Cost Management

UNIT 10 VARIANCE ANALYSIS

Objectives

This unit aims at:

• acquainting you with the ways in which the management can monitor and
guide the operations of a business to meet the desired goals, particularly in
respect of costs and sales.

• helping you in identifying the factors responsible for deviation of actual

performance from the standard performance and in taking such remedial
measures as may be necessary.

Structure
10.1 Introduction
10.2 Meaning of Variance
10.3 Cost Variances
10.4 Direct Material Variances
10.5 Direct Labour Variances
10.6 Overhead Variances
10.7 Sales Variances
10.8 Control of Variances
10.9 Variance Reporting
10.10 Summary
10.11 Key Words
10.12 Self-assessment Questions/Exercises
10.13 Further Readings

10.1 INTRODUCTION
Profit making is the prime objective of business enterprise. Profit depends
basically on two factors-Costs and Sales. In order to achieve better performance, it
is necessary that you lay down your targets in respect of both of them. Your
objective should e to maximise the sales and minimise the costs. This will result
in maximisation of the profits and, in the long run the wealth of the firm.
Variance analysis is intimately connected with budgetary control which 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.

10.2 MEANING OF VARIANCE

Variance is the difference between budgeted and the actual level of activity. Since, as
explained earlier, profitability of a business depends both on costs and sales, it will be

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Cost variance is the difference between ` what should have been the cost' (popularly Variance Analysis
termed as standard cost) and `what has been the cost ` (i.e. actual cost). In case the
actual costs is less than the standard cost, the variance is termed as `favourable'.
However, if the actual cost is more than the standard costs, variance is termed as
`adverse' or `unfavourable'.

Sales variance is the difference between `what should have been the sales'
(popularly) termed as Budgeted sales) and `what have been the sales ` (i.e. the
actual sales). In case the amount of actual sales is more than the budgeted sales,
the variance is termed as 'favourable'. However, if the amount of actual sales is
less than the budgeted sales, the variance is termed as `adverse' or `unfavourable'.

Thus, variances may be classified into two categories:

In the following pages, we will explain both the above types of variances in
details.

10.3 COST VARIANCES

Cost variances can be put in the following chart:

Direct expenses constitute an insignificant portion of the total cost of the product.
Hence, direct expense variance is generally not calculated. If it is desired to
calculate the direct expense variance, it can be computed in the same way as the
variable overhead variance is calculated, since in most cases direct expenses are
variable.

At this point, however, we suggest that you have a look at Exhibit -10.1, given
towards the end of this unit, which presents a bird's eye view of all the variances
discussed in this unit and their inter-relationships. Whenever you are in doubt, a
reference to this Exhibit may prove helpful.

In the course of discussion in this unit, you will find that abbreviations for
different variances have been used. For your facility, we present below a list of all
such abbreviations together with the full names of the variances.

Abbreviations for Different Variances

DMCV - Direct Material Cost Variance 73

DMPV - Direct Material Price Variance
Cost Management DLCV - Direct Labour Cost Variance

DLRV - Direct Labour Rate Variance

DLEV - Direct Labour Efficiency Variance

OCV - Overhead Cost Variance

VOCV - Variable Overhead Cost Variance

FOCV - Fixed Overhead Cost Variance

FOEXPV - Fixed Overhead Expenditure Variance

FOVV - Fixed Overhead Volume Variance

SVV - Sales Value Variance

SPV - Sales Price Variance

SVOLV - Sales Volume Variance

10.4 DIRECT MATERIAL VARIANCES

Three types of direct material variances are explained here. The first one is Direct
Material Cost Variance (DMCV) which is equal to the difference between the
standard cost of direct materials specified for the output achieved and the actual cost
of direct materials used. The standard cost of materials is computed by multiplying
the standard price with the standard quantity for actual output, and the actual cost is
computed by multiplying actual price with the actual quantity.

Formula for Computation:

Direct Material Total Standard

Cost Variance = Cost for _ Total Actual Cost

(DMCV) Actual Output

(Standard Price x Std. Qty. for Actual Output) - (Actual Price x Actual Quantity)

If the actual cost is more than the standard cost, it would result in an adverse variance
and vice-versa. Let us take an example.

Standard output 800 units

Actual output 1,000 units
Std. qty. per unit 1 kg
Total actual qty. used 1,200 kg.
Std. rate per unit Rs.4 per kg
Actual rate per unit Rs. 5 per kg.

DMCV = Standard Cost for actual output Actual Cost

= 1,000 x 1 x 4-1,200 x 5

= Rs. 4,000 - Rs. 6,000

= Rs. 2,000 (Adverse)

If standard output and actual output are different as in this case, the variances are to.
be calculated keeping in view the actual output. The information regarding standard
74 output (which is different from standard quantity) is thus not relevant.
The material cost variance may arise either on account of change in price or Variance Analysis
change in quantity or both. Thus, material cost variance may be further analysed
as `material price variance' and `material usage variance'

Direct Material Price Variance

DMPV is concerned with that portion of the direct material cost variance which is
due to the difference between the standard price specified and the actual price
paid.
Formula for computation

If the actual price is more than the standard price, the variance would be adverse
and in case the standard price is more than the actual price, it would result in a
favourable variance.
The material price variance, on the basis of figures given in the above example will
be computed as follows:
DMPV = 1,200 x (4 - 5)
= Rs. 1,200 (Adverse)
The reasons for price variance may be as under:
i) Fluctuations in market prices:
a) Market trends may be bullish or bearish.
b) Increase or decrease in prices on account of agreement between
various suppliers or on account of Government intervention. .
ii) Buying efficiency or inefficiency
iii) High or low costs of transportation and carriage of goods.
iv) Changes in or laxity in pursuing purchase policy:
a) Superior or inferior (non-standard) material might have been
purchased;
b) Purchases might have been effected in small quantities instead of in
bulk or vice versa;
c) Substitute and cheaper materials might have been used.
v) Emergency purchase- placing rush orders for immediate delivery at the
prevalent price.
vi) Fraud in purchases and loss of discounts.
vii) Incorrect: setting of standards.
Some of the facts may be controlled by the management if care or proper control is
exercised, while others may be beyond the control of management. If the factors are
controllable, the buying department is usually answerable for unfavourable
variations. 75
Cost Management Direct Material Usage or Quantity Variance

DMUV is that portion of direct material cost variance which is due to the difference
between the standard quantity specified (for the output achieved) and the actual
quantity used.

Formula for computation

The actual quantity, if more than the standard quantity, would cause an unfavourable
variance and vice-versa.

The usage variance will be computed as follows on the basis of figures given in the
above example.

DMUV = 4 X (1,000-1,200)

= Rs. 800 (Adverse)

The total of material price and quantity variances is equal to material cost variance.

Thus, DMCV = DMPV + DMUV

= Rs.1200 (A) +800 (A)

= Rs. 2,000 (A)

The reason for direct material usage variance may be as under:

i) Inefficiency, lack of skill or faulty workmanship resulting in more

consumption of raw materials.

ii) Lack of proper unkeep and maintenance of plant and equipment, and
frequent breakdown during production process leading to wastage of material

iii) Non-consideration of product design and method of processing, etc. which

fixing standards.

iv) Incorrect processing of materials resulting in wastages.

v) Non-recording of returns of material to stock (or stores) or inter-transfers

from one job to another.

vi) Improper inspection and supervision of workmen resulting in adverse

quantity variance due to careless handling and processing.

vii) Too strict supervision or inspection resulting in excessive rejections of

materials.

viii) Substitution of specified materials with unspecified materials causing greater

consumption of the latter. Price variance could be favourable because
unspecified material is likely to be cheaper.

ix) Incorrect setting of standards, leading to variations.

x) Excessive wastage, scrap, Spoilage, Shrinkage, leakage, etc. causing an

adverse usage variance.
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Computation of Various Direct Material Variances Variance Analysis
Illustration 10.1
Form the following particulars, let us find the(i) Material Cost Variance, (ii) Material.
Usage Variance, (iii) Material Price Variance.
Quantity of material purchased 4,000 units
Value of material purchased Rs.10,000
Standard quantity of materials per unit of
finished product 2 kg
Standard rate of material Rs.2 per kg
Opening stock of material 1,000 kg
Closing stock of material 2,000 kg
Finished products during the period 1;000 units
Standard Quantity of materials required : 1,000 x 2 = 2,000 kg.
Actual Qty. of Material used = Material purchased + Opening Stock - Closing Stock
= 4,000+1,000-2,000 = 3,000 kg.
Standard Price = Rs. 2 per unit.
Actual Price = Rs.10,000 = Rs.2.50 per unit.
4,000 units

*Presuming FIFO Method

ii) DMUV = Standard Price x (Standard Quantity - Actual Quantity)
= Rs. 2 x (2,000 - 3,000)
= Rs. 2 x (-1,000) = Rs. 2,000 (Adverse)
iii) DMPV = Actual Quantity x (Standard Price - Actual Price)
= 1,000 x (2 - 2) + 2,000 x (2 - 2.50) = Rs. 1,000 (Adverse)
It will be observed that the total of materials usage and material price variance is
equal to material cost variance.
Activity 10.1
Calculate: (i) material usage variance, (ii) material price variance, and (iii) material
cost variance in respect of a manufacturing concern which has adopted standard
costing. The firm furnishes the following information.
Standard data
Material for 100kg.of finished products (140 kg),
Price of materials Rs. 4 per kg
Actual data

Output 60,000 kg
Material used 80,000 kg
Cost of material Rs. 2,60,000
77
Cost Management 10.5 DIRECT LABOUR VARIANCES
The deviations in cost of direct labour may occur because of two main factors: (1)
difference in actual rates and standard rates of labour, and (ii) the variation in actual
time taken by workers and the standard item prescribed for performing a j( ) or an
operation.

Labour variances are very much similar to material variances and they can be very
easily calculated by applying the same techniques as used in calculation of mater .1
variances. (The readers can work out the various formulae for Direct Labour
Variances by simply putting the word `time' in place of `qty'. in the formula meant
for Direct Material Variances.) The various labour variances may be put as under.

It is the difference between the standard direct wages specified for the activity
achieved and the actual direct wages paid. Formula for computation.

Illustration 10.2

Standard output 200 units

Standard time per unit 2 hours

Standard rate per hour Rs. 3

Actual output 160 units

Total actual time taken 300 hours

Actual rate per hour Rs.3.50

DLCV = Rs. 3 x 160 x 2 - Rs. 3.50 x 300

= Rs. 960 - 1,050 = Rs. 90 (Adverse)

The direct labour cost variance may arise on account of difference in either rate of
wages or time. Thus, it may be further analysed as (i) Rate variance, and (ii) Ti e or
Efficiency variance. This has been shown in the chart below:

Direct Labour (Wages) Rate Variance

It is that portion of direct labour (wages) variance which is due to the difference
between the standard or specified rate of pay and actual rate paid. Formula for
78 computation.
Direct Labour Rate = Actual time x (Standard Rate - Actual Rate) Variance Analysis
Variance (DLRV)
If the actual rate is higher than the standard rate, it shall result in an unfavourable
variance and vice versa.
Taking the figures given in the above illustration, the direct labour rate variance will
be computed as follows:
DLRV = 300 hrs x (Rs. 3 - Rs. 3.50)
= Rs.150 (Adverse)
The reasons for direct labour rate variance may be as under:
i) Deployment of more efficient and skilled workers giving rise to higher
payment.
ii) Higher payment due to shortage of availability of labour.
iii) Lesser payment due to abundant availability of labour or high competition
among them for employment.
iv) Employment of unskilled labourers causing lower actual rates of pay.
v) Extra-Shift allowance to workers or overtime allowance (for work done after
normal hours) leading to higher wages.
vi) Higher piece rates for better quality production
vii) Change in the system of wage payment( from time wages to piece wages or
vice versa , introduction or withdrawal or incentive or bonus schemes etc.
viii) Change in wage rates, probably due to a revised agreement with labour
union/
ix) Higher rates during seasonal or emergency operations
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.
Formula for computation

Labour Efficiency = Standard Rates x Standard time _ Actual time

Variance (for actual output)

Taking the figures given in Illustration 10.2, the labour efficiency variance will be
computed as follows:
Labour Efficiency Variance = Rs. 3 x (320 hrs -300 hrs). = Rs.60 (Favourable)
It will be seen that the work has been finished in 150 hours, compared to 160 hours-
the standard time set for the production. This could be attributed to efficiency of
workers. That is why, this variance is known as Labour Efficiency Variance. The
total of labour rate and efficiency variance is equal to labour cost variance.
Verification
DLCV = Labour Rate Variance + Labour Efficiency Variance
= Rs. 150'(A) + 60 (F)
= Rs. 90 (Adverse)
Labour efficiency variance may be caused by the following:
i) Defective or bad materials
ii) Breakdown of plant and machinery
79
iii) Failure of power
Cost Management iv) Efficient working by the labourers and fuller utilisation of time due to
incentives given.
v) Loss of time due to delayed instructions from management or delay in receipt
pf raw materials.
vi) Alteration in the method of production.
vii) More time taken by workers due to lack of proper supervision and control by
management, making the workers lazy and inefficient.
viii) Too rigid a system of inspection and control.
ix) Poor working conditions
x) Lower productivity due to lack of training, ability or experience on the part
of workers
xi) Labour turnover or change -over of workers form one operation or process c
department to another.
Computation of Labour Variances
Illustration 10.3
Form the following details calculate the direct labour variances:
Direct Labour Rate : Re. 1 per hour
Hours set per unit : 10 hours
Actual data are given below:
Units produced : 500
Hours worked : 6,000
Actual Direct Labour Cost : 4,800
Let us work out the various labour variances.
Standard Time = 10 hours x 500 units = 5,000 hours
Standard Cost = Standard Rate x Standard Time
= Re.1 x 5,000 hours = Rs.5,000
i) Direct Labour = Standard Cost - Actual Cost
Cost Variance
(DLCV) = Rs.5,000 - Rs.4,800 = Rs. 200 (F)
ii) Direct Labour = Actual Time X (Standard Rate -Actual Rate)
Rate Variance
(DLRC)

Hence, Labour Rate Variance = 6,000 hours x (Rs. 1.80 p.)

= Rs. 1,200 (F)
iii) Direct Labour Efficiency = Standard Rate x (Standard Time – Actual Time)
Variance (DLEV).
= Re.1 x (5,000 - 6,000 hours)
= 1,000 (Adverse)
Verification
DLCV = DLRV + DLEV
= Rs. 1,200 (F) + Rs. 1,000 (A)
80 = Rs. 200 (Favourable)
Activity 10.2 Variance Analysis
Calculate labour variances for Travancore Supply Company which produces a single
article. The product goes through two operating departments. The standard costs card
for this article indicated the following data:
Standard time Standard rate Total
Department A 2 hours Rs.5 Rs.10
Department B 1.5 hours Rs.6.00 Rs.9
The production for the month of July was, 2,000 units. The actual labour costs in the
two departments were:
Hours Cost
Department A 4,000 Rs. 24,000
Department B 2,000 Rs. 15,000

10.6 OVERHEAD VARIANCES

The term overhead includes indirect material, indirect labour and indirect expenses.
Overheads may relate to factory, office, or selling and distribution departments.
However, for the purposes of variance analysis, we can broadly divide the overhead
cost variance into two categories as shown below:

Each of these variances are discussed below:

Overhead Cost Variance (OCV)
It is the difference between the standard overheads for actual output (i.e. recovered
overheads) and actual overheads. It is the total of both fixed and variable overhead
variances.
Overhead Cost variance = Recovered Overheads - Actual Overheads Variable
Overhead
Cost Variance (VOCV)
It is the difference between standard variable overheads for actual output ( or recov-
ered 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 expenses 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 clue to spoilage or defective workmanship or excessive
overtime work, etc. 81
Cost Management 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 ma;
be on account. (i) a higher or lower amount of fixed overheads, compared to budge :d
fixed overheads, might have been incurred for the same production during the same
period (ii) the same amount of fixed overheads might have been incurred for a high
or lower production than the budgeted production during the same period.
Computation of Overhead Variances
Illustration
Budgeted Output 10,000 units

Budgeted Overheads Rs. 10,000

Fixed 6,000
Variable 4,000
Actual Overheads 12,000
Fixed 6,000
Variable 6,000
Actual output 8,000 units
Let us calculate the various overhead variances.
It will be appropriate to make the following basic calculations before computing th
various Overhead Variances.
Standard/Budgeted Overhead = Budgeted Overheads
Rate per Unit Budged Output

Rs. 10,000 = Re.1

= 10,000
Standard/Budgeted Fixed = Budgeted Fixed Overheads
Overhead Rate per Unit Budged Output
= Rs. 6,000 = Re. 60
10,000
Standard/Budgeted Variable = Budgeted Variable Overheads
Overhead Rate per unit Budged Output
= Rs. 4,000 = Re. 0.40
10,000
Various Overhead Variances can now be calculated
OCV = Recovered Overheads - Actual Overheads
= Rs. 1 x 8,000 -12,000 = 4,000 (Adverse)
VOCV = Recovered Variable Overheads -Actual Variable Overheads
= 8,000 x Re. 0,40 - Rs. 6,000
= 3,200 = 6,000
= 2,800 (Adverse)
FOCV = Recoverd Fixed Overheads Actual Fixed Overheads
= 8,000 x Re. 0.60 - Rs. 6,000
82 = Rs. 4,800 - Rs. 6,000 = Rs. 1,200 (Adverse)
Verification Variance Analysis
OVC = VOCV + FOCV
4,000 (A) = 2,800 (A) + 1,200 (A)

Activity 10.3

Calculate different overhead variances from the following standard and actual data:
Standard Overhead rate: Per unit

Variable Rs. 3.00

Fixed (Rs. 36,000 / 3,000) Rs. 12.00

Rs. 15.00
Actual data during the period:
Output 2,400 units
Overhead:
Variable Rs. 6,000
Fixed Rs. 28,000 Rs. 34,000
Classification of Fixed Overhead Variance
Fixed Overhead Variance may be classified as shown in the following chart:

Fixed Overhead Expenditure or Budget or Controllable Variance (FOEXPV)

This variance is due to the difference between Budgeted Fixed Overheads and the
Actual Fixed Overheads incurred.
FOEXPV = Budgeted Fixed Overheads-Actual Fixed Overheads

Fixed Overhead Volume Variance (FOVV)

This variance arises on account of difference between standard and actual output
resulting in under or over-recovery of fixed overheads. It is, therefore, the difference
between overheads absorbed on actual output (or recovered overheads) and those on
budgeted output (or budgeted overheads).
FOVV = Recovered Fixed Overheads Budgeted Fixed Overheads.

Illustration 10.5

Calculate the Fixed Overhead Expenditure Variance and Fixed Overhead Volume
Variance on the basis of data given in Illustration 10.3.
FOEXPV = Budgeted Fixed Overheads -Actual Fixed Overheads
= Rs. 6,000 - Rs. 6,000 = Nil
FOVV = Recovered Fixed Overheads - Budgeted Fixed Overheads
83
= Rs. 4,800 - Rs 6,000 = Rs. 1,200 (Adverse)
Cost Management Verification
FOCV = FOEXPV + FOVV
1,200 (A) = Nil + 1,200 (A)
Activity 10.4
Caren late the overhead variance with the following data:

Item Budgeted Actual

No. of working days in a month 20 2
Man hours per day 6,000 6,400
Output per man hour in units 1.0 9
Overhead cost (Rs.) 1,20,000 1,28,000

10.7 SALES VARIANCES

Sales are affected by two factors (i) the selling price and (ii) the quantum of sales fhe
variations in the standards set and actuals for the purpose may be mainly due to
change in market trends. Normally, if the selling price increases, the volume of sales
will be lower than the standard. It may result in a favourable variance as to price Id

unfavourable variance as to quantity. It is to be borne in mind that higher price here is

to be viewed as a favourable variance (higher price paid for material, it will be
recalled, causes an adverse variance) and lower volume of sales is to be viewed a
unfavourable (in case of materials, it is the other way around, i.e. lower usage of
materials than the standard causes a favourable variance).

It is well known that demand and supply position in the market decides the quantity
of sales as well as the selling price. The variations may be on account of control lab :
as well as non-controllable factors. changes in market conditions and demand by
customers¬ are, of course, beyond the control of management, but certain factors like
urn ably high prices are controllable, and an effort should be made to check adverse
variations due to these factors.

Sales variances can be understood with the help of the following chart

Sales Value Variance

Sales Price Sales Volume Variance

Sales Value Variance

The difference between budgeted sales and actual sales results in Sales Value < xi-
ance. The Formula is:

Sales Value Variance = Budgeted Sales - Actual Sales

If actual sales are more than the budgeted sales, a favourable variance would '
reported and vice versa.

The difference in value may be on account of difference in price or volume of ales

which is therefore analysed further.
84
Sales Price Variance Variance Analysis
It can be calculated like material price variance. It is on account of the difference in
actual selling price and the standard selling price for actual quantity of sales. The
formula is:

Actual quantity sold X (Standard Price - Actual Price)

OR

Price Variance = Standard Sales - Actual Sales

Sales Volume Variance

It can be calculated like material usage variance. Budgeted sales may be different
from the standard sales. In other words, budgeted quantity of sales at standard price
may vary from the actual quantity of sales at standard prices. Thus, the variance is a
result of difference in budgeted and actual quantities of goods sold. The formula is:

Standard Price X (Budgeted Quantity - Actual Quantity)

OR

Volume Variance = Budgeted Sales - Standard Sales

If the standard sales are more than the budgeted sales, it would cause a favourable
variance and vice versa?

The total, of price and volume variances would be equal to sales value variance.

Computation of Sales Variances

Illustration 10.6

8 5

85
Cost Management Verification

Sales value variance = Sales Price Variance + Sales Volume Variance

= 18,000 (A) + 18,000 (F)

= Nil

*Budgeted Sales = Budgeted Price x Budgeted Quantity

10.8 CONTROL OF VARIANCES

After the variance have been computed and analysed, 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 been 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 of
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.

86
It may be noted that variance analysis, in itself, would not help in achieving the Variance Analysis
desired objective of in minimising 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 minimised 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.

10.9 VARIANCE REPORTING

As stated above, the deviations alongwith their causes should be reported to the
management regularly and at the opportune time so that corrective action may be
taken immediately. The person or department may be held responsible for any
adverse variations after duly accounting for it.
The information as to the profit earned by the business is presented through a simple
Profit and Loss Account where a system of historical costing is prevalent. Its
proforma is given below:
Trading and Profit and Loss Account
For the Year ending
To Direct Materials ... By Sales ….
" Variable Expenses …
" Fixed Expenses …
" Net Profit …
However, when a system of standard costing is in operation the information about the
standards, the actual and the variances alongwith their causes should be depicted
through a statement, so that the management may be able to take quick action in
respect of any inefficiencies thus revealed. The statement draws a reconciliation
between the Budgeted Profit/Standard Profit and Actual Profit. The preparation of
this statement can be understood with the help of the following
The profit statement, submitted to the management, should contain notes to explain
the causes of the variances. Since the rule of `management by exception' is followed,
greater attention in the reported statement is drawn towards the adverse variances, i.e,
the reasons for the failure or poor performance are highlighted in particular,
alongwith comments on general overall performance.
Illustration 10.7
From the following particulars let us try to draw a reconciliation between actual and
the budgeted profit explaining the variances due to the various causes:
Budgeted /Standards Actual
Units 4,000 3,500
Net price per unit Rs.20.00 21.00
Material per unit Kgs. 4.00 4.00
Rate of material per Kg. Rs. 2.00 2.25
Labour hours per unit Hrs. 5.50 4.50
Rate per labour hour Re. 0.50 0.60
Variable overhead per labour hour Rs. 0.80 1.00
Fixed overhead per unit Re. 1.00 1.20
Direct Material Price = Actual qty. x (Std. price - Actual price)
Variance (DMPV) = 14,000 x (Rs. 2.00 - Rs. 2.25)
= Rs. 3,500 (Adverse)

87
Cost Management

88
Variance Analysis

89
Cost Management Activity 10.5
From the following details, reconcile the budgeted sales with actual sales and
standard profit with actual profit in terms of variances:

Activity 10.6
Identify the type of variance which will result in each of the stated situations and also
indicate whether the variance is favourable or unfavourable:
• Jammnadas, a worker in the finishing department of a furniture factory,has gone
on leave due to illness and is temporarily replaced by Gangaram. Jamanadas's
wages are Rs. 200 per day whereas Ganga is to be paid at Rs. 220 per day.
• Because of the machining error, the cutting department got only three table tops
from each piece of a teak board. Proper cutting should have resulted in four table
tops per sheet of teak board.
• Installation of a new office equipment reduced factory office cost by Rs.
1,00,000 a month.
• The price of teak board increased by 5 per cent. This price increase was
anticipated and was included in the computation of standard material cost.
• A shipment of lumber from Assam is delayed in transit because of transporters'
strike. As a result, it is necessary to substitute a more expensive type of lumber.
• The standard time for shaping legs is 16 minutes per table. A new manwas
assigned to this operation and while he was learning the job, his production rate
was three table legs every 21 minutes.
• The production level in 2002 was 22 per cent higher than estimated at the
beginning of the year, while total fixed manufacturing overhead costs were as
budgeted.
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10.10 SUMMARY
Profitability of a business enterprise depends basically on two factors; costs and
sales. The efforts of the management should be to minimise the cost without
compromising on the quality and pushing up the sales of the products. This requires
proper monitoring of both costs and sales performance. Targets have to be fixed and
the actual results should be compared with the pre-determined targets and variances
90 found out.
Variance refers to the difference between the standard (or budgeted performance) and Variance Analysis
actual performance. Variance analysis is mainly concerned with ascertaining the
quantum of variances together with the analysis of the causes responsible for such
variances.
It may be noted that in the case of cost variance, if the actual cost is more than the
standard cost, it is termed as an adverse variance. While in the case of sales
variances, if the actual amount of sales is more than the budgeted sales, it is termed
as a favourable variance.
Variance reports have to be submitted to the management from time to time. These
reports contain details regarding the budgeted/standard performance, actual perfor-
mance, the quantum of variances and the departments/executives responsible for
adverse variances. On the basis of these reports, the management can fix the
responsibilities on the executives for controllable variances, and takes necessary steps
so that such variances do not occur in future. For variances caused by uncontrollable
factors, management should try its best to minimise the effect of such factor or revise
budgeted/standard performance, if necessary.
Various types of variances can be understood with the help of Exhibit 10.1
Exhibit 10.1: A diagrammatic presentation of variances and their Inter-
relationships.

10.11 KEYWORDS
Direct Labour Cost Variance: It is the difference between the direct wages
specified or the activity achieved and the actual wages paid.
Direct Labour Efficiency Variance: It is that portion of direct labour cost variance
which is due to the difference between the standard labour hours specified for the
activity achieved and the actual labour hours expended.
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Cost Management Direct Labour Rate Variance: It is that portion of direct Labour Cost Variance
which is due to the difference between the standard rate of wage specified and actual
rate paid.
Direct Material Cost Variance: It is the difference between the standard cost of
direct materials specified for the output achieved and the actual cost of direct material
used.
Direct Material Price Variance : It is that portion of the direct material cost
variance which is due to difference between the standard price specified and actual
price paid.
Direct Material Usage Variance: It is that portion of the direct material cost
variance which is due to difference between the standard quantity specified (for the
output achieved) and the actual quantity used.
Fixed Overhead Cost Variance: It is the difference between recovered fixed
overheads (i.e. standard fixed overheads for actual output) and the actual fixed
overheads.
Fixed Overhead Expenditure Variance: It is the variance due to the difference
between budgeted fixed overheads and the actual fixed overheads incurred.
Fixed Overhead Volume Variance: It is the variance due to the difference between
recovered overheads (i.e. standard overheads for actual output) and the budgeted
overheads.
Over head Cost Variance: It is the difference between recovered overheads (i.e.
standard overheads for actual output) and the actual overheads.
Sales Price Variance: It is the variance on account of difference between actual
selling price and standard selling price for actual quantum of sales.
Sales Value Variance: It is the difference between the budgeted sales and the actual
sales.
Sales Volume Variance: It is the variance on account of difference between
budgeted and actual quantity of goods sold at standard price.
Variance: It is the difference between the standard/budgeted performance and the
actual performance.
Variable Overhead Cost Variance: It is the difference between recovered variable
overheads (i.e. standard variable overheads for actual output) and the actual variable
overheads.

10.12 SELF-ASSESSMENT QUESTIONS/EXERCISES

1 What is a Variance? Why are the variances computed?
2 How can the Variance be controlled?
3 List some possible causes, separately for “material price variance” and
“material usage variance"
4 What is Direct Labour Efficiency (Time) Variance? What the managers or
supervisors can (or should) do to ensure that their is no such unfavourable
Variance?
5 Distinguish between Variable Overhead Cost Variance and Fixed Overhead
Cost Variance. Why such variances are caused?
6 Discuss the importance of variance analysis in operational and management
control. How does this technique help in, what is popularly known as
management by exception’?

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7 State whether each of the following statements is “True or False” : Variance Analysis
a) A cost variance is said to be favourable if the
standard cost is more than the actual cost. True False
b) Material usage variance is that portion of material
cost variance which arises due to the difference
between standard quantity for the output achieved
and the actual quantity. True False

c) Labour efficiency variance is the difference

between standard hours for the actual output and
the actual hours. True False
d) Direct labour rate variance is the difference
between the standard direct wages specified for
the activity achieved and the actual direct wages
paid. True False

e) Standard sales and budgeted sales are synonymous

terms. True False
f) Recovered overheads and absorbed overheads
mean one and the same thing. True False

g) Fixed overhead cost variance is the aggregate of

the expenditure variance and the volume variance. True False
h) The selling department is responsible for factory
overhead volume variance. True False

8 Fill in the blanks:

a) Variance analysis involves………….…..and ……………... of variance.
b) Variance is the difference between standard performance and the
…………………… performance.
c) Material cost variance is sub-divided into ………………….. variance
and ………………….. Variance.
d) Overhead cost variance can be classified into …………..………..
overhead cost variance and …………..….. overhead cost variance.
e) Sales value variance is the difference between …...…………… sales and
………………….… sales.
9 From the following particulars, compute Direct Material Variances:
Quantity of direct materials, consumed 2,500 kgs.
Actual rate of material purchased Rs. 3 per kg.
Standard quantity of materials required per tonne of output 30 kg.
Standard rate of material Rs. 2.50 per kg.
Output during the period 80 tonnes.
10 XYZ Ltd., which has opted standard costing, furnishes you the following
information:
Standard:
Material for 700 units of Finished products 1,000 Kgs.
Price of materials Re. 1 per kg.
Actual:
Output 2,10,000 units
Opening Stock Nil
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Cost Management Purchases 3,00,000 kg.
For Rs. 2,70,000
Closing stock 20,000 kgs.
You are require to calculate
(a) Direct Material Usage Variance, (b) Direct Material Price Variance and
(c) Direct Material Cost Variance.
11 In a production department of a factory there are 80 workers and the average arte
of wages per worker is Re. 1 per hour. Standard working hours per week are 45
and the standard performance is six units per hour.
12 The following information is gathered from the labour records of Bajaj Electrical
for January 2003.
Pay roll allocation for direct labour Rs. 40,000
Time card analysis shows that 8,000 hours were worked on production lines.
Production reports for the period showed that 2,000 units have been completed,
each unit requiring standard labour time of 3 hours and a standard labour rate f
Rs. 4 per hour.
Calculate the labour variances.
13 Basu Industries turns out only one article the prime cost standards for which have
been established as follows
Total
Materials – 5lbs. @ Rs. 4.20 Rs. 21
Labour – 2 hours @ Rs. 3 Rs. 6
The production schedule for the month of July, 2003 required completion of 5,000 pieces.
However, 5,120 pieces were actually completed. Purchases for the month of July 2003
amounted to 30,000 lbs. of material at the total invoice price Rs. 1,35,000.
Production records for the moth of July 2003 showed the following actual results:
Material used 25,700 lbs.
Direct labour – 15,150 hours Rs. 48,480
Calculate the appropriate material and labour variances.
14 From the following data, calculate overhead variance:
Fixed overhead budget for November Rs. 50,000
Variable overhead budget for November Rs. 1,00,000
Budgeted production for the month 25,000 units
Actual production for the month 27,000 units
Actual Fixed overhead incurred Rs. 60,000
Actual variable overhead incurred Rs. 1,20,000
15 The budgeted and actual sales of Vikas Ltd. Manufacturing and marketing a
single product are furnished below:
Budgeted Sales 10,000 units at Rs. 10 per unit
5,000 units at Rs. 8 per unit
Actual Sales 8,000 units at Rs. per unit
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Calculate (a) Sales Value Variance Variance Analysis
(b) Sales Price Variance and
(c) Sales Volume Variance
Answers to Activities
10.1 DMCV = Rs. 76,000 (F)
DMPV = Rs.60,000 (F)
DMUV = Rs. 16,000 (F)
10.2 DLCV = Department A Rs. 4,000 (A)
Department B 3,000 (F) 1,000 (A)
DLRV = Department A 4,000 (A)
Department B 3,000 (A) 7,000 (A)
DLEV = Department A Nil
Department B 6,000 (F) 6,000 (F)
10.3 OCV = Rs. 2,000 (F)
VOCV = 1,200 (F)
FOCV = 800 (F)
10.4 FOCV = Rs. 1,280 (A)
FOEXPV = 8,000 (A)
FOVV = Rs. 6,720 (F)
Notes:
FOCV = Recovered Fixed Overheads – Actual Fixed Overheads
= 1,26,720 – 1,28,000
= 1,280 (A)
Recovered Fixed Overheads have been calculated as under:
Man hours per day 6,400
Multiplied by output per man hour in units X 0.9
Total units produced per day
Multiplied by No. of working days 5,760
Total units produced in the month X 22
Multiplied by standard overhead 1,26,720
Cost per unit i.e., Rs. 1,20,000 divided by
1,20,000 (6,000 X 1 X 20) X1
Rs. 1,26,720

FOEXPV = Budgeted Fixed Overheads – Actual Fixed Overheads

= 1,20,000 – 1,28,000
= 8,000 (A)
FOVV = Recovered Fixed Overheads – Budgeted Overheads
= 1,26,720 – 1,20,000
= 6,720 (F)
10.5 Sales Variance
Sales value variance Rs. 3,000 (A)
Sales Price variance Rs. 1,000 (A)
Sales volume variance Rs. 2,000 (A)
Budgeted Sales Rs. 1,46,000
Less sales price variance (A) -1,000
Less sales volume variance (A) -2,000
Actual sales 1,43,000
Profit variance 500 (A)
Price variance 1,000 (A)
Volume variance 1,000 (A)
Overall cost variance 500 (A) 95
Cost Management
Statement of Reconciliation of Actual Profit with Budgeted Profit
Budgeted Profit = Rs. 60,000
Less unfavourable variances:
Due to Price Rs. 1,000*
Due to cost 500* 1,500

Add favourable variances due 58,500

to volume*** 1,000
Actual Profit 59,500

* Sales Price Variance is Rs. 1,000 as earlier shown.

** Variance in profit due to cost is: (Standard cost –Actual cost) X Actual
Quantity.
Applying the formula –
A (12-13) X 4,000 = 4,000 (A)
B (10-9) X 3,500 = 3,500 (F)
500 (A)

*** Variance in profit due to volume is (Standard Quantity – Actual Quantity) X

Standard Profit

Applying formula –
A (3,000 – 4,000 X 10 = 10,000 (F)
B (10-9) X 3,500 X 6 = 9,000 (A)
1,000 (F)
10.6 a) Labour cost increased because a higher wage was paid. Hence
unfavourable Direct Labour Rate Variance (DLRV).
b) Material was wasted. More material was used than allowed by the
standard. Hence unfavorable Direct Material Usage Variance
(DMUV).
c) Factory office costs are a part of manufacturing overhead. As such it is
a favourable Overhead Cost Variance (OCV).
d) Because the price change was anticipated and was already included for
calculating standard material cost, it does not result in a variance from
standard. Hence, no variance.
e) The substitution resulted in a higher price for material used
though the quantity was not affected. Hence unfavourable Direct
Material Price Variance (DMPV).
f) Whereas the standard time per leg is four minutes, the new
worker took seven minutes. Hence unfavourable Direct Labour
Efficiency variance (DLEV).
g) In this situation the actual fixed overhead costs and the budgeted costs
were the same though the production level was higher by 22 per cent.
The recovery for fixed overhead in made on per unit basis. This will
result in favourable Fixed Overhead Volume Variance (FOVV).

Answers to Self-assessment Questions/Exercises

7 (a) True; (b) True; (c) True; (d) True; (e) False (f) True; (g) True;
(h) True; (i) False.
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8 (a) calculation, interpretation; (b) actual; (c) price, quantity; (d) fixed, Variance Analysis
variable; (e) budgeted, actual.

9 DMCV Rs. 1,500 (A); DMPV Rs. 1,250 (A); DMUV Rs. 250 (A)

10 (a) Rs. 20,000 (F); (b) Rs. 28,000 (F); (c) Rs. 48,000 (F)

11 Labour Rate Variance Rs. 360 (F)

(Hint: Standard wages Rs. 14,400; Actual wages Rs. 14,040

No note is to be taken of idle time).

12 Rate Variance Rs. 8,000 (A); Efficiency Variance Rs. 8,000 (A); Cost
Variance Rs. 16,000 (A);

13 DMCV Rs. 8,130 (A); DMPV = Rs. 7,710 (A); DMUV Rs. 420 (A)
DLCV Rs. 2,400 (A); DLRV = Rs. 3,030 (A); DLEV Rs. 630 (F)

14 Volume Variance Rs. 4,000 (F); Expenditure Variance

Rs. 10,000 (A); Fixed Overhead Cost Variance Rs. 6,000 (A); Variable Over-
head cost variance Rs. 12,000 (A)
15 (a) Rs. 36,000 (F); (b) Rs. 6,000 (F), (c) Rs. 30,000 (F)

10.13 FURTHER READINGS

Bhatta Chary S.K., Dearden John 2002, Costing for Management, Vikas Publishing
House, New Delhi (Chapter 7)
Khan M.Y. and Jain P.K., 2002, Management Accounting (Chapter 17), Tata
McGraw Hill : New Delhi
Daff, Trevor. 1986, Cost and management Accounting, Woodhead Fulkner
(Chapter 8).
Davidson, S. and R.L. Weil. 1977, Handbook of Modern Accounting, McGraw-hill
(Chapter 13).
Glautier, M.W.E. and B. Underdown. 1982, Accounting Theory & practice, ELBS
(English Language Book Society) (Chapter 37).
Douch N., Birnberg J.G. and Demiski, Joel. 1982, Cost Accounting. Harcourt Brace
Jovanovich: New York (Chapter 11).
Maheshwari, S.N. 1987, Management Accounting and Financial Control, 5th edition,
Mahavir Book Depot: Delhi (Section C, Chapter 3).

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