ACCA – APPLIED KNOWLEDGE

MANAGEMENT ACCOUNTING

BISC TRAINING CENTER

Ms. Nguyen Thi Phuong Thao, ACCA
www.bisc.edu.vn
085 8822 168
[email protected]

Chapter 15
VARIANCE
ANALYSIS

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 0. CHAPTER 15 – MAIN PARTS
Variance analysis

Variable cost Sales Applying

Fixed cost variences
variances variances variances

Direct material cost Absorption costing Interpretation

variances of variances
Marginal costing
Direct labour cost
variances

Variable production
overhead variances

1. VARIABLE COST VARIANCES

Variance: The difference between a planned, budgeted or standard cost
and the actual cost incurred. The same comparisons may be made for
revenues. The process by which the total difference between standard and
actual results in analysed is known as variance analysis

Variable cost variances

Variance Fixed production overhead variances

Sales variances

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 1. VARIABLE COST VARIANCES
Direct material cost variances

Direct material total variance: The difference between what the

output actually cost and what it should have cost, in terms of material.
Direct material price variance: The difference between the standard
cost and the actual cost for the actual quantity of material used or
purchased. In other words, it is the difference between what the
material did cost and hwat it should have cost.
Direct material usage variance: The difference between the standard
quantity of materials that should have been used for the number of
units actually produced, and the actual quantity of materials used,
valued at the standard cost per unit of material

1. VARIABLE COST VARIANCES

Direct material cost variances
Short formula
Price Usage
Actual Cost Standard Cost Budgeted Cost
Act. Qty Act Qty Std Qty
X x x
Act Price Std Price Std Price

Std Qty= Actual Output x Budget usage/output

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 1. VARIABLE COST VARIANCES
Full formula
Total material variance – based on actual production – what should the actual
production use and what should that material cost? What did it, cost?
$
‘Should’ Actual number of units should use and should cost X
‘Did’ Actual material used did cost (X)
Variance X

Material price variance – based on actual purchases – what should materials cost?
What did they cost?
$
‘Should’ Actual kg purchased should cost X
‘Did’ Actual kg purchased did cost (X)
Variance X

1. VARIABLE COST VARIANCES

Full formula
Material usage variance – based on actual production – how much should it use?
How much did it use?
Kgs
‘Should’ Actual production should use X
‘Did’ Actual production did use (X)
Difference X
Valued at standard cost per kg $X

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 1. VARIABLE COST VARIANCES
Activity: News Co
News Co operates a standard costing system. It purchased and used
53,000 kg of material at a cost of $2.38 per kg
The budgeted production was 25,000 units which requires 50,000 kg of
material at a total standard cost of $125,000. The actual production was
27,000 units.
Required
1. Calculate the total material variance
2. Calculate the direct material price variance
3. Calculate the direct material usage variance

1. VARIABLE COST VARIANCES

Answer – Short Formula

Summary:
SQ= 27,000 x 2 = 54,000 kg
SP = 125,000/50,000 = $2.5/kg
AQ= 53,000 kg
AP= $2.38/kg
Total material variance:
APxAQ-SPxSQ= 53,000x2.38-54,000x2.5= $8,860(F)
Material price variance
APxAQ-SPxAQ= 53,000x2.38-53,000x2.5= $6,360(F)
Material usage variance
SPxAQ-SPxSQ= 53,000x2.5-54,000x2.5= $2,500 (F)
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 1. VARIABLE COST VARIANCES
Answer – Full Formula
1. Total material variance:
‘Should’
Actual production x standard usage x 27,000 units x 2kgs* x $2.5 135.000
standard cost per kg
‘Did’ 53,000 kgs x $2.38 126,140
8,860 (F)
*Standard usage = 50,000 kg / 25,000 units = 2 kg per unit
Standard cost per kg = $125,000 / 50,000 kg = $2.50 per kg

2. Material price variance

$
‘Should’
Actual purchases x standard cost per kg 53,000 kgs x $2.50 132,500
‘Did’
Actual purchases x actual cost per kg 53,000 kgs x $2.38 126,140
Variance 6,360 (F)
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1. VARIABLE COST VARIANCES

Answer – Full Formula
3. Material usage variance
Kgs
‘Should’
Actual production x standard usage 27,000 units x 2kgs 54,000
‘Did’
Actual production (units) x actual usage per unit 53,000 kgs (53,000)
Difference 1,000 (F)
Variance Valued at the standard cost $2,500 (F)
per kg $2.50

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 1. VARIABLE COST VARIANCES
There are two main advantages in extracting the material price variance
at the time of receipt.
 If variances are extracted at the time of receipt they will be brought
to the attention of managers earlier than if they are extracted as the
material is used  management action can be more timely.
 Since variances are extracted at the time of receipt, all inventories
will be valued at standard price. This is administratively easier and it
means that all issues from inventory can be made at standard price. If
inventories are held at actual cost it is necessary to calculate a
separate price variance on each batch as it is issued. Since issues are
usually made in a number of small batches this can be a time-
consuming task, especially with a manual system.

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1. VARIABLE COST VARIANCES

Direct labour cost variances

Direct labour total variance: The difference between what the output
should have cost and what it did cost, in terms of labour.
Direct labour rate variance: Similar to the direct material price
variance. It is the difference between the standard cost and the
actual cost for the actual number of hours paid for.
Direct labour efficiency variance: Similar to the direct material usage
variance. It is the difference between the hours that should have
been worked for the number of units actually produced, and the
actual number of hours worked, valued at the standard rate per hour.

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 1. VARIABLE COST VARIANCES
Direct labour cost variances
Short formula
Rate Efficiency
Actual Cost Standard Cost Budgeted Cost
Act. Hrs Act Hrs Std Hrs
X X X
Act Rate Std Rate Std Rate

Std Qty= Actual Output x Budget hours/output

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1. VARIABLE COST VARIANCES

Full formula
Total labour variance – based on actual production – what should the actual
production use and what should that labour cost? What did it cost?
$
‘Should’ Actual units should use and should cost X
‘Did’ Actual labour used did cost (X)
Variance X

Labour rate variance – based on hours paid – what should they have cost? What
did they cost?
$
‘Should’ Actual hours paid should cost X
‘Did’ Actual hours paid did cost (X)
Variance X

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 1. VARIABLE COST VARIANCES
Full formula
Labour efficiency variance – based on actual production – how should it take?
How long did it take?
Hours
‘Should’ Actual production should take X
‘Did’ Actual production did take (X)
Difference X
Value at standard rate per hour $X

Idle time variance – difference between hours paid and worked

Hours
‘Should’ Hours paid X
‘Did’ Hours worked (X)
Difference X
Value at standard rate per hour $X
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1. VARIABLE COST VARIANCES

Activity: Yard Co
Yard Co operates a standard costing system and expects to produce
3,000 units of Y using 12,000 hours of labour. The standard cost of labour
is $12.50 per hour
Last month the company actually made 2,195 units. The actual labour
cost was $110,750 for the 9,200 hours worked
Required
1. Calculate the total direct labour variance
2. Calculate the direct labour rate variance
3. Calculate the direct labour efficiency variance

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 1. VARIABLE COST VARIANCES
Answer – Short Formula

Summary:
SH= 2,195 x 4 = 8,780 hrs
SR = $12.50/hr
AH= 9,200 hrs
AR= $110,750/9,200
Total labour variance:
AHxAR-SHxSR= 110,750-8,780x12.50= $1,000(A)
Rate variance
AHxAR-SRxAH= 110,750-12.50x9,200= $4,250(F)
Efficicency variance
SRxAH-SRxSH= 12.50x9,200-8,780x12.50= $5,250(A)
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1. VARIABLE COST VARIANCES

Answer - Full Formula
1 $
Total labour variance
Actual units should cost (2,195 x 4 hrs x $12.50) 109,750
Actual labour used did cost 110,750
1,000 (A)
2 $
Rate variance
Actual hours paid should cost (9,200 x $12.50) 115,000
Actual hours paid did cost 110,750
4,250 (F)
3 Hrs
Efficicency variance
Actual production should use (2,195 x 4 hrs) 8,780
Actual production did use 9,200
420 (A)
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@ std cost $12.50 $5.250 (A)

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 1. VARIABLE COST VARIANCES
Variable production OH variances

Variable production overhead expenditure variance: The difference

between the amount of variable production overhead that should have
been incurred in the actual hours actively worked, and the actual
amount of variable production overhead incurred.
Variable production overhead efficiency variance: If you already know
the direct labour efficiency variance, the variable production overhead
efficiency variance is exactly the same in hours, but priced at the
variable production overhead rate per hour.

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1. VARIABLE COST VARIANCES

Variable production OH variances
Short formula
Expenditure Efficiency

Actual cost Standard Cost Budgeted Cost

Act. Hrs Act Hrs Std Hrs

X X X
Act Rate Std rate Std rate

Std Qty= Actual Output x Budget hours/output

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 1. VARIABLE COST VARIANCES
Full formula
Variable production overhead total variance – based on actual units of
production and actual labours hours
$
‘Should’ Actual production x standard variable overhead cost per hour x X
standard labour hours per unit
‘Did’ Actual hours worked x actual variable overhead cost per hour (X)

Variance X

Variable production overhead expenditure variance – based on actual hours

worked. What did they cost?
$
‘Should’ Actual hours worked x standard variable overhead cost per hour X

‘Did’ Actual hours worked x actual variable overhead cost per hour (X)

Variance X
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1. VARIABLE COST VARIANCES

Full formula
Variable production overhead efficiency variance – based on actual production.
How long should it have taken? How long did it take?
Hours
‘Should’ Actual production shoule take X

‘Did’ Actual production did take (X)

Difference X
Valued at standard variable overhead rate per hour $X
Note. It is usually assumed that variable overheads are incurred during active
working hours, but are not incurred during idle time (for example the machines
are not running, therefore power is not being consumed, and no indirect material
are being used)

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 1. VARIABLE COST VARIANCES

Activity: Dog Co
Dog Co manufactures product D and has established that the standard
variable production overhead cost of product D is as follows:
4 hours at $2.00 = $8 per unit
In the last month, 5,000 units of product D were manufactured. During
this time the labour force were paid for 21,000 hours, but due to delay in
raw materials arriving at the factory, only 20,500 hours were worked.
The variable overhead cost for the month was $42,100.
Required
1. Calculate the total variable production overhead variance
2. Calculate the variable production overhead expenditure variance
3. Calculate the variable production overhead efficiency variance

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1. VARIABLE COST VARIANCES

Answer – Short Formula

Summary:
SH= 5,000 x 4 = 20,000 hrs
SR = $2/hr
AH= 20,500 hrs
AR= $42,100/20,500 per hr
Total variable production overhead variance:
AHxAR-SHxSR= 42,100-20,000x2= $2,100(A)
Expenditure variance
AHxAR-SRxAH= 42,100-20,500x2= $1,100(A)
Efficiency variance
SRxAH-SRxSH= 20,500x2-20,000x2= $1,000(A)
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 1. VARIABLE COST VARIANCES
Answer - Full Formula
1. Total variable production overhead variance
$
‘Should’
Actual production x standard variable 5,000 units x $2 x 4 hours 40,000
overhead cost per hour x standard labour
hours per unit
‘Did’ 42,100
Variance 2,100 (A)
*Standard usage = 50,000 kg / 25,000 units = 2 kg per unit
Standard cost per kg = $125,000 / 50,000 kg = $2.50 per kg
2. Expenditure variance
$
‘Should’
Actual labour hours x standard variable 20,500 hours x $2 41,000
overhead cost per hour
‘Did’ 42,100
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Variance 1,100 (A)

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1. VARIABLE COST VARIANCES

Answer - Full Formula
3. Efficiency variance
Hours Hours
‘Should’
Actual production x standard 5,000 units x 4 hours 20,000 20,000
labour hours per unit
‘Did’ Labour hours worked 20,500 (20,500)
Difference 500 (A) (500) (A)
Valued at standard variable
Variance production overhead rate per hour $2 $1,000 (A) $1,000 (A)

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 2. FIXED PRODUCTION OH VARIANCES

Fixed production OH variances

Exam focus point

To calculate the fixed overhead variances, you must be able to distinguish
between marginal costing and absorption costing

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2. FIXED PRODUCTION OH VARIANCES

Fixed production OH variances - Absorption costing

 Fixed overhead total variance: The difference between fixed

overhead incurred and fixed overhead absorbed.
 Fixed overhead expenditure variance: Measures the under- or over-
absorbed overhead caused by the actual total overhead being
different from the budgeted total overhead.
Fixed expenditure variance = Actual expenditure - Budgeted (planned)
expenditure
 Fixed overhead volume variance: Measures the under- or over-
absorbed overhead caused by the actual activity level being different
from the budgeted activity level.
Fixed volume variance = (Actual volume - Budgeted (planned) volume) x
standard absorption rate per unit.

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 2. FIXED PRODUCTION OH VARIANCES

Fixed production OH variances - Absorption costing

Fixed overhead volume efficiency variance: The difference between

the number of hours that actual production should have taken, and
the number of hours actually taken (that is, worked) multiplied by the
standard absorption rate per hour.
Fixed overhead volume capacity variance: The difference between
budgeted (planned) hours of work and the hours worked, multiplied
by the standard absorption rate per hour.

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2. FIXED PRODUCTION OH VARIANCES

Fixed production OH variances - Absorption costing

Short formula
Expenditure Volume
Actual Cost Budgeted Cost Standard Cost
Act. Hours Bg Hours Std Hours
X X X
Act Rate Std rate Std rate

• Volume Variance can also be subdivided into efficiency and

capacity variances

Capacity Efficiency
Bg Hrs Act. Hours Std Hrs
X X X
Std Rate Std Rate Std Rate 32

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 2. FIXED PRODUCTION OH VARIANCES
Full formula
Total fixed overhead variance
$
‘Should’ Fixed overheads absorbed ie Actual production x OAR X
per unit
‘Did’ Actual fixed overheads incurred (X)
Variance X

Fixed overhead expenditure variance

$
‘Should’ Budgeted fixed overheads X

‘Did’ Actual fixed overheads (X)

Variance X

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2. FIXED PRODUCTION OH VARIANCES

Full formula
Fixed overhead volume variance – absorption costing only
$
‘Should’ Budgeted production x standard OAR per unit X

‘Did’ Actual production x standard OAR per unit (X)

Variance X

Fixed overhead volume efficiency variance – absorption costing only

Hours
‘Should’ Actual production x standard labour hours per unit X

‘Did’ Actual labour hours (X)

Difference X
Variance Valued at standard OAR per labour hour $X

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 2. FIXED PRODUCTION OH VARIANCES
Full formula
Fixed overhead volume capacity variance – absorption costing only
Hours
‘Should’ Budgeted labour hours X
‘Did’ Actual labour hours (X)
Difference X
Variance Valued at standard OAR per labour hour $X

Remember: Fixed overhead volume efficiency variance + fixed overhead volume

capacity variance = Fixed overhead volume variance

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2. FIXED PRODUCTION OH VARIANCES

Activity: Fixed overhead variance calculations
Armour Co has budgeted to make 1,100 units of a product called Soul during the
month of April 20X3. The budgeted fixed overhead cost is $33,000 and the
standard time to make a unit of Soul in three hours.
The actual fixed overhead cost during the month turns out to be $33,980. 1,000
units of Soul were produced and the labour force worked for 3,500 hours
Required
Calculate the following variances

Adverse (A) or
favourable (F)
The fixed overhead total variance
The fixed overhead expenditure variance
The fixed overhead volume variance
The fixed overhead volume efficiency variance
The fixed overhead volume capacity variance

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 2. FIXED PRODUCTION OH VARIANCES

Answer – Short Formula

Summary:
SH= 1,000 x 3 = 3,000 hrs
SR = 33,000/3,300= $10/hr
AH= 3,500 hrs
AR= $33,980/3,500 per hr
BH= 1,100x3= 3,300 hrs
Fixed overhead total variance:
AHxAR-SHxSR= 33,980-3,000x10= $3,980(A)
Fixed overhead expenditure variance
AHxAR-SRxBH= 33,980-3,300x10= $980(A)
Fixed overhead volume variance
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SRxBH-SRxSH= 3,300x10-3,000x10= $3,000(A)
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2. FIXED PRODUCTION OH VARIANCES

Answer – Short Formula

Summary:
SH= 1,000 x 3 = 3,000 hrs
SR = 33,000/3,300= $10/hr
AH= 3,500 hrs
AR= $33,980/3,500 per hr
BH= 1,100x3= 3,300 hrs
Fixed overhead volume efficiency variance:
SRxAH-SRxSH= 3,500x10-3,000x10= $5,000(A)
Fixed overhead volume capacity variance
SRxBH-SRxAH = 3,300x10-3,500x10= $2,000(F)

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 2. FIXED PRODUCTION OH VARIANCES
Answer - Full Formula
Adverse (A) or favourable (F)
The fixed overhead total variance $3,980 (A)
The fixed overhead expenditure variance $980 (A)
The fixed overhead volume variance $3,000 (A)
The fixed overhead volume efficiency variance $5,000 (A)
The fixed overhead volume capacity variance $2,000 (F)

The standard fixed overhead cost of a Soul is $33,000/1,100 = $30 per unit
3 hours at $10 per hour = $30 per unit
The fixed overhead total variance
$
Amount of overhead absorbed (1,000 units x $30 per unit) 30,000
Fixed overhead incurred 33,980
FIXED OVERHEAD TOTAL VARIANCE (under absorbed) 3,980 (A)

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2. FIXED PRODUCTION OH VARIANCES

Answer - Full Formula
The fixed overhead expenditure variance
$
Budgeted fixed overhead expenditure 33,000
Actual fixed overhead expenditure 33,980
FIXED OVERHEAD EXPENDITURE VARIANCE 980 (A)

The fixed overhead volume variance

$
Budgeted production 1,100 units
Actual production 1,000 units
100 units (A)
Valued at the standard absorption rate per unit x $30
FIXED OVERHEAD VOLUME VARIANCE 3,000 (A)

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 2. FIXED PRODUCTION OH VARIANCES
Answer - Full Formula

The fixed overhead efficiency variance

1,000 units of Soul should take (3 hrs) 3,000 hours
But did take 3,500 hours
500 hours (A)
Valued at the standard absorption rate per hour x $10
FIXED OVERHEAD EFFICIENCY VARIANCE $5,000 (A)

The fixed overhead capacity variance

Budgeted hours of work (3 hrs x 1,100 untis) 3,300 hours
Actual hours of work 3,500 hours
200 hours (F)
Valued at standard absorption rate per hours (x$10) x $10
FIXED OVERHEAD VOLUME CAPACITY VARIANCE $2,000 (F)

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2. FIXED PRODUCTION OH VARIANCES

Fixed overhead variance reasons
In general, a favourable cost variance will arise if actual results are less
than expected results. Be aware, however, of the fixed overhead volume
variance and the fixed overhead volume capacity variance which give rise
to favourable and adverse variances in the following situations.
• A favourable fixed overhead volume variance occurs when actual
production is greater than budgeted (planned) production.
• An adverse fixed overhead volume variance occurs when actual
production is less than budgeted (planned) production.
• A favourable fixed overhead volume capacity variance occurs when
actual hours of work are greater than budgeted (planned) hours of work.
• An adverse fixed overhead volume capacity variance occurs when actual
hours of work are less than budgeted (planned) hours of work.

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 2. FIXED PRODUCTION OH VARIANCES

Fixed production OH variances – Marginal costing

Expenditure variance = Actual Fixed OH – Budget Fixed OH

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3. SALES VARIANCES

Sales price variance: The sales price variance compares what the sales
revenue should have been for actual sales compare to the actual sales
revenue and shows the impact of a different selling price to the
standard.
Sales volume variance: The sales volume variance calculates the
impact on profit (under an absorption costing system) or contribution
(under a marginal costing system) of a different sales volume to
budgeted (planned) quantity.

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 3. SALES VARIANCES
Price
Actual Revenue Standard Revenue
Act Volume Act Volume
X X
Act Price Std Price
Volume
Act Volume Budgeted Volume
X X
Std Profit /Contribution Std Profit/Contribution
per unit per unit
@ Std profit per unit: AC
@ Std contribution per unit: MC

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3. SALES VARIANCES

Sales price variance – based on the number of units sold. What should actual
units sold sell for? What did they sell for?
$
‘Should’ Actual sales x standard sales price per unit X
‘Did’ Actual sales x actual sales price per unit (X)
Variance X

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 3. SALES VARIANCES

Sales volume variance – How many units should be sold? How many were sold?
What is the impact of this on profit (absorption costing) or contribution (marginal
costing)?
Units
‘Should’ Budgeted sales X
‘Did’ Actual sales (X)
Difference X
Variance Valued $X
@ standard profit per unit (AC)
@standard contribution per unit (MC)

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3. SALES VARIANCES
Activity: Sales price variance calculation
The following data is available about Product B for period 3:
Period 3 - Actual Period 3 - Budget
Sales (units) 10,100 10,000
$ $
Total sales value 52,520 51,000
Total manufacturing costs at (43,430) (43,000)
standard cost
Manufacturing profit 9,090 8,000

1. What is the sales price variance? 2. What is the sales volume variance?
A. $1,010 adverse A. $80 favourable
B. $510 favourable B. $90 favourable
C. $520 favourable C. $510 favourable
D. $1,010 favourable D. $520 favourable

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 3. SALES VARIANCES
Significance of sales variances
The possible interdependence between sales price and sales volume
variances:
 A reduction in the sales price might stimulate greater sales demand
 An adverse sales price variance might be counterbalanced by a
favourable sales volume variance.
 A price rise would give a favourable price variance, but possibly at the
cost of a fall in demand and an adverse sales volume variance.
The overall consequence should be considered; that is, has there been a
counterbalancing favourable variance as a direct result of the
unfavourable one?

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4. APPLYING VARIANCES
Operating statement: An operating statement is a regular report for
management of actual costs and revenues, usually showing variances
from budget.

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 4. APPLYING VARIANCES
Activity: Operating statement
Canary Co is a manufacturer of mobile phone car kits and has the following
financial data:
Budget Unit Total
$ $
Sales (8,700 units) 75 652,500
Production (8,700 units)
Materials 4kg @ $4.50 18 156,600
Labour 5 hrs @ $5 25 217,500
Variable overheads 5 hrs @ $2 10 87,000
53 461,100
Budgeted contribution 191,400
Budgeted fixed overheads 130,500

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4. APPLYING VARIANCES
Activity: Operating statement
Actual
$
Sales (8,900 units) 649,700
Production (8,900 units)
Materials purchased and used 34,928 kgs 161,043
Labour (45,400 hours paid and worked) 224,515
Variable overheads 87,348
472,906
Actual contribution 176,794
Actual fixed overheads 134,074
Actual profit 42,720
Required
Produce an operating statement using marginal costing and absorption costing
principles
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 4. APPLYING VARIANCES
Answer – Marginal costing
$
Budgeted contribution (8,700 units at $22/unit) 191,400
Sales volume variance 4,400 (F)
Flexed contribution (ie contribution from actual sales) 195,800
Sales price variance (17,800) (A)
Cost variances F A 178,000
Materials - price 3,867
- usage 3,024
Labour - wage rate 2,485
- efficienct 4,500
Var. O/head - expenditure 3,452
- efficiency . 1,800
8,961 10,167 (1,206)
176,794
Less: Fixed costs:
Budgeted 130,500
Expenditure variance 3,574 (A) (134,074)
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Actual profit 42,720

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4. APPLYING VARIANCES
Answer – Absorption costing
$
Budgeted profit (191,400-130,500) 60,900
Sales volume variance 1,400 (F)
Flexed profit (ie profit from actual sales) 62,300
Sales price variance (17,800) (A)
44,500
Cost variances F A
Materials - price 3,867
- usage 3,024
Labour - wage rate 2,485
- efficienct 4,500
Var. OH - expenditure 3,452
- efficiency . 1,800
Fixed OH - expenditure 3,574
- efficiency 2,700
- capacity 5,700
14,661 16,441 (1,780)
Actual profit 42,720
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 4. APPLYING VARIANCES
Exam focus point
You will not have to produce an operating statement in your examination, but
you could have to calculate any of the elements and you must understand the
layout and purpose of an operating statement, as well as the differences
between an operating statement prepared under AC compared to MC.

Absorption costing Marginal costing

Sales volume variance Valued at standard profit Valued at standard
per unit contribution per unit
Treatment of fixed FOH Expenditure variance FOH Expenditure
overhead (FOH) FOH Volime variance: variance only
variances • Capacity
• Efficiency
In addition, when you are preparing an operating statement under absorption
costing, you reconcile budgeted profit to flexed budgeted profit to actual profit.

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4. APPLYING VARIANCES
Interpretation of variances

Variance Favourable Adverse

• Unforeseen discounts received • Price increase
Material
• Greater care in purchasing • Careless purchasing
price
• Change in material standard • Change in material standard
• Material used of higher quality • Excessive waste or theft
than standard • Defective material
Material
• More efficient use of material • Stricter quality control
usage
• Errors in allocating material to • Errors in allocating material to
jobs jobs
• Use of workers at a rate of pay • Wage rate increase
Labour rate
lower than the standard

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 4. APPLYING VARIANCES
Interpretation of variances

Variance Favourable Adverse

• Output produced more quickly • Lost time in excess of standard
than expected because of • Output lower than standard set
worker motivation, better because of lack of training, sub-
Labour
quality materials etc standard materials etc
efficiency
• Errors in allocating time to jobs • Errors in allocating time to jobs
• Higher grade of labour than
originally planned
Fixed • Savings in costs incurred • Increase in cost of services used
overhead • More economical use of • Exceesive use of services
expenditure services • Chang in type of service used
Fixed
• Production or level of activity • Production or level of activity
overhead
greater than budgeted less than budgeted
volume

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4. APPLYING VARIANCES
Interpretation of variances

Cheaper materials Favourable price variance

Adverse usage variance

Inferior quality Adverse efficiency variance (labour
and overheads)

Higher rate for labour Adverse price (rate) variances

Favourable efficiency variances.

Higher efficiency
Favourable usage variances (materials)

 Do not look at individual variances in isolation

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Interpretation of variances
When to investigate variances
Once variances have been calculated, which variances need investigating
must be decided.
General factors for consideration would be:
 Size of the variance
 Controllability of variance
 Cost of investigation
 Interrelationships with other variances
 Level of standard
 Trend emerging

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The control action which may be taken will depend on the reason why the variance
occurred. Some reasons for variances are outlined in the paragraphs below:
Measurement errors
Scales may be misread, the pilfering or wastage of materials may go unrecorded,
items may be wrongly, or employees may make adjustments to records to make their
own performance look better.
An investigation may show that control action is required to improve the accuracy of
the recording system so that measurement errors do not occur.
Out-of-date standards
 Price standards are likely to become out of date when changes to the costs of
material, power, labour and so on occur, or in periods of high inflation. In such
circumstances, an investigation of variances is likely to highlight a general change
in market prices rather than efficiencies or inefficiencies in acquiring resources.
 Standards may also be out of date where operations are subject to technological
development or if learning curve effects have not been taken into account.
Investigation of this type of variance will provide information about the
inaccuracy of the standard and highlight the need to frequently review and
update standards.
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Efficient or inefficient operations
Spoilage and better quality material/more highly skilled labour than standard are all
likely to affect the efficiency of operations and therefore cause variances.
Investigation of variances in this category should highlight the cause of the
inefficiency or efficiency and will lead to control action to eliminate the inefficiency
being repeated or action to compound the benefits of the efficiency.
Random or chance fluctuations
A standard is an average figure. It represents the mid-point of a range of possible
values and therefore actual results are likely to deviate unpredictably within the
predictable range.
As long as the variance falls within this range, it will be classified as a random or
chance fluctuation and control action will not be necessary.

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Activity: Control action

Sweatshop Co has found that it has had an increasing adverse labour
efficiency variance for the last three months. You earn that the company
is using lots of temporary workers in a bid to keep up with increased
demand for its single product, the Z.
Required
Which TWO of the following control actions could be implemented by
the company to try to eliminate this?
A. Increase the hourly rate paid to temporary workers
B. Offer paid overtime to the company’s existing skilled workers
C. Implement training for the temporary employees
D. Reduce the number of supervisors

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Exam focus point – Backwards
If you have to work backwards to derive actual results always jot down
the variance calculations and fill in the information you have; the
missing number will then be easier to spot.

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Activity: Backwards variances – standard labour hours

The direct labour cost for Cricket Co for last month was as follows:
Actual hours worked 28,000 hours
Total direct labour cost $117,600
Direct labour rate variance $8,400 (A)
Direct labour efficiency variance $3,900 (A)
Required
To the nearest thousand (in hours), what were the total standard labour hours
last month?

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Answer
Labour rate variance
$
Should Actual labour hours (28,000) x standard 𝛽 109,200
labour rate (?)*
Did Actual labour hours x actual labour rate 117,600
Labour rate variance 8,400 (A)
*Standard labour cost = $109,200/28,000 hours = $3.90 per hour

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Answer
Labour efficiency
variance
$
Should Actual unit should take 𝛽 27,000
Did Actual unit did take 28,000
Diff 𝛽 1,000 (A)
Labour efficiency Valued @ standard cost ($3.90) per hour, $3,900 (A)
variance calculated from labour rate variance

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 Q&A

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