ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 12: Standard costing and variance analysis
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In a standard absorption costing system, the sales volume variance might be called
a sales volume profit variance. A method for calculating the sales volume variance
is as follows:
Sales volume variance: usual method of calculation
units of sale
Actual sales volume (units) AV
Budgeted sales volume (units) BV
Sales volume variance in units AV – BV (F) or (A)
× Standard profit per unit × $P
Sales volume variance in $
(AV – BV) × $P
(F) or (A)
The volume variance is favourable if actual sales volume is higher than the
budgeted volume, and adverse if the actual sales volume is below budget.
There is an alternative method of calculating the sales volume variance, which
produces exactly the same figure for the variance.
Sales volume variance: alternative method of calculation
$
Actual sales at standard selling price A
Budgeted sales revenue B
Sales volume variance in $ revenue (A – B) (F) or (A)
Standard profit/sales price ratio P%
Sales volume variance (profit variance) (A – B) × P% (F) or (A)
Example
A company budgets to sell 7,000 units of Product P456. It uses a standard absorption
costing system. 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 (× $50) 360,000
They did sell for 351,400
Sales price variance 8,600
(A)
The sales price variance is adverse because actual sales revenue from the units sold
was less than expected.
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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 (7,200 × $50) 360,000
Budgeted sales (7,000 units × $50) 350,000
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.
Exercise 6
A company budgets to sell 42,000 units of Product P567. The standard sales price of
Product P567 is $20 per unit and the standard cost per unit is $16. Actual sales were
39,200 units, which sold for $802,300.
Required
Calculate the sales price variance and the sales volume variance (profit variance) for
the period. The company uses a standard absorption costing system.
7.3 Sales: possible causes of variances
Possible causes of sales variances include the following:
Sales price variance
Actual increases in prices charged for products were higher or less than expected
due to market conditions.
Actual sales prices were less than standard because major customers were given
an unplanned price discount.
Competitors reduced their prices, forcing the company to reduce the prices of its
own products.
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Sales volume variance
Actual sales demand was more or less than expected.
The sales force worked well and achieved more sales than budgeted.
An advertising campaign had more success than expected.
A competitor went into liquidation, and the company attracted some of the
former competitor’s customers.
The products that the company makes and sells are going out of fashion earlier
than expected; therefore the sales volume variance was adverse.
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Interrelationships between variances
The nature of interrelationships between variances
Sales price and sales volume
Materials price and usage
Labour rate and efficiency
Footnote: the importance of reliable standard costs
8 Interrelationships between variances
8.1 The nature of interrelationships between variances
In your examination, you might be required to show an understanding of the
possible causes of variances. Some causes of individual variances have already been
listed.
The reasons for variances might also be connected, and two or more variances
might arise from the same cause. This is known as an interrelationship between two
variances.
For example, one variance might be favourable and another variance might be
adverse. Taking each variance separately, the favourable variance might suggest
good performance and the adverse variance might suggest bad performance.
However, the two variances might be inter-related, and the favourable variance and
the adverse variance might have the same cause. When this happens, management
should look at the two variances together, in order to assess their significance and
decide whether control action is needed.
Examples of interrelationships between variances are given below.
8.2 Sales price and sales volume
A favourable sales price variance and an adverse sales volume variance might have
the same cause. If a company increases its selling prices above the standard price,
the sales price variance will be favourable, but sales demand might fall and the sales
volume variance would be adverse.
Similarly, in order to sell more products a company might decide to reduce its
selling prices. There would be an adverse sales price variance due to the reduction
in selling prices, but there should also be an increase in sales and a favourable sales
volume variance.
8.3 Materials price and usage
A materials price variance and usage variance might be inter-related. For example,
if a company decides to use a material for production that is more expensive than
the normal or standard material, but easier to use and better in quality, there will be
Chapter 12: Standard costing and variance analysis
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an adverse price variance. However a consequence of using better materials might
be lower wastage. If there is less wastage, there will be a favourable material usage
variance. Therefore, using a different quality of material can result in an adverse
price variance and a favourable usage variance.
8.4 Labour rate and efficiency
If there is a change in the grade of workers used to do some work, both the rate and
efficiency variances may be affected.
For example, if a lower grade of labour is used instead of the normal higher grade:
there should be a favourable rate variance because the workers will be paid less
than the standard rate
however the lower grade of labour may work less efficiently and take longer to
produce goods than the normal higher grade of labour would usually take. If the
lower grade of labour takes longer, then this will give rise to an adverse
efficiency variance.
Therefore the change in the grade of labour used results in two ‘opposite’ variances,
an adverse efficiency variance and a favourable rate variance.
When inexperienced employees are used, they might also waste more materials
than more experienced employees would, due to mistakes that they make in their
work. The result might be not only adverse labour efficiency, but also adverse
materials usage.
8.5 Footnote: the importance of reliable standard costs
It is important to remember that the value of variances as control information for
management depends on the reliability and accuracy of the standard costs. If the
standard costs are inaccurate, comparisons between actual cost and standard cost
will have no meaning. Adverse or favourable variances might be caused by
inaccurate standard costs rather than by inefficient or efficient working.
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8.5
Reconciling budgeted and actual profit: standard absorption costing
Purpose of an operating statement
Format of an operating statement
9 Reconciling budgeted and actual profit: standard
absorption costing
9.1 Purpose of an operating statement
A management report called an operating statement might be prepared, showing
how the difference between budgeted and actual profit is explained by the sales
variances and cost variances. An operating statement reconciles the profit that was
expected in the budget with the actual profit that was achieved.
The purpose of an operating statement is to report all variances to management, so
that management can assess the effect they are having on profitability. Senior
management can also use an operating statement to assess the success of junior
managers in controlling costs and achieving sales.
9.2 Format of an operating statement
In a standard absorption costing system, an operating statement can be set out as
follows. You should try to familiarise yourself with this type of statement.
Operating statement (standard absorption costing)
$
Budgeted profit BP
Sales price variance X (F) or (A)
Sales volume variance X (F) or (A)
Actual sales minus the standard production cost
of sales
X
(F) (A)
Cost variances $ $
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 (see note) X
Total cost variances Totals X (F) or (A)
Actual profit AP
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Note: 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.
In a system of absorption costing:
The operating statement begins with the budgeted profit.
The sales variances are shown next. These are added to (favourable variances) or
subtracted from (adverse variances), and the resulting figure is shown as a sub-
total. This figure is the actual sales revenue in the period minus the standard
production cost of sales.
The cost variances are listed next. They can be listed in any format, but showing
separate columns for favourable variances and adverse variances helps to make
the statement clear to the reader. Adverse variances reduce the profit and
favourable variances add to profit.
The cost variances are added up and then shown as a total.
The actual profit is shown as the final figure, at the bottom of the operating
statement.
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Standard marginal costing
Standard marginal costing and standard absorption costing compared
Fixed production overhead variances in standard marginal costing
Sales volume variance in standard marginal costing
Standard marginal costing operating statement
Standard absorption costing and standard marginal costing: differences in
profit
10 Standard marginal costing
10.1 Standard marginal costing and standard absorption costing compared
When a company uses standard marginal costing rather than standard absorption
costing:
units produced and finished goods inventory are valued at standard variable
production cost, not standard full production cost
variances are calculated and presented in exactly the same way as for standard
absorption costing, but with two important differences:
- fixed production overhead variances
- sales volume variances.
10.2 Fixed production overhead variances in standard marginal costing
In standard marginal costing, there is a fixed production overhead expenditure
variance, but no fixed production overhead volume variance.
The fixed production overhead expenditure variance is calculated in the way
already described and is the same amount in a standard marginal costing system as
in a standard absorption costing system.
10.3 Sales volume variance in standard marginal costing
In standard absorption costing, the sales volume variance is calculated by applying
the standard profit per unit to the volume variance in units.
In standard marginal costing, the sales volume variance is calculated using standard
contribution, and the variance might be called the sales volume contribution
variance. Contribution is the difference between the selling price and the variable
cost.
Standard contribution is therefore the difference between the standard selling
price per unit and the standard variable cost.
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Standard contribution can also be expressed as a contribution to sales ratio,
which is the ratio of the standard contribution per unit to the standard selling
price per unit. The standard contribution to sales ratio is a constant value.
A sales volume contribution variance is calculated in either of the following ways.
(Both methods produce the same variance).
Sales volume variance: usual method of calculation
units
Actual sales volume (units) AV
Budgeted sales volume (units) BV
Sales volume variance in units AV – BV (F) or (A)
Standard contribution per unit $C
Sales volume variance (contribution variance)
(AV – BV) × $C
(F) or (A)
Sales volume variance: alternative method of calculation
$
Actual sales at standard selling price A
Budgeted sales B
Sales volume variance in $ revenue (A – B) (F) or (A)
Standard contribution /sales ratio C%
Sales volume variance (contribution variance)
$(A – B) × C%
(F) or (A)
Both methods of calculating the sales volume (contribution) variance produce the
same answer.
10.4 Standard marginal costing operating statement
With standard marginal costing, an operating statement is presented in a different
way from an operating statement with standard absorption costing. Budgeted
contribution can be reconciled with actual contribution, by means of the sales price
variance, sales volume variance and variable cost variances. Fixed cost expenditure
variances should be presented in a separate part of the operating statement.
Operating statement: standard marginal costing
$
Budgeted profit BP
Add budgeted fixed costs BF
Budgeted contribution (BP + BF) BC
Sales price variance X (F) or (A)
Sales volume variance X (F) or (A)
Sales less standard variable cost of
sales
X
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Variable cost variances (F) (A)
$ $
Direct materials price X
Direct materials usage X
Direct labour rate X
Direct labour efficiency X
Variable production overhead rate X
Variable production o’head efficiency X
Total variable cost variances Totals X (F) or (A)
Actual contribution AC
Budgeted fixed overhead expenditure BF
Fixed overhead expenditure variance X (F) or (A)
Actual fixed production overheads AF
Actual profit (= AC – AF) AP
Try to familiarise yourself with the format of an operating statement with standard
marginal costing.
The operating statement begins with budgeted profit. However, most variances
in standard marginal costing should show the effect of variances on total
contribution. The budgeted profit should therefore be ‘converted’ into budgeted
contribution, by adding the budgeted fixed costs.
The sales variances are shown next, which is the same as in an operating
statement with standard absorption costing.
The variances for variable costs only are listed next, and the total of all variances
for variable cost items is shown.
The actual contribution is the difference between the budgeted contribution and
the sum of the sales variances and the variable cost variances. Adverse variances
reduce the profit and favourable variances add to profit.
Actual fixed costs are deducted from actual contribution to arrive at the actual
profit at the bottom of the operating statement. Actual fixed cost expenditure
should be shown as the budgeted fixed overheads plus the adverse fixed
overhead expenditure variance or minus the favourable fixed overhead
expenditure variance.
10.5 Standard absorption costing and standard marginal costing:
differences in profit
A previous chapter explains the difference in the reported profit using absorption
costing compared with marginal costing. The same principles apply in standard
costing.
The reported profit using standard absorption costing will differ from the reported
profit using standard marginal costing, and the difference in the reported profit can
be explained entirely by differences in the increase or decrease in inventory
valuation during the period.