Lecture 05

Paper C01 Fundamentals of management accounting

Standard Costing and Variance Analysis
Prepared by Ian Fenech as extracted from CIMA book 1

Objective of this lecture

Today, we will be looking at standard costs: how they are set; and how they are used as the basis of variance analysis to monitor and control an organisations performance.
Prepared by Ian Fenech as extracted from CIMA book 2

Definition of Standard Costing

The CIMA Terminology defines standard costing as a control technique that reports variances by comparing actual costs to pre-set standards facilitating action through management by exception.
Prepared by Ian Fenech as extracted from CIMA book 3

Introduction
1.

2. 3. 4. 5.

6.

Requires planning in advance amount and price of resources as well as selling prices and sales volumes; Provide a basis for planning; A target for achievement; A benchmark to compare with; Actual costs and revenues recorded after the event are then compared with the pre-set standards and the differences are recorded as variances; Management by exception.
Prepared by Ian Fenech as extracted from CIMA book

Introduction
1.

2.

3.

4.

If resource price or usage is above standard, adverse variance; If sales volume of selling price is below standard, adverse variance; If resource price or usage is below standard, favourable variance; If sales volume of selling price is above standard, favourable variance.
Prepared by Ian Fenech as extracted from CIMA book 5

What is standard cost?

1.

2.

A standard cost is a carefully predetermined unit cost which is prepared for each cost unit and contains details of the standard amount and price of each resource that will be utilised in providing the service or manufacturing the product; Therefore we must be able to identify a measurable cost unit, and so must be capable of standardising (difficult with some services).
Prepared by Ian Fenech as extracted from CIMA book 6

What is standard cost?

Standard cost card: product 176 EUR per unit Direct materials: 30kg @ EUR4.30 Direct wages: 12 hours @ EUR11.80 Prime cost Variable production overhead: 12 hours @ EUR0.75 Variable production cost 129.00 141.60 270.60 9.00 279.60

1. Standard amounts and costs are used for each resource; 2. Actual amounts and costs need to be collected for comparison purposes; 3. Try out Exercise 5.1 on page 121
Prepared by Ian Fenech as extracted from CIMA book

What is standard cost? - example

Prepared by Ian Fenech as extracted from CIMA book

What is standard cost? - example

Prepared by Ian Fenech as extracted from CIMA book

Performance levels A standard

1.

2.

The CIMA Terminology defines a standard as a benchmark measurement of resource usage or revenue or profit generation, set in defined conditions; The basis which can be used to set the standard could be based on:
A prior level of performance by the same organisation (if found to be acceptable); The level of performance achieved by comparable organisations (the best of the rest); The level of performance required to meet organisational objectives (sufficient for objective).
Prepared by Ian Fenech as extracted from CIMA book

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A standard could be based on:

1.

2.

3.

Ideal standard no allowance for inefficiencies - will result in adverse variances de-motivating; Attainable standard include allowances for losses, waste, downtime, etc any adverse variances are over and above expected inefficiencies - not de-motivating; Current standard set on current performance levels do not encourage improvement.
Prepared by Ian Fenech as extracted from CIMA book 11

Setting standard costs

List down the sources of information which may be used to determine: 1. Standard material price; 2. Standard material usage; 3. Standard labour rate; 4. Standard labour time; 5. Variable production overhead costs.

Prepared by Ian Fenech as extracted from CIMA book

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Updating standards
1.

2.

Standard costs should be kept as up-todate as possible so that they are meaningful, valid and relevant; Standards are not updated for every small change that occurs but any significant changes should be adjusted as soon as possible.

Prepared by Ian Fenech as extracted from CIMA book

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Standard costing in the modern business environment

1.

Main criticisms of standard costing are:

The business environment is less stable today than it was when standard costing was developed. This instability makes the use of standard cost for control purposes difficult; Performance to standard used to be judged as satisfactory, leaving little space for improvement; Labour variances are no longer appropriate due to automated production methods;

2.

3.

An organisations decision to use standard costing depends on its effectiveness in helping managers to made the correct decisions; Although the business environment is less stable, there will always be standard components, activities, etc.
Prepared by Ian Fenech as extracted from CIMA book 14

What is variance analysis?

1.

2.

3.

4.

A variance is the difference between the expected standard cost and the actual cost incurred; A unit standard cost contains details concerning both usage of resources and the price paid for them; Variance analysis involves breaking down the total variance to explain how much of it is caused by usage (being difference from standard) and how much of it is caused by price (being difference from standard); Variance can be combined to reconcile the total cost difference.
Prepared by Ian Fenech as extracted from CIMA book 15

Variable cost variances

1.

Direct material cost variances (always indicate whether a variance is adverse or favourable):
Direct material total variance (standard cost less actual cost); Direct material price variance (actual kgs at standard price less actual cost); Direct material usage variance (actual units at standard kgs less actual kgs, all multiplied by the standard cost).

2. 3.

Total variance = price variance + usage variance; See example on page 125
Prepared by Ian Fenech as extracted from CIMA book 16

Variable cost variances - Example

Prepared by Ian Fenech as extracted from CIMA book

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The direct material price variance and inventory valuation

1.

2.

3.

4.

If there are inventories, the direct material price variance could be based either on the material purchased or on the material used; The method to use depends on the inventory valuation method; If inventory is valued at standard cost, use material purchased; If inventory is valued at actual cost, then use material used.
Prepared by Ian Fenech as extracted from CIMA book 18

Direct labour cost variances

1.

Direct labour cost variances (always indicate whether a variance is adverse or favourable):
Direct labour total variance (standard cost less actual cost); Direct labour rate variance (actual hours at standard cost less actual cost); Direct material usage variance (actual units at standard hours less actual hours all multiplied by the standard cost).

2. 3.

Total variance = price variance + usage variance; See example on page 127
Prepared by Ian Fenech as extracted from CIMA book 19

Variable overhead cost variances

1.

2. 3.

Variable overhead cost variances (always indicate whether a variance is adverse or favourable): Variable overhead total variance (standard cost less actual cost); Variable overhead expenditure variance (actual hours at standard cost less actual cost); Variable overhead efficiency variance (actual units at standard hours less actual hours all multiplied by the standard cost). Total variance = price variance + usage variance; See example on page 127
Prepared by Ian Fenech as extracted from CIMA book

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Sales variances
1.

Sales price variance;

The difference in total revenue caused by charging a different selling price from standard (actual sales units x standard selling price less actual sales units x actual selling price);

2.

Sales volume contribution variance;

The contribution difference which is caused by selling a different quantity from that budgeted (actual sales volume budgeted sales volume x standard contribution per unit).

3.

See example on page 129.

Prepared by Ian Fenech as extracted from CIMA book 21

Sales variances - Example

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Summary

Prepared by Ian Fenech as extracted from CIMA book

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Task
1.

Attempt some of the multiple choice questions to test the knowledge you gained so far and to practice for assessment purposes.

END
Prepared by Ian Fenech as extracted from CIMA book 24