Variance analysis article.pdf

7/27/2019 Variance analysis article.pdf

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44 Study notes

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By the examiner for paper P1

Variance analysis is a standard management

accounting technique, but too many P1 candidates

struggle to apply it because they dont bother to

understand what all the variances actually mean

S

tudents tend to nd the P1 exam di-cult because the inormation given inthe scenarios and the requirementsvary considerably rom question to

question. Rote learning or this paper,thereore, will not be eective.

Section C o the exam oten includes a questionrequiring a variance analysis. I have invariablybeen disappointed by how badly most candidateshave perormed on answering such questions, par-ticularly because its a core area o the syllabusthat they should see as their bread and butter.Post-exam guides have stated that students tendto try to learn by rote or this subject, rather thanunderstanding what they are trying to achieve.Variance analysis is not about learning ormulas;its about working out what the variances mean.Once these are understood, the gures necessaryto calculate them usually become clear.

Lets attempt question 3 in section C o theNovember 2011 P1 paper, which required candi-dates to perorm a variance analysis. Here is thescenario it gives, along with part A o the require-ment:

TP makes wedding cakes that are sold to special-

ist retail outlets, which decorate the cakes accord-

ing to the customers specic requirements. The

standard cost per unit o its most popular cake is

as ollows:Direct material: $

Ingredient A 4kg at $25 per kg 100

Ingredient B 3kg at $22 per kg 66Ingredient C 2kg at $11.50 per kg 23

Direct labour: 3 hours at $12 per hour 36

Variable overhead: 3 hours at $8 per hour 24

Standard cost: 249

The budgeted production or the period was

10,000 uni ts.Actual results or the period we re as ollows:

Production: 9,000 u nits.

Direct material: $

Ingredien t A 35,000kg 910,000

Ingredien t B 28,000kg 630,000

Ingredien t C 27,000kg 296,000

Direct labour: 30,000 hours 385,000

Variable overhead: 230,000

The general market prices at the time of purchase

or ingre dient A and i ngredient B were $23 per kgand $20 per kg respectively.

TP operates a just-in-time (JIT) purchasing

system for ingredients and a JIT production system.

Therefore, there was no inventory during the period.

Prepare a s tatement that reco ncil es the fexedbudget material cost and the actual material cost.

Your statement should include the material priceplanning variances and the operational variances,

including material price, material mix and mate-

rial yield (12 marks).The rst thing to note is that a reconciliation

statement is required. Many candidates didntproduce a statement and, while this omission wastreated airly leniently in the marking, the post-exam guide or that paper warned that this mightnot always be the case. Such questions test notonly your ability to calculate variances, but alsoyour ability to calculate the appropriate variancesthat will explain the dierence between the budgetgures and the actual gures.

In addition, the reconciliation should bebetween the fexed budget material cost and theactual material cost. The original productionbudget was 10,000 units, but only 9,000 unitswere actually made. Thereore we need to recon-cile the budget cost o 9,000 units i.e. the fexedbudget with the actual cost o 9,000 units.

The second part o the requirement makes itclear which variances need to be calculated: thematerial price planning variances and the opera-tional variances, including the material price,

material mix and material yield variances. Despitethis, a disappointingly high number o candidateswasted a lot o valuable time calculating labourvariances and variable overhead variances. Thismay have been because questions they had prac-tised during their revision required the reconcil-iation o prot or contribution. It is important toread the question requirements careully, becauseno marks will be awarded or perorming calcula-tions that are not required. Other candidates,

I have

invariably been

disappointed by

how badly mostcandidates have

performed on

answeringvariance analysis

questions


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46

TOTALPROFIT

VARIANCE

Further reading CIMA Ofcial Study Text Perormance Operations (2011-12 edition), CIMA Publishing, 2011.

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Study notes

while they didnt calculate labour or overheadvariances, worked out the material usage variance.This meant that there was a duplication o vari-ances, because the material usage variance is acombination o the material mix variance and thematerial yield variance.

The diagram below shows the chart o variancesusing absorption costing principles. The sameapplies under marginal costing, except that thesales variances will relate to contribution andthere will be no urther breakdown o the xedproduction overhead total variance.

Many questions on variance analysis requirethe reconciliation o budget and actual prot.They will ask candidates to show variances in asmuch detail as possible. I the scenario involvesa rm selling multiple products and/or a productthat requires a mix o dierent inputs, you shouldcalculate sales mix and sales quantity variancesand/or material mix and yield variances. But youshould not then also calculate the sales volumevariance and the material usage variance, as thiswould result in duplication and it would be impos-sible to reconcile the budget and actual gures.

Chart of variances using absorption costing principles

Selling price variance

SALES Sales mix proft variance

VARIANCES Sales volume proft variance

Sales quantity proft variance

Direct material price variance

Direct material total variance Direct material mix variance

Direct material usage variance

Direct material yield variance

Direct labour rate variance

Direct labour total variance

Direct labour efciency variance

PRODUCTION

VARIANCES

Variable production overhead

expenditure variance

Variable production overhead

total variance Variable production overhead

efciency variance

Fixed production overhead

expenditure varianceFixed production overhead

total variance Fixed production overhead

volume variance

Marketing cost variance

NON-PRODUCTION

COST VARIANCES

Administrative cost variance Source: CIMA Ocial Terminology, 2005 edition.


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Study notes 47

The rst step is to calculate the fexed budgetmaterial cost. This should be based on 9,000 unitsand the original standard material cost i.e. thetotal cost o ingredients A, B and C, which is $189.

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GlObal cOntact details

Lets now consider the variance calculations.The reconciliation statement is as ollows:

The next step is to calculate the material plan-ning variances. The scenario makes it clear thatthe general market prices o the ingredients at thetime o purchase were dierent rom the originalstandard cost, so we need to adjust the originalstandard to refect these changes. The price oingredient A has allen rom $25 to $23 per kg,resulting in a avourable variance o $2 per kg,since the revised budget will be lower than theoriginal budget. Each unit requires 4kg o ingre-dient A, so or 9,000 units the standard amounto ingredient A will be 36,000kg, resulting in aavourable total planning variance o $72,000.

The same calculation can be perormed or ingre-dient B, or which the market price has also allenby $2 per kg. I we then deduct the avourable var-iances rom the original standard we end up witha revised materials budget o $1,575,000.

The next step is to calculate the operationalvariances. The rst one we must deal with, pricevariance, compares the standard cost o the actualquantity o material purchased with the actualcost o what was purchased. The reason or usingthe actual quantity purchased is that we are tryingto isolate the eect o price changes that is,exclude any eect o usage gains or losses. Wethereore multiply the actual quantity o each

$

Flexed budget material 9,000 units x $189 1,701,000

cost (original standard)

Material price planning 36,000kg x ($25/kg $23/kg) 72,000

variance ingredient A favourable

Material price planning 27,000kg x ($22/kg $20/kg) 54,000

variance ingredient B favourable

Flexed budget material 1,575,000

cost (revised standard)

Material price operational (35,000kg x $23/kg) $910,000 105,000

variance ingredient A adverse

Material price operational (28,000kg x $20/kg) $630,000 70,000variance ingredient B adverse

Material price variance (27,000kg x $11.50/kg) $296,000 14,500

ingredient C favourable

Material mix variance Workings to follow 74,500

favourable

Material yield variance Workings to follow 175,000

adverse

Actual material cost 1,836,000


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Study notes

ingredient purchased by the revised standard costand compare this with the actual cost. Note thatthe operational variances use the revised stand-ard, as we are trying to assess operational e-ciency, which makes it necessary to exclude anyplanning variances since these are not within theoperational managers control.

Normally, the next material variance to calcu-late would be the material usage variance. But, asthis process uses a number o ingredients, we needto calculate the material mix and material yieldvariances. The material mix variance calculates

the eect on cost resulting rom any change to thestandard mix o input materials. It is concernedsolely with the eect o changes to the mix, so itcompares the actual quantity o material used atthe standard mix with that used at the actual mix.The total quantity o material used was 90,000kgand the standard mix was 4kg o A to 3kg o B to2kg o C. We thereore take 90,000kg and applythe standard mix the result o which is shown inthe second column o the table below. Columnthree shows the actual ingredients at the actualmix (given in the scenario). Column our showsthe variance, which is avourable (Fav in thetable) or A and B, as the actual input was lower

than the standard. For C it is adverse (Adv), asthe actual input was higher than the standard that is, more o C than expected was used in themix. Note that the total o the variance columnwill always be zero. We then multiply the variancesin kg by the standard costs and again its therevised standard costs that should be used, becausewe are calculating an operational variance.

An alternative method or calculating the mixvariance, which uses the dierence between therevised standard cost and the weighted-averagestandard cost in column ve, can also be used andwould be equally acceptable.

The nal variance to calculate is the material

yield. This measures the eect on cost o any di-erence between the actual usage o material andthe standard required or the output produced.The workings are as ollows:l Standard weight o material per cake = 9kg.l 9,000 cakes x 9kg = 81,000kg.l Actual usage = 90,000kg.l Variance = 9,000kg Adv.lWeighted-average standard cost per kg = $19.444.lVariance = 9,000kg x $19.444/kg = $175,000 Adv.

Here, the yield variance o 9,000kg is valued atthe weighted-average standard cost per kg, whichis calculated by dividing the revised material costo $175 per unit by 9kg per unit. Once again, its

the revised standard cost that is used, as this is anoperational variance.

Alternatively, the material yield variance canbe calculated by comparing the output that shouldhave been produced rom the material input withthe actual output. The workings are as ollows:l 90,000kg should produce 10,000 cakes.l 9,000 cakes were actually produced.l Yield variance = 1,000 Advl Standard material cost per unit = $175.l Yield variance = 1,000 x $175 = $175,000 Adv.

Once all the variances have been calculated,the nal task is to work out the actual material

cost. For this, you add the actual cost given in thescenario or all three ingredients. This should becalculated independently o the variances, justin case you have made an error in working outany o these variances. But, once you have calcu-lated the actual material cost, you can then checkthat the budget material cost, plus an d minus allthe variances, gives the same gure. I it doesnt,then you have made a mistake somewhere andyoull need to check your variance calculations.

Material mix variance calculation

Ingredien t Actual input Actual input Variance Standard Variance

at standard at actual (kg) cost ($/kg) ($)

mix (kg) mix (kg)

A 40,000 35,000 5,000 Fav 23 115,000 Fav

B 30,000 28,000 2,000 Fav 20 40,000 Fav

C 20,000 27,000 7,000 Adv 11.50 80,500 Adv

90,000 90,000 74,500 Fav

exam dOs and dOnts

Do read the question requirements careully.

Do answer the question that you have been asked, not the one

that youd like to have been asked.

Do practice answering past exam questions, but dont assume

that all uture questions will cover exactly the same ground.

Dont rely on rote learning understand what you are

calculating and why you are calculating it.

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