MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 334

MAF 334
2018

221

Standard Costing

READING REFERENCES:
Drury 9th edition: Chapter 17 and 18.

TUTORIAL QUESTIONS:

ST01 – Working backwards

ST02 – Dr Jenkins

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 TABLE OF CONTENTS

INTRODUCTION PAGE

i. LEARNING OBJECTIVES 3

ii. OVERVIEW 3

iii. THE TABLE METHOD 4

iv. ISSUES TO BE AWARE OF 5

A. CALCULATION AND ANALYSIS OF VARIANCES 6

1. Basic production variances 8

2. Basic sales variances 9

3. Mix and yield variances 9

4. Sales volume: Market share & size 10

5. Reconciliation of actual to budgeted profit 11

6. T-accounts 12

7. Variable and absorption costing 15

B. INVENTORY VALUATION IN TERMS OF IAS 2 16

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 i. LEARNING OBJECTIVES

At the end of this module you should be able to:

- Explain what standard costing is and when it is applicable;

- Discuss the advantages/disadvantages of standard costing;
- Explain how are standards set;
- Calculate material, labour, overhead and sales variances;
- Split material usage variance into material mix and yield variances where appropriate;
- Split labour efficiency variance into labour mix and yield variances where appropriate;
- Split sales volume variance into market size and share variances (one product scenario!)
- Reconcile actual profit with original budgeted profit;
- Handle a change in raw material inventories;
- Handle a change in finished goods inventories;
- Identify the causes of material, labour, overhead and sales variances;
- Understand difficulties in interpreting sales variances;
- Distinguish between standard variable costing and standard absorption costing;
- Record standard costs and variances in T-account format;
- Understand the IAS2 implications.

ii. OVERVIEW

A standard costing system enables the variances between actual- and budgeted figures to be
analysed in detail, thus enabling costs to be controlled more effectively. Standard costs are
predetermined target costs per unit that should be incurred under efficient operating conditions.

Two key differences between standard costing and IFRS:

- Inventory is carried at standard cost

- Variances are recognised in full in the period the behaviour occurs

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 iii. TABLE METHOD

You are encouraged to use the table method outlined below to calculate standard costing variances. It is very important that you show ALL your
calculations for each variance so that your variance calculations can be marked through should you make a mistake somewhere.

Basic table:

Original Budget Flexed Budget Quantity AQI@SP Price Actual Cost

(Aup x SQ/u x variance (Aup x AQ/u x variance (Aup x AQ/u x
SP/kg*) SP/kg*) AP/kg*)
Direct material

Direct labour

Variable overheads

Fixed manufacturing Flexed Budget Original Budget Actual Cost

overheads (Aup x SQ/u x
SP/kg*)

* - per unit of INPUT i.e. kg’s, litres, hours etc.

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Where:

P – Price (or rate/tariff)

Q – Quantity
S – Standard
A – Actual
var – Variance
Aup – Actual units produced (not sold!!)
SQ/u – Standard quantity per unit
SP/kg* - Standard price per kg*

iv. ISSUES TO BE AWARE OF

1. Flexing
a. (1) FB = OB x Au/Bu; or (2) SC/u x Au
b. Revenue & Sales Exp Au SOLD Beware  FG!!
Production Costs Au PRODUCED
c. FMOH:
i. Absorbtion Cost = Flex
Var Cost = Don’t Flex
d. Fixed selling Exp: Don’t Flex

2. Materials variances
a. Price – AQpurchased Beware  RM!!
b. Usage – Aqused

3. Labour variances

4. VOH
a. Basis: units, labour hrs, machine hrs, activity No efficiency var
possible!

5. FMOH
a. Basis: units, labour hrs, machine hrs, activity Does not change Vol Var!
b. Volume variance = under/over absorption as a result of absorption costing
c. Volume variance = Capacity + Efficiency var

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A. CALCULATION AND ANALYSIS OF VARIANCES

Lecture example

You are the management accountant at Auto Seats SA (Pty) Ltd (ASSA), a manufacturer of
automotive seats. ASSA uses a FIFO standard absorption costing system for cost control and
performance evaluation as well as to value its inventory for GAAP purposes. Monthly detailed
variance reports are prepared for management to allow for “management by exception”. Standards
are set at “tough but attainable” levels following a participative budgetary process. Standards are
generally reassessed every six months. Management use the variance reports with care to ensure
that the appropriate managers are held responsible for the variances. Management consider all
variances to be material.

Below is data relating to the month of May 2012.

Budget Actual
Seat sales 550 seats 490 seats
Chair production 600 seats 500 seats
Selling price R600 R640
Fixed admin overhead R12 400 R12 000

Standard cost card for one seat: R

Metal tubing 6m @ R6 36
Leather 2m2 @ R14 28
Foam – Type A 1 kg @ R12 12
Foam – Type B 2 kg @ R6 12
Direct labour – Skill level 1 2 hrs @ R40 80
Direct labour – Skill level 2 1 hr @ R80 80
Variable manufacturing overhead 2 hrs @ R62 124
Fixed overhead 2 hrs @ R80 160
Total cost per seat 532

There was no raw material inventory on hand at the beginning of the month. There was no opening
or closing WIP for the month. There were 50 completed seats on hand at the beginning of May.
Variable and fixed manufacturing overheads are allocated based on direct machine hours. The
denominator level of activity is 1 200 machine hours.

Actual costs for May were as follows:

 Metal tubing purchases were 3 600 metres @ R5.00 per metre. There was no opening raw
material inventory. The closing raw material inventory was 100 metres.
 R24 000 was spent on purchasing 1 500 sqr metres of leather. All the leather was used in
production.
 400 kg of Type A foam was purchased at R10 per kg. 600 kg of Type B foam was
purchased at R8 per kg. All of the foam was used in production.
 Skill level 1 workers worked 1 200 hrs at a rate of R44, while skill level 2 workers worked
625 hrs at a rate of R70 per hour.
 Variable overhead costs amounted to R70 000. The actual variable overhead rate was R56
per machine hour.
 The actual fixed overhead rate was R84 per machine hour.
 The leather price and usage variances for May were R3 000 unfavourable and R7 000
unfavourable, respectively.

The expected industry sales volumes for the month was 5 500 seats. A market share of 10% was
expected. The actual industry sales volume for the month was 6 000 seats.

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REQUIRED

1. Basic production variances

Calculate the following variances:

1.1 Metal tubing price variance

1.2 Metal tubing usage variance
1.3 Foam price variance
1.4 Foam usage variance
1.5 Direct labour rate variance
1.6 Direct labour efficiency variance
1.7 Variable overhead expenditure variance
1.8 Variable overhead efficiency variance
1.9 Fixed overhead expenditure variance
1.10 Fixed overhead volume variance

2. Basic Sales Variances

2.1 Sales margin price variance (sales price variance)

2.2 Sales margin volume variance (sales volume variance)

3. Mix and Yield Variances

3.1 Split the Foam usage variance into the Foam mix and yield variances.
3.2 Split the labour efficiency variance into the labour mix and yield variances.

4. Fixed overhead capacity and efficiency variance

4.1 Split the fixed overheads into capacity and efficiency variance.

5. Sales volume: Market Share & Size

5.1 Calculate the market size and market share variances.

6. Reconciliation of Actual to Budgeted profit

6.1 Calculate actual net income for May (show ALL workings).
6.2 Show a detailed reconciliation statement between original budgeted and actual profit for May
2012.

7. T-Accounts

7.1 Show all ledger accounts (before closing variance accounts at month end).

8. Variable v Absorption Costing

8.1 Tabulate the differences between a standard variable costing system and a standard
absorption costing system.

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1. Basic production variances

Concept: Isolate the variances that relate to the difference in the quantity of inputs that was used
and the price that was paid for that input.

FB (SPxSQ) Q var AQxSP P var Actual

(AQ@SP) (AQI@SP) (APxAQ)
Metal tubing AQ x SP

= R21 600 R3 600F = R18 000

SP x SQ AQ x SP

= R18 000 R3 000U = R21 000

Foam Type A
=R6 000 R1 200F =R4 800 R800F =R4 000

Foam Type B
=R6 000 R2 400F =R3 600 R1 200U =R4 800

=R3 600 F =R400U

Direct Labour Level 1

=40 000 8 000U =48 000 4 800U =52 800

Direct Labour Level 2

= 40 000 10 000U =50 000 6 250F = 43 750

=18 000U =1 450F

Variable overhead
variances
=62 000 15 500U =77 500 7 500F =70 000

Fixed overhead SP x SQ Static AP x AQ

variances budget
=80 000 16 000U =96 000 9 000U =105 000

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 2. Basic Sales Variances

Concept: Identify the effect on profit of:

i) The change in sales volume

ii) The change in sales price

Sales variances

2.1) Sales margin price variance = sales price variance

= [(SP- std COS) – (AP – std COS)] AQ sold
(note: std COS is used since sales function have no control over cost)
= (SP – AP) AQ
=(640 – 600)* 490 = 19 600 F

2.2) Sales margin volume variance = sales volume variance

= (AQ – SQ) (budget GP)
= (490 – 550) * (600 – 532)
= 4 080 U

3. Mix and Yield Variances

Concept: Mix and yield variances should be calculated for material and/or labour that are
interchangeable.

Foam In kg's
(1) (2) (3)
Flexed Budget Yield Revised Standard Mix Actual
Quantity (1) – (2) Quantity (2) – (3) Quantity
Input
Type A 500 166.66F 333.33 66.66U 400
[500x1] [(400+600) * 1/(1+2)]
Type B 1000 333.33F 666.66 66.66F 600
[500x2] [(400+600) * 2/(1+2)]
Total 1500 1000 1000

(1) Standard quantity in standard proportion

(2) Actual quantity in standard proportion
(3) Actual quantity in actual proportion

Foam mix var = R12x66.66U + R6x66.66F = R400U

Foam yield variance = R12x166.66F + R6x333.33F = R4 000F

Sum of mix and yield variances = R400U + R4 000F = R3 600F (Check: equals the total Foam
usage variance)

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Labour In hrs
(1) (2) (3)
SQ output Yield AQ input in std mix Mix AQ input in
in std mix (1) – (2) (2) – (3) actual mix
Level 1 1 000 216.67U 1216.66 16.67F 1 200
[500x2] [(1200+625)x(2)/(2+1)]
Level 2 500 108.33U 608.33 16.67U 625
[500x1] [(1200+625)x(2)/(2+1)]
1500 hrs 1 825hrs 1 825hrs

(1) Standard quantity in standard proportion

(2) Actual quantity in standard proportion
(3) Actual quantity in actual proportion

Labour mix var = R40x16.67F + R80x16.67U = R666.67U

Labour yield variance = R40x216.67U + R80x108.33U = R17 333.3U

Sum of mix and yield variances = R666.67U + R17 333.3U = R18 000U (which equals the total
Labour usage variance).

4. Fixed overhead capacity and efficiency variance

In hours
(1) (2) (3)
Flexed Efficiency Actual machine Capacity Budget
machine (1) – (2) hours (2) – (3) machine
hours hours
FMOH 1 000 250U 1 250 50F 1 200
[500x2] [70 000/56] [600x2]

Fixed overhead efficiency variance = R80x250U = R20 000U

Fixed overhead capacity variance = R80x50U = R4 000F

Sum of fixed overhead efficiency and capacity variances = R20 000U + R4 000F = R16 000U
(which equals the total Fixed overhead volume variance).

[Link] volume: Market Share & Size

Note: the sales volume variance is usually split into the sales mix and sales quantity variance.
The sales quantity variance is then split into the market size and market share variance.
However, where there is only one product there is no sales mix variance, thus the sales volume
variance can be split into a market size and market share variance. We will only deal with the
one product scenario in this course.

5.1 Market size variance = (budgeted market share %) x (actual industry sales volume in units –
budgeted industry sales volume in units) x budgeted ave GP per unit
= 10 % * (6 000 – 5 500) x (600 – 532)
=10 % * (500) x (68)
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= 3 400 F

Market share variance = (actual market share % - budgeted market share %) x actual industry
sales volume in units x budgeted ave GP per unit
= [(490/6 000) – 10%] * 6 000 * 68
= (8,2% - 10%) * 6 000 * 68
= 7 480 U

Sum of market size and market share variances = (4 080U) (=sales volume variance)

6. Reconciliation of Actual to Budgeted Profit

6.1. Calculate actual net income for May (show ALL workings)

Actual sales revenue 313 600

Less COS: 316 430
Metal tubing purchased 18 000
Less: Metal tubing c/s @ std (600)
Leather 24 000
Foam 8 800
Labour 96 550
Variable overhead 70 000
Fixed overhead 105 000
Less: closing fin gd @ std (31 920)
Add: opening fin gd @ std 26 600
Actual GP/(loss) (2 830)
Less fixed admin OH 12 000
Actual net profit ………………. (14 830)

a. Show a detailed reconciliation statement between budgeted and actual profit for May
2012.
Reconciliation statement:
Original budget sales 330 000
Less std COS (292 600)
Less std admin (12 400)
Budget net income 25 000
Sales volume variance (4 080)
Standard profit for actual sales 20 920
volume
(300-266)x490 – 6 200
Sales P variance 19 600
Metal tubing P variance 3 600
Metal tubing Q variance (3 000)
Leather P variance (3 000)
Leather Q variance (7 000)
Foam P variance (400)
Foam Q variance 3 600
Labour rate variance 1 450
Labour effic variance (18 000)
Var OH spending variance 7 500
Var OH effic variance (15 500)
Fixed OH budget variance (9 000)

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Fixed OH volume variance (16 000)
Admin expenditure variance 400
Actual net income/(loss) ………………… (14 830)

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T-Accounts

Bank
Sales 313 600 Metal tubing inventory 18 000
Leather inventory 24 000
Foam type A inventory 2 000
Foam type B inventory/P var 4 800
WIP/labour level 1 rate & effic var 52 800
WIP/labour level 2 effic var 43 750
WIP/var OH effic var 70 000
WIP/fixed OH budget & volume var 105 000
Bal c/d 8 750
322 350 322 350
Bal b/d 8 750

Metal tubing inventory

o/b 0
Bank 21 600 WIP/usage var 21 000
Bal c/d 600
21 600 21 600
Bal b/d 600

Leather inventory
o/b 0
Bank 21 000 WIP/usage var 21 000
Bal c/d 0
21 000 21 000
Bal b/d 0

Foam Type A inventory

Bank 4 800 WIP 4 800
Bal c/d 0
4 800 4 800
Bal b/d 0

Foam Type B inventory

Bank 3 600 WIP 3 600
Bal c/d 0
3 600 3 600
Bal b/d 0

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 WIP
Metal tubing inventory 18 000 Finished goods 266 000
Leather inventory 14 000
Foam Type A inv/usage var 6 000
Foam Type B inv/usage var 6 000
Bank (lab level 1) 40 000
Bank/labour level 2 rate var 40 000
Bank/ var OH exp var 62 000
Bank (FOH) 80 000 Bal c/d 0
266 000 266 000
Bal b/d 0

Finished goods
o/b 26 600 COS 260 680
(50x532)
WIP 266 000
Bal c/d 31 920
292 600 292 600
Bal b/d 31 920
(60x532)

COS
Finished goods 260 680

Sales
bank 313 600

Metal tubing p var

Metal Tubing inventory 3 600

Metal Tubing usage var

Metal tubing inventory 3 000

Leather p var
Bank 3 000

Leather usage var

Leather inventory 7 000

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 Foam type A p var
Foam type A 800
inventory

Foam type A usage var

WIP 1 200

Foam Type B p var

Bank 1 200

Foam Type B usage var

WIP 2 400

Labour level 1 rate var

Bank 4 800

Labour level 1 efficiency var

Bank 8 000

Labour level 2 rate var

WIP 6 250

Labour level 2 efficiency variance

Bank 10 000

Var OH expenditure var

WIP 7 500

Var OH efficiency var

Bank 15 500

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 Fixed OH budget var
Bank 9 000

Fixed OH volume var

Bank 16 000

Solution to lecture example 8

Standard variable costing Standard absorption costing

Fixed manufacturing overheads are not Fixed manufacturing overheads are allocated
allocated to products. to products.
Sales margin variances are reported in terms Sales margin variances are reported in terms
of contribution margins (selling price less of gross profit margins (selling price less full
variable manufacturing cost). manufacturing cost).
There is no fixed overhead volume variance. There is a fixed overhead volume variance.
Variable costing is not allowable by IFRS. Standard absorption costing is allowable by
IFRS as long as standard costs approximate
actual.

Fixed overhead SP x SQ Static Spending AP x AQ

variances – Absorption budget Variance
costing
=80 000 16 000U =96 000 9 000U =105 000
Budget Actual
Fixed Overhead 96 000 9 000U 105 000
Variance – Variable
costing

Variable Fixed
Sales Volume Variance 13 680U 4 080U
‘(490-550)* (600-372) ‘(490-550)* (600-532)

FOH vol var - 16 000U

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INVENTORY VALUATION IN TERMS OF IAS 2

Standard costing systems are not used with the intention of valuing inventory but rather for control
purposes. However, for financial reporting purposes, cost measurement through the use of a
standard costing system is allowed provided that certain adjustments are made.

IAS 2 – Inventory
Lower of:

Cost Net Realisable Value

IAS 2:21 – “Techniques for the measurement of the cost of inventories, such as the standard cost
method may be used for convenience if the results approximate cost.”
(Assumed to not be an issue)

Thus any variances that are not material can just be written off to COS. However, if a variance is
material it must be prorated (i.e. allocated in proportion to inventory and COS) so that inventory is
restated to actual cost.

Two cases where we don’t prorate:

1. Abnormal wastage – para 16(a)

2. Under application – para 13

1. Abnormal wastage
When standards are set, a certain amount of wastage is included in the standard as it is
considered to be part and parcel with the production process. In other words it is “normal” wastage.
Thus, any unfavourable quantity variance for materials or labour would be considered abnormal.

Price variances are never considered abnormal. Thus, price variances should all be prorated if
material.

2. Under application
According to IAS 2:13 overhead allocation should be based on normal capacity.

Normal Capacity: the production expected to be achieved on average over a

number of periods or seasons under normal circumstances, taking into account the
loss of capacity resulting from planned maintenance. (IAS 2:13)

In periods where actual production levels are below normal capacity a portion of overheads will
remain unapplied at the end of the period. These unapplied overheads are recognised as an
expense in the period in which they are incurred (i.e. written off to cost of sales) and not prorated.

If actual production < normal production - under applied

If actual production > normal production - over applied

In periods of high production volumes the overheads applied should not exceed the total overhead
incurred as this would result in inventory being stated above cost. Thus, if actual production is
greater than normal production, overheads should be allocated based on actual production
volume.

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Note: variances may be prorated etc. at end of period but at beginning of new period entries are
reversed so that inventory carried at standard cost.
Discussion and analysis of variances

 Identifying reasons for the variances

- Take note of the relative size of the variances

 Inter-relationship between cost variances, e.g. cheaper labour rate (favourable rate variance)
vs. less productive work (unfavourable efficiency variance)

- Also discuss the net effect

- If it is a permanent change -> adjust standards

 Inter-relationship between cost and sales variance, e.g. cheaper materials used may cause a
drop in sales prices or volumes.

- Also consider how the quality of the products will affect the company’s reputation
- Effect on market share and profit etc.

 Variance beyond the company’s control (due to general market conditions): adjust standards.

 Watch out for the base on which overheads are allocated (integration with ABC)

 Take all other information into consideration - (marks will be awarded for good quality
arguments as well as the extent to which it is justified, explained and logical.)

You may be asked to give advice on what action needs to be taken in response to the reported
variances.

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ST 01 (working backwards) (38 MARKS)

Buyer (Pty) Ltd has recently acquired Seller (Pty) Ltd, a small firm manufacturing a specific type of
industrial kitchen scale used for weighting food in restaurant kitchens. Unfortunately, Seller has a
very poor record of internal controls, and a master disk with some fundamental cost data for the past
year was accidentally erased. No backup exists.
You, the management accountant at Buyer, have been assigned the task of reconstructing some of
the cost records. The only information you have about the past year results of Seller is the following
variance reports and actual figures:

Variances R
Material price variance 10 000 U
Material usage variance 100 000 F
Labour efficiency variance 32 000 U
Variable overhead efficiency variance 40 000 U
Variable overhead spending variance 20 000 U
Underapplied fixed overhead 30 000 U
Fixed [Link] Volume Variance 40 000 F
Market share variance 223 560 F
Market size variance 315 000 F

Excerpt from actual results:

Direct Materials 10 000 kg purchased and used, costing R510 000

Production 20 000 units
Labour cost 4 400 hours totaling R344 200
Fixed overhead cost R110 000
Variable overhead cost R460 000

You also interviewed Seller’s financial manager and discovered that overheads are allocated based on
direct labour hours. The normal capacity is 2 000 labour hours. Production and sales were expected to be
10 000 units for the year. Buyer’s financial manager expected a market share of 12.5%.

The actual selling price per scale was R184. The scales were sold at a 20% discount to the standard price.

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Required:

a) Compute the standard cost per kg of raw material. (3 marks)

b) Compute the standard kilograms of raw material per scale. (3 marks)

c) Compute the predetermined variable overhead absorption rate. (3 marks)

d) Compute the standard amount of labour hours per scale. (3 marks)

e) Compute the standard rate per hour of labour. (3 marks)

f) Compute the labour rate variance. (3 marks)

g) Compute the fixed overhead spending variance. (2 marks)

h) Compute the predetermined fixed overhead absorption rate. (3 marks)

i) Prepare a standard cost sheet in good form. Show fixed and variable overhead as separate items.
(8 marks)

j) Compute the actual number of units sold. (4 marks)

k) Compute the actual market size. (4 marks)

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ST 01 Suggested solution

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 FB Usage AQI@SP Price Actual
Material 600 000 100 000 500 000 -10 000 510 000

Labour -32 000 -32 000 344 200

Variable overheads 400 000 -40 000 440 000 -20 000 460 000

Fixed overheads 80 000 40 000 40 000 -70 000 110 000

a) Standard costper kg 50

b) Standard kg per unit 0,60

c) Variable OH standard rate 100,00 (i.)

Standard
d) Standard labour hrs per unit 0,20 Quantity Price Cost
Material 0,60 50,00 30,00
e) Standard labour rate per hr 80 Labour 0,20 80,00 16,00
[Link] 0,20 100,00 20,00
f) Labour rate variance 7 800 F [Link] 0,20 20,00 4,00
1,20 70,00
g) Fixed OH Spending variance -70 000
Standard selling price 230,00
h) Fixed OH [Link] 20 Standard cost 70,00
Standard gross profit per unit 160,00
j) Actual units sold 13 366

k) Actual market size 95 750

Expected market size 80 000

Plus size variance on units 1 969
81 969
WORKINGS:
(j.)
Budgeted sales 10 000
Add:
Market share var. in units 1 397
Market size var. in units 1 969
13 366

(k.)
315 000 (Actual market size - Exp market size) x [Link] x [Link]
315 000 (x - 80 000) x 12.5% x R160
15 750 (x - 80 000)
x 95 750

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ST02 (Source: UCT) (38 Marks: 46 Minutes)

Dr Jenkins has just been unexpectedly appointed director of Sunflower Hospital in Milnerton, Cape
Town. The previous director had recently implemented a standard costing system. His use of tight
budgetary controls, and regular review of cost variances via computer-generated reports, was
extremely unpopular with the hospital’s staff. This led to his removal by the hospital’s board of
directors. Dr Jenkins suspected that he had been chosen for the job because of his popularity
rather than his innate management ability. He thought himself a physician rather than a manager.

Shortly after taking over as director, the hospital’s lab supervisor came storming into Dr Jenkins’
office, threw a computer-generated report on Dr Jenkins’ desk, and angrily stated: “Here, look at
this report. It says we spent too much money in the Lab department. We spent more than had
been authorized in the budget. Well, of course we did! Practically every department in the hospital
asked for more blood tests than they had predicted at budget time! What are we supposed to do,
refuse to run tests as soon as we go over budget?” Dr Jenkins responded: “Of course not. You
have to run the blood tests. However, we also have to keep some control over our spending. On
the other hand, I agree it isn’t fair to hold you to the original budget. Let me look into it and let’s
meet in a week’s time.”

The report prepared by the previous director for the lab was as follows:

Variance report for the LAB for September 2007:

Budgeted Actual Variance

Number of blood tests 5,000 8,400

R R R
Glass plates (used) 40,000 116,000 -76,000 unfavourable

Labour 195,000 160,000 35,000 favourable

Variable overheads 37,500 50,000 -12,500 unfavourable

Fixed costs 250,000 540,000 -290,000 unfavourable

Total costs 522,500 866,000 -343,500 unfavourable

Upon further investigation Dr Jenkins discovered the following regarding Sunflower’s lab:

 Only one type of test is performed in the lab – blood tests. During the past month, 8 400 blood
tests were performed in the lab. The previous director had drawn up the budget based on an
expected 5,000 blood tests per month. He had held the lab’s supervisor accountable for any
excess costs beyond the costs budgeted for the expected amount of lab tests.

 The current price charged by the lab for one blood test is R200. Charges for blood tests are
consistently higher at Sunflower than at other hospitals, which has resulted in many
complaints. Also, because of strict regulations on amounts reimbursed for lab tests, payments
received from insurance companies and governmental units have not been high enough to
cover lab costs.

 Small glass plates are used in the testing. During the past month, the hospital purchased
24 000 plates at a cost of R120 000. This cost is net of a 5% trade discount. 3 000 of these
Module : Standard Costing Page 23
 plates were unused at the end of the month; 2 000 plates were on hand at the beginning of the
month.

 During the month, R200 000 was incurred for all lab labour costs. 20% of this related to
supervisor’s costs and 30% to senior lab technician costs. The remaining 50% relates to junior
lab technician costs. Junior and senior lab technicians do the same type of work. The lab’s
supervisor has some discretion to choose the level of skill of the lab technicians that work in
his team. The lab technicians do not have authority to perform the work done by the lab
supervisor. The lab technicians are paid per hour worked, while the supervisor receives a fixed
salary of R40 000 each month. The hourly rates paid in September were as follows:
- senior lab technician R100 per hour; and
- junior lab technician R80 per hour.

 The lab’s variable overhead cost for September was R50 000. The variable overheads are
allocated based on lab technician labour hours.

 The fixed costs for the month was R500 000 (excluding the lab supervisor’s salary).

The former director had based his budget on the following nationwide averages for hospital labs:

 Plates: Two plates are required per lab test. These plates cost R4 each and are disposed of
after the test is completed.

 Labour: Each blood test needs 0.2 hrs of senior lab technician time and 0.3 hrs of junior lab
technician time. The average industry rate per hour is R90 for a senior lab technician and R70
for a junior lab technician.

 In most hospitals, 40% of the labour hours worked by technicians are worked by senior
technicians. In an effort to reduce costs, Sunflower senior technicians worked only 32% of the
technician labour hours in September.

 Variable overhead: Variable overhead is based on lab technician labour hours. The industry
average rate for variable overhead is R15 per lab technician labour hour.

 Fixed costs: On investigation the former director had determined that the fixed cost of
operating a lab seemed to be related to the physical size of the laboratory, and calculated that
the cost of operating a lab of the size of Sunflower hospital’s, should be about R250,000.

 The industry norm is to charge R150 for a blood test.

REQUIRED:

1. Comment on the Lab’s performance as well as the former director’s variance report. In order
to do so, you should calculate all the variances necessary to explain the difference between
the actual profit and originally budgeted profit of the Lab, and further analyse these variances
in as much detail as possible, to the extent that it is meaningful to do so. Marks will be
awarded as follows:
a. Variance analysis (27 marks)
b. Discussion (9 marks)
(note: you are not required to perform the reconciliation)

Module : Standard Costing Page 24

 2. From your computations, do you think that the standards are appropriate? How would you
improve the current standard costing system for cost control and performance evaluation
purposes? (2 marks)

STO2 Soln

Cost variances:

actual cost flexed budget

APXAQ P var SPXAQ Q var SPXSQ

Number of
blood tests 8,400 8,400

R R R
Glass
plates 120,000 24,000 U 96,000
[=R4x24 000]

92,000 24,800 U 67,200

[=R4x(2 000+24 000-3 [=(40 000/5 000)x8
000)] 400
or 8 400x2xR4]

Labour:
Senior lab -
technician 60,000 6,000 U 54,000 97,200 F 151,200
[.3xR200
000] [R90x(R60 000/R100)] [R90x(.2x8 400)]
[R90x600 hrs]
Juniour lab -
technician 100,000 12,500 U 87,500 88,900 F 176,400
[.5xR200
000] [R70x(R100 000/R80)] [R70x(.3x8 400)]
[R70x1 250 hrs]
-
186,10
0 F

Variable -
overheads 50,000 22,250 U 27,750 35,250 F 63,000
[=R15x(600hrs+1 [=(37 500/5 000)x8
250hrs)] 400
or 8
400x(0.2+0.3)XR15]

Static budget
290,00
Fixed costs 540,000 0 U 250,000 - 250,000
Not flexed – not a
Module : Standard Costing Page 25
 manufacturing OH!
Thus absorbtion
costing does not
apply.

Sum of all cost variances = R27,900 F

Module : Standard Costing Page 26

Summary of cost variances:

Glass plates price var 24,000 U (2)

quantity var 24,800 U (2)
Labour:
Senior lab technician rate var 6,000 U (1.5)
efficiency var -97,200 F (1.5)

Juniour lab technician rate var 12,500 U (1.5)

efficiency var -88,900 F (1.5)

Variable overheads spending var 22,250 U (1.5)

efficiency var -35,250 F (1.5)

Fixed costs budget var 290,000 U (1.5)

volume var - - (1.5)

Sales variances:

sales price variance: (SP-AP)xAQ

=(R150 - R200)x8 400 tests
-420,000 F (2)

sales volume variance: (SQ-AQ)x(std cm/u)

=(5 000-8 400)(R150-(R272500/5 000))
=(5 000-8 400)(R150-R54.5)
-324,700 F (3)

Lab technician mix and yield variances:

SP AQ mix var AQ in std mix yield var SQ std mix

R 90 600 -140 F 740 -940 F 1,680 40%

R 70 1,250 140 U 1110 -1,410 F 2,520 60%
1,850 1,850 4,200

Mix variance = R90xR140F+ R70xR140U

-2,800 F (3)

Yield variance = R90xR940F+R70xR1 410F

-183,300 F (3)

sum = R 2 800F + R183 300F

-186,100 F

Module : Standard Costing Page 27

Discussion: (1 for every valid point) (max 9)

The former director’s cost variance report showed an unfavourable R343 500 for the month.
However, the former director had made the fundamental error of not flexing the budget for
comparison to actual costs. Thus, the variances are not useful and penalize the Lab for doing more
work than budgeted! The is exceptionally poor as the report disregards the fact that with the extra
costs comes extra revenue – this is a profit centre, yet it is being treated as a cost centre!! The
variances between actual costs and the flexed budget show a different overall picture where the
department has an overall favourable cost variance of R27 900. The sales variances also show a
large favourable variances. Thus, from a cost and revenue perspective the Lab has performed well
against the flexed budget.

The variances are large, which may raise questions about whether the standards are appropriate.
The standard costing system is relatively new and the industry standards were used, rather than
standards specific to Sunflower’s Lab.

Looking at the individual variances:

Glass plates shows unfavourable price and quantity variances. There are a large number of factors
which may have caused this. Some of these factors are controllable, others are not. E.g. the price
variance may have resulted from incorrect standard prices, a lazy purchasing agent, rushed orders
because of poor planning, a general increase not budgeted for. The quantity variance could have
been caused by poor standards, abnormal spoilage, pilferage etc. The quantity variance is very
large – almost 25% extra plates have been used. Since glass plates are not an item that is “spoilt”
easily in the process of being used (unless there is a high error rate and number of repeat tests
that need to be done, due to the more junior levels of staff), such a large variance is more likely
due to an incomplete stock count (did a box of plates get miscounted?) or a box of plates being
dropped (glass breaks on impact).

Senior and Junior lab technician costs both show unfavourable rate variances and very large
favourable efficiency variances. Mix and yield variances for technician labour are relevant since
they are interchangeable and the Lab supervisor has discretion over the mix of senior and junior
staff used. The mix variance is small and favourable showing that by using more junior staff
compared to the standard mix, the total labour hours used is marginally better than budget. The
yield variance is large and favourable and shows that the favourable technician efficiency variance
are due to factors other than changing the mix of workers. E.g. there may be good supervision,
there may be motivated staff who are exceeding expectations, the equipment used may be more
advanced than budgeted etc. Performing work in less time than standard is a typical characteristic
of staff operating at levels close to capacity. Further, due to the higher number of tests than
budgeted, it is likely that more of the same type of test is being requested, than budgeted, which
may be more efficient to carry out (do tests in batches, save setup times, etc).

The variable overhead spending variance is unfavourable, but the efficiency variance reflects the
efficient use of the allocation basis (lab technician labour hours) (it says nothing about the efficient
or inefficient use of variable overheads!).

Module : Standard Costing Page 28

The fixed overhead budget/spending variance is very large and unfavourable. This needs to be
further investigated. The former director seems to have identified size as the main cost driver.
Maybe this is only partly true. It may be that the lab is having to work longer shifts that usual for
the industry, due to higher utilisation rates than anticipated. In this case, many costs that would
be regarded as fixed – eg electricity (lighting and aircon would burn longer), would actually
increase.

The sales price and volume variances are both large and favourable. It is surprising that although
there have been complaints about the Lab’s high charges, the customers still choose to use the
Lab and are not moving to cheaper sources of testing. Perhaps convenience is an overriding factor.

2.
The variance computations show excessively high variances, which leads one to question whether
the standards are appropriate. I do not think the current standard costing system is useful since it
is based on industry standard costs, not standard costs relevant to the circumstances of
Sunflower. Further, the budgetary process at present is imposed as opposed to participatory.
Hence, managers are being evaluated against standards that they did not help set. Also, the
standard costing system is relatively new and thus there may be “teething” problems in setting the
standards.

I recommend that the management accountant use the industry info, in conjunction with past
results of Sunflower and discussions with lab staff, to revise the standards. This should make the
standards more relevant and useful for cost control. The staff will hopefully buy into the process,
which will make the standard costing system a useful performance evaluation tool, together with
aligning the interests of the hospital with the self-interest of managers and staff. A balanced
scorecard approach is recommended to increase the non-financial measures of performance.

Module : Standard Costing Page 29