Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Financial Management
Topic 8:
Standard Costing and Variance Analysis (2)

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Standard Costing and Variance Analysis (2) Topic 8 - 8.2

Scope and Coverage

This topic will cover:
Calculation and interpretation of variable overhead
variances.
Calculation
C l l ti and
d iinterpretation
t
t ti off fifixed
d overhead
h d
variances.
Investigation of variances.
Practical application of variance analysis.

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Standard Costing and Variance Analysis (2) Topic 8 - 8.3

Learning Outcomes for Topic 8

By the end of this topic students will be able to:

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Calculate variable and fixed overhead variances.

Interpret variable and fixed overhead variances.
Explain the investigation of variances.
Discuss the practical application of variances.

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Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Standard Costing and Variance Analysis (2) Topic 8 - 8.4

Overheads
Costs that cannot be identified directly with products
or services.
Split into:
Variable
V i bl overheads
h d
- vary in direct proportion to the volume of activity
- recovered by number of labour or machine hours

Fixed overheads
- remain constant over range of activity levels

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Standard Costing and Variance Analysis (2) Topic 8 - 8.5

Overhead Variances
Overhead Variances

Variable

Rate

Fixed Overhead
Expenditure

Efficiency

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Standard Costing and Variance Analysis (2) Topic 8 - 8.6

Total Variable Overhead Variance

Total Variable Overhead Variance SC - AC
Abbreviations:
- Standard cost = SC
- Actual cost = AC

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Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Standard Costing and Variance Analysis (2) Topic 8 - 8.7

Variable Overhead Rate Variance

Variable Overhead Rate Variance (SR - AR) x AH
Abbreviations:
- Standard recovery rate per hour = SR
- Actual recovery rate per hour = AR
- Actual hours = AH

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Standard Costing and Variance Analysis (2) Topic 8 - 8.8

Variable Overhead Efficiency

Variance
Variable Overhead Efficiency Variance (SH - AH) x SR
Abbreviations:
- Standard hours for actual production = SH
- Actual hours = AH
- Standard recovery rate per hour = SR

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Standard Costing and Variance Analysis (2) Topic 8 - 8.9

Example: Variable Overhead

Variance - 1
Standard hours = 7
Standard rate = 3 per hr
Actual overheads = 22,000 Actual hours = 7,500
1,000 units produced.
Variable Overhead Efficiency Variance = (SHAH)xSR
= [(1000 units x 7hrs) 7500 hrs] x 3
= 1500 A

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Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Standard Costing and Variance Analysis (2) Topic 8 - 8.10

Example: Variable Overhead

Variance - 2
Variable Overhead Rate Variance = (SR AR) x AH
= [3 (22,000 7,500 hrs)] x 7500 hrs
= 500 F
Total Variable Overhead Variance = SC AC
= (1000 x 7hrs x 3) - 22,000 = 1,000 A

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Standard Costing and Variance Analysis (2) Topic 8 - 8.11

Interpretation of Variable Overhead

Variance
Favourable variable overhead rate variance
- an item of variable overhead cost less than expected
- e.g. due to different supplier, bulk discount

Adverse variable overhead efficiency variance

- more labour hours used to make the 1000 units produced
than was expected.
- same explanation as for adverse labour efficiency
variance.

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Standard Costing and Variance Analysis (2) Topic 8 - 8.12

Fixed Overhead Expenditure

Variance
Fixed Overhead Expenditure Variance BFO - AFO
Abbreviations:
- Budgeted fixed overhead = BFO
- Actual fixed overhead = AFO

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Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Standard Costing and Variance Analysis (2) Topic 8 - 8.13

Example: Fixed Overhead

Variance
Budgeted fixed overheads = 32,000
Actual fixed overheads = 37,000
Fixed Overhead Expenditure Variance = BFO AFO
= 32,000 - 37,000
= 5,000 A

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Standard Costing and Variance Analysis (2) Topic 8 - 8.14

Interpretation of Fixed Overhead

Variance
Fixed overhead expenditure variance of 5,000
adverse
Fixed overheads were greater than budgeted
(adverse variance)
Possible reason for adverse variance include an
increase in fixed overhead cost or an extra category
of fixed overhead which was not budgeted.
Remember that fixed overheads do not vary by
volume of output or activity levels.

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Standard Costing and Variance Analysis (2) Topic 8 - 8.15

Investigation of Variances
Once variances have been calculated:
Decide which variances should be investigated
all variances > 10% of total standard cost
all variances > 10,000
professional judgement or intuition

Need a balance between investigating everything

and nothing
costs time and money to investigate resources e.g. is it
worth investigating a variance of 5 pence?

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Topic 8 - Standard Costing and Variance Analysis (2)

Financial Management

Standard Costing and Variance Analysis (2) Topic 8 - 8.16

Practical Application of Variance

Analysis
How do you set realistic standards?
- e.g. how much should an item actually cost? Will this
stay valid over a period of time?

Who is responsible
p
for the variance?
- e.g. need to allocate responsibilities for costs

Who actually uses standard costing?

- most suitable to manufacturing companies who produce
large numbers of the same product
- difficult to apply to service industry

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Standard Costing and Variance Analysis (2) Topic 8 - 8.17

References
Drury, C. (2008) Management and Cost Accounting.
7th Edition. Cengage Learning.
McLaney, E. and Atrill, P. (2010) Accounting: An
Introduction. 5th Edition. FT Prentice Hall.
Weetman, P. (2011) Financial & Management
Accounting: An Introduction. 5th Edition. FT Prentice
Hall.

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Standard Costing and Variance Analysis (2) Topic 8 - 8.18

Topic 8 - Standard Costing and Variance

Analysis (2)
Any Questions?

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