DEBRE BERHAN UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

MASTERS OF BUSINESS ADMINISTRATION
PROGRAM

Group Assignment(G1)
Standard Costing and Variance
Analysis
FINANCIAL AND MANAGERIAL ACCOUNTING (MBA 611)

Presentation
31/12/2019
 Group members
 Anwar Muhammed PEG/P/025/12
 Adimachew burga PEG/P/022/12
 Amare Azmeraw PEG/P/023/12
 Anteneh Solomon PEG/P/024/12
 Biruktait yirgalem PEG/P/029/12
 Ejigayehu bogale PEG/P/O34/12
 Lealem Addise PEG/P/024/
 INTRODUCTION
• The success of a business enterprise depends to a greater extent
upon how efficiently and effectively it has controlled its cost.
• In a broader sense the cost figure may be ascertained and
recorded in the form of Historical costing and predetermined
costing
 The term Historical costing refers to ascertainment and
recording of actual costs incurred after completion of production
 Historical Costing is not an effective method of exercising cost
control because it is not applied according to a planned course
of action.
 The purpose of standard costing reports is to investigate the
reasons for significant variances so as to identify the problems
and take corrective action.
 Definitions
 Standard
• It’s a norm or bench mark.
• It is useful for comparison.
• It may indicate minimum quality
 Standard Cost: “Standard cost is the pre-determined cost
based on the technical estimates for materials, labour and
overhead for a selected period of time for a prescribed set
of working conditions.”
 Standard Costing: “the preparation of standard costs and
applying them to measure the variations from the actual
costs and analyzing the causes of variations with a view to
maintain maximum efficiency of the operations so that any
remedial action may be taken immediately.
 Standard Costs
Based on carefully
predetermined amounts.

Standard Used for planning labor, material

Costs are and overhead requirements.

The expected level

of performance.

Benchmarks for
measuring performance.
 Setting Standard Costs
Accountants, engineers, personnel administrators, and
production managers combine efforts to set standards based
on experience and expectations.
 Standards vs. Budgets

A standard is the
expected cost for one
Are standards the unit.
same as budgets? A budget is the
expected cost for all
units.
 Types of standards
1.Ideal Standards
The term "Ideal Standard" refers to the standard which
can be attained under the most favorable conditions
possible.
In other words, ideal standard is based on high degree
of efficiency
It assumes that there is no wastage. no machine
breakdown. No power failure, no labour ideal time in the
production process.
 In practice it is difficult to attain this ideal standard.
2.Basic Standards/bogey
which is established for use is unaltered over a long period of
time
standard is fixed in relation to a base year and is not changed in
response to changes in material costs. labour costs and other
expenses
The application of this standard has no practical importance
from cost control and cost ascertainment point of view.

3.Current Standard
"a standard established for use over a short period of time
related to current conditions which reflects the performance
that should be attained during the period.“
These standards are more suitable and realistic for
control purposes.
4.Normal Standards
 the standards that may be achieved under normal
operating conditions
 This standard resents an average standard in past which, it is
anticipated, can be attained over a future period of time, preferably
long enough to cover one trade cycle.
 The usefulness of such standards is very limited for the
purpose of cost control
5.Expected Standard
 "the
standard which may be anticipated to be attained
during a future specified budget period.“
 These standards set targets which can be achieved in a
normal situation.
 As such it is more realistic than the Ideal Standard.
Where do we obtain information to set
standards?????????
 the standards that may be achieved under normal
operating

 Production plans (materials,labour,overheads)

 Production records (materials.labour,overheads)
 Product specifications (materials)
 Supplier price lists (materials)
 Work studies (materials,labour)
 Supplier invoices(overheads)
 Wages records (labour)
 HR departemnts (labour)
 ADVANTAGES AND DISADVANTAGE OF
STANDARD COSTING
Advantages
Basis for sensible cost comparisons.
Employment of management by exception.
Means of performance evaluation for employees.
Result in more stable product cost.
Disadvantages
Too comprehensive hence time-consuming.
Precise estimation of prices or rates is difficult.
Requires continuous revision with frequent changes in
technology/ market trends.
Focus on cost minimization rather than quality or
innovation.
 Variance Analysis
“Variances" may be defined as the difference between
Standard Cost and actual cost for each element of cost
incurred during a particular period.
•Variance Analysis: is the resolution into constituent
parts and the explanation of the variances
The variance may be Favorable & Unfavorable
Variances And Controllable & Uncontrollable
Variances
• Controllable variances: are those, which can
be controlled by the departmental heads
• Uncontrollable variances: are those, which
are beyond their control. If uncontrollable variances are
of significant nature and are persistent, the standards
may need revision.
.
 Material Variance
•Material cost variance arises due to variance in the price of
material or its usage.
Reasons of Material Variance
•Change in Basic price.
•Fail to purchase anticipated standard quantities at appropriate price.
•Use of sub-standard material.
•Ineffective use of materials.
 Labour
Material variancesVariances
Reasons of Labour Variance
Change in design and quality standard.
Low Motivation.
Poor working conditions.
Improper scheduling/placement of labour.
Inadequate Training.
Increments / high labour wages.
Overtime.-
Labour shortage leading to higher rates.
Union agreement.
Labor Efficiency Variance- Causes
Poorly Poor
trained quality
workers materials

Unfavorable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
 Overhead Variances
• Overhead variances arise due to the difference between actual overheads
and absorbed overheads. The estimate of budget of the overheads is to be
divided into fixed and variable elements. i.e.

1. Variable overhead variances.

– Variable overhead budget or expenditure variance, and
– Variable overhead efficiency variance.
2. Fixed overhead variances.

Reasons of Overheads Variance

 Under or over absorption of fixed overheads.
 Fall in demand/ improper planning.
 Breakdowns /Power Failure.
 Labour issues.
 Inflation.
 Lack of planning.
 Lack of cost control
 Formulas
Variable Overheads (OH) Variance calculation
Variable OH Cost Variance =
(Standard Hrs X Standard Variable OH
Rate) – Actual OH Cost
Variable OH Variance calculation
•Variable OH Expenditure Variance = (Actual Hrs X
Standard Variable OH Rate) – Actual OH Cost
•Variable OH Efficiency Variance = (Standard Hrs -
Actual Hrs) X Standard Variable OH Rate
Fixed Overheads (OH) Variance calculation

•Fixed OH Cost Variance = Absorbed OH – Actual OH

•Absorbed OH = Actual Units * Standard OH Rate per unit

Fixed OH Variance calculation
•Fixed OH Expenditure Variance = Budgeted OH – Actual OH

•Fixed OH Volume Variance = Absorbed OH – Budgeted OH

•Fixed OH Efficiency Variance = Standard OH Rate per hour (Standard

Hrs - Actual Hrs)
•Fixed OH Capacity Variance = Standard OH Rate per hour (Budgeted
Hrs - Actual Hrs)
 Sales Variances
Reasons of Sales Variance
- Change in price.
- Change in Market size.
-Change in Market share.

Sales Variances calculation

•Sales Value Variance = Budgeted Sales –
Actual Sales
•Sales Price Variance = Actual Quantity
(Actual Price - Budgeted Price)
•Sales Volume Variance = Budgeted Price
(Actual Quantity - Budgeted Quantity)
 MARGINAL COSTING
Marginal costing
•An approach where variable costs are charged to cost
units, but the fixed cost for the relevant period is
written off in full against the total contribution for
that period.
• is change in total cost due to increase or decrease
one unit or output.
The principle of marginal costing
• Revenue will increase by the sales value of one item
•Costs will only increase by the variable cost per unit
•The increase in profit will equal sales value less variable costs
 Importance
•Fixed expenses are not allocated to cost units but are
charged against ‘fund’ which arises out of excess of
sales price over total variable costs.
Advantages of marginal costing
preferable for decision-making, as contribution is the most
reliable criteria upon which to base a decision.
avoids arbitrary apportionment of fixed costs and the
under- or over-absorption of overheads.
gives a more accurate picture of how an organisation’s
cash flows and profits are affected by sales and volume.
In manufacturing organisations, it avoids the manipulation
of profits through increased production volumes.
 Limitations
Technical difficulties.
Time taken for completion of jobs is not given due
attention.
Less effective.
Balance sheet will not exhibit true and fair view.
Problem of apportionment of variable cost still arises.
Difficulty to apply in contract or ship building industry.
Does not provide any standard.
General reduction in selling price and thus losses.
General Marginal cost equation
SALES=VARIABLE COSTS +FIXED EXPENSES+P/L
OR S-V=F+P/L
 Cost-Volume-Profit (CVP) analysis
CVP analysis examines the interaction of a firm’s
sales volume, selling price, cost structure, and
profitability. It is a powerful tool in making
managerial decisions including marketing,
production, investment, and financing decisions.
• How many units of its products must a firm sell to break
even?
• How many units of its products must a firm sell to earn
a certain amount of profit?
• Should a firm invest in highly automated machinery and
reduce its labor force?
• Should a firm advertise more to improve its sales?
 Objective of CVP analysis
to establish what would happen to profit if sales
volume fluctuates in the short term.
The focus is on the volume of activity for a
business, because this is one of the most important
variables affecting sales, costs and profit.
One Product Cost-Volume-Profit Model
Net Income (NI) = Total Revenue – Total Cost

Total Revenue = Selling Price Per Unit (P) * Number of Units Sold (X)

Total Cost = Total Variable Cost + Total Fixed Cost (F)

Total Variable Cost = Variable Cost Per Unit (V) * Number of Units Sold (X)
 Marginal cost equation
SALES=VARIABLE COSTS +FIXED EXPENSES+P/L
Contribution margin
CONTRIBUTION =SELLING PRICE –MARGINAL COST
Profit /volume ratio
P/V=CONTRIBUTION /SALES OR F+P/L/V.C+F.C+P/L=[F+P/S] OR S-
V/S=CHANGE IN PROFITS OR CONTRIBUTION/CHANGE IN SALES
Breakeven point
B.E.P=FC/P/V OR TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER UNIT
OR TOTAL FIXED EXPENSES/CONTRIBUTION PER UNIT
Value of sales to earn desired amount of profit
SALES=F.C+D.P/P/V RATIO
Margin of safety……….. MOS=PROFIT/P/V RATIO
 BREAKEVEN POINT
is the point at which neither a profit nor a loss is
incurred. Break-even occurs where total contribution
is exactly equal to fixed cost and hence sales revenue
is exactly equal to variable cost plus fixed cost.
 Fixed expenses
Break-even point =
Unit contribution margin
in units sold

Break-even point in Fixed expenses

total sales =
CM ratio
 APPLICATION OF MARGINAL COST & COST,
VOLUME & PROFIT ANALYSIS
•COST CONTROL.
•PROFIT PLANNING.
•EVALUTION OF PERFORMANCE.
•DECISION MAKING.
•FIXATION OF SELLING PRICE.
•KEY LIMITING FACTOR.
•SUITABLE PRODUCT MIX
 Ch
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