Page 1

F5 revision

ACCA June 2008 examinations 

TRADITIONAL ABSORPTION v ACTIVITY BASED COSTING A company manufactures two products: X and Y. Information is available as follows: (a) Product Total production X 1,000 Y 100

Labour time per unit 0.5 hours 1.0 hour

Total overhead: $16,500

Calculate the overhead content of each product using traditional absorption methods.

(b)

The total overhead has now been broken down into: Materials handling 4,800 Production scheduling 6,500 Machine-related 5,200

Number of purchase orders received (total) Number of production runs (total) Number of machine operations (per unit)

Product X 8 3 2

Product Y 4 2 6

Recalculate the overhead content of each product using an activity-based costing approach.

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F5 revision

ACCA June 2008 examinations 

ACTIVITY BASED COSTING *

Gives fairer valuation of cost per unit •

*

Identifies cost driver for each overhead rather than absorb all at one arbitrary rate

Focuses attention on cost drivers •

Leads to better control of overheads

BUT:

*

time - consuming to identify cost drivers

*

not always possible to identify a cost driver

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F5 revision

ACCA June 2008 examinations 

Throughput accounting A company produces 3 products, details of which are given below:

Selling price Materials Labour Variable overheads Fixed overheads Profit p.u. Machine hours p.u. Maximum demand

A 50 10 10 18 5 43 7 1 hr 500u

B 60 15 5 20 8 48 12 2 hrs 500u

C 40 8 6 4 10 28 12 2 hrs 500u

The machine time is limited to 1,800 hours. Determine the optimum production plan and calculate the maximum profit (a) using key factor analysis (b) using throughput accounting

Main assumptions of throughput accounting: *

in the short term, all costs except materials are fixed

*

inventory levels are kept to a minimum, ideally zero. www.opentuition.com


F5 revision

ACCA June 2008 examinations 

LIFE CYCLE COSTING Consider costs and revenues over the estimated entire life of a product.

Phases of life cycle:

*

Development

*

Introduction

*

Growth

*

Maturity

*

Decline

For example, might plan to have high selling price initially (high development/introduction costs, low competition), and then to have lower prices during the maturity phase (higher volume of sales, lower costs, more competition) and plan for eventual withdrawal of product (and replacement with new product) towards end of life cycle.

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F5 revision

ACCA June 2008 examinations 

TARGET COSTING 1.

Determine a realistic / competitive selling price.

2.

Determine the profit required (e.g. required profit margin)

3.

Calculate the maximum cost p.u. in order to achieve the required profit.

4.

This is the target cost

5.

Compare the estimated actual cost with the target cost. If higher, look for ways of achieving the target cost.

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F5 revision

ACCA June 2008 examinations 

JUST-IN-TIME INVENTORY MANAGEMENT The objective is to remove the need to keep inventory.

The main steps in order to achieve this are: *

total quality management if there is no waste or damage to materials, there is less need for stock if all finished goods are ‘perfect’ there is less need for stock

*

fast production the faster the production the less work-in-progress goods can be produced to order, rather than being produced for stock

*

frequent, guaranteed deliveries of raw materials it is the supplier who then has to keep stock, rather than the company

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F5 revision

ACCA June 2008 examinations 

PRICING Full cost plus: Take full cost (i.e. including fixed overheads) and add on a percentage Example variable cost of production $5 p.u. budgeted fixed costs $60,000 p.a. budgeted production 20,000 units p.a. mark-up of 30%

fixed costs p.u. = 60,000/20,000 = $3 full cost = 5 + 3 = $8 p.u. selling price = $8 + 30% x $8 = $10.40 p.u.

Ensures that company covers fixed costs, BUT how to budget the level of production? Takes no account of the effect of the selling price on demand.

Marginal cost plus: Take marginal (variable cost) and add on a percentage Example Variable cost of production budgeted fixed costs budgeted production

$5 p.u. $60,000 p.a. 20,000 units p.a.

mark-up of 50%

marginal cost = $5 p.u. selling price = $5 + 50% x $5 = $7.50 p.u.

Avoids the problems of absorbing fixed overheads, BUT what percentage to add in order to ensure that fixed overheads are covered? Takes no account of the effect of the selling price on demand.

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F5 revision

ACCA June 2008 examinations 

Theoretical Pricing 1.

At a selling price of $80 p.u., the demand will be 50,000 units p.a.. For every $5 change in the selling price, the demand will change by 2,000 units.

Derive the price/demand equation.

2.

At a selling price of $100 p.u., the demand will be 80,000 units p.a.. For every $10 change in the selling price, the demand will change by 5,000 units.

Derive the price/demand equation.

3.

At a selling price of $200, the demand will be 100,000 units p.a.. The demand will change by 10,000 units for every $30 change in the selling price. The marginal revenue is given by: MR = 500 – 0.006Q The total costs will be 60,000 + 8Q

What should be the selling price p.u. to achieve maximum profit p.a.?

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F5 revision

ACCA June 2008 examinations 

RELEVANT COSTING *

Suitable for one-off contracts.

*

Calculate the future, incremental (i.e. extra), cash flows which will result from doing the contract.

Sunk costs:

costs already incurred - not relevant

Opportunity costs:

lost income as a result of doing the contract - are relevant

Fixed costs:

only relevant if the total changes as a result of doing the contract

Examples: 1.

Contract requires 200 kg of material X. Company has 500 kg in stock, which originally cost $6 per kg.. Material X has no other use, and if not used in the contract will be scrapped for $2 per kg..

2.

Contract requires 300 kg of material Y. Company has 600 kg in stock, which originally cost $10 per kg.. Material Y is in regular use by the company has the current purchase price is $12 per kg..

3.

Contract requires 50 hours of skilled labour. The company pays skilled labour $5 per hour, and there is currently plenty of idle time.

4.

Contract requires 80 hours of skilled labour. Labour is paid $5 per hour. There is no spare time, and the contract would have to be done in overtime. Overtime is paid at normal rate plus 50%.

5.

Contract requires 100 hours of skilled labour. Labour is paid $5 per hour. Labour is currently fully occupied making another product which is generating a contribution of $8 p.u. Each unit of the other product requires 2 hours of skilled labour.

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F5 revision

ACCA June 2008 examinations 

UNCERTAINTY Sales per week Sales (units) 10 20 30 Selling price: Cost:

Probability 0.3 0.5 0.2 $20 p.u. $10 p.u.

Any unsold units must be sold as scrap for $1 p.u. The company can contract to purchase 10, 20 or 30 units each week. How many units should they contract for? (a) Expected Values

(b) Maximax

(c)

Maximin

(d) Minimax Regret

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F5 revision

ACCA June 2008 examinations 

BUDGETING (1) Incremental budgeting Take last years figures and adjust for growth and inflation. Easiest and most common approach, but assumes that we continue to do things the same way. (For example, if we make our products by hand, we will budget to continue to make them by hand and ignore the fact that maybe there are now machines capable of producing them.)

Zero based budgeting Ignore what currently happens. Instead, identify different solutions available, cost them out, and budget on adopting the best solution. For example, if our product can be made by hand or made by machine, then cost out both approaches, see which is the cheaper, and budget on that basis. Although zero based is in principle a much better approach, it is time-consuming and requires expertise. A realistic way of using a zero based approach is to apply it to one area of the business each year, and budget the other areas using an incremental approach.

Activity based budgeting Use an activity based costing approach. Budget the costs for each activity and how each activity is being used, in an attempt to ensure that each activity is being used efficiently.

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F5 revision

ACCA June 2008 examinations 

BUDGETING (2)

Top-down budgeting Budget is prepared centrally and then imposed on the managers of each department Bottom-up budgeting Each manager produces his/her budget. It is the job of central management to make sure the budgets are challenged and that different departments budgets coordinate with each other.

Bottom-up budgeting is regarded as being more motivational for managers. However the budgets do need to be challenged well otherwise there is the danger of managers introducing slack into their budgets.

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F5 revision

ACCA June 2008 examinations 

BUDGETING (3)

Fixed budget

– The original budget based on the originally estimated levels of sales and production. The original budget profit remains the overall target of the company.

Flexed budget

– The budget is adjusted (or flexed) for the actual levels of sales and production. This is usually done monthly and is used for the purpose of control (compare the actual results with the flexed budget. i.e. variance analysis)

Rolling budget – Update the budget each month and always have a budget for the next 12 months (continuous budgeting)

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F5 revision

ACCA June 2008 examinations 

FORECASTING HIGH LOW METHOD Month

Sales (units)

1

23100

2

24000

3

24100

4

24800

5

25000

6

26030

7

26000

8

27100

9

27200

10

27800

11

27800

12

27500

High Low Difference

Month 12 1 11

Units 27500 23100 4400

Change per month: 4400 / 11 = 400 Forecast for next month:

27500 + 400 = 27900 units

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F5 revision

ACCA June 2008 examinations 

FORECASTING REGRESSION x

y

Month

Sales (units)

xy

x2

1

23100

23100

1

2

24000

48000

4

3

24100

72300

9

4

24800

99200

16

5

25000

125000

25

6

26030

156180

36

7

26000

182000

49

8

27100

216800

64

9

27200

244800

81

10

27800

278000

100

11

27800

305800

121

12

27500

330000

144

Σx = 78

Σy = 310430

Σxy = 2081180

Σ x = 650 2

n = number of pairs of observations = 12 b=

a=

Σy n

nΣxy – ΣxΣy nΣx2 – (Σx)2

=

12 x 2081180 – 78 x 310430 12 x 650 – 78 x 78

bΣx n

=

310430 12

=

443.25 x 78 = 22988 12

y = 22988 + 443.25x Forecast for month 13 = 22988 + 443.25 x 13 = 28750 units

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760620 1716

= 443.25


F5 revision

ACCA June 2008 examinations 

FORECASTING TIME SERIES Sales (units)

2005 – qtr 1

1200

2005 – qtr 2

1100

2005 – qtr 3

1250

2005 – qtr 4

1000

2006 – qtr 1

1300

2006 – qtr 2

1180

2006 – qtr 3

1340

2006 – qtr 4

1110

2007 – qtr 1

1410

2007 – qtr 2

1290

2007 – qtr 3

1450

2007 – qtr 4

1200

Moving Average

Centred Average

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Seasonal Variation

Seasonal Variation

(Additive)

(Multiplicative)


F5 revision

ACCA June 2008 examinations 

LEARNING CURVES As cumulative output doubles, the cumulative average time (labour cost) per unit falls to a fixed percentage of the previous average time (labour cost) Example 1 First batch takes 100 hours to produce. There is a 75% learning effect. How long will it take to produce another 7 batches.

Example 2 First batch takes 60 hours to produce. There is an 80% learning effect. How long will it take to produce the 7th batch?

Learning curve formula: y = axb y = average time per batch a = time for initial batch x = number of batches b = learning factor log r b= log 2

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F5 revision

ACCA June 2008 examinations 

Operating Statement (Absorption Costing) Original Budget Profit Sales Volume Variance units Actual sales Budgeted sales units × Standard profit p.u.

Sales Price Variance Actual sales at actual S.P. Actual sales at standard S.P

Materials Expenditure Variance Actual purchases at actual cost Actual purchases at standard cost

Materials Usage Variance kg Actual usage Standard usage for actual production kg × Standard cost

Labour Rate of Pay Variance Actual hours paid at actual cost Actual hours paid at standard cost

Labour Idle Time Variance hours Actual hours paid Actual hours worked × Standard cost

Labour Efficiency Variance hours Actual hours worked Standard hours for actual production × Standard cost

Variable Expenditure Variance Actual hours worked at actual cost Actual hours worked at standard cost

Variable Efficiency Variance hours Actual hours worked Standard hours for actual production × Standard cost

Fixed Overhead Expenditure Variance Actual total Budget Total

Fixed Overhead Volume Variance units Actual production Budget production × Standard cost per unit

Actual Profit www.opentuition.com


F5 revision

ACCA June 2008 examinations 

Operating Statement (Marginal Costing) Original Budget Profit Sales Volume Variance units Actual sales Budget sales units × Standard contribution p.u.

Sales Price Variance Actual sales at actual S.P. Actual sales at standard S.P

Materials Expenditure Variance Actual purchases at actual cost Actual purchases at standard cost

Materials Usage Variance kg Actual usage Standard usage for actual production kg × Standard cost

Labour Rate of Pay Variance Actual hours paid at actual cost Actual hours paid at standard cost

Labour Idle Time Variance hours Actual hours paid Actual hours worked × Standard cost

Labour Efficiency Variance hours Actual hours worked Standard hours for actual production × Standard cost

Variable Expenditure Variance Actual hours worked at actual cost Actual hours worked at standard cost

Variable Efficiency Variance hours Actual hours worked Standard hours for actual production × Standard cost

Fixed Overhead Expenditure Variance Actual total Budget Total

Actual Profit

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F5 revision

ACCA June 2008 examinations 

VARIANCE ANALYSIS Budget sales and production of Product X are 600,000 units p.a. at a standard selling price of $100 p.u. The original standard costs of production were: Materials: 2 kg @ $20 per kg Labour: 1.5 hrs @ $2 per hr Variable overheads: 1.5 hrs @ $6 per hr Fixed overheads were budgeted at $10.8M for the year. Since preparation of the budget, the suppliers of the materials had announced a permanent price increase of 10%. As a result the manufacturing process was examined and ways were found of reducing material usage by 5% without affecting the quality of finished goods. Actual results for January were as follows: Sales: 53,000 units @ $95 p.u. Production costs for 55,000 units produced: Materials (110,000 kg) Labour (85,000 hrs) Variable Overheads Fixed Overheads

$2,300,000 $180,000 $502,000 $935,000

Prepare an operating statement. (Note: the company’s policy is to use marginal costing)

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F5 revision

ACCA June 2008 examinations 

VARIANCES 1.

Always marginal costing in exam unless told otherwise, but check carefully.

2.

Always show standard cost per unit (cost card) unless given in question. (Make sure you still get the marks even if you have misread something).

3.

Examiner sometimes uses the word ‘cost variance’ to mean ‘total variance’. (e.g. ‘calculate for materials the cost, expenditure, and usage variances’. Means expenditure and usage as normal + total variance. Do not calculate total separately, it is simply the total of expenditure + usage).

4.

If more than one material, do NOT calculate mix & yield variances unless asked for. (or unless he says ‘the materials are substitutable’ but he is unlikely to use these words).

5.

Remember: for cost variances we are always comparing actual costs with standard cost for actual level of production. It is worth writing down the actual level of production if you have misread, it is then obvious what you were trying to do.

6.

Planning and Operational Variances (a)

Planning (or Revision) Variance • This is the difference between original budget profit and revised budget profit, due to permanent changes. • This variance cannot be ‘corrected’ (or controlled) but when it is identified that it is going to occur company may decide to change plans for the future ie. feed-forward control.

(b)

Operational Variances • •

These are differences between actual results and revised budget. Normally calculated monthly. It is too late to do anything about the period under review, but can use information to attempt to correct (or control) any problems for the future. ie. feedback control.

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F5 revision

ACCA June 2008 examinations 

FIXED OVERHEAD VARIANCES A company uses absorption costing. The standard cost card is as follows: Materials (2 kg at $30 per kg) Labour ( 4 hours at $5 per hour) Fixed overheads (4 hours at $4 per hour) Standard selling price

60.00 20.00 16.00 $96.00 $120.00

Budget production and sales:

50,000 units

Actual production and sales:

60,000 units

All sales were made at the standard selling price, and materials usage and cost were as per the standard cost card. 230,000 labour hours were paid and worked, at a cost of $ 1,150,000 Actual expenditure on fixed overheads was $ 1,000,000

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F5 revision

ACCA June 2008 examinations 

LABOUR VARIANCES - EXCESS IDLE TIME The standard costs of labour are as follows: 5 hours (paid) at $3.60 per hour = $18 p.u. It is budgeted that there will be 10% idle time. The actual production is 10,000 units and the actual labour costs are as follows: $185,000 was paid for 48,000 hours, of which 46,000 were actually worked.

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F5 revision

ACCA June 2008 examinations 

MIX & YIELD VARIANCES Standard cost per unit of output: A B

6 kg @ $8 2 kg @ $4

Actual results: Materials input

A B

48 8 56 99,000 kg at a total cost of $800,000 36,000 kg at a total cost of $140,000

Actual production: 16,000 units

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F5 revision

ACCA June 2008 examinations 

MIX & YIELD - ANSWER EXPENDITURE/PRICE

A B

Actual @ purchases kg 99,000 36,000 135,000

Actual @ Standard cost purchases kg $ 99,000 $8 $792,000 36,000 $4 144,000 135,000 $936,000

Actual cost $ 800,000 140,000 $940,000

$4,000 (A)

MIX Actual usage @ Standard cost A B

kg 99000 36000 135,000

$ 792,000 144,000 $936,000

Std mix for actual total input kg (6/8) 101,250 33,750 (2/8) 135,000

Standard cost $ 810,000 135,000 $945,000

@ $8 $4

$9,000 (F)

YIELD

A B

Std mix for actual total input kg 101,250 33,750 135,000

@ Standard cost $ 810,000 135,000 $945,000

@

(6/8) (2/8)

Std mix for final production kg 96,000 32,000 128,000

Standard cost

$8 $4

$ 768,000 128,000 $896,000

16,000 @ 8kg $49,000 (A)

SUMMARY: EXP MIX YIELD

4,000 (A) 9,000 (F) 49,000 (A)

44,000 (A) (TOTAL) 40,000 (A) usage

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F5 revision

ACCA June 2008 examinations 

PERFORMANCE INDICATORS Profit before interest & tax Long term capital

RETURN ON CAPITAL

GEARING

Long term debt or Equity

INTEREST COVER

Long term debt Equity + Long term debt

Profit before interest & tax Interest

OPERATING PROFIT MARGIN

Operating Profit Sales

CURRENT RATIO

Current Assets Current liabilities

QUICK RATIO

× 100%

Current Assets – Stock Current liabilities

EARNINGS PER SHARE (E.P.S.)

Profit after interest & tax Number of shares

P / E ratio

Market value per share Earnings per share

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× 100%


F5 revision

ACCA June 2008 examinations 

RETURN ON INVESTMENT v RESIDUAL INCOME Division X of Y plc is currently reporting profits of $100,000 p.a. on capital employed of $800,000 A new project is being considered which will cost $100,000 and is expected to generate profits of $15,000 p.a. The Cost of Capital of Y plc is 16% (a)

Should Y plc accept or reject the project?

(b) Will the manager of Division X be motivated to accept the project if his performance is measured

(i) on Return on Investment? (ii) on Residual Income?

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F5 revision

ACCA June 2008 examinations 

DIVISIONAL PERFORMANCE MEASUREMENT Type of responsibility centre: Cost centre:

Manager has authority for decisions over costs (but not revenue)

Revenue centre:

Manager has authority for decisions over revenue (but not costs)

Profit centre:

Manager has authority for decisions over costs and revenues (but not capital investment decisions)

Investment centre:

Manager has authority for decisions over costs, revenues, and new capital investment.

Controllable factors:

The manager should only be assessed over those items over which he has control. For example, if a manager is given authority to make decisions over everything except salary increases which are dictated by central management, then it would be unfair to include salaries in his performance measurement. If (for example) it is a profit centre, then for the purposes of measuring his performance the profit of the division should be calculated ignoring salaries.

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F5 revision

ACCA June 2008 examinations 

TRANSFER PRICING OBJECTIVES: *

Goal congruence

*

Performance appraisal

*

Divisional autonomy

OVERALL: *

Must maximise group profit

PRACTICAL: *

T.P. often fixed by Head Office

*

Problem

– loss of autonomy – possibility of dysfunctional decisions

APPROACH: Allow individual managers to negotiate the transfer price

Selling division:

Minimum T.P. = Marginal cost + opportunity cost

Receiving division:

Maximum T.P. is lower of (a) external purchase price (on intermediate market) and (b) net marginal revenue (selling price less costs of receiving division)

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F5 revision

ACCA June 2008 examinations 

TRANSFER PRICING [S = selling division; R= receiving division] 1.

Variable production cost Final selling price $30

2.

As (1), but intermediate market exists.

S 15

R 8

S can sell intermediate market at $18; R can buy on intermediate market at $20 (a) S has unlimited production capacity and there is limited demand on the intermediate market (b) S has limited production capacity and there is unlimited demand on the intermediate market 3.

S has restricted capacity to make A and B R wants product A. A 80 100

S’s Variable production cost per unit S’s Intermediate market price per unit

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B 120 150


F5 revision

ACCA June 2008 examinations 

Non-financial performance measures

Quality

Flexibility

Efficiency (Resource utilisation)

Innovation

Competitiveness

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F5 revision

ACCA June 2008 examinations 

BACKFLUSH COSTING Traditional costing systems use sequential tracking of costs which means that means that costing is synchronised with the physical sequences of production: purchase, work-in-progress, finished goods. In a system where there were several stages of production, this approach led to very complex accounting as costs were gradually built up in a unit as it progressed.

Traditional costing:

Material Materials account Costs in Costs out to WIP WIP stage 1

WIP stage 2

Finished goods To cost of sales

Conversion costs Costs in Costs out to WIP

In just-in-time manufacturing environments, work-in-progress should be very low and the effort spent carefully costing each stage of production might not be worthwhile. Backflush costing does not attempt to value work-in progress (other than material content) and this can greatly simplify accounting. Typically, material costs and conversion costs are initially debited to appropriate accounts then are transferred straight to finished goods as these are produced. Backflush costing is sometimes called ‘delayed costing’ which is a more informative name. ‘Trigger points’ refer to where inventory costing take place. In the following example there are two trigger points: 1 2

The purchase of materials Production of finished goods.

There are only two sorts of inventory – raw materials and finished goods. Costs are transferred only when finished goods are produced. WIP is not separately valued.

Material Materials account Costs in Costs out to finished goods

Finished goods To cost of sales

Conversion costs Costs in Costs out to WIP

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F5 revision

ACCA June 2008 examinations 

Fixed Overhead Variances - Absorption Costing Total Variance Actual total fixed overheads Standard cost for actual production

Analysis of Total Variance Expenditure Variance Actual Total Budget Total Volume Variance units Actual Production Budget Production ×

Standard cost per unit =

×

Standard cost per hour =

×

Standard cost per hour =

Analysis of Volume Variance Capacity Variance hours Actual hours worked Budget hours Efficiency Variance hours Actual hours worked Standard hours for actual production

Summary Expenditure Variance Capacity Variance Efficiency Variance

Note: A  nalysis Volume Variance into capacity and efficiency variances assumes that budget production was limited by labour hours available. Therefore we can only produce more than budget if a) we have more hours available (capacity) and/or b) workers work faster (efficiency)

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F5 revision

ACCA June 2008 examinations 

Variances - Differences between Marginal and absorption costing All the variances are the same in both cases, except: Sales Volume Variance: Take difference in units between budget and actual sales, and cost out at: Marginal costing:

Standard contribution per unit

Absorption costing:

Standard profit per unit

Fixed Overheads Variances Marginal costing:

Only expenditure variance

Absorption costing:

Expenditure variance and volume variance (Volume Variance can be analysed into capacity and efficiency - see separate sheet)

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ACCA Paper F5  

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