Chapter – 10 Variance Analysis

1. Chapter Introduction

2. Variance Introduction

3. Variable & Fixed Overhead Cost Variance

4. Direct Labour rate & Efficiency Variance

5. Direct Material Price & Usage Variance

6. Practical Problems


1.   Chapter Introduction:

Profitability of a business enterprise depends basically on two factors: costs and sales. The efforts of the management should be to minimize the cost without compromising on the quality and pushing up the sales of the products. This requires proper monitoring of both costs & sales performances. Targets have to be fixed and the actual results should be compared with the pre-determined targets and variance found out.

Variance refers to the difference between the standard (or budgeted performance) and actual performance. Variance analysis is mainly concerned with ascertaining the quantum of variances together with the analysis of the causes responsible for such variances.

2. Variance Introduction:

A Variance is the difference between the actual cost and standard cost. If the effect of the variance is to increase the profit, the variance is said to be favorable. In the reverse case, it is adverse or unfavorable.

Variances are of two categories, those relating to quantities which are the result of efficiency or inefficiency in the use of material, labour etc., and those relating to price or rates. The first mentioned category of variance is calculated as follows:

Standard rates x Difference between actual and standard quantities.

The second type of variance is calculated as follows:

Actual quantities x Difference between actual and standard prices.

The variances may be classified into two categories:

  1. Cost Variances
  2. Sales Variances
1.  Cost Variances :

1. Materials Variances



How it is calculated?

(i ) Materials cost variance

It shows the difference between the standard cost of direct material specified for the production achieved, whether completed or not and the actual cost of materials used.

Difference between standard cost and actual cost for actual output. Here standard cost means standard cost of materials for actual output.

(ii) Materials price variance

Showing excess amount spent or the amount saved due to a change in price.

Actual quantity x Difference between actual and standard price.

(iii) Materials usage variance

Showing to what extent there is wastage or saving in use of materials.

Standard price x Difference between actual and standard quantities of material.

(iv) Materials mix variance

Showing the difference because of a change in the proportion of various materials used.

Total actual quantity x Difference between the standard cost per unit of the standard mix and the standard cost per unit of the actual mix.

(v) Materials yield variance

Showing the difference between the actual output and the output which should have resulted from actual input.

Standard rate of yield x Difference between standard yield and actual yield.

Labour variances: These are similar to material variances.



How it is calculated?

1. Labour Cost Variance

It shows the difference between the standard wages specified for the actual production, whether completed or not, and the actual direct wages incurred.

Difference between the standard cost of standard hours for actual output and actual labour cost.

2. Wage rate variance

Showing the difference made to the wages spent because of a change in wage rates.

Actual number of hours x Difference between the actual and standard wage rates.

3. Labour idle time variance

Loss due to the idle time (abnormal)

Abnormal idle time x Standard wage rates.

4. Labour efficiency variance

Loss or saving due to changes in the level of efficiency.

Standard wage rate x Difference between the actual time spent (deducting abnormal idle time, if any) and standard time.

5. Labour mix variance

Difference made to the total wages spent due to a change in the proportion of various skills of labour

Actual time x Difference between standard wage cost per unit of standard mix and standard wage cost per unit of actual mix.

Overhead variances

Overhead variances arise due to the difference between actual overheads and absorbed overheads. Thus if we have to calculate an overhead variance, we have to know the amount of the actual overheads and that of absorbed overheads.

The actual overheads can be known only at the end of the accounting period, when the expense accounts are finalised. The absorbed overheads are the overhead charged to each unit of production on the basis of a pre-determined overhead rate. This predetermined overhead rate is also known as standard overhead recovery rate, standard overhead absorption rate or standard overhead burden rate. To calculate the standard overhead recovery rate, we have to first make as estimate of the likely overhead expenses for each department for the next year. The estimate of budget of the overheads to be divided into fixed and variable elements. An estimate of the level of normal capacity utilisation is then made either in terms of production or machine hours or direct labour hours. The estimated capacity level to calculate the pre-determined overhead absorption rate as shown below divides the estimated overheads:

Standard Fixed Overhead Rate = Budgeted Fixed Overheads/Normal Volume

Standard Variance Overhead Rate = Budgeted Variable Overheads/Normal Volume


2. Sales Variances : The Sales variances can be computed in the two following ways:

  1. Sales turnover or value method
  2. Profit of sales margin method
Sales turnover or sales value method: In the sales turnover or sales value method, the variances are computed on the basis of sales value. This method will give the sales manager an idea of the effect of various factors affecting sales such as prices, quantity and sales mix on the overall sales value.

The sales value variances are more or less similar to material cost variances or labour cost variances.

1. Firstly, the total sales value variance is to be calculated. Obviously, this is the difference between the actual sales and budgeted sales. The variance can be bifurcated into sales price variance and sales volume variance.

2. Sales price variance can be calculated as below:

Actual quantity X (Actual price - Budgeted price) or Actual sales minus actual quantity at budgeted price.

3. Sales volume variance can be calculated by the following formula:

Budgeted price X (Actual quantity - Budgeted quantity) or Actual quantity at budgeted price minus budgeted sales.

As in the case of materials, the sales volume variance can be bifurcated into sales mix variance and sales quantity variance. The former shows the difference in sales value due to the fact that the actual sales mix is different from what was expected as the budgeted mix. The latter shows the effect of total quantity being larger or smaller than what was budgeted.

For calculating the sales mix variance, we have to calculate the average budgeted price per unit of budgeted mix and the budgeted price per unit of actual mix.

The sales mix variance can then be calculated as below:

Actual quantity x (Budgeted price per unit of budgeted mix minus Budgeted price per unit of actual mix)

The sales quantity variance can be calculated as below:

Budgeted price per unit of budgeted mix x (Budget total qty. - Actual total qty.)

Profit or sales margin method - The purpose of measuring the variances under this method is to identify the effect of changes in sale quantities or selling prices on the profits of the company. The quantity and mix variances should be analyzed in conjunction with each other because the sales management is responsible for both these variances. Where a company is engaged in the manufacture and sale of multiple products, the variances between budgeted sales and actual sales' may arise due to the following reasons:

(a) Changes in unit price and cost.

(b) Changes in the physical volume of each product sold. This is quantity variance.

(c) Changes in the physical volume of the more profitable or; less profitable products. This is mix variance.

There are five distinct variables that can cause actual performance to differ from budgeted performance. They are:

(a) Direct substitution of products.

(b) Actual quantity of the constituents of sales is different from the budgeted quantity.

(c) Actual total quantity being different from budgeted total quantity.

(d) Difference between actual and budgeted unit cost.

(e) Difference between actual and budgeted unit sale price.

The sales management should consider particularly the interaction of more than one variable in making decisions. For example, decrease in selling price coupled with a favorable product quantity variance may help to assess the price elasticity of demand. The formulae for the calculation of sales margin variances are as under:

(a) Total sales margin variance (TSMV): It is the difference between the standard margin and the actual margin.

(b) Sales margin price variance (SMPV): This variance arises because of the difference between the standard price of the quantity actually sold and the actual price thereof.

SMPV = Actual quantity X (Std. margin per unit - Actual margin per unit).

(c) Sales margin volume variance (SMVV): This variance arises because of the difference between the budgeted and actual quantities of each product both evaluated at standard margin.

SMVV = Std. margin per unit X (Budgeted units - Actual units sold)

This can be further sub-divided into the following two variances:

(d) Sales margin quantity variance (SMQV): This variance arises because of the difference between the budgeted quantity and the actual quantity and is ascertained by multiplying this difference by standard margin per unit of standard mix.

(e) Sales margin mix variance (SMMV): This variance arises because of the change in the quantities of actual sales mix from budgeted sales mix and can be computed as below: .

SMMV = Total actual quantity sold X (Standard margin per unit of standard mix Standard margin per unit of actual mix)

Objective of Computation of Variance:

As we all know that profit making is the prime objective of a business enterprise, which depends basically on two factors i.e. Costs and Sales. In order to achieve better performance, it is necessary that a business lay down target in respect of both of them. Variance analysis is intimately connected with budgetary control that helps the management in:

  1. Planning future activities
  2. Comparing actual performance with the budgeted performance
  3. Identifying the variances as to their causes
  4. Ensuring that remedial measures are taken at appropriate time.

Control of Variance:

After the variances have been computed and analyzed, the next logical step for the management is to trace the responsibility for the variances to particular individuals or departments. The Management/Cost Accountant may be required to prepare necessary report for this purpose. The report submitted to the management should clearly indicate where action is required. On the basis of this report, the management will try to identify the specific individuals for adverse controllable variances, which being within their control could have avoided. It was earlier mentioned that certain factors, such as changes in market conditions, demand and supply position, etc. are beyond the control of managers. Hence, action to pinpoint responsibility for such uncontrollable variances is not called for.

In case of controllable variances, the responsibility could be traced as shown below to the different departments for different variances:

Variance Department to be held responsible




Purchasing Department

Quantity or Grade

Stores, Purchase or Process Department

Waste, scrap or spoilage

Production Department





Rate – for difference in rates

Personal Department

for work requiring higher rates to pay

Production Department

Time – lack of proper supervision

Production Department






Sales Department


Production Department



Higher rates of indirect worker

Personnel Department

Higher prices of indirect materials

Purchasing Department

Higher consumption of indirect materials

Production Department

Excessive expenditure in factory

Production Department

Excessive expenditure for selling and distribution

Selling Department





Price and Volume

Selling Department
It may be noted that variance analysis, in itself, would not help in achieving the desired objective of minimizing costs, unless managerial action is prompt and is in the right direction. The direction, of course, shall be indicated by the analysis of variances, but it is the executive side which would be responsible for taking immediate action, exercising proper control, having a close watch over operations, etc., so that economies may be effected inefficiencies minimized and performance improved. A continuous and rigorous effort in the direction of cost control would help the management to achieve the goal of standard costing.

Q. What is variance? Why are variances computed? (Jan. 01)

Please refer to the previous question for details.

3. Variable & Fixed Overhead Cost Variance:


Q. Distinguish between variable overhead cost variance and fixed overhead cost variance. Why are such variances caused? (June 00)


Variable Overhead Cost Variance (VOCV):

It is the difference between standard variable overheads for actual output (or recovered variable overheads) and actual variable overheads.

VOCV = Recovered Variable Overheads – Actual Variable Overheads

Causes of Variance: This variance may be due to advance payment of expenses, or outstanding expense or payment of past outstanding expenses during this period, or on account of certain abnormal expenses incurred such as, repairs of machinery due to breakdown, expenses due to spoilage or defective workmanship or excessive overtime work, etc.

Fixed Overhead Cost Variance (FOCV):

It is the difference between standard fixed overheads for actual output (or recovered overheads) and actual fixed overheads.

FOCV = Recovered Fixed Overheads – Actual Fixed Overheads

Causes of Variance: Difference between actual and recovered fixed overheads may be on account

  1. A higher or lower amount of fixed overheads, compared to budgeted fixed overheads, might have been incurred for the same production during the same period.
  2. The same amount of fixed overheads might have been incurred for a higher or lower production that the budgeted production during the same period.



4. Direct Labour rate & Efficiency Variance:



Q. Distinguish between direct labour rate variance and direct labour efficiency variance. What causes any lead to direct labour efficiency variance? (Dec. 01)

Direct Labour Rate (Wages) Variance: It is that portion of direct labour variance which is due to the difference between the standard or specified rate of pay and actual rate paid.



Direct Labour rate variance (DLRV) = Actual time x (Standard rate - Actual rate)

Direct Labour Efficiency (time) Variance: It is that portion of the direct labour variance which is due to the difference between the standard labour hours specified for the activity achieved and the actual labour hours expended.



Labour Efficiency variance = Standard Rate (Standard time - Actual time)

Labour Efficiency variance may be caused due to the following:

  1. Defective or bad materials.
  2. Breakdown of plant and machinery.
  3. Failure of power.
  4. Efficient working by the labourers and fuller utilization of time due to incentives given.
  5. Loss of time due to delayed instructions from management or delay in receipt of raw materials.
  6. Alteration in the method of production.
  7. More time taken by workers due lack of proper supervision and control by management, making the workers lazy and inefficient.
  8. Rigid system of inspection.
  9. Poor working conditions.
  10. Lower productivity due to lack of training, ability, or experience on the part of workers.
  11. Labour turnover or change-over of workers from one operation or process or department to another.

5. Direct Material Price & Usage Variance:


Q. Distinguish between Direct Material Price Variance and Direct Material Usage Variance? What causes could lead to material usage variance? (June 01)

Direct Material Price Variance: It is that portion of the direct material cost variance which is due to the difference between the standard price specified and the actual price paid.



DMPV = Actual Quantity x (Standard price- Actual price)

If the actual price is more than the standard price, the variance would be adverse and vice versa.

Direct Material Usage or Quantity Variance: It is caused due to the difference between the standard quantity specified (for the output achieved) and the actual quantity used.



DMUV = Standard rate x (Standard quantity for actual output - Actual quantity)

The reasons leading to direct material usage variance are listed below:

  • Inefficiency, lack of skill or faulty workmanship resulting in more consumption of raw materials.
  • Improper maintenance of plant & equipment.
  • Incorrect processing of materials resulting to wastage.
  • Non recording of returns of material to stock.
  • Improper inspection & supervision of workmen.
  • Too strict supervision or inspection.
  • Substitution of specified materials with unspecified materials causing greater consumption of the latter.
  • Incorrect setting of standards, leading to variations.
  • Excessive wastage, scrap, spoilage, leakage, etc.

6. Practical Problems:

Q. A manufacturing concern which has adopted standard costing, furnishes the following information: (Dec. 02)


Materials for 70 units of finished product = 100 kg

Price of meterial per kg = Re. 1


Output = 2,10,000 units

Materials used = 2,80,000 kg

Cost of materials = Rs. 2,52,000

Calculate material usage variance, material price variance, and material cost variance. Also state the possible causes of Material Usage Variance







Material used

(2,10,000/70) X 100

2,80,000 kg


3,00,000 untis


Cost of material



Price per kg

Re. 1

90 paise

Total cost of material

Rs. 3,00,000


i) Material Usage Variance = Standard material used - Actual material used

= 3,00,000 - 2,80,000 = 20000 Kg. (favourable)

ii) Material Price Variance = Standard quantity of material X (Standard price - Actual price)

= 3,00,000 (1 - .90)

= Rs. 30,000 (favourable)

iii) Material Cost Variance = Standard cost of material - Actual cost of material

= 3,00,000 - 2,52,000

= 48,000 (favourable)

> For possible causes of material usage variance, please refer to the theory part.

  « Chapter – 9 Cost-Volume-Profit Analysis Chapter – 11 Ratio Analysis »  

  Posted on Thursday, December 11th, 2008 at 7:31 AM under   Variance Analysis | RSS 2.0 Feed

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