ACCA F5 Performance Management - 2010 - Study text

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Chapter 10: Basic variance analysis

However, the total fixed overhead cost variance is the amount of under-absorbed

fixed production overhead (adverse variance) or over-absorbed fixed production

overhead (favourable variance).

Standard fixed overhead cost of units produced X

(units produced × standard fixed cost per unit)

Actual fixed overhead costs Y

Total fixed production overhead cost variance X - Y (F) or (A)

(= fixed overheads over- or under-absorbed)

The variance is favourable when actual costs are less than standard costs, and there

is over-absorption of overheads.

The variance is adverse when actual costs are higher than standard costs, and there

is under-absorption of overheads.

5.3 Fixed overhead expenditure and volume variances

The total fixed overhead cost variance is usually analysed into an expenditure

variance and a volume variance.

Fixed production overhead expenditure variance $

Budgeted fixed overheads X

Actual fixed overheads Y

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

Fixed overhead expenditure should be the same in total at any volume of output. If

actual fixed overhead costs differ from expected fixed costs (budgeted fixed costs),

the difference is an expenditure variance.

 The expenditure variance is favourable if actual fixed overhead costs are less

than budgeted.

 The expenditure variance is adverse if actual fixed overhead costs are more than

budgeted.

Fixed production overhead volume variance units

Actual production volume X

Budgeted production volume Y

Fixed production overhead volume variance in units X – Y

× Standard fixed overhead cost per unit

Fixed production overhead volume variance in $

(X – Y) × $C (F) or (A)

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Higher production volume results in greater overhead absorption so when actual

volume exceeds budgeted volume the variance is favourable.

Example

A company budgeted to make 5,000 units of a single standard product in Year 1.

Budgeted direct labour hours are 10,000 hours. Budgeted fixed production overhead

is $40,000. Actual production in Year 1 was 5,200 units and fixed production

overhead was $40,500.

Required

Calculate for Year 1:

 the fixed overhead total cost variance

 the fixed overhead expenditure variance

 the fixed overhead volume variance

Answer

Standard fixed overhead cost per unit = $8 (2 hours per unit × $4 per hour).

Fixed production overhead total cost variance

5,200 units: standard fixed cost (× $8) = fixed overhead absorbed 41,600

Actual fixed overhead cost expenditure 40,500

Fixed production overhead total cost variance 1,100 (F)

The variance is favourable, because fixed overhead costs have been over-absorbed.

Fixed overhead expenditure variance

Budgeted fixed production overhead expenditure 40,000

Actual fixed production overhead expenditure 40,500

Fixed overhead expenditure variance 500 (A)

This variance is adverse because actual expenditure exceeds the budgeted

expenditure.

Fixed overhead volume variance units of production

Budgeted production volume in units 5,000

Actual production volume in units 5,200

Fixed overhead volume variance in units 200 (F)

Standard fixed production overhead cost per unit $8

Fixed overhead volume variance in $ $1,600 (F)

Chapter 10: Basic variance analysis

This variance is favourable because actual production volume exceeded the

budgeted volume.

Summary

Fixed overhead expenditure variance 500 (A)

Fixed overhead volume variance 1,600 (F)

Fixed overhead total cost variance 1,100 (F)

5.4 Fixed overhead efficiency and capacity variances

The fixed overhead volume variance can be analysed into an efficiency variance and

a capacity variance. Together, efficiency and capacity variances explain why actual

production volume in units was more or less than the budgeted production volume.

These variances are calculated as follows:

Fixed production overhead efficiency variance hours

Actual units produced should take (× standard hours per unit)

They did take Y

Fixed production overhead efficiency variance in hours X – Y (F) or (A)

× Standard fixed overhead rate per hour

Fixed production overhead efficiency variance in $

(X – Y) × $R (F) or (A)

Fixed production overhead capacity variance hours

Budgeted hours of work X

Actual hours of work Y

Capacity variance in hours X – Y (F) or (A)

× Standard fixed overhead rate per hour

Fixed overhead capacity variance in $

(X – Y) × $R (F) or (A)

If actual hours are greater than budgeted, this is an increase in capacity. More

products can be produced and this will increase profit. This is a favourable variance.

The efficiency variance is the same in hours as the efficiency variance for direct

labour and variable production overheads. It is priced, however, at the fixed

production overhead rate per hour.

The capacity variance is an hours worked variance. It is the difference between the

budgeted hours and the actual hours worked, and it is priced at the fixed

production overhead rate per hour.

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Example

A company budgeted to make 5,000 units of a single standard product in Year 1.

Budgeted direct labour hours are 10,000 hours. Budgeted fixed production overhead

is $40,000. Actual production in Year 1 was 5,200 units in 10,250 hours of work, and

fixed production overhead was $40,500.

Required

The fixed production overhead volume variance is $1,600(F), calculated earlier.

Calculate for Year 1:

 the fixed overhead efficiency variance

 the fixed overhead capacity variance.

Answer

Fixed production overhead efficiency variance hours

5,200 units produced should take (× 2 hours per unit)

10,400

They did take 10,250

Fixed production overhead efficiency variance in hours 150 (F)

× Standard fixed overhead rate per hour

Fixed production overhead efficiency variance in $ $600 (F)

Fixed production overhead capacity variance hours

Budgeted hours of work 10,000

Actual hours of work 10,250

Capacity variance in hours 250 (F)

× Standard fixed overhead rate per hour

Fixed overhead capacity variance in $ $1,000 (F)

The capacity variance is favourable because actual hours worked exceeded the

budgeted hours (therefore more units should have been produced).

Summary

Fixed overhead efficiency variance 600 (F)

Fixed overhead capacity variance 1,000 (F)

Fixed overhead volume variance 1,600 (F)

Chapter 10: Basic variance analysis

Sales variances: sales price and sales volume variances

 Sales price variance

 Sales volume variance: units method

 Sales volume variance: standard selling price method

 Causes of sales price and sales volume variances

6 Sales variances: sales price and sales volume

variances

Sales variances, unlike cost variances, are not recorded in a standard costing system

of cost accounts. However, sales variances are included in variance reports to

management.

 They help to reconcile actual profit with budgeted profit.

 They indicate to management to assess performance.

There are two sales variances:

 a sales price variance, and

 a sales volume variance.

These are calculated as shown below, when a standard absorption costing system is

used.

6.1 Sales price variance

The sales price variance is the difference between:

 the actual sales revenue from the units sold, and

 the expected sales revenue from the units sold.

The sales price variance is calculated as follows:

Actual units sold should sell for (× standard sales price per unit)

They did sell for (actual sales revenue) Y

Sales price variance X – Y (F) or (A)

The variance is favourable when actual sales revenue is higher than the value of

sales at the standard selling price. The variance is adverse when actual sales were

for less than the standard price.

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6.2 Sales volume variance: units method

The sales volume variance, in standard absorption costing, explains:

 the difference between budgeted and actual profit

 that was caused by actual sales volume being different from the budgeted sales

volume.

The sales volume variance can be calculated in units, as follows, and then converted

into a monetary amount at the standard profit per unit.

Sales volume variance, absorption costing Units of sales

Budgeted sales volume (units) X

Actual sales volume (units) Y

Sales volume variance in units X – Y (F) or (A)

x Standard profit per unit

× $P

Sales volume variance in $

(X – Y) × $P

(F) or (A)

6.3 Sales volume variance: standard selling price method

There is an alternative method of calculating the sales volume variance, which

produces exactly the same figure for the variance. This is shown below.

Sales volume variance, absorption costing:

alternative method of calculation

Actual sales at standard selling price X

Budgeted sales Y

Sales volume variance in $ revenue (X – Y) (F) or (A)

Standard profit/sales price ratio P%

Sales volume variance (profit variance)

(X – Y) × P%

(F) or (A)

Example

A company budgets to sell 7,000 units of Product P456. The standard sales price of

Product P456 is $50 per unit and the standard cost per unit is $42.

Actual sales were 7,200 units, which sold for $351,400.

The sales price variance and sales volume variance would be calculated as follows:

Sales price variance

7,200 units should sell for (x $50) 360,000

They did sell for 351,400

Sales price variance 8,600 (A)

Chapter 10: Basic variance analysis

The sales price variance is adverse because actual sales revenue from the units sold

was less than expected.

Sales volume variance: usual method of calculation units

Actual sales volume (units) 7,200

Budgeted sales volume (units) 7,000

Sales volume variance in units 200 (F)

Standard profit per unit ($50 – $42 = $8) $8

Sales volume variance (profit variance) $1,600 (F)

The sales volume variance is favourable because actual sales exceeded budgeted

sales.

Sales volume variance: alternative method of calculation

Actual sales at standard selling price (5,200 × $50)

260,000

Budgeted sales (5,000 units × $50)

250,000

Sales volume variance in $ revenue 10,000 (F)

Standard profit/sales price ratio ($8/$50) 16%

Sales volume variance (profit variance) $1,600 (F)

Both methods of calculating the sales volume variance produce the same answer.

6.4 Causes of sales price and sales volume variances

Some of the possible causes of sales price and sales volume variances are set out in

the table below.

Possible causes

Sales price variance Sales volume variance

Strong demand for the product or

service, so that higher sales prices could

be charged.

Customers attracted by low price or

deterred by high price for the product or

service

Weak demand; therefore sales prices

reduced to obtain sales.

Major new customer in the market,

adding to total sales demand.

Trade discounts given to major

customers for bulk orders.

Loss of major customer from the market,

resulting in a fall in total market demand

Inflation, resulting in higher prices.

General increase in prices in the market

for the product or service.

Effective or ineffective advertising

campaign.

New competitor in the market, so that

prices were reduced as a competitive

reaction.

Improvements in distribution methods,

resulting in higher demand for the

entity’s products.

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Improvements in the product deign or

service delivery, resulting in higher

demand for the entity’s products.

Poor after-sales service resulting in loss

of customers and fall in sales.

Chapter 10: Basic variance analysis

Reconciling budgeted and actual profit: standard absorption costing

 Purpose of an operating statement

 Format of an operating statement

7 Reconciling budgeted and actual profit: standard

absorption costing

7.1 Purpose of an operating statement

A management report called an operating statement might be prepared, showing

how the difference between the original budgeted profit and the actual profit is

explained by the sales variances and cost variances.

The purpose of an operating statement is to enable management to assess actual

performance, and identify aspects of performance where investigation or control

action might be appropriate.

7.2 Format of an operating statement

In a standard absorption costing system, an operating statement can be set out as

follows:

Operating statement (standard absorption costing)

Budgeted profit BP

Sales price variance X (F) or (A)

Sales volume variance X (F) or (A)

Cost variances (F) (A)

£ £

Direct materials price X

Direct materials usage X

Direct labour rate X

Direct labour efficiency X

Variable production o’head expenditure X

Variable production o’head efficiency X

Fixed production overhead expenditure X

Fixed production overhead efficiency X

Fixed production overhead capacity X

Other overhead expenditure variances X

Total cost variances Totals X (F) or (A)

Actual profit AP

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Other overhead expenditure variances, assuming administration overheads and

selling and distribution overheads are all fixed costs, are the difference between:

 budgeted other overheads expenditure, and

 actual other overheads expenditure.

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

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