Week 8- Variance analysis

Question 1

What is standard costing?

Answer 1

Standard costing is a control technique which
compares standard costs and revenues with
actual results to obtain variances which are used
to stimulate improved performance.

Accountants and representatives from other
functions such as engineers, personnel
department managers, and production managers
combine efforts to set standards based on
experience and expectations.

Ideal standards assume peak efficiency at all
times. They are therefore not going to be achieved
in most cases.

Practical standards allow for normal machine
downtime and other work interruptions and that
can be attained through reasonable, though highly
efficient, efforts by an average worker.

They are challenging but achievable targets and are
therefore most frequently used.

Question 2

What is a standard cost?

Answer 2

– A standard cost is an estimated unit cost.
– Usually expressed on a per unit basis.
– Benchmark for measuring performance against actual
results.

Question 3

What are variances? They may relate to changes in what? What are U and F variances?

Answer 3

• Quantity
• Price

• Variances which reduce income or increase
costs are unfavourable (or adverse ) U (or A)
• Variances which increase revenue or reduce
costs are favourable (F)

Question 4

What is a statis budget?

Answer 4

Expected (budgeted) amounts for a single
level of planned output.

Based on one level of output: no adjustment
is made to budgeted units

Question 5

What are flexible budgets?

Answer 5

Expected (budgeted) amounts for a range of
output levels (“flexed” version of static
budget).
Budgeted amounts are adjusted (ie flexed) to
recognise the actual level of output. A flexed
budget is calculated after the period end
using the actual level of output

Question 6

What are deficiencies of statis budgets?

Answer 6

• Problem: In static budget based variance analysis,
variances caused by changes in output cannot be separated from variances caused by changes in price/cost.

Flexible budgets adjust budgeted standards for
actual output. Thereby, variances caused by
changes in output levels can be separated from
variances caused by changing prices and levels of input.

Question 7

static budget variance

Answer 7

static budget variance=actual results - static budget amount

Question 8

Sales volume profit (or contribution) variance

Answer 8

The sales volume variances are those variances which are created
because actual sales volume is different from the budgeted sales
volume .
Sales volume variance in the context of contribution and profits:
(Actual Sales Units – Budget Sales Units ) × Standard Margin
Where Standard margin = Standard contribution per unit
(marginal costing)
Or
Standard profit per unit (absorption costing)

Question 9

What are the 3 levesl of variance analysis

Answer 9

Static budget variance: flexible budget variance + sales volume variance

flexible budget varience: price variance + efficiency variance (for input factors)

Question 10

static budget variance

flexible budget variance

Answer 10

Formula sheet

ex: Flexible budget variance= actual cost - flexible cost

Question 11

What are price and efficiency variances?

Answer 11

•Price and efficiency variances are concerned
with the actual and budgeted prices and
quantities of inputs (such as direct materials
purchased or used).

FMsheet

Question 12

Material Usage (Efficiency) - If unfavourable:

Answer 12

• Defective material
• Excessive waste (abnormal loss)
• Unskilled labour
• Pilferage
• Errors in allocating material to jobs
• Obsolete machinery (or highly depreciated)

Question 13

Who is responsible for Unfavourable

MATERIAL USAGE VARIANC?

Answer 13

•Production manager is responsible to keep
tabs on unnecessary or extravagant use of
materials.
•If purchase manager purchases low quality
materials to improve the direct materials price
variance then purchasing department would be
held accountable for the variance.

Question 14

Material Usage - If favourable:

Answer 14

Material used of higher quality than
standard i.e. stricter quality control
• More effective use made of material
• Errors in allocating material to jobs
• Automated processes or modern
machinery
• Skilled labour
• Training and development of workforce OR
motivated workforce

Question 15

Material Price - If unfavourable:

Answer 15

-Price increase
• Careless purchasing
• Better quality material
• Inflation (increase in all prices)
• Not benefitted from bulk discount
• Increased transportation costs
• Just in time management can lead to material
shortages and may have needed urgent orders
-damaged goods sold for lower price
-original sales price was unrealistic and was lowered

Question 16

Who is responsible for unfavourable MATERIAL PRICE VARIANCE?

Answer 16

•Primarily Purchasing department is responsible
and accountable to place orders for direct
materials so this variance is generally considered
the responsibility of purchase manager.
•Beware! that should not always be the case.
above reasons clarify that the materials price
variance may or may not be the result of
inefficiencies of the purchasing department.

Question 17

How to determine true material cost?

Answer 17

Direct materials price standards should reflect the
final delivered cost of the materials.
In some instances, when oil prices are high.
shipping costs exceed the cost of the cargo itself.
e.g. In Oct 2007, it cost about $88 to ship a ton of
iron ore from Brazil to Asia; whereas, the iron ore
itself was only costs $60 per ton.

Question 18

Material Price – If favourable:

Answer 18

Unforeseen discounts received e.g. bulk
purchasing leading to discounts
• Greater care in purchasing; cheaper supplier
• Lower quality material
• Efficiencies in upstream value chain (efficient
procurement) e.g. Economic order quantity e.g.
economically best courses of action regarding
reordering point, ordering cost, carrying cost,
order lead time, Purchasing cost per unit
-discount (ex: bulk discount)
-weak exchange rates

Question 19

Suggested causes of material variance:

Answer 19

• change of supplier
• increased purchase price
• increased delivery costs
• exchange rates are weak
• more material used
• cheaper material use that increases wastage and more units to be reproduced
• shortage of material, thus increasing price
• seasonal variation
• careless purchasing
• inflation
• not benefited from bulk discount
• increased transportation costs
• just in time management

Question 20

Explaining unfavourable variances:

Labour efficiency variance

Answer 20

 Inexperienced/junior doctors
 Poor level of motivation workers
 Tiredness
 Equipment needs improvement?
 Purchase of low quality materials (more relevant in
manufacturing businesses)
 Poor supervision
 Unrealistic (even dangerous) expectations for efficiencies and
therefore wrong standard length of times.

Question 21

Explaining unfavourable variances:
Labour rates (price) variance

Answer 21

The hourly pay for doctors may have been higher
than expected, because…
 Some medics may have worked overtime and therefore cost
more
 Comparatively senior staff (more expensive) may have been
available to offer the services
 Skills shortages may have required hiring at different pay rates
 There may have been promotions of staff into higher pay
levels
 The outcome of contract negotiations with union may have
favoured the medics

Question 22

Variable OH efficicency variance

Variable OH spending variance

Answer 22

FM SHEET

Question 23

Possible reasons for

VOH EFFICIENCY VARIANCE

Answer 23

• A variance does not necessarily mean that a company
has incurred less/more actual overhead, it simply
means that there was a deterioration in USAGE of
the allocation base (e.g. as machine hours here) that
was used to apply overhead.
• Actual machine hours used have been higher than the
budgeted machine hours. It could be for a number of
reasons e.g. planning errors, old machinery, poor
quality of raw materials and therefore more difficult
to work with etc.

Question 24

Possible reasons for

VOH SPENDING VARIANCE

Answer 24

Suppliers of various overhead services (e.g.
electricity supplies) may have changed their
prices, which have not yet been reflected in
updated standards.
• OH Absorption basis (e.g. labour hours) may
not have been the most appropriate one as a
standard for absorbing variable overheads
–Discount on purchase of indirect materials and supplies because of large order sizes.
-A sudden decrease in the prices of indirect materials or the rates of indirect labor that were not expected at the time of setting overhead standards.

Question 25

Why do we use variances?

Answer 25

Key use of variance analysis: performance evaluation. Consider possible interdependencies among variances and don’t interpret variances in isolation of each other e.g. automation improving labour efficiency variance , or unskilled labour may improve rate variance but efficiency may have been compromised. • Consider trade-offs between variances (eg price and efficiency Sometimes variances will affect each other. For instance, direct labor variance might be favorable because lower wages are paid to workers. However, this might also mean unfavorable material usage variance (due to waste that occured during production), unfavorable labor efficiency variance (less efficient workers and less productivity), unfavorable overhead efficiency variance or unfavorable overhead volume variance (high machine breakdowns because of less skilled operators). Material price and usage could be another example. Cheaper materials would give a favourable price variance. However, such material would increase wastage and more units to be reproduced. This might result in adverse usage variance and adverse labour efficiency variance. However, with expensive quality material, price variance will be unfavorable but usage variance might be favorable. Lastly, unfavourable variable OH variance may result in favourable labour efficiency and material usage. For instance, heating could keep staff and material warm, enabling workers to work properly and more efficiently.

Question 26

What are suggested causes of FC?

Answer 26

- The business process re-engineering, optimization of production facilities or other improvement techniques carried out during the period which resulted in lowering actual fixed overhead. - Inaccurate planning at the start of the period. - The business expansion planned at the time of setting budgets was not carried out during the period.

Question 27

What are the suggested causes of labour variance?

Answer 27

- more expensive staff - outsourcing - staff worked efficiently - workforce restructure (some staff not required) - skilled workforce - experienced workers - motivated workforce - improved equipment - quality supervision

Question 28

How should standards be developed (Rapid changes in digital world)

Answer 28

Standards must be consistently revised when there is: • Sudden increase in the price of materials due to a rapid increase in global market prices (e.g. the price of oil or other commodities) • Change in working methods and procedures that alters the expected direct labour time for a product or service. • Design specifications of materials used to make a product or provide a service • Unforeseen changes in the rate of pay to the workforce.

Question 29

Criticism of standard costing

Answer 29

Potential effects on staff morale. • Only financial aspect is investigated; misses out on quality, service, customer satisfaction etc. • May be time consuming and tedious to install and keep up to date. • JIT factories may not benefit as much. Standard costing was developed when the business environment was more stable and operating conditions were less prone to change. In the present dynamic environment, such stable conditions may not be presen -Historically performance to standard used to be judged as satisfactory, but in today’s climate constant improvement must be aimed, in order to remain competitive. • In manufacturing environments the emphasis on labour variances is diminishing with the increasing use of automated production methods. (However in service sector the importance for labour variances cannot be undermined) - standards can quickly become outdated - factors beyond the control of the manager may affect the variance - difficult to demarcate management responsabilities - no incentive to achieve beyond standardsű-standars may create perverse incentives

Question 30

Why might managers find a Level 2 flexible-budget analysis more informative than a Level 1 static-budget analysis?

Answer 30

A Level 2 flexible-budget analysis enables a manager to distinguish how much the difference between an actual result and a budgeted amount is due to (a) differences between actual and budgeted output levels, and (b) differences between actual and budgeted sales and costs due to the factors other than just the difference in the volume of output.

Question 31

Describe the difference between a direct materials efficiency variance and a variable manufacturing overhead efficiency variance.

Answer 31

A direct materials efficiency variance indicates whether more or less direct materials were used than was budgeted for the actual output achieved. A variable manufacturing overhead efficiency variance indicates whether more or less of the chosen allocation base was used than was budgeted for the actual output achieved.

Question 32

Why is the flexible-budget variance the same amount as the spending variance for fixed manufacturing overheads?

Answer 32

The flexible budget amount for fixed overhead does not change with changes in production, so this amount remains the same regardless of actual production. There is never an efficiency variance for fixed overhead because managers cannot be more or less efficient in dealing with an amount that is fixed regardless of the output level. The result is that the flexible-budget variance amount is the same as the spending variance for fixed manufacturing overhead.

Question 33

Under what circumstances will you expect the volume variance to be favourable? Unfavourable? What does the variance measure?

Answer 33

Variance is a statistical measure of how much a set of observations differ from each other. In accounting and financial analysis, variance also refers to how much an actual expense deviates from the budgeted or forecast amount. The Sales Volume Variance quantifies the effect of a change in the level of sales on the profit or contribution over a given period. The variance will be unfavourable when the actual level of output is lower than the budgeted level of output (as per the static budget). The volume variance in terms of material usage and labour efficiency is favourable when the activity for a period, at standard, is greater than the denominator activity level. Conversely, if the activity level, at standard, is less than the denominator level of activity, the volume variance is unfavourable. The variance does not measure total deviations in spending. It measures deviations in the actual level of input activity from the denominator level of standard input activity for the actual output.

Question 34

Critically asses: A F DL rate variance can only be caused by staff working more efficiently than budgeted.

Answer 34

F DL means tha the rate per hour paid is less than budgeted. Normally this is not linked to efficient working. However, if the budgeted hours envisaged some overtime working, the actual rate may be below standard if efficiency has removed the need for overtime.

Question 35

Critically asses: Selling more units than budgeted, because the units were sold at less than standard price, automatically leads to F sales volume variance.

Answer 35

True. It may lead to problems elsewhere and an adverse sales price variance, but the sales volume varianve must be F.

Question 36

Critically asses: Using below standard materials will tend to lead to adverse materials usage variances but cannot affect labour variances.

Answer 36

It can also affect L variances because working on materials that would not form part of the output would be a waste of labour time.

Question 37

Critically asses: Higher than budgeted sales could not possibly affect the labour rate variance.

Answer 37

yes becazse producing additional work may require overtime working at premium rates.

Question 38

An adverse sales price variance can only rise from selling a product as less than standard price.

Answer 38

True. Only because of that.