ACCA F5 Performance Management - 2010 - Study text

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Chapter 9: Standard costing

What would be the standard direct material cost per unit of output:

(a) if an ideal standard is used, and the standard does not provide for any loss in

process?

(b) if the standard cost allows for a loss of 10% of input materials in producing

each unit of output.

Answer

(a) Ideal standard

No loss; therefore standard cost =

1 unit of direct materials at $4.50 per unit of material = $4.50 per unit of output.

(b) Attainable or current standard: allow for 10% loss

Standard input to produce one unit of = 1/0.9 units = 1.111 units.

Therefore standard cost =

1.111 units of materials at $4.50 per unit = $5 per unit of output.

Example

A company produces sandwiches. Each sandwich requires two slices of bread and a

loaf of bread contains 24 slices. Each loaf of bread costs $6. It is estimated that

currently 20% of bread is wasted. Management would like to reduce this wastage to

10%.

Calculate a standard material cost for a sandwich based on

a) Ideal conditions

b) Current conditions

c) Attainable conditions

Answer

Standard cost per slice of bread = $6/24 slices = $0.25

(a) Ideal standard: 2 slices × $0.25 = $0.50

(b) Current standard: 2/0.80 slices = 2.5 slices at $0.25 = $0.625

Note that the current and attainable standard costs include an allowance for

wastage, and a materials usage variance will occur only if the actual wastage rate

differs from the standard wastage rate.

2.3 Idle time and standard costs

Idle time occur when the direct labour employees are being paid but have no work

to do. The causes of idle time may be:

 A breakdown in production, for example a machine breakdown that halts the

production process

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 Time spent waiting for work due to a bottleneck or hold-up at an earlier stage in

the production process

 Running out of a vital direct material, and having to wait for a new delivery of

the materials from a supplier.

 A lack of work to do due to a lack of customer orders.

A feature of idle time is that it is recorded, and the hours ‘lost’ due to idle time are

measured.

Sometimes idle time may be an unavoidable feature of the production process, so

that an allowance for idle time is included in the standard cost.

Methods of including idle time in standard costs

There are at least three ways of allowing for idle time in a standard cost.

 Method 1. Include idle time as a separate element of the standard cost, so that

the standard cost of idle time is a part of the total standard cost per unit.

 Method 2. Allow for a standard amount of idle time in the standard hours per

unit for each product. This is the same approach described above for materials

wastage and standard costing. The standard hours per unit therefore include an

allowance for expected idle time.

 Method 3. Allow for the expected idle time by adjusting the standard rate per

hour. This approach has been used in the suggested solutions to an F5

examination question in the past. However, we strongly advise against it,

because idle time is about efficiency and labour time, not the rate per hour paid

to employees. Even so, the technique is illustrated below.

Example

A company manufactures Product X. Due to the nature of the production process,

there is some idle time and it has been estimated that the ‘normal’ amount of idle

time is 10% of hours worked.

Ignoring idle time, the standard time to make 1 unit of Product X is 0.36 hours.

Labour is paid $18 per hour.

This means that the labour time to make 1 unit of product X is 0.36/0.90 = 0.40

hours, of which 0.04 hours are idle time.

There are three ways of making an allowance for in the standard cost the expected

idle time.

Method 1: Include idle time as a separate element of the standard cost. The standard

cost per unit will include the following items:

Active hours worked: 0.36 hours × $18 per hour

6.48

Idle time: 0.04 hours × $18 per hour

0.72

7.20

Chapter 9: Standard costing

Method 2

Include an allowance for expected idle time in the standard efficiency rate:

Standard cost = 0.40 hours × $18 per hour = $7.20

Method 3 (not recommended)

Adjust the rate of pay per hour to allow for the expected idle time.

The rate per hour should be adjusted to $18/0.90 = $20 per hour.

Standard cost = 0.36 hours × $20 = $7.20.

Method 3 is not recommended because:

 The calculation of variances is more complex than with methods 1 and 2, and

 It is unrealistic to adjust the rate of pay per hour: the rate of pay per hour and

idle time are unrelated issues.

The next section of this chapter will demonstrate the calculation of variances when

wastage of materials or idle time is provided for in the standard cost.

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Paper F5

Performancemanagement

CHAPTER

Basic variance analysis

Contents

1 Standard costs and cost variances

2 Direct materials: price and usage variances

3 Direct labour: rate and efficiency variances

4 Variable production overheads: expenditure and

efficiency variances

5 Fixed production overhead variances: absorption

costing

6 Sales variances: sales price and sales volume

variances

7 Reconciling budgeted and actual profit: standard

absorption costing

8 Standard marginal costing

9 Variances with waste and idle time

10 Other aspects of basic variances

11 Deciding whether to investigate a variance

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Standard costs and cost variances

 Standard costing and budgetary control

 Cost variances: favourable and adverse variances

 Variances and performance reporting

 The total cost variance for a variable cost item

1 Standard costs and cost variances

1.1 Standard costing and budgetary control

In a previous chapter, it was explained that flexed budgets can be used to compare

actual results with expected (budgeted results), and differences between actual

results and the budget can be explained as the sum of several variances:

 A sales price variance

 A direct materials cost variance

 A direct labour cost variance

 A variable production overheads cost variance

 A fixed overhead variance, which can be analysed into an expenditure variance

and a volume variance

 An expenditure variance for ‘other costs’ (administration and sales)

 A sales volume variance.

Standard costs can be used to provide similar variance information to variances

using a flexed budget, with the difference that the reasons for cost variances are

analysed into more detail.

You may be familiar with the calculation of basic variances from your previous

studies. If you are not familiar with basic variances, their calculation and possible

causes are explained in this chapter.

1.2 Cost variances: favourable and adverse variances

In a standard costing system, all units of output are valued at their standard cost.

The cost of production and the production cost of sales are therefore valued at

standard cost.

Actual costs will differ from standard costs. A cost variance is the difference

between an actual cost and a standard cost.

 When actual cost is higher than standard cost, the cost variance is adverse [(A)]

variance or unfavourable [(U)].

 When actual cost is less than standard cost, the cost variance is favourable [(F)].

Chapter 10: Basic variance analysis

Several different variances are calculated, relating to direct materials, direct labour,

variable production overhead and fixed production overhead. There are also some

sales variances.

In a cost accounting system, cost variances are adjustments to the profit in an

accounting period.

 Favourable variances adjust the profit upwards.

 Adverse variances adjust the profit down.

Variance reports are produced at the end of each control period (say, at the end of

each month).

 Large adverse variances indicate poor performance and the need for control

action by management.

 Large favourable variances indicate unexpected good performance.

Management might wish to consider how this good performance can be

maintained in the future.

The method of calculating cost variances is similar for all variable production cost

items (direct materials, direct labour, variable production overhead).

A different method of calculating cost variances is required for fixed production

overhead.

1.3 The total cost variance for a variable cost item

The total cost variance for the variable cost item is the difference between the actual

variable cost of production and the standard variable cost of producing the items.

However, the total cost variance is not usually calculated. Instead, the total cost

variance is normally analysed into two causes:

 Price variance/rate variance/expenditure per hour variance. This compares the

actual cost of the material resources used or the actual hours worked with the

standard price of the materials or the standard rate per hour.

 Usage/efficiency variance. This measures the difference in cost between the

actual materials used and the standard usage quantity, or the actual hours

worked and the standard hours for the work.

Total variable cost variance

X units actually produced:

X units of output should cost (× Standard cost per unit)

X units of output did cost

Total cost variance for the variable cost item

A – B

(F) or (A)

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Example

A unit of Product P123 has a standard cost of five litres of Material A at $3 per litre.

The standard direct material cost per unit of Product 123 is therefore $15.

In a particular month, 2,000 units of Product 123 were manufactured. These used

10,400 litres of Material A, which cost $33,600.

The total direct material cost variance is calculated as follows:

2,000 units of output (product P123) should cost (× $15)

30,000

They did cost 33,600

Total direct materials cost variance 3,600 (A)

The total direct materials cost variance is adverse, because actual costs were higher

than the standard cost.

Chapter 10: Basic variance analysis

Direct materials: price and usage variances

 Direct materials price variance

 Direct materials usage variance

 Causes of materials price and usage variances

2 Direct materials: price and usage variances

The direct materials total cost variance can be analysed into a price variance and a

usage variance.

2.1 Direct materials price variance

A materials price variance is the difference between:

 the actual cost of the materials purchased (or used) and

 what they should have cost (the actual materials purchased or used at their

standard price).

The calculation of a materials price variance can be set out in a table, as follows:

Materials price variance $

Units of materials purchased should cost

(actual materials purchased × standard price per unit)

They did cost Y

Material price variance X - Y (F) or (A)

The variance is:

 favourable if the actual cost was less than the expected cost of the materials, and

 adverse if the actual cost was more than the expected cost.

Example

A unit of Product P123 has a standard cost of five litres of Material A at $3 per litre.

The standard direct material cost per unit of Product 123 is therefore $15. In a

particular month, 2,000 units of Product 123 were manufactured. These used 10,400

litres of Material A, which cost $33,600.

The total direct material cost variance is $3,600 (A), as calculated earlier, in the

previous example.

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The materials price variance is calculated as follows:

10,400 litres of materials should

cost (× $3)

31,200

They did cost 33,600

Material price variance 2,400

(A)

The price variance is adverse because the materials cost more to purchase than they

should have.

2.2 Direct materials usage variance

A materials usage variance is the difference between:

 the actual materials used and

 the amount of materials that should have been used for the quantity of units

produced (the actual units of output produced × standard usage quantity per

unit).

This variance is converted into a money value at the standard price per unit of

materials.

The calculation of a materials usage variance can be set out in a table, as follows:

Materials usage variance

Units of

material

Units produced should use

(× standard material usage per unit)

They did use Y

Material usage variance in quantities X – Y (F) or (A)

× Standard price per unit of material

Material price variance in $

(X – Y) × $P (F) or (A)

Example

Using the same example above that was used to illustrate the material price

variance, the usage variance should be calculated as follows:

kilos

2,000 units of Product P123 should use (× 5 kilos) 10,000

They did use 10,400

Material usage variance in kilos 400 (A)

Standard price per kilo of Material A $3

Material usage variance in $ $1,200 (A)

ACCA F5 Performance Management - 2010 - Study text - Emile Woolf Publishing

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