Trainee Accountant Webinar. F2 Management Accounting. Variance Analysis

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Trainee Accountant Webinar F2 Management Accounting Variance Analysis Presented By: Rosemarie Kelly, Examiner CPA Ireland Skillnet CPA Ireland Skillnet, is a training network that is funded by

The CPA Ireland Skillnet provides excellent value CPE (continual Professional Education) in accountancy, law, tax and strategic personal development to accountants working both in practice and in

1 Trainee Accountant Webinar F2 Management Accounting Variance Analysis Presented By: Rosemarie Kelly, Examiner CPA Ireland Skillnet CPA Ireland Skillnet, is a training network that is funded by Skillnets, a state funded, enterprise led support body dedicated to the promotion and facilitation of training and up-skilling as key elements in sustaining Ireland s national competitiveness. The CPA Ireland Skillnet provides excellent value CPE (continual Professional Education) in accountancy, law, tax and strategic personal development to accountants working both in practice and in industry. However our attendees are not limited to the accountancy field as we welcome all interested parties to our events. The CPA Ireland Skillnet is funded by member companies and the Training Networks Programme, an initiative of Skillnets Ltd. funded from the Department of Education and Skills. 2

2 Outline Rationale for variance analysis What is variance analysis? Calculation of variances Variance exam questions Worked example 3 Rationale for variance analysis Where an organisation has activities that are common or repetitive Composition of products or services may be specified accurately Product standard costs may be developed based on observation of repetitive operations 4

3 What is variance analysis? Comparison of actual results to budget Differences are called variances and described as favourable or adverse Variances are calculated for each category of product cost: direct materials, direct labour, variable production overhead and fixed production overhead 5 What is variance analysis? Variances are also calculated for sales revenue Variances calculated differ depending on whether variable costing or absorption costing is used to obtain product cost Explanations for variances are obtained and used to inform operations and improve future performance 6

4 Calculation of variances Flex budget to show budgeted costs of actual quantity produced Formulas for calculating variances For variable costing and absorption costing systems: Same variances/formulas used for direct materials, direct labour, and variable production overhead Different variances/formulas used for sales and fixed production overhead 7 Calculation of variances Variable costing and Absorption costing Direct materials Direct labour Variable production overhead Variable cost Fixed production overhead Absorption cost XX XX XX XXXX XX XXXX 8

5 Variance formulas for both variable and absorption costing Direct materials Materials price variance = (SP AP) x AQ Materials usage variance = (SQ AQ) x SP Direct labour Labour rate variance = (SR AR) x AH Labour efficiency variance = (SH AH) x SR 9 Variance formulas for both variable and absorption costing Variable production overhead Variable production overhead rate variance = (SR AR) x AH Variable production overhead efficiency variance = (SH AH) x SR 10

6 Variance formulas for variable costing only Fixed production overhead Only one variance Fixed production overhead expenditure variance = (BFO AFO) Sales Sales margin price variance = (AP SP) x AV Sales margin volume variance = (AV BV) x SM Where SM = Standard contribution margin per unit 11 Variance formulas for absorption costing only Fixed production overhead Fixed production overhead expenditure variance = (BFO AFO) Fixed production overhead volume variance = (AP BP) x SR Where SR = Standard fixed overhead rate per unit 12

7 Variance formulas for absorption costing only Sales Sales margin price variance = (AP SP) x AV Sales margin volume variance = (AV BV) x SM Where SM = Standard profit margin per unit 13 Variance analysis exam questions Check if company is using variable costing or absorption costing May be required to prepare Profit statement or cost statement May be required to prepare a standard cost card If not required a good idea to do so anyway 14

8 Variance analysis exam questions PROFIT STATEMENT Original Budget 5,500 (a) Flexed Budget 5,000 (b) Actual Results 5,000 (a) (b) Total Variance Units Sales revenue Less: Direct materials Direct labour Variable production overhead Fixed production overhead Total costs Profit 15 Variance analysis exam questions COST STATEMENT Original Budget 5,500 (a) Flexed Budget 5,000 (b) Actual Results 5,000 (a) (b) Total Variance Units Direct materials Direct labour Variable production overhead Fixed production overhead Total costs 16

9 Worked example Budget Actual Sales - units 1,400 1,500 - revenue 25,200 26,250 Direct materials - EVA (cubic metres-m 3 ) Cost 6,615 7,140 Direct labour - Hours Cost 4,480 3,969 Variable production overhead 910 1,170 Fixed production overhead 3,800 Variable overhead is absorbed into production based on direct labour hours. Total fixed production overhead is budgeted to be 35,280 for the year and normal annual production is budgeted to be 16,800 units. Worked example Requirement: (a) Prepare a standard cost card for ONE unit (b) Calculate all relevant variances (c) Reconcile budgeted profit to actual profit (d) Suggest TWO reasons to explain the material variances 18

10 (a) Workings for standard cost card Direct materials cost Material cost per cubic metre 6,615 /189 cubic metres = 35 per cubic metre Material used per unit 189 cubic metres/1,400 units = cubic metres per unit Per unit cubic metres x 35 per cubic metre => per unit 19 (a) Workings for standard cost card Direct labour cost Labour cost per hour 4,480/280 labour hours = 16 per labour hour Labour time per unit 280 labour hours /1,400 units = 0.2 labour hours per unit Per unit 0.2 labour hours x 16 per labour hour => 3.20 per unit 20

11 (a) Workings for standard cost card Variable production overhead cost Variable production overhead cost per hour 910/280 labour hours = 3.25 per labour hour Labour time per unit (as for direct labour cost) 280 labour hours /1,400 units = 0.2 labour hours per unit Per unit 0.2 labour hours x 3.25 per labour hour => 0.65 per unit 21 (a) Workings for standard cost card Fixed production overhead cost NOTE: Company is operating a standard absorption costing system as the question gives enough information to calculate fixed costs per unit produced Fixed production overhead cost per unit = Budgeted fixed production overhead Budgeted production = 35,280 = 2.10 per unit 16,800 units 22

12 (a) Standard cost card for one unit Standard cost card Direct materials Direct labour 3.20 Variable production overhead 0.65 Fixed production overhead 2.10 Total product cost per unit (b) Variance calculations Direct materials Materials price variance = (SP AP) x AQ = (( 35 ( 7,140/210) x 210 = 210 F Materials usage variance = (SQ AQ) x SP = ((0.135 x 1,500) 210) x 35 = A 24

13 (b) Variance calculations Direct labour Labour rate variance = (SR AR) x AH = (( 16 ( 3,969/325) x 325 = 1,231 F Labour efficiency variance = (SH AH) x SR = ((0.20 x 1,500) 325) x 16 = 400 A 25 (b) Variance calculations Variable production overhead Variable production overhead rate variance = (SR AR) x AH = (( 3.25 ( 1,170/325) x 325 = A Variable production overhead efficiency variance = (SH AH) x SR = ((0.20 x 1,500) 325) x 3.25 = A 26

14 (b) Variance calculations Fixed production overhead Fixed production overhead expenditure variance = (BFO AFO) = (( 35,280/12 )- 3,800) = 860 A Fixed production overhead volume variance = (AP BP) x SR = (1,500 1,400) x 2.10 = 210 F 27 Sales (b) Variance calculations Sales margin price variance = (AP SP) x AV = (( 26,250/1,500) ( 25,200/1,400)) x 1,500 = ( ) x 1,500 = 750 A Sales margin volume variance = (AV BV) x SM = (1,500 1,400) x ( ) = F 28

15 Variance (b) Variance calculations - summary Adverse Favourable Materials price Materials usage Labour rate 1, Labour efficiency Variable overhead expenditure Variable overhead efficiency Fixed overhead expenditure Fixed overhead volume Sales margin price Sales margin volume , , Net adverse variance (c) Reconcile budgeted and actual profit Calculation of actual profit Sales revenue 26,250 Less: Direct materials 7,140 Direct labour 3,969 Variable production overhead 1,170 Fixed production overhead 3,800 Profit 10,171 30

16 (c) Reconcile budgeted and actual profit Calculation of budgeted profit Sales revenue 25,200 Less: Direct materials 6,615 Direct labour 4,480 Variable production overhead 910 Fixed production overhead 2,940 Profit 10, (c) Reconcile budgeted and actual profit Budgeted profit 10,255 Total variances net adverse ( 84) Actual profit 10,171 32

17 (d) Reasons to explain material variances Variance Favourable Adverse Materials price Materials usage Unforeseen discounts received Greater care in purchasing Change in material quality Material used of higher quality than standard More effective use made of material Errors in allocating material to jobs Price increase Careless purchasing Change in material quality Defective material Excessive waste Theft Stricter quality control Errors in allocating material to jobs

F2 Financial Accounting

F2 Financial Accounting CPA Ireland Skillnet CPA Ireland Skillnet, is a training network that is funded by Skillnets, a state funded, enterprise led support body dedicated to the promotion and facilitation of training and upskilling