CHAPTER – 11 VARIANCE ANALYSIS (1)

VARIANCE ANALYSIS

Standard costs are used for preparation of budgets. As a part of performance measurement, at end of
period, actual results are compared with budgets. Then the differences are analyzed to the lowest possible
level. This process is called variance analysis. Following major categories of variances are calculated:
 Cost variances:
- Direct material cost variances
- Direct labor costs variances
- Variable overhead variances
- Fixed overhead variances
 Sale variances
After calculation of all variances, a statement is prepared which reconciles budgeted profit with actual
profit incorporating all variances. This statement is called operating statement.
2. COST VARIANCES

2.1) Material variances (single raw material)

Case - I Material quantity purchased = Material quantity consumed
(i) Total material cost variance Here:
= SC x SQ – AC x AQ SC = Standard cost per Kg
OR AC = Actual cost per Kg
= MPV + MQV AQ = Actual total quantity used for actual output
(ii) Material price variance [MPV] SQ = Standard total quantity which should have been used
= AQ x SC – AQ x AC for actual output
(iii) Material usage/quantity variance [MQV]
= SC x SQ – SC x AQ

Case - II Material quantity purchased ≠ Material quantity consumed

(a) If inventory is measured at standard cost (i.e. MPV is recorded at the time of purchase)
(i) Total material cost variance
= SC x SQ – [SC x Opening RM + AC x AQ(purchased) – SC x Closing RM]
OR
= MPV + MQV
(ii) Material price variance
= AQ(purchased) x SC – AQ(purchased) x AC
(iii) Material usage variance
= SC x SQ – SC x AQ(used)

(b) If inventory is measured at actual cost (i.e. MPV is recorded at the time of issuance)
[If nothing is mentioned even then assume this case in question]
(i) Total material cost variance
= SC x SQ – AC x AQ(used)
OR
= MPV + MQV

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (2)

(ii) Material price variance

= AQ(used) x SC – AQ(used) x AC
(iii) Material usage variance
= SC x SQ – SC x AQ(used)

Illustration 1
Standard cost card (per unit):
Direct material 4Kg at Rs. 15 per Kg

Actual data for the month:

Finished goods produced 5,000 units
Material used 22,500Kg
Material purchase cost Rs. 14.25 per Kg

Required:
Calculate (i) Material cost variance (ii) Material price variance (iii) Material usage/quantity variance,
assuming material quantities purchased and used are same.

Illustration 2
Standard cost card (per unit):
Direct material 4Kg at Rs. 12 per Kg

Actual data for the month:

Finished goods produced 6,000 units
Material purchased 25,400Kg (Rs. 10 per Kg)
Material used 25,000Kg

Required:
Calculate (i) Material cost variance (ii) Material price variance (iii) Material usage/quantity variance,
assuming material inventory is valued at standard cost.

2.2) Direct labor variances (single type of labor)

Case - I No separate record of idle time is kept OR Hours worked = hours paid
(i) Total labor cost variance Here:
= SR x SH – AR x AH SR = Standard rate per hour
OR AR = Actual rate per hour
= LRV + LEV AH = Actual total hours used for actual output
(ii) Labor rate variance [LRV] SH = Standard total hours which should have been used
= SR x AH – AR x AH for actual output
(iii) Labor efficiency variance [LEV]
= SR x SH – SR x AH

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CHAPTER – 11 VARIANCE ANALYSIS (3)

Case - II Separate record of idle hours is kept OR Hours worked ≠ hours paid
(a) Idle time is not part of standard cost (i.e. ignored in standard card) (default case in exam)
(i) Total labor cost variance
= SR x SH – AR x AH(paid)
OR
= LRV + LEV + Idle time variance

(ii) Labor rate variance

= AH(paid) x SR – AH(paid) x AR

(iii) Idle time variance

= SR x AH(worked) – SR x AH(paid)

(iii) Labor efficiency variance

= SR x SH – SR x AH(worked)

(b) Idle time is made part of standard cost as a separate element

(i) Total labor cost variance
= SR x SH(paid) – AR x AH(paid) Here:
OR SH (paid) = Standard total hours which should have been
= LRV + LEV + Idle time variance paid for actual output
(ii) Labor rate variance SH (idle) = Standard total hours which should have been
= AH(paid) x SR – AH(paid) x AR remained idle for actual output
(iii) Idle time variance SH (worked) = Standard total hours which should have been
= SH (idle) x SR – AH (idle) x SR worked for actual output
(iv) Labor efficiency variance
= SR x SH(worked) – SR x AH(worked)

Illustration 3
Standard cost card (per unit):
Direct labor 4 hours at Rs. 200 per hour

Actual data for the month:

Finished goods produced 4,000 units
Hours worked/paid 14,800 hours
Labor was paid at a rate 2.5% lower than standard.

Required:
Calculate (i) labor cost variance (ii) labor rate variance (iii) labor efficiency variance.

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (4)

Illustration 4
Standard cost card (per unit):
Direct labor 4 hours at Rs. 200 per hour

Actual data for the month:

Finished goods produced 4,000 units
Hours worked 14,100 hours
Hours paid 14,800 hours
Labor was paid at a rate 2.5% lower than standard.

Required:
Calculate (i) labor cost variance (ii) labor rate variance (iii) labor efficiency variance (iv) idle time variance.

Illustration 5
Standard cost card (per unit):
Direct labor:
Work 3 hours at Rs. 100 per hour
Idle 0.5 hour at Rs. 100 per hour
Paid 3.5 hours at Rs. 100 per hour

Actual data for the month:

Finished goods produced 5,000 units
Hours paid 17,900 hours
Labor actually took 10% more hours of work than standard and was paid at a rate 15% higher than
standard.

Required:
Calculate (i) labor cost variance (ii) labor rate variance (iii) labor efficiency variance (iv) idle time variance.

2.3) VOH variance

(i) Total variable OH cost variance
= SR x SH – AR x AH Here:
OR SR = Standard rate per hour (machine or labor)
= Spending variance + Efficiency variance AR = Actual rate per hour (machine or labor)
(ii) VOH expenditure / spending variance AH = Actual total hours (machine or labor) used for
= AH x SR – AH x AR actual output
(iii) VOH efficiency variance SH = Standard total hours (machine or labor) which
= SR x SH – SR x AH should have been used for actual output

Illustration 6
Standard cost card (per unit):
Variable overheads 5 machine hours at Rs. 20 per hour

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (5)

Actual data for the month:

Finished goods produced 6,000 units
Machine hours worked 33,000 hours
Variable overheads Rs. 759,000.

Required:
Calculate (i) variable OH cost variance (ii) variable OH expenditure variance (iii) variable OH efficiency
variance.

2.4) Fixed OH variance

(i) Total fixed OH cost variance
= Applied fixed OH – Actual fixed OH Here:
AH = Actual total hours (machine or labor) used
OR for actual output
= Spending variance + volume variance SH = Standard total hours (machine or labor) which
(ii) Fixed OH expenditure / spending variance should have been used for actual output
= Budgeted fixed OH – Actual fixed OH BH = Standard total hours (machine or labor) which
would be used for budgeted output
(iii) Fixed OH volume variance Applied fixed OH = SR x SH
= Applied fixed OH – Budgeted fixed OH Budgeted fixed OH = SR x BH

Volume variance can be further analyzed into:

(a) Fixed OH efficiency variance
= SR x SH – SR x AH
(b) Fixed OH capacity variance
= SR x AH – BH x SR
Notes - In case of marginal costing, there is NO fixed OH volume variance

Illustration 7
Standard cost card (per unit):
Fixed overheads 4 labor hours at Rs. 80 per hour

Budgeted production 5,200 units

Actual data for the month:

Finished goods produced 4,500 units
Labor hours worked 19,000 hours
Fixed overheads Rs. 1,615,000.

Required:
Calculate (i) fixed OH cost variance (ii) fixed OH expenditure variance (iii) fixed OH volume variance (iv)
fixed OH efficiency variance (v) fixed OH capacity variance.

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (6)

2.5) Possible causes of cost variances

Variance Reasons for favorable variance Reasons for adverse variance

Material price variance o Different suppliers were used  Different suppliers were used
who charged a lower price than who charged a higher price
the usual supplier. than the usual supplier.
o Materials were purchased in  Suppliers increased their
sufficient quantities to obtain a prices by more than expected.
bulk purchase discount.  There was a severe shortage
o Materials were bought that of the materials, so that
were of lower quality than prices in the market were
standard and so cheaper than much higher than expected.
expected.  Materials were bought that
were better quality than
standard and more expensive
than expected.
Material usage variance o Wastage rates were lower  Wastage rates were higher
than expected. than expected.
o Improvements in production  Poor materials handling
methods resulted in more resulted in a large amount of
efficient usage of materials. breakages.
 Materials used were of
cheaper quality than
standard.
Labor rate variance o Using direct labour employees  An increase in pay for
who were relatively employees.
inexperienced and new to the  Working overtime hours paid
job thus paid less than at a premium above the basic
‘normal’. rate.
o Actual pay increase turning  Using direct labour employees
out to be less than expected. who were more skilled and
experienced thus paid more
than the ‘normal’.
Labor efficiency variance o More efficient methods of  Using employees who are less
working. experienced than ‘standard’,
o Good morale amongst the resulting in adverse efficiency
workforce and good variances.
management which increased  An event causing poor morale.
productivity.
o Incentive schemes are
introduced to encourage
employees to work more
quickly.
o Using employees who are
more experienced than
‘standard’ are able to
complete their work more
quickly.

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (7)

Variable OH spending o Forecast increase in costs not  Unexpected increases in

variance materialising energy prices
Variable OH efficiency o More efficient methods of  Using employees who are less
variance working. experienced than ‘standard’,
o Good morale amongst the resulting in adverse efficiency
workforce and good variances.
management which increased  An event causing poor morale.
productivity.
o Incentive schemes are
introduced to encourage
employees to work more
quickly.
o Using employees who are
more experienced than
‘standard’ are able to
complete their work more
quickly.
Fixed OH spending variance o Good control over overhead  Poor control over overhead
spending. spending.
o Effective budgeting for  Poor budgeting for overhead
overhead spending. spending. If the budget for
o Unplanned decreases in items overhead expenditure is
of expenditure for fixed unrealistic, there will be an
production overheads. expenditure variance due to
poor planning rather than
poor expenditure control.
 Unplanned increases in items
of expenditure for fixed
production overheads.
Fixed OH volume variance o Efficient working by direct  Working more hours than
labour results in a favourable budgeted (capacity variance).
fixed overhead efficiency  An unexpected decrease in
variance. demand for a product, with
o Working less hours than the result that shorter hours
budgeted (capacity variance). were worked.
o An unexpected increase in  Strike action by the
demand for a product, with workforce, resulting in a fall in
the result that longer hours output below.
were worked.  Extensive breakdowns in
machinery, resulting in lost
production.

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (8)

3. SALE VARIANCE
3.1) Sales price variance
= AQ (sale) x Actual price – AQ (sale) x Standard price

3.2) Sales volume variance

(a) Sales profit volume variance [used in case of absorption costing]
= [AQ (sale) – BQ (sale)] x standard profit per unit
(It is used if SCC is prepared on absorption costing)
(b) Sales contribution volume variance [used in case of marginal costing]
= [AQ (sale) – BQ (sale)] x standard contribution per unit

Illustration 8
Standard cost card (per unit):
Rs.
Sale price 25

Material cost 8
Labor cost 4
Variable OH 2
Fixed OH 3

Budgeted sales for the month 9,200 units

Actual sales for the month Rs. 270,000 (Rs. 27 per unit)
Labor hours worked 19,000 hours
Fixed overheads Rs. 1,615,000.

Required:
Calculate:
(i) sale price variance
(ii) sale volume variance, assuming absorption standard costing system is followed
(iii) sale volume variance, assuming marginal standard costing system is followed

Exam notes:
- If not given in question, students should prepare a detailed standard cost card first from
information given in question. It will help in calculating variances.
- If standard cost card is not given but budgeted P&L is given in question, then “per unit costs” from
budgeted P&L will be the standard costs.
- All above formulas are designed so that “positive” answer shows “favorable variance” and
“negative” answer shows “adverse variance”.
- All cost variances are calculated for actual FG production for the period instead of sales.
- If process costing is mixed, then SH/AH and SQ/AQ will be based on "equivalent produced FG
units for the period calculated using FIFO basis" instead of "actual FG units produced for the
period"

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CHAPTER – 11 VARIANCE ANALYSIS (9)

3.3) Possible causes of sale variances

Variance Reasons for favorable variance Reasons for adverse variance

Sale price variance o Actual increases in prices  Actual increases in prices
charged for products were charged for products were
higher than expected due to less than expected due to
market conditions. market conditions.
 Actual sale prices were less
than standard because major
customers were given an
unplanned discount.
 Competitors reduced their
prices, forcing the company
to reduce the prices of its
own products.
Sale volume variance o Actual sales demand was  Actual sales demand was less
more than expected. than expected.
o Sales force worked well and  The products the company
achieved more sales than makes and sells are going out
budgeted. of fashion earlier than
o An advertising campaign had expected.
more success than expected.
o A competitor wound-up its
business and the company
attracted some of the
competitor’s customers.

4. OPERATING STATEMENT [i.e. Reconciliation of budgeted profit and actual profit]

Rs. Rs.
Budgeted GP X
Sale variances:
Sale price variance X
Sale volume variance X X
Cost variances:
Material price variance X
Material usage variance X
Labor rate variance X
Labor efficiency variance X
Labor Idle time variance X
VOH spending variance X
VOH efficiency variance X
FOH spending variance X
FOH volume variance [Only for absorption costing] X X
Actual profit X

Nasir Abbas FCA

CHAPTER – 11 VARIANCE ANALYSIS (10)

Exam notes:
- Add all “favorable variances” and deduct all “adverse variances” in above format.
- Replace "fixed OH efficiency and capacity variances" with "fixed OH volume variance" and
"Material yield and mix variances" with "material usage variance" if separately required in
question.
- If FG and WIP stocks are valued at actual cost then an adjustment is required as follows:
[Actual cost of closing stock - Standard cost of closing stock] XXX
[Standard cost of opening stock - Actual cost of opening stock] XXX

5. ADVANCED VARIANCE ANALAYSIS

5.1) Material mix and yield variances
If a product uses more than one type of direct materials and such materials are substitutable (i.e. less of one type
of material can be compensated by more of another material), then material usage variance is further analyzed
into:
- Material mix variance
- Material yield variance
The total of these two variances is equal to material usage variance.
(i) Mix variance
- Following formula is applied to each RM individually and then totaled:
= [AQ in SM – AQ in AM] x SC
here:
AQ in SM = Actual total, of all material quantities used, split in standard mix
AQ in AM = Actual material quantities used

(ii) Yield variance

- Following formula is applied to each RM individually and then totaled:
= [SQ in SM – AQ in SM] x SC
here:
AQ in SM = Actual total, of all material quantities used, split in standard mix
SQ in SM = Standard material quantity of each material to be used for actual output

Exam notes:
If losses are also incorporated as a part of standard card then “SQ in SM” column is calculated as
follows:
If FG is given units:
SQ in SM = standard material (kg) x Actual FG production (units) / FG units for which standard is
set
If FG is given Kgs:
SQ in SM = standard material (kg) x Actual FG production (Kgs) / FG Kgs of which standard is set

Nasir Abbas FCA