By Benjamin Simpson,2014-05-20 17:42
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    Ch16 Further variance analysis

    Sales Variances

     Two sales variances

     There are two basic ways in which sales performance can affect profit: selling at

    giving rise to a price variance and selling a different price from the standard price

    a different quantity from that budgeted giving rise to a volume variance.

     Sales price variance

     To calculate this variance, ask yourself: “how many units were sold; what was received for these sales; what should have been received?” The difference will represent the sales price variance.

     Sales price variance = Actual sales revenue - Actual units sold×Standard

    selling price

     Or, in abbreviated form = AQ×AP - SP

     You will notice that these abbreviated formulae make more use of unit costs and revenues than their “more wordy forms”. This can be more convenient or may cause problems of rounding. If any actual costs or selling prices per unit turn out not to be round numbers, keep hold of the unrounded unit figures in your calculator to avoid making rounding errors.

     Sales volume variance

     The questions to ask now are: “How many units were sold; how many units should have been sold?” The difference provides an indication of the sales volume variance. Since our aim is usually to produce a reconciliation that either starts from budgeted profit or from budget contribution, the volume variance is subsequently expressed in terms of standard profit per unit for standard total absorption

    costing or in terms of standard contribution per unit for standard marginal


     Sales volume variance =Actual sales volume - Budgeted sales units

    ×Standard margin per unit,

     or=AQ - BQ×SM

     Causes of variance are probably the results of:

     a.unplanned price increase;

     b.unplanned price reduction.



     Causes of variance are probably the results of:

     a.unexpected fall in demand due to recession

     b.addition demand attracted by reduced price

     c.failure to satisfy demand due to production difficulties.


     On Sales margin volume variance

     The use of absorption or marginal costing affects the calculation of the sales volume variance.

     1 Under absorption costing any difference in units is valued at the standard profit per unit;

     2 Under marginal costing such a difference in units is valued at the standard contribution per unit;

     In neither case is the standard selling price used. This is because when volumes change so do production costs and the purpose of calculating the variance is to find the effect of profit.

     The operating statement

     The purpose of calculating variances is to identify the different effects of each item of cost/income on profit compared to the expected profit. These variances are summarized in a reconciliation statement, known as an operating statement.


    A.In an absorption system:

     l The statement commences with the budgeted profit which is based upon budgeted cost and activity levels;

     l This is then adjusted by the sales volume variance to reflect any difference in actual and budgeted activity. The result, which is referred to as the “Standard profit on actual sales” represents the profit which would be achieved if:

     a.the selling price was as budgeted;

     b.all variable costs were as per the standard unit cost

     c.all fixed costs were as budgeted

     The selling price and cost variances are then included under the headings of adverse and favorable as appropriate. The total of these should reconcile the actual

    profit to the standard profit on actual sales.

     B.A marginal costing operating statement evaluates:

     The volume variance using contribution per unit;

     There is no fixed overhead volume variance.

     Summarized absorption costing statement


     Budgeted profit X

     Sales volume variance X

     Standard profit on actual sales X

     Sales price variance X

     Profit before cost variances X

     Cost variances X

     Actual profit X

     Total absorption costing operating statement


     Budgeted profit X

     Sales volume variance X

     Standard profit on actual sales X

     Sales price variance X

     Profit before cost variances X

     Cost variances Fav Adv


     Materials -priceusage × ×

     Labour -rate,eff‟y idle time × ×

     Variable overhead -rate effciency × ×

     Fixed overhead -exp‟re eff‟ycap‟y × ×

     × × ×


     Marginal costing


     Budgeted profit X

     Sales volume variance X

     Standard profit on actual sales X

     Sales price variance X

     Cotribution before cost variances X

     Variable cost variances Fav Adv


     Materials,LabourVariable overheads × ×

    × × ×

     Actual contribution ×

     Fixed overhead

     Budget ×

     Expenditure variance ×

     Actual ×

     Actual profit ×


     Standard Marginal Costing

     The second operating statement, based on standard marginal costing principles, shows some of the minor differences that a firm needs to make to its standard costing system if using marginal rather than absorption costing.

     1.The basic principles of calculating variances are the same as for standard absorption costing;

     2.The operating statement will be slightly different;

     3.It is easier to show budgeted contribution as the starting point for reconciling budgeted and actual figures.

     4.The sales volume variance will be in terms of standard contribution per unit.

     5.Variable cost variances will be exactly the same as for standard absorption costing.

     6.The only fixed overhead variance is the expenditure variance.


     Selling overheads

     The cost variances that need to be calculated in most exam questions will be production cost variances. One question under the previous syllabus, Paper 8, has also

    tested selling overhead cost variances. These provide information about whether a firm has spent too much on sales commission or advertising, etc. Their calculation differs from production cost variances in one obvious respect.

     Total selling overhead cost variance = Standard cost of actual SALES - Actual selling overhead cost

     It is unlikely that you will be able to analyze further a variable selling overhead cost variance. However a fixed selling overhead cost variance can be split into expenditure and volume.

     Fixed selling overhead cost variances:

     Expenditure = Budgeted total fixed selling overhead cost - Actual total fixed selling overhead cost

     Volume = Actual units sold - Budgeted sales X Standard fixed selling

    overhead cost per unit


     ZA Ltd manufactures a product called Kappa. The following standard costs apply for the production of 100 Kappas.

     Material 600kgs@$0.60 per kg $360

     Labor 25hours@$1.40 per hour $35

     Fixed $6000

     Overheads 20,000units $30


     Budgeted monthly production/sales budget is 20,000 Kappas. Selling price is $7.50 per unit. In month 3 actual results were:

     Product produced and sold 21,000 units

     Sales value $156,000

     Material purchased and used 127,500kgs $76,000

     Labor 5,200 hours $7,350

     Fixed overheads $6,500

     Require to prepare an operating statement for Month 3 detailing all the variance.


     aUsing absorption costing

     Budgeted profit w1 $65,000

     Add: Sales volume variance w2 $3,250

     Standard profit on actual sales $68,250

     Variance Adv $ Fav$

     Sales price w3 1,500

     Material price w4 500

     Material usage w5 900

     Wages rate w6 70

     Labor efficiency w7 70

     Fixed overhead expenditurew8 500

     Fixed overhead capacity w9 240

     Fixed overhead efficiency w10 60

     2,970 870 2,100

     Actual profit 66,150

     Actual profit is calculated as follows:

     Sales $156,000

     Less: Material $76,000

     Labor $7,350

     Fixed overhead $6,500



     w1: 20,000!?$7.50-$425/100= $65,000

     w2: 1,000!?$7.50-$425/100= $3,250

     w3: 21,000$7.50=$157,500-$156,000=$1,500 A

     w4: $76,000-127,500$0.6= $500 F

     w5: 600kg/10021,000= 126,000kg- 127,500kg=1,500kg$0.6=$900 A

     w6: $1.405,200 hours=$7,280- $ 7,350= $70 A

     w7: 25hours/10021,000=5,250 hours - 5,200 hours= 50hours$1.40= $70


     w8: $30/10020,000=$6,000-$ 6,500=$ 500 A

    25/100=200hours$1.20=$ 240 F w9: 5,200-20,000

     w10: 21,00025/100=5250hours-5200hours=50hours$1.2=$60 F

     b Using marginal costing

     Budgeted profit $65,000

     Add: Sales volume variance w1 $3,550

     Standard profit on actual sales $68,550

     Variance Adv$ Fav$

     Sales price 1,500

     Material price 500

     Material usage 900

     Wages rate 70

     Labor efficiency 70

     Fixed overhead expenditurew2500

     2,970 570 2,400

     Actual profit 66,150


     Sales $7.5

     Less: Material $3.6

     Labor $0.35 $3.95

     Standard contribution per unit $3.55

     w2 there is no fixed overhead volume variance to calculate under marginal

    costing because there is no absorption of fixed overheads.

     Advantages and Disadvantages of the Analysis


     Variances are more relevant, especially in a turbulent environment.

     The operational variances give a “fair” reflection of the actual results achieved in

the actual conditions that existed.

     Managers are, theoretically, more likely to accept and be motivated by the variances reported which provide a better measure of their performance.

     It emphasizes the importance of planning and the relationship between planning and control and is a better guide for cost contro1.

     The analysis helps in the standard setting learning process, which will hopefully result in more useful standards in the future.


     The use of planning and operat ional variances is not widespread. Therefore, there may be perceived disadvantages:

     The establishment of ex-post budgets is very difficult. Managers whose performance is reported to be poor using such a budget are unlikely to accept them as performance measures because of the subjectivity in setting such budgets.

     There is a considerable amount of administrative work involved first to analyze the traditional variances and then to decide on which are controllable and which are uncontrollable.

     The analysis tends to exaggerate the interrelationship of variances, providing managers with a „pre-packed‟ list of excuses for below standard performance. Poor performance is often excused as being the fault of a badly set budget.

     VI.Criterion of carrying out the investigation of variance

     It is rarely practical, or even worthwhile, to investigate every variance produced in an analysis. The factors to consider when deciding whether or not to investigate a variance include the following:

     1Size of variance-it might be assumed that greater cost savings will result from investigating larger variances which also have a major effect on a manager‟s performance report.

     - Fixed size of variance

     - Fixed percentage rule

     - Statistical decision rule

     2Favorable or adverse-the general impression would be that only adverse variances should be investigated, although by investigating favorable variances an organization can:

     -remove the effect of budget padding when assessing performance

     -produce more realistic budgets in the future

     -establish ways in which performance might be improved still further in the future.

     3 Costs and benefits of correction- if the likely cause of a variance is known but it is felt that it will cost too much to eliminate that cause, the variance may not be investigated. It may be that standards have to be revised.

     4Ability to correct a variance-this is related to the previous factor, but now the point at issue is whether a cause of a variance will stay corrected once money has been spent to rectify cause.

     5Past pattern of variances-if a variances merely the result of random variations

    in cost then no amount of remedial action will bring about a cost saving.

     6Reliability of budgets-whilst establishing the extent to which a variance is due to bad budgeting will have all the benefits set out for planning and operationa1 variances, if a variance is purely the resu1t of a badly set budget there will be no major cost savings following the investigation.

     7Reliability of measurement and recording systems -poor measurement and recording systems can give rise to a variance, for instance if closing stock is incorrectly recorded then an incorrect figure for materials usage is assumed and a variance might result. The benefits of investigation are similar to those of investigating the consequences of bad budgeting.

     Several of these considerations give rise to criteria or techniques for variance investigation. Point 5 is taken into account by constructing statistical control charts whilst points3and 4can be assessed using decision trees. The matter of

    mere size gives rise to a number of investigation criteria.

     Costs, benefits and ability to correct variances

     The cost/benefit decision-making rule is that the variance should be investigated if the cost of doing so is less than the expected value of the net benefit.


     Variance Analysis

     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


     Direct labour 2 hours at 8/per hour 16

     Variable production overheads 2 hours at 2 1/hour

     Fixed production overheads 2 hours at 5 2.50/hour


     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 labor, 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. Labor should have taken 2 hours per

    unit and labor 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


     4,150 Production and sales

    units units:


     and used 61,350 21,250kg costing Materials:

    a total of

     paid for

    8,250 hours

    costing a total of 68,500 Labour: 150 labour hours

    were lost due to

    delivery problems

     8,225 Variable overheads:

     19,000 Fixed overheads:

     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


     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

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