ACCA F5 Performance Management - 2010 - Study text

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Chapter 10: Basic variance analysis

The usage variance is adverse because more materials were used than expected, and

this has added to costs.

2.3 Causes of materials price and usage variances

Some of the possible causes of materials variances are set out in the table below.

Note that there may be some inter-relationship between a usage variance and a

price variance: for example buying and using low-quality materials might provide a

favourable price variance, but due the lower quality there may be more wastage and

so an adverse materials usage variance

Possible causes

Materials usage variance Materials price variance

Inefficient use of materials: wastage rates

higher than expected.

Actual purchase prices higher or lower

than standard

Efficient use of materials: wastage rates

lower than expected

Price inflation higher or lower than

expected (and allowed for in the

standard price)

Inexperienced work force; therefore

greater wastage of materials

Buying in larger quantities than

normal, so that the entity benefits from

better trade discounts.

Poor quality of materials than ‘standard’,

resulting in higher quantity of loss or

waste

Buying smaller quantities than normal,

so that the entity loses trade discounts

from suppliers.

Better quality of materials than

‘standard’, resulting on lower loss or

wastage.

A new supplier has been identified

who sells the materials at a lower price.

Improvements in production methods,

resulting in more efficient use of

materials.

Some materials had to be purchased in

an emergency and at short notice, so

that the price paid (for a fast delivery

service) was much higher than normal.

Better quality control in the production

process (favourable usage variance)

Inefficient buying. Buying without

asking two or more suppliers to quote

a price.

Also: Also:

The standard usage rate in the standard

cost for materials might be a poor

estimate

The standard materials price in the

standard cost for materials might be a

poor estimate

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Direct labour: rate and efficiency variances

 Total direct labour cost variance

 Direct labour rate variance

 Direct labour efficiency variance

 Causes of labour rate and efficiency variances

3 Direct labour: rate and efficiency variances

3.1 Total direct labour cost variance

The total cost variance for direct labour is the difference between the standard and

actual direct labour cost for the units produced.

Example

Product P123 has a standard direct labour cost per unit of:

1.5 hours × $12 per direct labour hour = $18 per unit.

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

took 2,780 hours to make and the direct labour cost was $35,700.

Required

Calculate the total direct labour cost variance.

Answer

2,000 units of output should cost (× $18) 36,000

They did cost 35,700

Total direct labour cost variance 300

(F)

The variance is favourable, because actual costs were less than the standard cost.

The direct labour total cost variance can be analysed into a rate variance and an

efficiency variance. The calculations are similar to the calculations for the materials

price and usage variances.

3.2 Direct labour rate variance

A direct labour rate variance is the difference between:

 the actual cost of the direct labour (hours paid for) and

 what the hours should have cost (the actual hours paid for at their standard

rate).

Chapter 10: Basic variance analysis

The calculation of a direct labour rate variance can be set out in a table, as follows:

Direct labour rate variance

The hours worked should cost

(actual hours worked × standard rate per hour) X

They did cost Y

Direct labour rate variance X - Y (F) or (A)

The variance is:

 favourable if the actual cost was less than the expected cost of the hours worked,

and

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

Example

Using the same example that was used previously to calculate the total labour cost

variance, calculate the direct labour rate variance.

Answer

2,780 hours should cost (× $12)

33,360

They did cost 35,700

Direct labour rate variance 2,340

(A)

The rate variance is adverse because the labour hours worked cost more than they

should have.

3.3 Direct labour efficiency variance

A direct labour efficiency variance is the difference between:

 the actual hours worked and

 the hours that should have been required to make the quantity of units

produced (the actual units of output produced × standard hours per unit).

This variance is converted into a money value at the standard labour rate per hour.

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The calculation of a labour efficiency variance can be set out in a table, as follows:

Direct labour efficiency variance hours

Actual units produced should take

(× standard hours per unit) X

They did take Y

Direct labour efficiency variance in hours X – Y (F) or (A)

× Standard rate per hour

Direct labour efficiency variance in $

(X – Y) × $R (F) or (A)

Example

Using the same example above that was used to illustrate the total direct labour cost

variance and the direct labour rate variance, the efficiency variance should be

calculated as follows:

hours

2,000 units of Product P123 should take (× 1.5 hours)

3,000

They did take 2,780

Efficiency variance in hours 220

(F)

Standard direct labour rate per hour $12

Direct labour efficiency variance in $ $2,640

(F)

The efficiency variance is favourable because production took less time than

expected, which has reduced costs.

Labour cost variances: summary

Labour rate variance 2,340

(A)

Labour efficiency variance 2,640

(F)

Total direct labour cost variance 300

(F)

3.4 Causes of labour rate and efficiency variances

Some of the possible causes of labour variances are set out in the table below. As

with materials, note that there may be some inter-relationship between a labour rate

variance and an efficiency variance: for example using employees with relatively

little experience of the work may result in a favourable rate variance, but also an

adverse efficiency variance.

Chapter 10: Basic variance analysis

Possible causes

Labour efficiency variance Labour rate variance

Efficient or inefficient working by the work

force. Efficiency variance will always be

adverse when an ideal standard is used and

will often be adverse when an

attainable/target standard is used.

The grade or level of labour

actually used was different from

the grade of labour in the standard

cost

Due to high labour turnover, the work force

was relatively new and inexperienced,

resulting in lower efficiency

Due to high labour turnover, the

work force was relatively new and

inexperienced, and paid less than

the standard rate of pay

Quality of supervision good or bad, resulting

in favourable or unfavourable efficiency

variance

Wage rates have been altered

(usually, raised).

The effect of a new incentive scheme, which

has been an improvement in efficiency

Problems in the production process, for

example machine breakdowns, reducing

efficiency

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Variable production overheads: expenditure and efficiency variances

 Total variable production overhead cost variance

 Variable production overhead expenditure variance

 Variable production overhead efficiency variance

 Causes of variable overhead variances

4 Variable production overheads: expenditure and

efficiency variances

4.1 Total variable production overhead cost variance

The total cost variance for variable production overhead is the difference between

the standard and actual variable production overhead cost for the units produced.

Example

Product P123 has a standard variable production overhead cost per unit of:

1.5 hours × $2 per direct labour hour = $3 per unit. During a particular month, 2,000

units of Product 123 were manufactured. These took 2,780 hours to make and the

variable production overhead cost was $6,550.

Required

Calculate for the month the total variable production overhead cost variance.

(Note: This same example will be used to illustrate the variable overhead

expenditure and efficiency variances.)

Answer

2,000 units of output should cost (× $3) 6,000

They did cost 6,550

Total variable production overhead cost variance 550

(A)

The variance is adverse, because actual costs were more than the standard cost.

4.2 Variable production overhead expenditure variance

Variable production overheads are assumed to vary with the direct labour hours

worked.

A variable production overhead expenditure variance is the difference between:

 the actual variable production overhead cost of the hours worked, and

Chapter 10: Basic variance analysis

 what the hours worked should have cost (the actual hours paid for at their

standard rate per hour of variable overhead expenditure).

The calculation of a variable production overhead expenditure variance can be set

out in a table, as follows:

Variable production overhead expenditure variance

The hours worked should cost

(actual hours worked × standard expenditure per hour) X

They did cost Y

Variable production overhead expenditure variance X – Y (F) or (A)

The variance is:

 favourable if the actual cost was less than the expected cost of the hours worked,

and

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

Example

Using the same example that was used previously to calculate the total variable

production overhead cost variance, calculate the variable production overhead

expenditure variance.

Answer

2,780 hours should cost (× $2)

5,560

They did cost 6,550

Variable production overhead expenditure variance 990 (A)

The expenditure variance is adverse because the expenditure on variable overhead

in the hours worked was more than it should have been.

4.3 Variable production overhead efficiency variance

A variable production overhead efficiency variance is the difference between:

 the actual hours worked, and

 the hours that should have been required to make the quantity of units

produced (the actual units of output produced × standard hours per unit).

This is the same variance in hours as the direct labour efficiency variance

(excluding any hours of idle time variance, because it is assumed that variable

overhead expenditure is not incurred during idle time). This variance in hours is

converted into a money value at the standard expenditure rate per hour.

Paper F5: Performance management

The calculation of a variable production overhead efficiency variance can be set out

in a table, as follows:

Variable production overhead efficiency variance hours

Units produced should take (× standard hours per unit)

They did take Y

Variable production overhead efficiency variance in hours X-Y (F) or (A)

× Standard expenditure rate per hour

Variable production overhead efficiency variance in $

(X-Y) × $R (F) or (A)

Example

Using the same example that was used previously to calculate the total variable

production overhead cost variance and the variable production overhead

expenditure variance, calculate the variable production overhead efficiency

variance.

Answer

hours

2,000 units of Product P123 should take (× 1.5 hours) 3,000

They did take 2,780

Efficiency variance in hours 220 (F)

Standard variable production overhead rate per hour $2

Variable production overhead efficiency variance in $ $440 (F)

The efficiency variance is favourable because production took less time than

expected, which has reduced costs.

Variable production overhead variances cost variances:

summary

Variable production overhead expenditure variance 990 (A)

Variable production overhead efficiency variance 440 (F)

Total variable production overhead cost variance 550 (A)

4.4 Causes of variable overhead variances

It is difficult to identify the causes of variable overhead variances, because variable

overhead costs arise in all ‘overhead’ areas of operations, and the variable overhead

rate per hour is likely to be an estimate obtained from high-low analysis or linear

regression analysis of overhead costs.

Chapter 10: Basic variance analysis

The causes of variable overhead efficiency variances are the same as the causes of

labour efficiency variances, when variable overhead expenditure is assumed to vary

with the number of direct labour hours worked.

The causes of variable overhead expenditure variances may be:

 efficient or inefficient spending on overhead items of cost

 inaccurate estimates of the variable overhead expenditure rate per hour.

Paper F5: Performance management

Fixed production overhead cost variances: absorption costing

 The structure of fixed overhead variances

 Total fixed overhead cost variance

 Fixed overhead expenditure and volume variances

 Fixed overhead efficiency and capacity variances

 ABC based variances

5 Fixed production overhead cost variances:

absorption costing

5.1 The structure of fixed overhead variances

With standard absorption costing, the standard cost per unit is a full production

cost, including an amount for absorbed fixed production overhead. Every unit

produced is valued at standard cost.

This means that production overheads are absorbed into production costs at a

standard cost per unit produced.

However, this standard fixed cost per unit is derived from a standard number of

direct labour hours per unit and a fixed overhead rate per hour.

Fixed overhead variances are as follows:

5.2 Total fixed overhead cost variance

The total fixed overhead cost variance is rarely calculated, because it is more usual

to calculate the expenditure and volume variances.

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

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