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Standard Costing and Performance Evaluation

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In this chapter we will explore further aspects of the practice of standard costing. In particular, we will consider more detailed analysis of particular variances, the separation of variances into operational and planning components and the preparation of performance reports for management based on standard costing. We will also conduct a general exploration of the role of standard costing in perform- ance evaluation and consider how that role may be changing in the modern economic environment. You should become aware that the relevance of a number of traditional man- agement accounting practices is being questioned in the era of flexible manufacturing and a service-based economy.
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3
Standard Costing and
Performance Evaluation
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Standard Costing
and Performance
3
Evaluation
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LEARNING OUTCOMES
After completing this chapter, you will be able to
calculate and explain planning and operational variances;
discuss the behavioural implications of setting standard costs;
apply standard costing methods within costing systems and demonstrate the reconciliation
of budgeted and actual pro?t margins;
prepare reports using a range of internal and external benchmarks and interpret the results.
3.1 Introduction
In this chapter we will explore further aspects of the practice of standard costing. In
particular, we will consider more detailed analysis of particular variances, the separation of
variances into operational and planning components and the preparation of performance
reports for management based on standard costing.
We will also conduct a general exploration of the role of standard costing in perform-
ance evaluation and consider how that role may be changing in the modern economic
environment. You should become aware that the relevance of a number of traditional man-
agement accounting practices is being questioned in the era of ?exible manufacturing and
a service-based economy.
3.2 Material mix and yield variances
The direct material usage variance measures the change in total direct material cost brought
about by using a non-standard amount of material in production. Sometimes it is possible
to subdivide the usage variance into a direct material mix variance and a direct material yield
variance. This subdivision is most likely to be found in process industries, where a standard
input mix is the norm, and recognisable individual components of input are combined duri
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ng
93
2007.1

94
STUDY MATERIAL P1
the production process to produce an output in which the individual items are no longer sep-
TION
arately identi?able. Paint manufacture provides a typical example: if a blue paint is required,
the basic paint base will be introduced to the mixing process, along with the blue dye; at the
ALUA
input stage, both raw process materials are separately identi?able, but at the end of the
process, blue paint emerges, with the individual components no longer separately identi?able.
In many process industries, it may be necessary from time to time to vary the input mix
perhaps because of shortages of raw material, or in order to take advantage of attractive
input prices. Whether the input mix is a standard or a non-standard one, there is a possibil-
ity that the outcome from the process will differ from that which was expected. In addition
to unexpected differences in yield, it is perfectly normal in some processes for the physical vol-
ume of output from the process to be less than the total volume of input, that is, there may
be unavoidable losses inherent in the operation of an ef?ciently working process. In the
blended whisky industry, for example, such losses arise from evaporation, and the volume
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of output from the process is expected to be less than the volume of the input. The direct
material mix variance measures the change in cost brought about by an alteration to the con-
ANDARD COSTING AND PERFORMANCE EV
stituents of the input mix, while the direct material yield variance measures the change in cost
ST
brought about by any deviation in output from the standard process output.
The data below will be used to calculate mix and yield variances in the subsequent examples.
Example
A company has the following standards for a mix to produce 500 kg of product C:
Input
kg
Cost/kg
Total cost of mix
A
200
£1.00
£200
B
400
£1.60
£640
600
£840
600 kg of input should produce 500 kg of C at
a standard cost of £1.68/kg
In a particular period, the actual results of the process were as follows:
Actual input
kg
Actual cost/kg
Total actual cost
A
300
£1.00
£300
B
300
£1.60
£480
600
£780
Actual output: 400 kg of C
Note that, in the above data, there is no direct material price variance, as the actual cost per kilogram of inputs A
and B was the standard cost in each case. The whole of the direct material variance is thus due to changes in the usage
thereof. The total variance is the difference between the standard cost of the output of 400 kg of C (400
£1.68
£672) and the actual cost of £780. This gives an adverse direct material usage variance of £108. This material usage
variance may be split into mix and yield components.
(a) Direct material mix variance
For an input of 600 kg:
Actual
Standard
Mix
Standard
Mix
Material
input
mix of input
variance
price per kg
variance
kg
kg
kg
£
£
A
300
200
100 (A)
1.00
100 (A)
B
300
400
100 (F)
1.60
160 (F)
600
600
160 (F)
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2007.1

MANAGEMENT ACCOUNTING – PERFORMANCE EVALUATION
95
ST
The material mix variance demonstrates the cost impact of using an ingredient mix different from that which is stan-
ANDARD COSTING AND PERFORMANCE EV
dard. That standard mix of 600 kg input is 200 kg of A and 400 kg of B. The actual mix of the 600 kg input is
300 kg of A and 300 kg of B. In this case, ingredient A has been substituted for ingredient B in the mix – and the
net cost impact of this is £60 favourable.
Material mix variance: (Actual material input
standard cost per unit)
(actual total material input in
standard proportions
standard cost per unit).
The CIMA Terminology offers an alternative methodology for working the material mix variance.
This other methodology works the components of the mix variance on the basis of the difference between budget
usage for output achieved and the difference between the standard average and the standard cost of the materials
input. In this case the standard average price of the material used is £1.40 per kg (that is £840/600 kg). This may
be illustrated by reworking the mix variance calculated above using the alternative methodology:
Material
(a)
(b)
(c)
(d)
(e)
(f)
(g)
kg
kg
kg
£
£
£
£
ALUA
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A
300
160
140
1.40
1.00
0.40
56 (F)
B
300
320
20
1.40
1.60
0.20
4 (F)
TION
Total
60 (F)
Key:
(a) actual usage
(b) budget input for output achieved A
200 kg/500 kg
400 kg, B
400 kg/500 kg
400 kg
(c) mix variance (kg), (a)
(b)
(d) standard average price per kg
(e) standard price per kg
(f) (e)
(d)
(g) mix variance (£), (c)
(f).
The logic here is more complex but it may be argued that it gives a more rigorous analysis of the situation. We
are using more of the cheap ingredient and less of the expensive ingredient. So, it might be argued, both compo-
nents of the mixture variance should be favourable.
Material mix variance (alternative methodology): ((Actual input quantity
budget material input quantity for the out-
put produced)
(standard weighted average cost per unit input
standard cost per input unit)).
When answering an examination question simply requiring the calculation of a mix variance, the student is advised
to always use the simple method illustrated at the start of this section. However, students should be aware that alter-
natives do exist and that the examiner may invite the student to demonstrate familiarity with these.
(b) Direct material yield variance
Standard cost per kg of output
£840/500
£1.68
kg
600 kg input should have yielded
500 of C
But did yield
0400 of C
Yield variance
0100 (A)
x standard cost per kg of output (£1.68)
Yield variance
£168 (A)
The material yield variance demonstrates the cost impact of generating above or below standard output from a
given quantity of input. In this case, the input of 600 kg is associated with a standard output of 500 kg, but the
actual output was only 400 kg.
The yield variance is 100 kg adverse (that is, 500 kg standard output – 400 kg actual output).
The cost impact of this is £168 adverse.
Material yield variance: (Standard output for actual input
actual output)
standard cost per unit of output.
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2007.1

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