This series describes in detail variance analyses - what it is about, when is the varince significant and how to breakdown and analyse the variances on various types of costs.
The purpose of variance analysis is to ascertain the quantitative deviation between budgeted, forecasted or otherwise estimated figures and accounting actuals and analyze this deviation into bigger detail. It is a valuable control mechanism.
Factors to consider when deciding whether it is worth to investigate the variance:
In general, direct costs, revenues and margin variances can be split into:
Calculation: (actual unit price – budgeted unit price) x actual quantity
Interpretation: reveals how much the costs/revenues/margin changed as the consequence of the changed price (unit margin).
Calculation: (actual quantity – budgeted quantity) x budgeted unit price
Interpretation: reveals how much the costs/revenues/margin changed as the consequence of the changed quantity sold/produced.
More detailed variance calculations can be found here:
Variable production overheads variance
Fixed production overheads variance
Direct material cost variance can be split into:
Calculation: actual total material costs - (actual quantity of total material used x budgeted price per unit of material used)
Interpretation: calculates the portion of variance driven by the changed prices of raw materials
Possible reasons for variances: price increases/discounts, changes in material quality (27; p.232-8), poor budgeting
Calculation: (actual quantity of total material used - budgeted quantity of total material used) x budgeted price per unit of material used
Interpretation: calculates the portion of variance driven by the changed quantity of raw materials consumed
Possible reasons for variances: changes in material quality, care devoted to quality control, thefts, errors in allocating material to products (27; p.232-8), change in wastage level due to changes in staff qualification and skills, poor budgeting
Budget: 5 units of raw material purchased at €8/piece; produced output is 1 000 units
Actual: 6 units of raw material purchased at €7/piece; produced output is 1 100 units
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Total variance = (6 * 7* 1 100) – (5 * 8 * 1 000) = 46 200 – 40 000 = 6 200 (unfavorable)
Direct material price variance = (6 * 7 * 1 100) – (1 100 * 6 * 8) = 46 200 – 52 800 = - 6 600 (favorable)
Direct material quantity (usage) variance = (1 100 * 6 – 1 000 * 5) * 8 = 12 800 (unfavorable)
Check: Price variance + Quantity variance = - 6 600 + 12 800 = 6 200
Direct labor cost variance can be split into:
Calculation: actual total direct labor costs - (total actual labor hours worked x budgeted labor hour rate)
Interpretation: calculates the portion of labor costs variance driven by the changed labor rate per hour
Possible reasons for variances: changes in staff qualification and skills, general increase of wages in economy, premiums paid to finish a job quickly, poor budgeting
Calculation: (total actual hours worked – total budgeted hours worked) x budgeted labor hour rate
Interpretation: calculates the portion of labor costs change driven by the changed number of labor hours worked
Possible reasons for variances: the effect of learning curve, errors in allocating labor hours to products (27; p.232-8), changes in staff qualification and skills, changes in material quality, idle time, poor budgeting
Variable production overheads variance is calculated similarly as direct labor cost variance. Only variable production overhead per labor hour must be calculated instead of labor rate.
Budget: 10 labor hours per €10/hour are necessary to produce a unit; produced output is 1 000 units
Actual: 8 labor hours per €12/hour are necessary to produce a unit; produced output is 1 100 units
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Total variance = (1 100 * 8 * 12) – (1 000 *10 * 10) = 105 600 – 100 000 = 5 600 (unfavorable)
Direct labor rate variance = (1 100 * 8 * 12) – (1 100 * 8 * 10) = 105 600 – 88 000 = 17 600 (unfavorable)
Direct material quantity (efficiency) variance = (1 100 * 8 – 1 000 *10) * 10 = - 12 000 (favorable)
Check: Rate variance + Quantity variance = 17 600 – 12 000= 5 600
total actual overheads – overheads absorbed to products = total actual overheads – (budgeted overheads per unit of production quantity * actual production quantity)
It can be split into:
Calculation: total actual overheads - total budgeted overheads
Interpretation: calculates the portion of fixed production overheads variance driven by the changed amount of overheads
Calculation: (budgeted production quantity - actual production quantity) * total budgeted overheads per budgeted number of units
Interpretation: calculates the portion of fixed production overheads variance driven by the changed production volume. If the actual production quantity is higher than budgeted, this variance will be favorable and vice versa.
Fixed production overheads quantity variance can be further split into:
Calculation: (actual labor hours for the actual production quantity - budgeted labor hours that would be needed for the actual production quantity) * budgeted labor hour rate
Interpretation: calculates the portion of fixed production overheads volume variance driven by the changes in labor efficiency. If total actual labor hours are lower than budgeted labor hours necessary to produce actual quantity, the variance is favorable, because the staff worked more efficiently and vice versa.
Calculation: (budgeted total labor hours - actual total labor hours) * budgeted labor hour rate
Interpretation: calculates the portion of fixed production overheads volume variance driven by the changes of the number of hours worked. If total actual labor hours are higher than budgeted, the variance is favorable, because the staff worked extra hours (e.g. overtimes) and vice versa (e.g. breakdowns).
Budget: 10 labor hours per €10/hour are necessary to produce a unit; produced output is 1 000 units
Actual: 8 labor hours per €12/hour are necessary to produce a unit; produced output is 1 100 units and total fixed production overheads 120 000
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Total fixed production overheads variance = unabsorbed overheads = 120 000 – (10 * 10 * 1 100) = 120 000 - 110 000 = 10 000 (under-absorbed overheads) split into:
Fixed production overheads expenditure variance = 120 000 – (10 * 10 * 1 000) = 120 000 – 100 000 = 20 000 (unfavorable)
Fixed production overheads quantity (volume) variance = (1 000 – 1 100) * (10 * 10) = - 10 000 (favorable) split into: