21
VARIANCE ANALYSIS
MATERIAL & LABOUR VARIANCE
Variance analysis is an important central point in the system of standard costing. In fact
it is variance analysis which completes the process of standard costing and helps in achieving
the objectives of standard costing i.e., cost control and profit planning. ·
MEANING OF VARIANCE ANALYSIS
In standard costing variance means difference between standard level and actual
performance. The term variance analysis refers to "the systematic evaluation of variances in an
attempt to provide managers with useful information for measuring efficiency and improving
performance." The process of analysis of variance involves following three steps:
l. Computation of Variances: First of all, variances are computed on the basis of various
formulae. In this context total cost variances are divided into material variances, labour
variances and overhead variances and again these variances are segregated into several
sub-variances.
2. Determination of the Causes of Vari~nces : After computation of variances, causes
responsible for each variance are determined. In fact variances by themselves are not the end
unless tlie causes responsible for them are identified. Hence, variance analysis includes detailed
study of the causes of variances and their effects.
3. Disposition of Variance, : In this step, causes are identified as contro- llable and
uncontrollable. Thereafter, a report is prepared for necessary actions to deal controllable
variances, so that management may take necessary corrective measures.
CLASSIFICATION OF VARIANCES
Normally, the basis of classification and their classified forms may be as under:
I. On Functional Basis
On functional basis, variances may broadly be classified into two groups, viz. , Cost
Variances and Sales Variances.
1. Cost Variances : Cost variances refer to differences between standard level and actual
performance in respect of various elements of cost. This is the most important type of variance
and includes the calculation of following :
(i) Direct Material Variance
(ii) Direct Labour Variance ,
(iii) Overhead Variance :
(a) Variable Overhead Variance,
(b) Fixed Overhead Variance. ·
2. Sales Variances : A sales variance reveals the difference between actual sales and
budgeted sales during a budget period. This variance may arise due to change in sales price,
sales volume and sales mix. Sales variances may be calculated in two different ways i.e. , these
V A R ~~~=-- - - - - --:-:-:-::--;-;-~;--- - - -55~39
-------------=:.::::~ys1s: MATERIAL & LABOUR VARIANCE
rnaY be computed so to show th h the effect on
sales value. e effect on profit or these may be calculated to 8 ow
JI. On Result Basis
On the basis of result th .
' e vanances may be of the following two types :
1. Faf:vourable Variance : If the actual cost is less than the standard cost the difference is
1,.-.own as avourable or cred1·t • . . 'd d as a good
l\,1•. • • vanance. Generally, a favourable vanance 1s cons1 ere
indicator ofbusmess efficiency.
2· Un(avourable or Adverse Variance : If the actual cost exceeds the standard cost, th e
difference is ~own as an [Link] adverse or debit variance. Norm~lly, these variances
indicate the mefficienc_y and hence, th~se variances require closer and deeper analysis. . .
Note : 1~the answer of a vanance is in positive (+) sign it will be favourable variance and if it is in negative (-) Sign it
will be unfavourable variance.
Ordinarily, _a favourable variance is considered a sign of efficiency, whereas an
unfavourable variance as a sign of inefficiency. But some times this general logic may prove to
be untru~. It is possible that standards are not fixed properly or favourable results of one or
some vanances may become the cause of unfavourable results of other variances. For example,
favourable material variance will be considered as a sign of efficiency but it is possible that due
to extraordinary care i~ the use of material, the labour efficiency variance may become
unfavourable. Similarly favourable labour rate variance may be obtained by employment of
low-paid untrained workers but it may become a cause of unfavourable labour efficiency
variance. Thus, it is clear that all variances should be interpreted in relation to each other and
corrective actions·should be determined keeping in view the net results of variances.
III. On Measurement Basis
On this basis also, variances may of the following two types :
1. Absolute Variances : The variances calculated on the basis of monetary amount of
standard cost and actual cost are known as absolute variance and generally variances are
calculated in this form. 1
2. Relative Variances: If variances are expressed as percentage of standard cost, they are
known as relative variances.
IV. On Controllability Basis
The basis of controllability is of much significance from the view of managerial decisions.
On this basis variances may be controllable or uncontrollable :
1. Controllable Variances : Controllable variances are those which can be controlled by the
management or necessary steps can be taken to control these variances. It is possible only when
any specified person or department may be held responsible for the variance. According to
l .C.M .A., London, "Controllable cost variance is a cost variance which can be identified as
primary responsibility of a specified person." For example, the supervisor may be held
responsible for extra wastage in material or purchase officer may be held responsible for the
purchase of material of inferior quality.
2. Uncontrollable .Variances _: Variances, for which a particular person or a specific
department cannot be held responsible, are known as uncontrollable variances. In other words
~f any variance is due to the factors beyond ~he contr~l ofhthe ~oncerned_person or department'
1t is said to be uncontrollable. For examp1e, mcrease m t e pnce of material d t . .'
• . • · d . ue o mcrease m
import or excise duties or mcrease m wages ue to new wage settlement et th
· h f: t
uncontrollable unfavourable vanances. Ast ese ac ors are beyond the co t ' c. are
f e cases of
· 1
revision of standards is required to avo1'd sueh vanances
· · future.
m n ro O management ,
Difference between Controllable and Uncontrollable Variance• :
Cl) In case of controllable variances, the concerned person or department m~y be held
responsible but in case of uncontrollable variances such respons1·b·1·t
1 1 Y cannot be assigned ·
(2) Corrective actions are effective in case of controllable variances but such action is not
determined in case of uncontrollable variances.
(3) Generally standards are not modified in controllable variances but uncontrollable
variances ar'e disposed off just by modifying the standards.
(4) All basic variances arising due to non-monetary factors and sub-variances are said to
be controllable variances whereas all basic variances due to monetary factors are said to be
uncontrollable.
V. On the basis of Nature
1. Basic Variances: Basic variances are those variances which arise on account of monetary
rates (i.e., price of raw material or rate oflabour) [Link] on account of non-monetary factors
(i.e., physical units in quantity or time). Basic variances due to monetary factors are Material
Price Variance, Labour Rate Variance and Expenditure Variance, while basic variances due to
non-monetary factors are Material Quantity Variance, Labour Efficiency Variance and Volume
Variance.
2. Sub-Variances: Basic variances arising due to non-monetary factors are further analysed
and classified into sub-variances taking into account the factors responsible for them. Thus,
Material Quantity Variance may be divided into Material Mix Variance, Material Revised Usage
Variance, Material Yield Variance, etc. Similarly Labour Efficiency Variance can be divided into
several sub-variances.
IMPORTANCE OF VARIANCE ANALYSIS
Or
MANAGERIAL USES OF VARIANCE ANALYSIS
1. Measurement of Operational Efficiency : Efficiency of business activities can easily be
measured on the basis of variances. If variances are favourable, the activity is considered
efficient. If it is otherwise the activity is considered inefficient.
2. Technique of Cost Control: Variance analysis is a useful managerial technique from the
view of cost control because necessary corrective measures may be taken after analysing the
cause of unfavourable variances.
3. Knowledge of Variance Centres : Variance analysis helps in identifying the level, activity
or departments where variances are occurring so that special attention may be focussed to these
activities or departments. , ·
4. Determination of Responsibility : On the basis of variance analysis the persons or
departments responsible for variances can be identified which helps in taking corrective
measures.
5. Measurement of Accuracy of Standards : If there is no variance or variances are very
limited, it is an indication of accuracy of standards. On the contrary permanent existence of
variances indicates the inaccuracy of standards.
6. Relative Measurement ofPerformance : The performance of different departments of an
enterprise can easily be evaluated in relative terms on the basis of variance analysis.
7. Basis of Future Action and Planning : Analysis of causes of variances, identification of
responsible persons and suggestions of corrective measures provide a useful base for future
action and planning by management.
VARIANCE
541
. ANALYSIS : MATERIAL & LABOUR VARJANCE
8. Cost Consciousness . V . r
fi ng of cost
sciousnessamongemploy· anance analysis and its reporting develops the _ee lltoolfrolll
co Jl f
tile view o management.
ees and . •
executives, which proves an effective mo
tivationa
· _
On the basis of above facts 1.t . . . rt of standard
casting." is said that "Variance analysis is an integral pa
CAUSES OF VARIANCES
J. iaterial Cost Variance
Material Cost Variance m . . . th .
. . ay anse due t.o variance in price or quantity or m bo ·
1. Matenal Pnce Vari .M . . . . fi . · auses :
. Ch . ance · atenal pnce vanance may anse due to o11owing c
(1) .anges m market price ofm ate n·a1s,
(ii) a1.1ure to secure expected di scount on purchases,
F
(ii) F ru1ure to purchase
. matenals
.
at proper time,
(iv) Changes m prices of mat enals • due to changes in tax by government ,
(v) Purchasing non-standard lots and the consequent reduction in quantity discount,
(vi) Inc~ease in transport cost due to small lot or additional transport coSt for quick
delivery, ·
(vii) Excessive shrinkage or loss in transit ,
(viii) Fai~ure purchase the standard quality of materials.
A m~tenal pnce variance is normally the responsibility of the purchase manager· However'
price vanances due to frequent market fluctuations or changes in tax fall in the category of
uncontrollable variances.
2. Material Usage Variance : The variance arising due to difference in quantity of material
is called as Material Usage Variance or Material Quantity Variance. This variance may arise
due to the following causes :
(i) Negligence in the handling and use of materials,
(ii) Increase in wastage either due to untrained workers or defective method of production,
(iii) Increase in the usage rate of material due to difference in quality,
(iv) Change in technique or method of production,
(v) More or less yield from materials,
(vi) Change in material mix, etc.
II. Labour Cost Variance
The variances in labour cost may arise due to the following causes :
1. Labour Rate Variance :
(i) Changes in basic wage rates, ·it may be either due to change in demand and supply of
workers or due to new wage settlement,
(ii) Different rates being paid to workers employed to meet seasonal demands or to get
urgent work done,
(iii) Employment of workers of different grades and wage rates,
(iv) New workers being paid lower rates from the standard rates,
(v) More payment of overtime wages, etc. ,
It may be mentioned that major portion oflabour rate varianc~ is beyond the direct control
of management.
542 __ MANAGEMENT ACCOUNTTIS"G:_ . ,
1
1 .
2. Labour Efficiency or Labour Time •
Variance .• If th e actual
- hours Thiare less
. worked • or more
th an standard hours the difference 1s known as lab our e ffi c iency variance. s vanance may
•
'
be unfavourable on account
•
of following causes :
(i) Use of sub-standard materials requiring extra labour;
(ii) _ Defective working conditions,
(iii) Lack of proper supervision of work,
(iv) Use of defective machinery and equipment,
(v)Inadequate training of eD?,ployees,
(vi) Discontentment among workers due to unsatisfactory working conditions, etc.
are: 3. Idle Time Variance : I twill always be unfavoura:qle and the main causes of this variance
(i) Non-availability of material at proper time, , _,
(ii) Gap in work due to defect in machinery,
(iii) Stoppage of work due to power failure, ·
(iv) Closure of work due to strike or lock out.
4. Labour Mix Variance : If diffei-ent types oi- grades of employees are engaged in a work
and
to practically
such theisactual
difference calledcomposition differs
as labour mix from the· standard composition, the variance due
variance.
COMPUTATION OF VARIANCES
Cost variances are classified into three Categories : Direct Material Variance, Direct Labour
discussed in detail.
Variance and Overhead Variance. In this chapter only material and labour variancP.s: ,..,.,, h,,;~~
~~===========~~~~~~~~==~~;=-=-=-=-=~~-=-=-=---===----
584
MANAGEMENT AccoUN'fING
Important Fonnulae
-------
MATERIAL VARIANCES
I. When only type of material is used :
(1) [Link] Cost Variance or MCV = (SQ x SP)- (AQ x AP)
(2) [Link] Price Variance or MPV= AQ (SP -AP) 1
(3) [Link] Usage Variance or MUV = SP (SQ - AQ) ked b:L~~ch a case:
In some questions [Link] Yield Variance can also be as · 1 '.
(4) MYV = SC per unit (AY - SY) ,1 1'
n. When two or more types of material• are uaed : , If ' l
(A) When total of SQ and AQ are equal :
MCV=SC-AC
MPV= AQ (SP - AP)
[Link] Mix Variance or MMV = SP (SQ - AQ)
(B) When total of SQ and AQ are not equal: • I
MCV(SC-AC)
I MUV [SP (SQ -AQ)]
MPV [AQ (SP - AP)]
.I
7
I
MRUV or MSUV [SP (SQ - RSQ)] .
. .MMV [SP (RSQ -AQ)]
N,0 te ·. RSQ = SQ in Standard Mix Total A tual Mix
Total Standard Mix x c
(C) When SY and AY both are given and they differ: ·'
In such a case MYV is also calculated in addition to variances required in
(B) as above. Its formula is :
MYV = SC per unit (AY - SY or RSY)
LABOUR VARIANCES
I. When only one type (grade) of labour is used :
(1) Labour Cost Variance or LCV = (ST x SR) - (AT x AR)
(2) Labour Rate Variance or LRV = AT (SR - ~)
(3) Labour Efficiency Variance or LEV= SR (ST -AT)
Notes: l. In these formulae SH and AH can also be used in place of ST and AT.
2. Labour Yield Variance = SC per unit (AY - SY)
3. If there is idle time in the question, then ·
Labour Idle Time Variance or LITV = IT x SR
In such a case : LEV= SR (ST - ATW)
ATW = Actual Time Worked or (ST- IT)
4. Thus, LCV = LRV +LEV+ LITV
II. When two or more types (grades) of labour are used :
(A) When total of ST (SID is equal to total of AT (AH) :
(i) LCV = SLC -ALC
(ii) LRV = AT (SR - AR)
(iii). LMV = SR (ST - AT)
(B) When total of ST (SH) is not equal to total of AT (AID :
LCV (SLC -ALC)
LEV [SR (ST - AT)]
LRV [AT (SR- AR)]
I
LREV [SR (ST- RST)] LMV [SR (RST -AT)]
Notes : (1) lfin such type of quEistion, LEV and not LREV has been asked, then LEV= LREV.
(2) If there is idle time also, then :
.. 585
VARIANCE ANALYSI~ :'MATERIAL &.LABOUR VARIANCE
LCV (SLC _-e- ALC)
·I
' - .
-
1
I I LITV-[SR x IT]
LEV [SR (ST - ATW)]
LRV [AT (SR - AR)]
I
-r
I;REV [SR (ST - RST)l LMV [SR (RST - ATW)l
-j ' .
( C) When SY aDd AY both are given but they. differ : . .
In such a case LaboUI" Yield Variaitce js also calculated in addition to all other variances as discussed
in (B) above. LYV = SC per unit (AY -SY·or RSY) ,
Note: The aIJlOUJlt ofLREV is equal to amount of~Y'l. ..' '
· QUESTIONS·
-«er Questions . ces? Explain th:eir different types.
J. Long' ~ ;0 you und~rstand by·=;°Analysis' and describe its significance_. , . •· .
t. W}la_ . the Jllealllng ?f 'V~ uss 'Material •Variances' and 'Labour V~ances with referenc~ to ~t.
2. EJtPlaJ~tl:llldard Cos~ng. ~iscd distinguish between controllable and uncontrollable variances.
3 • pe:fill~ the terill 'Van~c: Jana favourable varianc.e always indicator ·of efficiency operation?
.4 E,q,Ia~ .,...,.;ance analysis_- s m· Standard Costing? Explain the possible causes for Material Price
~• t 1s -qc;µ... • t vanance · _ .
-t11h8. _,1,,or1al cos -- 1
_ "t°T... ....;onr.P..