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# Variance Analysis

## Buy Custom Variance Analysis Essay

Variance is defined as the difference between actual result of performance and the budget expectation. Favorable variance occurs when there result of actual performance is better than the budget expectation, while unfavorable variance occurs when the actual result of performance is lower than the budget expectation (Kirlyn, R.N & V.Govind, 1992).. This section describes how material and labor variances are calculated and what causes each of those variances.

### Insightful Note

In a typical organization, the planning process starts with a budget followed by actual performance. The budget will usually be based on standard costs of the desired output units. But how does a budget actual performance relate?

- Budgets are followed by performance
- Performance leads to preparation of a performance report, which compares the budgeted performance and the actual performance, and therefore determines whether there is a favorable(F) or unfavorable(U) variance. These variances are exceptions, thus the performance report (Variance report) is an exceptions report (Matheny, P. 1992).

a) Direct Materials Total Variance

Direct materials total variance refers to the difference between the standard direct material cost of the actual production volume and the actual cost of the direct material. The direct materials total variances is a sum of two sub-variances: direct material price variance, and direct material usage variance ( Shank, V.J. & Horngren, J.K. 1989)

- The Direct Material Price Variance; Refers to the difference between the standard price and the actual purchase price for the actual quantity of materials. It can be calculated at the time of purchase or time of usage. The latter is specific to the quantity of material utilized in production. But generally, in the calculation of direct material price variance, the quantity purchased is used as the basis of the variance.

The variance can be calculated as follows:

Direct material = (Actual Quantity x Actual Price) – (Actual Quantity x Standard Price)

Price Variance

Direct Material Price Variance = AQ (AP – SP)

During the month, 6,500 kg of raw materials were purchased at shs.3.80 per kilo and all of it was used to produce 2000 units of finished products. Also, 4,500 hours of direct labor time were used at a total cost of shs.64,350.

Direct Materials price variance = (AQ X AP) – (AQ X SP) = (6,500 X 3.80) – (6,500 X 4) = 6,500 (3.80 – 4) = Kshs.1,300 Favorable

From the above equation, it is clear that the direct material price variance is as a consequence of the actual purchase price of direct materials being different from the standard price of the direct materials. The variance is favorable since the actual price is less than the standard price.

### Typical Causes of Material Price Variances

a) Paying higher or lower prices than planned.

b) Losing or gaining quantity discounts by buying in smaller or larger quantities than planned.

c) Buying lower or higher quality than planned.

- Direct Material Usage (Efficiency) Variance: Refers to the difference between the actual quantity used and the standard quantity specified for the actual production, all valued at the standard purchase price.

This can be calculated as follows:

Direct Material = (Actual Quantity x Standard Price) – (Standard x Standard

Price Usage Variance Quantity

Basing on example I above:

Direct Materials usage variance = (AQ X AP) – (SQ X SP) = (6,500 X 3.80) – (6,000 X 4) = 24,700 – 24,000 = 700 Unfavorable

The variance is unfavorable since we used more quantity than the standard quantity.

It is again clear that the direct material usage variance arises due to the production department using more materials than expected (the standard).

### Typical Causes of material Usage (Efficiency) Variances

a) Greater or lower field from material than planned.

b) Gains or losses due to use of substitute or rather/lower quality than planned.

c) Inefficiency or efficient machinery.

d) Poorly trained workers or extremely high quality labor.

b) Direct Labor Total Variance

This is the difference between the standard direct labor cost and the actual direct labor cost incurred for the production achieved. It is a sum total of the direct labor rate variance and the direct labor efficiency variance (Hilton, R.W., M.W. Maher F.H.Selto & B.J.Sainty 2001).

Direct Labor Rate Variance: This is the difference between the actual direct labor rate and the standard direct labor rate for the total hours worked.

Using an equation, this can be shown as follows;

Direct labor rate = Actual labor x Actual _ Actual x Standard

Variance hours Rate Labor Hours Rate

Example II

The standard cost for the production of a cell phone is as follows:

4,500 hours of direct labor time were used at a total cost of shs.64,350.

NB: AH x AR = Shs.64,350

Labor Rate Variance = 64,350 – (4,500 x 14) = Shs.1,350 Unfavorable.

The rate is unfavorable because we spent more than expected.

It is clear from the above equation that the direct labor rate variance arises due to the actual rate paid for the actual labor hours worked differing from the standard rate that was expected to be paid for those labor hours.

### Typical Causes Labor Rate Variances

a) Higher rates being paid than planned due to wage (increase) awards.

b) Higher or lower grade of workers being used than planned.

c) Payment of unplanned overtime or bonus.

Direct Labor Efficiency Variances This is the difference between the standard hours allowed for the actual production achieved and the hours actually worked, all valued at the standard labor rate. Using an equation, this can be shown as follows:

Direct labor = Actual labor x Standard _ Standard x Standard

Efficiency Variance hours Rate Labor Hours Rate

Direct Labor efficiency variance = SR (AHrs – SHrs).

From the example II above:

Labor Efficiency (usage) variance: = (AH X SR) – (SH x SR) = (AH – SH) SR = (4,500 – 5,000) 14 = 7,000 Favorable

The variance is favorable since the actual hours worked are less than the standard hours.

Thus, the direct labor efficiency variance arises due to the actual hours used in production varying from the standard hours expected to have been used.

### Typical Causes of Labor Efficiency Variances

a) Use of incorrect grade of labor e.g. poorly trained personnel.

b) Poor workshop organization or supervision.

c) Incorrect materials or machine problems.

Rational explanation of Material and Labor Variance

The calculation of material and labor variances is not enough; we need to know how the variance could have typically occurred in the first place, and whether there is any connection between one cause of the variance to another. For example, a higher price of materials could have resulted in an unfavorable direct material price variance: but, due to the high quality (though high priced) input materials; this could have led to a favorable efficiency variance!