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The management evaluates the performance of a company by comparing it with some predetermined measures Therefore, it can be used as a process of measuring and correcting actual performance to ensure that the plans are properly set and implemented
Set the predetermined standards for sales margin and production costs Collect the information about the actual performance Compare the actual performance with the standards to arrive at the variance Analyze the variances and ascertaining the causes of variance Take corrective action to avoid adverse variance Adjust the budget in order to make the standards more realistic
Valuation
Assigning the standard cost to the actual output Use the current standards to estimate future sales volume and future costs
Planning
Controlling
Evaluating performance by determining how efficiently the current operations are being carried out
Motivation
Variance
Variance analysis
A variance is the difference between the standards and the actual performance When the actual results are better than the expected results, there will be a favourable variance (F) If the actual results are worse than the expected results, there will be an adverse variance (A)
Profit variance
Selling and administrative Cost variance
VO Expenditure variance
VO Efficiency variance
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Cost variance
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Cost variance
Cost variance = Price variance + Quantity variance Cost variance is the difference between the standard cost and the Actual cost Price variance = (standard price actual price)*Actual quantity A price variance reflects the extent of the profit change resulting from the change in activity level Quantity variance = (standard quantity actual quantity)* standard cost A quantity variance reflects the extent of the profit change resulting from the change in activity level
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Example
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000
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The actual sales and production is 800 units. The actual income statement is shown as follows:
Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000
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Material price variance Material usage variance Total Material cost variance
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Labour rate variance $3200 (A) Labour efficiency variance $4000 (A) Total labour cost variance $7200 (A)
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Overheads variance
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Overheads variance
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Variable overheads variance is the difference between the standard variable overheads absorbed into the actual output and the actual overheads incurred
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Actual VO
VO efficiency variance
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Step 1
Budgeted overheads POAR = Budgeted activity level in standard hours
Step 2
Overhead absorbed = POAR * Standard hours for actual number of units produced
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Example
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000
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The actual sales and production is 800 units. The actual income statement is shown as follows:
Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000
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Budgeted overheads POAR = Budgeted activity level in standard hours = $6000 3000 = $2 Overhead absorbed = POAR * Standard hours for actual number of units produced = $2 *3 hr per unit * 800 units Standard hr per unit = 3000 hr /1000 units
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Variable overheads variance = variable overheads absorbed actual variable overheads incurred = $4800 - $5500 = $700 (A) Variable overheads expenditure variance = standard variable overheads for actual hours worked Actual variable overheads incurred = ($2* 3200 hr) - $5500 = $900 (F)
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Variable overheads efficiency variance = Standard variable overheads for standard hours of output Actual variable overhead absorbed = (standard hours for actual output Actual hours worked)* standard price = (3 hr *800 units 4 hr *800 units)*$2 = $1600 (A) Actual hour per unit = $3200 hr/800 units
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Variable overheads expenditure variance $900 F Variable overheads efficiency variance $1600 A Total Variable overhead variance $400 A
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Sales variance
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Actual contribution
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Sales margin volume variance = (Actual volume Budget volume)* Standard contribution per unit
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Example
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000
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The actual sales and production is 800 units. The actual income statement is shown as follows:
Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000
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Sales variance
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Sales margin price variance Sales margin volume variance Total sales variance
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$14000/1000 units
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Sales margin price variance Sales margin volume variance Total sales variance
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Actual FO
Budgeted FO
FO volume variance
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Fixed overheads variance = Fixed overheads absorbed Actual fixed overheads incurred Fixed overheads expenditure variance Budgeted fixed overheads Budgeted overheads absorbed Fixed overheads volume variance = Absorbed fixed overheads Budgeted overheads absorbed
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Example
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000
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The actual sales and production is 800 units. The actual income statement is shown as follows:
Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000
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Fixed overheads variance = Fixed overheads absorbed Actual fixed overheads incurred = ($1*3*800) - $2600 = $200 A Fixed overheads expenditure variance = Budgeted fixed overheads Budgeted overheads absorbed = $3000 - $2600 = $400 F Fixed overheads volume variance = Absorbed fixed overheads Budgeted overheads absorbed = ($1*3*800) - $3000 = $600 A
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In marginal costing:
Fixed overheads are charged as period costs instead of charging to product in marginal costing. It is assumed that the fixed overheads remain unchanged with the change in the level of activity. Single fixed overhead expenditure variance will be used
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In absorption costing
Fixed overheads are charged to the products and included in the valuation of closing stock. Total fixed overheads variance is divided into fixed overheads price variance and fixed overheads volume variance
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Profit reconciliation statement is used to sum up all variances It can help the top management to explain the major reasons for the difference between budgeted and actual profits The sales margin variance and fixed overheads variance are different between absorption and marginal costing system
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Marginal costing
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Profit Reconciliation Statement $ $ Budgeted profit Sales variances Sales margin price 8000 F Sales margin volume 3400 A 4600 F Materials cost variance Materials price 480 A Material usage 2400 F 1920 F Labour cost variance Labour rate 3200 A Labour efficiency 4000 A 7200 A Variable overhead variance VO Expenditure 900 F VO Efficiency 1600 A 700 A Fixed overhead expenditure variance 400F Actual profit
$ 14000
980 A 13020
Absorption costing
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Profit Reconciliation Statement Budgeted profit Sales variances Sales margin price 8000 F Sales margin volume 2800 A 5200 F Materials cost variance Materials price 480 A Material usage 2400 F 1920 F Labour cost variance Labour rate 3200 A Labour efficiency 4000 A 7200 A Variable overhead variance VO Expenditure 900 F VO Efficiency 1600 A 700 A Fixed overhead variance FO expenditure 400F FO Volume 600 A 200 A Actual profit
14000
980 A 13020
Price changes in market conditions Change in the efficiency of purchasing dept. to obtain good terms from suppliers Purchase of different grades or wrong types of materials
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More effective use of materials/ wastage arising from the efficient production process Purchase of different grade or wrong types of materials Wastage by the staff Change in production methods
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Non-controllable market changes in the basic wage rate Use of higher/lower grade of workers Unexpected overtime allowance paid
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Purchase of different grade or wrong types of materials Breakdown of machinery High/low labour turnover Changes in production method Introduction of new machinery Assignment wrong type of worker to work Adequacy of supervision Changes in working condition Change in motivation methods
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It may be caused by the non-controllable change in the price level of indirect wages or utility rates since the predetermined rate is set It is meaningless to interpret this kind of variance on its own. One should look various components of the fixed overheads
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Both the variable overheads and direct labour cost vary with the direct labour hours worked
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It is meaningless to interpret this kind of variance on its own. It may be caused by the change in the price levels of rent, rates and other fixed expenses
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When the level of activity is higher than the budgeted level, there is a favourable variance
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Change in the pricing strategies of the company Response to the change of pricing policies of its competitors Higher profit margin with growing demand for the product Lower profit margin for simulating sales
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Change in prices and demand Change in the market share of its competitiors
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