UNIT FOUR

FLEXIBLE BUDGET, STANDARDS COSTING AND VARIANCE ANALYSIS

4.1. Introduction
Dear learners in the previous unit you have studied the benefit of budget as a planning tool. Hence, budgets are
planning tools that are usually prepared prior to the start of the period being budgeted. However, the
comparison of the budget to actual results provides valuable information about performance. Therefore,
budgets are both planning tools and performance evaluation tools. In this unit, therefore the discussion focuses
on how budget are used to evaluate feedback and variances aid managers in their control function.
In evaluating performance the budgeted performance are compared with actual operational results and the
resulting variance will be examined so as to identify the causes for variance on the bases of which performance
can be rewarded for favorable variance or corrective actions will be taken to avoid unfavorable variance on the
coming operational periods.
The unit highlights the importance of variance analysis and show how the budget initially prepared at planning
stage creates problem while comparing actual results with the budget. In this unit you are also introduced with
the advantage of flexible budget over the static budget, steps in the preparation of flexible budget and evaluating
performance using flexible budget.
4.2. Budget and Variance analyses
The use of budget as performance evaluation tool focuses on determining the discrepancies between the
planned and actual performance at the end of the operating cycle.
Variance is the difference between an amount on an actual result and the corresponding budgeted amount i.e.,
the actual amount of something and the amount it was supposed to be according to the budget. The budgeted
amount is a point of reference from which comparison may be made. The difference between budget and actual
result can be favorable or unfavorable based upon the impact of the discrepancy on the overall profitability of
the firm. If the variance has an increasing effect on the operating income as compared to the budgeted amount,
it is said to be favorable variance. On the other hand unfavorable or adverse variance occurs when the
variance has a decreasing effect on the operating income relative to the budgeted amount.
Variances assist managers in their planning and control decisions. It enables to exercise Management by
Exception (MBE), which is the practice of concentrating attention on areas not operating as expected and giving
less attention to areas operating as expected. Managers regularly pay attention to areas with large variances.
Variances are also used in performance evaluation. For example Production line managers in a manufacturing
company may have quarterly efficiency incentives linked to achieving a budgeted amount of operating costs .
4.2.1. Fixed or Static Budget
The static budget is the budget that is based on the projected level of output, prior to the start of the period. In
other words, the static budget is the “original” budget. The static budget variance is the difference between
any line-item in this original budget and the corresponding line-item from the statement of actual results.
 Static budget is a budget that is based on one level of activity.
Evaluating performance based upon the master budget which fixed and prepared at single level of activity may
not provide accurate picture of performance. This because usually the planned and actual output or activities
levels may not be equal, as a result the comparison is performed at two different level of activity which hides
the variance attribute to the actual performance units as well as overall organization. For example, if a company
budgeted to produce and sell 12,000 units, but the actual performance showed only 10,000 units, the
comparison of revenue, cost and profit at the budget and actual level of output do revels only the variance
resulted from the difference in the level of output. Therefore unless the analysis is redone by adjusting the
budgeted level of output towards the actual units produced and sold, the variance is not helpful to the

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management as performance evaluation tool.
 Static Budget Variance [SBV] is the difference between an actual result and the
corresponding budgeted amount in a static budget.
4.2.2. Flexible Budget
The flexible budget is a performance evaluation tool. It cannot be prepared before the end of the period. A
flexible budget adjusts the static budget for the actual level of output so as to avoid the inherent limitation of
using static budget for performance evaluation. The motivation for the flexible budget is to compare apples to
apples.
The flexible budget variance is the difference between any line-item in the flexible budget and the
corresponding line-item from the statement of actual result.
To have a better understanding of causes for variance managers usually require variance calculated at different
level. Variance according to the degree of detailed feedback on performance can be classified as:
 Level 0 variance analysis  Level 3 variance analysis
 Level 1 variance analysis  Level 4 variance analysis
 Level 2 variance analysis
In this unit the focus is on level 0, 1, and 2 variances, and the reaming will be discussed in length on the next
unit.
Now let see the preparation of flexible budget as well as analysis of variance using the following illustration:
Illustration 4.1: Hosanna Garment Co. manufactures and sells a jacket. Sales are made to distributors who sell
to independent clothing stores. Hosanna Garment’s only costs are manufacturing costs. All units manufactured
in May 2016 are sold in May 2016. There is no beginning or ending inventory. Hosanna Garment has variable
cost categories. The budgeted data for May 2016 are:
Cost category Variable cost / jacket.
DM costs………………………………… Br. 60
DL costs…………………………………. 16
Variable MOH costs…………………… 12
Total variable costs ……………… Br. 88
The number of units manufactured is the cost driver for all variable-manufacturing costs. The relevant range for
the cost driver is from 0 to 12,000 jackets. Budgeted manufacturing fixed costs are Br. 276,000 for production
between 0 & 12,000 jackets. Budgeted selling price is Br.120/jacket. The static budget for May 2016 is based
on selling 12,000 jackets.
The actual data for May 2016 are as follows:
Units sold ………………… 10,000 jackets
Revenues …………………. Br. 1,250,000
Variable costs:
DM …………………….. 621,600
DL……………………… 198,000
Variable MOH……….. 130,500
Fixed costs …………….. 285,000

1. Level 0 or Static Budget Variance for operating income

Level zero variance analysis the least detail analysis which simply compares the operating income at static
budget income statement with the operating income at the actual income statement. The level zero variance for
Hosanna Garment from the above given data is determined as,

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 Actual operating income………………… Br. 14,900
Budgeted operating income……………… 108,000
SBV for operating income………………. Br. 93,100 U
The analysis revealed unfavorable variance as the actual operating income is lower than the budgeted operating
income by Birr 93,100. The result here couldn’t provide the management useful information as it couldn’t
show the contribution revenue and each cost element to operating income variance.
2. Static Budget Variance (SBV)
Level one variance can offer management a better insight about their organizational performance than level zero
analysis. At this level, operating income variance will be decomposed into revenue and cost component as a
result the management will identify the responsibility center that demands attention.
Static Budget Variance
Actual Results Static Budget Static Budget
(1) Variance(SBV) (2) Result (3)
Items = (1) – (3)
Unit sales 10,000 2,000U 12,000 .
Revenues Br.1,250,000 Br. 190,000U Br. 11,440,000
Variable costs:
DM 621,600 98,400F 720,000
DL 198,000 6,000U 192,000
MOH 130,500 13,500F 144,000

Total variable costs 950,100 105,900F 1,056,000

Contribution Margin 299,900 84,100U 384,000

Fixed Costs 285,000 9,000U 276,000

Operating Income Br. 14,900 Br. 93,100U Br. 108,000

Br. 93,100U (SBV)

The static budget variance shows an unfavorable variance for revenue, fixed costs whereas favorable variance
of total variable cost. These variances are due primarily to the fact that the static budget was built on an output
level of 12,000 units, while the company actually made and sold 10,000 units. The revenue variance might also
be due to an average unit sales price that differed from budget. The variable cost variances might also be due to
input prices that differed from budget or input quantities that differed from the per-unit budgeted amounts that
may be identified at the later stages of the variance analysis.

Level 2-variance analysis [Flexible Budget Variance (FBV) & Sales-Volume Variance (SVV)]
To identify the amount of variance attributed the difference in the level of output as well as to real performance
of the company, at this level the static budget variance will be decomposed into the flexible budget variance and
sales volume variance.
Flexible Budget Variance (FBV) is a better measure of operating performance because they compare actual
revenues to budgeted revenues and actual costs to budgeted costs for the same output level.
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Sales-Volume Variance (SVV) is the difference between the flexible budget amounts and static budget amounts.
It represents the variance caused solely by the difference in the actual output volume and budgeted quantity of
output expected to be produced and sold in the static budget.
To determine the flexible budget variance and sales volume variance, first you need to develop a flexible
budget. The flexible budget, for the example given above is prepared at the end of the period after the actual
output level of 10,000 jackets is known. The flexible budget is that Hosanna Garment would have prepared at
the start of the budget period had it correctly forecasted the actual level of 10,000 jackets.
In preparing the flexible budget,
(1) The budgeted selling price is the same Br. 120/ jacket.
(2) The budgeted variable costs per unit are the same Br. 88/ jacket.
(3) The budgeted fixed costs are the same Br. 276, 000, are used.
The only difference between the static budget and the flexible budget is that the static budget is prepared for the
planned output level of 12,000 jackets, whereas the flexible budget is based on the actual output of 10,000
jackets.
The following stapes are used to prepare a flexible budget:
Step [Link] the Actual Quantity of Output produced and sold.
10,000jackets.
Step 2. Calculate the flexible budget for revenues based on Budgeted Selling Price and
Actual Quantity of Output.
Flexible Budget for Revenues = Br. 120 /jacket X 10,000jacket
= Br. 1,200,000
Step 3. Calculate the Flexible Budget for Costs based on Budgeted Variable Costs per
Unit, Actual Quantity of Output and Fixed Costs.
Flexible Budget for Variable Costs:
DM: Br. 60/j X 10,000j Br. 600,000
DL: Br. 16/j X 10,000j 160,000
MOH: Br. 12/j X 10,000j 120,000
FB for TVC Br. 880,000
FB for FC 276,000
FB for Costs Br. 1,156,000
Step 4: Building the flexible budget based on the information from steps 1 and 2, and step 3 results a flexible
budget presented on column 3 of the following table.
After the flexible budget is developed it is possible to determine the flexible budget variance by comparing the
flexible budget and the actual operational results, and sales volume variance by comparing the flexible budget
results and the static budget as shown on the following table.

Actual Flexible Flexible Sales Static

Results Budget Budget Volume Budget
Variance Variance
(1) (2) = (1) – (3) (3) (4) (5) .
Unit sales 10,000 0 10,000 2,000 12,000
Revenues 1,250,000 50,000F 1,200,000 240,000U 1,440,000
Variable costs:
DM 621,600 21,600U 600,000 120,000F 720,000
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 DL 198,000 38,000U 160,000 32,000F 192,000
MOH 130,500 10,500U 120,000 24,000F 144,000
Total variable costs 950,100 70,100U 880,000 176,000F 1,056,000
Contribution Margin 299,900 20,100U 320,000 64,000U 384,000
Fixed Costs 285,000 9,000U 276,000 0 276,000
Operating Income Br. 14,900 Br. 29,100U Br. 44,000 Br. 64,000U Br. 108,000
Br. 29,100U. Br. 64,000U
FBV SVV
Br. 93,100U
SBV
From this table, Hosanna Garment sees that after adjusting for sales volume, revenue was higher than would
have been expected. The favorable Birr 50,000 variance must be due entirely to an average sales price that was
higher than planned which was Bir125 per jacket compared to the original budget of Birr120 per jacket.
Materials costs were higher than would have been expected for a sales volume of 2,000 units. This unfavorable
variance is due to higher material prices, or to inefficient utilization of fabric (more waste than expected), or a
combination of these two factors. Labor and overhead were higher than expected, even after adjusting for the
sales volume of 2,000 units. This unfavorable flexible budget variance implies that either wage rates were
higher than planned, or labor was not as efficient as planned, or both. Similarly, the components of variable
overhead were either more expensive than budgeted, or were used more intensively than budgeted. For
example, electric rates might have been higher than planned, or more electricity was used than planned per unit
of output.

4.3 VARIANCES AND STANDARD COSTING

4.3.1 Introduction
The main advantage of the standard costing system is variance analysis. The principle of “management by
exception” is practiced easily with the help of variances. Variance may be defined as the difference between
standard and actual for each element of cost and sometimes for sales. And ‘variance analyses’ may be defined
as the process of analyzing variance by sub –dividing the total variance in such a way that management can
assign responsibility for off –standard performance. When the actual results are better than expected, a
‘favorable’ variance arises; where they are not up to the standard, an ‘adverse variance’ occurs.
Variances help to fix the responsibilities so that management can ascertain the person responsible for the poor
results. For example, an adverse material usage variance would indicate that excess material cost was due to
inefficient use of materials. This would enable management to fix the responsibility on the supervisor in charge
of a particular operation in which the inefficiency occurred. It may be discovered that the variance was caused
by (say) inefficient handling, purchase of poor quality materials or employment of trainees. The important point
is that the reason for the variance must be found, explained and wherever necessary, corrective measures taken.

4.3.2 STANDARD COST SYSTEMS

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Standard costs are predetermined costs that are usually expressed on per unit basis. In other word, standard cost
is a predetermined calculation of how much costs should be incurred under specified working condition. It is
built up from an assessment of the value of direct material, direct labor and overhead items.

4.3.2 Classification of variances

Budget Variances indicate the total deviation of actual costs from expected costs. However, they do not give the
complete story about deviations between budgeted and actual results; i.e. it is not yet clear what contributed to
the variances unless further investigations are made.
Hence, a total flexible budget variance (FBV) is the difference between total actual costs incurred and total
standard cost applied to the output produced during the period. This variance can be diagrammed as follows:
Actual Cost of Actual Production Input Standard Cost of Actual Production Output

Total Variance (FBV)

Since total variances do not provide useful information for determining why cost differences occurred; to help
managers in their control objectives, total variances are subdivided into price and usage components

[Link] DIRECT MATERIAL AND LABOR VARIANCES

A. DIRECT MATERIAL COST VARIANCES:
To completely and meaningfully analyze the flexible budget variance for material, it should be analyzed in
terms of the materials price standard and the materials quantity standard. This level of analysis resulted in: (i)
material price variance that identifies the effect of differences in prices paid for materials. (ii) Material quantity
(usage) variance that identifies the effect of difference in the quantities of materials used.
i) Material Price Variance(MPV)
A material price variance is the difference between the actual price of material/unit and the standard price of
material per unit multiplied by the actual quantity of material purchased. In other words, the material price
variance (MPV) indicates whether the amount paid for material was below or above the standard price.
Material price variance can be calculated as:

MPV = (SP – AP) AQ

where: SP is the standard price of material per unit

AP is actual price of material per unit
AQ is the actual quantity of material purchased and consumed

If the actual price is larger than the standard price, this variance is unfavorable (U); if the standards are larger
than the actual; the variance is favorable (F)
ii) Materials Quantity (usage) Variance(MQV)
The material quantity variance (MQV) indicates whether the actual quantity used was below or above the
standard quantity allowed for the actual output. This difference is multiplied by the standard price per unit of
material. i.e. A material quantity (usage) variance is the difference between the actual quantity of materials
used and the standard quantity of materials that should have been used to produce the actual output, multiplied
by the standard price of materials per unit. It can be calculated as:

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 MQV = (SQ-AQ) x SP

where: SP is the standard price of material per unit

SQ is the actual quantity of material used for units produced
AQ═ the actual quantity of material used

If the actual quantity amounts are larger than the standard quantity amounts, this variance is unfavorable (U); if
the standards are larger than the actual; the variance is favorable (F)
Example 4.1 In May 2016, East Publishing Company’s costs and quantities of paper consumed in
manufacturing were as follow:
Actual unit purchase price Br 0.16 per page
Standard quantity allowed for good production 195,800 pages
Actual quantity purchased 230,000 pages
Actual quantity used 200,000 pages
Standard unit price Br 0.15 per page
Required:
a) Calculate the total cost of purchases.
b) Compute the material price variance on the bases of purchase
c) Calculate the material quantity variance.
d) Total FBV
Solution:
a) Total cost of purchases for August would be:
Actual unit purchase price (a) -------------------------------- Br 0.16 per page
Actual quantity purchased during August (b) ---------------- 230,000 pages
Total cost (a x b) ------------------------------------ Br.31, 220
b) MPV = (SP – AP) AQ
= (Br 0.15 per page - Br 0.16 per page) 230,000 pages= Br. 2,300 (U)
c) MQV = (SQ-AQ) x SP
= (195,800 pages - 200,000 pages) Br 0.15 per page= Br. 630(U)
d) Total FBV═ Br 2,300U + Br. 630U═ Br.2,930 U

B. LABOR COST VARIANCES:

Just like we have done for material inputs, we will do the same meaningful analysis for labor inputs. Hence, the
variance investigation to flexible budget variance for labor resulted in: (i) labor rate variance that identifies the
effect of differences in the rates paid to workers, and (ii) labor efficiently or usage variance that identifies the
effect of differences in the quantities of labor used.
i. Labor Rate Variance(LRV)
The labor rate variance (LRV) shows the difference between the actual wages paid to labor for the period and
the standard wages for all hours worked. Thus, Labor rate variance is the difference between the actual rate of
labor per hour and the standard rate of labor per hour, multiplied by the actual hours of labor worked.

LRV= (SR-AR) x AH
Where: SR is standard rate of labor per hour
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 AR is actual rate of labor per hour,
AH is a total actual hour of labor worked

ii. Labor Efficiency Variance (LEV)

A labor efficiency variance is the difference between the actual labor hours worked and the standard labor hours
that should have been worked to produce the actual output, multiplied by the standard rate of labor per hour.
Thus, multiplying the standard labor rate by the difference between the actual minutes worked and the standard
minutes for the production achieved results in the labor efficiency variance (LEV)

LEV = (SH – AH) x SR

Where: SH is standard hours of labor for the actual unit produced
AH is actual labor hours used for the unit produced
SR is standard rate of labor per hour

Example 4.2 Sagittarius Corp. has established the following standards for the prime costs of one of its chief
product, dart boards.
Standard Qty standard Price (Rate) Total Standard cost
Direct material 8.5 pounds Br.1.80/pound Br.15.30
Direct labor 0.25 hour 8.00/hour 2.00
Br.17.30
During May, Sagittarius purchased 160,000 pounds of direct material at a total cost of Br.304, 000. The total
wages for May were Br.42, 000, 90% of which were for DL. Sagittarius manufactured 19,000 dart boards
during May; using 142,500 pounds of direct material & 5,000 direct labor hours.
Required: Compute the following variances for May.

Direct material price variances Direct labor rate variance

Direct material usage variance Direct labor efficiency variance
Direct material cost variance Direct labor cost variance

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Solution
Material Variances
i). SQ = Standard Quantity of Direct material for Actual Output would be:
1 dart board = 8.5 pounds Direct material
19,000 dart boards = ?
So, SQ = 8.5 pounds Direct material x 19,000 = 161,500 pounds

ii). SP = Standard price of Direct material = Br. 1.80/pounds.

iii). AP = Actual Price of Direct material = Total cost of Direct material purchased
Total units of direct material purchased
= Br. 304,000 = Br.1.90/ pounds
160,000 pounds
iv). AQ=Actual Quantity of Direct material purchased or used = 142,500 pounds
a) MPV= (SP – AP) AQ
= (Br.1.80/pds - Br.1.90/ pds) 142,500 pounds = Br. 14,250(U)
b) MQV = (SQ-AQ) x SP
= (161,500 pounds - 142,500 pounds) Br. 1.80/pounds= Br. 34,200(F)
c) Material cost variance = MPV + MQV
= Br. 14,250 (U) + Br. 34,200 (F) = Br. 19,950 (F)
Labor Variances
i) SR= Standard Rate of DL per hour= Br.8.00/Hr
ii) SH=Standard Hours of DL for Actual Output would be:
0.25Hrs=1dart board
? = 19,000 dart boards
SH = 0.25x19, 000=4,750Hrs
iii) AH=Actual hrs of DL used = 5,000 hrs
iv) AR= 0.9 x 42,000 = 37,800 = Br.7.56/Hr
5,000 5,000
d) LRV= (SR-AR) x AH
= (Br.8.00/Hr - Br.7.56/Hr) 5,000 hrs = Br. 2,200 (F)
e) LEV = (SH – AH) x SR
= (4,750Hrs - 5,000 hrs) Br.8.00/Hr = Br.2, 000(U)
f) labor cost variance = LRV + LEV= Br. 2,200 (F) + Br.2, 000(U) = Br. 200 (F)

c) MIX AND YIELD VARIANCES

Most companies use a combination of many materials and various classifications of direct
labor to produce goods. In such settings, the material and labor variance analysis presented in
the above section are insufficient.
When a company’s product uses more than one material, the goal is to combine those
materials in such a way as to produce the desired product quality in the most cost-beneficial
manner. Sometimes, materials can be substituted for one another without affecting product
quality. In other instances, only one specific material or type of material can be used. For
example, a furniture manufacturer might use either oak or maple to build a couch frame and
still have the same basic quality. A perfume manufacturer, however, may be able to use only
a specific fragrance oil to achieve a desired scent.

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Labor, like materials, can be combined in many different ways to make the same product.
Some combinations will be less expensive than others; some will be more efficient than
others. Again, all potential combinations may not be viable.
Management desires to achieve the most efficient use of labor inputs. As with materials,
some amount of interchangeability among labor categories is assumed. Skilled labor is more
likely to be substituted for unskilled because interchanging unskilled labor for skilled labor is
often not feasible. However, it may not be cost effective to use highly skilled, highly paid
workers to do tasks that require little or no training. A rate variance for direct labor is
calculated in addition to the mix and yield variances.
Each possible combination of materials or labor is called a mix. Management’s standards
development team sets standards for materials and labor mix based on experience, judgment,
and experimentation. Mix standards are used to calculate mix and yield variances for
materials and labor. An underlying assumption in product mix situations is that the potential
for substitution exists among the material and labor components. If this assumption is invalid,
changing the mix cannot improve the yield and may even prove wasteful. In addition to mix
and yield variances, price and rate variances are still computed for materials and labor.
a. Material Mix and Yield Variances
A material price variance shows the Birr effect of paying prices that differ from the raw
material standard. The material mix variance (MMV) measures the effect of substituting a
nonstandard mix of materials during the production process. The material yield variance
(MYV) is the difference between the actual total quantity of input and the standard total
quantity allowed based on output; this difference reflects standard mix and standard prices.
The sum of the material mix and yield variances equals a material quantity variance; the
difference between these two variances is that the sum of the mix and yield variances is
attributable to multiple ingredients rather than to a single one. A company can have a mix
variance without experiencing a yield variance.
Computations for the price, mix, and yield variances are given below in a format similar to
that used in the above section.
Actual Mix X Actual Mix X Standard Mix X Standard Mix X
Actual Quantity Actual Quantity Actual Quantity Standard Quantity
X Actual X Standard X Standard X Standard
Price Price Price Price

Material Price Material Mix Material Yield

Variance Variance Variance
The formula to compute material mix and yield variance would be:
To compute material mix variance:
Material Mix Variance(MMV)= (RSQ – AQ)SP
Where, RSQ = revised standard quantity( i.e. actual quantity at standard mix)
= SQ for each material x Total AQ (OR)
Total SQ

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 = Total AQ X standard mix ratio
AQ= Actual Quantity at actual mix SP = standard price
To compute material yield variance:
MYV = (SQ – RSQ)SP
Where, SQ= Standard Quantity at standard mix
RSQ = Revised Standard Quantity SP = standard price

Example4.3The Scent Makers Company produces perfume. To make this perfume, Scent
makers uses three different types of fluids: Dycone, Cycone, & Bycone are used in standard
proportions of 4/10, 3/10, & 3/10 and their standard costs are Br. 6.00, Br. 3.50 & Br. 2.50
per unit, respectively. The chief engineer reported that for the past few months the standard
yield has been 80% on 100 pints of mix. The Company maintains a policy of not carrying any
direct material, as inventory storage space is costly.
Last week the company produced 75,000 pints of perfume at a total direct material cost of
Br. 449,500. The actual number of pints used and costs per unit for the three fluids are as
follows:
Material Actual Pints Cost/Pint
Dycone 45,000 Br. 5.50
Cycone 35,000 4.20
Bycone 20,000 2.75
100,000
Required
1) Compute the total direct material yield & mix variances for the last week..
2) Compute the total direct material price & usage variances for perfume made in the
last week.
Solution:
i) SQ = Standard quantity for actual output
Standard yield (80% on 100 pints of mix)
i.e. 80pints required = 100 pints of mix
For actual production of 75,000 pints = ?
=75,000 x 100 = 93,750 pints of mix
80
So, SQ for: Dycone: 0.4 x 93,750 = 37,500
Cycone: 0.3x93, 750= 28,125
Bycone: 0.3x93, 750= 28,125
b. RSQ for:
Standard Mix Actual quantity Proportion RSQ
Dycone : 0.4 45,000 0.4 x 100,000 40,000
Cycone : 0.3 35,000 0.3 x 100,000 30,000
Bycone : 0.3 20,000 0.3 x 100,000 30,000
Total 100,000
Thus, the direct material cost variances, in diagram, would be:
1 2 3 4
SP x SQ SP x RSQ SP x AQ AP x AQ

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Dycone: 6 x 37,500 6 x 40,000 6 x 45,000 5.5 x 45,000
Cycone: 3.5x28, 125 3.5x30, 000 3.5x35, 000 4.2 x 35,000
Bycone: 2.5x28,125 2.5x30,000 2.5x20,000 2.75x20,000
393,750 420,000 442,500 449,500

26,250U 22,500U
Yield Mix
7,000U
48,750U Price
Usage

55,750U
FBV for direct material

Note:
a) MYV = 1-2= SP x (SQ x RSQ) = Br. 26,250U
b) MMV =2-3= SP x (RSQ-AQ) = Br. 22,500U
c) MQV=1-3 = (SP x SQ) – (AP x AQ) =MYV+ MMV= Br. 48,750U
d) MPV=3-4= (SP-AP)AQ= Br. 7,000 U
e) FBV for DM= 1-4= (SP x SQ) –(AP x AQ)= MQV+ MPV= Br. 55,750 U
ii. Labor Mix, and Yield Variances
The labor rate variance is a measure of the cost of paying workers at other than standard
rates. The labor mix variance is the financial effect associated with changing the
proportionate amount of higher or lower paid workers in production. The labor yield variance
reflects the monetary impact of using more or fewer total hours than the standard allowed.
The sum of the labor mix and yield variances equals the labor efficiency variance. The
diagram for computing labor rate, mix, and yield variances is as follows:
(Actual Mix) X (Actual Mix) X (Standard Mix) X (Standard Mix) X
(Actual Hours) (Actual Hours) (Actual Hours) (StandardHours)
X (Actual Rate) X (Standard Rate) X (Standard Rate) X (Standard Rate)

Labor Rate Variance Labor Mix Variance Labor Yield Variance

The formula to compute labor mix and yield variance would be:
To compute labor mix variance:
Labor Mix Variance (LMV)= (RSH – AH)SR
Where: RSH= revised standard hour (i.e. actual hours at standard mix)
= SH for each labor x Total AH ( OR )
Total SH
= Total AH X standard mix ratio
AH=Actual hours at actual mix SR= standard rate per hours

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To compute Labor Yield Variance
Labor Yield Variance(LYV) = (SH-RSH)SR
Where: SH= standard hours at standard mix
RSH= revised standard hour SR= standard rate per hours

Example4.4 Buffon Legal Services has three labor classes: secretaries, paralegals, and
attorneys. The standard wage rates are shown in the standard cost system as follows:
secretaries, Br 25 per hour; paralegals, Br 40 per hour; and attorneys, Br 85 per hour. The
firm has established a standard of 0.5 hours of secretarial time and 2 hours of paralegal time
for each hour of attorney time in probate cases. The actual direct labor hours worked on
probate cases and the standard hours allowed for the work accomplished for one month in
2001 were as follows:

Standard Hours
Actual Labor Hrs for Output Achieved
Secretarial 500 500
Paralegal 1,800 2,000
Attorney 1,100 1,000
Total: 3, 400hrs 3,500hrs
Required: Calculate the amount of the direct labor efficiency variance for the month and
decompose the total into the following components:
1. Direct labor mix variance
2. Direct labor yield variance
Solution:
i) SR= Standard Rate per DL Hr
For Secretarial: Br. 25, Paralegal: Br 40, and for Attorney: Br 85
ii) RSH: Revised Standard hours = SH for each labor x Total AH
Total SH
RSH for Secretarial: 500 hrs x 3, 400hrs = 486hrs
3,500hrs
For Paralegal: 2,000 hrs x 3, 400hrs = 1,943hrs
3,500hrs
For Attorney: 1,000 hrs x 3, 400hrs = 971hrs
3,500hrs
a) LMV= (RSH – AH)SR
For Secretarial: (486hrs - 500 hrs) Br. 25 = Br. 350 (U)
For Paralegal: (1,943hrs - 1, 800 hrs) Br 40 = 5,720(F)
For Attorney: (971hrs - 1, 100 hrs) Br 85 = 10,965(U)
Total Br.5, 595(U)
b) LYV = (SH-RSH)SR
For Secretarial: (500 hrs - 486hrs) Br. 25 = Br. 350 (F)

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 For Paralegal: (2,000 hrs- 1,943hrs) Br 40 = 2,280(F)
For Attorney: (1,000 hrs - 971hrs) Br 85 = 2,465(F)
Total Br. 5, 095(F)
[Link] OVERHEAD COST VARIANCES
In developing overhead application rates, a company must specify an operating level or
capacity. Capacity refers to the level of activity. Alternative activity measures include
theoretical, practical, normal, and expected capacity. Because total variable overhead changes
in direct relationship with changes in activity and fixed overhead per unit changes inversely
with changes in activity, a specific activity level must be chosen to determine budgeted
overhead costs.
The use of separate variable and fixed overhead application rates and accounts allows
separate price and usage variances to be computed for each type of overhead.
a. VARIABLE OVERHEAD COST VARIANCE (VOHV)
This is the difference between standard variable overheads for actual production and the
actual variable overheads.

Symbolically,
VOHV =SC-AC
Where: SC= standard variable overheads for actual production
AC= actual variable overheads

It can be sub –divided into Variable overhead expenditure variance, and Variable overhead
efficiency variance.
i) VOH expenditure variance is the difference between the standard variable overheads
for the actual hours worked, and the actual variable overheads incurred. The formula
for computing it is as follows:
VOH Exp. Variance = AVOH –SVOH.
Where: AVOH is actual variable overheads incurred
SVOH is standard variable overheads for the actual hours worked,

ii) VOH efficiency variance arises when the actual output produced differs from the
standard output for actual hours worked. It is a measure of extra overhead (for
saving) incurred solely because of the efficiency shown during the actual hours
worked. The formula to compute it is as follows:
VOH efficiency variance = (SHOV for actual hours worked)- (SHOV for actual output)

Example 4.5 From the following information, calculate VOH cost variances assuming labor
hours as cost driver for variable manufacturing overhead.
Budget output 5000 units
Budgeted hours 10,000
Budgeted variable overheads Br. 2,000
Actual variable overheads Br. 3,000
Actual output 4,000 units
Actual hours 12,000 hours

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Solution
i) VOH cost variance =AVOH –SVOH for actual production
= Br.3, 000 - (4000 x Br 0.40*)
= Br...3,000 - Br. 1600= Br.1400 (U)
ii) VOH expenditure variance = AVOH – SVOH for actual hours worked
= Br.3000 - (12000 x 0.20**) =Br. 600 (U)
iii) VOH efficiency variance = SVOH for actual Hrs - SVOH for actual output
=Br. 2400 – Br. 1600=Br. 800 (U)
Workings:
*SVOH per unit of output –Br.2000/5000 = Br.0.40 per unit
** SVOH pre hours = Br.2000/10,000 = Br.0.20 per hour

b. FIXED OVERHEADS COST VARINANCE (FOHV)

This is the difference between the standard fixed overheads for actual output and actual fixed
overheads. The reasons for the variance are over absorption or under –absorption of
overheads for the actual production the budgeted production may be different from the actual
production for the actual overheads incurred. The major sub –divisions of FOHV are FOH
expenditure variance and FOH volume variance. The formula for FOHV is as follows:
FOHV =AFOH –SFOH
Where: AFOH = actual fixed overheads.
SFOH = standard fixed overheads for actual output

Note that, if the AFOH is less than the SFOH, the variance is favorable (F), and vice versa.
This variance can be classified into two.
i) FOH expenditure variance (FOHEV)
This is the difference between Actual fixed overhead costs and Budgeted fixed overhead
(Symbolically, FOHEV= AFOH –BFOH)
If the actual is greater than the budgeted, this variance is adverse (U), and vice versa
ii) FOH volume Variance (FOHVV)
This is the difference between the budgeted fixed overheads and the standard fixed overheads
absorbed on actual production. The formula is as follows:
FOHVV =BFOH –SFOH on actual production.
If the BFOH is greater than the SFOH on actual production, the variance is adverse (U) and
vice versa.
Example 4.6: From the following data calculate FOH cost variance.
Budgeted hours: 10,000 hours; Budgeted output: 5,000 units, Budgeted FOH: Br.3,000
Actual hours: 12,000hours; Actual output: 4,800 units; Actual FOH: Br.3,600
Solution:
a. FOHV = AFOH – SFOH on actual output
= Br.3600 - (0.60* x4800)
= Br. 3600 - Br. 2880 =. Br.720 (U)
b. FOHEV= AHOH – BFOH
= Br.3600 – Br.3000 =. Br.600 (U)
c. FOHVV = BFOH – SFOH on actual output
= Br.3000 - (0.60 x 4800)
= Br.3000 – 2880 =. Br.120 (U)

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 Workings:
*SFOH per unit = Br. 3000/5000= Br.0.60 per unit

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