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COST CONTROL: STANDARD COSTING & VARIANCE ANALYSIS
Dr. Alok Dixit
IIM Lucknow
COST CONTROL
Managers, quite often, are confronted with the situation where Actual Profits are different from Budgeted Profits. And, it gives rise to the need of a control system which minimizes such deviations.
Important for ensuring that the standard fixed in the beginning of the period could be achieved with least possible deviations.
Need to be carried out on frequent intervals (say, weekly or daily) to spot the deviations, if any, in time.
Diagnosis of such variations is needed to ascertain the possible reasons and nature of such variances in terms of controllable & uncontrollable.
And, a suitable action can be initiated to bridge the gap between standard and actual so that standards can be met at the end of the budgeted period.
TOOL FOR COST CONTROL
Variance Analysis is used as one of the most important tool for cost controls.
It attempts to compare actual vs. a suitable benchmark, fixed in the beginning of the budgeted period (standard).
Deviations, if any, are spotted, analyzed in terms of Favourable/ Unfavourable, controllable/ uncontrollable.
And finally, for controllable variances, concerned employee/ centre is held accountable for.
STANDARD COSTING
Variance analysis requires some suitable benchmark for comparing the actual performance;
Standard costing provides those suitable benchmarks for assessing the actual performance;
For effective control, the standards should be set cautiously.
These should neither be too tight nor too loose as they have got their own implications.
If the standard itself is incorrect, measurement of variance will become a futile exercise;
VARIANCE ANALYSIS
PROFITSBUDGETED
PROFITSACTUAL
SALES VARIANCES
COST VARIANCES
LABOUR VARIANCES
OVERHEADS VARIANCES
MATERIAL VARIANCES
MATERIAL COST VARIANCES
Total Material Cost Variance
(TMCV)
Material Price Variance
(MPV)
Material Quantity Variance
(MQV) Material Yield Sub Variance(MYSV)
Material Mix Sub Variance(MMSV)
MATERIAL VARIANCE: AN EXAMPLE
MATERIAL VARIANCE: EXAMPLE 2
Detailed Solution is given in the material on Variance Analysis (scanned copy).
SOLUTION: MATERIAL COST VARIANCES
TMCV={TAQ*AP-TSQ*SP}
MPV ={AP-SP}*TAQ
MQV ={TAQ-TSQ}*SP
MYSV={Actual Yield for standard mix - Standard Yield of Standard Mix}*SP of finished output
MMSV={Actual Mix of Actual
Quantity - Standard Mix of Actual Quantity}*SP
Material A = 4000 (U) Material B= 20000 (U)Material C= 40000 (F)Total= 16000 (F)
Material A = 6000 (F) Material B = Zero Material C= 10000 (U)Total= 4000 (U)
Material A =10000 (U) Material B= 20000 (U)Material C= 50000 (F)Total= 20000 (F)
Material A = 5000 (U) Material B = 14000 (U)Material C =60000 (F)Total= 41000 (F)
Material A = 5000 (U) Material B = 6000 (U)Material C =10000 (U)Total= 21000 (U)
TSQ= SQ (PER UNIT)*ACTUAL OUTPUT
LABOUR COST VARIANCES
LABOUR COST VARIANCES
** Labour efficiency variance need to be revised for idle hours, if any. The labour efficiency variance net of the idle hours cost will give a true measure of Labour efficiency as Labour can’t be held responsible for idle time.
Total Labour Cost Variance
(TLCV)
Labour Rate Variance (LRV)
Labour Efficiency
Variance (LEV)Revised**
Labour Yield Sub Variance(LYSV)
Labour Mix Sub Variance(LMSV)
Labour Idle Time Variance
(LITV)
PROBLEM: LABOUR COST VARIANCE
SOLUTION
SOLUTION
SOLUTION
SOLUTION
SOLUTION
SOLUTION
Total Labour Cost Variance
(TLCV)
Labour Rate Variance (LRV)
={AR-SR}*TAH
Labour Efficiency Variance (LEV)
Revised={TAH-TSH}*SR
Labour Yield Sub Variance(LYSV)
={Actual Yield for standard mix - Standard Yield of Standard Mix}*SR of finished output
Labour Mix Sub Variance(LMSV)
={Actual Mix of Actual Quantity - Standard Mix of Actual Quantity}*SR
Unskilled= 1000 (U) Semi-skilled= 200 Skilled = 520 (U)Total= 1320 (U)
Unskilled= 1600 (U) Semi-skilled= 520 (F) Skilled = 1320 (U)Total= 2400 (U)
Unskilled= 600-480 = 120 (U) Semi-skilled= 320+384=704 (F) Skilled = 800-480 = 320 (U)Total= 1080-1344=264 (F)
Labour Idle Time Variance (LITV)
={Idle Hours}*SR
Unskilled= 480 (U) Semi-skilled= 384 (U) Skilled = 480 (U)Total= 1344 (U)
TSH*= Standard Hours required to support the Actual Output
Important: Idle hours should be apportioned based on Standard Mix to ensure that the deviations, if any, on account of changes in Standard Mix should get reflected in LMSV; Such deviation should not get reflected in Cost of Idle Time.
Unskilled= 200 (U) Semi-skilled= 640 (F) Skilled = 400 (U)Total= 40 (F)
Unskilled= 80 (F) Semi-skilled= 64 (F) Skilled = 80 (F)Total= 224 (F)
OVERHEADS COST VARIANCES
OVERHEADS COST VARIANCES
Total Overhead
s Cost Variance (TOCV)
Variable Overheads Cost Variance(VOCV)
={(TAH*AVOR) – (TSH*SVOR)}
Fixed Overheads Cost
Variance (FOCV)
={(TAH*AFOR) – (TSH*SFOR)}
Fixed Overheads Efficiency Variance (FOEV)
={TAH-TSR}*SFOR
Fixed Overheads Spending Variance (FOSV)
={TAFOC- Budgeted Fixed Overheads Cost}
Variable Overheads Efficiency Variance
(VOEV)={TAH-TSR}*SVOR
Variable Overheads Spending Variance
(VOSV)={AVOR-SVOR}*TAH
Capacity Variance={TAH- Normal Hours}*SFOR
Volume Variance
={Actual Volume- Budgeted Volume}* SH*SFOR
PROBLEM: VARIABLE OVERHEADS COST VARIANCES
SOLUTION: VARIABLE OVERHEADS COST VARIANCES
Variable Overheads Efficiency Variance (VOEV)
={TAH-TSR}*SVOR={2300-2000}*10 =
3000 (U)
Variable Overheads Spending Variance (VOSV)
={AVOR-SVOR}*TAH={11-10}*2300= 2300 (U)
Variable Overheads Cost Variance(VOCV)
={2300*11-2000*10}= 5300 (U)
PROBLEM: FIXED OVERHEADS COST VARIANCES
SOLUTION: FIXED OVERHEADS COST VARIANCES
Capacity Variance={TAH- Normal Hours}*SFOR
={2300-2500}*20= 4000 (U)
Fixed Overheads Efficiency Variance (FOEV)
={TAH-TSR}*SFOR={2300-2000}*20=
6000 (U)
Fixed Overheads Spending Variance (FOSV)
={TAFOC- Budgeted Fixed Overheads Cost
={50600-50000}= 600 (U)Fixed
Overheads Cost Variance (FOCV)
={(TAH*AFOR) – (TSH*SFOR)}
={50600-(2000*20)}=1060
0 (U)
Volume Variance
={Actual Volume- Budgeted Volume}* SH*SFOR={1000-
1250}*2*20= 10000 (U)
SALES VARIANCES
SALES VARIANCES
PROFITSBUDGETED
PROFITSACTUAL
SALES VARIANCES
COST VARIANCESLABOUR
VARIANCES
OVERHEADS VARIANCES
MATERIAL VARIANCES
SALES VARIANCES
SALES VARIANCES=SPV+SVV
Sales Quantity Variance
Sales Price Variance
Profit Variance
Sales Volume Variance
=SMV+SQV
Sales Mix Variance
PROBLEM: SALES VARIANCES
SOLUTION: SALES VARIANCES
SOLUTION: SALES VARIANCES
SOLUTION: SALES VARIANCES
SALES VARIANCES=SPV+SVV
Sales Quantity Variance
Sales Price Variance
={ASP-SSP}*AQS
Sales Volume Variance
=SMV+SQV
Sales Mix Variance
Product A= 8000 (U) Product B= 16000 (F) Total = 8000 (F)
Product A= 7529(F) Product B= 9412 (U) Total = 1883 (U)
Product A= 4471 (F) Product B= 13412 (F) Total = 17883 (F)
Actual Sales at Budgeted PricesProduct A = 8000*10=80000Product B = 16000*8 = 128000Total Actual Sales at Budgeted Prices = 208000Standard Mix Ratio = 5:12
Product A= 12000(F) Product B= 4000 (F) Total = 16000 (F)
Product A= 4000(F) Product B= 20000 (F) Total = 24000 (F)
This solution is based on sales value to determine the mix and quantity variance. The impact is visible in Sales Mix and Sales Quantity variances. However, Sales volume variance turns out to be the same.
COMPREHENSIVE ANALYSIS: PUTTING IT ALTOGETHER
COMPREHENSIVE PROBLEM: VARIANCE ANALYSIS
STEPS INVOLVED IN VARIANCE ANALYSIS
Determine the Profit Variance. Profit Variance = Actual Profit – Budgeted Profit
Try to trace the variance by analyzing cost variances and sales variances.
Prepare a reconciliation statement.
For detailed analysis go through the material provided (scanned copy) on variance analysis.
SOLUTION: COMPREHENSIVE PROBLEM