VARIANCE ANALYSIS 1

LECTURE 8

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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

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• 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

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Flexible BudgetAn Example

Budgeted: Selling price = £100 per unitRaw materials = £40 per unitLabour = £20 per unit

Actual Results Original Budget Flexible Budget

Output (units) 900 1,000 900£ £ £

Sales 92,000 100,000 90,000Raw Materials (36,900) (40,000) (36,000)Labour (17,500) (20,000) (18,000)Fixed O/H (20,700) (20,000) (20,000)Profit 16,900 20,000 16,000

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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

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• 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

VariancesStandard Costing

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• 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

VariancesStandard Costing

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• 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

Variance Analysis

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Direct Material Variances

• Material variance = difference between the actual expenditure and budgeted expenditure on direct materials

• Material Budget Variance – Price variance– Usage/Efficiency variance

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Materials Price Variance

Material J

Standard price per metre £4

Standard usage per unit of product 5 metres

Actual price per metre £3

Actual usage per unit of product 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.

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Materials Price VarianceMaterial K

Standard price per metre £9

Standard usage per unit of product 8 metres

Actual price per metre £11

Actual usage per unit of product 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.

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Materials Usage Variance

Material L

Standard price per tonne £5

Standard usage per unit of product 100 tonnes

Actual price per tonne £5

Actual usage per unit of product 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.

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Materials Usage VarianceMaterial M

Standard price per tonne £8

Standard usage per unit of product 60 tonnes

Actual price per tonne £8

Actual usage per unit of product 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 £6

Standard usage per unit of product 25m

Actual price per metre £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 £6

Net variance (£18)

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• 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

Material VariancesWhat caused the variance?

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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

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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.

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Labour Efficiency VarianceProduct 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.

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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

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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 £36

Net variance (adverse / unfavourable) (£56)

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• 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

Direct Labour VariancesWhat caused the variance?