FINANCIAL MANAGEMENT CASE STUDIES

Introduction

This series of financial management case studies will be based around the business of
Coverdrive Ltd, a manufacturer of high quality, hand made cricket bats.

Coverdrive Ltd is based in Whitby North Yorks and is an owner-managed company. It

had been originally formed in the early 1980’s as a partnership with the aid of some
European funding.

It currently has a budgeted turnover of £2.75m with anticipated profit for the year of
£0.40m.

This first case study focuses on the concept of standard costing, variance analysis and
the reconciliation of budget to actual profit through an analysis of the main cost
variances.

The scenario assumes that you work as an assistant in the SME business services unit
of Dunn and Musgrave a firm of accountants and consultants. You have recently
introduced, at Coverdrive Ltd a system of standard costing and budgetary control.

The objective of the system is to generate a monthly report to show the following:

Budget Operating Statement

Actual Operating Statement
Control Ratios

An analysis of variances to show:

Direct Labour Variances:

 Rate
 Efficiency

Direct Material Variances:

 Price
 Usage

Variable Overhead Variances:

 Expenditure
 Efficiency

FINANCIAL MANAGEMENT CASE STUDIES

Fixed Overhead Variances:

 Expenditure
 Volume:
Capacity
Efficiency

Sales Variances:

 Sales Price Variance

 Sales Margin Quantity Variance

Reconciliation budget to actual profit

Break-Even Point:

 Budget
 Actual

Standard Costing – a definition

“A control technique which compares standard costs and revenues with actual results to
obtain variances which are used to stimulate improve performance.” (CIMA)

The Objectives of Standard Costing and Variance Accounting

Terry Lucy in his excellent text “Management Accounting” outlined these as:

 “To provide a formal basis for assessing performance and efficiency.

 To control costs by establishing standards and analysing variances.

 To enable the principle of ‘management by exception’ to be practised at the

detailed, operational level.

 To assist in setting budgets.

 The standard costs are readily available substitutes for actual average unit costs
and can be used for stock and work-in-progress valuations, profit planning and
decision making, and as a basis for pricing where ‘cost-plus’ systems are used.

 To assist in assigning responsibility for non-standard performance in order to

correct deficiencies or to capitalise on benefits.

 To motivate staff and management.

FINANCIAL MANAGEMENT CASE STUDIES

  To provide a basis for estimating.

 To provide guidance on possible ways of improving performance”.

In addition to the objectives stated by Lucy it can be said that, it can be the basis for
‘good practice’ in establishing not only cost control but cost reduction programmes.

In ‘activity based’ environments it can, by forcing a review of good practice, help in

identifying activities and cost drivers.

An activity is defined as “a value adding process which consumes resources”.

A cost driver is “an activity or factor which generates cost”.

Variance Accounting

This is defined as “A method by which planned activities (quantified in budgets, standard

costs, standard sales and standard profits) are compared with actual results. Provides a
basis for variance analysis”.

Variance analysis being “The analysis of performance by means of variances; used to

promote management action at the earliest possible stages”. (CIMA)

Control through Variance Accounting

The primary objective of standard costing technique is to monitor current performance

against predetermined standards by the use of variance analysis.

Flexible budgetary control uses the same principles but standard costing informs a more
detailed analysis of variances.

Variance analysis directs management attention to the reasons underpinning

off-standard performance, so that corrective action is taken as early as possible.

Direct action can result in improved efficiency, greater utilisation of resources and in
some cases reduction in cost.

Reporting systems should detail variances in such a way that through the mechanism of
“responsibility accounting” individual managers should be held accountable for the
specific variances.

The objectives and principles outlined above are those which underpin the accounting
methods and techniques visited in this case study.

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Financial Management Case Study (1)
Variance Accounting and Reporting

The purpose of this case study is to illustrate the principles of standard absorption
costing and the reconciliation process of matching budget to actual performance by the
use of variance analysis.

A traditional approach to the variance analysis model is based on the following:

(1) Direct Labour Cost Variance

(1.1) Direct Labour (1.2) Direct Labour

Rate Variance Efficiency Variance

(2) Direct Material Cost Variance

(2.1) Direct Material (2.2) Direct Material

Price Variance Usage Variance

(3) Variable Overhead Variance

(3.1) Variable Overhead (3.2) Variable Overhead

Expenditure Variance Efficiency Variance

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 (4) Fixed Overhead Variance

(4.1) Fixed Overhead (4.2) Fixed Overhead

Expenditure Variance Volume Variance

(4.3) Fixed Overhead Fixed Overhead

Capacity Variance Efficiency Variance

In addition to these variances are series of control ratios include:

 Efficiency Ratio - a measure of productivity

 Capacity Ratio - a measure of resource utilisation

 Activity Ratio - a measure of production volume

The Situation

Coverdrive Ltd is a company which manufactures high quality cricket bats. The
business was originally formed in the 1980’s by Steve Howe and Steven Ambrose and
for some years operated as a partnership. It is located in Whitby, North Yorkshire.

The company now has a budgeted turnover of £2.75m with an anticipated profit for the
current year of £0.4m.

You work for Dunn and Musgrave a firm of accountants and consultants and Coverdrive
Ltd is one of your clients. Your role is in the business advisory unit and you have
recently installed a monthly management accounting reporting system based on
standard costing techniques.

In early February 2010 you receive the attached memo from Pauline Dunn your firm’s
senior regarding the reporting system.

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 Memo

From: Pauline Dunn 5 February 2010

To: Planning Assistant

Re: Coverdrive Ltd

As you are aware we recently installed a standard costing system at Coverdrive Ltd.

The details attached show the budget for the month of January, together with the
standard specification for each product in the range.

Also shown is the budgeted fixed and variable overheads for the period.

Yesterday I called in at Coverdrive and Steven Ambrose supplied me with a printout

from the computer showing a summary of actual output, hours worked, direct wages
paid, material usage and material prices incurred; together with actual fixed and
variable overheads for the period.

I have arranged a meeting for next Wednesday 12 February, to discuss the figures for
the month of January.

Could you please prepare the following schedules by Tuesday am, so that we can
review these prior to the meeting:

 Budgeted operating statement for January.

 Actual operating statement for the period.

 The control ratios, with brief comments on the figures.

 A variance analysis report showing the variances outlined in the model above –
highlighting any areas for concern.

 A reconciliation of budget to actual profit for the month.

 The breakeven point in £ turnover and % capacity for both the budget and actual
positions.

Coverdrive Ltd Budget Date January 2010

Production and Sales in Units Selling Price Standard Hours per Unit
£
Coverdrive “Special” 1250 70 4
Coverdrive “Super” 1000 60 3.5
Coverdrive “Classic” 1250 55 3

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Standard direct labour rate per hour £6

Standard material usage per unit of output:

“Special” 1.4
“Super” 1.3
“Classic” 1.2

Standard price per unit of material £10

Budgeted fixed costs for month £33550

Budgeted variable overhead for month £30500

Coverdrive Ltd – Computer Printout 4/2/02 SA/02 January 2010

Actual output and sales in units:

“Special” 1275
“Super” 1100
“Classic” 1220

Actual selling prices were as budgeted.

Actual hours worked (direct labour):

“Special” 5228
“Super” 3740
“Classic” 3721

Cost code: 100.01 Direct Labour

“Special” £31629
“Super” £22814
“Classic” £22512

Cost code: 100.02 Direct Material:

Cost Usage
Units of Material
“Special” £18160 1798
“Super” £14342 1420
“Classic” £15029 1488

Cost code: 100.03 fixed overhead £34000

Cost code: 100.04 variable overhead £31000

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Allocated and apportioned as:

“Special” £12654
“Super” £8857
“Classic” £9489

Memo

To: Pauline Dunn 11 February 2010

From: Planning Assistant

Re: Coverdrive Ltd

In reply to your request of 5 February, I attach the report for January 2010.

My comments on the overall performance are included on each section of my report.

I look forward to discussing the results in our review meeting planned for tomorrow.

Coverdrive Ltd
Actual Operating Statement January 2010

“Special” “Super” “Classic” Total

Production and sales in units 1275 1100 1220 3595

£ £ £ £
Sales 89250 66000 67100 222350

Less Variable Costs:

Direct labour 31629 22814 22512 76955

Direct material 18160 14342 15029 47621
Variable overhead 12654 8857 9489 31000
62443 46013 47030 155486

Contribution 66864
Fixed costs 34000
Profit / (Loss) £32864

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 Coverdrive Ltd
Budgeted Operating Statement January 2010

“Special” “Super” “Classic” Total

Production and sales in units 1250 1000 1250 3500

£ £ £ £
Sales 87500 60000 68750 216250

Less Variable Costs:

Direct labour 30000 21000 22500 73500

Direct material 17500 13000 15000 45500
Variable overhead 12449 8714 9337 30500
59949 42714 46837 149500

Contribution 27551 17286 21913 66750

Fixed costs 33550
Profit / (Loss) £33200

Coverdrive Ltd January 2010

“Special” “Super” “Classic” Total

Budgeted production (units) 1250 1000 1250 3500

Standard hours / units 4 3.5 3
Budget in standard hours 5000 3500 3750 12250
Actual production (units) 1275 1100 1220 3595
Standard hours produced 5100 3850 3660 12610
Actual hours worked 5228 3740 3721 12689

Efficiency Ratio:

Standard hours produced x 100/1

Actual hours worked

Capacity Ratio:

Actual hours worked x 100/1

Budgeted hours

Activity Ratio:

Standard hours produced x 100/1

Budgeted hours

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 Control Ratios Summary

“Special” “Super” “Classic” Total

Efficiency 97.55 102.94 98.36 99.38

Capacity 104.56 106.86 99.23 103.58
Activity 102.00 110.00 97.60 102.94

The overall efficiency for the month was almost as planned, although efficiency on
“Special” and ‘Classic” was marginally adverse. This was offset by the favourable
efficiency on “Super”.

Capacity was approximately 4% greater than forecast, with extra capacity allowed on
“Special” and “Super” lines. This resulted in the overall activity on level of production
volume being approximately 3% more favourable than planned.

Variance Analysis Report

January 2010

Direct Labour (NB: F = favourable, (A) = adverse)

Standard Cost of
Product Actual Production Actual Cost Variance F (A)

“Special” 1275 x 4 STD hrs

5100 STD hrs @ £6 / hr 5228 hrs @ £6.05
£30600 £31629 (1029)

“Super” 1100 x 3.5 STD hrs

3850 STD hrs @ £6 / hr 3740 hrs @ £6.10
£23100 £22814 286 F

“Classic” 1220 x 3 STD hrs

3660 STD hrs @ £6 3721 hrs @ £6.05
£21960 £22512 (552)
(1295)

The total direct labour cost variance is adverse, as the actual labour cost for the period
is greater than that allowed for the actual production volume.

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Direct Labour Efficiency Variance:

(Standard hours produced – actual hours worked) standard rate

F (A)
“Special” (5100 – 5228) £6 (768)
“Super” (3850 – 3740) £6 660
“Classic” (3660 – 3721) £6 (366)
(474)

There is a net adverse efficiency variance, as in the case of “special” and “classic” the
actual hours worked were greater than that allowed for ‘the actual volume of output’.
“Super” however showed higher productivity.

Direct Labour Rate Variance:

(Standard rate – actual rate) actual hours

“Special” (£6.00 – £6.05) 5228 (261)

“Super” (£6.00 – £6.10) 3740 (374)
“Classic” (£6.00 – £6.05) 3721 (186)
(821)

The net variance is adverse, as in all cases the actual labour rate was greater than
specified.

£
Summary: Efficiency (474)
Rate (821)
Total Variance £(1295)

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Direct Material

Standard Cost of
Actual Production Actual Cost Variance

“Special” 1275 x 1.4

= 1785 units @ £10 1798 units @ £10.10
£17850 £18160 (310)

“Super” 1100 x 1.3

1430 units @ £10 1420 units @ £10.10
£14300 £14342 (42)

“Classic” 1220 x 1.2

1464 units @ £10 1488 units @ £10.10
£14640 £15029 (389)
(741)

The net total material variance is adverse as the actual cost in all cases, is greater than
the cost specified for the volume achieved.

Direct Material Usage Variance:

(Standard usage – actual usage) standard price

“Special” (1785 – 1798) £10 (130)

“Super” (1430 – 1420) £10 100

“Classic” (1464 – 1488) £10 (240)

(270)

The net usage variance is adverse as in the case of “special” and “classic” the actual
usage of material is greater than that specified for the volume of output achieved.
“Super” showed an efficient use of material.

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Direct Material Price Variance:

(Standard price – actual price) actual usage

“Special” (£10 – £10.10) 1798 (180)

“Super” (£10 – £10.10) 1420 (142)

“Classic” (£10 – £10.10) 1488 (149)

(471)

The net material price variance is adverse as the actual unit price of material is greater
than the predetermined or standard price.

£
Summary: Usage (270)
Price (471)
Total Variance (741)

Variable Overhead Variance:

Variable Overhead Recovery Rate

Budget variable overhead

Budget, standard hours

£30500 = £2.48980
12250 per standard hour

Variable overhead recovered in production achieved:

Standard hours produced x variable overhead recovery rate

12610 standard hours

x £2.48980

= £31396

Actual variable overhead £31000

Over-recovered favourable variance £396

The amount recovered in production achieved is greater than the actual incurred.

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Variable Overhead Efficiency Variance:

(Standard hours produced – actual hours worked) VORR

(12610 – 12689) £2.48980 (197)

adverse
under-recovered

The marginal lack of efficiency of labour results in an under-recovery here.

Variable Overhead Expenditure Variance:

(STD VORR – Actual VORR) Actual Hrs

(£2.48980 – * £2.4431) 12689 593

Favourable
Underspend

*actual overhead
actual hours

= £31000 = £2.4431 per hour

12689

The underspend is due to the operating cost per hour being less than standard.

£
Summary: Efficiency (197)
Expenditure 593
Total Variance £396

Fixed Overhead Variance:

Fixed overhead recovery rate:

= Budget fixed cost

Budget, standard hours

= £33550 £2.73878 per std hour

12250

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Fixed overhead recovered in the month:

Standard hours produced x FORR

= 12610 x £2.73878 £34536

Actual fixed cost £34000

£536
favourable, over-recovery

The amount recovered is greater than that incurred.

Fixed Overhead Expenditure Variance:

£
Budgeted fixed overhead 33550
Actual fixed overhead 34000
Adverse, over-spend £(450)

There is a marginal overspend in some area of Fixed Costs.

Volume Variance:

(Standard hours produced – budget hours) FORR

(12610 – 12250) £2.73878 = £986

favourable
over-recovery

The additional volume achieved is the factor which influences this over-recovery.

The volume variance is sub-divided to:

Capacity and;

Efficiency

Fixed Overhead Capacity Variance:

(Budget hours – actual hours) FORR

(12250 – 12689) £2.73878 £1202

favourable
over-recovery

A greater capacity was utilised.

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Fixed Overhead Efficiency Variance:

(Standard hours produced – actual hours) FORR

(12610 – 12689) £2.73878 £(216)

adverse
under-recovery

The marginal lack of efficiency is highlighted here.

Summary:
£ F/(A)
Total variance 536
Expenditure (450)
Volume * 986
536

£
* Efficiency (216)
Capacity 1202
986

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Coverdrive Ltd

Reconciliation Budget – Actual Profit

January 2010

£ F/(A)
Budget Profit 33200
Actual Profit 32864
Profit Variance (336)

Summary of Cost Variances:

Direct Labour Rate (821)

Direct Labour Efficiency (474)
Direct Material Price (471)
Direct Material Usage (270)
Variable Overhead Efficiency (197)
Variable Overhead Expenditure 593
Fixed Overhead Expenditure (450)
Fixed Overhead Volume 986
(1104)

Sales Margin Quantity Variance:

* Units x STD margin / unit

“Special” 25 x £11.08 277

“Super” 100 x £7.70 770
“Classic” (30) x £9.31 (279) 768
(336)

The adverse variance on direct labour is due to the incidence of overtime worked.

The efficiency of labour and usage of material is well within line with predetermined
levels planned.

These marginal adverse elements are offset by both the variable overhead expenditure
and fixed overhead volume variances.

Fixed overhead expenditure was almost as planned.

The performance for the month was most acceptable.

* This is the additional or shortfall in units ie: budget to actual

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Break-Even Point

£ Turnover

Fixed Costs
(Contribution / Sales)

Budget Actual

£33550 £34000
(66750 / 216250) (66864 / 222350)

= £108692 = £113064

% Capacity 50.3% 50.85%

FINANCIAL MANAGEMENT CASE STUDIES