Qualification Paper Chapter Learning Objective Template ID Source

ACCA F5 10. Advanced variances CD1

Chapter Learning Objectives

Upon completion of this chapter you will be able to:

Define, for a manufacturing company, material mix and yield variances Calculate, from information supplied, material mix and yield variances For given or calculated material mix and yield variances, interpret and explain possible causes, including possible interrelationships between them. Explain, using simple non-numerical examples, the wider issues involved in changing mix e.g. cost, quality and performance measurement issues. Identify and explain the interrelationship between price, mix and yield, using a simple numerical example. Suggest and justify alternative methods of controlling production processes in manufacturing environments. Using revised standards supplied, calculate a revised budget. From supplied data, calculate planning and operational variances for sales (including market size and market share) From supplied data, calculate planning and operational variances for materials. From supplied data, calculate planning and operational variances for labour Identify and explain those factors that, in general, should and should not be allowed to revise an original budget Explain and resolve the typical manipulation issues in revising budgets Describe the dysfunctional nature of some variances in the modern environment of JIT and TQM Describe the major behavioural problems resulting from using standard costs in rapidly changing environments Discuss, the major effects that variances have on staff motivation and action

Advanced variances

Material mix and yield

Planning and operational variances

Using variances in the modern environment

1 Material Mix and Yield

Qualification Paper Chapter Learning Objective

ACCA F5 10 Define, for a manufacturing company, material mix and yield variances Yes ACCA 2.4 study notes and study text

Content, illustration and TYU included? Source

1.1 Material mix and yield variances

In certain industries it is possible that the materials (and other components) input to the product are interchangeable. In this situation it makes sense to identify variances related to the substitution of one material for another. Mix and yield variances are a sub-analysis of the usage variance.
Total material variance

Price

Usage

Mix

Yield

Illustration

MIX
Inputs

Malt Barley
2 tonnes

Feed Barley
8 tonnes

Y I E L D

PROCESS

Normal loss = 4 tonnes

Output

Malt extract = 6 tonnes

Material Mix The relationship of one material input to another. The standard mix shows the proportion of a material that we expect to use in a given mix. The mix variance identifies the amount by which the actual proportion differs to the standard mix. In the above example it is possible that the amount of feed barley (say) is more or less than 80% of the total. The mix variance would value the effect of that difference. Material Yield the relationship of inputs in total to the outputs. In most questions of this type there is a yield loss, this means that the input is expected to be greater than the output, there is an expected or normal loss in the process. A yield variance identifies if the inputs (in total) are greater or less than expected for a given output.

Test your understanding 1

Explain the circumstances under which a materials mix variance is relevant to managerial control.
Solution (to be put at end of chapter)

Manufacturing processes often entail the combination of a number of different materials to obtain one unit of finished product. Examples of such processes are chemicals, paints, plastics, fabrics and metal alloys.

The basic ingredients can often be combined in a variety of proportions (or mixes), without perhaps affecting the specified quality characteristics or properties of the finished product. The sub-analysis of variances into mix and yield components can provide a valuable aid to management decisions as these two variances are often interrelated. The use of a different mixture of raw materials may reduce the cost of the mix but could produce an adverse yield effect. However, a yield variance can arise for reasons other than a change in the mixture of raw materials, for example due to poor management supervision or deliberate wastage of materials by operatives. A change in the mixture of raw materials may also affect other variances, in particular labour and variable overhead efficiency variances. A study of mix variances (and of other related variances) may be particularly important when management is experimenting with the introduction of a material substitute.

Qualification Paper Chapter Learning Objective

ACCA F5 10 Calculate, from information supplied, material mix and yield variances For given or calculated material mix and yield variances, interpret and explain possible causes, including possible interrelationships between them. Identify and explain the interrelationship between price, mix and yield, using a simple numerical example.

Content, illustration and TYU included? Source

yes ACCA 2.4 study notes and study text, CIMA p1 study notes

1.2 Calculation and interpretation of material mix and yield variances.

Material mix and yield variances can be calculated using the following formulae; Mix variance = (AQAM AQSM) Standard price Yield variance = (AQSM SQSM) Standard price Usage variance = (AQAM SQSM) Standard price Or mix + yield = usage Usage + price = total material variance What do they mean?
Mix A favourable total mix variance would suggest that more lower value material is being used hence reducing the overall average cost per unit. Yield An adverse total yield variance would suggest that less output has been achieved for a given input, i.e. that the total input in volume is more than expected for the output achieved.

These variances may be interrelated. A favourable material mix variance may lead to an adverse yield variance and vice versa. Any change in mix can be judged on the impact on the overall total materials variance.

The analysis required can be summarised as follows: Actual total quantity in actual proportions at actual prices Actual total quantity in actual proportions at standard prices Actual total quantity in standard proportions at standard prices Standard total quantity in standard proportions at standard prices

PRICE

MIX

YIELD

Illustration

The following shows the standard input and cost for 6 tonnes of output Tonnes Malt barley Feed barley Total Yield loss 40% Expected output Production 2.0 @ 230 8.0 @ 110 10.0 (4.0) 6.0 270 tonnes 460 880 1,340 0 1,340

The actual input, output and costs are shown below: Input Malt barley (MB) 70 tonnes costing 16,100 Feed barley (FB) 430 tonnes costing 48,355
Required:

Prepare all material variances and discuss their causes. Price variance Material: AQAP AQSP Variance Malt barley Feed barley Total

Usage variances

Workings

Material: 1. AQAM (Actual quantity at actual mix) 2. AQSM (Actual quantity at standard mix) 3. SQSM (Standard quantity at standard mix-for actual output) 4. Standard price () Variances (all at standard price) Material: Mix

Malt barley

Feed barley

Total

Malt barley

Feed barley

Total

Yield

Usage
Solution

Price variance Material: AQAP AQSP Variance Usage variances Material: 1. AQAM 2. AQSM 3. SQSM 4. Standard price () Variances Material: Mix Yield Usage Malt barley 30 x 230 = 6,900 (F) 10 x 230 = 2,300 (A) 20 x 230 = 4,600 (F) Feed barley 30 x 110 = 3,300 (A) 40 x 110 = 4,400 (A) 70 x 110 = 7,700 (A) Total 3,600 (F) 6,700 (A) 3,100 (A) Malt barley 70 100 90 230 Feed barley 430 400 360 110 Total 500 500 270/0.6 = 450 Malt barley 16,100 16,100 0 Feed barley 48,355 47,300 1,055 (A) Total

1,055 (A)

The total material variance can be calculated; Standard material cost for 270 tonnes of output 1,340/6 x 270 Actual material cost Total material variance 60,300 64,455 4,155 A

This is made up of Price variance Mix variance Yield variance The sum of the mix and yield variances is the usage variance.
Causes

1,055A 3,600 F 6,700A

The price variance is adverse because the feed barley price is higher than expected. The mix variance is favourable because a greater proportion of feed barley has been used than would normally be used in the standard mix. Feed barley is a cheaper material than malt barley. The yield variance is adverse because less output has been achieved than was expected from the materials input. It is possible that changing the mix to include a greater proportion of cheaper feed barley has led to the reduction in yield. Overall this has led to a total adverse usage variance of 3,100 and this will adversely affect profit

An alternative layout for calculations is shown in the following example. Example Standard materials cost for 990 tonnes of production. Material A B C Tonnes 550 330 220 ____ 1,100 110 ____ 990 ____ = 6.00 5.00 4.50 Price per tonne 3,300 1,650 990 _____ 5,940 _____ 5,940 _____

Less: Normal process loss (10%) Standard cost for

This represents a standard material cost per tonne of 6.00.

Actual materials cost of 990 tonnes.

Material A

Tonnes 444

Price per tonne 3,330 7.50

B C

446 240 _____ 1,130 140 _____ 990 _____

6.00 4.50

2,676 1,080 _____ 7,086 _____

Less: Process loss Actual cost for

7,086 _____

Workings

Material

Actual quantity used in actual proportions (mix) at standard prices Tonnes Standard price per tonne 6.00 5.00 4.50

Actual quantity used in standard proportions (mix) at standard prices Tonnes Standard price per tonne 6.00 5.00 4.50

A B C

444 446 240 _____ 1,130 _____

2,664 2,230 1,080 _____ 5,974 _____

565 339 226 _____ 1,130 _____

3,390 1,695 1,017 ____ 6,102 _____

Materials price variance = (Actual material input standard prices)

(Actual input actual prices)

= 5,974 7,086 = 1,112(A)

Materials mix variance = (Total material input in standard mix standard prices) (Actual material input standard prices)

= 6,102 5,974 = 128 (F)

Materials yield variance =(Standard quantity of materials specified for actual production standard prices) (Actual total material input in standard proportions standard prices)

= 5,940 6,102 = 162 (A) Usage variance = 128(F) + 162(A) = 34 (A)

Test your understanding 2

Pan-Ocean Chemicals has one product, which requires inputs from three types of material to produce batches of product Synthon. Standard cost details for a single batch are shown below:

Materials Material type Standard kg. Standard price per kg. Standard hours

Labour Standard rate per hour

S1 S2 S3

8 5 3

0.30 0.50 0.40

5.00

A standard loss of 10% of input is expected. Actual production was 15,408 kg. for the previous week. Details of the materials used were:
Actual material used (kg.)

S1 S2 S3

8,284 7,535 3,334

Total labour cost for the week was 6,916 for 1,235 hours worked.
Required:

(a) (b)

Calculate total material mix, yield and usage variances Explain why the sum of the mix variances for materials measured in kg. should be zero.

Solution (to be put at end of chapter) (a) Direct materials mix variance: Material: S1 S2 S3 Total

1. AQAM 2. AQSM 3. SQSM 4. Standard Price () Variances

Material:

8,284 9,576.5 8,560 0.3

S1

7,535 5,985.3 5,350 0.5

S2

3,334 3,591.2 3,210 0.4

S3

19 153 19 153 15,408/0.9 =17120

Total

Mix () Yield () Usage ()

387.75 F 304.95 A 82.80 F

774.85 A 317.65 A 1,092.50 A

102.88 F 152.48 A 49.60 A

284.22 A 775.08 A 1,059.30 A

(b) The total mix variance measured in quantity is zero since the expected mix is based on the total quantity actually used and hence the difference between total expected and total actual is nil.

Test your understanding 3

Using the variances calculated in TYU 2 write a report to management, which explains and interprets your results.

The report should pay particular attention to: explaining what is meant by mix and yield variances in respect of materials, and possible reasons for all the results you have derived.

Solution (to be put at end of chapter) Analysis of variance for Pan-Ocean Chemicals Circulation: Author: Date: General

Pan-Ocean Chemicals: Senior Management

xx/xx/xx

The appendix to this report (results in part (a)) details mix, yield and usage variances for materials and rate and efficiency variances for labour over the last seven days. The purpose of this report is to explain what is meant by the analysis undertaken and to interpret the results derived.
Materials variances

Materials variances can be categorised in four ways: usage, mix, yield and price. We are concerned only with mix and yield for the purposes of this report. The three types of material used to produce Synthon (S1, S2 and S3) are not always used in the same proportions. Whilst it is the intention of the production team to use a constant or standard mix, this is not always achieved. In practice, the proportions of input chemicals used can vary for many reasons, mostly associated with the physical properties of the chemicals (which need not concern us here). To the extent that the standard mix is not used in the production of Synthon, then mix variances arise which simply record to what extent the standard mix has not been followed. Materials yield variances record the differences arising in what inputs should have been used for the output achieved against what inputs have actually been used. Essentially, yield variances are a description of how efficiently inputs have been used. The adverse yield variance should give rise to some concern since such results indicate an inefficient use of inputs against what was expected. The adverse variance may have arisen, for example, because of a batch of poor quality input chemicals or because of inefficient working practices, which have led to a significant degree of spoilage.
Final comments

Variances of any type should be a signal for some sort of investigative action by management. This can involve either looking to see how the variances have arisen or re-assessing the suitability of the standards that have been set. It might have to be accepted that the standard by which materials is being measured might not be an accurate one.

Material mix variances- average valuation method

The mix variance in the previous examples has been valued using standard price. It can also be valued at the difference between actual price and standard price. This gives the same total mix variance but different variances for each individual material. The individual variances using this method are more meaningful. Less of a cheaper material will give rise to an adverse mix variance and vice versa.

Material

Material A kg

B kg

Total kg

1 2 3 4

Actual input Actual input in std proportions Difference in quantity x Difference in price (weighted average std price individual material std price ) x (X X) x (X X) Mix variance

X X ____ X

X X ____ X

XX XX ____

xX ____ X ____ x (X) ____ X ____ ____ X ____

Illustration

Hordru Ltd operates a standard costing system. The standard direct material mix to produce 1,000 kgs of output is as follows:
Material grade Input quantity (kgs) Standard price per kilo input

A B C

600 240 360

1.10 2.40 1.50

During April the actual output of the product was 21,000 kilos. The actual materials issued to production were:
Material grade Quantity (kgs)

A B C
Required:

14,000 5,500 5,500

(a)

Calculate material mix variances for each material grade and in total, and the material yield variance in total where individual material prices per kilo are used as the variance valuation base. Prepare an alternative summary giving the same range of variances as in (a) above but using the budgeted weighted average material price per kilo as the valuation base.
Solution

(b)

(a)
Mix variance Material Material A B Material C Total

kg 1 Actual input 14,000

kg 5,500

kg 5,50025,000

kg

Actual input in std proportions 50%:20%:30% 12,500 5,000 ______ ______ 1,500 A 500 A

7,500 25,000 ______ ______ 2,000 F x 1.50 ______ 3,000 F ______ 150 F ______

3 4 5

Difference in quantity x Std Price Mix variance

x 1.10 x 2.40 ______ ______ 1,650 A 1,200 A ______ ______

Yield variance

Std cost per kg of output

600 x 1.10 + 240 x 2.40 + 360 x 1.50 1,000 kg

kg

1.776/kg

Std yield 25,000 x

1,000 1,200

20,833.33 21,000 ________ x 1.776 ________ 296 F ________ =

2 3 4

Actual yield 166.67 F x Std price/cost per kg of output Yield variance

(b)

Weighted average std cost =

600 x 1.10 + 240 x 2.40 + 360 x 1.50 1,200 kg

1.48/kg

Mix variance Material Material A B Material C Total

kg 1 2 Actual input 50%:20%:30% 3 4 14,000 Actual input in std proportions

kg 5,500

kg 5,500 7,500 ______ 2,000

kg 25,000 25,000 ______

12,500 5,000 ______ ______

Difference in quantity 1,500 500 x Difference in price (weighted av. std price Ind. material std price) x (1.48 1.10) x 0.38 x (1.48 2.40) x 0.92 x (1.48 1.50) ______ ______ Mix variance 570 F 460 A ______ ______

0.02 ______ 40 F ______ 150 F ______

Yield variance This is calculated in exactly the same way under both methods.

Std cost per kg of output

600 x 1.10 + 240 x 2.40 + 360 x 1.50 1,000 kg

kg

= 1.776/kg

Std yield 25,000 x

1,000 1,200

20,833.33 21,000 ________ x 1.776 ________ 296 F ________

2 3 4

Actual yield 166.67 F x Std price/cost per kg of output Yield variance

Qualification Paper Chapter Learning Objective

ACCA F5 10 Explain, using simple non-numerical examples, the wider issues involved in changing mix e.g. cost, quality and performance measurement issues. yes Original

Content, illustration and TYU included? Source

1.3 Changing mix the wider issues

It has already been shown that changing the mix of material input can affect the material yield of the process. It can impact on; cost quality performance measurement

Illustration A company produces pre cast concrete sections for the construction industry. The mix of materials used to produce the concrete can be varied and different mixes are suitable for different products. Discuss the issues that management should consider when setting standard material costs. Solution For each product management should consider the optimum mix of input materials that will maximise profits to the business. This may involve consideration of the relationship between cost, quality and price. Reducing the cost of input materials by using a greater proportion of a cheaper material may reduce the quality of the product and lead to a reduction in the price that can be charged. Costs of reduced quality. Using a greater proportion of a cheaper input material may lead to higher quality failure costs.

Impact on other variances. Increasing the proportion of a cheaper input material may result in increased labour costs or overhead costs if this leads to more time having to be spent producing a product. Increased rejects may lead to higher overhead costs. It may be the case that, whilst changing a material mix could lead to an overall favourable material variance this could have an adverse impact on the profitability of the business if prices have to be reduced because of reduced quality or quality failure costs exceed material cost savings. Thus, in a TQM environment it is important to set the standard mix at the level which optimises profit taking all factors into consideration.

Test your understanding 4 Discuss how the performance measurement system should be designed when the mix of input materials can be varied in a process.

Solution (to be put at end of chapter) In a performance measurement system managers are often rewarded for improving the performance of cost and/or revenues under their control. The production manager may be responsible for the material mix decision and, if the reward system is based on achieving cost savings, then the cheapest mix may be used. This may have a detrimental effect on company profit if quality is reduced and this leads to a lower price or quality failure costs. It may therefore be preferable to reward managers on the basis of total company profit so that the full impact of the mix decision is taken into account.
Qualification Paper Chapter Learning Objective

ACCA F5 10 Suggest and justify alternative methods of controlling production processes in manufacturing environments yes CIMA P4 study text and study notes

Content, illustration and TYU included? Source

1.4 The control of production processes in manufacturing environments

In the modern manufacturing environment companies must continually seek ways of improving processes in order to compete and survive. Selecting the optimum material mix may be one factor in maximising profit. Computerised production control may assist in the planning and implementation of production.

Manufacturing Resource Planning (MRP)

Materials requirement planning, or MRP 1, is a computerised system for planning the requirements for raw materials and components, sub-assemblies and finished items. It is a system that converts a production schedule into a listing of the materials and components required to meet that schedule, so that adequate stock levels are maintained and items are available when needed.

Functions include: Identifying firm orders and forecasting future orders with confidence. Translating these into capacity requirements; Determining quantities of materials required; Determining the timing of material requirement; Calculating purchase orders based on stock levels; Automatically placing purchase orders; Scheduling labour and materials for future production. Benefits include: Reduced stock holding; Improved ability to meet orders; Reliable quotations of delivery times; Improved facilities utilisation; Less time spent on emergency orders; Better supplier relationships. Disadvantages are; MRP I is not suitable when it is impossible to predict sales in advance, or when sales demand for items is continuous and random. For example, an MRP I system would not be appropriate for a supermarket, or for systems that are used to manufacture non-standard items (such as contracting businesses or small jobbing businesses). An MRP I system can also be fairly complex, and might therefore be difficult to use when the MPS has to be changed regularly or frequently.

Manufacturing Resource Planning (MRPII)

Manufacturing resource systems or MRP II systems are an extension of MRP I, and MRP I is a core feature of MRP II.

MRP II systems differ from MRP I systems by integrating into the same system other processes that are related to materials requirements planning, and in particular: financial requirements planning labour scheduling equipment utilisation scheduling.

Illustration Oliver Wight, an early advocate of MRP, defined MRP II as a game plan for planning and monitoring all the resources of a manufacturing company: manufacturing, marketing, finance and engineering.

Without MRP II, the engineering function and the manufacturing function would have had separate files for bills of materials (BOM). Changes to the specification of a

product might be entered on one BOM file but not on the other, resulting in differences and discrepancies between the activities of the two functions. Similarly, the finance function might use a different product database for producing estimates of costs and comparing actual costs against the budget. The product file used by the finance function might differ from the product specifications of the BOM file used by the manufacturing function. Giving all functions access to the same product database removes the risks and problems of such differences and discrepancies.

Enterprise Resource Planning (ERP)

ERP is a management system that integrates all aspects of the business into a single computer-based system to meet the needs of all organisational users. Its scope moves into HR applications, logistics, sales, marketing and comprehensive management accounting as well as an Extranet to co-ordinate those outside of the organisation.

Typically, an ERP system provides an integrated database for: operations (e.g. manufacturing) purchasing and supply financial applications human resource management applications sales and marketing applications delivery and logistics applications customer services applications strategic reporting to senior management. Features of ERP systems include: allowing access to the system to any individual with a terminal linked to the systems central server decision support features, to assist management with decision-making in many cases, extranet links to the major suppliers and customers, with electronic data interchange facilities for the automated transmission of documentation such as purchase orders and invoices.

Optimised Production Technology (OPT)

These systems focus on bottleneck improvement. They identify constraints and use these to schedule production whilst determining ways of overcoming the capacity restriction so improving overall production capability.

An OPT system is a production scheduling system that focuses on bottlenecks. Production scheduling is based on the capacity of the bottlenecks, and the pace of throughput that these can handle. Some of the principles or rules of OPT are as follows. A bottleneck or critical resource determines the production capacity for the entire system. The level of utilisation of non-critical resources should reflect the requirements of the critical resources. An hour lost on a bottleneck is an hour lost to the entire production system. An hour saved at a non-bottleneck has no real impact or value. Bottlenecks determine the amount of throughput and the size of inventories. Why produce a component faster than a bottleneck can use it? All that will happen is an unnecessary and costly increase in inventories of the component. The size of a batch transferred from one stage in production to another does not need to be the same as the batch size produced by the process. The process batch size should be variable, to optimise throughput, and should not be a fixed or standard quantity. Production schedules should be developed by looking at all the constraints in the system. Production lead times will be a consequence of what is feasible within the schedules, and are not a predetermined length of time.

Just-in-time (JIT)

JIT is a pull-based system of planning and control pulling work through the system in response to customer demand. This means that goods are only produced when they are needed, eliminating large stocks of materials and finished goods. Key characteristics for successfully operating such a system are: High quality Speed Reliability Flexibility Low costs Possibly through deploying TQM systems; Rapid throughput to meet customers needs; Computer aided manufacturing technology will assist; Small batch sizes and automated techniques are used; Through all of the above.

Test your understanding 5 With fixed order quantity systems, a company manufacturing parts and components for its own finished products will choose to manufacture each part or component, as well as each finished product item, in fixed quantities or batch sizes. Similarly, it will purchase items from suppliers in fixed order quantities (EOQ sizes). Required Discuss how this approach differs from am MRP1 system. Solution (to be put at end of chapter)

Fixed order quantity system Order quantities determined individually for each end-product, component part and raw material separately New supply of each item when inventory level is low Production or purchase orders triggered by inventory reaching reorder level

MRP I system Materials requirements based on requirement for finished products Production of parts and purchases scheduled to meet production requirements of end products. Production or purchase orders triggered by scheduled timing in MRP I plan Compatible with just-in-time manufacturing and JIT purchasing Suitable when demand is lumpy and not continuous, or when demand is predictable.

Suitable when there is continuous random demand for the item

2 Planning and operational variances

Qualification Paper Chapter Learning Objective

ACCA F5 10 Using revised standards supplied, calculate a revised budget. Yes ACCA 2.4 study notes and study text, CIMA p1 study text

Content, illustration and TYU included? Source

2.1 Revised standards and budgeting

Traditionally when comparing standards to actual results the comparison has suffered from the time delay between setting the standard and the occurrence of the actual results. The standard is set as part of the budgeting process which occurs before the period to which it relates, this means that the difference between standard and actual may arise solely due to an unrealistic budget and not due to operational factors. The budget may need to be revised to enable actual performance to be compared with a standard that reflects these changed conditions.

Planning variances
Aims to update the original standards to reflect the change in conditions and environment. They compare original standards with revised standards. Often deemed to be uncontrollable. Management may not be held responsible.

Operational variances
Aims to measure efficiency and performance of operational staff. standards to actual results. Compares revised

Deemed controllable. Management held responsible for operational variances.

Original standard

Revised standard

Actual

Planning

Operational

Illustration

Rhodes Ltd manufactures Stops which it is estimated require 2 kg of material XYZ at 10/kg. In week 21 only 250 Stops were produced although budgeted production was 300. 450 kg of XYZ were purchased and used in the week at a total cost of 5,100. Later it was found that the standard had failed to allow for a 10% price increase throughout the material suppliers industry. Rhodes Ltd carries no stocks.
Planning and operational analysis

The first step in the analysis is to calculate: 1 2 3 Original flexed budget Revised flexed budget Actual results. (ex-ante). (ex-post).

(W 1 )

O r ig in a l f le x e d b u d g e t ( e x -a n t e ) 2 5 0 u n it s a t 2 k g p e r u n it fo r 1 0 / k g = 5, 0 0 0 P la n n in g v a ria n c e = 5, 5 0 0 O p e ra t io n a l v a ria n c e 5, 1 0 0

(W 2 )

R e v is e d fle x e d b u d g e t ( e x -p o s t ) 2 5 0 u n it s a t 2 k g p e r u n it fo r 1 1 / k g

(W 3 )

A c t u a l re s u lt s 4 5 0 k g fo r

Test your understanding 6

A transport business makes a particular journey regularly, and has established that the standard fuel cost for each journey is 20 litres of fuel at $2 per litre. Due to a change in the vehicle used for the journey and an unexpected rise in fuel costs, it is decided retrospectively that the standard cost per journey should have been 18 litres at $2.50 per litre. Calculate the original and revised flexed budgets if the journey is made 120 times in the period.
Solution (to be put at end of chapter)

Original flexed budget 120 x 20 x 2 4,800 Revised flexed budget 120 x 18 x 2.50 5,400
Qualification Paper Chapter Learning Objective

ACCA F5 10 From supplied data, calculate planning and operational variances for sales (including market size and market share) Yes ACCA 2.4 study text and original

Content, illustration and TYU included? Source

2.2 Planning and operational variances for sales

Planning and operational variances may be calculated for sales price and sales volume. In each case the total variance can be separated into a planning and operational element as follows;

Original standard

Revised standard

Actual

Planning Variance

Operational Variance

For sales volume the planning variance is known as a market volume variance and the operational variance is known as a market share variance Planning market volume variance Operational market share variance

Illustration Hudson Ltd has a sales budget of 400,000 units for the coming year based on 20% of the total market. On each unit, Hudson makes a profit of 3. Actual sales for the year were 450,000, but industry reports showed that the total market volume had been 2.2 million.

a) Find the traditional sales (margin) volume variance. b) Split this into planning and operational variances (market volume and market share).
Solution

(a)

Traditional sales volume variance = (Actual units sold Budgeted sales) Standard profit per unit = (450,000 400,000) 3 = 150,000 (favourable).

(b)

Planning and operational variances

The revised (ex-post) budget would show that Hudson Ltd should expect to sell 20% of 2.2 million units = 440,000 units. Original budget (ex-ante)
400,000 units @ 3 per unit Revised budget (ex-post) 440,000 units @ 3 per unit Actual results 450,000 units @ 3 per unit = 1,350,000 = 1,320,000 = 1,200,000 Planning ('Market volume') variance Operational ('Market share') variance

Planning (or market volume) variance = 1,320,000 1,200,000 Operational (or market share) variance = 1,350,000 1,320,000 Total sales volume variance = 120,000 (F) 30,000 (F) _______ 150,000 (F) _______

Most of the favourable sales volume variance can be attributed to the increase in the overall market volume, however some can be put down to effort by the sales force which has 450, 000 increased its share of the market a little from 20% to = 20.5%. 2, 200, 000

Test your understanding 7 A company sets its sales budget based on an average price of 14 per unit and sales volume of 250,000 units. Competition was more intense than expected and the company only achieved sales of 220,000 and had to sell at a discounted price of 12.50 per unit. The company was unable to reduce costs so profit per unit fell from 4 per unit to 2.50 per unit. It was estimated that the total market volume grew by 10% from 1,000,000 units to 1,100,000 units. Required; a) calculate the sales price and volume variances b) analyse the volume variances into market share and market size c) discuss whether the price variance is a planning or operational variance Solution (to be put at end of chapter) a) Sales price variance = 220,000 x (14 12.50) = 330,000 A Sales volume variance = (250,000 220,000) x 4 = 120,000 A b)Budgeted market share = 250,000/1,000,000 = 25% The company would have expected to achieve sales of 25% x 1,100,000 = 275,000 in the actual market conditions. The market size variance = (275,000 - 250,000) x 4 = 100,000 F The market share variance = (275,000 220,000) x 4 = 220,000 A The increased market size is favourable as the company should sell more if market share can be maintained. The market share variance was adverse as market share fell from 25% to 220,000/1,100,000 = 20% c) It could be argued that the increased competition in the market was not foreseen when the budget was set and the variance is a planning variance.

Qualification Paper Chapter Learning Objective

ACCA F5 10 From supplied data, calculate planning and operational variances for materials. Yes ACCA 2.4 study notes

Content, illustration and TYU included? Source

2.3 Planning and operational variances for materials

Planning and operational variances can be calculated for materials in the same way as for sales.

Illustration The standard cost per unit of raw material was estimated to be 5 per unit. The general market price at the time of purchase was 5.20 per unit and the actual price paid was 5.18 per unit. 10,000 units of the raw materials were purchased during the period. Calculate the purchasing planning and operational variances. Solution Planning variance:

AQ RSP AQ SP PRICE VARIANCE

Operational variance:

10,000 x 5.20 10,000 x 5

52,000 50,000 2,000 (A)

AQ AP AQ RSP PRICE VARIANCE

10,000 x 5.18 10,000 x 5.20

51,800 52,000 200 (F)

Test your understanding 8

Holmes Ltd uses one raw material for one of their products. The standard cost per unit at the beginning of the year was 28, made up as follows: Standard material cost per unit = 7 kg. per unit at 4 per kg. = 28

In the middle of the year the supplier had changed the specification of the material slightly due to problems experienced in the country of origin, so that the standard had to be revised as follows: Standard material cost per unit = 8 kg. per unit at 3.80 per kg. = 30.40 The actual output for November was 1,400 units. 11,000 kg. of material was purchased and used at a cost of 41,500.
Required:

(a) (b)

Material price and usage variances using the traditional method. All planning and operational material variances.

Solution (to be put at end of chapter)

(a)

Traditional variances

AQAP AQSP SQSP (b)

Planning variances

41,500 Price variance 11,000 x 4 1400 x 7 x 4 Usage Variance 39,200 44,000

2,500 (F) 4,800 (A)

RSQ x RSP RSQ x SP SQ x SP

Operational variances AQ x AP

1,400 x 8 x 3.80 42,560 Price variance 1,400 x 8 x 4 44,800 Usage variance 1,400 x 7 x 4 39,200

2,240 (F) 5,600 (A)

AQ x RSP RSQ x RSP

41,500 Price variance 11,000 x 3.80 41,800 Usage variance 1,400 x 8 x 3.80 42,560

300 (F) 760 (f)

Qualification Paper Chapter Learning Objective

ACCA F5 10 From supplied data, calculate planning and operational variances for labour Yes ACCA 2.4 study text and study notes

Content, illustration and TYU included? Source

2.4 Planning and operational variances for labour

Planning and operational variances for labour can be calculated in the same way as for materials.

Illustration The standard hours per unit of production for a product is 5 hours. Actual production for the period was 250 units and actual hours worked were 1,450 hours. The standard rate per hour was 10. Because of a shortage of skilled labour it has been necessary to use unskilled labour and it is estimated that this will increase the time taken by 20%. Calculate the planning and operational efficiency variances. Solution Planning variance:

RSH SR 6 x 250 x 10 SH SR 5 x 250 x 10 EFFICIENCY VARIANCE

Operational variance:

15,000 12,500 2,500 (A)

AH RSR 1,450 x 10 RSH RSR 6 X 250 x 10 EFFICIENCY VARIANCE

14,500 15,000 500 (F)

Test your understanding 9 POV Ltd uses a standard costing system to control and report upon the production of its single product. An abstract from the original standard cost card of the product is as follows:

Selling price per unit Less: 4 kgs materials @ 20 per kg 6 hours labour @ 7 per hour 80 42 __

200

122 ___ 78 ___

Contribution per unit For period 3, 2,500 units were budgeted to be produced and sold but the actual production and sales were 2,850 units. The following information was also available: (1) At the commencement of period 3 the normal material became unobtainable and it was necessary to use an alternative. Unfortunately, 0.5 kg per unit extra was required and it was thought that the material would be more difficult to work with. The price of the alternative was expected to be 16.50 per kg. In the event, actual usage was 12,450 kgs at 18 per kg. Weather conditions unexpectedly improved for the period with the result that a 50p per hour bad weather bonus, which had been allowed for in the original standard, did not have to be paid. Because of the difficulties expected with the alternative material, management agreed to pay the workers 8 per hour for period 3 only. During the period 18,800 hours were paid for. After using conventional variances for some time, POV Ltd is contemplating extending its system to include planning and operational variances.

(2)

Required:

(a) (b) (c)

Prepare a statement reconciling budgeted contribution for the period with actual contribution, using conventional material and labour variances. Prepare a similar reconciliation statement using planning and operational variances. Explain the meaning of the variances shown in statement (b).

Solution (to be put at end of chapter) Reconciliation of budgeted and actual contribution using conventional variances

Budgeted contribution: Variances Sales volume Direct material Direct labour

Price Usage Rate Efficiency

2,500 78 Favourable 27,300 24,900

195,000 Adverse

______ 52,200 ______

21,000 18,800 11,900 ______ 51,700 ______

500 _______ 195,500 _______

Actual contribution
Assumption: No sales price variance. Workings Conventional variances

(i) Materials Price = (Actual material purchased standard price) (Actual cost of material purchased) = (12,450 20) (12,450 18) = 249,000 224,100 = 24,900 (F) Usage = (Standard quantity for actual production standard price) (Actual material used at standard price) = (2,850 4 20) (12,450 20) = 228,000 249,000 = 21,000 (A) Labour Rate = (Actual hours worked standard direct labour rate) (Actual hours worked actual hourly rate) = (18,800 7) (18,800 8) = 131,600 150,400 = 18,800 (A) Efficiency = (Standard hours of actual production standard rate) (Actual hours worked standard rate) = (2,850 6 7) (18,800 7)

(ii)

= 119,700 131,600 = 11,900 (A) (iii) Sales volume contribution = (Budgeted sales units standard contribution per unit) (Actual sales units standard contribution per unit) = (2,500 78) (2,850 78) = 195,000 222,300 = 27,300 (F) Reconciliation statement using planning and operational variances Budgeted contribution for actual sales: 2,850 78 Planning variances Material Labour Price Usage Rate: weather Rate: material Favourable 44,887.50 28,500 8,550.00 53,437.50 Revised budgeted contribution (77.75 2,850) Operational variances Material Labour Price Usage Rate Efficiency Favourable 6,187.50 0 6,187.50 13,600.00 32,275.00 26,087.50 195,500.00 Adverse 18,675.00 25,650 54,150 222,300.00 Adverse

(712.50) 221,587.50

Actual contribution

Workings Planning variances

(i)

Material

(Standard material cost) (Revised standard material cost) = = = = 256,500 211,612.50 44,887.50 (F) 228,000 256,500 28,500 (A)

Price = (2,850 (4 + 0.5) 20) (2,850 (4 + 0.5) 16.50)

Usage = (2,850 4 20) (2,850 4.5 20)

(ii) (1) Weather bonus

Labour rate

= =

(2,850 6 7) (2,850 6 6.50) 119,700 111,150

= (2) Alternative material difficulties =

8,550 (F)

(2,850 6 6.50) (2,850 6 8) = 111,150 136,800 = 25,650 (A) Revised unit contribution is as follows. 200.00 4.5 16.50 6 8 74.25 48.00 _____ (122.25) ______ Contribution 77.75 ______

Selling price Direct material: Direct labour:

Operational variances (i) Material

Price = (12,450 16.50) (12,450 18) = 205,425 224,100 = 18,675 (A) Usage = (2,850 4.50 16.50) (12,450 16.50) = 211,612.5 205,425 = 6,187.5 (F) (ii) Labour Rate = 0 Efficiency = (2,850 6 8) (18,800 8) = 136,800 150,400 = 13,600 (A) (c) The analysis of variances in part (b) makes it possible to separate those variances which are non-controllable (the planning variances) from the variances which are controllable by the individual managers (the operational variances). In this case the change in type of material used was unavoidable. Similarly, the change in weather conditions could not have been anticipated. The cost implications of these changes are reflected in the planning variances. Managements attention should be focused primarily on the operational variances. In particular, why did the firm pay 18 per kg for material when this was expected to cost 16.50? The operational material usage variance indicates that less material was used than expected this could be due to the workers spending longer working with the material (as evidenced by the adverse efficiency variance).

Qualification Paper Chapter Learning Objective

ACCA F5 10 Identify and explain those factors that, in

general, should and should not be allowed to revise an original budget Explain and resolve the typical manipulation issues in revising budgets
Content, illustration and TYU included? Source

Yes CIMA P1 study text and ACCA 2.4 study text, some original

2.5 When should a budget be revised ?

There must be a good reason for deciding that the original standard cost is unrealistic. Deciding in retrospect that expected costs should be different from the standard should not be an arbitrary decision, aimed perhaps at shifting the blame for poor results from poor operational management to poor cost estimation. A good reason for a change in the standard might be: a change in one of the main materials used to make a product or provide a service an unexpected increase in the price of materials due to a rapid increase in world market prices (for example, the price of oil or other commodities) a change in working methods and procedures that alters the expected direct labour time for a product or service an unexpected change in the rate of pay to the work force. The aim of variance reporting should be to: identify responsibilities for performance, and attempt to put a realistic value to the costs or benefits arising from that performance.

If different managers are responsible for planning and operations, the responsibility for the variances can be attributed to the appropriate manager, and the principles of responsibility accounting can be properly applied. However, frequent errors in the ex ante standard should not happen, except in unusual circumstances, and the need to report planning and operational variances should therefore be occasional rather than a regular event.

Illustration A company is operating in a fast changing environment and is considering whether analysing existing variances into a planning and operational element would help to improve performance. Discuss the advantages and disadvantages of the approach. Solution

Advantages may include 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 emphasises the importance of planning and the relationship between planning and control and is a better guide for cost control.

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

Disadvantages are

Test your understanding 10 It might be argued that only operational variances have significance for performance measurement. Planning variances cannot be controlled and so have little or no value for performance reporting. Required: State briefly, with your reason or reasons, whether you agree with this point of view. Solution (to be put at end of chapter) A performance reporting and management control system depends on both reliable planning as well as control over operating activities. Some planning variances might be caused by factors that could not have been foreseen in advance. However, some planning variances might be caused by weaknesses in the planning process. If so, they can be significant and indicate the need for better planning procedures in the future.

3 Using variance analysis

Qualification Paper Chapter Learning Objective

ACCA F5 10 Describe the dysfunctional nature of some variances in the modern environment of JIT and TQM Yes

Content, illustration and

TYU included? Source

CIMA P1 study text, some original

3.1 Variance analysis in the modern manufacturing environment

Standard product costs are associated with traditional manufacturing systems producing large quantities of standard items. Key features of companies operating in a JIT and TQM environment are; High level of automation High level of overheads and low levels of direct labour costs Customised products, produced in small batches Low stocks

Emphasis on high quality Variance analysis may not be appropriate because; Standard product costs apply to manufacturing environments in which quantities of an identical product are output from the production process. They are not suitable for manufacturing environments where products are non-standard or are customised to customer specifications.

It is doubtful whether standard costing is of much value for performance setting and control in automated manufacturing environments. There is an underlying assumption in standard costing that control can be exercised by concentrating on the efficiency of the work force. Direct labour efficiency standards are seen as a key to management control. However, in practice where manufacturing systems are highly automated, the rate of production output and materials consumption are controlled by the machinery rather than the work force. Variances are the difference between actual performance and standard, measured in cost terms. The significance of variances for management control purposes depends on the type of standard cost used. For example, adverse variances with an ideal standard have a different meaning from adverse variances calculated with a current standard. Standard costing and adherence to a pre-set standard is inconsistent with the concept of continuous improvement, which is applied within Total Quality Management and JIT environments. When standard costing was first devised, the main elements of product costs were direct materials and direct labour. In modern manufacturing, production overhead costs are often a high proportion of total production costs. Standard costing is therefore not an appropriate system of performance measurement or effective management control. Variance analysis is often carried out on an aggregate basis (total material usage variance, total labour efficiency variance and so on) but in a complex and constantly changing business environment more detailed information is required for effective management control. Variance analysis control reports tend to be made available to managers at the end of a reporting period. In the modern business environment managers need more real time information about events as they occur. Shorter product life cycles in the modern business environment mean that standard costs will need to be reviewed and updated frequently. This will increase the cost of operating a standard cost system but, if the standards are not updated regularly, they will be of limited use for planning and control purposes. The extra work involved in maintaining up-to-date standards might limit the usefulness and relevance of a standard costing system.

Illustration

Explain why traditional variance analysis may be dysfunctional in a TQM environment

Solution

The reasons include; The underlying principles of TQM are zero defects and continuous improvement. Traditional variances are based on attainable standards which incorporate an acceptable level of inefficiency. This may send the wrong signals to managers about the may the company wishes to operate. Traditional variance analysis places the emphasis on controlling operations by using exception reporting at the end of each period. TQM seeks to empower employees to take action to improve processes immediately. In a TQM system there will be more emphasis placed on non-financial, real time feedback to correct problems as they occur. Traditional variance analysis measures actual performance against a predetermined standard for direct labour, direct materials and overhead costs and places the emphasis on operating at full capacity at the lowest cost possible. TQM operates on the principle that increasing prevention and appraisal costs leads to a reduction in failure costs. Increasing production costs may lead to higher quality and lower failure costs and therefore higher profitability.

Test your understanding 11 Comment on whether standard costing applies in both manufacturing and service businesses and how it may be affected by modern initiatives of continuous performance improvement and cost reduction. Solution (to be put at end of chapter)

Standard costing is most suited to organisations whose activities consist of a series of common or repetitive operations. Typically, mass production manufacturing operations are indicative of its area of application. It is also possible to envisage operations within the service sector to which standard costing may apply, though this may not be with the same degree of accuracy of standards which apply in manufacturing. For example, hotels and restaurants often use standard recipes for preparing food, so dealing with conference attendance can be like a mass production environment. Similarly, banks will have common processes for dealing with customer transactions, processing cheques etc. It is possible therefore that the principles of standard costing may be extended to service industries. In modern manufacturing and service businesses, continuous improvement and cost reduction are topical. In order to remain competitive it is essential that businesses address the cost levels of their various operations. To do this they have to deal with the costing of operations. But the drive to 'cost down' may mean in some cases that standards do not apply for long before a redesign or improvement renders them out of date. In such a setting an alternative to the use of standard costs is to compare actual costs with those of the previous operating period. We have seen in (a) above that a standard costing system has a variety of purposes. It is for management to judge their various reasons for employing standard costing, and consequently whether their aims of continuous improvement and cost reduction renders the system redundant.

Qualification Paper Chapter Learning Objective

ACCA F5 10 Describe the major behavioural problems resulting from using standard costs in rapidly changing environments Discuss, the major effects that variances have on staff motivation and action

Content, illustration and TYU included? Source

Yes P1 study text

3.2 Standard costs and behavioural issues

Standard costs are set with a view to measuring actual performance against the standard, and reporting variances to the managers responsible. The aims of setting standards include: setting a target for performance motivating the managers responsible to achieve those targets holding these managers accountable for actual performance perhaps rewarding managers for good performance and criticising them for poor performance. Managers and employees might respond in different ways to standard setting.
Standards as a target for achievement Individuals might respond to standards in different ways, according to the difficulty of achieving the standard level of performance. When a standard level of performance is high, for example an ideal standard, employees and their managers will recognise that they cannot achieve it. Since the target is not achievable, they might not even try to get near it. When the standard of performance is not challenging (for example, a current standard), employees and their managers might be content simply to achieve the standard without trying to improve their performance.

An attainable standard might be set that challenges employees and their managers to improve their performance. If this attainable standard is realistic, it might provide a target that they try to achieve.

Standard costs and motivation An argument in favour of setting attainable standards is that they can be used to motivate employees and their managers to improve performance. However, this argument is based on the assumption that individuals are motivated by challenging targets. This is not necessarily the case. If the standard is too difficult, it could have the opposite effect and de-motivate individuals. Even if the standard is attainable, individuals will not necessarily be motivated to achieve it. It might be necessary to provide motivation in the form of a bonus or other type of reward for achieving the standard.

Individuals might prefer standards to be set at a low level of performance, in order to avoid the need to work harder. Participation in standard setting It has been suggested that if managers and employees can participate in the standard setting process, their motivation will improve. They might become involved in trying to improve performance levels. Having set the standards, they will be motivated to try to achieve the targets they have set for themselves. Participation in standard-setting could therefore be a way of achieving improvements in performance. However, the effectiveness of participation in setting standards depends on a variety of factors, such as the type of staff involved, the attitudes of their managers, the organisation structure and culture and the nature of the work. Arguments in favour of participation It could motivate employees to set higher standards for achievement. Staff are more likely to accept standards that they have been involved in setting. Morale and actual performance levels might be improved. Arguments against participation Senior management might be reluctant to share responsibilities for budgeting. The standard-setting process could be timeconsuming. Staff might want to set standards that they are likely to achieve, rather than more challenging targets. They might try to build some slack into the budget. The standard setting process could result in conflicts rather than co-operation and collaboration. Staff might feel that their suggestions have been ignored.
Pay as a motivator If standards are used as a way of encouraging employees to improve their performance, motivation could be provided in the form of higher pay (or other rewards) if targets are reached or exceeded. However, if employees are offered a bonus for achieving standard costs, this could increase their incentive to set low standards of performance, and include slack in the standard cost. Lower standards will increase the probability that the standards will be achieved and a bonus will be earned.

Staff will understand more clearly what is expected of them.

Illustration Variance reporting should prompt positive responses, but in practice could result in negative and defensive actions by the manager responsible.

If there is a culture of blame when adverse variances occur, managers might try to disguise their poor results (for example, by deferring essential spending or rushing work though in order to improve efficiency regardless of quality). The response to adverse variances needs to be more positive. The aim of reporting adverse variances is to indicate problems that might have occurred, and encourage managers to take action to deal with their cause.

Test your understanding 12 Which one of the following is not an advantage of participation in standard setting? Answer options: A. The time taken to reach decisions will be quicker via assorted committee meetings. B. The quality of decisions should improve with collective decision making C. Improved communication between staff D. Staff are more likely to accept standards that they have helped set. Solution (to be shown at the end of the chapter) A is the correct answer.

Greater participation by staff in standard setting is likely to slow down the process of agreeing values.

Test your understanding 13 What are the major behavioural problems resulting from using standard costs in rapidly changing environments? Solution (to be shown at the end of the chapter) In a rapidly changing environment it may be necessary to continually revise standards to reflect up to date prices and methods of working frequently introduce new products or customise existing products This will involve frequent changes to standards and may mean that it is difficult to set meaningful standards for the measurement of performance too time consuming to encourage participation in the setting of standards It will be difficult to use standards effectively for planning and control and it may not be possible to use standards effectively to motivate staff.

Chapter Summary
Qualification Paper Chapter Template ID Source

ACCA F5 10

Advanced variances

Material mix and yield Definition Calculation When applicable Interpretation Interrelationship Impact on cost and quality Control of production

Planning and operational variances Revision budgets Planning and operational variances for sales (including market size and market share), materials and labour Manipulation issues

Using variances in the modern environment Variances in a TQM and JIT environment Level of standard and motivation Participation in standard setting