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Standard Cost Variance Analysis Example

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Part 1.

Standard cost for one unit of product X is as follow:

Material 7kg at £35 £245
Labour 20 h at £12 £240
Variable overhead 20h at £8 £160
Selling price £1500

Budgeted Income:

Budgeted units (8800)            (£)

Sales (8800*£1500)=        13200,000

Material (61600kg*35)=  (2156,000)

Labor (176000h*12)=     (2112,000)

Variable OH (176000h*8)=(1408,000)

Contributation             =     7524000

Actual Income:

Actual units (8700)                      (£)

Sales (8700*1394)=                  12125,000

Material (62450kg*34.96)=    (2183,000)

Labor (177450h*12.657)=      (2246,000)

Variable OH (177450h*8.086)= (1435,000)

Contributation             =              6261,000

Explanation: Budgeted and actual income shows that London plc are going to decrease their contributation in actual. Selling units are less than budgeted, their sale price also going low, material price per kg  also decrease but material utilize in actual is increase then budgeted.Labour hours and variable overhead increase as well as their per hour cost also increase. This simply shows that London plc has to bear high expenditure then receive profit.

Variances:

Sales price variance=Actual sale units*(actual price –standard price)

=8700*(1394-1500)=(922200)unfavorable

Sales volume variance= Standard unit price*(Actual sale unit-Budgeted sale unit)                        =1500*(8700-8800)=(150000)unfavorable

Sales variance shows that actual price is less than budgeted which is not favorable for company, its actual sale units also less than budgeted.

Material price variance=Actual Quantity*(St price-Act price)

=62450*(35-34.96)=2498 favorable

Material quantity variance=St Price*(st quantity-act qty)

=35*(61600-62450) =(29750)unfavorable

Material variances show that decrease in price is in favor of company but more material is going to use making less no of units which is not a good aspect.

Labor rate variance= actual labor hours*(st rate-act rate)

=177450*(12-12.657)=(116584) unfavorable

Labor efficiency variance= st hour rate*(st h-Act h)

=12*(176000-177450)=(17400)unfavorable

Labor variances shows that expenditure is high in case of labor because with more no of hours, it has to pay remuneration more than budgeted amount.

Variable overhead variances:

Variable overhead expenditure variance=(act h*Act rate- act h*st arte)

=(177450*8.086-177450*8)=(15260)unfavorable

Variable overhead efficiency variance=(act h*st rate-st h*st rate)

=(177450*8-176000*8)=(11600)unfavorable

Variable variance shows that actual expenses on overheads are high, not only this but also rate of hour is expensive which is not in favor of company.

In short, variances are identified to check whether our actual performance is match with budgeted planning if not, problem is happen in which area, our budgeting system which has to be improved or our actual performance which is going slow but our expenses is going to increase day by day.

Contributation reconciliation statement:

Budgeted contribution                                       =7524000

Sales volume variance                                      = (150000)

Standard contributation on actual sales        =13050000

Selling price                                                          = (922200)

                                                                                 19501800

Material price variance                                     = 2498

Material quantity variance                               =                    (29750)

Labor rate variance                                             =                    (116584)

Labor efficiency variance                                    =                    (17400)

Variable OH expenditure var                              =                    (15260)

Variable OH efficiency var                                    =                  (11600)

                                                                                                          (188096)

Part 2:

Limitations of Standard Costing and Variance Analysis:

Now we are going to consider these cost variances from the perspective of various department managers. The cost accountant has to consider that the benefits and flaws of costing system and discuss it with others. Firstly, it would be considered that what sort of Budgeting system we are going to calculate our all estimated sales units of material, labor hours and fixed and variable overheads. It’s the responsibility of accountants to verify all the historical data and then prepared budgeted cost and incomes which gives us a positive direction to perform in a better way in actual. Unfavorable variances experience that our budget and actual costing a huge difference. If our actual sales price units of sales our expenditures are not according to our estimation then company has to bear some swear loss.

The first person who have to response to the cost accountant comment must be the purchasing agent, taking a defensive posture, he consider the unfavorable variances were not in his control. He also focus on direct material, quality of material, it’s price and it’s actual requirement needed. Then production department are responsible to complete finish goods according to given order within provided material. The cost of labor also plays a very important role in these variances. If we budget lower cost of labor and in real, we have to pay higher amount then it’s completely a loss for company. Labor should utilize a appropriate number of hours for manufacturing goods, if they receive a reasonable remuneration.

Company has to bear overhead expenditures which may fix or variable. We also consider our variable overheads because fixed overheads, we have to pay in any case but we can control our variable overheads by minimum utilization.

Now we are going to talk about Standard Costing. A cost accounting system become more useful when it includes the budgeted or expected amounts of manufacturing cost to serve as standards for comparison with the cost actually incurred. These budgeted amounts are called standard cost. A standard cost is the per unit cost expected to be incurred under normal operating conditions. Standard costs are estimated separately for the material, direct labor and overhead relating to each type of product that the company manufactured. Comparison of the actual cost with these cost standards quickly direct managements attention to situation in which actual cost differ from actual cost. Any difference between the actual cost incurred and the standard cost charge to the work in process account are recorded in special cost variances account. A separate cost variance account is maintain for each type of cost variance, thus the cost accounting system provides manager with detail information as to the nature and amount of the differences between actual and manufacturing cost. Standard cost and variance accounts assist management in controlling cost by quickly bringing differences in actual and expected cost to management’s attention. Otherwise these cost differences might flow unnoticed into the finished goods inventory and cost of goods sold. Standard costs are established and revise each period during the budgeting process. Standard costs are continuously reviewed and periodically revise if significant changes occur in production method or in the prices paid for material labor and overhead.

For companies that used standard costing system, the accuracy of the inventory and cost of goods sold figure reported in their financial statements depend upon the reliability of these standards cost numbers. A company financial statement can be materially misstated when standard costs do not accurately represented the actual manufacturing cost incurred. The main problem we have to face while using this costing system is that this costing system is rely on historic data and past experiences. Today, we can see a very tuff competition in market companies has to prepare for upcoming demands and trend of markets. If we only consider the previous data we cannot face the latest challenges. We have to consider future prospect demand likeness and dislikeness of consumers. In the field of account many new costing system introduce which deals with previous data as well as also consider future prospect. We can use those new techniques for improve our estimation system. Few limitations of standard costing also given such as; making a proper standard for any task is very technical and tough ,it need very strong knowledge .because of this ,it require expenses more and not a better options for small level companies. Every business needs improvement and updating so, it’s our responsibility to upgrade our standards time to time for improved performance. Making a technical standard and all work perform according to that standard is not convince for every type of business. Few businesses work above any fix standard otherwise they couldn’t perform well. In some situations, making standard leaves adverse effects in such a way that we may create a high standard according to previous scenario but future scenario is going to be completely different then it may discourage the performance and leave poor effects on the reputations of company if we couldn’t meet those standards.

As we say before, standard include past experience as well as future prospects so, uncertainty is very much involved in standard costing and may very different from actual standards. Extreme care and full attention is compulsory while making standards and we also needs latest systems for our business otherwise all efficiency will be going to destroy.

Standard costing is also reasonable only for mass productive atmosphere. But if we produce items in small patches according to customers need then it is not possible for use to make standard only on few customers.

Variances analysis is better for verify whether actual rates or actual quantity is better as compare to estimated rates or quantity.

Standard costing and variance analysis is also very difficult to apply in services sector because no standard can be prepare for providing services ,it can only work in manufacturing areas. Whereas traditional variance analysis of overhead costs provide not a suitable standards which may control overheads costs properly. We may apply overhead estimations in services sector but it may require too much time and large amount for investment which is not a better idea.

Responsibility accounting is almost become part of variance analysis and standard costing. Variances are created due to making no proper estimations. It also shows planning flaws of estimation which can create more difficulties for operational performance. It also difficult in operational tasks can not specify for a single person, or a single task to operate smoothly. Variance analysis is normally calculated at the end of year. The importance of variance analysis is going to decrease as control setup as the reporting period is increased and gathering such type of information is time taking and lengthy process which causes delay in making managements their final decisions.

Continuously use of budgeting systems may cause a time issue for the management for making quick decisions until we have to gather all detailed data and without it our decision has no importance so, we can say that variance analysis is consider expensive in mean of time for management and high information system may required.

Standard costing and variance analysis is generally focus on short term production because their main focus on small durations.  Standard costing is not reasonable for long working and may have less worth for long duration. A negative effect of standard costing and variance analysis also shows on employees that perform only to meet standards but not perform to enhance their ability or making better production.

In simple words, we can say that standard costing and variance analysis is good for business but they have lot of issues and limitations which effect their efficiency and performance.

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