CIMA - C1 Fundamentals of Management Accounting

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190

8: Variance analysis ⏐ Part B Standard costing

Actual direct wages cost $171,320. P Co paid $5.50 for each kg of direct material. There were no opening or closing

inventories of the material.

Required

Calculate the following.

(a) Actual output (c) Average actual wage rate per hour

(b) Actual hours worked (d) Actual number of kilograms purchased and used

Solution

(a)

Total direct wages cost

171,320

Adjust for variances:

labour rate

(10,598)

labour efficiency

8,478

Standard direct wages cost

169,200

∴

Actual output = Total standard cost

unit standard cost

= $169,200

$72

= 2,350 units

(b)

Total direct wages cost

171,320.0

Less rate variance

(10,598.0

)

Standard rate for actual hours

160,722.0

standard rate per hour

÷ $12.0

Actual hours worked

13,393.5

hrs

(d) Number of kgs purchased and used = x

x kgs should have cost (

$6)

6.0x

but did cost (

$5.50)

5.5x

Direct material price variance

0.5x

∴

$0.5x = $18,840

∴

x = 37,680 kgs

Question

Actual rate of pay

XYZ Co uses standard costing. The following data relates to labour grade ll.

Actual hours worked 10,400 hours

Standard allowance for actual production 8,320 hours

Standard rate per hour $5

Rate variance (adverse) $416

What was the actual rate of pay per hour?

A $4.95

B $4.96

C $5.04

D $5.05

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Part B Standard costing ⏐ 8: Variance analysis

191

Answer

The correct answer is C.

Rate variance per hour worked =

$416

10,400

= $0.04 (A)

Actual rate per hour = $(5.00 + 0.04) = $5.04.

You should have been able to eliminate options A and B because they are both below the standard rate per hour. If the

rate variance is adverse then the actual rate must be above standard.

Option D is incorrect because it results from basing the calculations on standard hours rather than actual hours.

Question

Quantity of material X

The standard material content of one unit of product A is 10kgs of material X which should cost $10 per kilogram. In

June 20X4, 5,750 units of product A were produced and there was an adverse material usage variance of $1,500.

The quantity of material X used in June 20X4 is

kgs.

Answer

The quantity used is

57,650

kgs

Workings

Let the quantity of material X used = Y

5,750 units should have used (

10kgs)

57,500 kgs

but did use

kgs

Usage variance in kgs

(Y – 57,500) kgs

standard price per kg

× $10

Usage variance in $

$1,500

(A)

∴

10(Y – 57,500) = 1,500

Y – 57,500 = 150

∴

Y = 57,650 kgs

Make sure you can deal with this sort of variance analysis question as it is an ideal way of assessing your competence in

this area.

9 Inter-relationships between variances

In many cases, individual variances should not be looked at in isolation. One variance might be inter-related with

another, and much of it might have occurred only because the other, inter-related, variance occurred too.

When two variances are

interdependent

(

interrelated

) one will usually

be adverse and the other one favourable.

T F

RWAR

Assessment

focus point

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192

8: Variance analysis ⏐ Part B Standard costing

Here are some examples of interdependent variables.

(a)

Materials price and usage

It may be decided to purchase cheaper materials for a job in order to obtain a favourable price variance,

possibly with the consequence that materials wastage is higher and an adverse usage variance occurs. If

the cheaper materials are more difficult to handle, there might be an adverse labour efficiency variance

too.

If a decision is made to purchase more expensive materials, which perhaps have a longer service life, the

price variance will be adverse but the usage variance might be favourable.

(b)

Labour rate and efficiency

If employees in a workforce are paid higher rates for experience and skill, using a highly skilled team to do

some work would incur an adverse rate variance, but should also obtain a favourable efficiency variance.

In contrast, a favourable rate variance might indicate a larger-than-expected proportion of inexperienced

workers in the workforce, which could result in an adverse labour efficiency variance, and perhaps poor

materials handling and high rates of rejects too (adverse materials usage variance).

(c)

Sales price and sales volume

The possible interdependence between sales price and sales volume variances should (hopefully) be

obvious to you. A reduction in the sales price might stimulate bigger sales demand, so that an adverse

sales price variance might be offset by a favourable sales volume variance. Similarly a price rise would

give a favourable price variance, but possibly at the cost of a fall in demand and an adverse sales volume

variance.

(d)

Cost and sales variances

(i) If there are

favourable cost variances

(perhaps cheaper labour or material have been used, say, so

that there are favourable labour rate or material price variances), the possible drop in quality of the

product could lead to an

adverse sales volume variance

because customers don’t wish to buy the

lower quality product.

(ii) If product quality is improved this might result in an

adverse cost variance

– If more expensive material is used (adverse material price variance)

– If labour are more careful in production of the product and hence take longer than standard

(adverse labour efficiency variance)

– If more skilled labour is used (adverse labour rate variance)

But the change in quality might result in a

favourable sales volume variance

, customers wanting

to buy more of the higher-quality product.

(iii) If costs have risen (resulting in

adverse labour rate, material price and variable overhead

expenditure variances

), the sales price might have to be increased to cover the extra costs. This

would result in a

favourable sales price variance

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Question

Variance interrelationships

Hey Co has been let down by its supplier and has had to buy from an alternative source. The alternative materials are of

better quality but are more expensive than the original supplier's. What effect is this change in supplier likely to have on

the variances at the month end?

(a) Materials price variance Favourable

Adverse

(b) Materials usage variance Favourable

Adverse

Answer

Adverse, Favourable

The materials are more expensive which will lead to an adverse price variance. They are however, better quality which

means that the material usage variance should be favourable.

Chapter Roundup

•

Variances

measure the difference between actual results and expected results. t The process by which the total

difference between standard and actual results is analysed is known as

variance analysis

•

The

direct material total variance

(the difference between what the output actually cost and what it should have cost, in

terms of material) can be divided into the

direct material price

variance

and the

direct material usage

variance

•

Since material inventories are usually valued at

standard cost

in a standard costing system, direct material price

variances are usually extracted at the time of

receipt

of the materials, rather than at the time of usage.

•

The

direct labour total variance

(the difference between what the output should have cost and what it did cost, in terms

of labour) can be divided into the

direct labour rate

variance

and the

direct labour efficiency

variance

•

If idle time arises, it is usual to calculate a separate

idle time variance

, and to base the calculation of the

efficiency

variance

active hours

(when labour actually worked) only. It is always an

adverse

variance.

•

The

variable overhead total variance

can be subdivided into the variable overhead

expenditure

variance

and the

variable overhead

efficiency

variance (based on active hours).

•

There are a wide range of

reasons

for the occurrence of adverse and favourable cost

variances

•

The

sales price variance

is a measure of the effect on expected contribution of a different selling price to standard

selling price. It is calculated as the difference between what the sales revenue should have been for the actual quantity

sold, and what it was.

•

The sales volume variance in units is the difference between the actual units sold and the budgeted quantity. This

variance in units can be valued in one of three ways: in terms of standard revenue, standard gross margin or standard

contribution margin.

•

Operating statements

show how the combination of variances reconcile budgeted contribution and actual contribution.

•

Variances

can be

manipulated

so as to derive actual data from standard cost details.

•

When two variances are

interdependent (interrelated)

one will usually be adverse and the other favourable.

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8: Variance analysis ⏐ Part B Standard costing

Quick Quiz

1 Subdivide the following variances.

(a) Direct materials cost variance

(b) Direct labour cost variance

2 What are the two main advantages in calculating the material price variance at the time of receipt of materials?

3 Adverse material usage variances might occur for the following reasons.

I Defective material

II Excessive waste

III Theft

IV Unforeseen discounts received

A I

B I and II

C I, II and III

D I, II, III and IV

4 Hat Co makes a product Kap which requires material budgeted at 50c per kg. During June, 6,200 kg were purchased for

$3,224 and 6,000 kg were used. There was no opening inventory at the start of June. Inventory is valued at standard

cost.

(a) Calculate the material price variance for June.

A $224 C $244

B $124 D $144

(b) Is the variance favourable or adverse?

Favourable

Adverse

5 A regular report for management of actual cost and revenue, and usually comparing actual with budget (and showing

variances) is known as

A Bank statement C Budget statement

B Variance statement D Operating statement

6 A favourable sales price variance can result from a combination of a lower than budgeted sales volume and a higher than

standard selling price.

True

False

7 If two variances are interdependent, both must be either favourable or adverse.

True

False

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Part B Standard costing ⏐ 8: Variance analysis

195

8 The sales volume variance considers the difference between ………………… sales volume and ………………… sales

volume.

Fill in the gaps using two of the following words.

•

total

•

budgeted

•

actual

•

future

•

incremental

•

estimated

•

past

•

confirmed

9 HF Co budgeted to produce 3,000 units of product K in June. The budgeted materials for product K were 1,500 kg at a

cost of $3 per kg. The actual number of units produced was 2,200 and the material variances were as follows:

Direct material price variance $825(A)

Direct material efficiency variance $1,650(A)

Calculate the actual direct material kgs used.

A 550 kg

B 1,100 kg

C 1,650 kg

D 4,950 kg

10 Using the information in question 10, calculate the actual direct material cost for June.

A $825

B $4,125

C $4,950

D $5,775

Answers to Quick Quiz

Price

1 (a)

Usage

Rate

(b)

Efficiency

Expenditure

(c)

Efficiency

2 (a) The earlier variances are extracted, the sooner they will be brought to the attention of managers.

(b) All inventories will be valued at standard price which requires less administration effort.

3 C Unforeseen discounts received would lead to a favourable price variance.

4 B $124 Adverse

6,200 kg should have cost (× 50c)

3,100

But did cost

3,224

124

(A)

5 D

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8: Variance analysis ⏐ Part B Standard costing

6 True. The variance is favourable if the actual price is higher than standard.

7 False. Favourable material price and adverse material usage variances might be interdependent, for example.

8 The correct words are

budgeted

and

actual

9 C First we write out the way we would normally calculate the material efficiency variance and fill in the figures that

we know.

2,200 units should have used (x 3,000/1,500kg)

1,100

But did use

(Q)

Material efficiency variance in kgs

(P)

x standard cost per kg

x $3

$1,650

(A)

Working backwards we can see that the efficiency variance in kg (box (P))

= 1,650 ÷ $3

= 550 kg

Now that we know the efficiency variance in kg, we can work out the number of kg that were actually used (box

(Q))

= 550 kg + 1,100 kg

= 1,650 kg

10 D $5,775

1,650 kg should have cost (x $3) 4,950

But did cost

Materials price variance

825

(A)

Working backwards we can see that the actual cost must have been 825 + 4,950 = $5,775.

Now try the questions below from the Question Bank

Question numbers Page

37–46 359

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Part C

Financial planning and

control

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Topic list

Learning outcomes

Syllabus references

Ability required

1 Why do organisations prepare budgets? E(i) E(1) Comprehension

2 A framework for budgeting E(i), (ii) E(1) Comprehension/

Application

3 Steps in the preparation of a budget E(i), (ii) E(2) Comprehension/

Application

4 Functional budgets E(ii) E(2) Application

5 Cash budgets E(iii), E(iv) E(2) Application, Analysis

6 Master budgets E(iii) E(2) Application

7 Capital expenditure budgets E(ii) E(2) Application

8 Approaches to budgeting E(i) E(1) Comprehension

Budget preparation

Introduction

This chapter is the first of two on a new topic, budgeting. It is a topic which you will meet at

all stages of your examination studies so it is vital that you get a firm grasp of the basics

now. The chapter begins by explaining the reasons why an organisation might prepare a

budget and goes on to detail the steps in the preparation of a budget. The method of

preparing and the relationship between the various functional budgets is then set out.

The chapter also considers the construction of cash budgets and budgeted income

statements and statements of financial position, the these three budgets making up what is

known as a master budget.

In Chapter 10 we will build on the general awareness of budgeting gained in this chapter and

look at more specific budgeting issues.

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