Variances

• In case actual quantity purchased and actual quantity used both are
different then consider stock valuation method.

• If stocks (FG) are valued on the basis of STANDARD cost then formula of
material price variance will be
• MPV = actual quantity purchased (standard price – actual price)

• If stocks are valued on the basis of ACTUAL cost then formula of material
price variance will be
• MPV = actual quantity used (standard price – actual price)
• In case idle time is also given in the question then labour variances will be

• Labour rate variance = *TOTAL LABOUR HOURS (standard rate – actual rate)

• Labour efficiency variance = standard rate (standard hours allowed for actual
production – actual **PRODUCTIVE hours used)

• Idle time variance = standard wage rate (expected idle time – Actual idle
time)

• * TOTAL LABOUR HOURS include idle hours because labour get payment for idle hours too
• **PRODUCTIVE hours = total hours – Idle hours
Variance – Introduction
• A variance is the difference between a planned, budgeted, or standard cost and the
actual cost incurred.
• The same comparisons may be made for revenues. The process by which the total
difference between standard and actual results is analysed is known as variance
analysis.
• When actual results are better than expected results, we have a favourable variance
(F).
• If actual results are worse than expected results, we have an adverse variance (A).
• Variances can be divided into three main groups.
• Variable cost variances
• Sales variances
• Fixed production overhead variances.
Direct material cost variance
• Direct material total variance is the difference between what the output actually
cost and what it should have cost, in terms of material.
• Direct material price variance. This is the difference between the standard cost
(Std price * AQU) and the actual cost for the actual quantity (Actual price *
AQU) of material used or purchased. In other words, it is the difference between
what the material did cost and what it should have cost.
• Direct material usage variance. This is the difference between the standard
quantity of materials that should have been used for the number of units
actually produced, and the actual quantity of materials used, valued at the
standard cost per unit of material. In other words, it is the difference between
how much material should have been used and how much material was used,
valued at standard cost.
 Direct material cost variance
• Total material variance = standard material cost of actual production –
actual material cost

• Material price variance = actual quantity used (standard price – actual

price)

• Material usage variance = standard price (standard quantity allowed for

actual production – actual quantity used)
• In case actual quantity purchased and actual quantity used both are
different then consider stock valuation method.

• If stocks (FG) are valued on the basis of STANDARD cost then formula of
material price variance will be
• MPV = actual quantity purchased (standard price – actual price)

• If stocks are valued on the basis of ACTUAL cost then formula of material
price variance will be
• MPV = actual quantity used (standard price – actual price)
Direct material cost variance – example
• Product X has a standard direct material cost as follows.
• 10 kilograms of material Y at $10 per kilogram = $100 per unit of X.
• During period 4, 1,000 units of X were manufactured, using 11,700 kilograms of
material Y which cost $98,600.
• Required
• Calculate the following variances.
• (a) Direct material price variance
• (b) Direct material total variance
• (c) Direct material usage variance
• (d) Total material variance in %
Direct labour cost variance
• The direct labour total variance is the difference between what the output
should have cost and what it did cost, in terms of labour.
• The direct labour rate variance. This is similar to the direct material price
variance. It is the difference between the standard cost and the actual cost
for the actual number of hours paid for. In other words, it is the difference
between what the labour did cost and what it should have cost.
• The direct labour efficiency variance is similar to the direct material usage
variance. It is the difference between the hours that should have been
worked for the number of units actually produced, and the actual number
of hours worked, valued at the standard rate per hour. In other words, it is
the difference between how many hours should have been worked and how
many hours were worked, valued at the standard rate per hour
Direct labour cost variance
• Total labour variance = standard labour cost of actual production –
actual labour cost

• Labour rate variance = actual hours worked (standard rate – actual

rate)

• Labour efficiency variance = standard rate (standard hours allowed for

actual production – actual hours used)
• In case idle time is also given in the question then labour variances will be

• Labour rate variance = *TOTAL LABOUR HOURS (standard rate – actual rate)

• Labour efficiency variance = standard rate (standard hours allowed for actual
production – actual **PRODUCTIVE hours used)

• Idle time variance = standard wage rate (expected idle time – Actual idle
time)

• * TOTAL LABOUR HOURS include idle hours because labour get payment for idle hours too
• **PRODUCTIVE hours = total hours – Idle hours
Direct labour cost variance - example
• The standard direct labour cost of product X is as follows.
• 2 hours of grade Z labour at $5 per hour = $10 per unit of product X.
• During period 4, 1,000 units of product X were made, and the direct
labour cost of grade Z labour was $8,900 for 2,300 hours of work.
• Required
• Calculate the following variances.
• (a) The direct labour efficiency (productivity) variance
• (b) The direct labour rate variance
• (c) The direct labour total variance
Variable overheads variance
• The variable production overhead expenditure variance is the
difference between the amount of variable production overhead that
should have been incurred in the actual hours actively worked, and
the actual amount of variable production overhead incurred.

• The variable production overhead efficiency variance. If you already

know the direct labour efficiency variance, the variable production
overhead efficiency variance is exactly the same in hours, but priced
at the variable production overhead rate per hour.
Variable overheads variance
• Total VOHD variance = standard VOHD of actual production – actual VOHD cost

• VOHD expenditure variance = actual hours worked (standard VOHD rate – actual
VOHD rate)

• VOHD efficiency variance = standard VOHD rate (standard hours allowed for actual
production – actual hours used)

• In case of idle time, only productive hours will be considered in all overhead
variances because production overheads arise on productive hours or active hours
only
Variable overheads variance - example
• Variable production overhead cost of product X is as follows.
2 hours at $1.50 = $3 per unit
• During period 6, 400 units of product X were made. The labour force
worked 740 hours, of which 60 hours were recorded as idle time. The
variable overhead cost was $1,230.
• Calculate the following variances.
• (a) The variable overhead total variance
• (b) The variable production overhead expenditure variance
• (c) The variable production overhead efficiency variance
Fixed overheads variances
• Fixed overhead total variance is the difference between fixed
overhead incurred and fixed overhead absorbed. In other words, it is
the under– or over-absorbed fixed overhead.
• Fixed overhead expenditure variance is the difference between the
budgeted fixed overhead expenditure and actual fixed overhead
expenditure.
• Fixed overhead volume variance is the difference between actual and
budgeted (planned) volume multiplied by the standard absorption
rate per unit.
Fixed overheads variance
• Total fixed overheads variance = standard fixed overheads of actual
production – actual fixed overheads cost

• Fixed overhead expenditure variance = budgeted fixed production

overheads – actual fixed production overheads

• Fixed overheads volume variance = fixed OAR (actual production –

budgeted production)
Sales Variances
• The selling price variance is a measure of the effect on expected
profit of a different selling price to standard selling price. It is
calculated as the difference between what the sales revenue should
have been for the actual quantity sold, and what it was.
• The sales volume profit variance is the difference between the actual
units sold and the budgeted (planned) quantity, valued at the
standard profit per unit. In other words, it measures the increase or
decrease in standard profit as a result of the sales volume being
higher or lower than budgeted (planned).
Sales variances
• Sales price variance = (standard selling price – actual selling price) actual
sales volume

• Sales volume variance (absorption costing)

• = (budgeted sales volume – actual sales volume) standard gross profit per
unit

• Sales volume variance (marginal costing)

• = (budgeted sales volume – actual sales volume) standard contribution per
unit
 Reconciliation statement under Marginal costing
Budgeted contribution     368,000
Sales price variance     16,000
Sales volume variance     (73,600)
      310,400
Cost Variances Fav Adv  
Material price variance 32,000    
material usage variance   24,000  
Labour rate variance 16,000    
Labour efficiency variance   12,800  
Variable overheads expenditure variance 4,000    
Variable overheads efficiency variance   6,400  
  52,000 43,200 8,800
Actual contribution     319,200
Budgeted fixed overheads 256,000    
fixed overheads expenditure variance (60,000)   (196,000)
Actual profit under marginal costing     123,200
Reasons for variances
Reasons for material price variance
• Purchasing department is responsible for price variance
• Favourable (actual price less than standard price)
• Company might have used cheap quality material
• Company might have changed supplier
• Availability of unforeseen discount
• Overall decrease in price level
• Overall decrease in demand or increase in supply
• Standard might be inappropriate
Reasons for material price variance
• Adverse (actual price higher than standard price)
• Company might have used high quality material
• Urgent purchasing due to poor inventory management
• Overall increase in price level
• Overall increase in demand or decrease in supply
Reasons for material usage variance
• Production department is responsible for usage variance.
• Favourable (actual consumption less than standard consumption)
• Company might have used high quality material
• This might be result of skilled labour
• Proper machine maintenance
• Standard might be inappropriate
Reasons for material usage variance
• Adverse (actual price higher than standard price)
• Company might have used cheap quality material
• Company might have employed unskilled labour
• Lack of proper machine maintenance
• Standard might be inappropriate
Reasons for labour rate variance
• Personnel department is responsible for labour wage rate variance.
• Favourable (actual wage rate less than standard wage rate)
• Unskilled labour
• Low inflation than expected
• Increase in supply of labour
• Inappropriate standard
Reasons for labour rate variance
• Adverse (actual price higher than standard price)
• Use of experienced labour
• Overtime premium or other incentive paid to labour
• Increase in minimum wage rate by government
• Inappropriate standard
Reasons for labour efficiency variance
• Production department is responsible for usage variance.
• Favourable (actual hours less than standard hours required)
• Use of experienced labour
• Use of good quality material
• Better machine or equipment available for the manufacturing
• Improved working conditions
Reasons for labour efficiency variance
• Adverse (actual hours higher than standard hours required)
• Use of less skilled labour or lack of training
• Use of low quality material
• Lack of machine maintenance
• Poor working conditions
Sales price variance
• Change in demand or supply of product
• Different quality of product
• To achieve a targeted sales volume
• Increase or decrease in competition level
Sales volume variance
• Change in price of the product
• Reduction in market share
• Due to discontinuation of complementary product
Types of standards
• Ideal standard
• This is a standard that reflects perfect performance and is the minimum cost that is possible under
ideal operating conditions (for eg no losses, no idle time, 100% efficiency of labour, no machine
breakdown etc). Because ideal standards are unattainable, they are unlikely to be used in practice,
since inability to achieve them is likely to have a demotivating effect on managers and employees.

• Attainable standard
• This standard allows for normal levels of wastage and operation, and represents a cost level
achievable under reasonably efficient working. Attainable standards may be difficult to
achieve, but they do not represent impossible targets for employees.
• An attainable standard is considered to represent the best target against which to compare
current activity and is the preferred standard to use in planning, budgeting and cost control.
Types of standards
• Current standard
• This standard is one established for use over a short period of time and
relates to current conditions.

• Basic standard
• This is a standard that remains unchanged for long periods of time. Because it
remains unchanged, it allows efficiency trends over time to be identified.
Because basic standards do not reflect current conditions, they are of limited
use if current conditions differ significantly from those existing when the
standard was set. They are therefore seldom used.
Factors to decide whether to investigate a
variance or not
• (a) Materiality. A standard cost is really only an average expected cost and is not a
rigid specification. Small variations either side of this average are therefore bound
to occur. The problem is to decide whether a variation from standard should be
considered significant and worthy of investigation. (Reporting by exception)
• Tolerance limits can be set and only variances which exceed such limits would
require investigating.
• (b) Controllability. Some types of variance may not be controllable even once their
cause is discovered. For example, if there is a general worldwide increase in the
price of a raw material there is nothing that can be done internally to control the
effect of this. If a central decision is made to award all employees a 10% increase
in salary, staff costs in division A will increase by this amount
Factors to decide whether to investigate a
variance or not
• (c) The type of standard being used.
• (i) The efficiency variance reported in any control period, whether for materials or labour, will
depend on the efficiency level set. If, for example, an ideal standard is used, variances will
always be adverse.
• (ii) A similar problem arises if average price levels are used as standards. If inflation exists,
favourable price variances are likely to be reported at the beginning of a period, to be offset
by adverse price variances later in the period as inflation pushes prices up.
• (d) Interdependence between variances . Quite possibly, individual variances
should not be looked at in isolation. One variance might be inter-related with
another, and much of it might have occurred only because the other, inter-related,
variance occurred too. We will investigate this issue further in a moment.
• (e) Costs of investigation. The costs of an investigation should be weighed against
the benefits of correcting the cause of a variance.
Are Standards the Same as Budgets?
• Standards and budgets are very similar. The major distinction
between the two terms is that a standard is a unit amount, whereas
a budget is a total amount. The standard cost for materials at
Heirloom Pewter is $12 per pair of bookends. If 1,000 pairs of
bookends are to be manufactured during a budgeting period, then the
budgeted cost of materials will be $12,000. In effect, a standard can
be viewed as the budgeted cost for one unit of product .
• Chaff Co processes and sells brown rice. It buys unprocessed rice seeds and then, removes the outer husk of the rice to produce
the brown rice. There is substantial loss of weight in the process. The market for the purchase of seeds and the sales of brown
rice has been, and is expected to be, stable. Chaff Co uses a variance analysis system to monitor its performance.
• 1. The purchasing manager is stubborn, despite criticism from the production director, that he has purchased wisely and saved the
company thousands of dollars in purchase costs by buying the required quantity of cheaper seeds from a new supplier.
• 2. The production director is upset at being criticised for increasing the wage rates for month 1; he feels the decision was the right
one, considering all the implications of the increase. Morale was poor and he felt he had to do something about it.
• 3. The maintenance manager feels that saving $8,000 on fixed overhead has helped the profitability of the business. He argues
that the machines’ annual maintenance can wait for another month without a problem as the machines have been running well.
$
• Material price 48,000 (Fav)
• Material usage 52,000 (Adv)
• Labour rate 15,000 (Adv)
• Labour efficiency 18,000 (Fav)
• Labour idle time 12,000 (Fav)
• Variable overhead expenditure 18,000 (Adv)
• Variable overhead efficiency 30,000 (Fav)
• Fixed overhead expenditure 8,000 (Fav)
• Sales price 85,000 (Adv)
• Sales volume 21,000 (Adv)
• Chaff Co uses labour hours to absorb the variable overhead.
• Comment on the performance of the purchasing manager, the production director and the maintenance manager
• Sticky Wicket (SW) manufactures cricket bats using high quality wood and skilled labour using mainly traditional manual
techniques. The manufacturing department is a cost centre within the business and operates a standard costing system based on
marginal costs.
• At the beginning of April 2010 the production director attempted to reduce the cost of the bats by sourcing wood from a new supplier
and de-skilling the process a little by using lower grade staff on parts of the production process. The standards were not adjusted to
reflect these changes. The variance report for April 2010 is shown below (extract).
• Adverse Favourable
• Variances $ $
• Material price 5,100
• Material usage 7,500
• Labour rate 43,600
• Labour efficiency 48,800
• Labour idle time 5,400
• The production director pointed out in his April 2010 board report that the new grade of labour required significant training in April
and this meant that productive time was lower than usual. He accepted that the workers were a little slow at the moment but
expected that an improvement would be seen in May 2010. He also mentioned that the new wood being used was proving difficult
to cut cleanly resulting in increased waste levels.
• Sales for April 2010 were down 10% on budget and returns of faulty bats were up 20% on the previous month. The sales director
resigned after the board meeting stating that SW had always produced quality products but the new strategy was bound to upset
customers and damage the brand of the business.
• Required: Assess the performance of the production director using all the information above taking into account both the
decision to use a new supplier and the decision to de-skill the process.
• Standard material price per unit The price that should be paid for a
single unit of materials, including shipping, receiving, and other such
costs, net of any discounts allowed

• Standard quantity of material per unit The amount of materials that

should be required to complete a single unit of product, including
allowances for normal waste, spoilage, and other inefficiencies
• Standard rate per hour: The labour rate that should be incurred per
hour of labour time, including Employment Insurance, employee
benefits, and other labour costs

• Standard hours per unit: The amount of labour time that should be
required to complete a single unit of product, including allowances
for breaks, machine downtime, cleanup, rejects, and other normal
inefficiencies.
• Standard quantity allowed for actual production: The amount of
materials that should have been used to complete the period’s
output, as computed by multiplying the actual number of units
produced by the standard quantity per unit

• Standard hours allowed for actual production: The time that should
have been taken to complete the period’s output, as computed by
multiplying the actual number of units produced by the standard
hours per unit
• Standard cost per unit of finished product The standard cost of a unit
of product as shown on the standard cost card; it is computed by
multiplying the standard quantity or hours by the standard price or
rate for each cost element