培训课程
Variance analysis(Relevant to Paper 1.2)
Variance analysis using absorption costing
When considering variance analysis questions, students often try to tackle the problem using lots of formulae. Of course if you know the right formula, the answer is easy, but remembering such things in an exam situation can often be very difficult. If the reasons for variance analysis are understood then the calculation of the figures becomes relatively straightforward.
When we look at variances, we are trying to establish the difference between what has actually happened (what we did achieve) and what we thought should have happened, namely the original budget (what we should have achieved).
In the original budget, information regarding the standard cost per unit, the standard selling price and a budgeted level of production and sales would have been established. The standard cost would be based on expected levels of price, usage, hourly rates of pay and efficiency. It is how much we think a unit should cost, a budgeted cost figure per production unit. At the end of the accounting period this information is then compared to the actual results to see where there have been deviations from this original plan – that is to say where there are variances. If you look at the standard cost per unit of an item, the information can drive you towards the successful completion of any variance analysis question. See Figure 1.
Figure 1: Example Using absorption costing
Information regarding the standard cost, revenue and profit per unit:
£
Direct materials (5kg at £3/kg) 15
Direct labour (2 hours at £8/per hour) 16
Variable production overheads (2 hours at £1/hour) 2
Fixed production overheads (2 hours at £2.50/hour) 5
38
Profit 12
Selling price 50
Budgeted sales and production for the period were 4,000 units.
When considering materials, if we look at the end of the period to see what has actually happened, one question that could be asked is ‘‘The standard material cost per unit should have been £15, was this the case?’’ However, we should also consider the individual components of the total material cost per unit: we should have spent £3/kg on materials and we should have used 5kg per unit, did this happen?
Similarly for labour, an overall variance can be obtained by looking at whether we did pay out £16 per unit of production, but once again we can look further at the individual components making up that £16. Labour should have taken 2 hours per unit and labour should have cost the company £8 per hour, is this what happened?
The standard cost per unit is driving us to look for certain pieces of information: how much did we actually pay out on materials, did we really use 5kg per unit and so on. Let us now consider some actual data, Figure 2, so that we can carry out some variance analysis.
Figure 2: Actual data for the period under review
Production and sales units: 4,150 units
Materials: purchased and used 21,250kg costing a total of £61,350
Labour: paid for 8,250 hours costing a total of
150 labour hours were lost due to delivery problems £68,500
Variable overheads: £8,225
Fixed overheads: £19,000
Sales revenue: £205,425
Material Variances
To calculate the material variances we have already established that we would want to know if the price per kg was £3 (the price variance) and whether 5kg was used per unit (the usage variance).
All that is required now is the comparison of what we did actually pay or use compared to what we should have paid or used using the standard cost per unit (Figure 3).
Figure 3: Material price variance
£
Did pay for 21,250kg (ACTUAL) 61,350
Should have paid for 21,250 kg (21,250kg x £3/kg) 63,750
2,400 favourable
Notice that when the price variance is calculated we focus on the amount of material that has actually been purchased. It is easy to establish how much we did pay as this comes straight from the actual information given. When we calculate the amount we should have paid, we need to ensure that we are comparing like with like. That is why we continue to use the amount of material actually purchased rather than using a flexed figure based on actual levels of production. We need to focus on the material price so everything else must remain static.
In Figure 3 we can clearly see that we actually paid out less than expected giving rise to a favourable variance. Our material has cost us less than we thought.
We can approach the calculation of the usage variance in much the same way: what we did do (the actual amount of material used), compared to what we should have done (using the standard cost per unit), see Figure 4.
Figure 4: Material usage variance
kg
Did use to make 4,150 units (ACTUAL) 21,250
Should use to make 4,150 units (4,150 x 5kg/unit) 20,750
500 adverse
Once again it is important to note that we are looking at how much material it took us to make 4,150 units. This remains static in the calculations to enable us to make a true comparison between what we did do and what we should have done.
In this case we have used more material than expected so we have an adverse variance. However, the variance as it stands at the moment is in terms of kg. Since the reconciliation between budget and actual profit will be on a monetary basis this kg value must be turned into a £ value. To do this we turn again to the standard cost per unit. Having dealt with any difference in the price per kg in the price variance, we can use the standard cost per kg to translate this kg value into a monetary one (see Figure 5).
Figure 5: Material usage variance continued
Variance = 500kg adverse x £3/kg = £1,500 adverse
The approach of ‘‘should do, did do’’, can be applied to all of the variance calculations that are required at this level.
Labour variances
Now let us consider the labour variance. The standard cost per unit is made up of the standard hourly rate of £8/hour and a standard production time of 2 hours. Thus we will need to consider whether labour were actually paid £8/hour (the rate variance) and did labour take 2 hours per unit (the efficiency variance).
In Figure 6, labour were paid more than expected and so this will lead to an adverse variance.
Figure 6: Labour rate variance
£
Did pay labour for 8,250 hours (ACTUAL) 68,500
Should have paid labour for 8,250 hours (8,250 x £8) 66,000
2,500 adverse
Having focused on the monetary value we can now turn our attention to the non-monetary value, the labour hours. In Figure 2 there is a difference between the hours that have been paid and the hours that were worked. We are told that 150 hours were lost due to delivery problems. This means that although labour were paid for 8,250 hours they could not have worked for that many hours due to this loss of production time. The hours in which labour produced 4,150 units were 8,250 hours - 150 hours = 8,100 hours. It is this figure that will be used to see how efficient labour have been. However, we do need to consider this loss of production time.
In this example it was expected that labour were productive for all the time that they worked. As we have seen, 150 hours were lost due to delivery problems so the amount of time that labour was productive for was 8,100 hours (Figure 7). This variance will always be adverse as lost production time would not be acceptable in your exam questions.
Figure 7: Labour idle time variance
Hours
Did work for (ACTUAL) 8,100
Should have worked for 8,250
150 adverse
As the variance is stated in a non-monetary value, we need to convert it to a monetary value using the standard rate per hour of £8, see Figure 8.
Figure 8: Labour idle time variance continued
Variance = 150 hours adverse x £8/hour = £1,200 adverse
The final labour variance (Figure 9) deals with how efficiently labour have worked to produce the 4,150 units. We have already calculated it did take labour 8,100 hours to make this many units. Should it have taken the labour force that long to produce that many units?
Figure 9: Labour efficiency variance
Hours
Did take to produce 4,150 units (ACTUAL) 8,100
Should take to make 4,150 units (4,150 x 2 hours/unit) 8,300
200 favourable
Since labour took less time to make the 4,150 units than expected there is a favourable variance which needs to be converted into £ – see Figure 10.
Figure 10: Labour efficiency variance continued
Variance = 200 hours favourable x £8/hour = £1,600 favourable
Variable Production Overheads
We can now turn our attention to the variable production overhead variances. If we look at the standard cost per unit for this cost type we will see that it is made up of an hourly and a monetary figure. As usual with the monetary value we can look at how much was actually paid out for variable production overheads (did do) compared to what we should have been paying.
The variable production overheads are based on the number of labour hours. Notice in the standard cost per unit, the number of labour hours used to absorb the variable overheads are exactly the same as the number of labour hours needed to make one unit, but should we consider the number of hours labour were paid for, or the hours that they actually worked for? Variable production overheads are generally only incurred when labour is working, therefore, when we are considering this variance we shall need to focus on the number of hours that were actually worked.
The first variance, as we saw with materials and labour, deals with the monetary value; how much did we actually spend on variable production overheads compared with what we should have spent given the number of hours that labour worked for (see Figure 11).
Figure 11: Variable production overhead expenditure variance
£
Did cost given worked 8,100 hours (ACTUAL) 8,225
Should have cost given that labour worked 8,100 hours 8,100
(8,100 hours x £1/hour) 125 adverse
Since the actual cost of the variable production overheads exceeds what was expected the variance is adverse.
Next, in Figure 12, we look at the non-monetary value, the labour hours worked. Again we will need to look at the labour hours that we did work to make 4,150 units compared to the hours
Figure 12: Variable production overhead efficiency variance
Variance = 200 hours favourable x £1/hour = £200 favourable
that it should have taken. This should sound familiar as this is exactly the same calculation that we carried out for the labour efficiency variance. This enables us to save some time as the non-monetary value for the variance has already been established as 200 hours favourable. However, when we translate this into a monetary value we must remember that we are now dealing with the variable production overheads and so use the rate of £1/hour.
Having now dealt with the material, labour and variable production overhead variances, we are left with the last cost item in the standard cost per unit, the fixed overheads.
Fixed Production Overhead Variances
The fixed production overhead variances are usually the first ones that students meet in absorption costing. The under or over absorption of fixed production overheads is a key entry in the absorption costing profit and loss account, and is essentially the overall difference between the amount we should have paid out, namely the amount in the original fixed budget, and the amount absorbed, actual production units x fixed overhead absorption rate per unit. When looking at the variances for the fixed production overheads it is this under or over absorption that will drive the solution.
First we will consider the total amount included in the standard cost per unit (See Figure 13). In this example we are told that the amount for fixed production overheads per unit is £5. When this figure was originally calculated, the amount of budgeted fixed overheads would have absorbed over the number of budgeted units or budgeted labour hours.
Figure 13:
Fixed overhead absorption rate =
budgeted fixed production overheads
budgeted production units or labour hours
When considering the variances initially we always look at the numerator and the denominator (i.e. the top and bottom part of the equation). We need to establish whether we were correct in our estimate of the top part of the equation, namely did we get the budgeted overheads correct, and did we correctly estimate the bottom half of the equation, the production units. This then encourages us to look at the monetary value, what we did spend to what we should have spent, and to consider the non-monetary value being the production units.
Using our information we can now calculate these two variances, the expenditure variance comparing the cash and the volume variance comparing the units (Figure 14).
Figure 14: Fixed production overhead variances
Expenditure variance
£
Did spend (ACTUAL) 19,000
Should have spent (original budget) 20,000
1,000 favourable
Volume variance
Units
Did produce (ACTUAL) 4,150
Should have produced (original budget) 4,000
150 favourable
The expenditure variance has worked out to be £1,000 favourable as we have spent less than the original budget. The volume variance gives another favourable variance, this time of 150 units, as we produced more than originally expected. However, we will have to change this volume variance into a monetary figure. As before, we can look to the standard cost per unit which tells us that for every unit produced there are fixed production overheads absorbed of £5 per unit. It is this figure which is used to translate this variance into a monetary value (Figure 15).
Figure 15: Fixed production overhead volume variance continued
Variance = 150 units favourable x £5/unit = £750 favourable
If we look again at the standard cost card, we will notice that the fixed production overhead absorption rate is broken further into an hourly rate of £2.50/labour hour. We can now use this rate to calculate two more variances regarding fixed production overheads.
For any overhead that uses labour hours there will always be an efficiency variance. There was one included in the labour variances and, since variable production overheads were absorbed on a labour hour basis, there was an efficiency variance for this cost also. Fixed production overheads merely follow this trend so there is an efficiency variance, the non-monetary variance being calculated in exactly the same way as for the labour and variable production overheads (see Figure 16).
Figure 16: Fixed production overhead efficiency variance
Variance = 200 hours favourable x £2.50/labour hour = £500 favourable
When this efficiency variance is calculated we consider the actual hours worked to the standard hour for the level of production achieved. The last variance for the fixed overheads again considers hours but looks at the hours that were worked and compares them to the original budget. The amount of hours that should have been worked are not flexed for the actual level of production but are compared directly with the original budget (see Figure 17).
Figure 17: Fixed production overhead capacity variance
Hours
Did work (ACTUAL) 8,100
Should have worked (original budget) 8,000
100
Whether this is an adverse or favourable variance often leads to confusion since some students do not understand what the capacity variance is trying to show us. The original budget tells us the number of labour hours that the production workforce is expected to achieve. It is, if you like, a benchmark figure giving the number of hours the company believes it possible to work. If the actual number of hours worked exceeds the amount you thought possible would this be a good thing or a bad thing? Since the workforce would have exceeded what is expected of them this would be seen in a favourable light.
So, if the actual labour hours worked exceed the original budgeted labour hours, the benchmark, then this is a favourable variance. Thus the variance in Figure 18 is favourable and can be translated into a monetary value using the rate of £2.50/hour from the cost card.
Figure 18: Fixed production overhead capacity variance continued
Variance = 100 hours favourable x £2.50/hour = £250 favourable
If you add up the fixed production overhead efficiency and capacity variances they equal the fixed production overhead volume variance – see Figure 19.
Figure 19: Fixed production overhead variances
£
Efficiency variance 500 favourable
Capacity variance 250 favourable
Volume variance 750 favourable
Having considered all of the cost items we should now consider the revenue.
Sales Variances
The sales revenue figure that will be included in the profit and loss account would have been calculated by multiplying the total units sold by the price per unit. When looking at the sales variances we once again consider two aspects; was the selling price as per the original budget (the price variance) and were the number of units sold as budgeted (the volume variance). The first of these variances being in monetary terms and the second being in units.
The sales price variance, as you would expect, looks at the price that we did get, the actual revenue received from the sale of the units, and the price we should have got if the standard price per unit had been obtained. (See Figure 20).
Figure 20: Sales price variance
£
Did get for the sales of 4,150 units (ACTUAL) 205,425
Should have got given sold (4,150 units 4,150 x£50/unit) 207,500
2,075 adverse
The variance is clearly adverse since we did not receive the amount of money that we had expected from the sales. The price achieved was lower than the expected £50 per unit.
The last variance that we shall look at as previously mentioned focuses on the number of units sold – see Figure 21.
Figure 21: Sales volume variance
Units
Did sell (ACTUAL) 4,150
Should have sold (original budget) 4,000
150 favourable
As the number of sales exceeded the level included in the original budget, this is a favourable variance. All that needs to be done is to turn it into a monetary value.
A common error when calculating this variance is to use the standard selling price to establish the monetary value. Although this is partly correct there is more to the calculation of this variance figure.
The sales volume variance enables the difference between the original and the flexed budget profit budgeted. Since stocks are always valued at standard, any difference between the number of units sold and the level of production will be taken care of in the closing stock valuation, (if there is one). Thus the only real difference is the change in the level of sales units. Since we are trying to reconcile one profit to another and the standard costs and revenues do not change, this difference between the original budget profit and flexed budget profit is the change in sales volume valued at the standard profit per unit. Therefore the sales volume variance can be turned into a monetary figure using the standard profit of £12 per unit as in Figure 22.
Figure 22: Sales volume variance continued
Variance = 150 units favourable x £12/unit = £1,800 favourable
Operating Statement Under Absorption Costing
Having calculated all of the variances it will now be possible to reconcile between the original budget profit and the actual profit achieved (see Figure 23).
Figure 23: Operating statement
£
Original budget profit (£12/unit x 4,000 units) 48,000
Sales volume variance 1,800 Favourable
Flexed budget profit 49,800
Sales price variance (2,075) Adverse
Favourable Adverse
Cost variances
Material price 2,400
Material usage 1,500
Labour rate 2,500
Labour idle time 1,200
Labour efficiency 1,600
Variable production overhead expenditure 125
Variable production overhead efficiency 200
Fixed production overhead expenditure 1,000
Fixed production overhead efficiency 500
Fixed production overhead capacity 250 ______
5,950 5,325 625 Favourable
Actual profit (see below) 48,350
Actual profit calculation
£ £
Sales 205,425
Cost of sales
Material 61,350
Labour 68,500
Variable production overheads 8,225
Fixed production overheads 19,000 ________
157,075
48,350
As already discussed, the sale volume variance reconciles between the original budget and the flexed budget. The remaining variances reconcile the difference between the flexed budget profit and the actual results.
Variance Analysis Using Marginal Costing
So how would the above analysis change if marginal costing were being used? If we focus on the standard information per unit this will give us an indication as to which variances remain unchanged and which ones need to be recalculated – see Figure 24.
Figure 24: Example: Marginal costing
Information regarding the standard cost, revenue and contribution per unit:
£
Direct materials (5kg at £3/kg) 15
Direct labour (2 hours at £8/hour) 16
Variable production overheads (2 hours at £1/hour) 2
33
Contribution 17
Selling price 50
Budgeted sales and production for the period were 4,000 units.
As we can see, the figures for the direct material, direct labour and variable production overhead figures do not change. The selling price per unit has also stayed the same.
However, there are now no fixed production overheads included in the standard cost per unit and there is no longer profit but contribution. Therefore, the variances that were calculated under absorption costing for direct material, direct labour and variable production overheads will remain the same. The fixed production overhead variance analysis would change, as would the analysis for the sales variances.
If we now look at the fixed production overheads we can see that this cost is not absorbed over the number of units so there is no volume variance. Thus the fixed production overhead variance is reduced to the expenditure variance only. (Figure 25).
Figure 25: Fixed production overhead expenditure variances
£
Did spend (ACTUAL) 19,000
Should have spent (original budget) 20,000
1,000 favourable
As far as the sales variances are concerned, the price variance will not change as the budgeted selling price under either method is the same. If we consider the sales volume variance though, there is a change that needs to be considered. When calculating the sales volume variance under absorption costing we used the difference between actual and budget units of sale multiplied by the profit per unit. Under marginal costing, we focus on contribution rather than profit so we need to amend this calculation. Thus when turning the sales volume variance into a monetary value we now use the budgeted contribution of £17 per unit as in Figure 26.
Figure 26: Sales volume variance under marginal costing
Variance = 150 units favourable x £17/unit - £2,550 favourable
The operating statement would also be slightly different –see Figure 27.
Figure 27: Operating statement under marginal costing
£
Original budget contribution (£17/unit x 4,000 units) 68,000
Sales volume variance 2,500 Favourable
Flexed budget contribution 70,550
Sales price variance (2,075) Adverse
Favourable Adverse
Cost variance
Material price 2,400
Material usage 1,500
Labour rate 2,500
Labour idle time 1,200
Labour efficiency 1,600
Variable production overhead expenditure 125
Variable production overhead efficiency 200 ______
4,200 5,325
(1,125) Adverse
Actual contribution 67,350
Fixed production overheads
Original budget 20,000
Expenditure variance 1,000 Favourable
Actual expenditure (19,000)
Actual profit (as before) 48,350
Conclusion
Variance analysis may seem daunting but if the standard cost and revenue per unit is used to drive the solution then all that needs to be remembered is ‘‘should do, did do’’. The rest is just number crunching and a little bit of common sense!
Angela Newman is Examiner for Paper 1.2
When considering variance analysis questions, students often try to tackle the problem using lots of formulae. Of course if you know the right formula, the answer is easy, but remembering such things in an exam situation can often be very difficult. If the reasons for variance analysis are understood then the calculation of the figures becomes relatively straightforward.
When we look at variances, we are trying to establish the difference between what has actually happened (what we did achieve) and what we thought should have happened, namely the original budget (what we should have achieved).
In the original budget, information regarding the standard cost per unit, the standard selling price and a budgeted level of production and sales would have been established. The standard cost would be based on expected levels of price, usage, hourly rates of pay and efficiency. It is how much we think a unit should cost, a budgeted cost figure per production unit. At the end of the accounting period this information is then compared to the actual results to see where there have been deviations from this original plan – that is to say where there are variances. If you look at the standard cost per unit of an item, the information can drive you towards the successful completion of any variance analysis question. See Figure 1.
Figure 1: Example Using absorption costing
Information regarding the standard cost, revenue and profit per unit:
£
Direct materials (5kg at £3/kg) 15
Direct labour (2 hours at £8/per hour) 16
Variable production overheads (2 hours at £1/hour) 2
Fixed production overheads (2 hours at £2.50/hour) 5
38
Profit 12
Selling price 50
Budgeted sales and production for the period were 4,000 units.
When considering materials, if we look at the end of the period to see what has actually happened, one question that could be asked is ‘‘The standard material cost per unit should have been £15, was this the case?’’ However, we should also consider the individual components of the total material cost per unit: we should have spent £3/kg on materials and we should have used 5kg per unit, did this happen?
Similarly for labour, an overall variance can be obtained by looking at whether we did pay out £16 per unit of production, but once again we can look further at the individual components making up that £16. Labour should have taken 2 hours per unit and labour should have cost the company £8 per hour, is this what happened?
The standard cost per unit is driving us to look for certain pieces of information: how much did we actually pay out on materials, did we really use 5kg per unit and so on. Let us now consider some actual data, Figure 2, so that we can carry out some variance analysis.
Figure 2: Actual data for the period under review
Production and sales units: 4,150 units
Materials: purchased and used 21,250kg costing a total of £61,350
Labour: paid for 8,250 hours costing a total of
150 labour hours were lost due to delivery problems £68,500
Variable overheads: £8,225
Fixed overheads: £19,000
Sales revenue: £205,425
Material Variances
To calculate the material variances we have already established that we would want to know if the price per kg was £3 (the price variance) and whether 5kg was used per unit (the usage variance).
All that is required now is the comparison of what we did actually pay or use compared to what we should have paid or used using the standard cost per unit (Figure 3).
Figure 3: Material price variance
£
Did pay for 21,250kg (ACTUAL) 61,350
Should have paid for 21,250 kg (21,250kg x £3/kg) 63,750
2,400 favourable
Notice that when the price variance is calculated we focus on the amount of material that has actually been purchased. It is easy to establish how much we did pay as this comes straight from the actual information given. When we calculate the amount we should have paid, we need to ensure that we are comparing like with like. That is why we continue to use the amount of material actually purchased rather than using a flexed figure based on actual levels of production. We need to focus on the material price so everything else must remain static.
In Figure 3 we can clearly see that we actually paid out less than expected giving rise to a favourable variance. Our material has cost us less than we thought.
We can approach the calculation of the usage variance in much the same way: what we did do (the actual amount of material used), compared to what we should have done (using the standard cost per unit), see Figure 4.
Figure 4: Material usage variance
kg
Did use to make 4,150 units (ACTUAL) 21,250
Should use to make 4,150 units (4,150 x 5kg/unit) 20,750
500 adverse
Once again it is important to note that we are looking at how much material it took us to make 4,150 units. This remains static in the calculations to enable us to make a true comparison between what we did do and what we should have done.
In this case we have used more material than expected so we have an adverse variance. However, the variance as it stands at the moment is in terms of kg. Since the reconciliation between budget and actual profit will be on a monetary basis this kg value must be turned into a £ value. To do this we turn again to the standard cost per unit. Having dealt with any difference in the price per kg in the price variance, we can use the standard cost per kg to translate this kg value into a monetary one (see Figure 5).
Figure 5: Material usage variance continued
Variance = 500kg adverse x £3/kg = £1,500 adverse
The approach of ‘‘should do, did do’’, can be applied to all of the variance calculations that are required at this level.
Labour variances
Now let us consider the labour variance. The standard cost per unit is made up of the standard hourly rate of £8/hour and a standard production time of 2 hours. Thus we will need to consider whether labour were actually paid £8/hour (the rate variance) and did labour take 2 hours per unit (the efficiency variance).
In Figure 6, labour were paid more than expected and so this will lead to an adverse variance.
Figure 6: Labour rate variance
£
Did pay labour for 8,250 hours (ACTUAL) 68,500
Should have paid labour for 8,250 hours (8,250 x £8) 66,000
2,500 adverse
Having focused on the monetary value we can now turn our attention to the non-monetary value, the labour hours. In Figure 2 there is a difference between the hours that have been paid and the hours that were worked. We are told that 150 hours were lost due to delivery problems. This means that although labour were paid for 8,250 hours they could not have worked for that many hours due to this loss of production time. The hours in which labour produced 4,150 units were 8,250 hours - 150 hours = 8,100 hours. It is this figure that will be used to see how efficient labour have been. However, we do need to consider this loss of production time.
In this example it was expected that labour were productive for all the time that they worked. As we have seen, 150 hours were lost due to delivery problems so the amount of time that labour was productive for was 8,100 hours (Figure 7). This variance will always be adverse as lost production time would not be acceptable in your exam questions.
Figure 7: Labour idle time variance
Hours
Did work for (ACTUAL) 8,100
Should have worked for 8,250
150 adverse
As the variance is stated in a non-monetary value, we need to convert it to a monetary value using the standard rate per hour of £8, see Figure 8.
Figure 8: Labour idle time variance continued
Variance = 150 hours adverse x £8/hour = £1,200 adverse
The final labour variance (Figure 9) deals with how efficiently labour have worked to produce the 4,150 units. We have already calculated it did take labour 8,100 hours to make this many units. Should it have taken the labour force that long to produce that many units?
Figure 9: Labour efficiency variance
Hours
Did take to produce 4,150 units (ACTUAL) 8,100
Should take to make 4,150 units (4,150 x 2 hours/unit) 8,300
200 favourable
Since labour took less time to make the 4,150 units than expected there is a favourable variance which needs to be converted into £ – see Figure 10.
Figure 10: Labour efficiency variance continued
Variance = 200 hours favourable x £8/hour = £1,600 favourable
Variable Production Overheads
We can now turn our attention to the variable production overhead variances. If we look at the standard cost per unit for this cost type we will see that it is made up of an hourly and a monetary figure. As usual with the monetary value we can look at how much was actually paid out for variable production overheads (did do) compared to what we should have been paying.
The variable production overheads are based on the number of labour hours. Notice in the standard cost per unit, the number of labour hours used to absorb the variable overheads are exactly the same as the number of labour hours needed to make one unit, but should we consider the number of hours labour were paid for, or the hours that they actually worked for? Variable production overheads are generally only incurred when labour is working, therefore, when we are considering this variance we shall need to focus on the number of hours that were actually worked.
The first variance, as we saw with materials and labour, deals with the monetary value; how much did we actually spend on variable production overheads compared with what we should have spent given the number of hours that labour worked for (see Figure 11).
Figure 11: Variable production overhead expenditure variance
£
Did cost given worked 8,100 hours (ACTUAL) 8,225
Should have cost given that labour worked 8,100 hours 8,100
(8,100 hours x £1/hour) 125 adverse
Since the actual cost of the variable production overheads exceeds what was expected the variance is adverse.
Next, in Figure 12, we look at the non-monetary value, the labour hours worked. Again we will need to look at the labour hours that we did work to make 4,150 units compared to the hours
Figure 12: Variable production overhead efficiency variance
Variance = 200 hours favourable x £1/hour = £200 favourable
that it should have taken. This should sound familiar as this is exactly the same calculation that we carried out for the labour efficiency variance. This enables us to save some time as the non-monetary value for the variance has already been established as 200 hours favourable. However, when we translate this into a monetary value we must remember that we are now dealing with the variable production overheads and so use the rate of £1/hour.
Having now dealt with the material, labour and variable production overhead variances, we are left with the last cost item in the standard cost per unit, the fixed overheads.
Fixed Production Overhead Variances
The fixed production overhead variances are usually the first ones that students meet in absorption costing. The under or over absorption of fixed production overheads is a key entry in the absorption costing profit and loss account, and is essentially the overall difference between the amount we should have paid out, namely the amount in the original fixed budget, and the amount absorbed, actual production units x fixed overhead absorption rate per unit. When looking at the variances for the fixed production overheads it is this under or over absorption that will drive the solution.
First we will consider the total amount included in the standard cost per unit (See Figure 13). In this example we are told that the amount for fixed production overheads per unit is £5. When this figure was originally calculated, the amount of budgeted fixed overheads would have absorbed over the number of budgeted units or budgeted labour hours.
Figure 13:
Fixed overhead absorption rate =
budgeted fixed production overheads
budgeted production units or labour hours
When considering the variances initially we always look at the numerator and the denominator (i.e. the top and bottom part of the equation). We need to establish whether we were correct in our estimate of the top part of the equation, namely did we get the budgeted overheads correct, and did we correctly estimate the bottom half of the equation, the production units. This then encourages us to look at the monetary value, what we did spend to what we should have spent, and to consider the non-monetary value being the production units.
Using our information we can now calculate these two variances, the expenditure variance comparing the cash and the volume variance comparing the units (Figure 14).
Figure 14: Fixed production overhead variances
Expenditure variance
£
Did spend (ACTUAL) 19,000
Should have spent (original budget) 20,000
1,000 favourable
Volume variance
Units
Did produce (ACTUAL) 4,150
Should have produced (original budget) 4,000
150 favourable
The expenditure variance has worked out to be £1,000 favourable as we have spent less than the original budget. The volume variance gives another favourable variance, this time of 150 units, as we produced more than originally expected. However, we will have to change this volume variance into a monetary figure. As before, we can look to the standard cost per unit which tells us that for every unit produced there are fixed production overheads absorbed of £5 per unit. It is this figure which is used to translate this variance into a monetary value (Figure 15).
Figure 15: Fixed production overhead volume variance continued
Variance = 150 units favourable x £5/unit = £750 favourable
If we look again at the standard cost card, we will notice that the fixed production overhead absorption rate is broken further into an hourly rate of £2.50/labour hour. We can now use this rate to calculate two more variances regarding fixed production overheads.
For any overhead that uses labour hours there will always be an efficiency variance. There was one included in the labour variances and, since variable production overheads were absorbed on a labour hour basis, there was an efficiency variance for this cost also. Fixed production overheads merely follow this trend so there is an efficiency variance, the non-monetary variance being calculated in exactly the same way as for the labour and variable production overheads (see Figure 16).
Figure 16: Fixed production overhead efficiency variance
Variance = 200 hours favourable x £2.50/labour hour = £500 favourable
When this efficiency variance is calculated we consider the actual hours worked to the standard hour for the level of production achieved. The last variance for the fixed overheads again considers hours but looks at the hours that were worked and compares them to the original budget. The amount of hours that should have been worked are not flexed for the actual level of production but are compared directly with the original budget (see Figure 17).
Figure 17: Fixed production overhead capacity variance
Hours
Did work (ACTUAL) 8,100
Should have worked (original budget) 8,000
100
Whether this is an adverse or favourable variance often leads to confusion since some students do not understand what the capacity variance is trying to show us. The original budget tells us the number of labour hours that the production workforce is expected to achieve. It is, if you like, a benchmark figure giving the number of hours the company believes it possible to work. If the actual number of hours worked exceeds the amount you thought possible would this be a good thing or a bad thing? Since the workforce would have exceeded what is expected of them this would be seen in a favourable light.
So, if the actual labour hours worked exceed the original budgeted labour hours, the benchmark, then this is a favourable variance. Thus the variance in Figure 18 is favourable and can be translated into a monetary value using the rate of £2.50/hour from the cost card.
Figure 18: Fixed production overhead capacity variance continued
Variance = 100 hours favourable x £2.50/hour = £250 favourable
If you add up the fixed production overhead efficiency and capacity variances they equal the fixed production overhead volume variance – see Figure 19.
Figure 19: Fixed production overhead variances
£
Efficiency variance 500 favourable
Capacity variance 250 favourable
Volume variance 750 favourable
Having considered all of the cost items we should now consider the revenue.
Sales Variances
The sales revenue figure that will be included in the profit and loss account would have been calculated by multiplying the total units sold by the price per unit. When looking at the sales variances we once again consider two aspects; was the selling price as per the original budget (the price variance) and were the number of units sold as budgeted (the volume variance). The first of these variances being in monetary terms and the second being in units.
The sales price variance, as you would expect, looks at the price that we did get, the actual revenue received from the sale of the units, and the price we should have got if the standard price per unit had been obtained. (See Figure 20).
Figure 20: Sales price variance
£
Did get for the sales of 4,150 units (ACTUAL) 205,425
Should have got given sold (4,150 units 4,150 x£50/unit) 207,500
2,075 adverse
The variance is clearly adverse since we did not receive the amount of money that we had expected from the sales. The price achieved was lower than the expected £50 per unit.
The last variance that we shall look at as previously mentioned focuses on the number of units sold – see Figure 21.
Figure 21: Sales volume variance
Units
Did sell (ACTUAL) 4,150
Should have sold (original budget) 4,000
150 favourable
As the number of sales exceeded the level included in the original budget, this is a favourable variance. All that needs to be done is to turn it into a monetary value.
A common error when calculating this variance is to use the standard selling price to establish the monetary value. Although this is partly correct there is more to the calculation of this variance figure.
The sales volume variance enables the difference between the original and the flexed budget profit budgeted. Since stocks are always valued at standard, any difference between the number of units sold and the level of production will be taken care of in the closing stock valuation, (if there is one). Thus the only real difference is the change in the level of sales units. Since we are trying to reconcile one profit to another and the standard costs and revenues do not change, this difference between the original budget profit and flexed budget profit is the change in sales volume valued at the standard profit per unit. Therefore the sales volume variance can be turned into a monetary figure using the standard profit of £12 per unit as in Figure 22.
Figure 22: Sales volume variance continued
Variance = 150 units favourable x £12/unit = £1,800 favourable
Operating Statement Under Absorption Costing
Having calculated all of the variances it will now be possible to reconcile between the original budget profit and the actual profit achieved (see Figure 23).
Figure 23: Operating statement
£
Original budget profit (£12/unit x 4,000 units) 48,000
Sales volume variance 1,800 Favourable
Flexed budget profit 49,800
Sales price variance (2,075) Adverse
Favourable Adverse
Cost variances
Material price 2,400
Material usage 1,500
Labour rate 2,500
Labour idle time 1,200
Labour efficiency 1,600
Variable production overhead expenditure 125
Variable production overhead efficiency 200
Fixed production overhead expenditure 1,000
Fixed production overhead efficiency 500
Fixed production overhead capacity 250 ______
5,950 5,325 625 Favourable
Actual profit (see below) 48,350
Actual profit calculation
£ £
Sales 205,425
Cost of sales
Material 61,350
Labour 68,500
Variable production overheads 8,225
Fixed production overheads 19,000 ________
157,075
48,350
As already discussed, the sale volume variance reconciles between the original budget and the flexed budget. The remaining variances reconcile the difference between the flexed budget profit and the actual results.
Variance Analysis Using Marginal Costing
So how would the above analysis change if marginal costing were being used? If we focus on the standard information per unit this will give us an indication as to which variances remain unchanged and which ones need to be recalculated – see Figure 24.
Figure 24: Example: Marginal costing
Information regarding the standard cost, revenue and contribution per unit:
£
Direct materials (5kg at £3/kg) 15
Direct labour (2 hours at £8/hour) 16
Variable production overheads (2 hours at £1/hour) 2
33
Contribution 17
Selling price 50
Budgeted sales and production for the period were 4,000 units.
As we can see, the figures for the direct material, direct labour and variable production overhead figures do not change. The selling price per unit has also stayed the same.
However, there are now no fixed production overheads included in the standard cost per unit and there is no longer profit but contribution. Therefore, the variances that were calculated under absorption costing for direct material, direct labour and variable production overheads will remain the same. The fixed production overhead variance analysis would change, as would the analysis for the sales variances.
If we now look at the fixed production overheads we can see that this cost is not absorbed over the number of units so there is no volume variance. Thus the fixed production overhead variance is reduced to the expenditure variance only. (Figure 25).
Figure 25: Fixed production overhead expenditure variances
£
Did spend (ACTUAL) 19,000
Should have spent (original budget) 20,000
1,000 favourable
As far as the sales variances are concerned, the price variance will not change as the budgeted selling price under either method is the same. If we consider the sales volume variance though, there is a change that needs to be considered. When calculating the sales volume variance under absorption costing we used the difference between actual and budget units of sale multiplied by the profit per unit. Under marginal costing, we focus on contribution rather than profit so we need to amend this calculation. Thus when turning the sales volume variance into a monetary value we now use the budgeted contribution of £17 per unit as in Figure 26.
Figure 26: Sales volume variance under marginal costing
Variance = 150 units favourable x £17/unit - £2,550 favourable
The operating statement would also be slightly different –see Figure 27.
Figure 27: Operating statement under marginal costing
£
Original budget contribution (£17/unit x 4,000 units) 68,000
Sales volume variance 2,500 Favourable
Flexed budget contribution 70,550
Sales price variance (2,075) Adverse
Favourable Adverse
Cost variance
Material price 2,400
Material usage 1,500
Labour rate 2,500
Labour idle time 1,200
Labour efficiency 1,600
Variable production overhead expenditure 125
Variable production overhead efficiency 200 ______
4,200 5,325
(1,125) Adverse
Actual contribution 67,350
Fixed production overheads
Original budget 20,000
Expenditure variance 1,000 Favourable
Actual expenditure (19,000)
Actual profit (as before) 48,350
Conclusion
Variance analysis may seem daunting but if the standard cost and revenue per unit is used to drive the solution then all that needs to be remembered is ‘‘should do, did do’’. The rest is just number crunching and a little bit of common sense!
Angela Newman is Examiner for Paper 1.2
