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Cost assignment

This document is a group assignment from Rift Valley University focusing on Standard Costing and Flexible Budgets in the context of Cost and Accounting Management. It outlines the importance of budgeting as a planning and performance evaluation tool, discusses standard cost systems, their advantages and limitations, and the development of standard cost systems. The document also highlights the differences between budgetary control and standard costing, as well as considerations in establishing standards.

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Daniel Shebiru
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© © All Rights Reserved
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0% found this document useful (0 votes)
14 views

Cost assignment

This document is a group assignment from Rift Valley University focusing on Standard Costing and Flexible Budgets in the context of Cost and Accounting Management. It outlines the importance of budgeting as a planning and performance evaluation tool, discusses standard cost systems, their advantages and limitations, and the development of standard cost systems. The document also highlights the differences between budgetary control and standard costing, as well as considerations in establishing standards.

Uploaded by

Daniel Shebiru
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Rift Valley University Bale Robe Campus

Department Of Business Management

Group Assignment Of Cost and Accounting Management

Title:- Standard Costing and Flexible Budget

Program:- Degree 4rd Year

Modality:- Regular Section:- “ A “

No Student name ID

1. Daniel Shebiru................0192/14

2. Sime Jifar........................0081/14

3. Tadela Shimelis.............0093/14

4. Desta Dida....................0196/14

5. Sumaya A/selam.............0196/14

6. Sara Belachew..............0195/14

7. Meseret Dejene............00202/14

8. Aster Mekonin.................00199/14

9. Fatra Abdala......................0198/14

10. Kasahun Alemayew.........0266/14

Submitted to:- Mr. Gemechu.


Submission Date:- 23/12/2024 G
Contents
CHAPTER FOUR 2
STANDARDS COSTING AND FLEXIBLE BUDGET 2
4.1. Introduction 2
4.2. Standard Cost Systems 2
4.2.1. Meaning of Standard Costing 2
4.2.3. Why Standard Cost Systems Are Used 2
4.2.4. Budgetary Control vs. Standard Costing 3
4.2.5. Advantages and Limitations of Standard Costing 4
4.2.6. Development Of A Standard Cost Systems 5
4.2.7. Considerations in Establishing Standards 6
4.3 Classification of Budgets 7
4.3.1. Fixed or Static Budget 7
4.3.2. Flexible Budget 7
4.3.3. Variance Analysis 8
4.3.4. Flexible and static budget variances 8
4.3.5 Direct Material and Labor Variances 13

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CHAPTER FOUR
STANDARDS COSTING AND FLEXIBLE BUDGET

4.1. Introduction
Dear learners in the previous unit you have studied the benefit of budget as a planning tool. Hence, budgets are
planning tools that are usually prepared prior to the start of the period being budgeted. However, the comparison
of the budget to actual results provides valuable information about performance. Therefore, budgets are both
planning tools and performance evaluation tools. In this unit, therefore the discussion focuses on how budget are
used to evaluate feedback and variances aid managers in their control function.

In evaluating performance the budgeted performance are compared with actual operational results and the
resulting variance will be examined so as to identify the causes for variance on the bases of which performance
can be rewarded for favorable variance or corrective actions will be taken to avoid unfavorable variance on the
coming operational periods.

The unit highlights the importance of variance analysis and show how the budget initially prepared at planning
stage creates problem while comparing actual results with the budget. In this unit you are also introduced with
the advantage of flexible budget over the static budget, steps in the preparation of flexible budget and evaluating
performance using flexible budget.

4.2. Standard Cost Systems


4.2.1. Meaning of Standard Costing
Standard costs are predetermined costs that are usually expressed on per unit basis. In other word, standard cost
is a predetermined calculation of how much costs should be incurred under specified working condition. It is built
up from an assessment of the value of direct material, direct labor and overhead items.

4.2.3. Why Standard Cost Systems Are Used


A standard cost system has three basic functions: collecting the actual costs of a manufacturing operation,
determining the achievement of that manufacturing operation, and evaluating performance through the reporting
of variances from standard. These basic functions result in six distinct benefits of standard cost systems.

Clerical Efficiency:- A company using standard costs usually discovers that less clerical time and effort are
required than in an actual cost system. In an actual cost system, the accountant must continuouslyrecalculate
changing actual unit costs. In a standard cost system, unit costs are held constant for some period. Costs can be
assigned to inventory and cost of goods sold accounts at predetermined amounts per unit regardless of actual
conditions.

Motivation:- Standards are a way to communicate management’s expectations to workers. When standards are
achievable and when workers are informed of rewards for standards attainment, those workers are likely to be
motivated to strive for accomplishment. The standards used must require a reasonable amount of effort on the
workers’ part.

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Planning:- Planning generally requires estimates about the future. Managers can use current standards to
estimate future quantities and costs. These estimates should help in the determination of purchasing needs for
material, staffing needs for labor, and capacity needs related to overhead that, in turn, will aid in planning for
company cash flows. In addition, budget preparation is simplified because a standard is, in fact, a budget for one
unit of product or service. Standards are also used to provide the cost basis needed to analyze relationships
among costs, sales volume, and profit levels of the organization.

Controlling:- The control process begins with the establishment of standards that provide a basis against which
actual costs can be measured and variances calculated. Variance analysis is the process of categorizing the
nature (favorable or unfavorable) of the differences between actual and standard costs and seeking explanations
for those differences. A well-designed variance analysis system captures variances as early as possible, subject to
cost-benefit assessments. The system should help managers determine who or what is responsible for each
variance and who is best able to explain it. An early measurement and reporting system allows managers to
monitor operations, take corrective action if necessary, evaluate performance, and motivate workers to achieve
standard production.

Decision Making:- Standard cost information facilitates decision making. For example, managers can compare a
standard cost with a quoted price to determine whether an item should be manufactured in-house or instead be
purchased. Use of actual cost information in such a decision could be inappropriate because the actual cost may
fluctuate from period to period. Also, in making a decision on a special price offering to purchasers, managers can
use standard product cost to determine the lower limit of the price to offer. In a similar manner, if a company is
bidding on contracts, it must have some idea of estimated product costs. Bidding too low and receiving the
contract could cause substantial operating income (and, possibly, cash flow) problems; bidding too high might be
uncompetitive and cause the contract to be awarded to another company.

Performance Evaluation:- When top management receives summary variance reports highlighting the operating
performance of subordinate managers, these reports are analyzed for both positive and negative information. Top
management needs to know when costs were and were not controlled and by which managers. Such information
allows top management to provide essential feedback to subordinates, investigate areas of concern, and make
performance evaluations about who needs additional supervision, who should be replaced, and who should be
promoted. For proper performance evaluations to be made, the responsibility for variances must be traced to
specific managers.

4.2.4. Budgetary Control vs. Standard Costing


Budgetary control and standard costing are comparable system of cost accounting in that they are both
predetermined of forward – looking. The common objective is of controlling business operations by establishing
predetermined targets. However, there are a few differences between these two systems are which given below:

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Budgetary control system Standard costing system

Budgetary control is related to all types of items Standard costing is related to production and
of revenue and expenditure, whether they production costs. Hence, it is more rigorous and
belong to the product or not, i.e. to all types of intensive.
business activities. Hence, it is more extensive.
Standard is established on the basis of technical
Budget is based on past experience and in most estimates. It is the projection of accounts.
cases a projection of financial accounts.
Standard are very rigid and ‘ought to be’
Budgets are comparatively less rigid and ‘should estimates. They fix targets.
be’ estimates. They fix limits.
Standard costing system cannot operate well
Budgetary control can be operated without a without a budgetary control system. Also, it is
standard costing system. It can be adopted in not possible to operate the system in parts
part.
Variance analysis is a subject of special study of
The study of variances is not a subject of special standard costing.
study as in the case of standard costing

4.2.5. Advantages and Limitations of Standard Costing


Advantages of standard costing

1 The weakness of the traditional costing system can be estimated by compiling standard costs more carefully.

2. Standard costs can be used as a yardstick against which actual costs can be compared. It is an effective tool for
planning production costs. Hence, cost control is greatly facilitated.

3. Variance analysis helps management to have regular as well as better checks over costs incurred. It makes the
application of the principle of management by exception more easy. That is, the management can concentrate its
attention on variances only, leaving the other aspects of cost control to be taken care of at the lower level.

4. It is a valuable guide to management in the formulation of production and price policies in advance with
certainty. It also assists management in the areas of profit – planning, product –pricing, and inventory pricing,
etc.

5. Standard costing makes the reporting of operating data more meaningful and also fast. This makes the
interpretation of management reports easy.

6. As the emphasis of the standard costing system is more on cost variations, it makes the entire organization cost
conscious. It makes the employees recognize the importance of efficient operations so that costs can be reduced
by joint efforts.

7. Labor, materials and machines can be effectively used, and economies can be affected in addition to increase

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productivity. Standards may also be used as the basis for introducing incentive schemes.

Limitations of standard costing

1. Setting of standards is a very difficult task. It requires a lot of scientific studies such as time –study, motion
study, etc., and therefore it is very costly. Small firms may find it very difficult to operate such a system.

2 Standards are very rigid estimates and once set, are not changed for a considerable time. This makes the
standards highly unrealistic in certain industries which face fluctuations in prices of products due to frequent
changes.

3 The utility of variance analysis depends much more on the standard set. While a loosely set standard may be
ridicule the standards which are set very high may create frustration in the minds of the workers. At the same
time setting of correct standards is also, it is difficult to apply this system when production takes more than one
accounting period.

4.2.6. Development Of A Standard Cost Systems


Although standard cost systems were initiated by manufacturing companies, these systems can also be used by
service and not-for-profit organizations. In a standard cost system, both standard and actual costs are recorded in
the accounting records. This dual recording provides an essential element of cost control: having norms against
which actual operations can be compared. Standard cost systems make use of standard costs, which are the
budgeted costs to manufacture a single unit of product or perform a single service. Developing a standard cost
involves judgment and practicality in identifying the material and labor types, quantities, and prices as well as
understanding the kinds and behaviors of organizational overhead.

Once management has established the desired output quality and determined the input resources needed to
achieve that quality at a reasonable cost, quantity and price standards can be developed. Experts from cost
accounting, industrial engineering, personnel, data processing, purchasing, and management are assembled to
develop standards. To ensure credibility of the standards and to motivate people to operate as close to the
standards as possible, involvement of managers and workers whose performance will be compared to the
standards is vital.

Material Standards

The first step in developing material standards is to identify and list the specific direct materials used to
manufacture the product. This list is often available on the product specification documents prepared by the
engineering department prior to initial production. In the absence of such documentation, material specifications
can be determined by observing the production area, querying of production personnel, inspecting material
requisitions, and reviewing the cost accounts related to the product. Three things must be known about the
material inputs: types of inputs, quantity of inputs used, and quality of inputs used.

Specifications for materials, including quality and quantity, are compiled on a bill of materials. Even companies
without formal standard cost systems develop bills of materials for products simply as guides for production
activity. When converting quantities on the bill of materials into costs, allowances are often made for normal
waste of components. After the standard quantities are developed, prices for each component must be
determined. Prices should reflect desired quality, quantity discounts allowed, and freight and receiving costs.

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Although not always able to control prices, purchasing agents can influence prices. These individuals are aware of
alternative suppliers and attempt to choose suppliers providing the most appropriate material in the most
reasonable time at the most reasonable cost. The purchasing agent also is most likely to have expertise about the
company’s purchasing habits. Incorporating this information in price standards should allow a more thorough
analysis by the purchasing agent at a later time as to the causes of any significant differences between actual and
standard prices.

Labor Standards

Development of labor standards requires the same basic procedures as those used for material. Each production
operation performed by either workers (such as bending, reaching, lifting, moving material, and packing) or
machinery (such as drilling, cooking, and attaching parts) should be identified. In specifying operations and
movements, activities such as cleanup, setup, and rework are considered. All unnecessary movements by workers
and of material should be disregarded when time standards are set.

To develop usable standards, quantitative information for each production operation must be obtained. Time and
motion studies may be performed by the company; alternatively, times developed from industrial engineering
studies for various movements can be used. A third way to set a time standard is to use the average time needed
to manufacture a product during the past year. Such information can be calculated from employees’ past time
sheets. A problem with this method is that historical data may include inefficiencies. To compensate,
management and supervisory personnel normally make subjective adjustments to the available data.

Labor rate standards should reflect the employee wages and the related employer costs for fringe benefits, FICA
(Social Security), and unemployment taxes. In the simplest situation, all departmental personnel would be paid
the same wage rate as, for example, when wages are job specific or tied to a labor contract. If employees
performing the same or similar tasks are paid different wage rates, a weighted average rate (total wage cost per
hour divided by the number of workers) must be computed and used as the standard. Differing rates could be
caused by employment length or skill level.

Overhead Standards

To provide the most appropriate costing information, overhead should be assigned to separate cost pools based on
the cost drivers, and allocations to products should be made using different activity drivers. After the bill of
materials, operations flow document, and predetermined overhead rates per activity measure have been
developed, a standard cost card is prepared. This document summarizes the standard quantities and costs needed
to complete one product or service unit.

Data from the standard cost card are then used to assign costs to inventory accounts. Both actual and standard
costs are recorded in a standard cost system, although it is the standard (rather than actual) costs of production
that are debited to Work in Process Inventory. Any difference between an actual and a standard cost is called a
variance.

4.2.7. Considerations in Establishing Standards


When standards are established, appropriateness and attainability should be considered. Appropriateness, in
relation to a standard, refers to the basis on which the standards are developed and how long they will be
expected to last. Attainability refers to management’s belief about the degree of difficulty or rigor that should be

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incurred in achieving the standard.

Appropriateness:- Although standards are developed from past and current information, they should reflect
relevant technical and environmental factors expected during the time in which the standards are to be applied.
Consideration should be given to factors such as material quality, normal material ordering quantities, expected
employee wage rates, degree of plant automation, facility layout, and mix of employee skills. Management should
not think that, once standards are set, they will remain useful forever. Current operating performance is not
comparable to out-of-date standards.Standards must evolve over the organization’s life to reflect its changing
methods and processes. Out-of-date standards produce variances that do not provide logical bases for planning,
controlling, decision making, or evaluating performance.

Attainability:- Standards provide a target level of performance and can be set at various levels of rigor. The level
of rigor affects motivation, and one reason for using standards is to motivate employees. Standards can be
classified as expected, practical, and ideal. Depending on the type of standard in effect, the acceptable ranges
used to apply the management by exception principle will differ. This difference is especially notable on the
unfavorable side.

4.3 Classification of Budgets


4.3.1. Fixed or Static Budget
The static budget is the budget that is based on this projected level of output, prior to the start of the period. In
other words, the static budget is the “original” budget. The static budget variance is the difference between any
line-item in this original budget and the corresponding line-item from the statement of actual results. Often, the
line-item of most interest is the “bottom line”: total cost of production for the factory and other cost centers; net
income for profit centers.

Static budget is a budget that is based on one level of activity.

Evaluating performance based upon the master budget which fixed and prepared at s ingle level of activity may
not provide accurate picture of performance. This because usually the planned and actual output or activities
levels may not be equal, as a result the comparison is performed at two different level of activity which hides the
variance attribute to the actual performance units as well as overall organization. For example, if a company
budgeted to produce and sell 12,000 units, but the actual performance showed only 10,000 units, the comparison of
revenue, cost and profit at the budget and actual level of output do revels only the variance resulted from the
difference in the level of output. Therefore unless the analysis is re done by adjusting the budgeted level of output
towards the actual units produced and sold, the variance is not helpful to the management as performance
evaluation tool.

Static Budget Variance [SBV] is the difference between an actual result and the corresponding budgeted
amount in a static budget.

4.3.2. Flexible Budget


The flexible budget is a performance evaluation tool. It cannot be prepared before the end of the period. A flexible
budget adjusts the static budget for the actual level of output so as to avoid the inherent limitation of using static

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budget for performance evaluation. The flexible budget asks the question: “If I had known at the beginning of the
period what my output volume (units produced or units sold) would be, what would my budget have looked like?”
The motivation for the flexible budget is to compare apples to apples. If the factory actually produced 10,000 units,
then management should compare actual factory costs for 10,000 units to what the factory should have spent to
make 10,000 units, not to what the factory should have spent to make 9,000 units or 12,000 units or any other
production level.

4.3.3. Variance Analysis


The main advantage of the standard costing system is variance analysis. The principle of “management by
exception” is practiced easily with the help of variances. Variance may be defined as the difference between
standard and actual for each element of cost and sometimes for sales. And ‘variance analyses’ may be defined as
the process of analyzing variance by sub –dividing the total variance in such a way that management can assign
responsibility for off –standard performance. When the actual results are better than expected, a ‘favorable’
variance arises; where they are not up to the standard, an ‘adverse variance’ occurs.

Variances help to fix the responsibilities so that management can ascertain the person responsible for the poor
results. For example, an adverse material usage variance would indicate that excess material cost was due to
inefficient use of materials. This would enable management to fix the responsibility on the supervisor in charge of
a particular operation in which the inefficiency occurred. It may be discovered that the variance was caused by
(say) inefficient handling, purchase of poor quality materials or employment of trainees. The important point is
that the reason for the variance must be found, explained and wherever necessary, corrective measures taken.

4.3.4. Flexible and static budget variances


The flexible budget variance is the difference between any line-item in the flexible budget and the corresponding
line-item from the statement of actual results.

To have a better understanding of causes for variance managers usually require variance calculated at different
level. Variance according to the degree of detailed feedback on performance can be classified as:

☆ Level 0 variance analysis ☆Level 1 variance analysis

☆Level 2 variance analysis ☆Level 3 variance analysis

☆Level 4 variance analysis

In this unit the focus is on level 0, 1, and 2 variances, and the reaming will be discussed in length on the next unit.
Now let see the preparation of flexible budget as well as analysis of variance using the following:

Illustration 3.1: Kombolcha Garment Co. manufactures and sells a jacket. Sales are made to distributors who sell
to independent clothing storesKombolcha Garment’s only costs are manufacturing costs. All units manufactured
in April 2003 are sold in April 2003. There is no beginning or ending inventory. Kombolcha Garment has variable
cost categories. The budgeted data for April 2003 are:

Cost category Variable cost / jacket.

DM costs………………………………… Br. 60

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DL costs…………………………………. 16

Variable MOH costs…………………… 12

Total variable costs ……………… Br. 88

The number of units manufactured is the cost driver for all variable-manufacturing costs. The relevant range for
the cost driver is from 0 to 12,000 jackets. Budgeted manufacturing fixed costs are Br. 276,000 for production
between 0 & 12,000 jackets. Budgeted selling price is Br.120/jacket. The static budget for April 2003 is based on
selling 12,000 jackets.

The actual data for April 2003 are as follows:

Units sold ………………… 10,000 jackets

Revenues …………………. Br. 1,250,000

Variable costs:

DM …………………….. 621,600

DL……………………… 198,000

Variable MOH……….. 130,500

Fixed costs …………….. 285,000

1. Level 0 or Static Budget Variance for operating income

Level zero variance analysis the least detail analysis which simply compares the operating income at static
budget income statement with the operating income at the actual income statement. The level zero variance for
Kombolcha Garment from the above given data is determined as,

Actual operating income………………… Br. 14,900

Budgeted operating income……………… 108,000

SBV for operating income………………. Br. 93,100 U

The analysis revealed unfavorable variance as the actual operating income is lower than the budgeted operating
income by Birr 93,100. The result here couldn’t provide the management useful information as it couldn’t show
the contribution revenue and each cost element to operating income variance.

2. Static Budget Variance (SBV)

Level one variance can offer management a better insight about their organizational performance than level zero
analysis. At this level, operating income variance will be decomposed into revenue and cost component as a result
the management will identify the responsibility center that demands attention.

Static Budget Variance

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Actual Results Static Budget Static Budget
(1) Variance(SBV) (2)
= (1) – (3) Result (3)

Items

Unit sales 10,000 2,000U 12,000 .

Revenues Br.1,250,000 Br. 190,000U ,440,000

Variable costs:

DM 621,600 98,400F 720,000

DL 198,000 6,000U 192,000

MOH 130,500 13,500F 144,000

Total variable 950,100 105,900F 1,056,000


costs

Contribution 299,900 84,100U 384,000


Margin

Fixed Costs 285,000 9,000U 276,000

Br. 14,900 Br. 93,100U Br. 108,000

Operating Income

Br. 93,100U______________SBV

The static budget variance shows an unfavorable variance for revenue, fixed costs whereas favorable variance of

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total variable cost. These variances are due primarily to the fact that the static budget was built on an output level
of 12,000 units, while the company actually made and sold 10,000 units. The revenue variance might also be due to
an average unit sales price that differed from budget. The variable cost variances might also be due to input prices
that differed from budget (e.g., the price of fabric), or input quantities that differed from the per-unit budgeted
amounts (e.g., yards of fabric per jackets) that may be identified at the later stages of the variance analysis.

Level 2-variance analysis [Flexible Budget Variance (FBV) & Sales-Volume Variance (SVV)]

To identify the amount of variance attributed the difference in the level of output as well as to real performance of
the company, at this level the static budget variance will be decomposed into the flexible budget variance and
sales volume variance.

Flexible Budget Variance (FBV) is a better measure of operating performance because they compare actual
revenues to budgeted revenues and actual costs to budgeted costs for the same output level.

Sales-Volume Variance (SVV) is the difference between the flexible budget amounts and static budget amounts. It
represents the variance caused solely by the difference in the actual output volume and budgeted quantity of
output expected to be produced and sold in the static budget.

To determine the flexible budget variance and sales volume variance, first you need to develop a flexible budget.
The flexible budget, for the example given above is prepared at the end of the period after the actual output level
of 10,000 jackets is known. The flexible budget is that Kombolcha Garment would have prepared at the start of the
budget period had it correctly forecasted the actual level of 10,000 jackets.

In preparing the flexible budget,

The budgeted selling price is the same Br. 120/ jacket.

The budgeted variable costs per unit are the same Br. 88/ jacket.

The budgeted fixed costs are the same Br. 276, 000, are used.

The only difference between the static budget and the flexible budget is that the static budget is prepared for the
planned output level of 12,000 jackets, whereas the flexible budget is based on the actual output of 10,000jackets.

The following stapes are used to prepare a flexible budget:

Step 1.Identify the Actual Quantity of Output produced and sold.

10,000jackets.

Step 2. Calculate the flexible budget for revenues based on Budgeted Selling Price and

Actual Quantity of Output.

Flexible B for Revenues = Br. 120 /jacket X 10,000jacket

= Br. 1,200,000

Step 3. Calculate the Flexible Budget for Costs based on Budgeted Variable Costs per

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Unit, Actual Quantity of Output and Fixed Costs.

Flexible Budget for Variable Costs:

DM: Br. 60/j X 10,000j Br. 600,000

DL: Br. 16/j X 10,000j 160,000

MOH: Br. 12/j X 10,000j 120,000

FB for TVC Br. 880,000

FB for FC 276,000

FB for Costs Br. 1,156,000

Step 4: Building the flexible budget based on the information from steps 1 and 2, and step 3 results a flexible
budget presented on column 3 of the following table.

After the flexible budget is developed it is possible to determine the flexible budget variance by comparing the
flexible budget and the actual operational results, and sales volume variance by comparing the flexible budget
results and the static budget as shown on the following table.

PARTICULARS AR (1) FBV (2) = 1-3 FB(3) SVV (4) SB (5)

Units sold 10000 0 10,000 2,000 12,000

Revenues 1,250,000 50,000 F 1,200,000 240,000 U 1,440,000

Direct material 621,600 21,6000 U 600,0000 120,000 F 720,000

Direct manfg. labor 198,000 38,000 U 160,0000 32,000 F 192,000

Variable manuf. Overhead 130,500 10,500 U 120,0000 24,000 F 144,000

Total Variable costs 950,100 70,100 U 880,0000 176,000 F 1,056,000

Contribution margin 299,900 20,100 U 320,000 64,000 U 384,000

Fixed costs 285,000 9,0000 U 276,0000 0 276,000

Operating income 14,900 29,100 U 44,0000 64, 0000 U 108,000

From this table, Kombolcha Garment sees that after adjusting for sales volume, revenue was higher than would
have been expected. The favorable Birr 50,000 variance must be due entirely to an average sales price that was
higher than planned which was Bir125 per jacket compared to the original budget of Birr120 per jacket.

Materials costs were higher than would have been expected for a sales volume of 2,000 units. This unfavorable
variance is due to higher material prices, or to inefficient utilization of fabric (more waste than expected), or a
combination of these two factors. Labor and overhead were higher than expected, even after adjusting for the

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sales volume of 2,000 units. This unfavorable flexible budget variance implies that either wage rates were higher
than planned, or labor was not as efficient as planned, or both. Similarly, the components of variable overhead
were either more expensive than budgeted, or were used more intensively than budgeted. For example, electric
rates might have been higher than planned, or more electricity was used than planned per unit of output.

The fixed cost variances are identical in this table to the previous table. In other words, the flexible budget and
flexible budget variance provide no additional information about fixed costs beyond what can be learned from the
static budget variance.

4.3.5 Direct Material and Labor Variances


How are material, labor, and overhead variances calculated? How materials and labor cost variance computed
when there are is only one type (classes) of material (labor) input used in the production? What about if there
are more than one type (classes) of material (labor) input used in the production?

4.3.5.1 Direct material cost variances:


To completely and meaningfully analyze the flexible budget variance for material, it should be analyzed in terms
of the materials price standard and the materials quantity standard. This level of analysis resulted in: (i) material
price variance that identifies the effect of differences in prices paid for materials. (ii)Material quantity (usage)
variance that identifies the effect of difference in the quantities of materials used.

4.3.5.2 Material Price Variance(MPV)


A material price variance is the difference between the actual price of material/unit and the standard price of
material per unit multiplied by the actual quantity of material purchased. In other words, the material price
variance(MPV) indicates whether the amount paid for material was below or above the standard price. Material
price variance can be calculated as:

MPV = (SP – AP) AQ

where: SP is the standard price of material per unit

AP is actual price of material per unit


AQ is the actual quantity of material
purchased and consumed

If the actual price is larger than the standard price, this variance is unfavorable (U); if the standards are larger
than the actual; the variance is favorable (F)

4.3.5.3 Materials Quantity (usage) Variance(MQV)


The material quantity variance(MQV) indicates whether the actual quantity used was below or above the

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standard quantity allowed for the actual output. This difference is multiplied by the standard price per unit of
material. i.e. A material quantity (usage) variance is the difference between the actual quantity of materials used
and the standard quantity of materials that should have been used to produce the actual output, multiplied by the
standard price of materials per unit. It can be calculated as:

MQV = (SQ-AQ) x SP

where: SP is the standard price of material per unit

SQ is the actual quantity of material used for


units produced

AQ═ the actual quantity of material used

If the actual quantity amounts are larger than the standard quantity amounts, this variance is unfavorable (U); if
the standards are larger than the actual; the variance is favorable (F)

Example In August 2001, East Publishing Company’s costs and quantities of paper consumed in manufacturing its
2002 Executive Planner and Calendar were as follow:

Actual unit purchase price Br 0.16 per page

Standard quantity allowed for good production 195,800 pages

Actual quantity purchased during August 230,000 pages

Actual quantity used in August 200,000 pages

Standard unit price Br 0.15 per page

Required:

Calculate the total cost of purchases for August.

Compute the material price variance on the bases of purchase

Calculate the material quantity variance.

Total FBV

Solution:

Total cost of purchases for August would be:

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Actual unit purchase price (a) -------------------------------- Br 0.16 per page

Actual quantity purchased during August (b) ---------------- 230,000 pages

Total cost (a x b) ------------------------------------ Br.31, 220

MPV = (SP – AP) AQ

= (Br 0.15 per page - Br 0.16 per page) 230,000 pages= Br. 2,300 (U)

MQV = (SQ-AQ) x SP

= (195,800 pages - 200,000 pages) Br 0.15 per page= Br. 630(U)

Total FBV═ Br 2,300U + Br. 630U═ Br.2,930 U

4.3.5.4 Labor cost variances:

Just like we have done for material inputs, we will do the same meaningful analysis for labor inputs. Hence, the
variance investigation to flexible budget variance for labor resulted in: (i) labor rate variance that identifies the
effect of differences in the rates paid to workers, and (ii) labor efficiently or usage variance that identifies the
effect of differences in the quantities of labor used.

4.3.5.5 Labor Rate Variance(LRV)


The labor rate variance(LRV) shows the difference between the actual wages paid to labor for the period and the
standard wages for all hours worked. Thus, Labor rate variance is the difference between the actual rate of labor
per hour and the standard rate of labor per hour, multiplied by the actual hours of labor worked.

LRV= (SR-AR) x AH

Where: SR is standard rate of labor per hour

AR is actual rate of labor per hour, AH is a total actual hour of labor worked

4.3.5.6 Labor Efficiency Variance (LEV)


A labor efficiency variance is the difference between the actual labor hours worked and the standard labor hours
that should have been worked to produce the actual output, multiplied by the standard rate of labor per hour.
Thus, multiplying the standard labor rate by the difference between the actual minutes worked and the standard
minutes for the production achieved results in the labor efficiency variance(LEV)

LEV = (SH – AH) x SR

Where: SH is standard hours of labor for the actual unit produced

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AH is actual labor hours used for the unit produced

SR is standard rate of labor per hour

4.3.5.7 Overhead Cost Variances


In developing overhead application rates, a company must specify an operating level or capacity. Capacity refers
to the level of activity. Alternative activity measures include theoretical, practical, normal, and expected capacity.
Because total variable overhead changes in direct relationship with changes in activity and fixed overhead per unit
changes inversely with changes in activity, a specific activity level must be chosen to determine budgeted
overhead costs.

A flexible budgetis a planning document that presents expected overhead costs at different activity levels. In a
flexible budget, all costs are treated as either variable or fixed; thus, mixed costs must be separated into their
variable and fixed elements. The activity levels shown on a flexible budget usually cover the contemplated range
of activity for the upcoming period. If all activity levels are within the relevant range, costs at each successive level
should equal the previous level plus a uniform monetary increment for each variable cost factor. The increment is
equal to variable cost per unit of activity times the quantity of additional activity.

The use of separate variable and fixed overhead application rates and accountsallows separate price and usage
variances to be computed for each type of overhead.

4.3.5.8 Variable overhead cost variance (VOHV)


This is the difference between standard variable overheads for actual production and the actual variable
overheads.

Symbolically,

VOHV =SC-AC

Where: SC= standard variable overheads for actual production

AC= actual variable overheads

It can be sub –divided intoVariable overhead expenditure variance, and Variable overhead efficiency variance.

VOH expenditure variance is the difference between the standard variable overheads for the actual hours worked,
and the actual variable overheads incurred. The formula for computing it is as follows:

VOH Exp. Variance = AVOH –SVOH.

Where: AVOH is actual variable overheads incurred

SVOH is standard variable overheads for the actual hours worked,

VOH efficiency variance arises when the actual output produced differs from the standard output for actual
hours worked. It is a measure of extra overhead (for saving) incurred solely because of the efficiency shown during

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the actual hours worked. The formula to compute it is as follows:

VOH efficiency variance = (SHOV for actual hours worked)- (SHOV for actual output)

Example From the following information, calculate VOH cost variances assuming labor hours as cost driver for
variable manufacturing overhead.

Budget output 5000 units

Budgeted hours 10,000

Budgeted variable overheads Br. 2,000

Actual variable overheads Br. 3,000

Actual output 4,000 units

Actual hours 12,000 hours

Solution

VOH cost variance =AVOH –SVOH for actual production

= Br.3, 000 - (4000xBr 0.40*)

= Br...3,000- Br. 1600= Br.1400 (U)

VOH expenditure variance = AVOH –SVOH for actual hours worked

= Br.3000 - (12000x0.20**) =Br. 600 (U)

VOH efficiency variance =SVOH for actualHrs- SVOH for actual output

=Br. 2400 – Br. 1600=Br. 800 (U)

Workings:

*SVOH per unit of output –Br.2000/5000 = Br.0.40 per unit

** SVOH pre hours = Br.2000/10,000 = Br.0.20 per hour

4.2.5.9 Fixed overheads cost varinance (FOHV)


This is the difference between the standard fixed overheads for actual output and actual fixed overheads. The
reasons for the variance are over absorption or under –absorption of overheads for the actual production the
budgeted production may be different form the actual production for the actual overheads incurred. The major
sub –divisions of FOHV are FOH expenditure variance and FOH volume variance. The formula for FOHV is as
follows:

FOHV =AFOH –SFOH

Where: AFOH = actual fixed overheads.

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SFOH = standard fixed overheads for actual output

Note that, if the AFOH is less than the SFOH, the variance is favorable (F), and vice versa. This variance can be
classified into two.

FOH expenditure variance (FOHEV)

This is the difference between Actual fixed overhead costs and Budgeted fixed overhead

(Symbolically, FOHEV= AFOH –BFOH)

If the actual is greater than the budgeted, this variance is adverse (U), and vice versa

FOH volume Variance (FOHVV)

This is the difference between the budgeted fixed overheads and the standard fixed overheads absorbed on actual
production. The formula is as follows:

FOHVV =BFOH –SFOH on actual production.

If the BFOH is greater than the SFOH on actual production, the variance is adverse (U) and vice versa.

Example : From the following data calculate FOH cost variance.

Budgeted hours: 10,000 hours; Budgeted output: 5,000 units, Budgeted FOH: Br.3,000Actual hours: 12,000hours;
Actual output:4,800 units; Actual FOH: Br.3,600

Solution:

FOHV =AFOH –SFOH on actual output = Br.3600-(0.60* x4800) = Br. 3600-Br. 2880=.Br.720 (U)

FOHEV=AHOH –BFOH = Br.3600 – Br.3000=.Br.600 (U)

FOHVV =BFOH –SFOH on actual output = Br.3000-(0.60x4800)= Br.3000 – 2880 =.Br.120 (U)

Workings:

*SFOH per unit = Br. 3000/5000= Br.0.60 per unit

The End Of Chapter Four


Thank You!!!!
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