Actual Sales Quantity: Use to calculate your sales variances
5

Raw materials variances

Total Raw Materials Variance

= Standard Cost Actual Cost
= (SQ x SP) (AQ x AP)
= RM Price Variance + RM Usage Variance

(SP AP) x AQ

(SQ AQ) x SP

Raw Materials
Purchased

Raw Materials
actually used

Mix Variance

Yield Variance
7

Raw materials Mix and Yield Variances

3 Things before you can have a mix and yield variance:
More than one raw material input
There is an optimal mix of raw materials that minimises cost while still meeting the
quality standards
A change in mix affects the yield (normal loss).

Only arises when you use different amounts of the inputs compared to budget
Mix variance = inputs
A mix variance arises when the actual mix differs from the predetermined standard mix.

(AQ in budgeted proportions - AQ) SP for each unit of input

Yield variance = outputs

A yield variance arises when the actual output differs from what should have come out the
process, based on what we put in.

(Actual production - What should have come out the process) SP for each unit of output
(actual yield - Actual quantity*standard yield )*SP (where SP is the budgeted average
cost per unit of output)
Example: expect a 15% loss, if produce 1 000 000l, expect output of 850 000l

 Standard ingredient of 1kg of product FDN is:

0.65kg of F @ R4.00
0.3kg of D @ R6.00
0.2kg of N @ R2.50
1.15kg

Standard
proportions:
F = 56.5%
D = 26.1%
N = 17.4%

Budgeted production of product X is 4000 kg

Actual production is 4200kg
Actual material costs:

2840kg of F
1210kg of D and
860kg of N
Total cost R20380.00

Total used: 4910kg

Raw materials Mix and Yield Variances: Example

Mix variance
A mix variance arises when the actual mix differs from the predetermined standard mix.

(AQ in budgeted proportions - AQ ) SP for each unit of input

F
D
N

(AQ in budg prop - AQ)SP

( 2775.22 - 2840 )
( 1280.87 - 1210 )
( 853.91 860 )
4910

4.00
6.00
2.50

259.13
425.22
15.22

4910

150.87

A
F
A
F

Yield variance
A yield variance arises when the actual output differs from what should have come out
the process, based on what we put in.
4*0.65kg+ 6*0.3kg+
2.5*0.2kg

(Actual production - What should have come out the process) SP

( 4200
4910kg x 1/1.15 ) x 4.9 = R340.87
= 4270kg

10

Raw materials Mix and Yield Variances

Material Usage Variance:
Usage Variance (Mix and Yield)
(The amount of raw materials I should have used at my actual level of production AQ)SP
My actual level of production is 4 200 units of FDN
My input at this level of production should have been 4 200 * 1.15 kg = 4 830 kg
(in other words, 4830kg should have been used to produce 4200kg based on budget)

( 4830 x( 0.65/1.15) =2730 - 2840 )

4830 x (0.3/1.15)=1260
4830 x (0.2/1.15)=840

4.00

- 1210 )

6.00

- 860 )

2.50

440
300
50

A
F
A

190 A

(SQ AQ) x SP

11

Sales Variances
Total Sales Variance =
Budgeted Contribution Actual Contribution
(BV x SM) (AV x AM)
Sales Margin Volume Variance + Sales Margin Price Variance

(BV AV) x SM

(SM AM) x AV or
(SSP ASP) x AV

12

Variable vs Absorption Costing

Variable Costing - The standard/actual margin is a contribution
margin:
Standard margin:
(Standard SP Standard VC)

Actual margin

Sales price variance:

(SM AM) x AV

(Actual SP Standard VC)

Absorption Costing The standard/actual margin is the profit

margin:
Standard margin
Standard SP (std VC + std FC)

Actual margin
Actual SP (std VC + std FC)

13

Sales mix and quantity variances

Where a company sells several different products that have different profit
margins, it is possible to divide the sales volume variance into a quantity and mix
variance.

Example:
Budgeted sales
A =
8 000 units at R20 contribution
B =
7 000 units at R12 contribution
C =
5 000 units at R9 contribution
20 000

Actual sales
A =
6 000 units at R20 contribution
B =
7 000 units at R12 contribution
C =
9 000 units at R9 contribution
22 000

=
=
=

R
160 000
84 000
45 000
289 000

=
=
=

R
120 000
84 000
81 000
285 000

Therefore,
AQ*std %=
A: 40% = 8 800
B: 35% = 7 700
C: 25% = 5 500

14

Total Sales Variance

Sales Margin Price Variance
(SM AM) x AV

Sales Margin Volume Variance

(BV AV) x SM

Quantity Variance
(Budgeted Volume - Actual Volume in
budgeted proportions ) x Std Margin

Actual volume in budgeted

proportions

BV
A 8 000
B 7 000
C 5 000
20 000

Mix Variance
(Actual Volume in budgeted proportions
- Actual Volume ) Std Margin

40%
35%

8800
7700

25%

5500

AV

A 6 000
B 7 000
C 9 000
22 000

SM
A R20
B R12
C R9

22000

15

Sales Variances
Sales Volume Variance: (BV AV )SM
A (8000 6000) 20 = 40 000A
B (7000 7000) 12 = 0
C (5000 9000) 9 = 36 000F
4 000A
Sales Mix Variance: = (AQ in budgeted proportions - AQ) Standard margin
A (8 800 6 000 ) R20 = R56 000 A
B (7 700 7 000 ) R12 = R 8 400 A
C (5 500 9 000 ) R9 = R31 500 F
22 000
22 000
R32 900 A

Quantity variance: = (BQ - AQ in budgeted proportions ) SM

A (8 000 8 800) R20
= R16 000 F
B (7 000 7 700) R12
= R 8 400 F
C (5 000 5 500) R9
= R 4 500 F
R28 900 F

16

Where published industry sales statistics are readily available, it is possible

to divide the sales quantity variance into a component due to changes in
market size and component due to changes in market share.

Total Sales Variance

Sales Margin Price Variance
(SM AM) x AV

Sales Margin Volume Variance

(BV AV) x SM

Quantity Variance

Mix Variance

(Budgeted Volume - Actual Volume in

budgeted proportions ) x Std Margin

(Actual Volume in budgeted proportions

- Actual Volume ) Std Margin

Market
size
variance

Market
share
variance

17

Market size and share variances

Market
size
variance

Market
share
variance

Budgeted
market
share
percentage

Actual
industry
sales
volume in
units

Actual
market
share
percentage

Budgeted
market
share
percentage

How much of
industry am I
supposed to get?

Budgeted
industry
sales
volume in
units

Actual
industry
sales
volume in
units

Budgeted
average
contribution
per unit

Budgeted
average
contribution
per unit

What sales volume should I

get due to change in market
share?
18

Previous example continued

Assuming that the budgeted industry sales volume for a company was
200 000 units and the actual industry sales volume was 275 000 units
Calculate the market size and market share variances
A: 40%
B: 35%
C: 25%

Budgeted sales

Market
size
variance

A =
B =
C =
Total

Actual sales

8 000 units at R20 contribution

7 000 units at R12 contribution
5 000 units at R9 contribution

A =
B =
C =

6 000 units at R20 contribution

7 000 units at R12 contribution
9 000 units at R9 contribution

20 000

Total

22 000

Budgeted
market
share
percentage

Actual
industry
sales
volume in
units

Budgeted
industry
sales
volume in
units

Budgeted
average
contribution
per unit

20 000/200 000

R14.45
275 000

Market
share
variance

Actual
market
share
percentage
22 000 / 275 000
= 8%

Budgeted
market
share
percentage
20 000/200 000
= 10%

200 000

Actual
industry
sales
volume in
units
275 000

Budgeted
average
contribution
per unit
R14.45

19

Solution
Market
size
variance

= R108 375 F

The market size variance indicates that an additional contribution of

R108 375 was expected, given that the market expanded from
200 000 to 275 000 units.
Market
share
variance

= R79 475 A

Sales
quantity
variance
=
28 900 F

However, the company did not attain the predicted market share of
10%. Instead, a market share of only 8% was attained, and the 2%
decline in market share resulted in a failure to obtain a contribution of
R79 475.

20

Ex post variance analysis

A major criticism is that actual performance is compared with a standard based on
the environment that was anticipated when the standard was set.

Planning
Standard

Operational
Revised standard

Actual

1. Planning variance:
Variances that have arisen due to unforeseen, or uncontrollable events, and therefore
management should not be evaluated on these variances as they are outside their control.
Planning variances can indicate how successful management is at forecasting.
Raw Materials planning variance:
(Budgeted production x SQ x SP - Budgeted production x revised SQ x revised SP)

2. Operating variance:
The variance calculations are exactly the same as before, except one uses revised
standards as opposed to the original standards in the calculations:
a) Raw Materials usage variance

b) Raw Materials price variance:

(Revised SQ AQ) Revised SP

(Revised SP AP) AQ

21

Ex post variance analysis example

The original budget for August 2011 is as follows:
Sales (R20 x 50 units )
Raw materials cost (2kg @ R5 per kg) x 50 units
The budgeted profit

R1 000
R 500
R 500

A shortage of raw materials in the market caused the market price for 1kg to
increase to R5.18 per kg for August 2011 only. These raw materials were of a
slightly lower quality, therefore 2.2kg were expected to be used. The actual
production and sales for August 2011 was 55 units, and the profit statement is
found below:
Actual Profit Statement for August 2011:
Sales (R20 x 55 units )
R1 100.00
Raw materials cost (2.1kg @ R5.2 per kg) x 55 units R 600.60
Actual profit
R 499.40
You are required:
1. Reconcile the budgeted and actual profit using conventional variance analysis.
2. Reconcile the budgeted and actual profit using ex post variance analysis.

22

1) Conventional Variance Analysis

Raw
usage
variance
RawMaterials
Materials
usage
variance
(SQ
SPSP
(SQ AQ)
AQ)
=(2kg-2.1kg)*55 units*R5
=R 27.50 Adverse
Raw
price
variance:
RawMaterials
Materials
price
variance:
(SP
AP)
AQAQ
(SP
AP)
=(R5.00-R5.20)*(55 units*2.1kg)
=R 23.10 Adverse
Sales
Volume
variance
before:
Sales
Volume
variance
before:
(BV
AV)
SM
(BV - AV) SM
=(R20-R10)*(55 - 50 units)
=R50 Favourable

Reconciliation
Reconciliation
Budgeted profit = 50 units (R20 - R10)

R 500.00

Raw materials price variance

-R 23.10

Raw Materials usage variance

-R 27.50

Sales Volume variance

R 50.00

Actual Profit

R 499.40

23

2) Ex post Variance Analysis

a) Planning variance
Raw Materials planning variance:
(Budgeted production x SQ x SP - Budgeted production x revised SQ x revised SP)
=50*2*5 50*2.2*5.18

-R69.8

b) Operating variances
Raw Materials usage variance
(revised SQ AQ) Revised SP
[(55*2.2) (55*2.1)]5.18
R28.49 Favourable
Raw Materials price variance:
(Revised SP AP) AQ
(5.18 5.20) 115.5
R-2.31 Adverse

Reconciliation
Budgeted profit
Planning variance
Operating variances
Raw materials price variance
Raw Materials usage variance
Sales Volume variance
Actual Profit

Revised std margin

(revised Std selling price - revised variable costs)

(R20 - 2.2kg x R5.18) = R8.604

R 500.00
-R 69.80
-R 2.31
R 28.49
R 43.02
R 499.40

Sales Volume variance

(BV - AV) x revised SM
(50units - 55units ) R8.604 per unit
R 43.02 Favourable

24

Conventional Variance Reconciliation

Budgeted profit
Sales Volume variance
Standard profit at actual level of sales
Variances
Raw materials price variance
Raw Materials usage variance
Actual Profit

Ex post Variance Reconciliation

Budgeted profit
Planning variance
Revised budgeted profit
Sales Volume variance
Standard profit at actual level of sales
Operating variances
Raw materials price variance
Raw Materials usage variance
Actual Profit

R 500.00
R 50.00
R 550.00
-R 23.10
-R 27.50
R 499.40

R 500.00
-R 69.80
R 430.20
R 43.02
R 473.22
-R 2.31
R 28.49
R 499.40

25

Investigation of variances

26

Investigation of variances
1. Reasons for variances
Measurement errors e.g. Number of labour hours is incorrectly added or assigned.
Out-of-date standards.
Frequent technological changes
Standard fails to take into account learning curve effects

Inefficient operations:
Failure to follow prescribed procedures, faulty machinery or human errors
pin point cause of inefficiency and implement corrective action.

Random or uncontrollable factors.

2. Investigation will indicate that variance is due to:

Random uncontrollable factors when the operation is under control.
Assignable causes, but the cost of investigation exceeds benefits.
Assignable causes, but the benefits of investigation exceed the cost.

Incorrect standard?
Corrective action needed?

A good
investigation
model would
only
investigate
these
variances

27

Integration with ABC (VOH and FOH)

Under traditional costing, there is one lot of fixed
(assumed to be indirect) costs that are allocated
over a budgeted allocation base to units (usually
budgeted production or labour hours).
Under ABC, the indirect costs are split into
activities, and for each activity, variances can be
performed:
Expenditure variance
Usage/efficiency variance
Note: under ABC, costs and variances may also be
performed per batch, not just per unit. However,
calculations remain the same
28

Fixed Overhead Variances

SR = Budgeted FMC
BP
(AP-BP) x SR

AP x SR

BP x SR

Volume

Expenditure

Budgeted
FMC

Allocated
FMC

Actual
FMC

SR
Budgeted
FMC
SR ==Budgeted
FMC
Budgeted allocation
base
Budgeted
labour hours

AH

SH

Volume Efficiency
Variance
(SH- AH) x SR

F when absorb more

than actual

BH

Volume Capacity
Variance
(AH BH) x SR

F when actual
exceeds budgeted,
otherwise
indication failed to
use capacity

29

ABC Variance Analysis Example

Information relating to the production set-up function:

Budget
Activity level (1 600 set-ups)
Practical capacity supplied (2 000 set-ups)
Total indirect fixed costs (R80 000)
Total indirect variable costs (R40 000)
Cost driver rates:
Variable
Fixed

Actual
Activity level (1 400 set-ups)
Total VC (R39 000)
Total FC (R70 000)

R40 000/1600 = R25 per set up

R80 000/2000 = R40 per set up

Assume that production takes place in batches of 100 units, and that the machine
needs to be set up before every batch. Actual production in units for the period is
150 000 units. Fixed costs are allocated based on practical capacity

30

Variable Overhead Variances

Total Variable Overhead Variance
Standard Cost Actual Costs
(SH x SR) (AH x AR)
Ovhd Expenditure Variance + Ovhd Efficiency Variance

(SR AR) x AH

(SH AH) x SR

31

Variable Set-up Variances

Total Variable Set-up Variance
Standard set-up costs Actual set-up costs
(Std number of set-ups x SR per set up) (Actual number of set-ups x AR per set up)

Set-up Expenditure Variance + Set-up Efficiency Variance

(SR per set up AR per set up ) x A SUs

(R25 R39 000/1 400) x 1 400
=R4 000 A

(Std SUs Act SUs) x SR per set up

(150 000/100 1 400) x R25
= 2 500 F

32

Fixed Set-up Variances

(Budgeted set-up costs Actual set up costs)

(R80 000 R70 000) =R10 000F

Allocated
set-up costs

Budgeted
set-up costs

Volume

SSU

ASU

BSU

1500

1400

1600

PSU
2000

SR = Budgeted fixed set-up costs

Practical no. of set ups
SR = R80 000 = R40 per set up
2 000 set ups
Volume Efficiency
Variance
(Ssus- Asus) x
SR per su

Volume Capacity
Variance
(Asus Bsus) x
SR per su

(1 500 1 400) x R40

= 4 000 F

(1 400 1 600) x R40

= R8 000A

Expenditure

Actual
set-up costs

E.g. Now use practical

capacity, as trying to
isolate cost of not
planning to use capacity.

Budgeted Unused
Capacity Variance
(Bsus PBsus) x
SR per su

(1 600 2 000) x R40

=R16 000 A

33

ABC and variance analysis:

Variance analysis for variable set-up expenses:
Variable set-up expenses charged to products (1 500 R25)
Variable set-up efficiency variance
Variable set-up expenditure variance
Total actual expenses

R
37 500
2 500 F
4 000 A
39 000

Variance analysis for variable set-up expenses:

R

Set-up expenses charged to products (1 500 R40)

Budgeted unused capacity variance (400 R40)
Capacity utilization variance (200 R40)
Volume Efficiency variance (100 R40)
Expenditure variance
Total actual expenses

60 000
16 000 A
8 000 A
4 000 F
10 000 F
70 000

34

MANAGEMENT ACCOUNTING IV

Inventory Valuation

Decision Making

- Job Costing/Process Costing

- Joint & By-product Costing
- Variable Costing
- Absorption Costing

ditional

Cost Classification

- CVP
- Decisions under uncertainty
(decision trees)
- Relevant Costing
- Pricing Decisions
- ABC
- Capital investment decisions

ABC

Production Cost
Period Cost

Fixed Cost
Variable Cost

Fixed Component
Variable Component

- Standard Costing
- Divisional performance
- Performance evaluation

Strategic
Management
- Strategy
- Sustainability reporting
- ABM/ TQM
- Just-in-time
- Balanced Scorecard

Inventory Valuation

Relevant Costing/Planning and Controlling Costs/ Inventory Valuation/CVP

Direct Costs Trace to products

Indirect Costs Allocate to products

How costs behave

Planning, Control &

Performance Measurements

Traditional Approach
ABC

Decision Making / Relevant Costing/Planning and Controlling Costs/ Inventory Valuation/CVP/Cost Estimation

35

INTEGRATION with Cost Estimation Principles

NB Linear Regression:
May need to split mixed costs into their fixed and variable components
before you can do your variance calculations.

NB Learning Curve:
Seldom linked, because the standard has been set over time. However if
temporary staff need to be employed, you may need to incorporate
learning curve into the variances. This would be very clear (a learning
curve percentage would be given).

INTEGRATION with Inventory Valuation Principles

NB Production v period costs

Only production costs can be included in the value of the inventory. These
will be included in the inventory at standard.

NB Absorption and variable costing - Affects your:

Fixed overhead variances (no volume, capacity and efficiency variances)
Sales variances (use the standard contribution margin and not the gross
profit margin).

36

INTEGRATION with Cost Classification Principles

NB Cost Behaviour
Need to identify whether costs are fixed or variable. This will determine
how the variances will be calculated.
With variable costs you flex the standard (standard quantity)
With fixed costs you compared budgeted to actual to absorbed (as these costs do not
vary with production)

INTEGRATION with Decision-Making tools

Not really linked to the decision making tools.

INTEGRATION with Performance Evaluation (often linked)

NB Responsibility centres
The person who was responsibility for the decision that resulted in the
variance should be evaluated on the variance.
E.g. Purchasing department purchase inferior quality raw materials,
therefore more was used by the production department. This usage
variance should be attributed to the purchasing department. NB:
You should only be evaluated on what you have control over.

NB Planning and operating variances

Will have an important link here

37

What are the reasons for using a standard

costing system?
To help set budgets.
To predict future costs needed for decision making purposes.
To evaluate managers performance:
Variances must be allocated to the correct responsibility centres in order to
ensure control and accountability

To control costs:
Reasons for variances must be identified and investigated
Remedial action should be undertaken

To value inventory. Standard costing can be used for financial

accounting purposes as long as standard costs approximate actual
costs. IAS 2

38