Institute of management and sciences

UNIVERSITY of Lucknow,
(2021-22)

“BBA” 3rd semester

Section - a
Subject - management accounting
Topic: variance analysis

Submitted By:- Submitted To:-

Abhishek Chauhan Dr. Priyanka Srivastava

Class Roll no - 43

University Roll No.: 200012035109

 Variance analysis
 Variance Analysis is defined as an analysis of the performance of a
business or process by means of variances which involves the process of
computing the amount and isolating the cause of variances between actual
cost and standard cost. Variance Analysis helps in analyzing the difference
between Actual Cost and Standard Cost.
 When the actual cost differs from the standard cost, it is called variance. If
the actual cost is less than the standard cost or the actual profit is higher
than the standard profit, it is called favorable variance. On the contrary, if
the actual cost is higher than the standard cost or profit is low, then it is
called adverse variance.

Elements Of Variance Analysis

 1. Direct Material Variances.
 The direct material variance is the difference between the standard cost
of materials resulting from production activities and the actual costs
incurred.
 FORMULA = Standard Price (Actual Quantity – Standard Quantity)
 Standard price is the price set for a specific product or material at the
beginning of the planning/budgeting stage.

(a) Material Price Variance -

 The material price variance is the difference between the actual cost of
direct material purchased and the standard cost of the actual quantity
purchased or used. It is also known as purchase price [Link] can be
calculated at the time of material used or purchased. It is usually
calculated at the time of purchase.
Material Price Variance (MPV) = Standard Cost of Actual Material – Actual Cost
of Material
MPV = (AQ x SP) – (AQ x AP)
Question - ABC Company manufactured 1,000 finished units using the 1,900
liters material during the year. The standard quantity of material per finished
unit is 2 liters. The actual price per liter and the standard price per liter is
$5.10 and $4.80 respectively. Calculate the material price variance (MPV).
Solution - Step 1: Identify the standard and actual details.
SP = Standard price per liter = $4.80
AQ = Actual the quantity purchased or used in the production activity = 1,900
liters
AP = Actual price per liter = $5.10

Step 2: Calculate the price variance (MPV).

Material Price Variance = AQ x (SP – AP)
 = 1,900 x ($4.80 – $5.10)
= 1,900 x (- $0.30)
= – $570 (Unfavorable)
Hence, the answer is negative then indicates an unfavorable variance.

 Importance of material price variance

1) Helps in Controlling Cost.
2) Helps in Decision Making.
3) Performance Measurement.

 Limitations Direct Material Price Variance

- Change in Supply and Demand.
- Change in Government Rules.

(b) Material Mixed Variance -

 Direct material mix variance (also known as direct material blend variance)
occurs as a result of mixing direct materials in a ratio that is different from
the ratio specified by standards to manufacture a product or produce a
certain quantity of finished output.

 This variance is computed by only those companies that process more than
one materials to produce their finished output. The companies belonging to
process type industries are popular examples of such companies.

 A favorable direct material mix variance indicates that a cheaper mix of

direct materials than standard mix has been used in manufacturing
process. An unfavorable variance, on the other hand, suggests that a more
 costly mix than the standard mix of direct materials has been used in
manufacturing process.

FORMULA -

Materials mix variance = Actual input at individual standard materials costs –

Actual input at weighted average of standard materials cost.

(c) Material Usage Variance -

 Direct material mix variance is the difference between the budgeted and
actual mixes of direct material costs used in a production process. This
variance isolates the aggregate unit cost of each item, excluding all other
variables.
 In simple words, it’s a quantity variance of material that is converted to its
cost to arrive at the monetary value of the variance. We can also call it
Material Quantity [Link] is a part of the material variances. One big
difference between the MYV and other variance is that the calculation of
other variance is on the basis of input, while MYV depends on the output

FORMULA -

(Actual unit usage - Standard unit usage) * Standard cost per unit

Question -

Company A makes plastic desks and estimates that it needs 8 kg of plastic to

produce one desk. In a year, Company A uses 315,000 kg of plastic to create
35,000 desks, or 9 kg to produce one desk. The standard cost of one kg of
plastic $0.50.

Solution -

The standard unit usage will be 8 kg * 35,000 desks or 280,000 kgs.

Putting the values in the formula: (315,000 - 280,000) * $0.50 = $17,500

Material yield variance. This variance is unfavorable because Company A uses
more than the standard usage.

2. Labour Cost Variance -

 It is the difference between the Standard labour costs and the actual
labour costs for the production achieved.
 As the cost of labour is determined by labour time and wages, the labour
cost variance is composed of either or both of variances relating to labour
time and labour rate.
 If the Standard Cost is higher, the variation is favourable -- vice versa =
Standard labour cost for actual output- Actual labour output = (Standard
hours for actual output * Standard rate per hour) - (Actual hours * Actual
rate per hour) = (SH * SR) - (AH * AR)

(a) Labour Rate variance -

• It is the difference between the standard and the actual direct Labour Rate
per hour for the total hours worked. The reasons for labour rate variance can
be more efficient and skilled workers might have been employed and higher
wages may have been paid to them, new workers not being allowed full
normal wage rates, use of different method of payment, higher wages paid on
account of overtime for urgent work.

• LRV will be an uncontrollable variance as labour rates are usually

determined by demand and supply conditions in the labour market, backed by
negotiation skills of the trade union.

FORMULA -

Labour Rate Variance = (Standard rate- Actual rate) * Actual Hours

Question -

Company A makes mobile, and it knows that it needs 2 labor hours at $2 per
hour to produce one unit of mobile. In a year, Company A pays $100,000 in
labor cost for 40,000 labor hours, and produces 20,000 mobiles.

Solution-

To come up with the Labor Rate Variance, we first need to calculate the Actual
Labor Rate.
Actual labor rate = $100,000 / 40,000 = $2.5 per hour

Now, putting the values in the formula:

LRV = ($2 per hour - $2.5 per hour) * 40,000 = -$20,000.

Here the actual payment is more than what the standard rate was. Hence, it is
an adverse/unfavorable variance.

(b) Labour Efficiency Variance -

• It is the difference between the standard hours for the actual production
achieved and the hours actually worked, valued at the standard labour rate.
The reasons for labour efficiency variance can be defective and bad material,
lack of proper supervision or stricter supervision than specified, poor working
conditions, breakdown of plant & machinery, failure of power etc.

• When the workers finish the specific job in less than the standard time, the
variance is favourable. If the workers take more time than the allotted time,
the variance is adverse.

FORMULA -

Labour efficiency variance =(Standard hours for actual output- Actual hours) *
Standard rate.

Question -

Company A manufacture shirt, base on experience, the company set the

standard cost of as following:

*Direct labor: 5 hours per unit

*Direct labor rate: $ 10 per hour

During the year, the company spends 200,000 hours to produce 35,000 of
output. The actual payment to the worker is $ 10 per hour.

Solution -

Standard hour = 35,000 unit * 5 hours = 175,000 hour

Labor efficiency variance = (190,000 hours * $ 10) – (200,000 hours * $ 10)

= $ 250,000

Unfavorable because the company spend more time than the expectation.

(c) Labour Mix Variance (LMV) -

• This variance arises if during a particular period the grades of labour used in
production are different from those [Link] is the difference between the
standard composition of workers and the actual gang of workers.

• It enables the management to study how much of the labour variance

occurred due to the changes in the composition of labour force

FORMULA -

LMV =(Revised Standard hours- Actual Hours) * Standard Rate

RSH = Total time of actual workers / Total time of standard workers *

Standard Time

3. Overhead Variances.
 Overhead variances arise when the actual overhead costs incurred differ
from the expected amounts. Managers want to understand the reasons
for these differences, and so should consider computing one or more of
the overhead variances described below. Each of these variances applies
 to a different aspect of overhead expenditures. It is not necessary to
calculate these variances when a manager cannot influence their
outcome.
 Overhead variances may be classified into fixed and variable overhead
variances and fixed overhead variance can be further analyse according to
the courses. In case of variable overheads, it is assured that variable
overheads vary directly with production so that any change in expenditure
can affect costs. Some authors say that a variance may arise through
inefficiency, but as these costs are usually very small per unit of output, it is
to be ignored and any variance in variable overhead is attributed to
expenditure variances.

EXAMPLE -

Efficiency variances occur when the labor force finishes a job in a different
amount of hours than was originally estimates. For instance, a job that should
have taken 10 hours to complete actually took 12 hours to complete would
result in a 2 hour variance.

Volume variances happen when different amounts of product are

manufactured than the estimated amount. Take a change of order for
example. The original order only called for 100 units, but the customer decided
to increase the order to 150 units. The 50 extra units creates a volume
variance from the estimated 100 units.

(a) Fixed Overhead Volume Variances -

 The fixed overhead volume variance is the difference between the

amount of fixed overhead actually applied to produced goods based on
production volume, and the amount that was budgeted to be applied to
produced goods.

EXAMPLE -

A company budgets for the allocation of $25,000 of fixed overhead costs to

produced goods at the rate of $50 per unit produced, with the expectation
that 500 units will be produced. However, the actual number of units
produced is 600, so a total of $30,000 of fixed overhead costs are allocated.
This creates a fixed overhead volume variance of $5,000.

(b) Variable Overhead Efficiency Variance -

 The variable overhead efficiency variance is the difference between the

actual and budgeted hours worked, which are then applied to the
standard variable overhead rate per hour.

FORMULA -
Standard overhead rate x (Actual hours - Standard hours) = Variable
overhead efficiency variance
Question-
Company A’s cost accounting staff, on the basis of historical and projected
labor patterns, projects that the production team, should work for 40,000
hours in a month and incur the variable overhead cost of $800,000 a month.
This gives a variable overhead rate of $20 per hour. However, a month later,
Company A buys a new machine that improves production efficiency. So, the
number of hours drops to 38,000 a month.
Solution -

Let us now put the values in the given formula to calculate VOEV.

VOEV = $20 (38,000 hours worked - 40,000 standard hours)

= $40,000
This is a favorable variance because the actual hours are less than the
standard hours.

 Advantages of Variable Overhead Efficiency Variance

1. Variable Overhead Efficiency Variance is a crucial component of total
overhead variance, as well as oh expenditure variance.
2. VOEV helps to identify any inefficiency in production.
3. It inspires operation managers and labors to strive for favorable variances.
4. It assists managers in differentiating between labor and overhead
deficiencies.

 Limitations of Variable Overhead Efficiency Variance

1) It is possible that the production team makes some estimation errors in
setting the budget.
2) It could take too much time and effort to find the reason for the variance.
This is because; the team needs to check all the accounts that may result
in variance.
3) If there is no threshold, then it could get difficult to determine whether or
not the variance is significant.

(c) Variable Overhead Spending Variance -

The variable overhead spending variance is the difference between the

actual and budgeted rates of spending on variable overhead. The variance is
used to focus attention on those overhead costs that vary from expectations.
Spending variance is a term used to describe the difference between the real
amount associated with a certain expense and the expected amount
associated with the same expense. It is the relation of the budgeted costs as
calculated by the cost accountants of a company versus the real cost. The
budgeted costs are known as variable overheads

FORMULA -
Actual hours worked x (Actual overhead rate - standard overhead rate) =
Variable overhead spending variance

Question -
Assume that during the month of June, the actual labor hours used in Factory
A are 100, the actual variable overhead rate is $10 per machine hour, and the
budgeted variable overhead rate is $12 per machine hour. The variable
overhead spending variance can be calculated in the following manner:

Solution -

Standard Variable Overhead Rate ($12) − Actual Variable Overhead Rate ($10)
= $2

Difference per Hour = $10 x Actual Labor Hours (100) = $1,000

Variable Overhead Spending Variance = $1,000

In such a situation, the variance is said to be favorable because the actual

costs are less than the budgeted costs.

Numerical
The standard product cost card of a product is shown below.
Materials 2 @ $16 $32
feet length,
1/4 inch thick
Factory @ $6 $24
overhead
labor 4 hours
Variable 4 @ $2 $8
hours
Fixed 4 hours @ $4 $16 $24
Total standard @ $80
production
cost

Fixed overhead was based on 36,000 hours a year.

Total fixed overhead estimated at $144,000 per annum.

Actual data for a month has been ascertained as follows:

 Actual hours worked = 3,800

 Units of product produced = 900

 Material used = 1,900 feet in length

 Price per foot = $15

 Actual labor wage rate = $5.80

 Actual factory overhead: variable = $6,200, fixed = $12,000

Required: Calculate two variances for each of the three elements of the
production cost.
Solution -
1. MATERIAL COST VARIANCE =
Standard quantity of output @ standard price:
900 units x 2 x $16 = $28,800
Actual quantity used @ standard price:
1,900 x $16 = $30,400
Actual quantity used @ actual price:
1,900 x $15 = $28,500
Total material cost variance:
$28,800 – $28,500 = $300 (favorable)

2. LABOUR COST VARIANCE -

Standard hours of output at standard wage rate:
900 units x 4 hours x $6 = $21,600
Actual hours for the output at standard wage rate:
3,800 hours x $6 = $22,800
Actual hours at actaul wage rate:
3,800 hours x $5,80 = $22,040
Total labor cost variance:
$21,600 – $22,040 = $440 (unfavorable)