1

Analysis of
variances
Chapter 18
Introduction to the
analysis of variances
• In the previous Chapter a broad approach to control was
adopted

• In this Chapter we shall describe a financial control system

that enables the deviations from budget to be analysed in
detail

• This system of control is called standard costing

2
Standard costing system
What is meant by ‘standard’?
- pre-determined quantity & price that should apply under
efficient operating conditions(budget)

Appropriate for?
- (1) Repetitive (routine) activities and
- (2) Specific inputs are required for a given output.

External reporting?
- IAS 2: Inventory may be valued at standard costs only if it’s
a fair representation of the actual costs.
3
Purposes
Standards are used for:

- Decision-making (future cost)

- Planning (budgets)

- Performance evaluations and control (comparison against

actual)

- Inventory valuation (inventory valued at standard cost)

4
Standard costing vs
Budgets
• Standard costing:
• Predetermined (future) target costs that should be incurred
under efficient operating conditions on a PER UNIT basis
• I.e.: Standard product cost = R3 per unit

• Budgets
• Are compiled for a TOTAL ACTIVITY, based on standards:
• Budgeted sales volumes and standard selling prices
• Budgeted production volumes and standard costs
• I.e.: Budgeted cost = R3 (Standard product cost)
x 1 000u (budgeted production volume)
= R3 000
5
 Standard costing
• Part of the planning & control function
1. Set standards per unit
2. Compile budgets based on standards
3. Compile actual reports
4. Reconcile budgeted result with actual result
(calculation of variances)
Distinction between static, flexible and actual results is fundamental

5. Interpret variances
6. Take corrective actions based on interpretation
6
 Budgets and actual
information
Reporting

BUDGET ACTUAL
Why are there differences?
Quantify differences

7
 8

Variance analysis
Class example
Class example 1

9
 Class example 1
The original budget for June is presesnted
below: Compiled based on std. Income / cost per unit
kg/hours/allocated RAND
Sales 540 sets 1 728 000.00
Cost of sales: -1 406 160.00
Direct material 43 740 meters 306 180.00
Direct labour 52 380 hours 419 040.00
Variable overheads Labour hours 157 140.00
Fixed overheads Labour hours 523 800.00
Budgeted profit 321 840.00

The actual information for June is presented

below: Compiled based on actual income/cost per unit
kg/hours/allocated RAND
Sales 530 sets 1 722 500.00

Cost of sales: -1 398 613.00

Direct material 42 845 meters 308 484.00
Direct labour 51 380 hours 400 764.00
Variable overheads Labour hours 156 709.00
Fixed oveheads Labour hours 532 656.00
Actual profit 323 887.00
10
 11
Reconciliation – ACM vs
VCM ACM VCM

Budgeted profit (fixed/static budget) R 321 840 R 321 840

Sales volume variance ? ?
Flexible budget covered in the
Flexible budget profit Budgets chapter
? ?
Sales price variance ? ?
Material usage variance ? ?
Material price variance ? ?
Labour usage variance ? ?
Labour price variance ? ?
Variable OH usage variance ? ?
Variable OH price variance ? ?
Fixed OH spending variance ? ?
Fixed OH volume capacity variance ? ?
Fixed OH volume efficiency variance ? ?
Actual profit R 323 887 R 323 887
Budgets and actual
information
Budgeted sales / production 540 Units
Actual sales / production 530 Units

FLEXIBLE
BUDGET ACTUAL
BUDGET
Budgeted profit Adjusted budgeted Actual profit
profit
R321 840 R?? R323 887
Differences? Differences?

Sales Quantity Later…

12
Budgets and actual
information
Remember from the Budgets chapter - we cannot compare the static (original) budget to the actual
results. We said it was not comparable because the budget was set up using 540 units while the actual
results were set up based on 530. So of course there will be a difference. Therefore I set up my flexible
budget. The flexible budget is when we are going to draw up a new budget using the actual units
manufactured and sold, i.e. 530 units and multiply this with std price and std quantity. In the budget
chapter we did it line item by line item but here we will take a short cut. The short cut to calculate the
flexible budget profit is to take the budgeted profit plus or minus the sales quantity variance.

Then, from there, I compare my flexible budgeted profit with my actual profit. I.e. 530 units with 530
units. If there are still differences then it is because the company:

1. Used too many or too few hours / kg etc per unit (std quantity does not equal actual quantity)
2. Paid too much or too little per hour / kg etc (std price does not equal actual price)

Then management can identify what happened and take corrective action.
Refer back to the L3 – Flexible budgets video for more information on the flexible budgets.
13
 Variance analysis
The first step in variance analysis is to reconcile the
budgeted profit with the flexed profit with one variance.

FLEXIBLE
BUDGET
BUDGET
Budgeted profit Adjusted budgeted profit

R321 840 R??

Difference?
Sales Quantity Sales volume-variance
14
Variance analysis
ALWAYS indicate if a variance is

Positive effect on actual profits

FAVOURABLE

or
Negative effect on actual profits
ADVERSE
Don't get marks if you don't indicate this!

15
 16

Income/Sales variances
Class example (continues)
Calculate INCOME
variances
540 530 530
units
BUDGET
units
FLEXIBLE units
BUDGET

???
=
Sales volume variance =
(Actual sales volume – Budgeted sales volume)
x STANDARD contribution per unit Depends on
OR costing system
X STANDARD gross profit per unit (ACM or DCM)!
17
 18
Calculate INCOME
variances
540 530
units
BUDGET
units
FLEXIBLE
BUDGET

??? VARIABLE COSTING METHOD

(VCM)
Diff. in units SOLD x STD
= Contribution. per unit
Sales volume variance
ABSORPTION COSTING METHOD
(ACM)
Diff. in units SOLD x STD Gross
Profit per unit
Calculate INCOME Instead of formula, ask two questions:
1) What SHOULD have happened (STD)
2) What ACTUALLY happened

variances
ACM
Should have sold 540
Actually sold 530
Difference 10 units

X Standard gross profit

19
Calculate INCOME
variances
ACM
ABSORPTION COSTING METHOD (ACM)
Diff. in units SOLD x STD Gross Profit per unit.

ACM
GP = Sales less COS (variable costs + fixed costs)

GP IN TOTAL = 321 840

GP PER UNIT = 321 840/540
GP PER UNIT = R596

20
Calculate INCOME Instead of formula, ask two questions:
1) What SHOULD have happened (STD)
2) What ACTUALLY happened

variances
ACM
Should have sold 540
Actually sold 530
Difference 10 units

X Standard gross profit (321 840/540) R596

Sales volume variance R5 960

We sold less than what we budgeted therefore ADVERSE variance

21
Calculate INCOME Instead of formula, ask two questions:
1) What SHOULD have happened (STD)
2) What ACTUALLY happened

variances
VCM
Should have sold 540
Actually sold 530
Difference 10 units

X Standard contribution

22
Calculate INCOME
variances
VCM
DIRECT COSTING METHOD (DCM)
Diff. in units SOLD x STD Contribution. per unit

DCM
Contribution = Sales less COS (variable costs)
Add back the
fixed OH costs
CONTR.IN TOTAL = 321 840+523 800 to get GP to
CONTR. PER UNIT = 845 640/540 Contr.

CONTR. PER UNIT = R1 566

23
Calculate INCOME Instead of formula, ask two questions:
1) What SHOULD have happened (STD)
2) What ACTUALLY happened

variances
VCM
Should have sold 540
Actually sold 530
Difference 10 units

X Standard contribution ((321 840+523 800)/540) R1 556

Sales volume variance R15 660

We sold less than what we budgeted therefore ADVERSE variance

24
Calculate FLEXIBLE
PROFIT
Reconciliation Units
Budgeted profit 540 units ACM R321 840 VCM R321 840

Sales volume
variance (530 – 540) X -R5 960 (530 – 540) X -R15 660
R596 R1 566
FLEXIBLE PROFIT 530 units R315 880 R306 180

540 530
units
BUDGET units
FLEXIBLE
BUDGET

=
Sales volume variance 25
 26
Reconciliation – ACM vs
VCM ACM VCM

Budgeted profit (fixed/static budget) 540 units R 321 840 R 321 840
Sales volume variance R- 5 960 R- 15 660
Flexible budget profit 530 units R 315 880 R 306 180
Sales price variance ? ?
Material usage variance ? ?
Material price variance ? ?
Labour usage variance ? ?
Labour price variance ? ?
Variable OH usage variance ? ?
Variable OH price variance ? ?
Fixed OH spending variance ? ?
Fixed OH volume capacity variance ? ?
Fixed OH volume efficiency variance ? ?
Actual profit 530 units R 323 887 R 323 887
Calculate INCOME
variances
Sales FLEXIBLE

540u 530u 530u

FLEXIBLE
BUDGET ACTUAL
BUDGET

R1 722 500
R1 728 000 R1 696 000
???
=
Sales price variance
(Actual SP – Budgeted SP) x ACTUAL
sales volume

27
Calculate INCOME Instead of formula, ask two questions:
1) What SHOULD have happened (STD)

variances
2) What ACTUALLY happened

SHOULD have sold @ R1 728 000 / 540 (STD SP) R3 200

ACTUALLY sold @ R1 722 500 / 530 (actual SP) R3 250
X actual units sold R50 per unit X 530
Sales price variance It was sold at a higher price. = R26 500
Therefore, FAVOURABLE.

28
 29
Reconciliation – ACM vs
VCM ACM VCM

Budgeted profit 540 units R 321 840 R 321 840

Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance ? ?
Material price variance ? ?
Labour usage variance ? ?
Labour price variance ? ?
Variable OH usage variance ? ?
Variable OF price variance ? ?
Fixed OH spending variance ? ?
Fixed OH vol capacity variance ? ?
Fixed OH vol eff. Variance ? ?
Actual profit 530 units R 323 887 R 323 887
Calculate INCOME
variances
TWO TYPES OF INCOME VARIANCES:
That is, multiply your VOLUME
(Quantity) difference with STD PRICE
1) VOLUME VARIANCES
Expressed in terms of standard price
That is, multiply your PRICE difference with
ACTUAL QUANTITY
2) PRICE VARIANCE
Expressed in terms of actual
quantities

30
 31
Cost variances
Class example (continues)
Calculation of COST
variances

BUDGET FLEXIBLE BUDGET ACTUAL

Budgeted profit Flexible profit Actual profit

R321 840 R306 180 R323 887

Difference? Differences?

Sales volume variance Sales Price Variance +

Other Variances

32
 33
Reconciliation – ACM vs
VCM ACM VCM

Budgeted profit 540 units R 321 840 R 321 840

Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance ? ?
Material price variance ? ?
Labour usage variance ? ?
Labour price variance ? ?
Variable OH usage variance ? ?
Variable OF price variance ? ?
Fixed OH spending variance ? ?
Fixed OH vol capacity variance ? ?
Fixed OH vol eff. Variance ? ?
Actual profit 530 units R 323 887 R 323 887
 Remember that
Calculate COST variances budgets are set based
on standard cost per
STEPS: units.

1. Calculate standard cost (consisting of standard price and standard

usage) per cost element (quantity x price)

2. Calculate variances

3. Investigate variances

34
 35
TIP: Use the budget, as it is compiled based on the standards.

Calculate standard cost

per unit
Quantity Price Std.cost
Cost element per unit
Direct raw METRE = 43 740 m / 540 u = R306 180 / 43 740m = 81m x R7/m
materials = 81 m/u = R7 / m =R567

HOURS = 52 380 h / 540 u = R419 040 / 52 380h = 97h x R8/h

Direct labour = 97 h/u = R8 / hour = R776
= R157 140 / 52 380h = 97h x R3/h
Variable HOURS = 97 h/u
overheads = R3 / hour = R291

HOURS = R523 800 / 52 380h = 97h x R10/h

= 97 h/u = R970
Fixed overheads = R10 / hour
STANDARD COST PER UNIT R2 604
 Calculate COST variances

DIFFERENCE =
FLEXIBLE BUDGET ACTUAL
COST VARIANCES

530
Two reasons for the
difference
530
units units
1) Usage

I manufactured 530 units. How many kg’s of

material was I supposed to use vs how many kg’s
did I actually use?
36
 Calculate COST variances

DIFFERENCE =
FLEXIBLE BUDGET ACTUAL
COST VARIANCES

530
Two reasons for the
difference
530
units units
2) Price

I used 100kg’s of material at R500. How much

was 100kg’s supposed to cost me?

37
Calculate COST variances

TWO TYPES OF COST VARIANCES:

That is, your QUANTITY difference multiplied
by STANDARD PRICE
1) USAGE VARIANCE
Expressed in terms of standard price
That is, your PRICE difference multiplied by ACTUAL
QUANTITY
2) PRICE VARIANCE
Expressed in terms of actual
quantities

38
Calculate COST variances

ALWAYS indicate whether a variance is

FAVOURABLE Positive effect on actual profit

or

ADVERSE Negative effect on actual profit

Won’t get marks if you don’t show this!

39
 40

Raw material variances

Class example (continues)
 Calculate COST variances
Raw Material

530 530
units units
FLEXIBLE BUDGET ACTUAL
Usage Price
? ?

Raw material usage variance =

(standard quantity raw material for actual production – actual quantity used)
X STANDARD price per raw material-unit 41
 Instead of formula, ask two questions:
1. How much SHOULD I have used for 530u
Calculate COST variances 2. How much did I ACTUALLY use for 530u

Direct raw materials usage

Actually manufactured 530 units

SHOULD have 530u (actual u manufactured)x 42 930m
used 81m(STD m/u)
ACTUAL usage 42 845m
X STD Price/m Price difference = x ACTUAL quantity
85m X R7
Quantity difference = x with STANDARD price

Raw material I used less than the standard. = R595

usage variance Therefore FAVOURABLE.

42
Calculate COST variances
Raw Material
530 530
units units
FLEXIBLE BUDGET ACTUAL
Usage Price
R595 ?

Raw material price variance =

(standard price – actual price per raw material-unit)
Depends on raw material X ACTUAL quantity raw material purchased
OR
valuation policy!
X ACTUAL quantity raw material used
43
 Instead of formula, ask two questions:
Calculate COST variances 1) What SHOULD I have paid for 42 845m
2) What did I ACTUALLY pay for 42 845m

Direct raw materials price

Accept for this example: purchased quantity = used quantity
SHOULD have (R306 180 / 43 740) R7 (STD price /m) R7
cost
ACTUAL cost R308 484 / 42 845) R7.20 (actual price/m) R7.20
X actual Price difference = x ACTUAL quantity R0.20
meters used Quantity difference = x with STANDARD price
per m
X 42 845

Raw material I paid more than the standard. = R8 569

price variance Therefore UNFAVOURABLE.

44
Calculate COST variances
Raw Material

530 530
units units
FLEXIBLE BUDGET ACTUAL
Usage Price
R595 (R8 569)

R7 974
ADVERSE

45
Reconciliation – ACM vs 46
VCM ACM VCM
Budgeted profit 540 units R 321 840 R 321 840
Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance R 595 R 595
Material price variance R -8 569 R -8 569
Labour usage variance ? ?
Labour price variance ? ?
Variable OH usage variance ? ?
Variable OF price variance ? ?
Fixed OH spending variance ? ?
Fixed OH vol capacity variance ? ?
Fixed OH vol eff. Variance ? ?
Actual profit 530 units R 323 887 R 323 887
Raw material price 47

variance
Alternative options for valuation of raw materials
MATERIAL PRICE variance
MATERIAL VALUATION POLICY
TWO OPTIONS:

1) Value material at ACTUAL COST

OR
2) Value material at STANDARD COST

48
 49
MATERIAL PRICE variance
Supplier
Warehouse

ACTUAL Price
ACTUAL Price OR
STANDARD Price

Production
STANDARD Price
 50
MATERIAL PRICE variance
Supplier
Warehouse

ACTUAL Price
No price
variance on
ACTUAL Price purchase
Price variance on
ISSUE because
actual is not = to
standard
Production
STANDARD Price
 51
MATERIAL PRICE variance
Supplier
Warehouse
STANDARD
Price variance Price
on PURCHASE
ACTUAL Price because actual
is not = to No price
standard variance on
issue
Production
STANDARD Price
Raw material price
variance
• RM valuation policy: @ Actual cost

Supplier Warehouse Production

Purchase RM Value RM Issue RM to WIP

@ actual price @ actual price @ standard price

RM PRICE variance on issue

• RM valuation policy: @ Standard cost Use issued quantity in calc

Supplier Warehouse Production

Purchase RM Value RM Issue RM to WIP

@ actual price @ standard price @ standard price

RM PRICE variance on purchase

52
Use purchased quantity in calc
MATERIAL PRICE variance
THUS Remember the following:

If raw material is valued at STANDARD COST, use actual

quantities PURCHASED and therefore actual cost should be
actual cost of PURCHASES.

If raw material is valued at ACTUAL COST, use actual quantities

ISSUED/USED and therefore actual cost should be actual cost
of ISSUES.

53
MATERIAL PRICE variance
Standard price per kg = R2.50

During the year 180 000 kg of material was purchased for R468 000.

183 000 kg of material were issued to production.

On 1 January there were 8 000 kg of material with an actual cost price

of R2.60 per kg on hand.

1) Material is valued at ACTUAL prices. The company makes use

of F.I.F.O for inventory valuation purposes.

2) Material is valued at STANDARD prices. The company makes

use of F.I.F.O for inventory valuation purposes.

Calculate the raw material price variance for scenario (1) and (2) above.
54
 Raw material price
variance
• RM valuation policy: @ Actual cost

Supplier Warehouse Production

Purchase RM Value RM Issue RM to WIP

@ actual price @ actual price @ standard price

RM PRICE variance on issue

Should have paid R2.50 Use issued quantity in calc
Actually paid R2.60
= R 0.10

X actual kg ISSUED x 183 000 kg

VARIANCE = R 18 300 55
Raw material price
variance
• RM valuation policy: @ Standard cost

Supplier Warehouse Production

Purchase RM Value RM Issue RM to WIP

@ actual price @ standard price @ standard price

RM PRICE variance on purchase

Use purchased quantity in calc

Should have paid R2.50

Actually paid R2.60
= R 0.10
X actual kg PURCHASED x 180 000 kg

VARIANCE = R 18 000 56
RAW MATERIAL PRICE -
variance
For the raw material PRICE variance read this carefully.

How does the company values ​their raw material, because this
will determine whether you use the quantity purchased or the
quantity used.

57
 58
Labour
variances
Class example (continues)
 Calculate COST variances
Direct Labour

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Tariff
? ?

Labour effi ciency variance =

(standard quantity labour hours for actual production – actual labour hours)
X STANDARD wage rate
59
 Instead of formula, ask two questions:

Calculate COST variances 1. How many hours SHOULD I use for 530 u
2. How many hours did I ACTUALLY use for 530 u

Direct labour efficiency

SHOULD have 530u (actual u manufactured) x 97h 51 410h

taken (STD h)
ACTUAL hours 51 380h
X STD rate/h Price difference = x ACTUAL quantity
Quantity difference = x with STANDARD price 30h X R8

Labour efficiency I took less hours than standard.

= R240
variance Therefore FAVOURABLE.

60
Calculate COST variances
Direct Labour

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Tariff
R240 ?

Labour tariff variance =

(standard wage per hour – actual wage rate)
x ACTUAL labour hours worked

61
 Instead of formula, ask two questions:

Calculate COST variances 1) What SHOULD I have paid for 51 380h

2) What did I ACTUALLY pay for 51 380h

Direct labour tariff

SHOULD have R8 (STD rate/h) R8

cost
ACTUAL cost (R400 764 / 51 380h) R7. 80 (actual R7.80
cost/hour)
X Actual hours Price difference = x ACTUAL quantity
R0.20 / h
used Quantity difference = x with STANDARD price
X 51 380h
Labour price I paid less than standard. = R10 276
variance Therefore FAVOURABLE.

62
Calculate COST variances
Direct labour

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Tariff
R240 R10 276

R10 516
Favourable

63
 64
Reconciliation – ACM vs
VCM ACM VCM
Budgeted profit 540 units R 321 840 R 321 840
Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance R 595 R 595
Material price variance R -8 569 R -8 569
Labour usage variance R 240 R 240
Labour tariff variance R 10 276 R 10 276
Variable OH usage variance ? ?
Variable OF price variance ? ?
Fixed OH spending variance ? ?
Fixed OH vol capacity variance ? ?
Fixed OH vol eff. Variance ? ?
Actual profit 530 units R 323 887 R 323 887
Calculate COST variances
Direct labour efficiency – Further analysis

FLEXIBLE BUDGET ACTUAL

Efficiency Tariff

Efficiency Idle time

PRODUCTIVE HOURS UNPRODUCTIVE
65
Labour idle time and overtime
NOT IN TEXTBOOK
Class example :
Std. labour cost per unit 2h/u x R10/h = R20
Power outage at factory Unproductive 200 hours lost
Normal productive hours 900 hours Productive
Overtime worked (to compensate for power outage) 200 hour Productive
Actual units of production 500 units

ACTUAL INFORMATION :
All labour hours were remunerated at R10 per hour during the period under
review and workers are compensated for overtime at a premium of 50% of
normal hourly wages.

REQUIRED: Calculate all labour variances for the period under review.

66
Labour idle time and overtime
Instead of formula, ask two questions:
1. How many hours SHOULD I use for 500 u
2. How many hours did I ACTUALLY use for 500 u
NOT IN TEXTBOOK
NB = labour efficiency variance = PRODUCTIVE HOURS

500 units should have utilised (x 2h/u) 1 000 hours

500 units actually utilised – productive hours 1 100 hours
900h + 200h
(normal hours + overtime hours)
Price difference = x ACTUAL quantity
Difference Quantity difference = x with STANDARD price
100 hours
@ Std. rate per hour x R10 / hour R1 000
Adverse
IDLE TIME VARIANCE (UNPRODUCTIVE HOURS)
500 units should have taken 0 hours
Price difference = x ACTUAL quantity
500 units actually took = x with STANDARD price
Quantity difference 200 hours
Difference 200 hours
@ Std. cost per hour x R10 / hour R2 000
Adverse
67
Labour idle time and overtime
NOT IN TEXTBOOK
Actual hourly wage rate of R10 = Std. hourly rate of R10
Therefore no labour price variance.
BUT what about the Overtime premium and Idle time?

TOTAL LABOUR EXPENSE SHOULD HAVE COST

200 h idle time @ R10/h R2 000
900 h normal productive time @ R10/h R9 000
200 h overtime at normal rate @ R10/h R2 000
TOTAL R13 000

68
Labour idle time and overtime
NOT IN TEXTBOOK
TOTAL LABOUR EXPENSE ACTUALLY COST
200 hours idle time @ R10/hour R2 000
900 hours normal productive time @ R10/u R9 000
200 hours overtime at normal rate @ R10/u R2 000
200 hours of overtime @ PREMIUM R1 000
(R10 x 50%) R5/u
TOTAL R14 000

Should have cost R13 000

Actual cost R14
000
Adverse price-variance R1 000

Thus, overtime premium negatively affects labour price variance 69

 70
Variable overhead
variances
Class example (continues)
Calculate COST variances
Variable overheads

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Price
? ?

Variable overhead effi ciency variance =

(standard quantity of input hours for actual production – actual input hours)
x STANDARD variable overhead rate
71
 Instead of formula, ask two questions:

Calculate COST variances

1. How many hours SHOULD I have used for 530 u
2. How many hours did I ACTUALLY use for 530 u

Variable overheads efficiency

SHOULD have 530e (actual u manufactured) x 97u 51 410h

taken (STD h/u)
ACTUAL hours 51 380h
X STD rate/h Price difference = x ACTUAL quantity
30h X R3
Quantity difference = x with STANDARD price

Variable = R90
overheads I took less hours than standard.
efficiency Therefore FAVOURABLE.
variance

72
Calculate COST variances
Variable overheads

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Price
R90 ?

Variable overhead spending variance =

(standard rate per hour – actual rate)
X ACTUAL activity level (e.g. Hours)
73
 Instead of formula, ask two questions:

Calculate COST variances 1) What SHOULD I have paid for 51 380h

2) What did I ACTUALLY pay for 51 380h

Variable overheads price

SHOULD have cost R3 (STD rate) R3

ACTUAL cost (R156 709 / 51 380) = R3.05 (actual R3.05

cost/ hour)
R0.05 /
X actual hours Price difference = x ACTUAL quantity hour
taken Quantity difference = x with STANDARD price X 51 380
hour

Variable = R2 569
overheads price I spent more than standard.
variance Therefore ADVERSE.

74
Calculate COST variances
Variable overheads

530 530
units units
FLEXIBLE BUDGET ACTUAL
Efficiency Price
R90 (R2 569)

(R2 479)
Adverse

75
Reconciliation – ACM vs 76

VCM ACM VCM

Budgeted profit 540 units R 321 840 R 321 840

Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance R 595 R 595
Material price variance R -8 569 R -8 569
Labour usage variance R 240 R 240
Labour price variance R 10 276 R 10 276
Variable OH usage variance R 90 R 90
Variable OH price variance R -2 569 R -2 569
Fixed OH spending variance ? ?
Fixed OH vol capacity variance ? ?
Fixed OH vol eff. Variance ? ?
Actual profit 530 units R 323 887 R 323 887
 77

Fixed overhead variances

Class example (continues)
 VCM
Fixed overhead variances
Fixed OH variance calculation depends on cost allocation
system, namely VCM and ACM.

Fixed overheads are deducted as a periodic expense on income

statement

FLEXIBLE BUDGET ACTUAL

Spending
78
 1. How much did I BUDGET to spend

VCM
Fixed overhead variances 2. How much did I ACTUALLY spend

Fixed cost spending

Budgeted to R523 800
spend
ACTUALLY R532 656
spent
Fixed costs I spent more than the standard. = R8 856
spending var. Thus ADVERSE.

79
 VCM
Fixed overhead variances

530 530
units units
FLEXIBLE BUDGET ACTUAL
Spending
(R8 856)

80
 ACM
Fixed overhead variances
Fixed OH variance calculation depends on cost allocation
system, namely VCM and ACM.

Fixed overheads are ABSORBED into products based on std. rate

(budgeted rate))

FLEXIBLE BUDGET ACTUAL

Capacity Efficiency Spending

81
REMEMBER! Over-/ under recovery

Budget = R523 800 / 52 380 hours = R10 per hour

= Fixed OH cost budgeted allocation rate
I always allocate fixed costs to units based on the budgeted rate.
THUS: What will I allocate to units?
ACTUAL HOURS x BUDGETED RATE per HOUR
= 51 380 U x R10 = R513 800
Actual cost = R532 656
= UNDER RECOVERY of R18 856

8 856 10 000
Fixed cost spending variance Volume capacity variance
(R532 656 – R523 800) (51 380u – 52 380u) x R10
82
 Fixed overhead rate : R523 800 / 540u = R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(Actual units – Budgeted

Spending var. Volume var. units) x Std.rate/U

Budgeted O/H - Actual Capacity var. Efficiency var.

overheads

(Budgeted hrs – Actual (Std.hrs – Actual hrs) x

hrs) x Std.rate Std.rate

83
 Fixed overhead rate : R523 800 / 540u = R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(Actual units – Budgeted

Spending var. Volume var. units) x Std.rate/U

R523 800 - R532 656 Capacity var. Efficiency var.

= (R8 856) Adverse

(Budgeted hrs – Actual (Std.hrs – Actual hrs) x

Remains the same as under DCM.
Total budgeted fixed OH less total
hrs) x Std.rate Std.rate
actual fixed OH.

84
 Fixed overhead rate : R523 800 / 540u = R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(540u – 530u) x R970

Spending var. Volume var. = (R9 700) Adverse

R523 800 - R532 656 Capacity var. Efficiency var.

= (R8 856) Adverse

(Budgeted hrs – Actual (Std.hrs – Actual hrs) x

hrs) x Std.rate Std.rate

85
Calculate COST variances:
Instead of formula, ask two questions:
1) How many units did I BUDGETED to manufacture
2) How many units did I ACTUALLY to manufacture
Fixed overhead volume

BUDGETED to 540 u
manufacture
ACTUALLY 530 u
manufacture
X STD price R523 800 / 540 10 u
Price difference = x ACTUAL quantity X R970
Quantity difference = x with STANDARD price

Fixed = R9 700
I manufactured less units than what I should
overhead
(my standard).
volume
Thus, ADVERSE
variance

86
 Fixed overhead rate : R523 800 / 540u =R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(540e – 530u) x R970

Spending var. Volume var. = (R9 700) Adverse

R523 800 - R532 656 Capacity var. Efficiency var.

= (R8 856) Adverse

(Budgeted hrs – Actual (530u x 97h) – 51 380h) x R10

hrs) x Std.rate = (51 410 – 51 380h) x R10
= R300 Favourable

87
Calculate COST variances: Instead of formula, ask two questions:
1. How many hours SHOULD I have used for 530 u

Fixed overhead efficiency 2. How many hours did I ACTUALLY use for 530u

SHOULD have 530u (actually manufactured) x 97 hour 51 410

taken (STD hour/u) hour
ACTUALLY 51 380
manufactured hour
X STD price R523 800 / 52 380 30 h
Price difference = x ACTUAL quantity X R10
Quantity difference = x with STANDARD price

Fixed = R300
overhead I used less hours than my standard.
efficiency Thus, FAVOURABLE
variance

88
 Fixed overhead rate : R523 800 / 540u =R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(540e – 530u) x R970

Spending var. Volume var. = (R9 700) Adverse

R523 800 - R532 656 Capacity var. Efficiency var.

= (R8 856) Adverse

(52 380h – 51 380h) x (530u x 97h) – 51 380h) x R10

R10 = (51 410 – 51 380h) x R10
= (R10 000) Adverse = R300 Favourable

89
Calculate COST variances: Instead of formula, ask two questions:
Fixed overhead capacity 1. How many hours did I BUDGET to use
2. How many hours did I ACTUALLY use

BUDGETED to 52 380
take hour
ACTUALLY 51 380
used hour
X STD price R523 800 / 52 380 1 000h
Price difference = x ACTUAL quantity X R10
Quantity difference = x with STANDARD price

Fixed I worked for less hours than I budgeted.

= R10 000
overhead Thus, ADVERSE
capacity
variance

90
 Fixed overhead rate : R523 800 / 540u =R970/unit
OR
R523 800 / 52 380h = R10/hour
Actual information : R532 656

Total variance

(540e – 530u) x R970

Spending var. Volume var. = (R9 700) Adverse

R523 800 - R532 656 Capacity var. Efficiency var.

= (R8 856) Adverse

(52 380h – 51 380h) x (530u x 97h) – 51 380h) x R10

Over/under recovery R10 = (51 410 – 51 380h) x R10
= (R10 000) Adverse = R300 Favourable

91
 ACM
Fixed overhead variances
Fixed costs ACM

530 530
units units
FLEXIBLE BUDGET ACTUAL

Capacity Efficiency Spending

(R10 000) R300 (R8 856)

92
Reconciliation – ACM vs 93
VCM ACM VCM

Budgeted profit 540 units R 321 840 R 321 840

Sales volume variance R -5 960 R -15 660
Flexible budget 530 units R 315 880 R 306 180
Sales price variance R 26 500 R 26 500
Material usage variance R 595 R 595
Material price variance R -8 569 R -8 569
Labour usage variance R 240 R 240
Labour price variance R 10 276 R 10 276
Variable OH usage variance R 90 R 90
Variable OF price variance R -2 569 R -2 569
Fixed OH spending variance R -8 856 R -8 856
Fixed OH vol capacity variance R -10 000 n/a
Fixed OH vol eff. Variance R 300 n/a
Actual profit 530 units R 323 887 R 323 887
Capacity vs Efficiency
• Capacity variance:
• If actual hours are MORE than the hours as per the
Budget (Capacity)
• = FAVOURABLE variance

• Efficiency variance:
• If actual hours are MORE than the standard hours
(efficient hours)
• = UNFAVOURABLE variance

94
 Direct vs. absorption costing

(Variances) (Direct cost) (Absorption cost)

(Variable costs) (Similar) (Similar)

Expenditure & Volume

(Fixed costs) (Expenditure) Remember volume consists
of efficiency and capacity

(Sales price) (Similar) (Similar)

(Sales volume) (Based on std. Contr.) (Based on std. GP)

95
Direct vs. absorption costs

See summary PDF slides on SUNLearn.

96
 Variance analysis
Summary:
To reconcile the budgeted profit with the flexed and actual profit
we need to look at the following variances:
Budgeted profit
• Sales variances
• Sales volume variance Income
Flexible profit
• Sales price variance variances
• Material variances
• Material usage variance
• Material price variance
• Labour variances Cost
• Labour efficiency variance
• Labour rate variance variances
• Variable production overhead variances
• Variable overhead efficiency variance
• Variable overhead expenditure variance 97
 Variance analysis
Summary:
To reconcile the budgeted profit with the flexed and actual profit
we need to look at the following variances:
• Fixed production overhead variance
• Fixed overhead expenditure variance
Variable /
Direct
OR Costing system
• Fixed production overhead variances
• Fixed overhead spending variance
• Fixed overhead efficiency variance Absorption
• Fixed capacity variance
Costing system
Actual profit
98
 99

Reasons for variances

Chapter 18
Discuss the impact of
events on variances
1. Which variance will be affected?

2. What will the impact be – favourable or adverse?

3. Why would that variance be affected and why would the

impact be favourable or adverse?

Remember: You will not receive marks for just identifying

the variance, you have to state your reasons. You must
discuss "how" and "why".

100
Reasons for variances
During the period under review the factory has been affected
by strikes and staff resignations

Variance affected: Labour Efficiency Variance

Also: Idle time variance
How: Adverse

Why: Strikes and staff resignation indicate low staff morale.

This could indicate that employees work inefficiently and that
more labour time would be needed than the standard time
expected to manufacture products.

101
Reasons for variances
During the period under review the factory has been
affected by strikes and staff resignations

Inter-relationship between variances: Other variances could

also be affected!

Variance: Raw material usage variance

How: Adverse

Why: If staff morale is low and employees don’t care about

their work, it is more likely that they would waste materials,
leading to higher material usage. 102
Reasons for variances
During the period under review the factory has been affected by
strikes and staff resignations

As a result, Management increased wages (not budgeted for)

Variance: Labour price variance

How: Adverse

Why: The actual rates paid were higher than the standard rates
due to management increasing rates after the strikes and
resignations.
103
Reasons for variances
During the period under review the factory has been
affected by strikes and staff resignations

After strikes employees worked overtime to make up for lost

time – paid overtime premium of 50% of normal wages.

Variance: Labour price variance

How: Adverse

Why: The actual rates paid were higher than the standard
rates, due to premium overtime rates being paid after the
strikes and resignations. 104
Reasons for variances
During the period under review the factory has been
affected by strikes and staff resignations.

Employ temporary workers to maintain production levels.

Remuneration less than the permanent staff’s wages.

Variance: Labour price variance

How: Favourable

Why: The actual rates paid were lower due to temporary

staff being used at lower rates than the standard rates
105
Reasons for variances
Employ temporary workers to maintain production levels.
Remuneration less than the permanent staff’s wages.

Secondary impacts
Variance: Labour efficiency variance

How: Adverse

Why: Temporary employees not trained, therefore work

slower as they are unfamiliar with the operations, resulting
in more labour time being used than standard.

106
Reasons for variances
Employ temporary workers to maintain production levels.
Remuneration less than the permanent staff’s wages.

Secondary impacts
Variance: Raw material usage variance

How: Adverse

Why: Temporary employees not trained, could result in

more wastage of materials, because they do not know how
to work with the raw material.

107
 108
Performance
evaluation
Use of variance for
performance evaluation
1. How are the standards set?
Refer to types of standards in the textbook (self-study)

2. Investigate reasons for variance – within the person’s

control?

REMEMBER: can only be evaluated based on events within

your control.

109
Old exam question...

110
 Budgeted
sales 1 500 Standard
Old exam question...
bottles gin price R180
per litre

Should have
used 1 500
hours

111
Old exam question...
1

Lets think…what can

the manager control?

112
Old exam question...
Should this variance be
Variance 1 What did the 2 included in the manager’s
manager control?
performance?
Sales volume Manager responsible for
variance the increase in sales units
He initiated the marketing
campaign.
Raw material Manager purchased the raw
price variance materials at a higher price to
support his cousin as opposed
to the lower price from their
usual supplier.

Labour usage The manager was not

variance responsible for the cash
prize initiative which
motivated the workers to
work efficiently  initiative
implemented by directors 113