Variance Analysis

COST CONTROL: STANDARD COSTING & VARIANCE ANALYSIS

Dr. Alok Dixit

IIM Lucknow

COST CONTROL

Managers, quite often, are confronted with the situation where Actual Profits are different from Budgeted Profits. And, it gives rise to the need of a control system which minimizes such deviations.

Important for ensuring that the standard fixed in the beginning of the period could be achieved with least possible deviations.

Need to be carried out on frequent intervals (say, weekly or daily) to spot the deviations, if any, in time.

Diagnosis of such variations is needed to ascertain the possible reasons and nature of such variances in terms of controllable & uncontrollable.

And, a suitable action can be initiated to bridge the gap between standard and actual so that standards can be met at the end of the budgeted period.

TOOL FOR COST CONTROL

Variance Analysis is used as one of the most important tool for cost controls.

It attempts to compare actual vs. a suitable benchmark, fixed in the beginning of the budgeted period (standard).

Deviations, if any, are spotted, analyzed in terms of Favourable/ Unfavourable, controllable/ uncontrollable.

And finally, for controllable variances, concerned employee/ centre is held accountable for.

STANDARD COSTING

Variance analysis requires some suitable benchmark for comparing the actual performance;

Standard costing provides those suitable benchmarks for assessing the actual performance;

For effective control, the standards should be set cautiously.

These should neither be too tight nor too loose as they have got their own implications.

If the standard itself is incorrect, measurement of variance will become a futile exercise;

VARIANCE ANALYSIS

PROFITSBUDGETED

PROFITSACTUAL

SALES VARIANCES

COST VARIANCES

LABOUR VARIANCES

OVERHEADS VARIANCES

MATERIAL VARIANCES

MATERIAL COST VARIANCES

Total Material Cost Variance

(TMCV)

Material Price Variance

(MPV)

Material Quantity Variance

(MQV) Material Yield Sub Variance(MYSV)

Material Mix Sub Variance(MMSV)

MATERIAL VARIANCE: AN EXAMPLE

MATERIAL VARIANCE: EXAMPLE 2

Detailed Solution is given in the material on Variance Analysis (scanned copy).

SOLUTION: MATERIAL COST VARIANCES

TMCV={TAQ*AP-TSQ*SP}

MPV ={AP-SP}*TAQ

MQV ={TAQ-TSQ}*SP

MYSV={Actual Yield for standard mix - Standard Yield of Standard Mix}*SP of finished output

MMSV={Actual Mix of Actual

Quantity - Standard Mix of Actual Quantity}*SP

Material A = 4000 (U) Material B= 20000 (U)Material C= 40000 (F)Total= 16000 (F)

Material A = 6000 (F) Material B = Zero Material C= 10000 (U)Total= 4000 (U)

Material A =10000 (U) Material B= 20000 (U)Material C= 50000 (F)Total= 20000 (F)

Material A = 5000 (U) Material B = 14000 (U)Material C =60000 (F)Total= 41000 (F)

Material A = 5000 (U) Material B = 6000 (U)Material C =10000 (U)Total= 21000 (U)

TSQ= SQ (PER UNIT)*ACTUAL OUTPUT

LABOUR COST VARIANCES

LABOUR COST VARIANCES

** Labour efficiency variance need to be revised for idle hours, if any. The labour efficiency variance net of the idle hours cost will give a true measure of Labour efficiency as Labour can’t be held responsible for idle time.

Total Labour Cost Variance

(TLCV)

Labour Rate Variance (LRV)

Labour Efficiency

Variance (LEV)Revised**

Labour Yield Sub Variance(LYSV)

Labour Mix Sub Variance(LMSV)

Labour Idle Time Variance

(LITV)

PROBLEM: LABOUR COST VARIANCE

SOLUTION

SOLUTION

SOLUTION

SOLUTION

SOLUTION

SOLUTION

Total Labour Cost Variance

(TLCV)

Labour Rate Variance (LRV)

={AR-SR}*TAH

Labour Efficiency Variance (LEV)

Revised={TAH-TSH}*SR

Labour Yield Sub Variance(LYSV)

={Actual Yield for standard mix - Standard Yield of Standard Mix}*SR of finished output

Labour Mix Sub Variance(LMSV)

={Actual Mix of Actual Quantity - Standard Mix of Actual Quantity}*SR

Unskilled= 1000 (U) Semi-skilled= 200 Skilled = 520 (U)Total= 1320 (U)

Unskilled= 1600 (U) Semi-skilled= 520 (F) Skilled = 1320 (U)Total= 2400 (U)

Unskilled= 600-480 = 120 (U) Semi-skilled= 320+384=704 (F) Skilled = 800-480 = 320 (U)Total= 1080-1344=264 (F)

Labour Idle Time Variance (LITV)

={Idle Hours}*SR

Unskilled= 480 (U) Semi-skilled= 384 (U) Skilled = 480 (U)Total= 1344 (U)

TSH*= Standard Hours required to support the Actual Output

Important: Idle hours should be apportioned based on Standard Mix to ensure that the deviations, if any, on account of changes in Standard Mix should get reflected in LMSV; Such deviation should not get reflected in Cost of Idle Time.

Unskilled= 200 (U) Semi-skilled= 640 (F) Skilled = 400 (U)Total= 40 (F)

Unskilled= 80 (F) Semi-skilled= 64 (F) Skilled = 80 (F)Total= 224 (F)

OVERHEADS COST VARIANCES

OVERHEADS COST VARIANCES

Total Overhead

s Cost Variance (TOCV)

Variable Overheads Cost Variance(VOCV)

={(TAH*AVOR) – (TSH*SVOR)}

Fixed Overheads Cost

Variance (FOCV)

={(TAH*AFOR) – (TSH*SFOR)}

Fixed Overheads Efficiency Variance (FOEV)

={TAH-TSR}*SFOR

Fixed Overheads Spending Variance (FOSV)

={TAFOC- Budgeted Fixed Overheads Cost}

Variable Overheads Efficiency Variance

(VOEV)={TAH-TSR}*SVOR

Variable Overheads Spending Variance

(VOSV)={AVOR-SVOR}*TAH

Capacity Variance={TAH- Normal Hours}*SFOR

Volume Variance

={Actual Volume- Budgeted Volume}* SH*SFOR

PROBLEM: VARIABLE OVERHEADS COST VARIANCES

SOLUTION: VARIABLE OVERHEADS COST VARIANCES

Variable Overheads Efficiency Variance (VOEV)

={TAH-TSR}*SVOR={2300-2000}*10 =

3000 (U)

Variable Overheads Spending Variance (VOSV)

={AVOR-SVOR}*TAH={11-10}*2300= 2300 (U)

Variable Overheads Cost Variance(VOCV)

={2300*11-2000*10}= 5300 (U)

PROBLEM: FIXED OVERHEADS COST VARIANCES

SOLUTION: FIXED OVERHEADS COST VARIANCES

Capacity Variance={TAH- Normal Hours}*SFOR

={2300-2500}*20= 4000 (U)

Fixed Overheads Efficiency Variance (FOEV)

={TAH-TSR}*SFOR={2300-2000}*20=

6000 (U)

Fixed Overheads Spending Variance (FOSV)

={TAFOC- Budgeted Fixed Overheads Cost

={50600-50000}= 600 (U)Fixed

Overheads Cost Variance (FOCV)

={(TAH*AFOR) – (TSH*SFOR)}

={50600-(2000*20)}=1060

0 (U)

Volume Variance

={Actual Volume- Budgeted Volume}* SH*SFOR={1000-

1250}*2*20= 10000 (U)

SALES VARIANCES

SALES VARIANCES

PROFITSBUDGETED

PROFITSACTUAL

SALES VARIANCES

COST VARIANCESLABOUR

VARIANCES

OVERHEADS VARIANCES

MATERIAL VARIANCES

SALES VARIANCES

SALES VARIANCES=SPV+SVV

Sales Quantity Variance

Sales Price Variance

Profit Variance

Sales Volume Variance

=SMV+SQV

Sales Mix Variance

PROBLEM: SALES VARIANCES

SOLUTION: SALES VARIANCES

SOLUTION: SALES VARIANCES

SOLUTION: SALES VARIANCES

SALES VARIANCES=SPV+SVV

Sales Quantity Variance

Sales Price Variance

={ASP-SSP}*AQS

Sales Volume Variance

=SMV+SQV

Sales Mix Variance

Product A= 8000 (U) Product B= 16000 (F) Total = 8000 (F)

Product A= 7529(F) Product B= 9412 (U) Total = 1883 (U)

Product A= 4471 (F) Product B= 13412 (F) Total = 17883 (F)

Actual Sales at Budgeted PricesProduct A = 8000*10=80000Product B = 16000*8 = 128000Total Actual Sales at Budgeted Prices = 208000Standard Mix Ratio = 5:12

Product A= 12000(F) Product B= 4000 (F) Total = 16000 (F)

Product A= 4000(F) Product B= 20000 (F) Total = 24000 (F)

This solution is based on sales value to determine the mix and quantity variance. The impact is visible in Sales Mix and Sales Quantity variances. However, Sales volume variance turns out to be the same.

COMPREHENSIVE ANALYSIS: PUTTING IT ALTOGETHER

COMPREHENSIVE PROBLEM: VARIANCE ANALYSIS

STEPS INVOLVED IN VARIANCE ANALYSIS

Determine the Profit Variance. Profit Variance = Actual Profit – Budgeted Profit

Try to trace the variance by analyzing cost variances and sales variances.

Prepare a reconciliation statement.

For detailed analysis go through the material provided (scanned copy) on variance analysis.

SOLUTION: COMPREHENSIVE PROBLEM