Stage 1 β The Budget: What we planned to achieve
Start by setting the budget. These are your standard/planned figures for the period. Change any input and watch the income statement rebuild instantly.
π Budget inputs β single product
Selling price per unit (R)
R300.00 per unit
Budgeted sales volume (units)
1 000 units
Budgeted production (units)
Plan to produce more/less than sales for stock build or release
1 000 units
Budgeted opening stock (units)
Stock on hand at the start of the budget period
0 units opening
Auto-calculated β Absorption basis
Budgeted closing stock: 0 units
Closing = Opening + Production β Sales
Material cost per unit (R)
Standard qty Γ Standard price
R60.00/unit
Labour cost per unit (R)
Standard hours Γ Standard rate
R40.00/unit
Variable overhead per unit (R)
Standard hours Γ VOH rate
R20.00/unit
Fixed overhead β total budget (R)
Period cost, absorbed over budget volume
R80 000 total β R80.00/unit
Budgeted Income Statement (Absorption basis)
Key ratios & insights
Budgeted Stock Movement (units)
What the budget tells us: This income statement is built entirely on standard (planned) figures,
using the absorption costing method. Every cost line is: Volume Γ Standard cost per unit.
If Budgeted Production differs from Budgeted Sales, a stock build or release is being planned β
a common, deliberate choice when smoothing production against seasonal demand. The budget is the benchmark β every actual result will be measured against this.
Stage 2 β What actually happened vs what we planned
Now enter the actual results. The two income statements sit side by side. Notice the profit gap β but can you explain why it happened?
π Actual results β change these to see the gap
Actual selling price (R/unit)
R285.00/unit
Actual units sold
1 100 units
Actual units produced
May differ from units sold β drives the stock movement
1 100 units produced
Actual opening stock (units)
Carries over from the budgeted closing stock
0 units opening
Auto-calculated
Closing stock: 0 units
Closing = Opening + Production β Sales
Actual material cost per unit (R)
R68.00/unit
Actual labour cost per unit (R)
R36.00/unit
Actual variable overhead per unit (R)
R22.00/unit
Actual fixed overhead spend (R)
R88 000 actual
Budget Income Statement (Absorption)
Actual Income Statement (Absorption)
Stock Movement β Actual (units)
The profit gap is visible β but the income statement alone cannot tell you why it occurred.
Was it because we sold more units? Or charged a lower price? Or because costs were higher?
All of these blend into a single profit number. This is the limitation the CFO must overcome.
Stage 3 β Basic variances: The first layer of insight
We now split the profit gap into its components. But notice β each variance is still a blended number. A cost variance mixes price and efficiency together. The real story is still hidden.
Budget IS
Actual IS
Basic Variance Summary
The limitation of basic variances:
A material cost variance of β tells you costs were different β but was it because the price per kg changed, or because we used more kg per unit? These are completely different management problems requiring completely different actions.
Basic variance = Actual cost β Budgeted cost
This blends price and efficiency into one number. Standard costing separates them.
A material cost variance of β tells you costs were different β but was it because the price per kg changed, or because we used more kg per unit? These are completely different management problems requiring completely different actions.
Basic variance = Actual cost β Budgeted cost
This blends price and efficiency into one number. Standard costing separates them.
Stage 4 β Standard costing: Separating Price from Efficiency from Volume
Now we need the underlying detail. Enter the standard and actual rates and quantities β not just the cost per unit. Watch how each blended variance splits into PV and EV.
π Standard costing detail β rates & quantities
Standard material qty per unit (kg)
3.0 kg/unit β Std price = R20.00/kg
Actual material qty used (kg total)
3 630 kg total
Standard labour hours per unit
2.0 hrs/unit β Std rate = R20.00/hr
Actual labour hours worked (total)
2 090 hrs total
Set in Stage 2 β Actual units produced
1 100 units produced
Change this on the Actual vs Budget tab β it drives both the stock movement and the standard quantity allowed here.
Auto-calculated from Stage 1 & 2 inputs
Std mat price = b-mat Γ· b-mq
Std labour rate = b-lab Γ· b-lh
Actual mat price = (a-mat Γ a-prod) Γ· a-mq
Actual labour rate = (a-lab Γ a-prod) Γ· a-lh
Std labour rate = b-lab Γ· b-lh
Actual mat price = (a-mat Γ a-prod) Γ· a-mq
Actual labour rate = (a-lab Γ a-prod) Γ· a-lh
Basic variances (Stage 3)
Standard costing β PV & EV breakdown
The standard costing insight: Each blended variance now splits into two independent signals.
Price Variance = (Std price β Actual price) Γ Actual quantity
Efficiency Variance = (Std qty β Actual qty) Γ Std price
Price variances are usually a procurement / market issue. Efficiency variances are a production / operations issue. They require completely different management responses.
Price Variance = (Std price β Actual price) Γ Actual quantity
Efficiency Variance = (Std qty β Actual qty) Γ Std price
Price variances are usually a procurement / market issue. Efficiency variances are a production / operations issue. They require completely different management responses.
Stage 5 β Absorption vs Marginal: Two lenses, two different profit answers
The same data, the same period β but two costing philosophies can give different reported profits whenever production and sales volumes differ. Understanding why is essential for management decisions.
π¦ Inventory movement β the real driver of the profit difference
Set in Stage 2 β Actual opening stock
0 units opening
Change this, Actual production, or Actual sales on the Actual vs Budget tab.
Auto-calculated
Closing stock: 0 units
Closing = Opening + Production β Sales
Absorption Costing β Operating Statement
Marginal Costing β Operating Statement
ABSORPTION COSTING
Fixed overhead is absorbed into each unit produced at a standard rate, and carried in stock value until the unit is sold.
Profit only reflects FOH for units actually sold this period.
Std FOH/unit = Budget FOH Γ· Budget units
FOH in Cost of Sales = Std FOH/unit Γ Units SOLD
If production exceeds sales, some FOH sits in closing stock instead of hitting the P&L β profit looks higher.
Std FOH/unit = Budget FOH Γ· Budget units
FOH in Cost of Sales = Std FOH/unit Γ Units SOLD
If production exceeds sales, some FOH sits in closing stock instead of hitting the P&L β profit looks higher.
MARGINAL COSTING
Fixed overhead is treated as a period cost β the full actual amount is deducted in the period incurred, regardless of how many units were produced or sold.
Contribution = Revenue β All variable costs
Profit = Contribution β Actual fixed overhead (in full)
No FOH is ever carried in stock. Closing stock is valued at variable cost only.
Contribution = Revenue β All variable costs
Profit = Contribution β Actual fixed overhead (in full)
No FOH is ever carried in stock. Closing stock is valued at variable cost only.
The management insight: The profit difference between absorption and marginal costing is not caused by the volume variance directly β
it is caused by fixed overhead sitting in closing stock under absorption costing. When production equals sales, no stock builds or depletes, and both methods report identical profit.
A CFO must always check the inventory movement before comparing profit figures prepared under the two methods.