# Standard Costing and Performance Evaluation

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3

Standard Costing and

Performance Evaluation

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Standard Costing

and Performance

3

Evaluation

**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

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

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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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

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.

2007.1

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