Standard Costing

CA Final Course Paper 5 Advanced Management

Accounting Chapter 5 Part 2
Arijit Chakraborty, FCA
 2

Budgetary Control

1. Objectives
2. Methods
3. Advantages of Budgetary Control
4. Problems
5. Characteristics
6. Administration
7. Budget Preparation
 3

Discussion on difference between

Standard Costing & Budgetary Control

1. Common Principles
2. System Differences
3. Overview
4. Applicability
5. Period
 4

Management Control

1. Variance Analysis
2. Management by Exception
3. Application in different organizations
4. Standard Cost & Behavioral Issue
 5

Management Control

1. Variance Analysis
2. Management by Exception
3. Application in different organizations
4. Standard Cost & Behavioral Issue
 6

Management Control

1. Variance Analysis
2. Management by Exception
3. Application in different organizations
4. Standard Cost & Behavioral Issue
 7

Management Control

1. Variance Analysis
2. Management by Exception
3. Application in different organizations
4. Standard Cost & Behavioral Issue
 8

Profit reconciliation statement

Concepts
 9

Profit reconciliation statement

• Profit reconciliation statement is used to sum up
all variances
• It can help the top management to explain the
major reasons for the difference between
budgeted and actual profits
• The sales margin variance and fixed overheads
variance are different between absorption and
marginal costing system
 10

Marginal costing
PRS
 11

Example
Profit Reconciliation Statement
$ $ $
Budgeted profit 14000
Sales variances
Sales margin price 8000 F
Sales margin volume 3400 A 4600 F
Materials cost variance
Materials price 480 A
Material usage 2400 F 1920 F
Labour cost variance
Labour rate 3200 A
Labour efficiency 4000 A 7200 A
Variable overhead variance
VO Expenditure 900 F
VO Efficiency 1600 A 700 A
Fixed overhead expenditure variance 400F 980 A
Actual profit 13020
 12

Absorption costing
PRS
 13

Example
Profit Reconciliation Statement
Budgeted profit 14000
Sales variances
Sales margin price 8000 F
Sales margin volume 2800 A 5200 F
Materials cost variance
Materials price 480 A
Material usage 2400 F 1920 F
Labour cost variance
Labour rate 3200 A
Labour efficiency 4000 A 7200 A
Variable overhead variance
VO Expenditure 900 F
VO Efficiency 1600 A 700 A
Fixed overhead variance
FO expenditure 400F
FO Volume 600 A 200 A 980 A
Actual profit 13020
 14

Reasons for Variance – Material,

Labour, OH
Production , processing and costing aspects
 15

Reasons for variances

Material price variance
• Price changes in market conditions
• Change in the efficiency of purchasing dept. to obtain
good terms from suppliers
• Purchase of different grades or wrong types of materials

Materials usage variance

• More effective use of materials/ wastage arising from the
efficient production process
• Purchase of different grade or wrong types of materials
• Wastage by the staff
• Change in production methods
 16

Reasons for variances

Labour rate variance

• Non-controllable market changes in the basic wage

rate
• Use of higher/lower grade of workers
• Unexpected overtime allowance paid
 17

Reasons for variances

• Labour efficiency variance

• Purchase of different grade or wrong types of materials
• Breakdown of machinery
• High/low labour turnover
• Changes in production method
• Introduction of new machinery
• Assignment wrong type of worker to work
• Adequacy of supervision
• Changes in working condition
• Change in motivation methods
 18

Reasons for variances

Variable overheads expenditure variance

• It may be caused by the non-controllable change in the price
level of indirect wages or utility rates since the predetermined
rate is set
• It is meaningless to interpret this kind of variance on its own.
One should look various components of the fixed overheads

Variable overheads efficiency variance

• Both the variable overheads and direct labour cost vary with
the direct labour hours worked
 19

Reasons for variances

Fixed overheads expenditure

• It is meaningless to interpret this kind of
variance on its own.
• It may be caused by the change in the price
levels of rent, rates and other fixed expenses
Fixed overhead volume variance
• When the level of activity is higher than the
budgeted level, there is a favourable
variance
 20

Reasons for variances

Sales margin price variance

• Change in the pricing strategies of the company
• Response to the change of pricing policies of its
competitors
• Higher profit margin with growing demand for the
product
• Lower profit margin for stimulating sales
Sales margin volume variance
• Change in prices and demand
• Change in the market share of its competitiors
 21

Enterprise Performance Management

using variance analysis
• Case study
Managerial Performance Report Using
Variance Analysis
Managerial Performance Report Using
Variance Analysis
 24

Additional aspects of Standard

Costing, interpretations &
implications of Variance analysis
Investigation of Standard Cost Variances
Please note that standard cost Related Learning Objectives:
variances are not a definitive sign 1. Explain how standard costs are
of good or bad performance. developed.
2. Calculate and interpret variances
for direct material.
These are merely indicators of 3. Calculate and interpret variances
potential problems which must be for direct labor.
investigated. 4. Calculate and interpret variances
for manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
Management by Exception
As investigation of standard cost Related Learning Objectives:
variances is itself a costly activity, 1. Explain how standard costs are
management must decide which developed.
variances to investigate. 2. Calculate and interpret variances for
Most managers practice direct material.
management by exception. 3. Calculate and interpret variances for
direct labor.
Usually an absolute rupee amount
or a percentage rupee amount. 4. Calculate and interpret variances for
manufacturing overhead.
5. Discuss how the management by
exception approach is applied to
investigation of standard cost
variances.
“Favorable” Variances May Be
Unfavorable

The fact that a variance is “favorable” does not mean that

it should not be investigated. Suppose inferior, low-priced
materials are ordered. One the one hand, a favorable
price variance will arise. On the other hand, most likely
there will be substantially more scrap and rework, and
thus a higher quantity variance.
Responsibility Accounting and Variances

Managers should be held responsible only for costs

they can control.

This is true in the area of variance analysis. For

example, a purchasing agent may be held
responsible for direct material price variances, but
not direct material quantity (usage) variances.
 29

Standard setting – vital issues

• Establishing Standards
• 1.Potential sources of quantitative standards
historical experience, engineering studies, and
input from operating personnel.
• a. Historical experience should be used with
caution because it may perpetuate operating
inefficiencies.
• b. Engineering studies and input from operating
personnel help determine the most efficient
level of input quantities.
 30

Standard setting – vital issues

• Responsibilities for establishing price standards
• a. Operations managers determine the quality of the inputs
required.
• b. Personnel and purchasing have the responsibility to
acquire the input quality at the lowest price that is limited by
market forces and trade unions.
Note that:
• Purchasing must consider discounts, freight, and
quality.
• Personnel must consider payroll taxes, fringe
benefits, and qualifications.
• c. Accounting is responsible for recording the price
standards and for preparing reports.
 31

Types of Standards
1. Ideal standards are standards that demand maximum
efficiency.

2. Currently attainable standards can be achieved under

efficient operating conditions.

3. Kaizen Standards are continuous improvement standards

that reflect a planned improvement. Kaizen standards are
currently attainable and have a cost reduction focus.

4. Activity-based Costing uses standards to:

An activity’s cost is determined by the amount of
resources consumed by each activity.
 32

Applying Standard costing

Standard costing systems can be used in both
manufacturing and service organizations. For example,
consider the standard costing in a hospital,
1. A relative value unit (RVU) is used to measure the
relative amount of time required to perform a procedure.
2. A standard cost per RVU is computed by dividing the
variable direct labor costs of a hospital department by
the number of RVUs performed by that department.
3. A standard direct labor cost for a given procedure can be
computed by multiplying the RVUs of the procedure by
the standard cost per RVU.
 33

Applying Standard costing

The standard cost sheet provides the standard costs and standard
quantities of materials, labor, and overhead that should be applied to a
single product or service, including:
1. A standard cost per unit is the per-unit cost that should be
achieved given materials, labor, and overhead standards. It can be
computed as follows:
Standard cost per unit = Standard price × Standard usage
2. The quantity of each input that should be used to produce one unit of
output is shown.
a) Standard quantity of materials allowed (SQ) is computed as follows:
SQ = Unit quantity standard × Actual output
b) Standard hours allowed (SH) is computed as follows:
SH = Unit quantity standard × Actual output
 34

Responsibility of Standard costing

• The responsibility for controlling the materials price variance is usually

the purchasing agent’s because he/she can influence controllable
factors such as quality, quantity discounts, distance of the source from
the plant, etc.

• The production manager is generally responsible for direct materials

usage because he/she can minimize scrap, waste, rework and other
ways to ensure that the standard is met.

• The production managers are responsible for the productive use of

direct labor and, thus, responsible for the direct labor rate variance and
efficiency variance.
 35

Limitations of Standard costing

• The cause of the variance may be attributable to other
departments.

• Frequent breakdown of machinery may cause interruptions

and nonproductive use of direct labor. But these breakdowns
are attributable to faulty maintenance by the maintenance
department, not production departments.

• Focusing on the direct material usage variance and/or direct

labor variances to evaluate performance can tempt the
manager to allow defective units to be transferred to avoid
using additional materials and/or hours because of rework.
These defective units may create customer-relation
problems once a customer gets stuck with the bad product.
 36

Disposition of variances
Disposition of Materials and Labor Variances:

1) Most companies dispose of variances at the end of the

year.
2) If the variances are not material, they simply are closed out
to Cost of Goods Sold.
3) If the variances are material, they are prorated to Work in
Process, Finished Goods, and Cost of Goods Sold.
4) GAAP requires that inventories be reported at actual costs.
( AS 2 / IAS 2)
5) But it is sometimes hard / unreasonable to justify carrying
costs of inefficiency as an asset.
 37

Controls & Variance analysis

Feedback control Feed forward Controls

• Steps are taken to get • Predictions are made

operations back on about what could go
track as soon as there wrong and then steps
is a signal that they taken to avoid that
have gone wrong outcome e.g. in the
preparation of budgets
 38

Kaizen Costing
• Kaizen costing is a cost-reduction system that is
applied to a product in production.

• It comes from the combination of the Japanese

characters ‘kai’ and ‘zen’ which mean ‘change’ and
‘good,’ respectively.

• The word ‘Kaizen’ translates to ‘continuous

improvement’ or ‘change for the better’ and aims to
improve productivity by making gradual changes to
the entire manufacturing process.
 39

Kaizen Costing
• Some of the cost-reduction strategies employed
involve producing cheaper re-designs, eliminating
waste and reducing process costs. Ensuring quality
control, using more efficient equipment, utilizing
new technological advances and standardizing work
are additional elements.
 40

Kaizen Costing
• Kaizen costing is variant of standard costing.
Standard costing specifies a cost target for the
production team for the coming period. Normally
standard cost is set for an year. It will be revised
every year. It is constant for an year as a planning
device. Any variances from it are examined and the
reasons are identified and understood.

• There is a learning effect in every activity

undertaken by the organization right from the
lowest cadre employee to the CEO and Board and
cost comes down.
 41

Evolution of Kaizen
• The Japanese implemented this cost reduction philosophy
in a systematic and objective manner. They made planned
reductions in the standard costs of an item every year. So
the production and sales team have to plan their
department and activity cost to achieve reduction in
standard cost. The idea was extended by them to monthly
costs.
• Such a reducing cost target for every month demands
some effort on cost reduction by departments every
month. Hence cost reduction is on the monthly agenda of
every department in the company. Kaizen costing is
providing the monthly cost target information and
accounting for actuals during the month.
 42

Kaizen costing & life-cycle costing

• Although most management accounting
techniques assess performance on a yearly basis
and normally focus on the production phase, it’s
accepted that a product starts incurring costs long
before it comes to the market.

• It incurs them from the time the initial idea is

conceived until the last unit is sold, the unsold
stock is scrapped and all other product-related run-
down activities cease.
 43

Kaizen costing & life-cycle costing

• The product’s total life-cycle costs include:

• Design and legal costs – eg, patenting.

• Research, development and testing.
• Recruitment and training. Manufacturing, which would include
any learning-curve effect.
• Marketing, sales and distribution.
• Inventory, storage, obsolescence etc.
• Retirement and disposal.
So, while target costing relates to planning and Kaizen costing
covers manufacturing, total life-cycle costing is relevant to all
stages of a product’s life.
 44

Kaizen vs. Standard costing

• In contrast, Kaizen costing is based around
improving the manufacturing process on a
continual basis, with changes being implemented
throughout the year.

• The cost deviation analysis done

in Kaizen costing examines the difference between
the target Kaizen costs and the actual cost
reduction achieved. The basic idea here is to
make tiny incremental cost reductions on a
continual basis in a product's life cycle.
 45

Kaizen vs. Standard costing

• Since the goal is to reduce costs on a monthly basis, every
department in the company makes an effort to introduce
operational changes on a daily basis.

• The fundamental basis of the Kaizen approach centers

around recognizing that employees who work on a particular
job are aware of how that particular task can be greatly
improved. They are then empowered to do so in
the Kaizen costing system. Employees are treated as
valuable sources of viable solutions, an approach that differs
greatly from the standard cost system that views employees
as laborers with variable performance levels.
 46

Standard costing & cost reduction – Case study :

Japan vs. US
• In the U.S., the purpose of standard costing is to practice
management by exception; i.e., management's attention is
directed towards situations where the actual results differ from
the expected results. The expected results are based on
standards set relative to the current manufacturing process.
Therefore, standard costing reflects existing technology and fails
to motivate improvements in the process.

• The Kaizen costing technique that is used at the Japanese car

manufacturer, Daihatsu, and is different to the U.S. method of
standard costing. Kaizen costing is a Japanese technique used
to manage costs during a product's planning and design
stages and has been used by some Japanese firms for over
twenty years.
 47

Standard costing & cost reduction – Case study :

Japan vs. US

• It is now widely used in Japan in such industries as

electronics, precision machinery, and automobiles. Its
objective is to reduce current costs by using various
improvement tools such as value engineering and functional
analysis for each manufacturing facility. The term “Kaizen”
translates as “continuous improvement”.

• A manager in the United States generally expects to use cost

information to make decisions about pricing or investments,
while a Japanese manager expects to use cost information to
reduce costs.
 48

Kaizen method
For a Japanese firm that uses target costing, a new
product project is established when a new product is
proposed. The actual costing system is implemented
during the initial design stage. There are 6 plans
involved in the product process:
• Plan 1 – Production, Distribution, and Sales Plan
(which includes projections of contribution margins
from sales).
• Plan 2 – Projected Parts and Materials Costs.
• Plan 3 – Plant Rationalization Plan (projected
reductions in manufacturing variable costs).
 49

Kaizen method Cont.…

• Plan 4 – Personnel Plan (for direct labor work force
and service department personnel).
• Plan 5 – Facility Investment Plan (capital budget
and depreciation).
• Plan 6 – Fixed Expense Plan (for prototype design
costs, maintenance costs, advertising and sales
promotion expenses, and general and
administrative expenses).
 50

Cost reduction through Kaizen

• Cost improvement through Kaizen is obtained by

reducing variable and fixed costs. Functional
analysis is applied at the design stage for a new
product, and a target cost for each function is set.
The functional target costs are summed, and the
result is a product target cost.
 51

Cost reduction through Kaizen

• After the first year of production for a new product,

the actual cost of the previous period becomes
the starting point for further cost reduction.
• This process of continuous improvement is
known as kaizen costing and encourages
continual improvements by tightening the
"standards."
 52

Continuous improvement
• Standard costs are steadily reduced by
continuous improvement efforts towards the target
cost. While the target cost is established during
the design stage, standard costs (as well as other
cost reduction techniques) are used during the
production stage to attain the target cost. Thus,
the standard costing system tracks progress in
achieving the target cost.
 53

Continuous improvement
• Cost reduction techniques include standard
costing. However, standard costing has limited
applicability and can lead to undesirable results.
For example, to minimize the purchase price
variance, a purchasing manager may purchase a
cheaper, lower quality part.
 54

Continuous improvement
• As a result, the quality of the product is likely to be
reduced, and the company may experience higher
overall costs in the form of rework or warranty
problems.
• In contrast, Kaizen costing is performed on a
company-wide basis and can be used in planning,
design, and other processes as well as production.
Kaizen costing activities do not reduce the overall
quality of the product; they do ensure that
expenditures result in the receipt of appropriate
value.
 55

Comparison

Standard Costing Concepts

• Cost control system concepts.
• Assume current manufacturing conditions.
• Meet cost performance standards.

Kaizen Costing Concepts

• Cost reduction system concepts.
• Assume continuous improvement in manufacturing.
• Achieve cost reduction targets.
 56

Comparison
Standard Cost Techniques
• Standards are set annually or semiannually.
• Cost variance analysis involving standard costs
and actual costs.
• Investigate and respond when standards are not met.

Kaizen Costing Techniques

• Cost reduction targets are set and applied monthly.
• Continuous improvement (Kaizen) is implemented during the year to
attain target profit or to reduce the gap between target profit and
estimated profit.
• Cost variance analysis involves target Kaizen costs and actual costs
reduction amounts.
• Investigate and respond when target Kaizen amounts are not attained.
 57

Performance Management
• CIMA defines standard costing as “a control technique
that reports variances by comparing actual costs to
preset standards facilitating action through management
by exception”.
• The main aim of this cost-control tool is to avoid adverse
variances, based on the assumption that manufacturing
conditions will not change. Standards are usually set
before the year to which they relate and do not change
for the whole period, unless a major cost or change in
circumstances renders them obsolete. Kaizen cost
targets, on the other hand, are usually set monthly.
 58

Performance Management

• One of the main criticisms of standard costing is that, as

long as adverse variances are avoided, no attempt is
made to seek further cost savings.
• Kaizen costing is a more proactive approach that
assumes improvements can always be made – it
promotes a culture in which all employees are constantly
seeking to reduce production costs.
• Relevance of SC and KC in service and manufacturing
sector
• Major professional opportunity for CA
 59

STANDARD COSTING –
CHALLENGES IN
IMPLEMENTATION IN TODAY'S
MANUFACTURING ENVIRONMENT
 60

Emerging issues

• In recent years, experts have argued that standard

costing variance analysis should not be used for cost-
control and performance-evaluation purposes in today's
manufacturing world.
• Its use, they argue, is likely to induce behaviour which is
inconsistent with the strategic manufacturing objectives
that companies need to achieve in order to survive and
prosper in today's intensely competitive international
economic environment.
 61

Standard setting
• The scientific management engineers divided the
production system into a number of simple repetitive tasks
in order to obtain the advantages of specialisation and to
eliminate the time wasted by workers changing from one
task to another.
• Once individual tasks and methods have been clearly
defined it is a relatively simple matter to set standards of
performance using work study and time and motion study.
These standards of performance then serve as the basis
for financial control: monetary values are assigned to both
standards and deviations from standard, i.e. variances.
These variances are then attributed to particular
operations/ responsibility centres.
 62

Business Environment
• Companies operating in today's manufacturing
environment, however, are likely to have strategies based
on objectives such as improving quality, increasing
flexibility to meet customers' individual requirements,
reducing manufacturing lead times and delivery times,
reducing inventories and unit costs.
• To help achieve these objectives, manufacturing
strategies such as just-in-time (JIT), advanced
manufacturing technology (AMT) and continuous
improvement are often applied. Kaplan and others argue
that standard costing is counter-productive in such an
environment.
 63

Standard Costing – specific

challenges
• Efficiency variances measure labour hour input against
the standard labour hours of the production achieved.

• Producing in smaller batch sizes will mean that more

labour time is spent on machine set-ups and
consequently the standard hours of output will be
lower relative to the labour hour input -- resulting in
adverse efficiency variances.
 64

FO Volume variance
• The fixed overhead volume variance arises as a result of a
given level of overhead expenditure being spread over a
different number of units from the number budgeted.
Adjusting output downwards to meet a fall in short-term
demand will, however, mean fewer units to absorb the fixed
overhead, resulting in an adverse volume variance.

• Hence managers may be motivated to produce for stock in

direct contravention of the philosophy of JIT.
 65

Material price variance

• Materials price variance: adverse materials
price variances may result from buying in
small quantities in order to keep stocks low
as part of the JIT philosophy.
• Measuring this variance may therefore put
pressure on purchasing managers to buy in
bulk to obtain quantity discounts and thus
favourable price variances
 66

Advanced Manufacturing Technology

• In an AMT environment, the major costs are those related to
the production facility rather than production volume related
costs such as materials and labour which standard costing is
essentially designed to plan and control
• Standard costing is concerned with comparing actual cost per
unit with standard cost per unit. Fixed costs imputed to the
product unit level are only notionally 'unit' costs.
• Any difference between the actual and standard fixed cost per
unit is not therefore meaningful for controlling operations, as it
does not necessarily reflect under or overspending --it may
simply reflect differences in production volume. What matters is
the total fixed overhead expenditure rather than the fixed
overhead cost per unit.
 67

Advanced Manufacturing Technology

• Therefore, in an AMT environment, standard costing
variances have at best a minor role to play and at worse
they may be counter-productive insofar as they force
managers to focus on the wrong issues.
• An activity-based cost management (ABCM) system may
be more appropriate, focusing on activities that drive the
costs in service and support departments which form the
bulk of controllable costs.
 68

JIT
• In a JIT/AMT/continuous improvement environment, the
workforce is usually, organised into empowered, multi-
skilled teams controlling operations autonomously
• The feedback they require is real time and in physical
terms. Periodic financial variance reports are neither
meaningful nor timely enough to facilitate appropriate
control action.
 69

TQM
• In a total quality management (TQM) environment,
standard costing variance measurement places an
emphasis on cost control to the likely detriment of quality
• TQM requires a total managerial and worker ethos of
improving and maintaining quality, and of resolving
problems relating to this.
• The emphasis of standard costing is on cost control;
variance analysis is likely to pull managerial and worker
interest away from perhaps critical quality issues. Thus
cost control may be achieved at the expense of quality
and competitive advantage.
 70

Need for modifying traditional

standard costing system
• In today's intensely competitive environment we no
longer look to the total unit cost in order to determine
selling price; instead, we use the selling price to help
determine the cost the market will allow. This allowable or
target cost per unit is a market-driven cost that has to be
achieved if desired profits are to be achieved.
• In a highly competitive, dynamic world there is likely to be
considerable downward pressure on this allowable cost.
Cost management must therefore consist of both cost
maintenance and continuous cost improvement.
 71

Need for modifying traditional

standard costing system
• In such a competitive, improvement-seeking environment,
standard costing may have limited application based on
predetermined engineering standards which creates a
mind set of achieving the standard rather than of
continuous cost reduction
 72

Standard Costing in Kaizen

• In a largely automated production system, most costs are
committed at the product design stage
• While many costs are, indeed, committed at the product
design stage, there is usually considerable scope for cost
variability at the production stage. This is exemplified by
the manner in which Kaizen is intended to complement
target costing.
• Target costing is applied in managing costs at the product
design stage via value engineering. Kaizen is then used to
encourage continuous improvement, i.e. cost reduction. It
does this by targeting reductions to current unit costs and
then comparing actual reductions against these targets.
 73

The ‘dark area’ of Standard costing

• Over-emphasis on cost control can be detrimental to
quality, customer satisfaction and market share.

• This is a danger which management should be aware of.

This does not justify the abandonment of cost control,
however. It simply reinforces the need to measure
performance through a range of indicators-cost, quality,
lead times, inventory levels and so forth.
 74

Limitations of Standard costing

• This traditional approach is one whereby actual
performance is compared with the standard cost of
activity achieved and is based on predetermined
standards. If the predetermined standard, set prior to the
budget period, is still realistic under current conditions
then the variance report will still be of added value to the
user.
• However if there has been changes in both internal and
external factors then the standards may no longer be
realistic and the variances reported will be of little use and
no longer relevant for control purposes.
 75

SC, Lean Statement & Decision Making

 Typical Line Items

• Net Sales

• Overtime

• Material Cost

• Supplies

• Gross Margin
 76

Lean Accounting
V/s
Standard Costing
• Focus & Approach
• Process Control
• Operational Differences
 77

Transformation to Lean
Accounting System

• 5 Steps process
 78

Standard Costing Software Program

• Objectives
• Capabilities
• Advantages
 79

Standard Costing
Corporate Insights

• Results of Global Survey & Research

 80

Standard Costing
• Future Role
• Transformation in approach
 81

Way forward
• The basic principle of accounting control embodied in
standard costing remains sound. The constituents of the
standard, the variances calculated and the way they are
interpreted may need to change.

• A fruitful productive area for future research is the way in

which organisations are retaining the cost control
methodology inherent in standard costing but are
adapting their systems to take account of the changing
production environment.
 82

Recap
• SC Concepts
• Budgetary Control
• RM, L, OH, S
• Variance Analysis
• Kaizen
• Quality Variance
• Lean Accounting
• Software
• Survey
 83

Introduction to MCQ & CA Final problems

• General
• CA Final exam questions
 84

Section A: Short Notes

1) Difference B/W SC & Budgetary Control
- Listen to Solution & Discussion
 85

Section A: Short Notes

2) Disposal of Cost Variances
- Listen to Solution & Discussion
 86

Section A: Short Notes

3) Reasons of Labour Rate Variance
- Listen to Solution & Discussion
 87

Section A: Short Notes

4) Problems of SC in Time of inflation
- Listen to Solution & Discussion
 88

Section A: Short Notes

5) Is SC a Post Mortem exercise
- Listen to Solution & Discussion
 89

Section A: Short Notes

6) Features of Partial Plan of SC
- Listen to Solution & Discussion
 90

Section B: Fill in the blanks

1. The difference between actual fixed overhead and budgeted fixed
overhead is the _____________.
fixed overhead spending variance
2. The difference between what was paid and what should have
been paid for actual inputs is called the ________ or the ______.
price variance, rate variance
3. The difference between the direct materials actually used and the
direct materials allowed for actual output multiplied by the
standard price is the ________________________________.
direct materials usage variance
4. A(n) _________________________________ is produced
whenever the actual rupee amount spent are greater than the
standard allowance.
unfavorable variance
 91

Fill in the blanks

5. The ____________________________ is the price that should
have been paid per unit of input; the quantity of input allowed
per unit of output is the _____________________________.
price standard, quantity standard
6. The difference between the actual payroll and what should
have been paid for the actual hours worked is the _________.
direct labor rate variance
7. The ___________________ is a measure of capacity
utilization.
fixed overhead volume variance
 92

Fill in the blanks

8. The difference between the actual labor hours worked and the standard
hours allowed multiplied by the variable overhead rate is the ________;
the difference between what was spent and what should have been spent
for variable overhead at actual hours is the ______________________.
variable overhead efficiency variance, variable overhead
spending variance
9. The per-unit cost that should be achieved given materials,
labor, and overhead standards is the ________ or _________.
standard cost per unit, unit standard cost
10. A listing of the standard costs and standard quantities of
materials, labor, and overhead that should apply to a single
product is the ________________________________.
standard cost sheet
11. The maximum allowable deviation from a standard is called the ________.
control limit
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12. A(n) ________________________ reflects perfect

operating conditions.
ideal standard
13. The difference between the actual cost of an input and its
planned cost is the _________________.
total budget variance
14. The difference between standard quantities and actual
quantities multiplied by the standard price is the ________.
usage variance
15. The difference between the standard material cost of the
standard yield and the standard material cost of the actual
yield is the _______________________.
yield variance
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16. The difference between the standard cost of the mix of

actual material inputs and the standard cost of the material
input mix that should have been used is the _________.
mix variance
17. A(n) __________ reflects an efficient operating state.
currently attainable standard
18. A(n) _________ is produced whenever the actual dollars
spent are less than the standard allowances.
favorable variance
19. A detailed listing of the type and quantity of materials
allowed for a given level of output is called the ________.
standard bill of materials
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20. The difference between what was paid for materials

purchased and what should have been paid is the ______.
direct materials price variance
21. The direct labor hours that should have been used to
produce the actual output is the _________; the quantity
of materials that should have been used to produce the
actual output is the _________________
standard hours allowed, standard quantity of
materials allowed
22. The difference between the actual direct labor hours used
and the standard labor hours allowed multiplied by the
standard hourly wage rate is the _____________.
direct labor efficiency variance
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SECTION C: MULTIPLE-CHOICE QUESTIONS

1. If more direct materials were used for production than were allowed for the
output, then the:
a. direct labor efficiency variance will be unfavorable.
b. direct labor rate variance will be favorable.
c. direct materials price variance will be favorable.
d. direct materials usage variance will be unfavorable.
e. overhead budget variance will be unfavorable.

2. The direct labor rate variance is computed as:

a. (Actual labor hours worked – Standard labor hours allowed) ×
Actual labor rate.
b. (Actual labor hours worked – Standard labor hours allowed) ×
Standard labor rate.
c. (Actual labor rate – Standard labor rate) × Standard hours allowed.
d. (Actual labor rate – Standard labor rate) × Actual hours worked.
e. none of the above.
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3. Which of the following variances would be least likely if

the materials used were of much poorer quality than the
standard?
a. unfavorable direct materials price variance
b. unfavorable direct materials efficiency variance
c. unfavorable direct labor efficiency variance
d. unfavorable variable overhead efficiency variance
e. All of the above would be equally likely to occur.

4. If the direct labor force is poorly trained, which of the following variances is
most likely to occur?
a. unfavorable direct labor efficiency variance
b. unfavorable direct labor rate variance
c. favorable direct materials efficiency variance
d. favorable fixed overhead spending variance
e. unfavorable variable overhead spending variance
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5. Which of the following circumstances is least likely to

cause a direct materials usage variance?
a. inexperienced workers
b. lack of regular maintenance of automated production machinery
c. materials of poorer than expected quality
d. price increases by suppliers
e. unanticipated changes in the design of the product

6. Which of the following would accompany an unfavorable

direct labor efficiency variance?
a. favorable direct materials usage variance
b. unfavorable direct materials price variance
c. unfavorable direct labor rate variance
d. unfavorable variable overhead efficiency variance
e. unfavorable fixed overhead spending variance
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7. The overhead spending variance computed using a three-variance

analysis:
a. consists only of fixed costs; no variable costs are included.
b. consists only of variable costs; no fixed costs are included.
c. consists of both variable and fixed costs.
d. is favorable when the direct materials price variance is favorable.
e. None of the above are true.

8. The overhead efficiency variance computed using a three-variance

analysis:
a. is (Flexible budget for actual hours worked – Flexible budget for standard
hours allowed).
b. consists only of variable costs; no fixed costs are included.
c. is [(Actual hours worked – Standard hours allowed) × Standard variable
overhead rate].
d. is unfavorable when the direct labor efficiency is unfavorable.
e. All of the above are true.
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9. The direct materials standard for XYZ Company is 10 pounds of input at

$4.00 per pound. XYZ purchased 25,000 pounds of material for $97,600. The
company used 22,000 pounds of material to produce 2,250 units of output.
The direct materials price variance is:
a. $2,000 unfavorable.
b. $2,400 favorable.
c. $7,600 unfavorable.
d. $9,600 unfavorable.
e. none of the above.

10. Assume the same information as in Question 9 above. The direct materials
usage variance is:
a. $2,000 unfavorable.
b. $2,400 favorable.
c. $7,600 unfavorable.
d. $9,600 unfavorable.
e. none of the above.
Please Note: “Favorable” Variances May
Be Unfavorable

The fact that a variance is “favorable” does not mean

that it should not be investigated. Raw materials are
good examples of this phenomenon, especially
considering the competitive pricing environment for most
commodities. Suppose inferior, low-priced materials are
ordered. On the one hand, a favorable price variance will
arise. On the other hand, most likely there will be
substantially more scrap and rework, and thus a higher
quantity variance.
Responsibility Accounting and Variances

As noted previously, managers should be held

responsible only for costs they can control. This is
true in the area of variance analysis. For example, a
purchasing agent may be held responsible for direct
material price variances, but certainly not direct
material quantity (usage) variances.
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Lesson Summary & CA Final Exam strategy

1. We have learnt the meaning and purpose of

standard costing

2. We had also seen the classification of

standard costing and discussed them under 4
groups – material, labour, OH, Sales

3. We had discussed the variance analysis

computation, PRS & reasons for variance
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Thank You