Mastering Control: A Deep Dive into Variance Analysis
In the world of manufacturing, a plan is everything. But a plan is only as good as its execution. How does a company measure its performance against this plan? The answer lies in the powerful management tool of variance analysis.
What is Variance and How is it Determined?
At its core, standard costing is the practice of establishing predetermined, or standard, costs for producing a single unit. A variance is simply the difference between this standard cost (for the actual level of output) and the actual cost incurred.
Formula: Variance = (Standard Cost for Actual Output) - (Actual Cost)
A Favourable (F) variance means we spent less than expected, while an Adverse (A) variance means we spent more.
Why is Variance Analysis Crucial?
- Cost Control: Acts as an early warning system to take corrective action.
- Performance Appraisal: Provides an objective basis for evaluating department and manager performance.
- Strategic Decisions: Helps identify if standards are outdated or if business strategies need to change.
- Accountability: Bridges the gap between budgeted and actual profit, explaining exactly why they differ.
How Do We Calculate Variances? A Practical Example
Let's walk through the provided data to understand the calculations.
Standard Cost Card (per unit)
| Raw Material (4kgs @ 5/=) | 20.00 Rs. |
| Direct Labour (2Hrs @ 8/=) | 16.00 Rs. |
| Variable Overhead (2Hrs @ 3.5/=) | 7.00 Rs. |
| Fixed Overhead (2Hrs @ 7/=) | 14.00 Rs. |
| Total Standard Cost | 57.00 Rs. |
| Selling Price | 70.00 Rs. |
Budget vs. Actual Info
| Budgeted Production/Sales | 1,000 Units |
| Actual Production/Sales | 1,300 Units |
| RM Purchases (5000kgs) | 22,700 Rs. |
| DL Used (2850Hrs) | 21,500 Rs. |
| VOH Cost | 7,800 Rs. |
| FPOH Cost | 14,600 Rs. |
1. Raw Material (RM) Variances
Total RM Variance: 3,300 (F)
- RM Price Variance: (Std Price 5 - Actual Price 4.54) x 5000 kgs = 2,300 (F). The Procurement team paid less than the standard price.
- RM Usage Variance: (Std Qty 5200 - Actual Qty 5000) x Std Price 5 = 1,000 (F). The production team used materials more efficiently than planned.
2. Direct Labour (DL) Variances
Total DL Variance: 700 (A)
- DL Rate Variance: (Std Rate 8 - Actual Rate 7.54) x 2850 Hrs = 1,311 (F). HR hired workers at a lower average wage.
- DL Efficiency Variance: (Std Hrs 2600 - Actual Hrs 2850) x Std Rate 8 = 2,000 (A). Workers took longer than the standard time.
3. Variable Overhead (VOH) Variances
- VOH Expenditure Variance: (Std Rate 3.5 x 2850 Hrs) - 7800 = 2,175 (F). Spending per hour was lower than budgeted.
- VOH Efficiency Variance: (Std Hrs 2600 - Actual Hrs 2850) x Std Rate 3.5 = 875 (A). Driven by the inefficiency of labour.
4. Fixed Production Overhead (FPOH) Variances
- FPOH Expenditure Variance: Budget 14000 - Actual 14600 = 600 (A). More was spent on fixed costs than planned.
- FPOH Volume Variance: (Actual Units 1300 - Budget Units 1000) x Std Rate 14 = 4,200 (F). Producing more units helped absorb fixed costs better.
5. Sales Variances
- Sales Price Variance: (Actual Price 68 - Std Price 70) x 1300 Units = 2,600 (A). The product was sold at a discount.
- Sales Volume Variance: (Actual Qty 1300 - Budget Qty 1000) x Std Profit 13 = 3,900 (F). More units were sold than budgeted.
A Special Case: Idle Time Variance
Idle time occurs when workers are paid but cannot work (e.g., machine breakdown). This cost should be isolated to avoid unfairly penalizing workers for inefficiency.
Idle Time Ltd. Calculation
Given 300 hours of idle time and a standard rate of 7/= per hour:
- Idle Time Variance: 300 Hrs x 7/= = 2,100 (A)
- DL Efficiency Variance (on worked hours): (Std Hrs 5400 - Worked Hrs 5200) x 7/= = 1,400 (F)
This shows the workforce was actually efficient when working, and the problem lay elsewhere.
Responsibility and Corrective Actions
Calculating variances is just the first step. The real value comes from assigning responsibility and taking action.
- Procurement: Responsible for Material Price Variances. Adverse variances may be due to poor negotiation or unexpected market changes.
- Factory Management: Responsible for Material Usage, Labour Efficiency, and Overhead Variances. They must investigate wastage, idle time, and spending.
- Human Resources: Responsible for Labour Rate Variances. Hiring cheaper, less-skilled staff can cause adverse efficiency variances.
- Sales & Marketing: Responsible for Sales Variances. They must justify pricing strategies and explain volume changes.