Chapter

Standard costing and

1 variance analysis

Syllabus Content
B - Standard Costing – 25%

Manufacturing standards for material, labour, variable overhead and fixed overhead.
Fixed overhead expenditure and volume variances. (Note: the subdivision of fixed overhead
volume variance into capacity and efficiency elements will not be examined.)
Price/rate and usage/efficiency variances for materials, labour and variable overhead. Further
subdivision of total usage/efficiency variances into mix and yield components. (Note: The
calculation of mix variances on both individual and average valuation bases is required.)
Planning and operational variances.
Sales price and sales revenue/margin volume variances (calculation of the latter on a unit basis
related to revenue, gross margin and contribution margin). Application of these variances to all
sectors, including professional services and retail analysis.
Standards and variances in service industries, (including the phenomenon of "McDonaldization"),
public services (e.g. Health), (including the use of "diagnostic related" or "reference" groups), and
the professions (e.g. labour mix variances in audit work). Criticisms of standard costing in general
and in advanced manufacturing environments in particular.
Interpretation of variances: interrelationship, significance.
Benchmarking.

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1.1 Introduction to standard costing

A standard cost is a planned or forecast unit cost for a product or service, which is assumed
to hold good given expected efficiency and cost levels within an organisation. It represents a
target cost and is useful for planning, controlling and motivating within an organisation.

Variance analysis is a budgetary control process, which compares standard or budgeted costs
and revenues with the actual results of an organisation, in order to obtain information
regarding any exceptions from budget, this information is also used to improve performance
through control action e.g. correcting problems.

Standard costing can be used for

• Budget preparation e.g. planning

• Control through exception reporting e.g. performance measurement
• Stock valuation
• Cost bookkeeping.
• Motivating staff

Under a standard costing system an organisation can value stock at standard cost,
incorporating this within the ledger or cost accounts of the organisation, the budget or
forecasts being a memorandum kept outside the ledger accounts.

Types of standard

• Ideal Standard e.g. attained under the most favourable conditions with no allowance
for any waste, scrap, idle time or downtime
• Attainable or Expected Standard e.g. what should be achieved with a reasonable
level of effort given current efficiency and cost levels
• Loose Standard e.g. loosely set and easy to achieve
• Basic Standard e.g. first standard ever used by the organisation and used as a basis or
yardstick for comparing current standards or monitoring trends over time
• Historical Standards e.g. standards used historically in previous accounting periods

Critism of standard costing

Sometimes hard to define an ‘attainable standard’

Uncontrollability of performance within operations e.g. discounts lost due to the
reduction in the quantity ordered or seasonal price fluctuations within the period of
appraisal
With more automation within operations, they become less valuable as information
Feedback not feed forward control e.g. out of date information
Revisions to standards may be too frequent to guide performance over time
Standard costing is an internal not external control measure e.g. improvement also
needs to consider competition and customers
Performance measurement would be inadequate as a process if the standard is wrong
The reason or cause of the variance are sometimes overlooked or not investigated

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How to create a standard cost

Standard material price • Supplier quotations and estimates

• Previous invoices/trends
• Internet/websites of suppliers
• Discounts for bulk purchases
• Price seasonality
• Cost to manufacture internally
• Differences between the quality of
different material

Standard material usage • Time/motion studies

• Quality of material e.g. natural
wastage
• Specification of standard product
manufactured
• Operational wastage expected

Standard labour rate • Market rate for grade/type of labour

• Internal rates from HR department
• Bonus schemes/piece work rates in
current use

Standard labour efficiency • Idle time expected during operations

• Time/motion studies
• Skill/expertise of staff
• Learning curve
• Motivation of staff
• Remuneration systems in place

Standard overhead rate • Overhead absorption rates obtained

by dividing forecast overhead with an
expected level of activity
• Review overhead
• Understand fixed and variable
relationship with output, labour hours,
machine hours or % of cost

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1.2 Methods for planning and control

A fixed budget is a budget prepared on the basis of an single estimated production and sales
volume. It does not mean it is never revised or changed, just fixed at a certain level of
output sold and produced. This tends to be a form of budgeting for a service organisation
where a high proportion of total cost is fixed, and therefore does not vary significantly, with
the volume or activity of the service performed. Such a form of budgeting would be little use
for control purposes, when comparing to actual results, if significant variable cost exists. A
fixed budget provides details of costs, revenues or resource requirements for a single
level of activity.

Flexible budgets are prepared for many different sales and production quantities and can be
used to plan more effectively for an organisation e.g. useful at the planning stage for ‘what
if?’ analysis. Flexible budgeting recognises different cost behaviour patterns, that may rise or
fall with the volume of production or sales and is a better system for control purposes. A
flexible budgeting system based upon its budget set at the beginning of the period can be
flexed to correspond to the actual activity volume of results for a period. When a budget is
flexed it would give an appropriate level of revenue and costs as a yardstick to compare like
for like to actual results, at the same activity level, meaningful variances can then be reported
to the managers responsible for control purposes.

Flexible budgeting

1. Useful at the planning stage (what if analysis)

2. Can be ‘flexed’ retrospectively and compared to actual results for control purposes

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Example 1.1

Butliness is a business that offers packaged holiday deals in 3 locations in the UK and as part
of this service has a restaurant that serves many different meals and puddings through out the
day to guests staying over in chalets on the holiday park. One such serving counter has been
a major concern for the management, the ‘All week Sunday lunch’ counter, as it is expensive
to run.

The stand uses 2 staff on different shifts to cook and serve meals at the counter, the standard
cost and price of the ‘Hungry man roast of the day’ is as follows:

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
Fixed overhead 15 mins @ £20.00/hr 5.00
8.75
Standard profit 3.20
Selling price (included in packaged price) 11.95

The counter works on a 6-day shift (all week except Sunday) and the budget aims to sell 500
meals within week 43 the following actual information was obtained.

Meals actually sold were 476 the revenue earned £5,688.

Ingredients purchased
Chicken Vegetables
Purchased 180kg (£405) 250kg (£140)
Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (wages paid £1,200)
Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead £150

Fixed overhead £2,750

Produce the original budget, flexed budget based upon actual sales volume, and
compare this to actual results in order to calculate any variances?

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Answer to Example 1.1

Budgets prepared for an organisation using absorption costing principles

Original Flexed Actual Variances

Production and sales 500 476 476

Sales 5,975 5,688 5,688 -

Chicken 375 357 368 11(A)

Veg 125 119 125 6 (A)
Labour 1,125 1,071 1,200 129(A)
Variable overhead 250 238 150 88(F)
Fixed overhead 2,500 2,380 2,750 370(A)
4,375 4,165 4,593 428(A)
Profit 1,600 1,523 1,095 428(A)

Budgets prepared for an organisation using marginal costing principles

Original Flexed Actual Variances

Production and sales 500 476 476

Sales 5,975 5,688 5,688 -

Chicken 375 357 368 11(A)

Veg 125 119 125 6 (A)
Labour 1,125 1,071 1,200 129(A)
Variable overhead 250 238 150 88(F)
1,875 1,785 1,843 58(A)
Contribution 4,100 3,903 3,845 58(A)
Fixed overhead 2,500 2,500 2,750 250(A)
Profit 1,600 1,403 1,095 308(A)

Notes

• The £368 actual charge for Chicken is the actual cost less standard cost of closing
stock e.g. (£405 less (15kg x £2.50))
• The £125 actual charge for Vegetables is the actual cost less standard cost of closing
stock e.g. (£140 less (30kg x £0.50))
• The absorption costing company charges fixed overhead to the profit and loss account
on the basis of £5.00 for every meal produced e.g. 476 meals x £5.00 per meal =
£2,380, for this reason, when a budget is flexed, we prorate the budgeted fixed
overhead, but never for marginal costing organisations, they do not charge or absorb
fixed overhead in this manner.

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1.3 Variance analysis

By comparing a flexed budget, which has been prepared using standard cost information to
actual results, total variances can be calculated. These reconcilable differences between the
two statements can then be sub-divided further, calculated, interpreted and used to correct
problems within the organisation to stay on target through control action by management or
employees.

Variances can occur for the following reasons

• Inaccurate data when creating standards, producing the budget or compiling actual
results
• A standard used which is either not realistic or perhaps out of date
• Efficiency of how operations were undertaken by management or employees during
the period of assessment
• Random or chance

Budgetary planning involves the production of budgets or forecasts using realistic standards
for cost and efficiency levels. Budgetary control identifies areas of responsibility for
management and is the process of regularly comparing actual results against budget or
standards. Because the original budget would have forecast a different number of units
produced or sold, when compared to actual units produced or sold, a ‘flexed budget’ would
be prepared in order to compare costs and revenues on a like with like basis.

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Variance calculations

Did sell (actual quantity sold x actual price) X

Sales price
Should sell (actual quantity sold x standard price) (X)
variance
Sales price variance X

units
Did sell (actual quantity sold) X
Should sell (budget quantity sold) (X)
X
x standard profit per unit*
Sales volume profit variance X

* Standard profit would be used if the organisation uses absorption

costing methods, when using marginal costing methods, the standard
contribution volume variance, rather than standard volume profit
variance would be used. The proforma above would be the same
however the difference in units above would be multiplied by the
standard contribution per unit rather than standard profit per unit.

Sales volume
profit There is also the calculation of the sales volume revenue variance
variance
units
Did sell (actual quantity sold) X
Should sell (budget quantity sold) (X)
X
x standard price
Sales volume revenue variance X

This would be a calculation considered in isolation from an operating

statement e.g. if an organisation wants to reconcile the difference
between the original sales budget revenue and actual sales revenue
achieved rather than profit or contribution.

Did spend (actual quantity purchased x actual price) X

Should spend (actual quantity purchased x standard price) (X)
Material Material price variance X
price
variance This variance calculation always uses the quantity of material actually
purchased never used, if there is a difference between the two within a
question.

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 Kg/litres
Actual production did use X
Actual production should use (actual production x standard usage) (X)
X
Material
x standard price
usage
Material usage variance X
variance
This variance calculation always uses the quantity of material actually
used never purchased, if there is a difference between the two within a
question.

Did spend (actual hours paid x actual rate) X

Should spend (actual hours paid x standard rate) (X)
Labour rate Labour rate variance X
variance
This variance calculation always uses the actual hours paid for never
hours worked if there is a difference between the two within a question.

Hours
Actual production did take X
Actual production should take (actual production x standard hours) (X)
Labour X
efficiency x standard rate
variance Labour efficiency variance X

This variance calculation always uses the actual hours worked never
hours paid if there is a difference between the two within a question.

Hours
Actual hours paid for X
Actual hours worked (X)
Labour idle Idle time X
time x standard rate
variance Labour idle time variance X

Only applicable if there is idle time e.g. a difference between labour

hours paid and worked.

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 Did spend (actual hours worked x actual OH rate) X
Should spend (actual hours worked x standard OH rate) (X)
Variable Variable overhead expenditure variance X
overhead
expenditure Variable overhead expenditure within a question will be assumed to be
variance driven by labour hours worked never paid if there is a difference
between the two e.g. if production stops and staff are idle then no
variable overhead should be incurred.

Hours
Actual production did take X
Actual production should take (actual production x standard hours) (X)
Variable X
overhead x standard overhead rate
efficiency Variable overhead efficiency variance X
variance
This variance calculation always uses the actual hours worked never
hours paid if there is a difference between the two within a question;
notice the proforma is similar to the labour efficiency variance.

Actual fixed overhead expenditure X

Fixed
Budgeted fixed overhead expenditure (X)
overhead
Fixed overhead expenditure variance X
expenditure
variance

units
Did produce (actual quantity produced) X
Should produce (budget quantity produced) (X)
X
Fixed
x overhead absorption rate (O.A.R)
overhead
Fixed overhead volume variance X
volume
variance
This variance calculation is only applicable if the organisation uses
absorption costing, never when marginal costing, and is to do with the
way the organisation charges the profit and loss account within the
production fixed overhead control account.

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1.4 Fixed overhead variances further explained

Traditional absorption costing takes the total budgeted fixed overhead for a period and
divides by a budgeted (or normal) activity level e.g. units, in order to find the overhead
absorption rate. This is a simple method of charging fixed overhead and allows fixed
overhead to be allocated to products, jobs or work-in-progress

Overhead absorption rate (OAR) = Budgeted production overhead

Normal/budget level of activity

Production fixed overhead control account

Actual production (units) x O.A.R

Actual production overhead X
= Charge to W.I.P during the period X

At the end of the period, the overhead ‘absorbed’ or charged to production is compared to the
actual production overhead incurred for the period. Any shortfall in overhead charged
would be an ‘under absorption’ of production overhead (DR profit and loss account CR
Production overhead control account). Any ‘over charge’ to the profit and loss account
during a period would be an ‘over absorption’ of production overhead (CR profit and loss
account DR Production overhead control account).

The sum of the fixed overhead expenditure and volume variance would be equal to the under
or over absorption, when sub-divided, explaining the two different causes as to how this
occurred during a period e.g. under or over spent and/or under or over produced when
compared to the original budget.

The difference between absorption costing and marginal costing organisations, is that the
marginal costing organisation makes no attempt to absorb or charge production overhead into
a cost unit or the profit and loss account. It treats production overhead as a period cost only
and does not absorb overhead, but rather charges it entirely to the profit and loss account for
each period. With marginal costing organisations only the fixed overhead expenditure never
the fixed overhead volume variance would be applicable within a question.

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Stock valuation under absorption and marginal costing systems

It is also important to remember that marginal costing organisations would also value stock
at variable production cost only never full production cost, when contrasted to an
absorption costing company.

Standard cost per unit:

Direct costs of production

Direct labour X
Direct material X
Direct variable production overhead X
Total direct variable cost or total prime cost X Marginal costing stock valuation

Indirect production overhead absorbed X

Full production cost X Absorption costing stock valuation

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Example 1.2

Butliness is a business that offers packaged holiday deals in 3 locations in the UK and
as part of this service has a restaurant that serves many different meals and puddings
through out the day to guests staying over in chalets on the holiday park. One such
serving counter has been a major concern for the management, the ‘All week Sunday
lunch’ counter, as it is expensive to run.

The stand uses 2 staff on different shifts to cook and serve meals at the counter, the
standard cost and price of the ‘Hungry man roast of the day’ is as follows:

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
Fixed overhead 15 mins @ £20.00/hr 5.00
8.75
Standard profit 3.20
Selling price (included in packaged price) 11.95

The counter works on a 6-day shift (all week except Sunday) and the budget aims to
sell 500 meals every week. During week 43 the following actual information was
obtained.

Meals actually sold were 476 the revenue earned £5,688.

Ingredients purchased
Chicken Vegetables
Purchased 180kg (£405) 250kg (£140)
Used 165kg 220kg

Chef wages for week 43

Hours paid 120 hours (Wages paid £1,200)
Hours worked 114 hours

6 hours were idle due to ovens failing on Tuesday afternoon

Variable overhead £150

Fixed overhead £2,750

Prepare an operating statement for week 43 for both an absorption and marginal
costing organisation, which reconciles any differences between actual results and
budget?

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Example 1.3 – working backwards

Butliness had a problem with the accountant during period 46; he left in a fume and took all
the actual accounts information with him as revenge. You have been called in from a
temping agency to sort out the mess. The following information has been provided to you.

Operating statement for week 43

Budget 1,600
Sales volume variance 77(A)
Flexed budget 1,523
Sales price variance 0
1,523

Cost variances F A

Chicken price variance 45

Chicken usage variance 55

Vegetable price variance 15

Vegetable usage variance 9

Labour efficiency variance 45

Labour rate variance 120
Idle time variance 54

Variable overhead efficiency variance 10

Variable overhead expenditure variance 78

Fixed overhead expenditure variance 250

Fixed overhead volume variance 120
187 614 427(A)

Actual profit 1,096

Standard cost information for 1 meal

£ Per meal
Chicken 0.3kg @ £2.50 per kg 0.75
Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
Fixed overhead 15 mins @ £20.00/hr 5.00
8.75
Standard profit 3.20
Selling price (included in packaged price) 11.95

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Additional information known

• Budgeted fixed overhead was £2,500

• Actual hours paid were 6 more than worked due to an electrical fault with the ovens
• Closing stock for chicken and vegetables rose during this period by 15kg and 30kg
respectively.
• Sales were the same as production during the week

You are required to

1. Calculate the actual production and sale of meals

2. Calculate actual hours worked for the chefs
3. Calculate the actual quantity of chicken purchased
4. Calculate the actual price paid for chicken
5. Calculate the actual variable overhead expenditure
6. Calculate the actual fixed overhead expenditure

Note: an alternative form of question would have been to provide you with actual
information and the variances, asking you to calculate budgeted or standard cost information
instead. The principle would be exactly the same as within this example.

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1.5 Mix and yield (or productivity) variances

A material usage variance can be subdivided into a mix and yield variance where there
exists two or more ingredients that can be substituted for one another. The sum of the
material mix and yield variances will total the sum of the material usage variance. The same
concept can also be applied to labour mix and yield variances, when one grade or skill of
labour can be substituted for another, when making a particular product or completing a job.
The labour efficiency variance in this case reanalysed further into the mix and yield
variances, exactly in the same way as the material usage variance.

Interpreting mix variances ‘individual valuation basis’

Actual output did use should use standard price variance

(at std mix)

Material/Labour A X kg/Hrs X kg/Hrs x £x = £x (F)

Material/Labour B X kg/Hrs X kg/Hrs x £x = £x (A)
X kg/Hrs X kg/Hrs £x (A)

• If you use a quantity of material which is more than standard mix there would be an
adverse variance
• If you use a quantity of material which is less than standard mix there would be a
favourable variance

Interpreting mix variances ‘average valuation basis’

Actual output did use should use standard price variance

(at std mix) less average price

Material/Labour A X kg/Hrs X kg/Hrs x £x = £x (F)

Material/Labour B X kg/Hrs X kg/Hrs x £x = £x (A)
X kg/Hrs X kg/Hrs £x (A)

• If you use a quantity of material which is more than standard mix and the material is
more expensive than the average cost, there would be an adverse variance
• If you use a quantity of material which is more than standard mix and the material is
less expensive than the average cost, there would be a favourable variance
• If you use a quantity of material which is less than standard mix and the material is
more expensive than the average cost, there would be a favourable variance
• If you use a quantity of material which is less than standard mix and the material is
less expensive than the average cost, there would be an adverse variance

Both totals of the individual and average valuation bases give the same answer; it is the
analysis which makes up the total, where you would find the differences between the two
methods.

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Interpreting yield (or productivity) variances

Yield

Actual material used or labour time did produce X

Actual material used or labour time should produce X
Over/(under) produced X
x standard cost of one unit of output x £x
£X (A)/(F)

The sum of the material mix/labour mix and material/labour yield variances will be equal to
the material usage/labour efficiency variance respectively. It is also worth noting that there
can be an interdependent relationship between a mix and yield variance e.g. a higher skill mix
of labour in substitute of a lower skill mix, would cause an adverse mix variance, but may
also cause at the same time a favourable yield variance, due to greater experience and
therefore efficiency by that type of labour. Lastly a word of caution favourable variances,
especially when dealing with mix and yield do not necessarily mean you have improved the
organisation e.g. more water and less flavouring would improve both mix and yield when
making soft drinks, but do little to improve the quality of the drink being made.

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Example 1.4

Butliness also does a ‘deep pan cheesy and tomato pizza’ on one of it’s counters, the
standard or budget cost and usage of the topping ingredients for one pizza are as
follows

£
0.5kg Tomatoes @ £1.40 a kg 0.70
0.6kg Cheese @ £7.50 a kg 4.50
5.20

1.1kg ingredients will produce or yield a 1kg pizza (due to evaporation in the cooking
process). On a Wednesday afternoon 60 pizzas were cooked (to the weight specified
of 1.0 kg) and the following ingredients were used during the process;

Tomatoes 28 kg £45.00
Cheese 40kg £270.00

Calculate the material usage, mix and yield variances for Butliness for this day?

Note: two methods exist for calculation of the mix variance, the individual valuation
and average valuation bases. Make sure you are familiar with both types of
calculation.

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1.6 Investigating variances

Statistical methods for interpretation

Variances can be expressed relatively rather than absolutely, the variance is normally
expressed as a percentage against the standard cost. In a past exam (old syllabus the
examiner asked students to express material mix and yield variances, the deviations in weight
rather than values, as a percentage of the standardised weight for the product being produced.

From the answer of example 1.4 above this would have been calculated as

Tomato ingredient – mix 3kg/31kg = 9.7% (F)

Cheese ingredient – mix 3kg/37kg = 8.1% (A)
Yield 1.8kg/61.8kg = 2.9% (A)
These percentages could be plotted on a graph from one period to the next, which would
provide managers with the following advantages.
9 Graphical presentation or percentages analysed over time allows easier interpretation
and clearer understanding by managers
9 Presenting variances over time allows trends to be identified easier
9 By working out percentages expressed against standard, it removes changes in
monetary size of the variance caused by changing activity levels, improving trend
analysis
Example of a variance chart

Favourable

0
JAN FEB MAR APR

Adverse

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Factors to consider before investigation
1. The size of it (materiality)
2. The general trend of it e.g. use of control charts for this
3. The type of standard that was used
4. Interdependence with other variances
5. The likelihood of identifying the cause of it
6. The likelihood that if a cause is found then it is controllable
7. The cost and benefits of correcting the cause
8. The cost of the investigation

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Example 1.5

Mr Chumney-Warner, the accountant that left Butliness, due to personal grievances against
the organisation and has set up an audit practice, providing work to local business within the
area. Even though being a service organisation, Mr Chumney-Warner recognises that
variances can also be applied to such organisations. He has created a standard cost of an
average audit, which normally takes a partner, semi-senior and junior together, 20 hours.

Details of one standard audit

£
Partner 3 hours @ £100 per hour 300
Semi-senior 5 hours @ £70 per hour 350
Junior 12 hours @ £30 per hour 360
1,010

During the period of February, time sheets recorded the following information. In total, 90
hours was logged as audit work, completing 5 audits during this period. The new junior that
had been recruited was under allot of pressure, and did not cope well. This had meant the
semi-senior had to be involved more in compliance work to improve the quality of audit files.
Mr Chumney-Warner was pleased however that his time as a partner was used less because
of the final quality of the audit files, due to more involvement from the semi-senior.

Actual time recorded on audit work

Partner 12 hours
Semi-senior 40 hours
Junior 38 hours
90 hours

You have again been recruited from an agency as a temp, your first job apart from idle
chit chat about working conditions at Butliness, is to produce labour mix and yield
calculations for Mr Chumney-Warner, within an operating statement, for the period of
February above. Your mix calculations to use both the average and individual bases of
valuation.

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1.7 Planning and operational variances

Planning variances are caused by the budget or standard at the planning stage being wrong.
The budget and standard used would therefore need revising if your operational variances are
to be more realistic.

Operational variances are your normal variance calculations as learned earlier within this
chapter, that is, assuming all planning errors within the budget have been adjusted for or
removed and your standard used is realistic.

Process of calculating planning variances

1. Calculate the planning variance and adjust the original budget within the operating
statement for this, before any operational variances are calculated
2. Adjust the standard cost used in the budget from ex ante to ex post (revised) standard
3. Now that the original budget and standard cost has been adjusted, the operational
variances that would be effected by the adjustment, will give a more realistic
standard.

The effect is to sub-divide a variance into 2 parts

1. The planning variance which is beyond the control of staff e.g. planning errors
2. The operational variances which may be within the control of staff

This allows better management information for control purposes

Planning and operational variances are not alternatives to the conventional approach; they
just produce a more detailed analysis. Further analysis of variances into groups e.g. planning
which are to do with poor planning or inadequate standards used compared with actual true
favourable or adverse operational variances, allow managers to be appraised truly on
deviations they can control not those variances which are beyond their control.

Advantages of planning variances

9 Highlight between variances which are controllable and uncontrollable

9 Help motivate managers and staff
9 Help use more realistic standards
9 Give a fairer reflection of operational variances

However critism includes still the question of determining a ‘realistic standard’ in the first
place and putting too much emphasis on ‘bad planning’ rather than ‘bad management’ and
the analysis can be more time consuming and costly than the conventional approach.

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Example 1.6

Using the information from Example 1.2, how should Butliness deal with the variance
calculations if you were told the following; due to salmonella scare across the country
the price of chicken had fallen to £2 a kg this should have been reflected in the budget
when it was completed, but was overlooked.

Adjust standard cost

Revised Standard cost information for 1 meal

£ Per meal

Chicken 0.3kg @ £2.00 per kg 0.60

Vegetables 0.5kg @ £0.50 per kg 0.25
Labour 15 mins @ £9.00/hr 2.25
Variable overhead 15 mins @ £2.00/hr 0.50
Fixed overhead 15 mins @ £20.00/hr 5.00
8.60
Standard profit 3.35
Selling price (included in packaged price) 11.95

Chicken price planning variance

500 meals should have cost (x 0.3kg x £2.00) according to new standard 300
500 meals should have cost (x 0.3kg x £2.50) according to old standard 375
75(F)

Revise operational variances now because standard has changed

180kg did cost 405

180kg should cost (x revised standard £2 per kg) 360
45(A)

476 meals did use 165kg

476 meals should use (0.3kg per meal) 143kg
22kg
Revised standard price x £2 per kg
44 (A)

Notice the biggest effect of this analysis is that the operational price variance changes
from £45 favourable to £45 adverse. This highlights that the purchasing of the
chicken is not as keener price as it should have been e.g. better control information.
The planning variance will be offset against the original budget, just before the offset
of the sales volume variance within the operating statement.

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1.8 Machine expenditure and efficiency variances

Such variances use the same method as labour rate, efficiency and idle time variances – so do
not be afraid when it comes to rate, efficiency and idle time variances for machines.

Example 1.7

In the bar at Butliness they produce a ‘banana extravaganza’ by using a machine

blender (it has proved to be very popular).

Standard processing time for every 50 half-pint glasses is 0.6 hours at £40 variable
overhead per hour.

During one hot summer week there was 42 hours of processing time at a total cost that
week of £1,880, 1,900 pints were produced.

Calculate the machine expenditure and efficiency variances for the machine?

What if you were told that the machine has been replaced with a machine, which is
20% faster than the previous model, but this had not been reflected in the budget?

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1.9 Causes of variances
Possible causes of the individual variances are:
¾ Material price variance
¾ Material usage variance
¾ Wages rate variance
¾ Labour efficiency variance
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• Different sources of supply.
• Unexpected general price increase.
• Alteration in quantity discounts.
• Alteration in exchange rates (imported
goods)
• Substitution of a different grade of
material
• Standard set at mid-year price so one
would expect a favourable price variance
for part of the year and an adverse
variance for the rest of the year.
• Higher/lower incidence of scrap.
• Alteration to product design.
• Substitution of a different grade of
material.
• Unexpected national wage award.
• Overtime/bonus payments different from
plan.
• Substitution of a different grade of
labour.
• Improvement in methods or working
conditions.
• Variations in unavoidable idle time.
• Introduction of incentive scheme.
• Substitution of a different grade of
labour.
 ¾ Variable overhead variance
¾ Fixed overhead expenditure variance
¾ Fixed overhead volume
¾ Operating profit variance due to selling
prices
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• Unexpected price changes for overhead
items.
• Labour efficiency variances (see above).
• Changes in prices relating to fixed
overhead items e.g. rent increase.
• Seasonal effects e.g. heat/light in winter.
(This arises where the annual budget is
divided into four equal quarters of
thirteen equal four-weekly periods
without allowances for seasonal factors.
Over a whole year the seasonal effects
would cancel out.)
• Change in production volume due to
change in demand or alterations to
stockholding policy.
• Changes in productivity of labour or
machinery.
• Production lost through strikes etc.
• Unplanned price increase.
• Unplanned price reduction e.g. to try and
attract additional business.
1.10 Benchmarking

“Continuous, systematic process for evaluating the products, services and work processes
of an organisation that are recognised as representing best practice, for the purpose of
organisational improvement.”

World-class organisations strive to obtain competitive advantage. This can be achieved by

using benchmarking. This is the process of comparing your performance with that of another
organisation considered to be the best in its class.

Benchmarking

1. Internal. Compare an internal function to the best found elsewhere internally within
the same organisation.
2. ‘Best practice’ or functional. Compare an internal function to that of the best, not
necessarily an organisation in the same industry.
3. Competitive. Product/service features compared to that of firms/competition in the
same industry.
4. Strategic. Compare yourself in terms of organisational structure and culture, mission
statement and strategic choices made to the most successful market leader.

Performance dimensions to gain competitive advantage

• Quality e.g. aesthetics (imperative to organisations like Dior or Cartier), features,

courtesy and friendliness of staff involved within the purchase stages within the
organisation, accuracy of administration
• Speed/flexibility e.g. AA/RAC 24/7, parcel force ‘overnight’, Concorde gave fast
transatlantic flights
• Cost e.g. if the organisation pursues cost leadership
• Differentiation e.g. brand recognition for certain product features such as image,
reliability or functional

Companies to be the very best must establish where customers perceive differences, set the
very best standards to exceed, establish what the competition is doing and encourage, manage
knowledge and ideas of staff to exceed standards set.

The process would involve

1. Select what you want to benchmark/set objectives

2. Consider benefits against the cost of doing it
3. Assign responsibilities to a team
4. Identify potential partners/known leaders
5. Breakdown of processes to complete
6. Test and measure (observation, experimentation or investigation/interview)
7. Gather information
8. Gap analysis
9. Implement changes/programmes/communicate
10. Monitor and control
11. Repeat regularly

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Benefits of benchmarking

9 Better understanding of competition and customers needs

9 Discourages complacency/improves business awareness of managers
9 You learn from other organisations mistakes
9 Don’t need to ‘re-invent the wheel’
9 Source of new ideas/faster awareness of innovation
9 Fewer complaints and warranty claims
9 Leaner more efficient organisation in terms of waste and reworks
9 Customer satisfaction and brand loyalty in the long-term
9 Efficiency and effectiveness of functions or processes improved within the
organisation
9 Sales and profitability improved

Drawbacks of benchmarking

Deciding and documenting what needs to be benchmarked is time consuming

Getting the information to actually do it maybe a problem
Confidential information could be leaked
Damn lies and ‘statistics’
Deciding who is the best in their class
Keeping employees motivated, as standards once exceeded, will normally be raised

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1.11 McDonaldization
Modern manufacturing questions the thought of whether standard costing still plays a
valuable part when considering information for control purposes.
• Dynamic environments
• Customisation/differentiation not homogenous products
• Shorter product life-cycles
• Automation
• Higher concern for quality rather than efficiency
George Ritver within his book ‘The McDonaldization of Society’ listed the advantages of
producing standard or homogenous products, the pinnacle comparison being McDonalds,
with its fast food strategy of uniformity of operations and delivery on a global basis. A
concept you will find within thousands of companies in the world, especially the larger
corporations e.g. Audi or V/W Group incorporating hundreds of components, including the
engine, within a large range of cars manufactured. Although surely you would understand
such an idea better through the use of a ‘Big Mac’ right? Standardisation of machinery,
uniforms and packaging e.g. sachets, drinking cups and paper bags. Automation of
dispensers, cooking processes and staff… have a nice day! Food already pre-prepared before
cooking e.g. cheese sliced, salads prepared, sauces all pre-packed and easy to open and serve.
This is uniformity or standardisation.
Some facts about McDonalds

• Started as a hot dog stand in 1939 by 2 brothers (Richard and Maurice McDonald)
• 30,000 outlets in 119 countries
• One of the first to end waiter service
• Cut their menus down to a few standard and homogenous dishes for simplicity
• Plates replaced with cardboard containers to save on washing up
Advantages of McDonaldization ‘standardisation reduces cost and improves efficiency’

9 Control e.g. easier to create a pre-defined standard as there is such uniformity within
the specification of the products produced, also easier to manage, organise, train and
control workers
9 Efficiency e.g. combined with specialisation it is the most efficient way of working
within large organisations
9 Predictability e.g. customer always knows what they are buying, giving reassurance
and brand recognition
9 Calculability e.g. quantitative not qualitative information so easier to interpret
9 Proficiency of staff can be assessed more effectively
Such a philosophy and its advantages are similar to the classical school of management, but
can have its disadvantages

Excessive specialisation of tasks e.g. work dull and boring

Removes initiative of workers e.g. reduces innovation and creativity
Boredom, frustration and de-motivation of workers

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1.12 Diagnostic related or reference groups (DRG) ‘can applied to a Big Mac’

Standard costing is and can be applied to service organisations such as the health service,
accountancy practice or even retail. The diagnostic reference group or healthcare resource
group is a system of classifying hundreds of different medical conditions within the health
sector, as a basis of recognising that similar medical illnesses require essentially similar
treatment or care. There are around 800 DRGs existing within the health service.

This enables health service management to

• Standardise resources e.g. beds/wards/consultancy/medication

• Standardise patient treatment e.g. specifications of how treatment applied
• Standardise codes for insurance companies or standardise payments to the NHS or
other private health providers for payment or charges made

Such standards can also be used by government to benchmark the performance and create
league tables of those hospitals that complete treatments within standard times and costs and
those that do not. The DRG approach also used to remunerate hospitals for each standard
treatment they perform.

Such a system is not without its critics, arguing that surely it is the qualitative factors in
patient treatment more than the quantitative measures that are more important when it comes
to patient care, and not every operation or treatment can be cured in a single best way. If
payments are made to hospitals based on a standard amount or price, this could mean
overzealous treatment of a patient causing overspending; this in itself could affect the level of
patient care given.

Characteristics of services

• Intangibility e.g. no material substance or physical existence of it when compared to

a tangible good
• Legal ownership e.g. no physical evidence often exists, so you can never return it if it
was faulty
• Instant perishability e.g. unlike goods, services cannot be stored
• Heterogeneity e.g. each time the service is performed even to the same customer it
can be different each time, goods generally are homogenous
• Inseparability e.g. cannot be separated from the person who provides it

It is for the above reasons, as well as the human influence in the quality and effectiveness of
the service performed, when compared to manufacturing a product, that makes standard
costing more difficult to apply within the service sector.

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 Solutions to lecture examples

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Example 1.2 - absorption costing organisation

Operating statement for week 43

Budget (500 x 3.20) 1,600

Sales volume variance (476-500 x 3.20) 77(A)
Flexed budget for 476 meals 1,523
Sales price variance (476 x (£11.95-£11.95) 0
1,523

Cost variances F A

Chicken price variance (180kg x 2.25-2.50) 45

Chicken usage variance (143-165 x 2.50) 55

Vegetable price variance (250kg x 0.50-0.56) 15

Vegetable usage variance (238kg-220kg x 0.50) 9

Labour efficiency variance (119-114 x £9) 45

Labour rate variance (120 x £10-£9) 120
Idle time variance (6 x £9) 54

Variable overhead efficiency variance

(119-114 x £2) 10
Variable overhead expenditure variance
(114 x £2-£1.32) 78

Fixed overhead expenditure variance

(£2500-£2750) 250
Fixed overhead volume variance
(476-500 x £5) 120
187 614 = 427(A)

Actual profit* 1,096

* Proof

Sales 5,688
Chicken 405
Closing stock (15kg x £2.50) (38)
Vegetables 140
Closing stock (30kg x 50p) (15)
Labour 1,200
V/OH 150
F/OH 2,750 (4,592)
1,096

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Example 1.2 - marginal costing organisation

Operating statement for week 43

Budget (500 x 8.20) 4,100

Sales volume variance (476-500 x 8.20) 197(A)
Flexed budget for 476 meals 3,903
Sales price variance (476 x (£11.95-£11.95) 0
3,903

Cost variances F A

Chicken price variance (180kg x 2.25-2.50) 45

Chicken usage variance (143-165 x 2.50) 55

Vegetable price variance (250kg x 0.50-0.56) 15

Vegetable usage variance (238kg-220kg x 0.50) 9

Labour efficiency variance (119-114 x £9) 45

Labour rate variance (120 x £10-£9) 120
Idle time variance (6 x £9) 54

Variable overhead efficiency variance

(119-114 x £2) 10
Variable overhead expenditure variance
(114 x £2-£1.32) 78
187 244 = 57(A)
Actual contribution 3,846

Budgeted fixed overhead 2,500

Fixed overhead expenditure variance (£2500-£2750) 250(A)
Actual profit* 1,096

* Proof

Sales 5,688
Chicken 405
Closing stock (15kg x £2.50) (38)
Vegetables 140
Closing stock (30kg x 50p) (15)
Labour 1,200
V/OH 150
(1,842)
Contribution 3,846
F/OH (2,750)
1,096

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Example 1.3

Calculate the actual production and sale of meals

Did sell 476 (balance figure)

Should sell 500 (£2500 Budget F/OH divided by £5 F/OH)
24
Standard profit per meal x £3.20
77(A)

Calculate actual hours worked for the chefs

476 meals did take 114 (balance figure)

476 meals should take (476 x 0.25 hrs) 119
5
Standard rate per hour x £9.00 per hour
45(F)

Hours paid for would have been 114 worked plus 6 hours idle time = 120 hours

Calculate the actual quantity of chicken purchased

476 meals did use 165 kg (balance figure)

476 meals should have used (x0.3kg) 143 kg
22 kg
Standard price per kg x £2.50
55 (A)

Calculate the actual price paid for chicken

165kg used as above + 15kg rise in closing stock levels = 180kg purchased.

180kg did cost 405 (balance figure)

180kg should cost (x £2.50 kg) 450
45(F)

Calculate the actual variable overhead expenditure

114 hrs worked did cost 150 (balance figure)

114 hrs should have cost (x £2 per hour) 228
78(F)

Calculate the actual fixed overhead expenditure

Actual fixed overhead 2,750 (balance figure)

Budget fixed overhead 2,500
250(A)

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Example 1.4
Usage variance

60kg pizza did use should use standard price variance

Tomato 28kg 30kg x £1.40 = £2.80 (F)

Cheese 40kg 36kg x £7.50 = £30.00 (A)
£27.20 (A)
Mix can be calculated by one of two ways

First method (individual valuation bases)

60kg pizza did use should use standard price variance

(W1)
Tomato 28kg 31kg x £1.40 = £4.20 (F)
Cheese 40kg 37kg x £7.50 = £22.50 (A)
68kg 68kg £18.30 (A)

(W1)

68kg ingredients x 0.5kg/1.1kg = 31kg of tomatoes you would have used had you kept to the
mix
68kg ingredients x 0.6kg/1.1kg = 37kg of cheese you would have used had you kept to the
mix

Second method (average valuation bases)

Weighted average cost of one Kg of ingredients

(0.5kg/1.1kg x £1.40) + (0.6kg/1.1kg x £7.50) = £4.73

Within the mix

(did use less should use) x (average standard cost less standard cost) = variance

Thus if an actual mixed quantity is greater than the standard quantity mixed for this
material, but this material costs less than average, then a favourable variance will
result, as also would using less of a relatively more expensive ingredient, when
compared to the average cost.

Tomatoes 28kg-31kg= 3kg x £4.73-£1.40 = £10.00 (A)

Cheese 40kg-37kg= 3kg x £4.73-£7.50 = £8.31 (A)
£18.31 (A)
For tomatoes 3kg used less than you should of but this costs less than the average cost,
adverse. For cheese 3 kg used more than you should of which costs more than the average
cost, adverse. Butliness have substituted a relatively less expensive ingredient for a more
expensive one, hence both variances adverse.

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Example 1.4 – continued.

Yield

68kg of cheese and tomato should yield (68kg/1.1kg per pizza) 61.8
68kg of cheese and tomato did yield 60.0
Under produced 1.8

x standard cost of one pizza average cost per kg £4.73 x 1.1kg/1.0kg x £5.20*
£9.37 (A)

*1.1KG INGREDIANT = 1.0KG OUTPUT THEREFORE THE COST OF ONE PIZZA

SHOULD BE 1.1/1.0 X £4.73 AVERAGE COST PER KG.

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Example 1.5

Labour Mix calculation - individual valuation basis

Actual hours Standard mix Standard hours Standard rate

Partner 12 3 / 20 13.5 1.5 £100 150.00 (F)
Semi-senior 40 5 / 20 22.5 -17.5 £70 -1225.00 (A)
Junior 38 12 / 20 54.0 16 £30 480.00 (F)
90 20 / 20 90.0 0.0 -595.00 (A)

Labour Mix calculation - average valuation basis

Actual hours Standard hours Standard rate - Average rate

Partner 12 13.5 1.5 £100 £50.50 -49.50 74.25 (F)
Semi-senior 40 22.5 -17.5 £70 £50.50 -19.50 -341.25 (A)
Junior 38 54.0 16 £30 £50.50 20.50 -328.00 (A)
90 90.0 0.0 -595.00 (A)

W1 Average rate
(3/20 x £100) + (5/20 x £70) + (12/20 x £30) = £50.50

Labour yield or productivity variance

90 hours did yield 5.0 audits

90 audits should yield (90 hours/20 hours an audit) 4.5 audits
0.5 audits
x standard cost of an audit (£1,010)
£505(F)

Operating statement

5 audits should cost (based on standard mix of labour) 5 x £1,010 = £5,050

Labour mix variance £595 (A)

Labour yield variance £505 (F)

5 audits did cost (assuming standard rates were correct e.g. no rate variance)
(12 hours x £100) + (40 hours x £70) + (38 hours x £30) = £5,140

Worse off by £90, the semi-senior improving productivity, due to higher quality of work, however this cost
the organisation £90 (adverse) labour efficiency variance due to the higher cost of using the semi-senior, shown
within the mix variance.

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Example 1.7

Machine expenditure and efficiency variances

Standard cost of 25 pints £40 x 0.6 hrs = £24 per 25 pints.

Efficiency

1900 pints did take 42.0 hrs

1900 pints should take (1900/25 x 0.6 hrs) 45.6 hrs
3.6 hrs
Standard cost per machine hour x £40
144(F)

Expenditure

42 hrs did cost 1,880

42 hrs should cost (42 x £40) 1,680
200 (A)

Operating statement

Flexed budget based on actual output achieved

Budget 1900/25 x £24 = 1,824
Efficiency 144(F)
Expenditure 200(A)
Actual 1,880

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Example 1.7 - continued

What if you were told that the machine has been replaced with a machine, which is 20%
faster than the previous model, but this had not been reflected in the budget?

Revise standard 0.6hrs x 0.8(20% faster time!!) x £40

Planning variance

1900 pints should have taken according to old standard 46hrs

1900 pints should have taken according to new standard 36hrs
10 hrs
x £40
400(F)

Operational expenditure variance no change

Operational efficiency variance (revised)

1900/25 x 0.6 hrs x 0.8 should take 36 hrs

Did take 42 hrs
6 hrs
x £40
240 (A)
Operating statement

Flexed budget based on actual output achieved

Budget 1900/25 x £24 = 1824
Planning 400(F)
Efficiency 240(A)
Expenditure 200(A)
Actual 1880

About £14 rounding difference above.

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