Acc304 Acc324 Topic 6.2 Va

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ACC304/ACC324 Cost & Activity Management

Topic 6.2 - VARIANCE ANALYSIS

BASIC VARIANCE ANALYSIS

1. Variance is the difference between a planned/budgeted/standard results and the actual

results, in terms of costs and revenues.

2. Variance analysis - is defined as the evaluation of performance by means of variances,whose timely reporting should maximize the opportunity for managerial action. In otherwords, the process by which the total difference between standard and actual results isanalyzed is known as variance analysis.

3. Favourable variances (F) - occurs, if actual results are better than expected results.

4. Adverse variance (A) actual results are worse than expected results

5. Cost Variances

Adverse (A) - when actual costs > standard costs.

Favorable (F) when actual costs < standard costs.

6. Revenue Variances

Adverse (A) when actual revenue < standard revenue.

Favorable (F) when actual revenue > standard revenue.

7. Variances can be grouped into three main groups;

Variable cost variances

Fixed production overhead variances

Sales variances.

8. The purpose of calculating variances is to show the effect of the variances on actual

profit compared to the budget. This overall effect is known as the profit variance. Thereconciliation between actual and budgeted profits using variances is presented as anoperating statement and also by using either the absorption or marginal costingapproach.

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9. Direct Material Variances========================

i. Direct Material Cost Variance is the difference between what the output actuallycost and what it should have cost, in terms of material. Direct material cost variancecan be divided into two sub-variances; direct material price variance and directmaterial usage variance.

Formula:

Actual minus Standard

(Actual Mat cost/unit) - (Std Mat cost/unit)(X Actual Qty produced) (X Actual Qty produced)

ii. Direct Material Price Varianceis the difference between the standard cost and theactual cost for the actual quantity of material used or purchased. In other words, it is

the difference between what the material did cost and what it should have cost.

Formula:


(Actual Mat Price/kg) - (Std Mat Price/kg)(X Actual Qty of Mat used) (X Actual Qty of Mat used)

iii. Direct Material Usage Variance is the difference between the standard quantity of

materials that should have been used for the number of units actually produced, andthe actual quantity of material used, valued at the standard cost per unit of material. Inother words, it is the difference between how much material should have been usedand how much material was used, valued at standard cost.

Formula:


(Actual Qty of Mat used) - (Std Qty of Mat used) X

(for actual production) (for actual production) Std Priceper unit

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10. Direct Labour Variances======================

i. Direct Labor Cost Variances is the difference between what the output should havecost and what it did cost, in terms of labor. It can be divided into three sub-variances;laborrate, laborefficiency and laboridle time.

Formula:Actual minus Standard

(Actual Lab cost/unit) - (Std lab cost/unit)(X Actual Qty produce) (X Actual Qty produce)

ii. Direct Labor Rate Variance is the difference between the std cost and the actualcost for the actual number of hours paid for. In other words, it is the differencebetween what the labor did cost and what it should have cost.

Formula:


(Actual Lab Rate/hr) - (Std Lab Rate/hr)(X Actual Hr. Paid) (X Actual Hr. Paid)

iii. Direct labor Efficiency Variance is the difference between the hours that shouldhave been worked for the number of units actually produced, and the actual number ofhours worked, valued at the std rate per hour. In other words, it is the differencebetween how many hours should have been worked and how many hours wereworked, valued at the std rate per hour.


(Actual Lab Hr/unit) - (Std Lab Hr/unit) X(X Actual Qty Produced) (X Actual Qty Produce) Std Lab Rate/hr

iv. Direct Labor Idle-time Variance is the difference between the actual hours paid forand the actual hours actively worked, valued at std labor rate per hour. This variance isalways an adverse variance because the labor force is still paid wages for the time atwork, but no actual work is done. Time paid for without any work being done isunproductive and therefore inefficient. Idle time may occur due to; machinebreakdown, shortage of orders from customers or because of bottlenecks inproduction.Formula:

Actual minus Standard( AHp - AHw) X Std Lab Rate/hr

11. Variable Overhead Variances

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===========================

i. Variable Production Overhead Cost Variances - is the difference between what theoutput should have cost and what it did cost, in terms of variable production overheadcosts. This cost variance can be divided into two sub-variances; variable productionoverhead expenditure variance & variable production overhead efficiency variance.


(Actual Var Ohd cost/unit) - (Std Var Ohd cost/unit)(X Actual Qty produced) ( X Actual Qty produced)

ii. Variable Production Overhead Efficiency Variance this variance is exactly thesame as the labor efficiency variance in terms of labor hours, but priced at the variableproduction overhead rate per hour.Formula:

(Same as Lab Efficiency Variance in Hours) X Std Var Ohd cost/hour

iii. Variable Production Overhead Expenditure Variance is the difference betweenthe amount of variable production overhead that should have been incurred in theactual hours actively worked, and the actual amount of variable production incurred.

Formula:


(Actual Var Ohd cost/hr) - (Std Var Ohd cost/hr)

( X AHw) ( X AHw)

12. Fixed Overhead Variances========================

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i. Fixed Production Overhead Cost Variances - is the difference between what theoutput should have cost and what it did cost, in terms of fixed production overheadcosts. It is the difference between fixed overhead incurred and fixed overheadabsorbed. In other words, it is the under or over absorbed fixed overhead.

Formula:

Actual FOAR/unit Std FOAR/unitX - X

Actual Qty produced Actual Qty produced

This cost variance can be divided into two sub-variances; fixed production overheadexpenditure variance and fixed production overhead volume variance.

The fixed production overhead volume variance can be further divided into two sub-variances: - fixed production overhead volume efficiency variance &

- fixed production overhead volumecapacity variance.

ii. Fixed Production Overhead Expenditure Variance is the difference between thebudgeted fixed overhead expenditure and the actual fixed overhead expenditure. Thisshows the effect on profit of the actual fixed overhead expenditure differing from thebudgeted value.

Formula:

Actual FOAR/unit Std FOAR/unit

X - XActual Qty Produced Budgeted Units

iii. Fixed Production Overhead Volume Variance is the difference between actualand budgeted (planned) volume multiplied by the standard absorption rate per unit. Itmeasures the difference between the amount actually absorbed compared to theamount to be absorbed.

Formula:

(Actual Qty Produced - Budgeted Qty to Produce) X Std FOAR/unit(AQ p) ( BQ)

iv. Fixed Production Overhead Efficiency Variance is the difference between thenumber of hours that actual production should have taken, and the number of hoursactually taken (that is, worked) multiplied by the standard absorption rate per hour.

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This variance measures whether the workforce took more or less time than expected inproducing their output for the period.

Formula:

(Same as Lab Efficiency Variance in Hours) X Std FOAR/hr

v. Fixed Production Overhead Capacity Variance is the difference betweenbudgeted (planned) hours of work and the actual hours worked, multiplied by thestandard absorption rate per hour. The capacity variance measures whether theworkforce worked more or less hours than budgeted for the period.

Formula:

( AHw - Budgeted Hours for Budgeted Qty) X Std FOAR/hr

13. Sales Price Variance the change in revenue caused by the actual selling price differingfrom that budgeted for the actual quantity sold.

Formula:

(SP - AP) x AQ sold

14. Sales Volume Variance the change in profit caused by sales volume differing from thatbudgeted.

Formula:

(BQ - AQ sold) x Std profit per unit ( AC method)

(BQ - AQ sold) x Std Contribution per unit ( MC method)

QUESTION 1

MAXIM Ltd produces a chemical component called Reach. The following standard costsapply for the manufacture of 10 components:

Material AX 30 litres @ 12.00 per litre 360

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Skilled labour 15 hours @ 7.00 per hour 105

Variable overhead 15 hours @ 4.00 per hour 60

Fixed overhead 15 hours @ 5.00 per hour 75____

600====The monthly sales and production budget is 18,000 components.Selling price per component is 85.

For the month of January just ended, the following data was extracted from the costledgers:Quantity produced and sold 20,000 componentsSales value 1,750,000Material purchased and used (62,000 litres) 730,000Labour paid (32,500 hours) 225,000

Labour hours worked (hours) 32,000Variable overheads 125,000Fixed overheads 152,000

Required:

Compute the variances for material, labour, overhead and sales.

I) CAUSES OF VARIANCES

====================

15. There are generally 4 causes of variances:

Bad budgeting insufficient time & resources are not applied when setting the

standards.

Bad measurement or recording of actual results - care taken when measuring

activity achieved, resources used and costs of resources.

Random factors the standards itself is an average target for a period of time and

thus, actual results will fluctuate randomly around this target. Such fluctuations will betaken as a variance but it should not be significant.

Operational factors this will only be true if we assume that the standards set, wereoriginally realistic and that actual results recorded are accurate, as such the variancesare not due to random factors but due to operational factors. (see below).

16. The Significances of Cost Variances

a) Management has to decide whether or not to investigate the variances calculated. It wouldbe very time consuming and expensive to investigate ALL variances, thus they have to

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decide which variances are worth investigating. Factors to be considered in this case, areas follows;

i. Materiality tolerance limits must be set first, and only those variances that exceedthis limit will be investigated.

ii. Controllability only those causes of variances that can be controlled need to beinvestigated. Uncontrollable variances call for a change in the plan, not an

investigation into the past.

iii. The type of standard being used if ideal standards are used, than there will bealways be an adverse variance.

iv. Interdependence between variances one variance might be inter-related withanother, and much of it might have occurred only because the other, inter-related,variance occurred too.

v. Costs of investigation the cost of investigation should be weighed against thebenefits of correcting the cause of a variance.

b) Interdependence between variance when two variances are interdependent, one willbe adverse and the other will be favorable.

c) Interdependence material price and usage variances buying of cheaper materialmay result in favorable price variance, but this may lead to higher material wastage andthus, adverse usage variance occurs. If cheaper materials are more difficult to handle, theremight be some adverse labor efficiency variance too.

d) Interdependence labor rate and efficiency variances employees are paid higherrates for experiences and skills, will result in adverse rate variance, at the same time as a

favorable efficiency variance.

17. OPERATIONAL CAUSES OF VARIANCES are as follows:

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Variance Favorable Adverse

Material Price Unforeseen discounts recd

More care taken in purchasing

Change in material quality.

Price increase.

Careless purchasing.

Change in material quality

Material Usage Higher quality used than std.

More effective use made of mat.

Errors in allocating mat to jobs

is reduced.

Defective mat used.

Excessive waste.

Theft.

Stricter quality control.

Errors in allocating mat to

jobs increased.

Labor Rate Use of apprentices or other

workers at a rate of pay lowerthan std.

Wage rate increase.

Use of higher grade labor.

Labor Idle time

N/A Machine breakdown

Non-availability of

material.

Illness or injury of worker.

Lack of supervisory.

Labor Efficiency Output produced more quickly

than expected because of workmotivation, better quality ofequipment or materials, orbetter methods.

Errors in allocating time to

jobs is reduced.

Lost time in excess of std

allowed. Output lower than std set

because of deliberaterestriction, lack of training,or sub-std material used.

Errors in allocating time

to jobs is increased.

Overhead

Expenditure Savings in costs incurred.

More economical use of

services.

Increased in cost of

services used.

Excessive use of service.

Change in type of service

used.

Overhead Volume

Efficiency Labor force working more

efficiently

Labor force working less

efficiently

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Overhead Volume

Capacity Labor force working overtime Machine breakdown,

Strikes

Labor shortages.

Operating Profit

Variance due sellingprice

Unplanned selling price

increased.

Unplanned selling price

reduction.

Operating Profit

Variance due to sales

volume

Additional demand attracted

by reduced price.

Promotional activities and

discounts offered.

Unexpected fall in

demand due to recession.

Failure to satisfy demand

due to productiondifficulties.

II) INVESTIGATING VARIANCES

a) Factors to be considered in assessing the significance of variances are as follows;i. Materiality tolerance limits must be set first, and only those variances that exceed

this limit will be investigated.

ii. Controllability only those causes of variances that can be controlled need to beinvestigated. Uncontrollable variances call for a change in the plan, not aninvestigation into the past.

iii. The type of standard being used if ideal standards are used, than there will bealways be an adverse variance.

iv. Interdependence between variances one variance might be inter-related withanother, and much of it might have occurred only because the other, inter-related,variance occurred too.

v. Costs of investigation the cost of investigation should be weighed against thebenefits of correcting the cause of a variance.

QUESTION 2

A companys budgeted production of Product Z for the month ending 30 November 20X2 was10,000 units. The fixed overheads were budgeted at $320,000.

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The standard costs for the product are:

Direct materials 6 litres of material A at $3.00 per litreDirect labor 4 hours at $5.00 per hourVariable overhead is absorbed at $4.00 per labor hour

The actual results for the month ended 30 November 20X2 were;

Production 9,800 unitsDirect materials 59,700 litres at a total cost of $176,115Direct labor 39,500 hours at a total cost of $192,080Variable overheads incurred $154,200Fixed overheads incurred $312,000

Required:

Calculate the following variances:

a) Direct material price

b) Direct material usage

c) Direct labor rate

d) Direct labor efficiency

e) Variable overhead expenditure

f) Variable overhead efficiency

g) Fixed overhead expenditure

h) Fixed overhead volume

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Acc304 Acc324 Topic 6.2 Va