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Interpretation of Cost Variance
Interpretation of Cost Variance
Interpretation of Variance
Mathematical Interpretation
The variances that we calculate are all value variances i.e. any Variance that we calculate is the
difference between two values.
⇒ Variance = Value1 − Value2
⇒ Variance = (Quantity1 × Price1) − (Quantity2 × Price2) [Since Value = Quantity × Price.]
Adverse/Negative/Unfavourable Variance
The variance is said to be either negative (−) or Adverse (Adv) or Unfavourable (Unf) if it indicates a
loss.
In relation to costs, we would incur a loss if the actual cost is greater than the standard cost.
In relation to profits or incomes, we would incur a loss if the actual profit or income is less than
the standard.
This type of variance is indicated by either a negative sign (−) placed before the value of the variance
or by writing the letters UF or Unf or Adv after the value.
Positive/Favourable Variance
The variance is said to be either Positive (+/Pos) or Favourable (Fav) if it indicates a gain position or
beneficial position.
In relation to costs, we would gain if the actual cost is less than the standard cost.
In relation to profits or incomes, we would gain if the actual profit or income is greater than the
standard.
This type of variance is indicated by either a positive sign (+) placed before the value of the variance or
by writing the letters Fav or F or Pos after the value.
Variance Formulae » Standard − Actual (Or) Actual − Standard ??
Many a times students would get struck up with deciding whether the standard data comes first or the
actual data. The basic idea behind all variances being Variance = Value 1 − Value 2, the standard value
should come first in case of cost variances and the actual value should come first in case of sales
variances.
To have a clear understanding assume an example and spend a few seconds to think over and decide
every time you are in doubt. Never mug it up. The below explanation is given as an aid.
Sstandard cost is Rs. 2,000 and the actual cost is Rs. 2,400.
This should indicate a negative variance.
How do you get a negative sign? 2,400 − 2,000 or 2,000 − 2,400.
Surely, it would be 2,000 − 2,400
Thus it should be Standard Cost − Actual Cost.
Standard income is Rs. 2,500 and the actual income is Rs. 3,000.
This should indicate a positive variance.
How do you get a positive sign? 2,500 − 3,000 or 3,000 − 2,500.
Surely, it would be 3,000 − 2,500
Thus it should be Actual Income − Standard Income.
Material Variances
The variance in the cost of materials i.e. the difference between the standard cost of materials for
actual output and the actual cost of materials would give the variance on account of materials. We call
this the "Material Cost Variance".
This would give an idea of how much more or less cost had been incurred when the actuals are
compared to plans. However, it does not give a scope for pin pointing the responsibility for the
variance and thereby take corrective actions.
We cannot identify whether the variance is on account of more or less purchase price being paid (in
which case, the purchases department should be held responsible) or on account of more or less
quantity of materials being used (in which case the production department should be held
responsible) etc.
Therefore to enable derivation of data that would be useful, material cost variance is analysed further
into its constituent parts.
Material Cost Variance as a Synthesis of its Constituent Variances
The analysis of material cost variance into its constituent parts gives an idea of the material variance in
various other angles. This possibility for anlaysis arises on account of the fact that material cost is a
product of (thereby is influence by) two factors, i.e. the quantity of materials and the price of
materials .
All the variances involving materials which are collectively called "Material variances" and their inter
relationships are depicted in the illustration below:
This can be understood as the "Material Cost Variance" broken down into its constituent parts and the
constituent parts further broken down wherever possible.
Inter-relationships
9,500 units of a product are planned to be produced using 900 kgs of Material A @ Rs. 15 per kg, 800 kgs of
Material B @ Rs. 45/kg and 200 kgs of Material C @ Rs. 85 per kg at a total cost of Rs. 66,500. 22,800
units of the product were manufactured using 2,250 kgs of Material A @ Rs. 16 per kg, 1,950 kgs of
Material B @ Rs. 42/kg and 550 kgs of Material C @ Rs. 90 per kg.
When two or more types of materials are used for the manufacture of a product, the total Material
Cost variance is the sum of the variances measured for each material separately.
The Total Material Cost Variance is nothing but the MCV for the mix.
Where AO = SO
AO
When AO = SO, becomes 1 thus nullifying its effect, in which case the formula would read as:
SO
For each material separately
Material cost variance for each material would be zero, when the actual quantity of material used and
the standard quantity of material for actual output are the same as well as the actual price at which
materials are purchased is equal to the standard price of materials.
TMCV = 0
When more than one type of material is used, the Total MCV may become zero
Therefore, it would not be appropriate to conclude that there is no variance on account of any
material just because the total MCV is zero.
Where the total MCV is zero, you have to verify individual variances before concluding that all the
variances (MCV's) are zero.
Solution [Using the data as it is]
For working out problems with the data consider as it has been given without having to do any
recalculations, use the above formulae (which are capable of being used in all cases)
Standard Actual
[Production: 9500 units] [Production: 22,800 units]
Quantit Quantit
Price Value/Cost Price Value/Cost
y y
Rs/kg (Rs) Rs/kg (Rs)
(kgs) (kgs)
Material
900 15 13,500 2,250 16 36,000
A
Material B 800 45 36,000 1,950 42 81,900
Material C 200 85 17,000 550 90 49,500
3,348
Total 1,900 35 66,500 4,750 1,67,400
95
Alternative for Total Variance
The total material cost variance can be calculated wihthout calculating the variances for individual materials
using the direct formula.
AO
Using TMCV i.e. MCVMix = ( × SQMix × SPMix) − (AQMix × APMix)
SO
22,800 units Rs. 3,348
=( × 1,900 kgs × Rs. 35/kg) − (4,750 kgs × /kg)
9,500 units 95
= (2.4 × Rs. 66,500) − (50 × Rs. 3,348)
= Rs. 1,59,600 − Rs. 1,67,400
= − Rs. 7,800 [Adv]
Solution [Using recalculated data]
Where you find that the SO ≠ AO, you may alternatively recalculate the standard to make the SO = AO and
use the figures relating to the recalculated standard in the working table. In such a case, the formulae that you
use would look simpler (without the adjustment factor AO/SO).
From the data relating to the problem, it is evident that AO ≠ SO. Thus we recalculate the standard data for
Actual Output [Refer to the calculations].
Consider the recalculated standard data and the actual data arranged in a working table.
Standard Actual
[Production: 22,800 units] [Production: 22,800 units]
Quantit Quantit
Price Value/Cost Price Value/Cost
y y
Rs/kg (Rs) Rs/kg (Rs)
(kgs) (kgs)
Material
2,160 15 32,400 2,250 16 36,000
A
Material B 1,920 45 86,400 1,950 42 81,900
Material C 480 85 40,800 550 90 49,500
3,348
Total 4,560 35 1,59,600 4,750 1,67,400
95
MCV = (SQ × SP ) − (AQ × AP)
Using, MCVMat = (SQMat × SPMat ) − (AQMat × APMat) Material Cost Variance due to
Note:
The above formula can be used only when the standard output and the actual output are the same.
The total material cost variance can be calculated wihthout calculating the variances for individual materials
using the direct formula.
Rs. 3,348
⇒ TMCV i.e. MCVMix = (4,560 kgs × Rs. 35/kg) − (4,750 kgs × /kg)
95
= Rs. 1,59,600 − Rs. 1,67,400
= − Rs. 7,800 [Adv]
You dont need to recalculate the standard
The formula with the adjustment factor AO/SO can be used in all cases i.e. both when AO = SO and AO ≠
SO. Therefore, you don't need to rebuild the working table by recalculating the standards for the purpose of
finding the variances.
Check:
The same problem was solved in both the cases above. The only difference being that in the second case, the
data was considered by recalculating the Standard for Actual Output to make AO = SO.
Who is held responsible for the Variance?
Since Material Cost Variance represents the total difference on account of a number of factors it would not
be possible to directly fix the responsibility for the variance. This explains the reason for analysing the
variance and segregating it into its constituent parts.
Constituents of Material Cost Variance
In the overview of material variances we have seen that the material cost variance is actually a synthesis of
two variances, "Material Price Variance" and "Material Usage/Quantity Variance".
We know,
AO
MCV = ({ × SQ } × SP ) − (AQ × AP)
SO
AO
= ({ × SQ } × SP ) + [− (AQ × AP)]
SO
[Adding and deducting (AQ × SP)]
AO
= ({ × SQ } × SP ) + [− (AQ × SP) + (AQ × SP)] − (AQ × AP)]
SO
[Adding and deducting the same quantity does not alter The value of the expression]
AO
= [({ × SQ } × SP ) − (AQ × SP)] + [(AQ × SP) − (AQ × AP)]
SO
= [Material Usage Variance] + [Material Price Variance]
MCV = MUV + MPV