EXCEL PROFESSIONAL INSTITUTE. LECTURE 9 Holy & Winfred

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1 EXCEL PROFESSIONAL INSTITUTE 1 LECTURE 9 Holy & Winfred

2 2 Q1. a) Investment Appraisal Lecture 10 &11 i. Types of Investment and Capital Expenditure ii. Objectives of Investment appraisal iii. Investment Appraisal Techniques iv. Capital Rationing v. Adjusting for Risk, Inflation and Taxation in Investment Appraisal vi. Specific Investment Decision (Lease or Buy, Asset Replacement) (10 marks) b) Performance Measurement Systems, Measurements & Control i. Performance Management Information Systems ii. Sources of management information and management reporting Lecture 1 iii. Scope of performance management & divisional performance appraisal. Lecture 12 iv. Transfer pricing Lecture 12 v. Performance analysis in not-for-profit organisations and public sector. Lecture 12 Vi External considerations & Behavioural aspects. Lecture 12 (15 marks)

3 3 Question 2 a) Nature, Purpose & Sources of Management Information i. Accounting for management Lecture 1 ii. Sources of data, cost classification and presentation of information. Lecture 1 (5marks) b) Budgeting & Budgetary Control Lecture 7 i. The concept of budgeting, objectives, types, administration and stages of budgeting process. ii. Preparation and analysis of Cash, Functional and Master Budgets. iii. Behavioural aspects of Budget. (15 marks) QUESTION 3 (25 marks) Cost accounting Techniques i. Accounting for material, labour & Overheads Lecture 2 ii. Absorption & Marginal costing, Job costing, Batch costing, Service costing, and Contract and Process costing. Lecture 2, & 3 (15 marks) b) Specialized cost & Management Accounting Techniques- Lecture 4 Activity Based Costing Target Costing Life cycles costing Throughput accounting (10 marks)

4 4 QUESTION FOUR (15 marks) a) Decision making techniques i. Relevant Costs Lecture 6 ii. Cost Volume Analysis Lecture 5 iii. Limiting factors Lecture 5 iv. Pricing Decisions Lecture 5 v. Make or buy decision, outsourcing, split or further processing, special order acceptance decisions. Lecture 6 vi. Dealing with risk and uncertainty in decision making (Profitability & Expected Values) Lecture 6 QUESTION FIVE (15 marks) a) Standard Costing & Variance Analysis Lecture 8 & 9 i. Nature, scope & objectives of standard costing, behavioural aspects of standard costing. ii. Types of standards and standard setting process. iii. Basic variances, mix and yield variances, causes and analysis of variance. iv. Operating Statements (Reconciliation of budgeted results with actual results using variances. v. Productivity, efficiency and capacity ratios.

5 5 Standard Costing & Variance Analysis

6 6 STANDARD COSTING VARIANCE ANALYSIS CONCEPT VARIANCE COMPUTATION

7 7 A standard cost is an estimated unit cost. Standard costing is used to value inventories, prepare cost budgets for production and provide control information (variance). Standards are very similar and interrelated to a budget but there are important differences between them

8 8 1. A budget is an overall plan while a standard is an estimated unit cost. 2. A budget gives planned total aggregate costs for a function or cost center whereas standard cost shows a unit resource usage for a single task. 3. A budget can be prepared for all functions, even where output cannot be measured but standard cost can be prepared to limited situations where repetitive actions are performed and output can be measured. 4. A Budget is expressed in money terms whereas standard costs need not to be expressed in money terms.

9 9 Both involve in looking to the future and forecasting what is likely to happen and are both used for control purposes. Standard unit cost act as a basis for a production cost budget.

10 10 Carefully planned standards are an aid to more accurate budgeting It provides a yardstick against which actual costs can be measured. A target of efficiency is set for employees to reach and costconsciousness is stimulated. Standard costs and variance analysis can provide a way of motivation to managers to achieve better results Variances can be calculated which enable the principle of management by exception to be practiced

11 11 Deciding on how to incorporate inflation into planned unit costs Agreeing on a performance standard (attainable or ideal) Deciding on the quality of the materials to be used Estimating on prices where seasonal price variations or bulk purchase discounts may be significant Finding sufficient time to construct standards since setting them can be time consuming Incurring the cost of setting up and maintain a system of establishing standards

12 12 Variances analysis only concentrates on narrow costs and does not give attention to issues such customer service and quality. It places too much emphasis on labor costs whiles in the modern era only a small portion of labor cost is incurred. Many of the variances focus on short term variable costs, most in modern business environment most of cost are fixed cost in nature including labor costs. The use of standard costing relies on repetitive operations and relatively homogenous product, nowadays many organizations are forced to respond to customer changing requirements. The standard costing was developed in an era where the business environment was stable and less prone to change, whiles the current business environment is dynamic. It assumes that performance to standard is acceptable, but current environment is more focused on continuous improvement.

13 13 Ideal Standards: This is a standard which can be attained under perfect operating conditions, thus no wastage, no inefficiencies, no idle time, no breakdowns. They can be seen as long-term targets but are not very useful for day -to-day control purposes. Their impact on employees can be an incentive to be more efficient or they may feel goals are unattainable and so they will not work so hard because standards and actual will always be adverse. Attainable Standard is a standard which can be attained if production is carried out efficiently, machines are properly operated and/or materials are properly used, thus allowing for some allowance of wastage and inefficiencies. This can be used for product costing, cost control, inventory valuation, estimating and as a basis for budgeting. Their impact it has on employees is that, it is an incentive to work harder as they provide a realistic but challenging target of efficiency. Current Standard is a standard on current working conditions (current wastage, current inefficiencies). It provides the best basis for budgeting because they represent the achievable level of productivity. This standard may not motivate them to work harder to achieve more than what they are currently doing. Basic standard is a long term standard which remains unchanged over the years to serve as a basis to show trend. This helps to show changes in efficiency or performance over a long period of time. This standard may have an unfavorable impact on employees motivation because, over time they will realize they are easily able to achieve the standards.

14 14 1. Establishment of Cost Centres 2. Formation of Standard Costing committee 3. Determination of type of standards to be applied 4. Setting of Standard 5. Review of standards

15 15 A variance is the difference between a planned, budgeted or standard cost or revenue and the actual cost or revenue incurred. Variances are categorized into 1. variable cost variance, 2. sales variance and 3. fixed overhead variance.

16 16

17 17 Material price variance arise from purchasing materials at a price different from standard cost per material unit. Causes of Price material variances 1. Recent changes in purchase price of materials. 2. Failure to purchase anticipated quantities when standards were established resulting in higher prices owing to non-availability of quantity purchase discounts. 3. Not taking cash discounts anticipated at the time of setting standards resulting in higher prices. 4. Substituting raw material differing from original materials specifications. 5. Freight cost changes and changes in purchasing and store-keeping costs if these are debited to the material cost.

18 18 Usage variance arise when quantity of material expected to be used for production of a unit of output varies from actual usage. Where production requires more than one type of material, usage variances will arise from two issues: variations from standard mix of material (mix variance) and variations in standard yield per standard mix of input (yield variance). Causes of Materials usage variance 1. Pool materials handling. 2. Inferior workmanship by machine operator. 3. Faulty equipment. 4. Cheaper, defective raw material causing excessive scrap. 5. Inferior quality control inspection. 6. Pilferage. 7. Wastage due to inefficient production method

19 19 Smart Salads-Yield Variance Smart Salads Ltd provided the following direct material cost extract for producing their Premium Smart Salad. Each plate of salad is produced by unique mix of Cabbage, Pepper and Noodles GHC Cabbage GHC 0.75 per gram 2.25 Pepper GHC 1.00 per gram 4.00 Noodles GHC 1.25 per unit 6.25 Total In the month under review, 95 plates have been produced with the following material cost GHC Cabbage GHC1 per gram 320 Pepper GHC0.75 per gram 360 Noodles GHC1.5 per gram 630 Total 1,310 Required: Compute Material price variance Material usage variance and detail as to mix and yield variances

20 20 Labour standards are premised on two variables; the wage rate and the labour hours. Wages rate are determined by company policy/negotiations between management and unions. Labour hours refer to the average time it takes to produce a product. Labour variances exist if actual labour cost (comprising actual wage rate and labour hours) varies from standard labour cost for actual production level. Thus, labour variance comprises labour rate variance and labour hour (efficiency variance).

21 21 Total labour variances are classified as follows: Labour Rate Variance or Wage Rate Variance Labour Efficiency Variance a. Labour Mix Variance b. Labour Yield Variance Labour Idle Time Variance

22 22 Ice Kenkey Master Ltd produce canned Ice Kenkey. In June 2018, 1,500 units of Canned Kenkey were made and the cost of labour was GHC17,500 for 3,080 hours. A unit the canned Kenkey is expected to use 2 hours of labour at a standard cost of GHC5 per labour hour. During the period, however, there was a shortage of customer orders and 100 hours were recorded as idle time. Required: Calculate the following variances. 1. The labour rate variance 2. The idle time variance 3. The labour efficiency variance

23 23 Variable overhead variances can be subdivided into: 1. variable overhead expenditure 2. variable overhead efficiency variance. Variable overhead expenditure (spending) variance is the difference between the amount of variable production overhead that should have been incurred in the actual hours actively worked and the actual amount of variable overheads incurred. It is calculated same manner as labour rate variance. Variable overhead efficiency variance is the difference between the number of hours that should have been used to produce the actual number of units and the actual hours used valued at the standard variable overhead rate per hour. It is calculated same manner as efficiency variances.

24 24 For a particular production department, the standard variable overhead has been budgeted as below: Budgeted Variable overhead for the period: GHC Budgeted Volume of Production for the period: units The actual variable overheads incurred during the period which is under review amounted to GHC 56000, whereas the actual production were units. Calculate the variable overhead variance.

25 25 Calculate Variable overhead cost variance, dividing the same into expenditure variance & efficiency variance from the following particulars: Standard time per unit 4 hours Budgeted output 1000 units Budgeted variable overhead GHC 3000 Actual output 900 units Actual hours worked 1700 hours Actual variable overhead GHC2680

26 26 Total fixed overheads for the period are charged as an expense to the period in which they are incurred. Fixed overheads are assumed to remain unchanged in response to changes in the level of activity, but they may change in response to other factors. Fixed overhead variance is therefore, the difference between Absorbed Fixed overhead and Actual Fixed Overhead. Fixed overhead variance can be attributed either unplanned expenditure or variation in volume of output. Thus fixed overhead variance is sub classified as 1. fixed overhead expenditure variance 2. fixed overhead volume variance. Further, the fixed overhead volume variance is categorized into a. volume efficiency b. volume capacity variances.

27 27 The following information was obtained from the records of Viva Malt Ltd s manufacturing unit using Standard Costing System. Budgeted Actual Production per 2,500 units Assume 8 hours/day Working days Fixed overhead 2,000 units month GHC50,000 GHC45,000 Variable overhead GHC15,000 GHC15,000 Required: Compute all fixed overhead variances

28 28 Failure to utilize normal capacity Lack of sales order Too much idle capacity Inefficient or efficient utilization or existing capacity Machine breakdown Defective materials Labour agitations and power challenges

29 29 standard costing system can be applied to sales revenue. Sales variances can be used to analyse the performance of the sales function. The most significant feature of sales variance calculations is that they are calculated in terms of profit or contribution margins rather than sales value. Like all variances, sales variance is a function of sales margin and volume of sale. Standards are thus set for margin and volume of sales. Sales price variance is the measure of the effect on expected profit of a different selling price to standard selling price. It is calculated as the difference between what the sales revenue should have been for the actual quantity sold and it was.

30 30 Sales price variance Standard selling price * actual units sold xx Actual sales xx Variance x F/A Sales margin volume variance is the difference between the actual units sold and the budgeted units to be sold valued at standard profit per unit (absorption) or standard contribution per unit (marginal costing). Budgeted sales unit xx Actual sales unit xx Variance (in units) x F/A Valued at standard profit per unit GHSXX F/A

31 Total Sales Margin Variance: 31 This is the basic variance by which the difference between the budgeted profit & actual profit is represented. The formula is: Budgeted profit Actual profit at standard purchase price This basic variance has two components (a) sales margin price variance, & (b) sales margin volume variance. Sales Margin Price Variance: The effect of a change in selling price on profits, other things being at standard is represented by Sales Margin Price variance. The formula is: Standard Profit Actual Profit Or, (Actual quantity sold * Standard profit per unit) Actual profit Or, (Standard profit per unit Actual profit per unit) * Actual quantity sold Sales Margin Volume Variance: The difference in price resulting from a change in sales volume is shown by Sales margin volume variance. The formula is: Budgeted Profit Standard Profit Or, Standard Profit per unit * (Budgeted quantity Actual quantity) The sales margin volume variance can be sub-divided into two components (a) sales margin mix variance & (b) sales margin quantity variance, when sale of more than one product is made.

32 Sales Margin Mix Variance: 32 The difference between the revised standard profit & the standard profit is shown by the sales margin mix variance. The formula is: Revised Standard Profit Standard Profit Or, Standard profit per unit * (Actual quantity at standard mix Actual quantity at actual mix) Sales Margin Quantity Variance: The difference between budgeted profit & revised standard profit is reflected by the sales margin quantity variance. The formula is: Budgeted Profit Revised Standard Profit Or, Standard profit per unit * (Actual quantity at standard mix Budgeted quantity at standard mix) Relationship between the variances: Total Sales Margin Variance = Price Variance + Volume Variance Sales Margin Volume Variance = Mix Variance + Quantity Variance

33 33 The summarized budget & actual working results of a co. for the year are given below: Budget Actual Details Products Products X Y Z X Y Z Selling Price per unit ($) Cost per unit ($) Sales (Units) Analyse the results & calculate the following: (a) Budgeted profit, actual profit & variance in profit (b) Analyse the variance in profit into the following: (1) Price Variance; (2) Cost Variance; (3) Sales margin volume variance; (4) Sales margin mix variance; (5) Sales margin quantity variance

34 34 One Corner Ltd recorded the following actual results for Product RS8 for the month of March 2018: Product RS8 2,100 units produced and sold for GHC14.50 per unit Direct material M3 GHC1,680 Direct material M7 GHC2,793 Direct labour GHC3,675 1,050 kg costing 1,470 kg costing 525 hours costing Variable production GHC1,260 overhead Fixed production GHC4,725 overhead Standard selling price and cost data for one unit of Product RS8 is as follows. Selling price GHC15.00 Direct material M3 0.6 kg at GHC1.55 per kg Direct material M kg at GHC1.75 per kg Direct labour direct labour hour Variable production overhead hour Fixed production overhead hour 14 minutes at GHC7.20 per GHC2.10 per direct labour GHC9.00 per direct labour At the start of the last month, 497 standard labour hours were budgeted for production of Product RS8. No stocks of raw materials are held. All production of Product RS8is sold immediately to a single customer under a just-intime agreement. Required: Prepare an operating statement that reconciles One Corner s budgeted profit with actual profit for Product RS8 for the last month. You should calculate variances in as much detail as allowed by the information provided. (15 marks)

35 35 Once variance has been calculated, management must decide whether to investigate the reasons or not. This depends on materiality of the variance, controllability of the variance, type of standard being used and interdependency between variances. Individual variances should not be looked at in isolation, this is because an adverse in one may be because of a favorable in another. Cost of investigating the variance, therefore the costbenefit analysis should be used to decide if it is worth investigating in the variance. Top management will be interested in the reason for the actual profit being different from the budgeted profit A variance operating report is needed to reconcile budgeted and actual profit.

36 36 Variance operating statement is prepared as follows: GHC Budgeted Profit Xx Favourable GHC Adverse GHC Detailed Revenue variances Xx (xx) Detailed cost variances Xx (xx) Total variance Actual profit xx/ (xx) xx

37 37 END

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