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 predetermined 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:
 Cost Variances
 Sales Variances
1. Materials Variances
Name 
Significance 
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. 
Name 
Significance 
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 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 predetermined 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 predetermined 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:
 Sales turnover or value method
 Profit of sales margin method
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 subdivided 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:
 Planning future activities
 Comparing actual performance with the budgeted performance
 Identifying the variances as to their causes
 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 
Materials 

Price 
Purchasing Department 
Quantity or Grade 
Stores, Purchase or Process Department 
Waste, scrap or spoilage 
Production Department 


Wages 

Rate – for difference in rates 
Personal Department 
for work requiring higher rates to pay 
Production Department 
Time – lack of proper supervision 
Production Department 


Overheads 

Volume 
Sales Department 
Efficiency 
Production Department 
Expenditure: 

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 


Sales 

Price and Volume 
Selling Department 
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
 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.
 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.
Mathematically
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.
Mathematically
Labour Efficiency variance = Standard Rate (Standard time  Actual time)
Labour Efficiency variance may be caused due to the following:
 Defective or bad materials.
 Breakdown of plant and machinery.
 Failure of power.
 Efficient working by the labourers and fuller utilization of time due to incentives given.
 Loss of time due to delayed instructions from management or delay in receipt of raw materials.
 Alteration in the method of production.
 More time taken by workers due lack of proper supervision and control by management, making the workers lazy and inefficient.
 Rigid system of inspection.
 Poor working conditions.
 Lower productivity due to lack of training, ability, or experience on the part of workers.
 Labour turnover or changeover 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.
Mathematically
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.
Mathematically
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)
StandardMaterials for 70 units of finished product = 100 kg
Price of meterial per kg = Re. 1
Actual
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

Standard 
Actual 
Output 
2,10,000 
2,10,000 
Material used 
(2,10,000/70) X 100 
2,80,000 kg 

3,00,000 untis 

Cost of material 

2,52,000 
Price per kg 
Re. 1 
90 paise 
Total cost of material 
Rs. 3,00,000 

= 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.