Basic Variance chapter 13 example 1.

It depends whether we are using absorption costing or marginal costing. In this example it is absorption costing (I explain the difference when it is marginal costing later). With absorption costing we are explaining why the actual profit is different from the standard profit for the actual level of activity, and the standard profit is $7 per unit. However using $7 per unit is treating the fixed overheads as though they are variable and are $15 per unit. Obviously they are not variable which is why later I analyse the total variance into the expense variance and the volume variance. (With marginal costing there is only the expense variance). With regard to the inventory valuation, obviously in financial accounts the inventory is valued at the actual cost. However in management accounting where variances are usually calculated monthly, we value the inventory at standard cost. The reason is that some months we. may overspend and some months we may underspend - it would be ridiculous to keep changing the value of the inventory when overall we are still trying to achieve the standard cost. (In practice there may be times when we change the standard cost during the year, but not in the Paper PM exam) Finally appreciate that example 1 is just very basic introduction to simple variance analysis. In the rest of the chapter lectures I analyse each of the variances in more detail. All of this chapter is just revision of what is examined in Paper MA (was Paper F3) and although understanding is needed for the following chapter on advanced variances, it is the advanced variances that are much more important for Paper PM.

Dear John, First of all thank you for nice explanation, in regard to inventory valuation I get your point but in regard to the fixed cost I don't get you actually sir I will make my question very clear to you I am asking about why fixed cost in the example has different values under static budget is different from flexible budget different from actual result i mean fixed cost is fixed by nature during the relevant range so, that's why I am asking why does fixed cost have different values under different budgets I thought it will has the same value as budgeted. Please if my question stills not clear ask me for further explanation. Thank you.

Dear John, In regard to the valuation of ending inventory under the actual result budget you used the standard cost per unit and you explained but I don't get you in full so please could you make your answer more clear may be through example. Sorry for asking about further explanation. Thank you in advance

The fixed cost does not have different values in different budgets. As far as budgets are concerned, the fixed cost stays fixed and does not change with the level of activity. The purpose of this first example is to explain why, if absorption costing is being used, then using a standard profit automatically treats the fixed overheads as though they are variable. Obviously they are not variable, which is why when we analyse the variance we analyse it into the price variance (which is logical) and the volume variance (which is effectively the over or under absorption which you should remember from Paper MA (was F2) or whatever exempted you). I explain the analysis in the later lectures. However, again, this is not something to worry too much about because it is very rarely relevant in Paper PM (because it was all examined in Paper MA). Variance analysis in Paper PM is almost always either (or both) planning and operational variances and mix and yield variances. I only revise basic variances because a basic understanding of the idea is needed to make sense of the advanced variances.

Thank you Sir, Thank you so much. ?

You are welcome :-)