Question 1

(a) Prepare the variances and an analysis

Direct Material Cost Variance

Actual Units Actual Units Standard Units

× × ×

Actual Cost Per Unit Standard Cost Per Unit Standards Cost Per Unit

9,000 units×10kg
100,000kg×RM0.40/kg 100,000kg×RM0.50/kg 90,000kg×RM0.50/kg

= RM 40,000 = RM 50,000 = RM 45,000

RM 10, 000 (F) RM 5,000 (A)

Direct Material Price Variance Direct material Usage Variance

RM 5,000 (F)

Direct Material Cost Variance

The direct material price variance of RM 10,000 is favorable because the actual price per
material unit is less than the standard price allowed per unit. The amount of actual price on
material is less than the standard amount. Thus, actual cost of RM 40,000 versus a standard cost
of RM50, 000 equal a favorable price variance of RM 10,000.

The direct material usage variance of RM 5,000 is adverse or unfavorable because the actual
quantity of materials used exceeds the standard quantity allowed at the level of activity achieved.
The amount of actual usage on material is more than the standard amount. Thus, actual cost of
RM 50,000 versus a standard of RM 45, 000 equals an adverse usage variance of RM 5,000.

The total direct material price variance of RM 5,000 is favorable, consisting of a favorable price
variance of RM 10,000 and an adverse usage variance of RM 5,000.
Direct Labor Cost Variance

Actual Hours Actual Hours Standard Hours

× × ×

Actual Rate Per Hour Standard Rate Per Hour Standard Rate Per Hour

9,000 units×2.5hrs
24000hrs×RM2.50/hr 24000hrs×RM2.40/hr 22500hrs×RM2.40/hr

= RM 60,000 = RM57, 600 = RM 54,000

RM 2,400 (A) RM 3,600 (A)

Direct Labor Wage Rate Direct Labor Efficiency Variance

Variance
RM 6,000 (A)

Direct Labor Cost Variance

The direct labor wage rate of RM 2,400 is adverse or unfavorable because the actual labor rate
per hour exceeds the standard labor rate per hour. The actual amount on labor rate is more than
the standard amount. Thus, actual cost of RM 60,000 versus a standard cost of RM 57,600 equal
an adverse labor rate variance of RM 2,400.

The direct labor efficiency variance of RM 3,600 is adverse or unfavorable because the actual
labor hours used more the standard hours allowed. The actual hour used to produce 9000 units is
more than the standard amount. Thus, actual cost of RM 57,600 versus a standard cost of RM
54,000 equal an adverse labor efficiency variance of RM 3,600.

The total direct labor cost variance of RM 6,000 is adverse or unfavorable, consisting of an
adverse labor rate variance of RM 2,400 and an adverse usage variance of RM 3,600.
Fixed Overhead Cost Variance

Actual Hours Budgeted Hours Actual Hours Standard Hours

× × × ×

Actual Rate Per Hour Standard Budgeted Standard Rate Standard Rate
Rate Per Hour Per Hour Per Hour

9,000 units×3hrs
30,000hrs×RM2/hr 15,000hrs×RM2/hr

RM 32,000 RM 30,000 = RM 60,000 = RM 54,000

RM 2,000 (A) RM 30,000 (F) RM 6,000 (A)

Fixed Overhead Fixed Overhead Fixed Overhead

Expenditure Variance Capacity Volume Efficiency Variance
Variance
RM 24,000 (F)

Fixed Overhead Volume Variance

RM 22,000 (F)
Fixed Overhead Cost Variance

The fixed overhead expenditure variance of RM 2,000 is adverse or unfavorable because the
actual expenditure exceeds the expenditure. The actual overhead expenditure is more than the
standard overhead expenditure. Thus, actual cost of RM 32,000 versus a standard cost of RM
30,000 equal a fixed overhead expenditure variance of RM 2,000.

The fixed overhead capacity volume variance of RM 30,000 is favorable because the actual units
produces is more than the budgeted quantity planned. The variance is favorable since the actual
volume produced of RM 60,000 is higher than the budgeted volume of RM 30,000.
The fixed overhead efficiency variance of RM 6,000 is adverse or unfavorable because the actual
manufacturing hours utilized in the production of 9,000 units is more than the standard. The
variance is adverse since the actual manufacturing hours of RM 60,000 is more than the standard
manufacturing hours of RM 54,000.

The fixed overhead cost variance of RM 22,000 is favorable, consisting of an adverse fixed
overhead expenditure variance of RM 2,000 and a favorable fixed overhead volume variance of
RM 24,000.
(b) Reasons caused all the variances occurred

Direct Material Cost Variance

Variance Reasons
Controllable:
 Purchase of lower quality materials (this will be
Favorable Material Price reflected in adverse material usage variance)
 More care taken in purchasing.
RM10,000 (F)  Implementation of better procurement practices
(e.g. invitation of price quotations from
multiple suppliers)
 Purchase discounts on larger orders

Uncontrollable :
 A fall in market prices.
 Suppliers reduce the price.
 Reduce in transportation cost.

Controllable :
 Poor management of material.
 Purchase lower quality materials (this will be
reflected in a favorable material price variance).
Adverse Material Usage  Less effective use made of material (excessive
RM5,000 waste)
Uncontrollable :
 Increase in material wastage due to depreciation
of plant and equipment.
 Defects in machinery during the process of
production.
Direct Labor Cost Variance
Variance Reasons
Controllable:
 Employment of skilled people.
Adverse Labor Wage Rate  Inefficient hiring by the HR department
RM 2,400 (A) Uncontrollable:
 Inflation (increase in price) would raise the actual
rate of labor than standard rate.
 High demand of labor would push the labor rate
upward
Controllable:

Adverse Labor Efficiency  Unskilled people and poor training.

 Lower quality materials so harder to use
RM 3,600 (A)
efficiently.
 Use of poor quality of raw materials requiring
more time to complete work.

Uncontrollable:
 Decrease in staff morale and motivation
 Increase in labor turnover.
Fixed Overhead Cost Variance

Variance Reasons
Adverse Fixed Overhead Expenditure Controllable:
 Expansion of business undertaken during the
RM 2, 000 (A) period
 Excessive use of services

Uncontrollable:
 Increase in cost of services used (eg: rental,
insurance premium)

Favorable Fixed Overhead Capacity Controllable:

Volume
 Fully utilized the plant capacity.
 Labor working overtime.
RM 30,000 (F)
 Increase in total capacity in number of men
employed, number of shifts or machines used

Uncontrollable:
 Increase in sales demand

Adverse Fixed Overhead Efficiency Controllable:

 Labor force working less efficiently (due to

RM 6,000 (A)
unskilled labor)
 Use of low quality material and defective
tools

Uncontrollable:

 Lost production through strike.

(c) Controllable and uncontrollable Cost

Variances are broadly of two types, controllable and uncontrollable. Controllable variances are
those which can be controlled by the departmental heads whereas uncontrollable variances are
those which are beyond control. Following are the examples of controllable and uncontrollable
cost for each variance:

Direct Material Cost Variance

i. Material price variance

 An adverse price variance might due to the actual prices exceed standard prices
because of a change in market conditions that causes a general price increase for the
type of material used. Thus, the price variance might therefore be beyond the control
of the purchasing departments.
 A favorable price variance might be due to the purchase of lower qualities materials,
which may lead to inferior product quality or more wastage. It is controllable cost
since the manager decided whether to purchase lower or higher quality materials.
ii. Material usage variance
 The material usage variance is normally controllable by the manager of the
appropriate production responsibilities department. Common causes of material usage
variances which are controllable include the changes in quality controls requirements,
pilferage, or the purchases of inferior quality materials.
Direct Labor Cost Variance

i. Labor rate variance

 The wage rate variance is probably the one that is least subject to control by
management. In most cases the variance is due to wage rate standard not being kept in
line with changes in actual wage rates, and for this reason it is not normally
controllable by managers.
 An adverse labor rate variance might be due to the employment of higher quality
people. It is controllable cost since the manager decided whether to hire lower or
higher quality employees.

ii. Labor efficiency variance

 The labor efficiency variance is normally controllable by the manager. For example,
the use of inferior quality materials, different grades of labor, failure to maintain
machinery in proper conditions or the introduction of new equipment or tools will all
affect the efficiency of labor.
 An efficiency variance may not always be controllable by the production foreman.
For example, it may due to poor production scheduling by the planning department,
or to a change in quality control standards.
Fixed Overhead Cost Variance

i. Fixed overhead expenditure variance

 For example, the difference of the actual expenditure and the budget expenditure may
be due to changes in salaries paid to supervisors, or the appointment of additional
supervisors. Generally, this variance is likely to be uncontrollable in short-term.

ii. Fixed overhead capacity volume variance

 Who is responsible for the overhead volume variance? No one in particular has
caused this variance. The estimated units in the budget differ from the actual units.
This variance is never investigated because the company knows why it exists.

iii. Fixed overhead efficiency variance

 Who is responsible for the overhead efficiency variance? The production supervisor
is responsible for making sure that all the resources such as labor and machine
capacity is fully utilized without wastage.
(d) Direct labor rate and efficiency variances could be interrelated.

It could be that the government increased the minimum wage rate, which result an adverse in
Medina Pottery labor rate variance. Unfavorable efficiency variances occur when Medina Pottery
direct labors are unskilled or semi-skilled, which takes more time to produce the good output
than the standard allows. Even though the government does not increase the minimum wage rate,
unskilled or semi-skilled labor taking more hours in the production than necessary, and this will
result in the high labor rates paid and idle hours.

It also could be that Medina Pottery employed more skilled or experienced work force who
demanded a higher rate of pay, resulting in an adverse labor rate variance. Unfavorable
efficiency variances can occur when new inexperienced workers begin work, or when workers
are not well motivated or poorly trained. Low quality material, inadequate equipment and
equipment maintenance can also cause an excessive amount of labor time. In addition, direct
labor efficiency variances are also influenced when the labor mix is different and individual rates,
rather than average rates, are used in the variance calculations.
Question 2

i. Standard Cost
A standard cost has been described as a predetermined cost, an estimated future cost,
an expected cost, a budgeted unit cost, a forecast cost, or a "should be" cost. Standard
costs are often a part of a manufacturer's annual profit plan and operating budgets.
Standard costs will be established for the following year's direct materials, direct labor,
and manufacturing overhead. Thus, standard cost is an extension of standard set for
machine time, labor time and material usage by the application of standard machine cost
per hour, standard wage rates and standard prices of material. Standard cost includes
standard overheads.

CIMA Official Terminology, 2005 defines standard costing as a control system that
enables any variances from standard cost or budget to be analyzed in some detail. They
suggested four elements of standard costing system. These are

i) Setting standard for each operation,

ii) Comparing actual with standard performance,

iii) Analyzing and reporting variances arising from the difference between actual and
standard performance, and

iv) Investigating significant variances and taking appropriate competitive action.

ii. Distinguish between standard costs and actual costs.
Standard Costs Actual costs
Standard cost is an estimated cost of a Actual cost refers to the cost incurred or
product considering the material, labor and paid.
overhead costs that should be incurred
Standard cost is recorded at the beginning Actual cost is recorded during the year
of the accounting period while budget while the company is conducting business.
preparation.
Using standard cost in financial statements Actual costs should be included in
is not allowed by accounting standards. financial statements.
Standard costs require periodic planning Actual costing does not require an annual
effort to establish a new standard cost each costing event and changes in costs are
year. Additionally the variances produced captured on an ongoing basis.
by standards must be monitored to evaluate
the accuracy of the standards.

It is important to clearly understand the difference between actual cost and standard cost
in order to understand many aspects of management accounting. The main difference
between actual cost and standard cost is that actual cost refers to the cost incurred or paid
whereas standard cost is an estimated cost of a product. Once a budget is prepared, there
should be a control mechanism to evaluate how successfully the budget was achieved.
Actual and standard cost enables such comparison.
iii. Benefits of comparing standard costs and actual costs in a standard costing systems.

 Variance Analysis
Standard cost also enables variance analysis. When exceptions occur, such as per-unit
cost dropping significantly below standard cost, management can assess the actual
costs for the cheaper units against the standard cost to determine the reason for the
change. The variance itself should not create immediate alarm on the part of either
management or workers, as it may stem from price changes for material inputs and
not any significant change in performance or process.

 Efficiency
Standard costing systems often prove less resource-intensive than comparable actual
costing systems. Actual costing systems require extensive calculations and ever
increasing data volume, which can slow performance of computer systems in ways
standard costing systems do not. While system lag poses few problems in production
done primarily with physical labor, the slower system could prove detrimental in
manufacturing that relies on computer control.

 Cost Benefits
Actual cost systems can provide more specific information or provide information in
close to real time, which some businesses may prefer, but standard cost systems often
produce information that meets all the needs of management at a lower price.