01
technical
standard operating RELEVANT to CAT Qualification paper 7
The CAT Paper 7 syllabus requires candidates to be able to prepare a reconciliation of standard and actual costs and profits under both absorption and marginal costing systems. This brief article illustrates the layout of these reconciliations by the use of an example. Standard costing is a control system for comparing the planned costs and revenues with actual results in order to report variances for the purpose of performance measurement and control. Cost variances are usually reported to management in cost reconciliation statements. When sales variances are included the reconciliation is usually in the form of a standard cost operating statement. The format of the reconciliation is different under marginal and absorption costing. Absorption costing Suppose the following variances had been calculated for the most recent period. $ Sales volume profit 80,000 adverse Sales price 10,000 favourable Direct material price 6,000 adverse Direct material usage 2,000 favourable Direct labour rate 8,000 adverse Direct labour efficiency 3,000 adverse Variable overhead expenditure 6,000 favourable Variable overhead efficiency 4,000 adverse Fixed overhead expenditure 12,000 favourable Fixed overhead volume 7,000 adverse
Budgeted sales and production for the period were 50,000 units. Standard selling price was $20 per unit and standard cost was $12 per unit, giving a standard profit of $8 per unit. Actually only 40,000 units were produced and sold and actual profit was $322,000 A reconciliation of budgeted and actual profits could be presented as shown in Figure 1 opposite. Throughout this article the text in italics is for information only and would not be necessary in the actual statement. Note that the statement clearly distinguishes between the effect of sales volume on profit, and operational expenditure and efficiency effects on profit. For a cost centre a reconciliation of budgeted and actual cost would be more appropriate. This could be presented as shown in Figure 2 on page 2. Note that because we are dealing with costs, adverse variances increase actual cost whereas favourable variances reduce actual cost. Marginal costing Marginal costing draws a distinction between fixed and variable cost. Assume in our example that standard variable cost was $11.30 per unit and standard fixed cost was $0.70 per unit, resulting in a standard contribution of $8.70 per unit. Under marginal costing principles two changes occur in the reported variances. First, the sales volume variance would be based upon contribution per unit rather than profit per unit. In our case it would change to $87,000 adverse (10,000 units × $8.70).
Standard costing is a control system for comparing the planned costs and revenues with actual results in order to report variances for the purpose of performance measurement and control. Cost variances are usually reported to management in cost reconciliation statements. When sales variances are included the reconciliation is usually in the form of a standard cost operating statement.
student accountant issue 05/2010
02
costing statements A clear reconciliation of budgeted and actual costs and revenues is important to help focus management attention on variances. FIGURE 1: OPERATING STATEMENT – STANDARD ABSORPTION COSTING Period: most recent $ Budgeted Profit (50,000 units × $8 per unit profit) 400,000 Sales volume profit variance 80,000 adverse Standard profit from actual sales (40,000 units × $8 per unit profit) 320,000 Variances (F) (A) $ $ Sales price 10,000 Direct material price (6,000) Direct material usage 2,000 Direct labour rate (8,000) Direct labour efficiency (3,000) Variable overhead expenditure 6,000 Variable overhead efficiency (4,000) Fixed overhead expenditure 12,000 Fixed overhead volume (28,000) (7,000) 30,000 (28,000) 2,000 Actual profit 322,000 Second, there would be no fixed overhead volume variance, as fixed overhead is not absorbed into production units. In addition there could potentially be changes in reported profit, but this is not the case in our example, as there is no change in finish goods inventory levels. The marginal costing operating statement is shown in Figure 3. Under marginal costing the effect of sales volume on contribution and expenditure and efficiency on contribution is clearly shown. Finally, Figure 4 shows a possible layout for the reconciliation of budgeted and actual total cost under marginal costing. Once again, sales volume effects are clearly separated from those of expenditure and efficiency variances.
Conclusion A clear reconciliation of budgeted and actual costs and revenues is important to help focus management attention on important variances. In practice the format of the above statements may vary, but whatever the layout is chosen, it is vital that they are laid out in a logical manner and distinguish between the sales volume and the rate and efficiency causes of deviations from budget. In the case of marginal costing it is important to separate the effects on contribution, fixed and variable costs. Steve Jay is examiner for CAT Paper 7
03
technical
FIGURE 2: cost reconciliation statement – standard absorption costing Period: most recent Budgeted cost (50,000 units × $12 per unit standard cost) Cost volume variance (10,000 units × $12 per unit standard cost) Standard cost of actual production (40,000 units × $12 per unit standard cost) Variances (F) (A) $ $ Direct material price (6,000) Direct material usage 2,000 Direct labour rate (8,000) Direct labour efficiency (3,000) Variable overhead expenditure 6,000 Variable overhead efficiency (4,000) Fixed overhead expenditure 12,000 Fixed overhead volume (7,000 (7,000) 20,000 (28,000) Actual total cost
$ 600,000 120,000 favourable 480,000
(7,000) (8,000) 488,000
FIGURE 3: operating statement – standard marginal costing Period: most recent Budgeted contribution (50,000 units × $8.70) Sales volume contribution variance Standard contribution from actual sales (40,000 × $8.70) Variances (F) (A) $ $ Sales price 10,000 Direct material price (6,000) Direct material usage 2,000 Direct labour rate (8,000) Direct labour efficiency (3,000) Variable overhead expenditure 6,000 Variable overhead efficiency (7,000 (4,000) 18,000 (21,000) Actual contribution Fixed costs $ Budget 35,000 Expenditure variance (12,000) favourable Actual fixed overhead Actual profit
435,000 (87,000) adverse 348,000
(3,000) 345,000
23,000 322,000
05
student accountant issue 05/2010
FIGURE 4: cost reconciliation – standard absorption costing Period: most recent Budgeted variable cost (50,000 units × $11.30 per unit standard cost) Cost volume variance (10,000 units × $11.30 per unit standard variable cost) Standard variable cost of actual production (40,000 units × $11.30 per unit standard variable cost)
$ 565,000 113,000 favourable 452,000
Variances (F) (A) $ $ Direct material price (6,000) Direct material usage 2,000 Direct labour rate (8,000) Direct labour efficiency (3,000) Variable overhead expenditure 6,000 Variable overhead efficiency 4,000 (4,000) 8,000 (21,000) (13,000) Actual variable cost 465,000 Fixed costs $ Budget 35,000 Expenditure variance (12,000) favourable Actual fixed overhead 23,000 Actual total cost 488,000
