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