Overhead, sales and profit variances; disposition and significance of variances; standard cost accounting
Cost and Management Accounting · Unit III · Topic 14 of 18 · 5 min read
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1. Overhead variances: formulas
Standard rates per hour come from the budget at normal capacity. SH = standard hours for actual output; AH = actual hours; BH = budgeted hours.
| Variance | Formula |
|---|---|
| Variable OH cost | SH × SR − actual variable OH |
| Variable OH expenditure | AH × SR − actual variable OH |
| Variable OH efficiency | SR × (SH − AH) |
| Fixed OH cost | Absorbed (SH × SR) − actual fixed OH |
| Fixed OH expenditure (budget) | Budgeted fixed OH − actual fixed OH |
| Fixed OH volume | Absorbed − budgeted fixed OH |
| of which efficiency | SR × (SH − AH) |
| of which capacity | SR × (AH − BH) |
2. Worked example
Budget: 10,000 units, 20,000 hours (2 hours a unit), fixed overhead Rs. 50,000 (Rs. 2.50 an hour), variable overhead Rs. 3 an hour. Actual: 9,000 units in 19,000 hours; fixed overhead 52,000; variable overhead 58,000. SH = 9,000 × 2 = 18,000.
- Variable OH cost = 18,000 × 3 − 58,000 = 54,000 − 58,000 = 4,000 A: expenditure 57,000 − 58,000 = 1,000 A; efficiency 3 × (18,000 − 19,000) = 3,000 A.
- Fixed OH cost = 18,000 × 2.50 − 52,000 = 45,000 − 52,000 = 7,000 A: expenditure 50,000 − 52,000 = 2,000 A; volume 45,000 − 50,000 = 5,000 A, split into efficiency 2.50 × (18,000 − 19,000) = 2,500 A and capacity 2.50 × (19,000 − 20,000) = 2,500 A.
Causes. Expenditure variances: price changes in power, stores, salaries; poor control of spending. Efficiency: the same causes as labour efficiency, since overheads accrue with hours. Capacity: idle plant from lack of orders, breakdowns, strikes, power cuts. A calendar variance (more or fewer working days than budgeted) is sometimes separated from capacity.
3. Sales variances (value method)
Budget: X 1,000 units at Rs. 50, Y 2,000 at Rs. 30 (1,10,000). Actual: X 1,200 at Rs. 48, Y 1,600 at Rs. 32 (57,600 + 51,200 = 1,08,800).
- Sales value variance = 1,08,800 − 1,10,000 = 1,200 A.
- Sales price variance = AQ (AP − BP): X 1,200 × (−2) = 2,400 A; Y 1,600 × 2 = 3,200 F; 800 F.
- Sales volume variance = BP (AQ − BQ): X 50 × 200 = 10,000 F; Y 30 × (−400) = 12,000 A; 2,000 A.
- Volume splits into mix = BP (AQ − RSQ), with RSQ = actual 2,800 units in the budgeted 1 : 2 ratio (933.33 and 1,866.67): 13,333.33 F + 8,000 A = 5,333.33 F; and quantity = BP (RSQ − BQ): 3,333.33 A + 4,000 A = 7,333.33 A.
Checks: 800 F + 2,000 A = 1,200 A; 5,333.33 F + 7,333.33 A = 2,000 A.
4. Profit variances (margin method)
Management cares about profit, not turnover, so sales variances are often measured in standard margin. Suppose standard cost is Rs. 40 for X and Rs. 22 for Y (margins Rs. 10 and Rs. 8). Budgeted margin = 10,000 + 16,000 = 26,000; actual margin at standard cost = 1,200 × 8 + 1,600 × 10 = 25,600.
- Sales margin variance = 25,600 − 26,000 = 400 A.
- Sales margin price variance = 800 F (as above).
- Sales margin volume variance = standard margin × (AQ − BQ): 2,000 F + 3,200 A = 1,200 A.
The total profit variance = actual profit − budgeted profit = sales margin variance + all cost variances (material, labour, overhead). The operating statement reconciles them: budgeted profit, plus favourable and minus adverse variances, equals actual profit.
5. Disposition of variances
- Transfer to costing profit and loss account at the end of the period: stock and cost of sales stay at standard. This is the usual method, especially for controllable variances.
- Apportion between cost of sales, finished goods and work-in-progress, so that stocks are close to actual cost; used when the variance is large and due to a wrong standard.
- Carry forward in a variance reserve to the next period, for seasonal variances that will reverse.
Abnormal variances (fire, strike) always go to profit and loss.
6. Assessing significance
Management by exception investigates only significant variances. Significance is judged by: size (absolute amount, and percentage of standard: many firms fix a tolerance such as 5%); trend (a small variance repeating every month matters more than a single large one); controllability (a price variance from a market rise is noted, not investigated); cost of investigation against likely saving; and interdependence (cheap material giving a favourable price variance and an adverse usage variance should be read together). Statistical control charts can set upper and lower limits.
7. Standard cost accounting
In standard cost accounting the variances are entered in the books. Under the single plan, work-in-progress is debited at standard and variances are isolated as costs are incurred (price variance at purchase, rate variance at payroll). Under the partial plan, work-in-progress is debited at actual and credited at standard, and variances are found at the end of the period. Each variance has its own account, closed to costing profit and loss.
How this is examined
For the overhead variance note: formulas, the split of fixed volume into efficiency and capacity, and causes. A disposition or significance question takes the three methods and five criteria above. If a sales or overhead problem is set, use the same layout as here: formula, figures, total and the checks.
Now try the real questions: Cost and Management Accounting past question papers.