MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT 334

MAF 334
2025

221

Standard Costing

READING REFERENCES:
Drury 11th edition: Chapters 17 and 18, pg. 493 to 496, 500 to 501

PLAN:

Week 1 Mon Period 6 & 7 Lecture Example 1

Thurs Period 1 & 2 Lecture Example 1

Week 2 Mon Period 5 ST02 Dr Jenkins

Mon Period 6 & 7 ST01 Working backwards

TUTORIAL QUESTIONS:

ST01 – Working backwards

ST02 – Dr Jenkins

Module : Standard Costing Page 1

 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 12

6. T-accounts 13

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 standards are set;
- Calculate material, labour, overhead and sales variances;
- Split material usage variance into the material mix and yield variances where appropriate;
- Split labour efficiency variance into labour mix and yield variances where appropriate;
- Split sales volume variance into the market size and share variances (one product
scenario!)
- Reconcile actual profit with the 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. You must 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!!)
AQI – Actual quantity of input
SQ/u – Standard quantity per unit
SP/kg* - Standard price per kg*

iv. ISSUES TO BE AWARE OF

1. Flexing
a. (1) Flexed Budget = Original Budget x Actual units/Budget units;
or (2) Std Cost/unit x Actual units
b. Revenue and Sales Expenses Actual units SOLD Beware  FG!!
Production Costs ` Actual units PRODUCED
c. Fixed Manufacturing Overheads (FMOH):
Absorption Cost = Flex
Variable Cost = Don’t Flex
d. Fixed selling Expenses: Don’t Flex

2. Materials variances
a. Price – Actual quantity purchased Beware  RM!!
b. Usage – Actual quantity used

3. Labour variances

4. Variable Overheads
a. Basis: units, labour hrs, machine hrs, activity possible! No efficiency variance

5. Fixed Manufacturing Overheads (FMOH)

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

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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 IFRS purposes. Monthly detailed
variance reports are prepared for management to allow for “management by exception”. Following
a participative budgetary process, standards are set at “tough but attainable” levels. Standards are
generally reassessed every six months. Management uses the variance reports with care to ensure
that the appropriate managers are held responsible for the variances. Management considers 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 work-in-progress (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 square 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 volume 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.

Module : Standard Costing Page 6

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 the 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 were used
and the price that was paid for that input.

Flexed Quantity AQ x SP Price Actual

Budget variance (AQI x SP) variance Cost
(Aup x (AQ x AP)
SQ x SP)
Metal tubing AQ x SP Price
3 600 x R6 3 600 x R5
= R21 600 R3 600F = R18 000
500 x 6 x Usage AQI x SP
R6 = 3 500 x R6
= R18 000 R3 000U = R21 000
Leather (given) 500 x 2 x Usage 1 500 x R14 1 500 x R16
R14
= R14 000 R7 000U R21 000 R3 000U = R24 000
Foam Type A 500 x 1 x Usage 400 x 1 x R12 Price 400 x R10
R12
= R6 000 R1 200F = R4 800 R800F = R4 000
Foam Type B 500 x 2 x Usage 600 x R6 Price 600 x R8
R6
=R6 000 R2 400F = R3 600 R1 200U = R4 800
Foam Type A and B =R3 600F =R400U
Direct Labour Level 1 500 x 2 x Efficiency 1 200 x R40 Rate 1 200 x R44
R40
= R40 000 R8 000U = R48 000 R4 800U = R52 800
Direct Labour Level 2 500 x 1 x Efficiency 625 X R80 Rate 625 x R70
R80
= R40 000 R10 000U = R50 000 R6 250F = R43 750
Direct Labour Level =R18 000U =R1 450F
1&2
Variable overhead 500 x 2 x Efficiency 1 250 x R62 Expenditure 1 250 x R56
variances R62
= R62 000 15 500U = R77 500 7 500F = R70 000
Fixed overhead SQ x SP Volume Static Expenditure/ AP x AQ
variances 500 x 2 x budget Budget 1 250 X
R80 600 x 2 x R80 R84
= R80 000 16 000U = R96 000 9 000U = R105 000

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2. Basic Sales Variances

Concept: Identify the effect on profit of:

i) The change in sales price

ii) The change in sales volume

Sales variances

2.1 Sales margin price variance = Sales price variance

= [(Standard Selling Price - Standard COS) – (Actual Selling Price – Std COS)] x AQ sold
(Note: Std Cost of Sales (COS) is used since the sales function has no control over cost)
=> (Standard Selling price – Actual Selling Price) x AQ sold
=> (R600 – R640) x 490 = 19 600 F

2.2 Sales margin volume variance = sales volume variance

= (Actual Quantity sold – Budgeted Quantity) x (Budgeted Gross Profit)
= (490 – 550) * (R600 – R532)
= R4 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
[500 x 1] [(400+600) x 1/(1+2)]
Type B 1000 333.33F 666.66 66.66F 600
[500 x 2] [(400+600) x 2/(1+2)]
Total 1500 kg’s 1000 kg’s 1000 kg’s

(1) Standard quantity in standard proportion

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

Foam mix variance = (R12 x 66.66U) + (R6 x 66.66F) = R400U

Foam yield variance = (R12 x 166.66F) + (R6 x 333.33F) = 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 hours
(1) (2) (3)
SQ output Yield AQ input in std mix Mix AQ input in
in the std (1) – (2) (2) – (3) actual mix
mix
Level 1 1 000 216.67U 1216.66 16.67F 1 200
[500 x 2] [(1200+625) x 2/(2+1)]
Level 2 500 108.33U 608.33 16.67U 625
[500 x 1] [(1200+625) x 1/(2+1)]
1500 hrs 1 825 hrs 1 825 hrs

(1) Standard quantity in standard proportion

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

Labour mix variance = (R40 x 16.67F) + (R80 x 16.67U) = R666.67U

Labour yield variance = (R40 x 216.67U) + (R80 x 108.33U) = R17 333.33U

Sum of mix and yield variances = R666.67U + R17 333.3U = R18 000U (which equals the total
Labour efficiency 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 hrs 250U 1 250 hrs 50F 1 200 hrs
[500 x 2] [R70 000 / R56] [600 x 2]

Fixed overhead efficiency variance = R80 x 250U = R20 000U

Fixed overhead capacity variance = R80 x 50U = R4 000F

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

5. Sales 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% x (6 000 – 5 500) x (R600 – R532)
= 10% x 500 x R68
= R3 400 F

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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%] x 6 000 x R68
= (8.2% - 10%) x 6 000 x R68
= R7 480 U

Sum of market size and market share variances = R4 080U = Sales volume variance.

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 the 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 Activity Based
Costing)

• 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 advise on what action needs to be taken in response to the reported variances.

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6. Reconciliation of Actual to Budgeted Profit

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

R R
Actual sales revenue 490 x R640 313 600
Less: Cost of Sales: (316 430)
Metal tubing purchased 3 600 x R5 18 000
Less: Metal tubing closing stock @ std 100 x R6 (600)
Leather Given 24 000
Foam (400 x R10) + (R600 x 8) 8 800
Labour (1 200 x R44) + (625 x R70) 96 550
Variable overhead Given 70 000
Fixed overhead 1 250 x R84 105 000
Less: closing finished goods @ std (50 + 500 – 490) x R532 (31 920)
Add: opening finished goods @ std 50 x R532 26 600
Actual Gross Profit/(loss) (2 830)
Less: Fixed admin overheads (12 000)
Actual net profit (14 830)

6.2 Show a detailed reconciliation statement between budgeted and actual profit for May 2012.

Reconciliation statement: R
Original budget sales 550 x R600 330 000
Less std COS 550 x R532 (292 600)
Less std admin Given (12 400)
Budget net income 25 000
Sales volume variance (4 080)
Standard profit for actual sales volume 20 920
(R600 – R532) x 490 – R12 400
Sales Price variance 19 600
Metal tubing Price variance 3 600
Metal tubing Quantity variance (3 000)
Leather Price variance (3 000)
Leather Quantity variance (7 000)
Foam Price variance (400)
Foam Quantity variance 3 600
Labour rate variance 1 450
Labour efficiency variance (18 000)
Var OH spending variance 7 500
Var OH efficiency variance (15 500)
Fixed OH budget variance (9 000)
Fixed OH volume variance (16 000)
Admin expenditure variance 400
Actual net income/(loss) ………………… (14 830)

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7. T-Accounts (before closing variance accounts at month end)

Bank
(1) Sales 313 600 (2) Metal tubing inventory 18 000
(5) Leather inventory/Price var 24 000
(8) Foam type A inventory 4 000
(11) Foam type B inventory/P var 4 800
(14) WIP/lab level 1 rate & effic var 52 800
(15) WIP/lab level 2 rate & effic var 43 750
(16) WIP/variable OH exp&effic var 70 000
(17) WIP/fixed OH budget & vol var 105 000
Bal c/d 8 750
322 350 322 350
Bal b/d 8 750

Metal tubing inventory (@std cost)

Opening balance 0 (3) Work in progress (500 x 6 x R6) 18 000
(2) Bank/Price var (3 600 x R6) 21 600 (4) Metal tubing usage variance 3 000
Balance c/d 600
21 600 21 600
Bal b/d 600

Leather inventory (@std cost)

Opening balance 0 (6) WIP (500 x 2 x R14) 14 000
(5) Bank (1 500 x R14) 21 000 (7) Leather inventory usage var 7 000
Balance c/d 0
21 000 21 000
Bal b/d 0

Foam Type A inventory

(8)Bank/Price var (400x1xR12) 4 800 (10) WIP (500 x 1 x R12) 6 000
(9) Foam Type A usage var 1 200 Balance c/d
6 000 6 000
Bal b/d 0

Foam Type B inventory

(11) Bank (600 x R6) 3 600 (13) WIP (500 x 2 x R5) 6 000
(12) Foam Type B usage var 2 400 Balance c/d 0
6 000 6 000
Bal b/d 0

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 Work in Progress (WIP) (@std cost)
(3) Metal tubing inventory 18 000 (18) Finished goods 266 000
(6) Leather inventory 14 000
(10) Foam Type A inventory 6 000
(13) Foam Type B inventory 6 000
(14) Bank (labour level 1) 40 000
(15) Bank (labour level 2) 40 000
(16) Bank (variable OH) 62 000
(17) Bank (fixed OH) 80 000 Bal c/d 0
266 000 266 000
Bal b/d 0

Finished goods
Opening bal (50 x R532) 26 600 (19) Cost of sales (490 x R532 260 680
(18) WIP (500 x R532) 266 000 Balance c/d (60 x R532) 31 920
292 600 292 600
Bal b/d 31 920

Cost of Sales
(19) Finished goods 260 680

Sales
(1) Bank 313 600

Metal tubing price variance

(2) Metal Tubing inventory 3 600

Metal Tubing usage variance

(4) Metal tubing inventory 3 000

Leather price variance

(5) Bank 3 000

Leather usage variance

(7) Leather inventory 7 000

Foam type A price variance

(8) Foam type A inventory 800

Foam type A usage variance

(9) Foam type A inventory 1 200

Foam Type B price variance

(11) Bank 1 200

Foam Type B usage variance

(12) Foam type B inventory 2 400

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 Labour level 1 rate variance
(14) Bank 4 800

Labour level 1 efficiency variance

(14) Bank 8 000

Labour level 2 rate variance

(15) Bank 6 250

Labour level 2 efficiency variance

(15) Bank 10 000

Variable OH expenditure variance

(16) Bank 7 500

Variable OH efficiency variance

(16) Bank 15 500

Fixed OH budget variance

(17) Bank 9 000

Fixed OH volume variance

(17) Bank 16 000

8. Variable versus Absorption costing

Standard VARIABLE costing Standard ABSORPTION costing

Fixed manufacturing overheads are not Fixed manufacturing overheads are allocated to
allocated to products. products.
Sales margin variances are reported in terms Sales margin variances are reported in terms of
of contribution margins (selling price less 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 variances Aup x SP x Volume Static Spending AP x AQ

– Absorption costing SQ variance budget Variance
= R80 000 16 000U = R96 000 9 000U = R105 000
Budget Actual
Fixed Overhead Variance R96 000 9 000U 105 000
– Variable costing

Variable Fixed
Sales Volume Variance R13 680U R4 080U
(490-550) x (R600-R372) (490-550) x (R600 - R532)

Module : Standard Costing Page 15

B. 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, the overhead allocation should be based on normal capacity.

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

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.

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

Module : Standard Costing Page 16

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 weighing 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’s 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 totalling 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.

Module : Standard Costing Page 17

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)

Module : Standard Costing Page 18

ST 01 Suggested solution

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. 1 397
Market size var. in 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

Module : Standard Costing Page 19

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 of himself as 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.”

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 plates were
unused at the end of the month; 2 000 plates were on hand at the beginning of the month.

Module : Standard Costing Page 20

 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 the 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 were R500 000 (excluding the lab supervisor’s salary).

The former director had based his budget on the following national 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 Hospitals, 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 the 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)

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)

Module : Standard Costing Page 21