Calculation of the main cost variances The following information has been extracted from the records of the Frost Production Company Limited for the year to 31 March 2016:

Question

Calculation of the main cost variances

The following information has been extracted from the records of the Frost Production Company Limited for the year to 31 March 2016:

Budgeted costs per unit:	£
Direct materials (15 kilograms × £2 per kilogram)	30
Direct labour (10 hours × £4 per direct labour hour)	40
Variable overhead (10 hours × £1 per direct labour hour)	10
Fixed overhead (10 hours × £2 per direct labour hour)	[latex]\underline{20}[/latex]
Total budgeted cost per unit	[latex]\underline{\underline{100} }[/latex]

The following budgeted data are also relevant:

1 The budgeted production level was 100 units.

2 The total standard direct labour hours amounted to 1000.

3 The total budgeted variable overhead was estimated to be £1000.

4 The total budgeted fixed overhead was £2000.

5 The company absorbs both fixed and variable overhead on the basis of direct labour hours.

Actual costs:	£
Direct materials	2100
Direct labour	4000
Variable overhead	1000
Fixed overhead	[latex]\underline{1600}[/latex]
Total actual costs	[latex]\underline{\underline{8700} }[/latex]

Note: 90 units were produced in 800 actual hours, and the total actual quantity of direct materials consumed was 1400 kilograms.

Required:
(a) Calculate the direct materials, direct labour, variable production overhead and fixed production overhead total cost variances.
(b) Calculate the detailed variances for each element of cost.

Accepted Answer

(a) In answering part (a) of this question the first thing that we need to do is to summarise the total variance for each element of cost for the actual 90 units produced:

	Actual costs	Total standard cost for actual production	Variance
	£	£	£
Direct materials	2100	2700 (1)	600 (F)
Direct labour	4000	3600 (2)	400 (A)
Variable production overhead	1000	900 (3)	100 (A)
Fixed production overhead	[latex]\underline{1600}[/latex]	[latex]\underline{1800}[/latex] (4)	[latex]\underline{200 }[/latex] (F)
Total	[latex]\underline{\underline{8700} }[/latex]	[latex]\underline{\underline{9000} }[/latex]	[latex]\underline{\underline{300} }[/latex] (F)

Notes:

(a) F = favourable to profit; A = adverse to profit.
(b) The numbers in brackets refer to the tutorial notes below.

Tutorial notes

1 The standard cost of direct material for actual production = the actual units produced × the standard direct material cost per unit, i.e. 90 × £30 = £2700.

2 The standard cost of direct labour for actual production = the actual units produced × standard direct labour cost per unit, i.e. 90 × £40 = £3600.

3 The standard variable cost for actual performance = the actual units produced × variable overhead absorption rate per unit, i.e. 90 × £10 = £900.

4 The fixed overhead cost for the actual performance = the actual units produced × fixed overhead absorption rate, i.e. 90 × £20 = £1800.

Comments on the answers to Example 16.3 (a)

Example 16.3(a) shows that the total actual cost of producing the 90 units was £300 less than the budget allowance. An investigation would need to be made in order to find out why only 90 units were produced when the company had budgeted for 100. Although the 90 units have cost £300 less than expected, a number of other variances have contributed to the total variance. So assuming that these variances are considered significant, they would need to be carefully investigated in order to find out what caused them.

As a result of calculating variances for each element of cost, it becomes much easier for management to investigate why the actual production cost was £300 less than expected. However, by analysing the variances into their major causes, the accountant can provide even greater guidance. This is illustrated in part (b) of the example.

(b) In answering part (b) of Example 16.3, we will deal with each element of cost in turn. As we do so we will take the opportunity to comment on the results.

Direct materials

1 Price = (actual cost per unit - standard cost per unit) × total actual quantity used

∴ the price variance = (£1.50 - 2.00) × 1400 (kg) = [latex]\underline{£700(F)}[/latex]

The actual price per unit was £1.50 (£2100/1400) and the standard price was £2.00 per unit.
There was, therefore, a total saving (as far as the price of the materials was concerned) of £700 (£0.50 × 1400). This was favourable (F) to profit.

2 Usage = (total actual quantity used - standard quantity for actual production) × standard cost

∴ the usage variance = (1400 - 1350) × £2.00 = [latex]\underline{£100(A)}[/latex]

In producing 90 units, Frost should have used 1350 kilograms (90 × 15 kg) instead of the 1400 kilograms actually used. If this extra usage is valued at the standard cost (the difference between the actual price and the standard cost has already been allowed for), there is an adverse usage variance of £100 (50 (kg) × £2.00).

3 Total = price + usage:

∴ the total direct materials variance = £700 (F) + £100 (A) = [latex]\underline{£600(F)}[/latex]

The £600 favourable total variance was calculated earlier in answering part (a) of the question. This variance might have arisen because Frost purchased cheaper materials. If this were the case then it probably resulted in a greater wastage of materials, perhaps because the materials were of an inferior quality.

Direct labour

1 Rate = (actual hourly rate - standard hourly rate) × actual hours worked

∴ the rate variance = (£5.00 - £4.00) × 800 DLH = [latex]\underline{£800(A)}[/latex]

The actual hourly rate is £5.00 per direct labour hour (£4000/800) compared with the standard rate per hour of £4. Every extra actual hour worked, therefore, resulted in an adverse variance of £1 or £800 in total (£1 × 800).

2 Efficiency = (actual hours worked - standard hours for actual production) ×Standard hourly rate.

∴ the efficiency variance = (800 - 900) × £4.00 = [latex]\underline{£400(F)}[/latex]

The actual hours worked were 800. However, 900 hours would be the allowance for the 90 units actually produced (90 × 10 DLH). If these hours were valued at the standard hourly rate (differences between the actual rate and the standard rate having already been allowed for when calculating the rate variance), a favourable variance of £400 arises. The favourable efficiency variance has arisen because the 90 units took less time to produce than the budget allowed for.

3 Total = rate + efficiency

∴ the total direct labour variance = £800 (A) + £400 (F) = [latex]\underline{£400(A)}[/latex]

The £400 adverse total variance was calculated earlier in answering part (a) of the question. It arises because the company paid more per direct labour hour than had been budgeted, although this was offset to some extent by the units being produced in less time than the budgeted allowance. This variance could have been caused by using a higher grade of labour than had been intended. Unfortunately, the higher labour rate per hour was not completely offset by greater efficiency.

Variable production overhead

1 Expenditure = actual variable overhead - (actual hours worked × variable production overhead absorption rate)

∴ the expenditure variance = £1000 - (800 × £1.00) = [latex]\underline{£200(A)}[/latex]

2 Efficiency = (standard hours for actual production - actual hours worked) × variable
production overhead absorption rate

∴ the efficiency variance = (900 - 800) × £1.00 = [latex]\underline{£100(F)}[/latex]

3 Total = expenditure + efficiency

∴ the total variable production overhead variance

= £200(A) + £100(F) = [latex]\underline{£100(A)}[/latex]

The adverse variance of £100 (A) arises because the variable overhead absorption rate was calculated on the basis of a budgeted cost of £10 per unit. In fact the absorption rate ought to have been £11.11 per unit (£1000/90) because the total actual variable cost was £1000. There would, of course, be no variable production overhead cost for the ten units that were not produced. The £100 adverse total variance was calculated earlier in answering part (a) of the example.

Fixed production overhead

1 Expenditure = actual fixed overhead - budgeted fixed expenditure

∴ the expenditure variance = £1600 - £2000 = [latex]\underline{£400(F)}[/latex]

The actual expenditure was £400 less than the budgeted expenditure. This means that the fixed production overhead absorption rate was £400 higher than it needed to have been if it had been the only fixed overhead variance.

2 Volume = budgeted fixed overhead - (standard hours of production × fixed production overhead absorption rate

∴ the volume variance = £2000 - (900 × £2.00) = [latex]\underline{£200 (A)}[/latex]

As a result of producing fewer units than expected, £200 less overhead has been absorbed into production.

3 The fixed production overhead total variance was calculated earlier in answering part (a) of the question. The simplified formula is as follows:

Total = expenditure + volume

= £400 (F) + £200 (A) = [latex]\underline{£200 (F)}[/latex]

As the actual activity was less than the budgeted activity, only £1800 of fixed overhead was absorbed into production instead of the £2000 expected in the budget. However, the actual expenditure was only £1600 so the overestimate of expenditure compensated for the overestimate of activity.

Question 16.3: Calculation of the main cost variances The following informa...

Related Answered Questions

Calculation of efficiency, capacity and production volume ratios The following information relates to the Frost Production Company Limited for the year to 31 March 2016: ...

Verified Answer:

Calculating sales variances The following data relate to Frozen Limited for the year to 31 July 2016: ...

Verified Answer:

Preparation of a standard cost operating statement Example 16.3 gave some information relating to the Frost Production Company Limited for the year to 31 March 2016. The cost data used in that example will now be used to illustrate the structure of a standard cost operating statement, along with ...

Verified Answer:

Milton Limited has produced the following information: Total actual sales: £99,000. Actual quantity sold: 9000 units. Budgeted selling price per unit: £10. Standard cost per unit: £7. Total budgeted units: 10,000 units. Required: Calculate: (a) the selling price variance (b) the sales volume ...

Verified Answer:

Using the data contained in the previous question, calculate the following performance measures: (a) efficiency ratio (b) capacity ratio (c) production volume ratio. ...

Verified Answer:

The following information relates to Bruce Limited: Actual hours: 1000. Actual wage rate per hour: £6.50. Standard hours for actual production: 900. Standard wage rate per hour: £6.00. Required: Calculate the following variances: (a) direct labour total (b) direct labour rate (c) direct labour ...

Verified Answer:

Verified Answer:

Verified Answer: