Variance analysis
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Variance analysis involves computing the differences between actual and standard costs. It has two phases - computation of individual variances and determining the causes of variances. Variances are classified as material, labor, and overhead. Material variance is caused by differences in actual and standard quantities and prices of materials. Labor variances can be due to mix of labor grades or wage rates. Overhead variances arise from differences between actual and standard overhead amounts. Variance analysis helps identify reasons for deviations from standards and improve performance.
Variance analysis
- 2. Definition The Institute of Cost & Management Accountants defines variance as the difference between a standard cost and the comparable actual cost incurred during a period Variance Analysis can be defined as the process of computing the amount of and isolating the cause of variances between actual costs and standard costs. It involves two phases: 1.Computation of individual variances 2.Determination of the cause(s) of each variance
- 3. Describe the basic concepts underlying variance analysis Explain the difference between a favourable and an adverse/unfavourable variance Compute materials usage and price variances Calculate labour efficiency and price/wage rate variances 3
- 4. Comparison Care to be taken while comparing actual and standard cost 1.Conditions might have changed, thus rendering the standard costs unrealistic – for instance the quality of available materials may be low. 2.Standards fixed upon on too idealistic a basis will remain unattainable. 3.The service rendered by a service departments may not be upto the mark so that, for example time is lost due to a machine working slow. 4.In certain activities, fixation of standard is either not possible or not desirable. Goods requiring artistic work of high quality cannot be and should not be subject to quantitative standards. In certain cases work cannot be properly measured. Standards in these cases will be useless.
- 5. Classification Variances are broadly classified into the following:
- 6. Material Cost Variance Material Cost Variance is the difference between the actual cost of direct materials used and standard cost of direct materials specified for the output achieved. This variance results from differences between quantities consumed and quantities of materials allowed for production and from differences between prices paid and prices predetermined. Can be computed using the formula: Material Cost Variance = (SQ x SP) – (AQ x AP) where, AQ = Actual Quantity AP = Actual Price SQ = Standard Quantity for the actual output SP = Standard Price
- 7. Labour Mix Variance The composition of actual gang of labour may differ from composition of standard gang due to shortage of a particular grade of workers or some other reason. It is that portion of the wages variance which is due to the difference between the actual labour grades utilized and the standard labour grades specified. Can be computed using the formula: Labour Mix variance = (Revised Standard labour hours – AH ) x Standard Wage rate Revised Standard hours = x SH
- 8. Variable OH Variances Variable Overhead Variance represents he difference between standard variable overhead (specified for actual units produced) and the actual variable overhead incurred. Can be computed using the formula: Variable OH Cost Variance = Standard Variable OH on actual production – Actual variable OH OR Variable OH Cost variance = (Actual time or standard hours for actual production x Standard variable OH Rate) – (Actual Variable OH) Where, Standard variable OH Rate per unit or per hours = Budgeted OH Budgeted output or hours
- 9. Fixed OH Cost Variance Fixed Overhead Cost Variance is the difference between standard overhead recovered or absorbed for actual output and the actual fixed overhead. Can be computed using the formula: Fixed OH Cost Variance = (Recovered or absorbed Fixed OH) – (Actual Fixed OH) OR (Actual output) x (Standard OH Rate) – (Actual OH Rate x Actual Output)
- 10. Standard costing uses the costs that should have been incurred Standard costing uses standards of performance and of prices derived from studying operations and of estimating future prices, for materials, labour, and overheads Each unit produced can have both actual and standard costs for direct materials, direct labour, and manufacturing overheads 10
- 11. Standard input ◦ A carefully determined quantity of input, e.g., square metres of laminated material Standard price ◦ A carefully determined price that a company expects to pay for a unit of input, e.g., £1 per square metres of laminated material Standard cost ◦ A carefully determined cost of a unit of output 11
- 12. Variances fall into 2 categories ◦ Favourable variances occur when actual amount is less than the standard amount ◦ Unfavourable variances arise when actual amount is greater than the standard amount 12
- 13. I CONCLUDE THAT VARIANCE ANALYSIS SHOWS CLARLY THE DIFFERENTIATION OF ACTUAL AND STANDARD COST.BASING ON THIS IF COMPANY FOLLOWS IT LEADS TO PROFIT. 13
Editor's Notes
- #11: When we discussed about static and flexible budgets, we compare the actual results with the expected results. Those expected results are actually the standard that we set based on what we think we should have achieved if everything runs according to plans. The method that we use to prepare the standards for all the costs that we think we should have incurred is called standard costing. It uses the costs that should have been incurred, instead of what we actually incurred. We prepare the standards based on our own expectations about the future performance, by carefully studying our operations, and by estimating what the future costs would be.