Faculty of Management

Bournemouth University Business School

Department of Accounting, Finance & Economics

Week 5 Lectures: Advanced

Variance Analysis

Dr Akanga
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 Learning Outcomes

 Define and explain the purpose of standard

costs
 Discuss the usefulness of variances
 Calculate and interpret variances

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 Recall

• Planning involves systematically looking at

the future, so that decisions can be made
today which will bring the company its desired
results.
• Control can be defined as the process of
measuring and correcting actual performance
to ensure that plans for implementing the
chosen course of action are carried out.

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 Currently Attainable Standard
Costs
• These standards represent those costs that
should be incurred under efficient operating
conditions. They are standards that are
difficult, but not impossible, to achieve.
Attainable standards are easier to achieve
than ideal standards because allowances
are made for normal spoilage, machine
breakdowns and lost time. Attainable
standards provides the best norm to which
actual costs should be compared.
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 Standard costing and
management by exception
• Standard costs when set are usually average unit
costs. Hence actual results will vary to some extent
above the average. These differences (or variances)
should only be reported if there is significant
difference between actual and standard.
• This costing therefore enables the principle of
management by exception to be practised.
• Management by exception is defined by CIMA as the
practice of concentrating on activities that require
attention and ignoring those which appear to be
conforming to expectations.

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 Setting standards costs

Standards for units of production or

service should be based on careful
investigation and research, and standards
should be continually monitored to ensure
that they are reasonable and reliable.
If there is an inaccuracy in the standard
cost, a comparison of actual against the
standard will provide meaningless and
unhelpful variance information.
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 Purpose of standard costing

• Predicting future costs that can be used for decision

making. Standard costs represents future target costs
derived from the elimination of avoidable inefficiencies
• Provides challenging targets that individuals are motivated
to achieve
• Assist in setting budgets and evaluating managerial
performances.
• Used for control by highlighting those activities that do not
conform to plan and alerting mangers about those
situations that maybe out of control
• Used in tracing costs to products for profit measurement
and inventory valuation purposes.

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 Managing Costs

Standard Actual
cost cost
Comparison between
standard and actual
performance
level

Cost
variance

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 Variance Analysis

• Variance = Standard Costs – Actual Costs

= SC – AC
• The variance could be either a favourable or
an adverse variance:
• A favourable variance arises when the actual
cost is less than the standard cost.
• An adverse (unfavourable) variance arises
when the actual cost is greater than the
standard cost.
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 Cost Variance Analysis

Standard Cost Variances

Price Variance Quantity Variance

(Rate Variance) (or Usage Variance)
(Efficiency Variance)

The difference between The difference between

the actual price and the the actual quantity and
standard price the standard quantity

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 Variances to be analysed
Sales

Direct Direct
Materials Labour

Manufacturing
Overheads
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 1. Direct materials

Price Quantity

Standard

Actual

Purchases Production
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 Direct Materials Cost
Variances
• Total Direct Material Cost Variance =

Standard Costs – Actual Costs

Purchases Manager Production Manager

• Standard Cost = Standard Price × Standard Quantity

SP SQ

• Actual Cost = Actual Price × Actual Quantity

AP AQ
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 Direct Materials Cost Variances

• The Total Direct Materials Variance is split up into

two Subsidiary Variances

1. Price Variance =
(Standard Price – Actual Price) × Actual Quantity
(SP – AP) × AQ
2. Usage Variance =
(Standard Quantity – Actual Quantity) × Standard
Price
(SQ – AQ) × SP

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 Material Price Variance

• Material price variance may arise due to number of

reasons like fluctuations in market prices, error in
buying due to wrong purchasing policy etc,
• This can be calculated by using the following formula,
• Material Price Variance = (SP – AP) x AQ
• Where,
SP  = Standard price per unit of material
AQ  = Actual quantity
AP  = Actual price per unit of material
• A positive result implies favorable variance and a
negative result implies unfavorable variance (adverse
variance).
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 Material usage Variance

• Material Usage variance is the difference between

the actual quantities of raw materials used in
production and the standard quantities that should
have been used to produce the product,

• MUV may arise due to number of reasons like

Pilferage of materials , Wastage , Sub-standard or
defective materials etc,

• This can be calculated by using the following

formula,
• Material Usage Variance = (SQ – AQ) x SP
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 REASONS FOR MATERIAL VARIANCES

Material Price Material Usage

Price has changed Quality was different Careless handling Pilfering

Emergency purchases due More wastage Inferior quality purchased

to poor stock control

Changes in production methods or

quality control requirements

Standard was wrong

Changes in quality could have usage implications

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 Summary

• Direct Material Variance = SC – AC

• Standard Cost = SP × SQ
• Actual Cost = AP × AQ
• Price Variance = (SP – AP) × AQ
• Price Usage = (SQ – AQ) × SP

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 Example 1

• Hanson Ltd has the following direct

material standard to manufacture
product Z:
• 1.5 kgs per product Z at £4.00 per kg
• Last week 1,700 kgs of material were
purchased and used to make 1,000 Zs.
The material cost a total of £6,630.

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 Example 1 Solution

• What is the actual price per pound

paid for the material?
a.£4.00 per kg.
b.£4.10 per kg.
AP = £6,630 ÷ 1,700 kgs.
c.£3.90 per kg. AP = £3.90 per kg.

d.£6.63 per kg.

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 Example 1 Solution Cont.

• What is Hanson’s direct-material price

variance (MPV) for the week?

a.£ 170 unfavourable.

b.£ 170 favourable.
c. £ 800 unfavourable.
d.£ 800 favourable. MPV = AQ(SP - AP)
MPV = (£ 4.00 - 3.90)x 1700 Kgs
MPV = £ 170 favorable

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 Example 1 Solution Cont.

Hanson’s direct-material quantity

variance (MQV) for the week was:
MQV = SP(SQ - AQ)
MQV = £4.00(1,500 kgs - 1,700 kgs)
MQV = £800 unfavorable

a.£170 unfavourable.
b.£ 170 favourable.
c.£ 800 unfavourable.
d.£ 800 favourable.
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 2. Direct Labour

Rate Hours

Standard

Actual

HR Production
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 Direct Labour Cost Variances

• Total Direct Labour Cost Variance =

Standard Costs – Actual Costs

HR Manager Production Manager

• Standard Cost = Standard Rate × Standard Hours

SR SH
• Actual Cost = Actual Rate × Actual Hours
AR AH

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 Direct Labour Cost Variances

• The Total Direct Labour Variance is split up into

two Subsidiary Variances:
1. Rate Variance =
(Standard Rate – Actual Rate) × Actual Hours
(SR – AR) × AH
2. Efficiency Variance =
(Standard Hours – Actual Hours) × Standard Rate

(SH – AH) × SR

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 REASONS FOR LABOUR VARIANCES

Labour Rate Labour Efficiency

Workers more or less efficient

Different grade used Overtime Inferior materials

Short production runs

Different mix of rates
Work flow problems
Machinery not maintained
Planned rate different to negotiated
Changes in production scheduling

Standard was wrong

Changes could occur due to presence of learning curve

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 Summary

• Direct Labour Variance = SC – AC

• Standard Cost = SR × SH
• Actual Cost = AR × AH
• Rate Variance = (SR – AR) × AH
• Efficiency Variance = (SH – AH) × SR

• Total Labour Cost Variance

= (SR x SH) – (AR x AH)
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 Example 2

• Hanson has the following direct labour

standard to manufacture one product
Zzz:
• 1.5 standard hours per Zzz at £10.00
per direct labour hour
• Last week 1,550 direct labour hours
were worked at a total labour cost of
£15,810 to make 1,000 Zzzs.
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 Example 2 Solution

What was Hanson’s Actual Rate (AR)

for labour for the week?

a.£10.20 per hour.

b.£ 10.10 per hour.
c.£ 9.90 per hour. AR = £15,810 ÷ 1,550 hours
AR = £ 10.20 per hour
d.£ 9.80 per hour.

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 Example 2 Solution Cont.

What was Hanson’s labour rate variance

(LRV) for the week?

a.£310 unfavourable.
b.£ 310 favourable.
c.£ 300 unfavourable. LRV = AH(SR - AR)
LRV = 1,550 hrs(£10.00 -
d.£ 300 favourable. £10.20)
LRV = £310 unfavorable

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 Example 2 Solution Cont.

The standard hours (SH) of labour that

should have been worked to produce
1,000 Zzzs is:

a.1,550 hours.
b.1,500 hours.
c.1,700 hours. SH = 1,000 units × 1.5 hours per unit
SH = 1,500 hours
d.1,800 hours.
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 Example 2 Solution Cont.

Hanson’s labour efficiency variance (LEV)

for the week was: LEV = SR(SH - AH)
LEV = £10.00(1,500 hrs - 1,550 hrs)
LEV = £500 unfavorable

a.£510 unfavourable.
b.£510 favourable.
c.£500 unfavourable.
d.£500 favourable.

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 3. SALES VARIANCES

Sales Variances should be calculated in terms of contribution

profit margins rather than sales revenues.

Budgeted sales =10,000 units × £11 = £110,000

Standard and actual cost per unit = £7
Actual sales =12,000 units × £10 = £120,000

Budgeted contribution margin = 10,000 × £4 = £40,000

Actual contribution margin = 12,000 × £3 = £36,000

NB. Objective is to maximise profits (not sales value)

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 SALES VARIANCES (cont’d)

• Where the variable cost is the same:

Sales Margin Price = (Actual Price – Budgeted Price) × Actual Volume
= (AP – BP) × AV
• Where variable cost is different:
Sales Margin Price = (Actual Margin – Budgeted Margin) × Actual
Volume
= (AM – BM) × AV

Sales Margin Volume = (Actual Volume – Budgeted Volume) ×

Standard Margin
= (AV – BV) × SM

It is difficult to interpret sales margin variances, there is a strong link

between price & volume. Changes may result from external factors,
competitors, economy.

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 Example 1

• The budgeted sales for a company are £110,000 consisting of

10,000Units at £11 per unit. The standard cost per unit is £7. Actual
sales are (£120,000) consisting of 12,000 units at £10 Per unit and
the actual cost per unit 7

• Calculate the:
• Budgeted sales
• Actual sales
• Sales volume variance
• Sales price variance
• Over all variance

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 Example 1 Solution

Going back to our example:

Budgeted sales =10,000 units × £11 = £110,000

Standard and actual cost per unit = £7
Actual sales =12,000 units × £10 = £120,000

Sales volume variance:

a)£8,000 F
b)£8,000 A SVV = (ASQ - BSQ)*SC
SVV = (12,000- 10,000)(£11- £7)
c)£8,500 F SVV = £ 8,000 favorable

d)£8, 500 A
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 Example 1 Solution

Sales price variance:

a.£11,000 F
b.£11,000 A
c.£12,000 A
d.£12,000 F SPV = (AP-SP) x AQ
SPV = (£10 - £11)*12,000
SPV = £ 12,000 A

Overall Price Variance = £8,000 – £12,000

= £4,000 A
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 SALES VARIANCES

The formulae that you may use to calculate sales

variances are as follows:
Sales Price Variance
•= (Actual selling price per unit – Standard selling price
per unit) X Actual sales quantity
•=(AP-SP) x AQ
Sales Volume variance
(Actual sales quantity – budgeted sales quantity)x
standard contribution per unit
= (AQ –BQ) X SC

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 Example 2

• A company budgets to sell 8,000 units of product J for

£12 per unit. The standard variable cost per unit is £7.
Actual sales were 7,700 units at price of £12.50 per
unit.

SPV = (AP-SP) x AQ
= (12.50-£12.00)*7,700
= £3,850 (F)
SVV = (AQ-BQ)X SC
= (7,700 – 8000) x (£12-£7)
= £1,500 (A)
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 4. Manufacturing Overhead
Variances
• Whereas direct materials and direct labour are
variable costs, manufacturing overhead is
comprised of both variable and fixed cost
components. Therefore, the analysis of the
overhead cost variance differs somewhat from
the analysis of materials and labour variances.
• There are two elements of the overhead cost
variance:
1. The Variable Overhead Variance; and
2. The Fixed Overhead Variance.

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 Manufacturing Variable
Overhead Variances
• Total Var. Overhead Variance = SC – AC
• Standard Cost = SR × SH
• Actual Cost = AR × AH
• Rate Variance = (SR – AR) × AH
• Efficiency Variance = (SH – AH) × SR

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 Manufacturing Fixed Overhead
Variances
• Total Fixed Overhead Costs Variance =

Budgetary Fixed Costs Actual Fixed Costs

Note that no one is responsible for this

variance because it results from scheduling
production at any level other than normal

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 Example

• Auto plc manufactures motorbikes. The

following is an extract from its last budgetary
period:
• Actual production: 275,000 units
• Budgeted production: 250,000 units
• Actual Fixed overheads: £526,000,000
• Budgeted fixed overhead; £50,000,000
• Calculate fixed overhead variance

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 Solution

• Fixed overhead absorption rate:

budgeted fixed overheads
budgeted output
• 50,000,000/250,000 = £2,000
Budgeted Fixed Overhead - Actual Fixed overhead
526,000,000 – 275,000*2,000
526,000,000 – 550,000,000 = £240,000,000

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 5. Variance Report: An Illustration
Example
• The following table summarises the standard costs to
be incurred in manufacturing one unit. It is planned that
the level of production would be 700 units in total.

Direct materials (2.64 kg at £25 per kg) £66

Direct labour (1.5 direct labour hours at £12 per £18
hour)
Manufacturing overhead:
Fixed (£5 600 per month / 700 units) £8
Variable (£4 per direct labour hour * 1.5 hour) £6 £14

Standard cost per unit £98

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 Variance Report: An Illustration
Example
• During March, the company experienced several production delays.
As a result, only 600 units were produced. Total manufacturing
costs actually incurred to produce 600 units during the month were
as follows:
Direct materials (1 800 kg at £20 per kg) £36 000
Direct labour (1 080 direct labour hours at £13
per hour) £14 040
Manufacturing overhead:
Fixed £4 880
Variable £3 780
£8 660

Actual total cost of finished goods £58 700

manufactured
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 Variance Report: An Illustration
Example
• By comparing the actual costs incurred in March to the
standard costs allowed to actually produce 600 units, we can
determine the total cost variance for the month as follows:
Actual total cost for March (from above) £58 700
Standard cost allowed for producing 600 units (600 units * £98) £58 800

Total favourable cost variance (actual costs are less than standard) £100

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 Materials Price and Quantity
Variances
• In establishing the standard material cost for
each unit of product, two factors are considered:
• (1) the quantity of materials required and
• (2) the prices that should be paid to acquire
these materials.
• Therefore, a total cost variance for materials
can result from differences in the quantities
used, in the prices paid to suppliers, or a
combination of these factors.

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• Total Direct Material Cost Variance =

Standard Costs – Actual Costs

• Standard Cost = SP × SQ
= £25 × ( 2.64
---- -------kg × 600 units)
----------
= £25 × 1 584 kg = £39 600
• Actual Cost = AP × AQ -
£20 × -------------
= ----- 1 800 kg = £36 000
Total Direct Material Variance = £3 600
Favourable Variance
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• This favourable variance of £3 600 is then split
up into two subsidiary variances as follows:

1. Price Variance 2. Usage Variance

(SP – AP) × AQ (SQ – AQ) × SP
-------------------------- ---------------------------------
(£25 - £20) × 1 800 kg (1 584 kg – 1 800 kg) × £25
= £9 000 = - £5 400
Favourable Variance Adverse Variance
Purchases agent Production manager

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Variances £ £
1: Direct Material:
Price Variance £9 000 (F)
---------
Usage Variance ---------
£5 400 (A)
£3 600 (F)
----------
2: Direct Labour:
Rate Variance
Efficiency Variance

3: Variable Overhead Variance:

Rate Variance
Efficiency Variance

4: Fixed Overhead Variance

Total Variances

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 Labour Rate and Efficiency
Variances
• In establishing the standard labour cost for
each unit of product, two factors are
considered:
• (1) the time required to produce each unit, and
• (2) the rate that should be paid to each hour.
• Therefore, a total cost variance for labour
can result from differences in the hours
required, in the rates paid, or a combination
of these factors.

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 Labour Rate and Efficiency
Variances
• Total Direct Labour Cost Variance = Standard Costs – Actual

Costs
• Standard Cost = SR × SH
= £12
600 units
1.5 hours × --------------
--- × ( ------------- )
= £12 × 900 hours = £10 800
• Actual Cost = AR × AH -
=
£13 1 080 hours =
----- × --------------------- £14 040
Total Direct Labour Variance = - £3 240
Adverse
Variance
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 Labour Rate and Efficiency
Variances
• This adverse variance of £3 240 is then split up into two
subsidiary variances as follows:

1. Rate Variance 2. Efficiency Variance

(SR – AR) × AH (SH – AH) × SR
-------------------------------- --------------------------------------
(£12 - £13) × 1 080 hours (900 hrs – 1 080 hrs) × £12
= - £1 080 = - £2 160
Adverse Variance Adverse Variance
HR manager Production manager

Note that the total of the subsidiary variances

must be always equal to the total variance, that is
-£1 080 + - £2 160 = - £3 240
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Variances £ £
1: Direct Material:
Price Variance £9 000 (F)
---------
Usage Variance £5---------
400 (A)
£3 600 (F)
----------
2: Direct Labour:
Rate Variance £1 080 (A)
----------
Efficiency Variance ----------
£2 160 (A)
----------
£3 240 (A)
3: Variable Overhead Variance:
Rate Variance
Efficiency Variance

4: Fixed Overhead Variance

Total Variances
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 Manufacturing Overhead
Variances
• There are two elements of the
overhead cost variance:
1. The Variable Overhead Variance; and
2. The Fixed Overhead Variance.

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 Variable Overhead Variance

1. Total Variable Overhead Cost Variance = Standard Costs – Actual

Costs
• Standard Cost = SR × SH
= £4
---- × 1.5 hours × 600
( ------------- units )
-----------
= £4 × 900 hours = £3 600
• Actual Cost = AR × AH -
= £3.5 1 080 hours
------ × ---------------- = £3 780
Total Variable Overhead Variance = - £180
Adverse
Actual rate = Actual costs / Actual Hours Variance
= £3 780 / 1 080 = £3.5
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 Variable Overhead Variance

• This adverse variance of £180 is then split up into two

subsidiary variances as follows:

1. Rate Variance 2. Efficiency Variance

(SR – AR) × AH (SH – AH) × SP
(£4 - £3.5) × 1 080 hrs (900 hrs – 1 080 hrs) × £4
= £540 = - £720
Favourable Variance Adverse Variance
Production manager Production manager
Note that the total of the subsidiary variances
must be always equal to the total variance, that is
£540 + - £720 = - £180
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 Variance Report
Variances £ £
1: Direct Material:
Price Variance £9 000 (F)
---------
Usage Variance £5 400 (A)
---------
----------
£3 600 (F)
2: Direct Labour:
Rate Variance £1 080 (A)
----------
Efficiency Variance ----------
£2 160 (A)
£3 240 (A)
----------
3: Variable Overhead Variance:
Rate Variance £540 (F)
---------
Efficiency Variance £720 (A)
---------
£180 (A)
----------
4: Fixed Overhead Variance

Total Variances
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 Fixed Overhead Variance

• Total Fixed Overhead Costs Variance =

Budgetary Fixed Costs
--------------------------- – Actual Fixed Costs
-----------------------
• Budgetary Fixed Costs (£8 × 600 units) = £4 800
• Actual Fixed Costs for March = £4 880
-
• Total Fixed Overhead Variance = - £80
Note that no one is responsible for this variance because it
results from scheduling production at any level other than normal
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Variances £ £
1: Direct Material:
Price Variance £9 000 (F)
---------
Usage Variance £5 400 (A)
---------
£3 600 (F)
----------
2: Direct Labour:
Rate Variance £1 080 (A)
----------
Efficiency Variance £2 160 (A)
----------
£3 240 (A)
----------
3: Variable Overhead Variance:
Rate Variance £540 (F)
---------
Efficiency Variance £720 (A)
---------
----------
£180 (A)
4: Fixed Overhead Variance £80 (A)
---------

£100
Total Variances ----------
(F)
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 Mix and Yield Variances:
Materials and Labour
• Mix variance: created whenever the
actual mix of inputs differs from the
standard mix

• Yield variance: occurs whenever the

actual yield (output) differs from the
standard yield

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 Mix and Yield Variances:
Materials and Labour
• Combining two or more mix of raw materials to
affect yield
• Start by determining the estimated cost of
different raw materials and the mix that
minimises output per unit cost while still
meeting standard requirements
• Changes in prices of raw materials can lead to
deviations in the standard mix of materials thus
affect yield and output per unit cost

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 Direct Materials Mix Variance

• Direct material mix occurs when the mix of

materials used in production differs from
predetermined standard mix used in cost
calculation
• If relatively more of a more expensive
input is used, the mix variance will be
unfavorable
• If relatively more of a less expensive input
is used, the mix variance will be favorable.
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 Direct Materials Mix Variance

• It can be represented by the following

formula:
• Material mix variance =
(Actual quantity in standard mix proportion – actual
quantity in actual mix proportions) x standard price

• (AQSM – AQAM)*SP

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 Material Yield Variance

• This variance compares the actual yield

(AY) obtained from the actual quantity
(AQ) input and the yield that was
expected (expected yield is standard
yield - SY) from the actual quantity (AQ)
input, the difference is valued at standard
cost of output.

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 Material Yield Variance

• It can be represented by the following

formula:
• Material yield variance  =
(Actual yield from actual quantity input – Standard
yield from actual quantity input) x standard cost

• (AYAQ – SYAQ)*SC

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 Material Mix and Yield
Variances: An Example
• XYZ Company Ltd. has established the following
standard mix for producing 9 Litres of product A
• (Notice that the table does not give standard cost
information per unit of output but instead it gives
standard information per 9 units of output)
• 5 Litres of material x at £7 per litre 35
• 3 Litres of material y at £5 per litre 15
• 2 Litres of material z at £2 per litre 4
54
• A standard loss of 10% of input is expected to occur.
Actual input was.
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 Material Mix and Yield
Variances: An Example
• 53000 litres of material x at £7 per litre 371,000
• 28000 litres of material y at £5.30 per litre 148,400
• 19000 litres of material x at £2.20 per litre 41,800
561,200
• Actual output for the period was 92,700 litres of
product A.
• Required
• Compute the direct material mix variance and direct
material yield variance.

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 Solution

• Material Mix Variance = (AQSM – AQAM)*SP

• X = (100,000*(5/10) – 53,000)*7 = 21,000 A
• Y= (100,000*(3/10) – 28,000)*5 = 10,000 F
• Z = (100,000*(2/10) – 19,000)*2 = 2,000 F
Total material mix Variance = £9,000 A
• Material Yield Variance = (AYAQ – SYAQ)*SC
• = (92,700 – 100,000*0.9)*(54/9) = 16,200 F
• Material Usage variance = 9,000A + 16,200F = 7,200F

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 Causes of Variances

• Material mix variance comes about when more of

the cheaper material is used in production (for a
favourable variance) reasons for this could be:
 Change in production manager’s strategy
 Change in standard specification for the product
 Intent of altering the quality of the product
 Availability/scarcity of certain materials

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 Causes of Variances

• Material yield variance on the other hand

occurs when the actual yield is different from
expected given actual quantity input into a
production process. Causes could be (but not
limited to)
 The mix of materials used
 (In)efficiency of the process
 (In)efficiency of employees
 Change of material quality

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 Sales mix and yield variances

• Applies to sales generated from different products with

different contribution margins
• Measures shifts between selling more or less of higher
or lower profitable products
Actual
Units of Actual Budgeted Budgeted
Sales-Mix
Variance = All X Sales-Mix Sales-Mix X Contribution
Products Percentage Percentage Margin per Unit
Sold

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 Sales-quantity variance

• Presented here is the formula for the sales-quantity

variance. This variance in conjunction with the
sales-mix variance explains the sales-volume
variance.

Actual Budgeted Budgeted Budgeted

Sales- Units of All Units of all
Quantity = Sales-Mix Contribution
Products Products X Percentage
X
Margin per Unit
Variance Sold Sold

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 Reading List

• Drury, C. (2015), Management & Cost

Accounting, 9th Edition, Chapter 17

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