#### Basic Variance Analysis: Please note that this lecture relates to Chapter 13 of the Course Notes and not Chapter 12 as stated in the lecture.

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Tobi says

Hi again John.

A quick one please. Hope its not silly…

Variable costs are usually calculated per unit. However I note that in this example, it is given in terms of hours. (which we can convert to per unit) i.e. from the budget, the Variable cost per unit is $10 unit. i.e. 1 unit=5hrs @$2/hr.

In calculating the Variable Expenditure Variance, would it be wrong (and why) to calculate it in terms of units?

i.e. Actual expenditure = 87,348 (for 8900 units)

less Standard exp. for 8900 units = 89,000 (@ $10/unit)

Thanks.

John Moffat says

For the total variance that is fine. However as you will see in the continuing lectures, it is not the total that matter for the exam but the analysis of it into expenditure and efficiency variances – for them you need the hours.

Tobi says

Hi John.

Many thanks for these lectures – your ability to explain is profound! The lectures are also straight to the point and, in my view, effective.

I have a little bother though, Its on the Fixed Costs for the flexed budget. I still don’t get why we did not leave it constant. And although you say that management would expect a particular profit margin at any activity level, I don’t think that is reason enough to adjust the fixed cost, as we can also explain to management, why the profit margin is not the same. Moreso, in the previous example (under Budget), we did not flex the fixed cost in our calculations.

You also mentioned (in an earlier response) that performing our variance analysis in an absorption costing environment, we treat the fixed overheads on a unit basis. Would this mean that it would be Ok to treat as a ‘constant’ if we were not performing a variance analysis?

Lastly, in shedding more light on this, can you also confirm that if we choose not to flex the fixed cost, the variance arrived at (i.e. 3574(A)) would be incorrect?

I hope my question is clear.

Thank you.

John Moffat says

Thank you for your comments.

A few things

Firstly, although I will answer your question, it is extremely unlikely these days that fixed overhead variances will be examined in Paper F5 (especially with absorption costing). In theory they could be, but it is extremely unlikely and so I would not worry too much. (They are examined in Paper F2)

Secondly, when we are simply flexing a budget normally we always assume that fixed overheads stay fixed. I only do it in this example to that later I can explain why we have ‘strange’ fixed overhead variances if we are using absorption costing.

Thirdly, you are right when you say that we can explain to management about the problem, – you will see later when I analyse the variance into expediture and volume variances, then the volume variance is the way we explain it.

Finally, if it is marginal costing (which is far more likely always in variance questions in the exam) then as again you will see in one of the following lectures, the variance is not 3574(A), but is simply the difference between the actual total and the budget total.

I hope that all makes sense

Tobi says

Thank you John.

I think I am almost there..

Are you therefore saying that if we were not doing Variance Analysis, it would be ok to not flex the fixed cost? Does this mean that there is some sort of ‘aberration’?

John Moffat says

If we are simply flexing a budget in the exam, then we do not flex the fixed cost.

I only do it here to hopefully make sense of the variances that follow if we are using absorption costing.

I don’t think aberration is quite the right word, but I know what you mean

Tobi says

Thank you John.

I am ‘there’ now.

John Moffat says

You are welcome

Lilit says

Hi, first of all I want to thank you for the lectures, they really help. There is one thing I cannot understand. How comes that Volume variance equals capacity+efficiency variance. Why we use budget hours in cap var and act hours in effic. Could you be so kind to derive the formula for me.

John Moffat says

It is not a question of deriving formulae, but of understanding.

The volume variance exists (when we are using absorption costing) because the actual production is more or less than the budgeted production. We assume that production is limited by the amount of labour available, and so the reason for being able to produce more or less is either because we have more or less labour available than we budgeted (the capacity variance) or because we work faster or slower (the efficiency variance).

I do explain this in the lecture, and illustrate why it is happening.

Lilit says

Thank you.

zahreddine says

From my earlier studies and F5 costing chapters, I clearly understood that within an absorption costing approach, fixed cost stay constant as a whole and vary per unit according to the level of output. could anybody please tell me why in this example they stay constant per unit and vary as a whole?, which makes them exactly like variable overheads

John Moffat says

Of course fixed overheads stay fixed in total!!!

I do not say any different in this lecture.

However, I am trying to explain in the lecture that when we are using absorption costing for variance analysis it is effectively treating the fixed overheads on a unit basis i.e. as though they are variable.

Obviously they are not variable and that is why we have a fixed overhead volume variance to ‘correct’ for this.

(It is actually exactly the same problem as you will have been through in Paper F2 on absorption costing (and in variance analysis – ‘basic’ variance analysis here is revision of F2. Because of what I have written above we had in F2 to be able to adjust for the over/under absorption of fixed overheads.)

sarath says

Rent is a fixed expense. Assume that the company is working on a rented building, and the company has to pay the entire rent for the month even if it doesn’t work for the entire month!

Hope that helps…..

alisy says

Can someone please help me with this question below. And if the answer can be supported by an explanation, it would be a great help.

A company has a fixed overhead volume variance that is $10,000 unfavorable. The most likely cause for this variance is that

a. the production supervisory salaries were greater than planned.

b. the production supervisory salaries were less than planned.

c. more was produced than planned.

d. less was produced than planned.

Cheers,

Ali

John Moffat says

The answer is d

The reason is that when using absorption costing, when the standard profit is calculated is is effectively assuming that fixed overheads are charged on a unit basis and the amount charged for fixed overheads will be the actual production at fixed cost per unit, which will be less than the budget production at fixed cost per unit.

It is difficult to explain here without numbers, but the lecture does explain.

However…..the easy way to remember whether the volume variance is favourable or adverse is to say: if production is more than budget then we have done well – it is good – and the variance is favourable. Vice versa if production is less than budget. That way of thinking always works

(answers a and b have clearly nothing to do with the volume variance – they will create a fixed overhead expenditure variance)

sarath says

a good answer! it further means, the each unit we produced in excess than planned, will make the situation more favorable, isn’t it?

John Moffat says

Yes – that is true.