VARIANCE ANALYSIS 1
LECTURE 8
OBJECTIVES:
• Describe the basic concepts underlying
variance analysis
• Explain the difference between a
favourable and an adverse/unfavourable
variance
• Compute materials usage and price
variances
• Calculate labour efficiency and price/wage
rate variances
2
Flexible Budget
• Steps in developing a flexible budget
– Identify the actual quantity of output
– Calculate the flexible budget for revenues
based on budgeted selling price and actual
quantity of output
– Calculate the flexible budget for costs based
on budgeted variable cost per output unit,
actual quantity of output, and budgeted fixed
costs
3
Flexible Budget
An Example
Actual Results
Output (units)
Sales
Raw Materials
Labour
Fixed O/H
Profit
Budgeted:
Original Budget
Flexible Budget
900
1,000
900
£
£
£
92,000
(36,900)
(17,500)
(20,700)
100,000
(40,000)
(20,000)
(20,000)
90,000
(36,000)
(18,000)
(20,000)
16,900
20,000
16,000
Selling price = £100 per unit
Raw materials = £40 per unit
Labour = £20 per unit
4
Variances
• Variance ~ difference between the
budgeted and actual amounts.
• Variance analysis ~ a means of assessing
these differences
• Variance is use to:
– Assist managers in planning and control
– Evaluate performance
– Suggest changes in strategies
5
Variances
Standard Costing
• Standard costing uses the costs that
should have been incurred
• Standard costing uses standards of
performance and of prices derived from
studying operations and of estimating
future prices, for materials, labour, and
overheads
• Each unit produced can have both actual
and standard costs for direct materials,
direct labour, and manufacturing
overheads
6
Variances
Standard Costing
• Standard input
– A carefully determined quantity of input, e.g.,
square metres of laminated material
• Standard price
– A carefully determined price that a company
expects to pay for a unit of input, e.g., £1 per
square metres of laminated material
• Standard cost
– A carefully determined cost of a unit of output
7
Variance Analysis
• Variances fall into 2 categories
– Favourable variances occur when actual
amount is less than the standard amount
– Unfavourable variances arise when actual
amount is greater than the standard amount
8
Direct Material Variances
• Material variance = difference between the
actual expenditure and budgeted
expenditure on direct materials
• Material Budget Variance
– Price variance
– Usage/Efficiency variance
9
Materials Price Variance
Material J
Standard price per metre
Standard usage per unit of product
Actual price per metre
Actual usage per unit of product
£4
5 metres
£3
5 metre
Actual cost per unit (5m * £4)
£20
Standard cost per unit (5m * £3)
£15
Variance (favourable)
£5
It is a favourable materials price variance because we actually paid
less than the standard that we should have been paid. The actual
usage is exactly the same as the standard. The only difference is
the PRICE for raw materials.
10
Materials Price Variance
Material K
Standard price per metre
Standard usage per unit of product
Actual price per metre
Actual usage per unit of product
£9
8 metres
£11
8 metre
Actual cost per unit
Standard cost per unit
Variance
The actual price paid is now greater than the standard price
should have been paid. It is an adverse/unfavourable materials
price variance. The quantity of materials actually used is the
same as the standard. The only difference is the PRICE.
11
Materials Usage Variance
Material L
Standard price per tonne
Standard usage per unit of product
Actual price per tonne
Actual usage per unit of product
£5
100 tonnes
£5
95 tonnes
Actual cost per unit (95 * £5)
£475
Standard cost per unit (100 * £5)
£500
Variance (favourable)
£25
The actual quantity used in producing 1 unit of product is less
than the standard quantity should have been used. It is a
favourable materials usage variance. No difference in price. The
only difference is the QUANTITY.
12
Materials Usage Variance
Material M
Standard price per tonne
Standard usage per unit of product
Actual price per tonne
Actual usage per unit of product
£8
60 tonnes
£8
65 tonnes
Actual cost per unit
Standard cost per unit
Variance
The actual quantity used is greater than the quantity should
have been used. It is an adverse / unfavourable materials
usage variance. No difference in price. The only difference is
the QUANTITY.
13
Materials Price & Usage Variances
~ Formulae
Materials price variance
(Standard price – Actual price) * Actual quantity purchased
(SP – AP) * AQ
Materials usage variance
(Standard quantity – Actual quantity) * Standard price
(SQ – AQ) * SP
14
Materials Price & Usage Variances
~ Formulae
Material N
Standard price per metre
Standard usage per unit of product
Actual price per metre
£6
25m
£7
Actual usage per unit of product
24m
Actual cost per unit (24m * £7)
£168
Standard cost per unit (25m * £6)
£150
Variance (adverse / unfavourable)
£18
Materials price variance:
(£6 - £7) * 24m
(£24)
Materials usage variance:
(25m – 24m) * £6
Net variance
£6
(£18)
15
Material Variances
What caused the variance?
• Price Variance
– Price changed due to inflation
– Government has imposed taxes on the
materials
– Purchase higher quality material
• Usage Variance
– Wastage occurs due to old machines
– Lack of training among employees
16
Direct Labour Variances
• Labour variance = difference between the
actual labour cost and the standard labour
cost for actual production
• Direct labour budget variance
– Direct labour wage rate variance
– Direct labour efficiency variance
17
Wage Rate Variance
Product A
Standard hours to produce
100
Actual hours to produce
100
Standard wage rate per hour
£0.9
Actual wage rate per hour
£1.0
Actual cost per unit
Standard cost per unit
Variance
The actual wage rate is higher than the standard wage rate that
should have been paid. It is an adverse wage rate variance. No
difference in quantity of labour hours. The only difference is the
WAGE RATE.
18
Labour Efficiency Variance
Product B
Standard hours to produce
400
Actual hours to produce
370
Standard wage rate per hour
£1.0
Actual wage rate per hour
£1.0
Actual cost per unit (370 * £1)
£370
Standard cost per unit (400* £1)
£400
Variance (favourable)
£30
The actual labour hours used are less than the standard labour
hours that should have been used. It is a favourable labour
efficiency variance. No difference in wage rate. The only
difference is the LABOUR HOURS.
19
Labour Wage Rate and Efficiency
Variances ~ Formulae
Wage rate variance
(Standard wage rate per hour – Actual wage rate) * Actual
hours worked/used
(SR – AR) * AH
Labour efficiency variance
(Standard labour hours for actual production – Actual labour
hours worked) * Standard wage rate per hour
(SH – AH) * SR
20
Labour Wage Rate and Efficiency
Variances ~ Formulae
Product C
Standard hours to produce
500
Actual hours to produce
460
Standard wage rate per hour
£0.9
Actual wage rate per hour
£1.1
Actual cost per unit (460 * £1.1)
£506
Standard cost per unit (500* £0.9)
£450
Variance (adverse / unfavourable)
£56
Wage rate variance:
(£0.9 - £1.1) * 460
(£92)
Labour efficiency variance:
(500 – 460) * £0.9
Net variance (adverse / unfavourable)
£36
(£56)
21
Direct Labour Variances
What caused the variance?
• Labour wage rate variance
– Anticipated wage increase failed
– Higher grade of labour was used
• Labour efficiency variance
– New training scheme reduce labour hours
– Employees worked more efficient due to
higher quality material used, less wastage
22