ACCA F5 Performance Management - 2010 - Study text - Emile Woolf Publishing
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Chapter 11: Advanced variance analysis
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− If there is less of an expensive material in the actual mix than in the standard
mix, the variance for the material is favourable.
The total mix variance is calculated by adding the mix variance for each
individual material.
Example
Calculate the materials mix in the previous example, using method 2.
Answer
The weighted average standard cost per kilo of material =
$90
10
kilos = $9 per kilo.
Material
Actual
mix
Standard
mix
Mix variance
in quantities
Standard price
per kilo minus
weighted
average
standard price
Mix variance
in value
kilos kilos
kilos
$ $
A 160 (1) 210
50
(20 – 9) = 11 550
(F)
B 180 (1) 210
30
(22 – 9) = 13 390
(F)
C 1,760 (8) 1,680
80
(6 – 9) = 3 240
(A)
2,100 2,100
0
1,180
(F)
Notes
(1) The mix variance for material A is favourable. This is because material A is an
expensive material (its standard price of $20 is higher than the weighted
average standard cost for the mix of $9). The actual usage of this expensive
material is less than the standard mix usage; therefore the mix variance for
material A is favourable.
(2) The mix variance for material B is also favourable, for similar reasons.
(3) The mix variance for material C is also favourable. This is because material C
is a cheap material (its standard price of $6 is lower than the weighted average
standard cost for the mix of $9). The actual usage of this expensive material is
more than the standard mix usage; therefore the mix variance for material C is
favourable.
The total mix variance of $1,180 (F) is the same as with method 1.
1.3 Calculating a direct materials yield variance
The direct materials yield variance is a total usage variance for all items of direct
materials.
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A materials usage variance is calculated for each item of materials individually.
A yield variance is calculated for all materials in total. It is converted into a
money value at the weighted average standard price per unit of materials.
A yield variance is calculated as follows:
Total
material
quantities
Actual quantity of units produced should use X
did use Y
Yield variance in quantities (X – Y) (F) or (A)
× Weighted average standard price per unit of material
$P
Yield variance in money value P x (X – Y) (F) or (A)
Example
Product N is produced from three direct materials that are mixed together in a
process, material materials A, B and C. The standard cost card for product N is as
follows:
Material
Quantity
Standard price
per kilo
Standard
cost
kilos $
$
A 1 20
20
B 1 22
22
C 8 6
48
10
90
Actual output during month 6 amounted to 200 units of product N in total. Actual
usage of each material was as follows:
Material kilos
A 160
B 180
C 1,760
2,100
Required
Calculate the direct materials yield variance for month 6, and prove that the mix
and yield variances add up to the total usage variance.
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Answer
Working
The weighted average standard cost per kilo of material =
$90
10
kilos = $9 per kilo.
kilos
200 units of product N
should use (
× 10 kilos)
2,000
did use 2,100
Yield variance in quantities 100 (A)
× Weighted average standard price per unit of material = $9
Yield variance in money value = $900 (A)
The materials usage variance (which is the sum of the mix and yield variances) is
calculated for each item of material individually, as follows.
Material To make 200 units of N Variance in
quantitiy
Standard price
per kilo
Usage
variance
Did use Should use
kilos kilos
kilos
$ $
A 160 200
40 (F)
20 800
(F)
B 180 200
20 (F)
22 440
(F)
C 1,760 1,600
160 (A)
6 960
(A)
280
(F)
The mix variance was calculated previously and is $1,180 (F). The variances can be
summarised as follows:
Summary
$
Mix variance 1,180
(F)
Yield variance 900
(A)
Usage variance (= mix + yield variances) 280
(F)
1.4 Changing the materials mix: factors to consider
Analysis of the material usage variance into the mix and yield components is
worthwhile if management have control of the proportion of each material used.
Management will seek to find the optimum mix for the product and ensure that the
process operates as near to this optimum as possible.
Identification of the optimum mix involves consideration of several factors:
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Cost. The cheapest mix may not be the most cost effective. Often a favourable
mix variance is offset by an adverse yield variance and the total cost per unit
may increase.
Quality. Using a cheaper mix may result in a lower quality product and the
customer may not be prepared to pay the same price. A cheaper product may
also result in higher sales returns and loss of repeat business.
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Planning and operational variances
The reasons for planning and operational variances
Ex ante and ex post standards or budgets
Using ex post standards (or ex post budgets) to calculate planning and
operational variances
Calculating planning and operational variances
Comparing planning and operational variances with traditional variances
More than one difference between the ex ante and ex post standard costs
Advantages and disadvantages of using planning and operational variances
Manipulation issues in revising budgets
2 Planning and operational variances
2.1 The reasons for planning and operational variances
The purpose of reporting variances is to inform management of any differences
between budgeted and actual results, or between standard costs and actual costs.
Managers can use information about variances to identify problems that should be
investigated, and where appropriate:
take control action to correct adverse results or
take measures to exploit favourable results.
The effectiveness of variance reporting, and the effectiveness of control
management based on variance reports, depends on reliable budgets and standards.
It is essential that the budget or standard cost must be reasonable, because variances
are calculated as the difference between actual results and the budget or standard.
If the budget or standard is unreliable, the variance reports will also be unreliable –
and so useless for management.
2.2 Ex ante and ex post standards or budgets
If management decide that the standard cost is unreliable and invalid, they can
prepare a more realistic or accurate standard cost. Similarly, if the original budget is
invalid, a more realistic budget can be prepared.
The original standard cost or budget is known as the ex ante standard or ex ante
budget
.
The revised and more realistic standard cost or budget is known as the ex post
standard or ex post budget
.
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2.3 Using ex post standards (or ex post budgets) to calculate planning and
operational variances
Ex post standards or budgets can be used to calculate variances, as an alternative to
the ‘normal’ method of calculating variances.
Actual results are compared with the ex post standard (or ex post budget) and
variances are calculated using the ex post standard. These variances are the
operational variances.
The ex post standard cost (or ex post budget) is compared with the ex ante
standard cost (or ex ante budget) and the difference between them is the
planning variance.
The planning variance is therefore a measurement of the amount by which an
unreliable standard cost (or unreliable budget) – in other words, poor planning or a
major revision to plans – is the cause of the difference between actual results and the
original ex ante standard cost or ex ante budget.
Planning variances are
uncontrollable,
in the sense that control action by management will not eliminate a
weakness in planning.
The operational variances, by comparing actual results with a realistic standard cost,
provide useful control information for management.
Operational variances may be
controllable variances
.
2.4 Calculating planning and operational variances
Planning and operational variances can be calculated for any aspect of a standard
cost or budget: for example, an ex post standard cost can be calculated for the direct
materials cost per unit, or the direct materials usage per unit, or the direct materials
price per unit, or the direct labour cost per unit, the direct labour hours per unit, and
so on.
Similarly, an ex post budget can be prepared with revised figures for sales volumes
or sales prices.
The following example will be used to illustrate the basic method of calculating
planning and operational variances.
Example
Product Z has a standard labour cost of 3 hours per unit at $8 per hour = $24 per
unit.
During the first month of the current year, 500 units of Product Z were
manufactured. These took 1,960 hours to make, at a labour cost of $16,500.
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Using traditional variances, the labour variances for the month would be as
follows:
Labour rate variance $
1,960 hours should cost (× $8)
15,680
But they did cost 16,500
Labour rate variance 820
(A)
Labour efficiency variance hours
500 units of product Z should take (× 3 hours)
1,500
But they did take 1,960
Efficiency variance in hours 460
(A)
Standard labour rate per hour $8
Efficiency variance in $ $3,680
(A)
The
total labour cost variance is $820 (A) + $3,680 (A) = $4,500 (A).
Suppose, however, that it is discovered early during the month that the planned
improvements in efficiency that were expected from introducing new equipment
could not be achieved, because the new equipment had suffered a major breakdown
and had been returned to the supplier for repair.
It is decided that a more appropriate labour cost for each unit of Product Z should
be:
4 hours × $8 per hour = $32.
This is accepted as a
new ex post standard cost for direct labour cost.
A planning variance compares the difference between:
the original standard cost or budget (the ex ante standard cost or ex ante
budget), and
the revised standard cost or budget (the ex post standard cost or ex post budget).
The planning variance is reported as the effect that this difference has had on
reported profit or cost.
In this example, the planning variance applies to the labour hours per unit, but it
can be calculated either on a labour cost per unit basis or a labour hours basis.
Since direct labour is a variable cost, the planning variance is calculated as the
difference between:
the standard labour cost with the ex ante standard, and
the standard labour cost with the ex post standard.
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Method 1
Total labour cost for 500 units of Z $
Ex ante standard cost (× $24)
12,000
Ex post standard cost (× $32)
16,000
Planning variance: labour efficiency 4,000
(
A)
The planning variance is adverse because the ex post standard cost is less
favourable (is more costly) than the ex ante standard cost.
Method 2
Since the planning error is in the labour hours per unit, the planning variance can be
calculated in labour hours:
Labour hours: time required to make 500 units
of product Z
hours
Ex ante standard (× 3 hours)
1,500
Ex post standard (× 4 hours)
2,000
Planning variance in standard hours 500
(
A)
Standard labour rate per hour $8
Planning variance in $, labour efficiency $4,000
(
A)
Operating variances are calculated in the same way as traditional variances, except
that the ex post standard cost (or ex post budget) is used, not the ex ante standard
cost.
In this example, only the labour efficiency variance is affected by the change. The
labour rate variance remains at $820(A). The operating variance for labour efficiency
is calculated as follows:
Labour efficiency (operating) variance Hours
500 units of product Z should take (× 4 hours) 2,000
But they did take 1,960
Efficiency variance in hours 40
(F)
Standard labour rate per hour $8
Efficiency variance in $ (operating variance) $320
(F)
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2.5 Comparing planning and operational variances with traditional
variances
The planning and operating variances in the previous example can be summarised
as follows:
$
$
Planning variance:
Labour efficiency
4,000
(A)
Operating variances
Labour rate 820
(A)
Labour efficiency 320
(F)
500
(A)
Total direct labour variances
4,500
(A)
This compares with the traditional variances, which are:
$
Labour efficiency 3,680
(A)
Labour rate 820
(A)
Total direct labour variances 4,500
(A)
The total variances come to the same amount.
However, it can be argued that planning and operational variances provide much
more useful control information to management than the traditional variances,
because the original (ex ante) standard cost is unreliable and incorrect.
2.6 More than one difference between the ex ante and ex post standard
costs
A situation could arise where there are planning errors or planning changes in two
parts of the ex ante standard cost, and the errors both relate to:
direct materials cost – with a planning variance in the standard material price
and another planning variance in the standard material usage per unit.
direct labour cost – with a planning variance in the standard labour rate per
hour and another planning variance in the standard labour hours per unit.
In these circumstances, the planning variance can be analysed to show the effect of
each separate planning variance.
The principle to apply in calculating the planning and operating variances is the
same as if there is just one planning error in the standard cost.
The planning variance in total is the difference between the ex ante standard cost
and the ex post standard cost.
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The operating variances are calculated using the ex post standard cost.
The only difference is that if the total planning variance is caused by two factors, it
should be possible to analyse the total planning variance into its different causes.
The method of analysing a total planning variance will be explained with an
example.
Example
Greenco manufactures product G, which has a standard direct material cost per unit
of: 5 kilos at $6 per kilo = $30.
Actual output during a month is 4,000 units of product G, and the materials actually
used in production were 16,500 kilos at a cost of $119,000.
The operations manager of Greenco persuades his colleagues that the standard cost
for direct materials is incorrect, and a more realistic standard cost is:
4 kilos at $7 per kilo = $28.
Required: Analyse the total planning variance for materials cost into a planning
variance for materials price and a planning variance for materials usage.
Answer
Total planning variance
The planning variance is caused by two factors, an incorrect price per kilo and an
incorrect usage quantity per unit of output. However, the total planning variance is
calculated in the same way as shown previously (method 1).
Total material cost for 4,000 units of G $
Ex ante standard cost (× $30)
120,000
Ex post standard cost (× $28)
112,000
Planning variance, materials 8,000
(F)
The planning variance is favourable because the ex post standard cost is more
favourable (is less costly) than the ex ante standard cost.
Further analysis of the total planning variance
The total planning variance can be analysed into a planning variance caused by each
planning change in the standard – in this example there is an error in the standard
for materials price and an error in the standard for materials usage and we can
therefore analyse the total planning variance for materials into a planning variance
for materials price and a planning variance for materials usage.
The two standard costs that we are comparing are as follows:
Ex ante standard
4,000 units
× 5 kilos = 20,000 kilos × $6
$120,000
Ex post standard
4,000 units
× 4 kilos = 16,000 kilos × $7
$112,000