Topic 11 Standard Costing & Variance Analysis

1. Topic 11 Standard Costing & Variance Analysis Activity 11.1 What does the word ‘standard’ mean to you and how what could it mean to a business? 1 A-level Accounting Year 13

2. This topic is about comparison. A department will be set a limit to what costs should be. If they spend more than this, is it good or bad for the business? Activity 11.2 A-level Accounting Year 13

3. Learning Outcomes At the end of this topic, you should be able to: • Define standard costing & variance analysis and explain how standard costs are set (Must) • Calculate all relevant variances/ sub-variances and identify their causes (Should) • Reconcile actual profit with budgeted profit (Could) A-level Accounting Year 13

4. What is Standard Costing? • Standard costs are the planned costs for individual products that should be achieved with efficient working conditions and manufacturing performance • Variance Analysis is the process of comparing standard costs with actual costs. The difference is called a variance A-level Accounting Year 13

5. How to calculate standard costs The financial directors of Legin Ltd has partially calculated the standard costs per unit of Keza as follows: How much material should they use? How many hours should it take? Activity 11.3 Calculate the standard cost per unit of Keza? A-level Accounting Year 13

6. Overview of a Standard Costing System A-level Accounting Year 13

7. When to Use Standard Costing? • Organisations whose operations are repetitive • Inputs to production can easily be measured • Manufacturing companies • Some service organisations E.g. banks • Non-repetitive organisations – standards cannot be measured A-level Accounting Year 13

8. Purpose of a Standard Costing System Assisting in budget setting and evaluating performance Acting as a control device – it highlights those activities that are not performing as expected and may need investigation and corrective action Provides information on future costs for future decision-making Provides motivation target for employees Provides acceptable cost for valuing inventory A-level Accounting Year 13

9. How are Standard Costs Set? • Each standard has two basis components: 1. A price 2. A level of usage • Can be established by using: 1. Past historical records, or 2. Engineering studies What do you think engineering studies involves? A-level Accounting Year 13

10. Activity 11.4 Can you identify some advantages and disadvantages of standard costing? 3 minutes End A-level Accounting Year 13

11. Advantages of Standard Costing • Predetermined standards make the preparations of forecasts and budgets easier • Costs and revenues are controlled through the use of variances – remedial action • Recording of inventory issues is simplified • Internal and external reports can be produced • Employees can be motivated to achieved targets A-level Accounting Year 13

12. Disadvantages of Standard Costing • Standards are useless if set either too high or too low (must be reviewed regularly) • Standards are best used for businesses that have a well-established and repetitive process so that resetting of standards is kept to a minimum • Collecting relevant information may be time consuming and costly A-level Accounting Year 13

13. Variable Production Costs - Variances • Direct material variances are subdivided into usage and price • Direct labour variances are subdivided into efficiency and rate • The method of calculation is the same for each of these cost types A-level Accounting Year 13

14. Sales - Variances • Two sub-variances are reported for sales: • sales volume variance • Sales price variance How would a sales variance be different to a cost variance? A-level Accounting Year 13

15. Variance Analysis • Comparison of actual costs with standard • Question: What did it cost versus what it should have cost? • Difference = variance A-level Accounting Year 13

16. Example 1 Legin Ltd produces a simple product, the Keza Activity 11.5 Can you explain the changes in cost between the standard and actual? Can you explain why these variances occur? A-level Accounting Year 13

17. Favourable vs adverse Can you explain the two scenarios? A-level Accounting Year 13

18. The Operating Statement • Variances are normally reported in the form of an operating statement • The operating statement starts with budgeted profit and then adds favourable and deducts adverse variances to arrive at actual profit • Sub-Variances are used to give maximum information A-level Accounting Year 13

19. Materials cost variance (total cost) Standard cost- actual cost = total cost variance A-level Accounting Year 13

20. Labour cost variance • Standard cost- actual cost = total cost variance A-level Accounting Year 13

21. Variances Formulae • Material Price A-level Accounting Year 13

22. Variances Formulae 2. Material Usage A-level Accounting Year 13

23. Variances Formulae 3. Labour Rate A-level Accounting Year 13

24. Variances Formulae 4. Labour Efficiency A-level Accounting Year 13

25. Variances Formulae 5. Sales Price A-level Accounting Year 13

26. Variances Formulae 6. Sales Volume A-level Accounting Year 13

27. Reasons For Variances • Variances must be investigated to establish underlying reasons and steps must be taken to deal with problems identified. • In analysing variances it is important to remember that • variances may be due to incorrect standards • there may be interdependence between variances. A-level Accounting Year 13

28. Activity 11.6 • Can you complete the hand out now and provide explanations for the cost and revenue variances. End A-level Accounting Year 13

29. Interrelationship between cost variances • Variances should not be viewed in isolation from each other • An adverse material price variance may be due to the fact that the material purchased was of a higher standard than normal • Leading to a favourable usage variance for that material because of the higher quality A-level Accounting Year 13

30. Cost reconciliation statement Why do we add adverse and less favourable? A-level Accounting Year 13

31. Profit reconciliation statement STD COST**Remember Revenue – direct costs- fixed costs= profit Sales price and volume can be replaced by difference in contribution from budgeted and actual A-level Accounting Year 13

32. How to flex a budget • Budgeted production levels are not always the same as the actual production levels • There is no point comparing costs at one level of production with costs of another level of production (Think like with like) • It is sometimes necessary to flex the budgeted figures Flexed budget amending standard costs for change in levels of production A-level Accounting Year 13

33. How to flex a budget A company has the following standard costs with expected productivity of 5,000 units: Direct Materials: 5kg at £30 per kg Direct Labour: 4 hours at £12 per hour The company actually produced 5,250 units. Activity 11.7 Flex the standard costs with actual production Why is it important to flex standard costs with actual production for a cost reconciliation? A-level Accounting Year 13

34. Activity 11.8 Question 2 of pack An example of this is in part c and d of this question. Can you complete this question now? A-level Accounting Year 13

35. Cost reconciliation when production levels are different • The reconciliation should reconcile the budgeted costs with the actual costs at the same level of production • Make sure in your statement that you change the budgeted costs for actual production levels A-level Accounting Year 13