VARIANCE ANALYSIS 1

1. VARIANCE ANALYSIS 1 LECTURE 8

2. OBJECTIVES: • 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. Flexible Budget • Steps in developing a flexible budget • Identify the actual quantity of output • Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output • Calculate the flexible budget for costs based on budgeted variable cost per output unit, actual quantity of output, and budgeted fixed costs

4. Flexible BudgetAn Example Budgeted: Selling price = £100 per unit Raw materials = £40 per unit Labour = £20 per unit

5. Variances • Variance ~ difference between the budgeted and actual amounts. • Variance analysis ~ a means of assessing these differences • Variance is use to: • Assist managers in planning and control • Evaluate performance • Suggest changes in strategies

6. VariancesStandard Costing • 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

7. VariancesStandard Costing • 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

8. Variance Analysis • 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

9. Direct Material Variances • Material variance = difference between the actual expenditure and budgeted expenditure on direct materials • Material Budget Variance • Price variance • Usage/Efficiency variance

10. Materials Price Variance It is a favourable materials price variance because we actually paid less than the standard that we should have been paid. The actual usage is exactly the same as the standard. The only difference is the PRICE for raw materials.

11. Materials Price Variance The actual price paid is now greater than the standard price should have been paid. It is an adverse/unfavourable materials price variance. The quantity of materials actually used is the same as the standard. The only difference is the PRICE.

12. Materials Usage Variance The actual quantity used in producing 1 unit of product is less than the standard quantity should have been used. It is a favourable materials usage variance. No difference in price. The only difference is the QUANTITY.

13. Materials Usage Variance The actual quantity used is greater than the quantity should have been used. It is an adverse / unfavourable materials usage variance. No difference in price. The only difference is the QUANTITY.

14. Materials Price & Usage Variances ~ Formulae Materials price variance (Standard price – Actual price) * Actual quantity purchased (SP – AP) * AQ Materials usage variance (Standard quantity – Actual quantity) * Standard price (SQ – AQ) * SP

15. Materials Price & Usage Variances ~ Formulae

16. Material VariancesWhat caused the variance? • Price Variance • Price changed due to inflation • Government has imposed taxes on the materials • Purchase higher quality material • Usage Variance • Wastage occurs due to old machines • Lack of training among employees

17. Direct Labour Variances • Labour variance = difference between the actual labour cost and the standard labour cost for actual production • Direct labour budget variance • Direct labour wage rate variance • Direct labour efficiency variance

18. Wage Rate Variance The actual wage rate is higher than the standard wage rate that should have been paid. It is an adverse wage rate variance. No difference in quantity of labour hours. The only difference is the WAGE RATE.

19. Labour Efficiency Variance The actual labour hours used are less than the standard labour hours that should have been used. It is a favourable labour efficiency variance. No difference in wage rate. The only difference is the LABOUR HOURS.

20. Labour Wage Rate and Efficiency Variances ~ Formulae Wage rate variance (Standard wage rate per hour – Actual wage rate) * Actual hours worked/used (SR – AR) * AH Labour efficiency variance (Standard labour hours for actual production – Actual labour hours worked) * Standard wage rate per hour (SH – AH) * SR

21. Labour Wage Rate and Efficiency Variances ~ Formulae

22. Direct Labour VariancesWhat caused the variance? • Labour wage rate variance • Anticipated wage increase failed • Higher grade of labour was used • Labour efficiency variance • New training scheme reduce labour hours • Employees worked more efficient due to higher quality material used, less wastage