VARIANCE ANALYSIS
Variance is the different between Expected Performance and Actual Performance. When
expected costs/standard costs are more (less) than actual costs then the difference is said to be
a favourable (adverse) variance. However when expected revenue or contribution is more (less)
than actual revenue or contribution then the difference is said to be an adverse (favourable)
variance.
Variance analysis is the sub analysis of variances into constituent components in a bid to
investigate and explain the sources of the variances. Eventually, all variances calculated explain
why planned/budgeted profits are different from actual profits. A statement called operating
statement, containing all computed variances reconciles budgeted profits to actual profits.
Illustration.
Zugzwang Ltd produces a single product known as Petroff. The product’s standard cost is
presented in the following standard cost card.
Standard cost card
$
Direct Material:
2kg of caro @ $ 8
1kg of kahn @ $12
16
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Zugzwang Ltd planned to produce 10,000 units of Petroff in the coming month of September.
Annual budgeted fixed overheads are $1,800,000 incurred evenly throughout the year.
The actual information for the month of September was as follows.
The actual profit for September.
$
Sales (9,000 units @$105)
D. Materials
A(17,000kg @$9)
B(11,000 kg @ $11)
$
945,000
153,000
121,000
Actual production and sales for the period was 9,000 units.
Material Variances.
Total Material Variance is the difference between the expected cost of materials given actual
output units (standard cost or flexed budget material cost) and the actual material costs
incurred. When standard cost (SC) is more than actual cost (AC) the variance is said to be
favourable whereas when SC is less than actual costsfor actual Production and the actual cost
(AC)
𝑇𝑜𝑡𝑎𝑙 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑐𝑜𝑠𝑡 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑐𝑜𝑠𝑡
= 𝑆𝐶 − 𝐴𝐶
= (𝐴𝑐𝑡𝑢𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑣𝑜𝑙𝑢𝑚𝑒 × 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑚𝑎𝑡𝑒𝑟𝑎𝑖𝑙 𝑐𝑜𝑠𝑡 /𝑢𝑛𝑖𝑡) − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑐𝑜𝑠𝑡
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𝑀𝑎𝑡𝑟𝑖𝑎𝑙 𝐶𝑎𝑟𝑜: 9,000 × 20 − 209,000 = 29,000 𝐴
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝐾𝑎ℎ𝑛: 9,000 × 15 – 141,400 = 6,400 𝐴
𝑇𝑜𝑡𝑎𝑙 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 $ 35,400 𝐴𝑑𝑣𝑒𝑟𝑠𝑒
Note: The formula has been arranged such that when the answer is positive the variance is
Favourable whereas when the answer is negative the variance is adverse.
The cost of materials which are used in manufacturing products are determined by two basic
factors: the price paid for the materials or the quantity of materials used in production. This
gives rise to two possibilities for the source of material variance: either the actual material price
was different from planned price (standard price per kg) or the actual usage of materials was
different the expected usage (standard quantity).
Material Price Variance.
Material price variance is the difference between the expected price per unit of materials
(standard price: SP) that should have been paid for the actual quantity of materials purchased
and the actual price (AP) that was paid for each unit of materials bought. Since the variance
occurs for every unit actually purchased, then the difference between SP and AP is multiplied by
the actual quantity of materials purchased (AQ). The variance is favourable when the actual
price (AP) is less than the expected price (SP) whereas the variance is adverse when AP is more
than SP. In summary material price variance is the different between standard price per unit of
materials (SP) and the actual price (AP) per unit of materials multiplied by the actual quantity of
materials purchased (AQ)
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑟𝑖𝑐𝑒 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑒 − 𝑎𝑐𝑡𝑢𝑎𝑙 𝑝𝑟𝑖𝑐𝑒)𝐴𝑐𝑡𝑢𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
= (𝑆𝑃 – 𝐴𝑃) 𝐴𝑄.
From illustration
Material A: (10 – 11)19,000 = −19000
$19,000 A
Material B (15 – 14 ) 10,100 = 10100
$10,100 F
Total material price variance
$8,900 A
Possible Causes.
i) Change in market conditions that causes a change in gem prices of materials used.
ii) Failure by purchasing department to seek most advantageous source of supply.
iii) A favorable price variance may be due to purchase of inferior quality materials which
may lead to inferior product quality or more wastage.
iv) Shortage of materials resulting from bad inventory control necessitating an emergency
purchase being made at short notice will make the supplies incur additional cost e.g.
handling freight charges e.t.c. and may charge a higher price for the materials.
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Direct Material Usage Variance.
i)
The difference between (SQ) standard Quantity of material. Amount of material that
should have been consumed in producing actual units of output and the actual
quantity (AQ) used in production. This difference is multiplied (valued at) by
standard price (SP).
From illustration.
Material A: if a unit requires 2kg of A, then to produce actual output of 9,000 units 2 × 9,000 =
18,000𝑘𝑔 should have been used (standard quantity)
Standard quantity = 𝑎𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 𝑢𝑛𝑖𝑡𝑠 × 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Therefore (18000 – 19000) × 10 = 10,000𝐴
Material B = (9000 × 1 – 10,100) × 15 = 16,500 𝐴
Possible Causes.
i)
Careless handling of materials by production personnel.
ii)
Purchase of interior quality materials.
iii)
Pilferages.
iv)
Changes in quality control requirement.
v)
Changes in method of production.
Fixed Overhead variance.
Fixed overhead variance is computed differently under marginal costing system and under
absorption costing system. This is so due to underlying assumptions of fixed overheads under
the two systems. Absorption costing system absorbs fixed overheads based on an appropriate
activity say number of units, thus it treats fixed overheads as if they are variable; in that more
fixed overheads will be absorbed when production volume increases. Marginal costing system
on the other hand treats fixed overhead costs as is their nature: fixed regardless of the activity
level. Under marginal costing, fixed overheads are expensed as period costs
Fixed overhead variance under marginal costing system
Fixed overhead costs under marginal costing are assumed to remain unchanged regardless of
changes in activity level. Actual fixed overhead costs however may be different from budgeted
in response to other factors say inflation, taxes change of suppliers etc that have an impact on
expenditure change. Fixed overhead variance therefore occurs only when budgeted expenditure
on fixed overheads (BFO) is different from actual expenditure on fixed overheads (AFO). Fixed
overheads variance under marginal costing is known as fixed overhead expenditure variance.
𝐹𝑖𝑥𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (𝐵𝐹𝑂 – 𝐴𝐹𝑂).
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Summary of Variances
Variance
Price Aspect
Quantity Aspect
Direct Material variance
Material Price
Material Usage
= 𝑆𝐶 − 𝐴𝐶
= (𝑆𝑃 – 𝐴𝑃) 𝐴𝑄
= (𝑆𝑄 – 𝐴𝑄) 𝑆𝑃
Direct labour variance
Labour Rate
Labour Efficiency
= 𝑆𝐶 − 𝐴𝐶
= (𝑆𝑅 – 𝐴𝑅) 𝐴𝐻
= (𝑆𝐻 – 𝐴𝐻) 𝑆𝑅
Variable Overheads
Variable Overheads
Expenditure
Variable Overheads Efficiency
= 𝑆𝐶 − 𝐴𝐶
= (𝑆𝑉𝑂𝑅 – 𝐴𝑉𝑂𝑅) 𝐴𝐻
= (𝑆𝐻– 𝐴𝐻) 𝑆𝑉𝑂𝑅
Sales Variance
Sales Price Variance
Sales volume varianve
= (𝐴𝑃 − 𝐵𝑃)𝐴𝑉
Under marginal costing
system
Under Absorption costing
system
Sales volume contribution
Variance
Sales volume profit Variance
= (𝐴𝑉 − 𝐵𝑉)𝑆𝐶𝑀
= (𝐴𝑉 − 𝐵𝑉)𝑆𝑃𝑀
FIXED OVERHEADS VARIANCE UNDER ABSORPTION COSTING
TOTAL FOH VARIANCE = over/(under) absorption
= 𝐴𝑏𝑠𝑜𝑟𝑏𝑒𝑑 𝑂𝐻 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝐻
= 𝐴𝑂𝑅 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 × 𝑎𝑐𝑡𝑢𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 − 𝑎𝑐𝑡𝑢𝑎𝑙 𝑂𝐻
FOH expenditure variance
= 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐹𝑖𝑥𝑒𝑑 𝑂𝐻 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝑂𝐻
= 𝐵𝐹𝑂 − 𝐴𝐹𝑂
FOH volume variance
= (Actual production vol – budgeted production vol) AOR per unit
= (𝐴𝑉 − 𝐵𝑉)𝐴𝑂𝑅 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
FOH Efficiency Variance
FOH capacity Variance
= (Std labour hrs – Actual labour hrs) AOR per hour
= (Actual labour hrs – budgeted labour hrs) AOR per hr
= (𝑆𝐻 – 𝐴𝐻) 𝐴𝑂𝑅 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
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= (𝐴𝐻 – 𝐵𝐻) 𝐴𝑂𝑅 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
By: Maloba
Definition of Terms
AFO
Actual fixed overheads
AH
Actual hours worked
AOR/hr
Budgeted Fixed Overheads per hr (Absorption overhead rate per hour)
AOR/unit
Budgeted Fixed Overheads per unit (Absorption overhead rate per unit)
AP
Actual Price
AQ
Actual material quantity (either purchased or used)
AR
Actual rate (of pay per hour for employees)
AV
Actual Volume (production or sales volume)
AVOR
Actual Variable Overhead rate
BFO
Budgeted fixed overheads
BH
Budgeted labour hours
BP
Budgeted selling price
BV
Budgeted Volume
SCM
Standard contribution margin
SH
Standard hours (Expected hours that should have been worked to produce actual quantity)
SP
Standard Price
SPM
Standard Profit margin
SQ
Standard (Expected) Quantity (of materials used to produce actual volume)
SR
Standard Rate
SVOR
Standard Variable Overhead rate
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