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

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)

100,000
(40,000)
(20,000)

90,000
(36,000)
(18,000)

(20,700)
16,900

(20,000)
20,000

(20,000)
16,000

Selling price = 100 per unit

Raw materials = 40 per unit

Labour = 20 per unit

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

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
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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
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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

Direct Material Variances

Material variance = difference between the
actual expenditure and budgeted
expenditure on direct materials
Material Budget Variance
Price variance
Usage/Efficiency variance

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

5 metres
3
5 metre

Actual cost per unit (5m * 4)

20

Standard cost per unit (5m * 3)

15

Variance (favourable)

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

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.
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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

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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)
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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
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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)
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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

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