Costing Methods and Variance Analysis

This assignment delves into the world of costing methods, examining various techniques such as absorption and standard costing. It further explores variance analysis, a crucial tool for identifying discrepancies between planned and actual costs, enabling informed decision-making for cost optimization.

MANAGEMENT
ACCOUNTING

Table of Contents
INTRODUCTION......................................................................................................................3
TASK 1......................................................................................................................................3
AC 1.1 Classifying different types of costs......................................................................3
AC 1.2 Different costing methods....................................................................................4
AC 1.3 Calculation of costs using appropriate techniques...............................................5
AC 1.4 Analysis of costs data using appropriate techniques............................................6
AC 2.1 Prepare and analyse routine cost reports..............................................................7
AC 2.2 Use performance indicators to identify potential improvement...........................8
AC 2.3 Suggest improvements to reduce costs, enhance value and quality.....................8
TASK 2......................................................................................................................................9
AC 3.1 Explain the purpose and nature of budgeting process..........................................9
AC 3.2 Select appropriate budgeting methods for the organization...............................10
AC 3.3 Preparation of budgets........................................................................................11
AC 3.4 Prepare a cash budget.........................................................................................12
AC 4.1 Calculate variances, its causes and corrective actions.......................................12
AC 4.2 Prepare a reconcile operating statement.............................................................13
AC 4.3 Report findings to the management with identified responsibility centres........14
CONCLUSION........................................................................................................................14
REFERENCES.........................................................................................................................14
Index of Tables
Table 1: C alculation of job cost for job no. 330........................................................................4
Table 2: Calculation of product cost .........................................................................................5
Table 3: Calculation of product cost .........................................................................................6
Table 4: Cost reports..................................................................................................................7
Table 5: production budget for XYZ Ltd.................................................................................11
Table 6: Material purchase budget for XYZ ltd.......................................................................11
Table 7: Cash budget for XYZ Ltd..........................................................................................12

INTRODUCTION
Management accounting is a broad term which is concerned with identifying,
presenting and interpreting financial performance of the business. The primary aim of
management accounting is to formulate policy, strategy, planning, controlling the activties
and taking efficient quality of decisions. In the present report, various tools of management
accounting such as budgeting, costing method and variance analysis will be discuss.
Moreover, the report will explain various types of costs that the organization incurred in the
production. Along with this, the report will explain that how organization can reduce its cost,
improve quality and value as well. This in turn, company can manage its operations effective
and without any operational hazards.
TASK 1
AC 1.1 Classifying different types of costs
Cost can be classified into various ways depending on its nature and specific purpose.
These classification of costs makes the cost information meaningful for business organization
( Łukaszewski and Wilk, 2016.). The following are the important ones in which cost can be
classified-
On the basis of nature: By the nature of expenses, cost can be classified into material,
labour and overhead. Raw materials become an integral part of the product that can be
conveniently traced by XYZ Limited. Labour cost are those cost that can be easily traced to
individual units of product.
On the basis of element: This classification is based on the relation of cost element
with the cost object. The classification is done into direct cost and indirect cost. XYZ Ltd.
incur the expenses on material and labour which can be economically traceable for a product,
job and service is known as direct cost. On the other side, expenses incurred on those items
which are not directly chargeable to production is known as indirect cost (Rumble, 2012).
On the basis of behaviour: As the level of business activities changes, some cost
change with change in output while others do not change. On the basis of behaviour, cost can
be done into fixed cost, variable cost and semi-variable cost. Fixed cost are those cost for
XYZ Ltd. which remain fixed irrespective of change in volume of output. Variable cost are
those cost which can be change with the change in output and semi-variable cost are those
which have the characteristics of both fixed cost and variable cost.

On the basis of controllability: From the point of view of controllability, cost can be
classified into two categories as controllable cost and uncontrollable cost. Controllable cost
are those cost which are controlled by specific members of an organization. Material, labour
cost are the examples of controllable cost (Drury, 2013). On the other hand, uncontrollable
cost are those which are not regulated by specific member of undertaking. Factory rent and
salary are example of uncontrollable cost.
AC 1.2 Different costing methods
There are various types of costing methods such as job costing, unit costing, process
costing, contract costing and batch costing.
Job costing: In this method, all the direct as well as indirect costs that are associated
to a seperate job of XYZ ltd, will be determined to compute total job costs (Costing methods,
2015.). For instance, job costing method is applying here to calculate cost for job no. 330 of
10000 units, as under:
Table 1: C alculation of job cost for job no. 330
Particulars Per unit Total costs for 10000 units
Direct material 5 50000
Direct labour 2 20000
Direct overheads 1 10000
Fixed overheads 37500
Total costs 117500
Fixed overheads for 20000 direct labur hours = £50000
Direct labour hours per unit for job no. 330 = 1.5
Fixed overhead for 10000 units = £50000/20000 hours*(1.5 hours*10000 units) = £37500
Thus, it has been clear that total job costs for 10000 units will be £117500.
Unit costing: Another costing method is unit costing that is helpful to determine cost
per unit, also called single output costing. It is mainly used to assess cost for the production

that can be expressed in quantiative terms. For instance, per unit cost for the above job no.
330, has been computed here as under:
Unit cost = Total production costs/number of units produced
= £117500/10000 units = £11.75
AC 1.3 Calculation of costs using appropriate techniques
Absorption costing: It is an appropriate costing method that incorporate all the fixed
as well as variable costs associated with the product (DRURY, 2013).
Table 2: Calculation of product cost
Basis of
allocation Ratio Production department
Service
departments Total
Machine 1 Machine 2 Stores
Maintena
ce
Inirect
material 200000 225000
42500
0
Indirect
wages 150000 160000
31000
0
Light and
heating
Occuied
area by the
departments (2:1:1:1) 37500 18750 18750 18750 75000
Machiney
insurance
Book value
of machine
(1:1:0.5:
0.5) 5000 5000 2500 2500 15000
Workers
salary
Number of
workers
(30:20:1
5:10) 30000 20000 15000 10000 75000
Total costs 422500 428750 36250 31250
90000
0
Re appropriation of service departments costs to the production departments

Costs as per
above table 422500 428750 36250 31250
Stores
Direct
material
(200000:
225000) 17059 19191 -36250
Maintenance
Direct
machine
hours basis
(150000:
200000) 13393 17857 -31250
Total costs 4.53 452952 465798 Nil Nil
Overhead absorption rates: If XYZ's uses machine hour rate than overhead absorption rates
will be calculated as under:
OAR = Total cost/Machine hour
Machine 1 = £452952/150000 = £3.02
Machine 2 = £465798/200000 = £2.33
Table 3: Calculation of product cost
Particulars Calculation Cost per unit
Direct material £8
Direct labour £7
Overheads
Machinery 1 £3.02*1.5 4.53
Machinery 2 £2.33*2 4.66
Total costs 2.33 24.19
AC 1.4 Analysis of costs data using appropriate techniques
If XYZ uses labour hour for absorption of overheads, than OAR can be calculated
here as under:

OAR = Total costs/labour hours
Machine 1 = £452952/300000 = 1.51
Machine 2 =£465798/200000 = 2.33
Particulars Calculation Cost per unit
Direct material £8
Direct labour £7
Overheads
Machinery 1 £1.51*3 4.53
Machinery 2 £2.33*1 2.33
Total costs 21.86
Interpretation: If XYZ uses material basis as allocation than per unit cost is £24.19
whereas in labour hours basis, it has been reduced to £21.86. Thus, it can be reported that
XYZ Ltd, has to use labour basis as it will be more appropriate because of low cost. This in
turn, helps to minimize costs and attain maximum profits (Bellahand and et. Al, 2013).
AC 2.1 Prepare and analyse routine cost reports
Cost reports: It can be prepare through combining actual as well as budgted targets.
In context to XYZ Ltd, it has been prepared here as under:
Actual production = 2200 units
Actual material price = £10 per unit
Actual labour rate = £8 per unit
Overhead rate = £5 per unit
Fixed overhead = £10000
Table 4: Cost reports
Particulars Budgeted ( 2500 Actual (2200 units) Variance

units)
Direct material 20000 22000 -2000
Direct labour 22500 17600 4900
Direct overhead 12500 11000 1500
Fixed overheads 10000 10000 0
Total costs 65000 60600 4400
Working note:
Actual material cost= 2200*10 = £22000
Actual labour cost = 2200*8 = £17600
Actual overhead cost = 2200*5 = £11000
Interpretation:There is an adverse variance in material cost because the standard price of
material is (£8) which is less than the actual price of material which is (£10). Apart from
this, the actual price of labour(£10) which is more than the standard price of labour(£8)
which result in favourable variance in labour cost. In overhead, actual and standard prices are
same but the units are changes which result in incur variances.
AC 2.2 Use performance indicators to identify potential improvement
XYZ Ltd, has to measure its performance on a regular basis (Steven, 2014. ). There
are various types of performance indicators that are helpful to identify areas for potential
improvements. Some of the key performance indicators (KPIs) are described below:
Sales revenues: Rising trend of XYZ;s sales revenue indicates better performance.
However, if sales revenues are continuously declining than XYZ needs to determine its
reasons and take decisions to improve it (Cost and management accounting, 2013.). Lower
customer demand, high prices, ineffective marketing, availability of substitute products and
poor quality may be the reason behind this.
Costs: Cost is also an important element that XYZ needs to be analyse. A balance
increase in costs with rising sales is quite good but if costs are increasing at high rate without
sales increases than XYZ needs to be focus on it (Blank, 2012. ). High material price, wages

rate, administrative and selling cost may be some of the reasons of it. Henceforth, XYZ Ltd,
has to execute effective control on this factors and maintain their cost.
Profitability: Rising trend is good but declining trend indicates poor performance.
Through getting high sales revenue and controlling costs, XYZ can improve its profitability
and operational performance as well (Shelby, 2013).
Product quality: Qualitative products helps to satisfy XYZ's customer to a great
extent. Therefore, any negative factor may influence customer adversely and lower the
performance.
Waiting time: It is a time length or time gap between demand and receipts of products
by the customer. Lower waiting time will be consider good for XYZ Ltd, and vice versa.
AC 2.3 Suggest improvements to reduce costs, enhance value and quality
Reduce costs: As said earlier, reduction in cost is a good sign of XYZ's performance.
It can be done by the following ways: Lower material buying price: It can be done through finding suppliers whose material
sales prices is comparatively lower than other suppliers (Pilleboueet and et. al.,
2015.). But still, it must be kept in mind that quality should not be deteriorated. Bargaining with labour: By appointing labour at lower wages rate helps to reduce
direct wages payment and reduce costs as well. Large production: It will provide benefits of economies of scale. It helps to reduce
per unit cost of the product in turn, per unit profit can be maximized.
 Monitoring and controlling: continuous monitoring of all the operational functions
helps to control XYZ's costs in a great manner. Curtailment of unnecessary expenditures will helps to reduce XYZ's cost. Sale of waste material: Waste material are the unusable products which company can
sale in the market to get some income and decline cost.
Enhance value and quality: XYZ Ltd, value and quality can be improved by
following ways:
 Quality can be improved through using better quality of material, using advanced and
better technological machinery for production purpose (Bonazziand and Iott, 2014.).

Standard product quality helps to satisfy large number of consumers and increase
repeated purchasing.
 Innovations, expansion, diversifying customer base, high profits, wide range of
products, high market share and market growth helps to enhance XYZ's value.
Furthermore, strategic capabilities, competitive strength, world wide operations, loyal
customers and high shareholder's return will increase corporate image and values as
well.
TASK 2
AC 3.1 Explain the purpose and nature of budgeting process
Budget: It is a financial planning tool that are helpful to manage XYZ's future
operations. XYZ's management can prepare various kinds of budgets such as production,
material purchase and cash budget
Process of budget
 Formulation Stage – At this step the income and expenses related to the company are
estimated after taking into consideration all the factors.
 Budget implementation – At the second phase, the numbers are inserted within the
budgets with appropriate estimation (Gesimba, Alvarand and Mante, 2014.).
 Control – It is the third stage where desired outcomes are compared with the real
outcomes for the purpose of monitoring.
 Calculation of variances – At this phase the variances are assessed and computed. The
reason for the unfavourable variances are estimated.
 Modification – At the last stage, corrective measures are taken to make sure that all
negative variances can be avoided.
Purpose and nature of budgeting
The budgets are considered as the financial instrument for estimation of different
types of costs within the company. It is capable of transforming the goals and objectives into
decisions (Ionescu, 2014.). The main purpose is to make appropriate utilization of all the
financial resources. The activity also tries to coordinate between the resources, production
and expenditures. It helps the company to move out from the debts and achieve balances with
the income. Hence it can be said that budgeting is the most significant activity within the

business. Company must adequate financial resources to achieve the proposed goals and
objectives of the business.
AC 3.2 Select appropriate budgeting methods for the organization
Appropriate budgeting technique for XYZ Limited is zero base budgeting. Zero base
budgeting is a method of budgeting in which all expenses must be justified for each new
period. Zero base budgeting starts from baseline and every function of organization is
analyzed for its need and cost. It tries to achieve an optimum allocation of resources to
different parts of business units where they rare most needed. Zero base budgeting allows the
top level management strategic goals to be implemented into budgeting process by providing
them to specific functional areas of business. On contrary to traditional method of budgeting
in which past sales and expenditures are recorded are expected to continue, zero base
budgeting assumes that there are no balance to be carried forward that are pre-specified. The
main advantages of this budgeting method is that it makes every department to revise each
and every item of the cash flow and compute their operational cost (Kavanagh, 2011). Zero
base budgeting leads to the identification of opportunities and increase the cost effective
ways by removing all the unproductive and extra activities which result in efficient allocation
of resources. It also improves the coordination and communication in the department and
motivate employees by involving them in decision making.
AC 3.3 Preparation of budgets
Production budget: It will assist XYZ Ltd, to determine required number of units that
it will need to produce for the future period (Shelby, 2013.). The benefits of this budget is
XYZ Ltd, can produce sufficient quantity of goods that will be need to meet future customer
demand.
Table 5: production budget for XYZ Ltd
Estimated sales 500000 650000 825000
Less: Opening inventory 75000 97500 123750
425000 552500 701250
Add: Closing inventory (15% of the
following month) 97500 123750 135000
Production 522500 676250 836250

Interpretation: XYZ ltd, has to produce 522500, 676250 and 836250 units of products
in the month of July, August and September. As per this budget, it can be seen that XYZ
desires to maintain 15% of upcoming month's sales as closing inventory. Further, it has been
assumed that in the month of October, XYZ's estimated sales will be 900000. Henceforth,
closing stock in September will be 135000.
Material purchase budget: This budget will answer that how much quantity of
material will be need to purchase from the suppliers to produce required quantity of goods
(Parmenter, 2015.).
Table 6: Material purchase budget for XYZ ltd
Material Require (2 per kg) 1045000 1352500 1672500
Less- Opening inventory 300000 270500 334500
745000 1082000 1338000
Add- Closing inventory (20% of the
following month) 270500 334500 360000
Purchase 1015500 1416500 1698000
Working note:
Required material in the month of October = 900000*2 = 1800000
Closing inventory in September = 1800000*20% = 360000
Interpretation: As per this budget, it can be seen that XYZ desires to maintain 20% of
upcoming month's material required as closing inventory. XYZ Ltd, need to purchase
1015500, 1416500 and 1698000 kg of material to assure estimated production.
AC 3.4 Prepare a cash budget
Table 7: Cash budget for XYZ Ltd
Particular July August September

Cash incomes
Cash sales 500000 650000 825000
Total cash revenues 500000 650000 825000
Cash Expenditures
Material Purchase 250000 300000 345000
Direct wages 75000 77000 80000
Variable overhead 15000 18000 25000
Fixed Overhead 55000 55000 55000
Total cash expenditures 395000 450000 505000
Net cash balance 105000 200000 320000
Opening cash balance 5000 110000 310000
Closing cash balance 110000 310000 630000
AC 4.1 Calculate variances, its causes and corrective actions
Sales Variance Material Variance
Sales volume variance (4,160 – 3,040) =
(1,120) (A)
Sales price variance (14,000- 13, 820) = (180)
(A)
AQ (1425kg) X AR (£2.40) = £3420
The material price variance 0 (A)
AQ (1425kg) X SR (£2.40) = £3420
The material usage variance 60(A)
SQ (3500units x 0.4) X SR (£2.40) =
£3360
The Labour Variance

AH (345hrs) * AR (£7.8) = £2690
The labour rate variance 70 (F)
AH (345hrs) * SR (£8.0) = £2760
The labour efficiency variance 40 (F)
SH (3500units x 0.1)350hrs * SR (£2.40) = £2800
Fixed Overhead
Actual fixed overheads = £ 4900
The fixed overhead expenditure variance 100(A)
Budgeted fixed production overheads = £4800
Outcomes of variance can be positive or negative. The causes of the variance are as follows:
Sales variance:
 Lack of stock
 Inappropriate selling
 Ineffectual marketing of services
Material variance
 Lack of efficiency among the employees
 Not good use of materials
 Inappropriate budgeting standards (Oshima Lee and Emanuel, 2013.)
 Poor performance from the employees
AC 4.2 Prepare a reconcile operating statement
Following is the operating statement for XYZ Ltd.
Variance
Calculation £
Particulars Budgeted Actual Variance
Sales revenue (A) 16000 13820 -2180
Material Cost (a) 3840 3420 -420

Labor hours (b) 3200 2690 -510
Fixed overheads (c) 4800 4900 100
Total Cost (a + b + c) 11840 11010 -830
Actual profit (A-Total cost) 4160 2810 -1350
From the above statement it can be interpreted that company is incurring a variance of
-1350. It is a sign of bad financial position. The sales have been low due to lack of
appropriate selling strategies (Bodenheimer, 2013).
AC 4.3 Report findings to the management with identified responsibility centres
Among the major findings it was observed that adverse variance have been occurred
in the month of May. It is mainly due to wrong estimation of the expenses and income. An
appropriate budgeting technique has not been applied. Estimation of raw materials and labour
hours was not done in appropriate manner (Standard costing and variance analysis,).
Company should work on adopting an appropriate pricing technique. For the purpose of
forecasting, time series analysis can be done. It will aid in identifying the marketing trends in
appropriate manner. The technique is effective because it includes the time value of money.
Another reason for variance is inefficient workforce hence there is a need to employ people
who can contribute greatly towards the business and its objectives.
CONCLUSION
In conclusion of the above report, it can be derived that management accounting plays
an significant role as it helps to reduce costs, enhance value and quality. The report
concluded that budgetary planning is an effective managerial tool that assist XYZ ltd, to
achieve its financial targets through identifying variances and recommend corrective actions
to mitigate it. Moreover, the report concluded that absorption costing is an appropriate
costing method that helps to determine correct cost of XYZ's product. Further, the report
inferred that profits, revenues, costs, quality, technologies and customer's waiting time are
some of the performance indicators that will assist XYZ Ltd, to improve potential
performance. This in turn, XYZ can ensure long run survival and achieve high growth.
REFERENCES
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