024 Variances in Materials Price Quantity

CONTROLLING COSTS OF DIRECT MATERIALS

Using standard costs to compute variances is an effective method of controlling the costs of direct
materials.

To illustrate the computation of the price and quantity variances for direct materials, let’s get into the
boating business. We’re going to manufacture a fishing boat. The standard cost for direct materials &
direct labor cost for this fishing boat are shown here:

In this topic, we’re only going to examine materials variances. We will use this example as well when we
get to analyzing labor variances in the next section.

Now, the company manufactured 100 boats during the period in question and used the following direct
materials to manufacture these boats and used the following DM to manufacture these boats.
10,150 board ft of wood had a cost of $9.60/ft (given), turns out the company also used 3,925 board ft
of fiberglass at a cost of $5.20/ft (given). Now obviously, many different kinds of RMs are required to
make boats. For simplicity, we assume only 2 materials are used.

So how did the company do with regard to its use of materials? We can compute how much material the
company should have used and how much material that it should have cost, and compare that to what
the company did use and what it did cost as shown here.

As we can see, the company spent more on wood than was expected. But is that it? Was the difference
because we used more or less than expected? Or because we paid more or less than expected? Or was it
a combination of the two?

We can break the difference down into 2 components:

MATERIALS PRICE VARIANCE

The materials price variance reflects the extent to which the actual price varies from the standard price
for the actual quantity of materials purchased or used. The price variance is computed by:

In this case, the materials price variance (for wood) is computed as follows:

The F indicates a favorable variance. The wood cost us less than we had expected. Doing the same
computation for fiberglass results in: (Meaning that the fiberglass cost more than what we expected)

Essentially if the actual price is more than the expected price, then we have an unfavorable variance.
And if the actual price is less than the expected price, then the variance is favorable.

It then makes sense to multiply the difference between these 2 prices by the actual quantity in order to
measure the total financial impact on the organization of paying a price or rate that is more or less than
was expected.

The standard quantity of material should reflect the amount needed for each completed unit of
product, but should allow for normal waste, spoilage, and other unavoidable inefficiency.

MATERIALS QUANTITY VARIANCE

Now the materials quantity variance compares the actual quantity of inputs to the standard quantity of
inputs allowed for actual output. Note one important concept: (Quantity allowed for actual output)

At the end of the period the accountant will multiply the standard quantity of materials per boat by the
actual volume of boats produced to determine the standard quantity allowed.
This number is then compared to the actual quantity of wood used to determine if there is a favorable
or an unfavorable quantity variance for materials. The accountanct will multiply this variance by the
standard price per wood in order to account for this variance in the accounting system as follows:

The unfavorable quantity variance for wood indicates that company used more wood than expected.

Doing the same thing for fiberglass: (with the F indicating that the company used less material than was
expected)

Now, note that the 2 variances add up to the total difference computed earlier.

The advantage of breaking down the total difference in its price and quantity components is that that
helps us determine who to speak to about the difference. Different people control the different
variances.
025 Labor Rate & Efficiency Variances

Typically when a standard cost system is being used in a manufacturing or service firm, a DL rate
variance and a DL efficiency variance are determined for employees directly involved in the creation of
the organization’s product or service. These variances are computed in a manner very similar to the
materials price & quantity variances.

We will now continue our boat manufacturing example to illustrate how labor variances are computed.

Actual labor used during the year to make 100 boats 7,880 hrs (given) at an average rate of $20.50/hr. It
looks like we had paid more for DL than we had planned. We can break this overall unfavorable variance
down into its 2 parts:
1. Rate
2. Efficiency

LABOR RATE VARIANCE

A labor rate variance is a price variance. It shows the difference between standard & actual wage rates.
Unfavorable labor rate variances may occur when:
1. Skilled workers with high hourly pay rates are placed in jobs intended for less skilled or lower
wage rate employees; or
2. When employees work overtime at premium pay, such as time and a half or double time

Conversely, favorable rate variances occur when less skilled or lower wage rate employees perform
duties intended for higher paid workers.

The labor rate variance is computed by:

This unfavorable variance resulted from our paying more than was expected. As this variance indicates,
the .50 difference between the standard wage rate and the actual average wage rate results in $3,940
more being spent than what is expected, given the actual number of DL hour used. Management now
needs to determine whether the variance should be investigated.

Depending on the company’s hiring policies and the degree of authority given to the operating manager
in setting wage rates & assigning workers to particular jobs, the operating manager may or may not be
responsible for this labor rate variance. This is because labor rates are often the responsibility of the
personnel manager who makes hiring & staffing decisions.

LABOR EFFICIENCY VARIANCE

The labor rate variance is a quantity variance. It measures the cost or benefit of using labor for more or
fewer hours as prescribed by the standard.

Computed in the same manner as materials quantity variance, the labor efficiency variance computation
is as follows: (with the F indicating that a favorable variance resulted from the company resulting to
fewer hours than what was expected)
(Note that total standard hrs are computed by multiplying the standard hrs per boat by the actual
number of boats produced, that is 80 hrs x 100 boats = 8,000 standard hrs.)

The manufacturing division used 120 less DL hrs than the standard allowed for the actual production
output which resulted in a favorable efficiency variance of $2,400.

“The labor efficiency variance shows how efficiently the workers performed.”

This variance might be unfavorable for a variety of reasons:

The labor efficiency variance is usually watched very closely by most organizations.

Again, note that the 2 variances add up to the total difference computed earlier.

The advantage in breaking down the total difference into its rate and efficiency components is that it
helps us determine who to speak with about the differences.
026 Controlling Materials & Labor Variances

MATERIALS PRICE VARIANCES

Materials price variances are usually under the control of the purchasing department.

The purchasing function involves:

Some of these factors will be less important when there are few suppliers or when purchasing contracts
with suppliers are for long periods of time. In any case, the existence of unfavorable price variances may
suggest a problem that needs correcting.

On the other hand, favorable price variances may also indicate if there’s a problem in the purchasing
process, such as:
1. The purchase of low quality materials, or
2. Purchasing too much material in order to get a larger bulk discount

The buyer responsible for purchases should be able to explain any variance from standard prices even
though the buyer may not be able to control its occurrence.

The point is that the cause of any significant variance (whether favorable or unfavorable) must be
explained and steps taken to avoid such variances in the future.

MATERIALS QUANTITY VARIANCES

Materials quantity variances may be caused by:

1. Quality defects
2. Poor workmanship
3. Poor choice of materials
4. Inexperienced workers
5. Machines that need repair, or
6. An inaccurate material’s quantity standard

Just as the purchasing manager must explain significant price variances, generally the production
manager must analyse significant quantity variances to determine their cost.

Again, the cause of the variance must be determined – only then can it be decided what action to take
to prevent this in the future.

Further, production managers should receive constant reports on these variances in order to maintain
good control of cost and usage. If this is done, production managers can take quick corrective actions
before problems become significant in size. Corrective action, for example, may involve being careful to
return excess materials to the store room rather than being careless about controlling the production
area which can then lead to waste or theft.

LABOR RATE VARIANCES

Now, labor rate variances are normally the responsibility of either the production manager (who’s
responsible for employees’ work and assignments) or the hiring manager ( the individuals responsible
for hiring employees). Deviations may be necessary in certain situations because of vacation, sickness,
or absence of other employees.

If these variances are caused by factors beyond the manger’s control, he/she should not be held
responsible for the unfavorable variance.

In a labor-intensive company, the labor efficiency variance is much more important than in a company
that has low labor cost. Depending on the intensity of management attention to labor cost, the related
variances can be separated into categories by cost, so that judgments can be made about what
corrective action should be taken.