INTRODUCTION Accounting information is quite useful to the Management in terms of arriving at a decision and also in planning, control and performance evaluation. Managers use accounting information to analyse the following questions : y y y y y After taking the decisions, what will be the projected profit level ? What happens to the Budgeted cost if sales volume drops by 10 % ? What is the criteria for measuring the efficiency of production ? How can the performance of each segment be measured ? How to design performance measurement systems to encourage employees to participate for the betterment of the Organisation ?

The answers to the above questions lie in the installation of a good accounting system encompassing an effective Budgetary control and Standard costing system. Establishing a Standard costing system will be quite useful to the Management in both planning and control. In the planning stage, it can assist the Management with necessary data; at the control stage, it can be used to find the deviations between the actuals vis-a-vis the standards. The measurement of such deviations is carried out through the technique Variance Analysis. Variance Analysis is defined to be an analysis of the cost variances into its component parts and the explanation of the same. It is that part of the process of control which involves the calculation of a variance and interpretation of results for identifying the causes thereof and also for pinpointing responsibility. Variances are normally calculated for all the cost components such as Materials, Labour and Overheads. Variances are also calculated for Revenues, i.e., Sales and also for Net profits (Sales Costs). In this article, we will introduce the various formulae for computing the variances. The formulae will be derived by using a simple figurative approach to understand the concepts. FUNDAMENTALS Let us understand the fundamentals of Variance Analysis with a simple example. ONE UNIT of Product A requires TWO Kgs. of Material X at a price of Rs.5 per Kg. TEN UNITS of Product A was manufactured and 22 Kgs. of X was consumed. The actual price was Rs.6 per Kg. Computation of the cost variance : For the actual production of 10 Units of A, the consumption at standard should have been 20 Kgs. of X. With a standard price of Rs.5 per Kg. the total standard cost for actual production works out to Rs.100; whereas the actual cost incurred for the same level of production happens to be Rs.132 (22 Kgs. x Rs.6 per Kg.). The above results in a total cost variance of Rs.32 Unfavourable. Anaysis of the cost variance : On analysing, it can be noticed that this variation of Rs.32 was caused because of : y an extra consumption of 2 Kgs. of X at the rate of Rs.5 per Kg - Rs.10.; and an extra payment of Re.1 per Kg. for all the 22 Kgs - Rs.22. The above example leads to the following concepts (1) THE TERM STANDARD FOR MEASUREMENT OF VARIANCES SIGNIFIES THE CONVERSION OF THE ACTUALS BASED ON

THIS CAN BE FURTHER EXTENDED TO DIFFERENT SITUATIONS.(5 . let us figuratively draw the example given above. THE TERM VOLUME IS EQUATED TO EFFICIENCY WITH RESPECT TO LABOUR AND USAGE WITH RESPECT TO MATERIALS. STEP 1 ACTUALS STANDARD 5 price AREA (5x20 = 100) price AREA (6x22 = 132) 6 volume STEP 2 20 volume 22 Combining the figures. THE VOLUME CAN BE FURTHER ANALYSED IN TERMS OF MIX. y WHERE THERE IS AN INPUT-OUTPUT SITUATION THE TERM STANDARD WILL SIGNIFY STANDARD INPUT WITH REFERENCE TO ACTUAL OUTPUT.DERIVATION OF FORMULAE : To understand the various variances regarding Materials. (2) VOLUME AND PRICE ARE THE TWO RELEVANT BASIC FACTORS THAT CAUSE THE VARIANCE.STANDARDS. y WHERE THERE IS A CONCEPT OF EQUIVALENT UNITS THE TERM STANDARD WILL SIGNIFY STANDARD INPUT FOR EQUIVALENT UNITS. 5 20 22 price volume Usage (20 .22) * 5 = . STANDARD FOR ACTUAL PRODUCTION. the variances can be analysed as follows : AP Price Variance .6) * 22 = -22.e. i. we arrive at the cost variance of 32 (20 + 2 + 10): 6 AREA = 20 5 price 10 2 By convention taken as price variance volume STEP 3 6 Price . CAPACITY etc.. DEPENDING UPON THE NATURE OF THE COMPONENT OF COST.10 20 22 STEP 4 Replacing the numbers by notation. SUBUSAGE / YIELD / SUB-EFFICIENCY. MATERIAL VARIANCES .

without any Mathematical analysis.AP]. the figure can be re-analysed to arrive at the three variances as follows : AP SP (1) SP.AQ.AP (1) .AP) SQ AQ NOTATIONS : SP . AP SP . in the figure.(2) = Usage 1 2 3 SQ AQ (2) SP.SQ (1) . The above steps clearly give the background for understanding the basic three variances of materials.(3) = Price (3) AQ.SQ . + Usage Variance .AQ) * SP = [SP. COST.AQ. Further the idea is to enable the student to understand and derive the formulae. Mathematically. AQ .ACTUAL PRICE. instead of memorising the same.AQ]. Hence.AQ. The student can notice that the Cost variance is the sum total of the Usage and Price variances. The student should note that the following figure is only an approach for understanding the formulae and not to be viewed mathematically.AQ (2) . it can be seen that the term SP.(3) = Cost Variance THE FINAL FIGURE : To complete the entirety of Material variances.AP) * AQ = [SP. we introduce the term REVISED STANDARD QUANTITY (RSQ) into the figure. The term Revised Standard Quantity is actually used when there is more than one Material for analysing the Usage Variance into the relative components. AP . namely.ACTUAL QUANTITY.AQ) * SP = Cost Variance (SP.SP. Sub-usage and Mix.SP (SP . it is shown in between SQ and AQ for analysing the variances. = Cost Variance .AQ .AP.STANDARD QUANTITY. SQ .(SQ .SQ SP.AP) * AQ + Usage Variance (SQ . On a further look at the elaboration of the formulae. this can be seen as follows : Price Variance . It should be understood that the Revised Standard Quantity is actually the Standard Ratio of the various elements of the Mix as applied to the Total actual Input. USAGE and PRICE.(SP .AQ is common to both Price and Usage.SQ . viz. although RSQ = AQ. Hence.STANDARD PRICE.

SQ of each element of the Mix put-together Average Standard Price = -------------------------------------------------------------------------------Total Standard Output. Hence. will always be equal. say.OF ACTUAL INPUT The sum total of SP.(3) etc. the sign of the others will also be the same. A SPECIAL PROPERTY OF SUB-USAGE / YIELD VARIANCE : Since. Total Standard Output = Total Standard Input of all elements . difference between (1) . the variance is denoted as Favourable. two or more ingredients are required for a final Product. i. MATERIAL PRICE VARIANCE : Where the Raw Material stocks are valued at Standard Price. Therefore this is the only variance which is quite unique in the sense that once the sign of the variance of one of the elements is known. the Standard itself is based on an acceptable loss proportion. it is unique because if the total variance is known the individual variance of the elements can be computed by apportioning the total variance with the weighted standard ratio of each of the elements. If the figures are Negative.(3) = Price (1) . Yield Variance can also be computed by the following formula : AVERAGE STANDARD PRICE STANDARD LOSS ACTUAL LOSS * OF ACTUAL INPUT . the difference of SQ . the variances are computed by applying the standard ratio on total actual input.e. a Chemical Industry or a Pharmaceutical Industry.(2) = Sub-Usage or Yield (1) .(2) or (2) . i.(4) = (2) . If the actual loss on actual input were to be more than the standard proportion of loss allowed on actual input.SQ. On the other hand if the actual loss is less.. the Yield Variance is positive.AQ (4) AQ. there arises a negative Yield Variance.SQ (2) SP.(4) = Cost Variance NOTE : If the figures are positive. suitably adjusted for value. YIELD VARIANCE : The concept of Yield arises when there is an Input-Output situation. Further. Mathematically.. the variance is denoted as Adverse or Unfavourable. the total standard output and total actual output. NOTE : Since the standard input is with reference to actual output. Hence.1 2 3 4 SQ (1) SP.RSQ will be either Positive or Negative or Nil.. SP. .e. In practical applications.AP (3) .RSQ (1) . it can be noticed that. This results in a loss which is usually acceptable under normal circumstances. it can be noticed that the Material Price variance will remain the same whether calculated on the quantity purchased or on the quantity consumed.(3) = Usage Mix RSQ AQ (3) SP. the Yield Variance equals the sum total of the Sub-Usage Variance of all the elements of the Mix put-together. it can be seen that.Standard loss. based on technical specifications.

The variances can be analysed as follows : (1) SP. the value will be = 80 * 20 = Rs. VARIANCES - TOTAL Rs. resulted in an output of 600 Kgs. and 40 Kgs.400 (A). of Chemical B @ Rs. CHEMICAL A Rs.20 per Kg. of Chemical C. Rs.20*20] = Rs. Actual Data 350 Kgs.1. At standard. 20 Kgs.20 per Kg.25 per Kg. Where Stocks are valued differently. A B Std. results in 60 Kgs. A COMPREHENSIVE EXAMPLE : Standard Data 30 Kgs.5 per Kg. 80 Kgs. of Chemical A @ Rs.AQ (4) AQ.RSQ Rs. This variance can also be computed on the quantity purchased.EXAMPLE : Opening Stock Purchases Closing Stock 10 Kgs. @ Rs. the price variance should be calculated only on the consumption suitably adjusted for value. CHEMICAL B Rs.1800.5 per Kg. the value will be = 70 * 20 = Rs.600..400.AP Chemical Rs. = [10*20 + 80*25 . Hence the variance is Rs. Therefore the price varaince is Rs. At standard. @ Rs. (3) SP.6 per Kg. and 420 Kgs. of Chemical A @ Rs.4 per Kg. of Chemical C.1.2. . of Chemical B @ Rs. Actual value of purchases will be = 80 * 25 = Rs. The Actual value of consumption for 70 Kgs. Input Loss TOTAL 3920 4 x 300 = 1200 6 x 400 = 2400 700 100 600 3600 3850 3960 4 x 330 = 1320 6 x 440 = 2640 770 4 x 350 = 1400 6 x 420 = 2520 770 170 600 350 x 5 = 1750 420 x 5 = 2100 (2) SP. @ Rs.400 (A).SQ Rs.000.

namely.(3) = Mix = 40 (F) (1) .A FIGURATIVE APPROACH . irrespective of whether it is normal or abnormal. we get the following : STEP 1 SR.600/60 * 30 = Chemical B . The figurative approach is elaborated in the case of Overheads only.AR As regards Labour. Variance Analysis is a very important area. they are viewed synonymously.RSH SR.AH AH. The student is advised to have sufficient practice to gain the requisite speed. i. LABOUR and OVERHEADS as well as SALES and PROFIT variances.SH SR.(4) = Cost = 250 (A) 120 (A) 80 (A) 200 (A) 350 (A) 550 (A) 240 (A) 120 (F) 120 (A) 420 (F) 300 (F) NOTE : y Yield Variance = [3600 / 600 ]* [770*(100/700) .600/60 * Chemical A Chemical B EXAMINATION HINTS : In all the professional Examinations. it is the opinion of the authors that this is the easiest one from an Examination point of view.170] = Rs.240 (A). VARIANCE ANALYSIS . y Standard Input for actual output of 600 Kgs. the idle-time variance is calculated using the following formula : .120 (A) and Rs.770 * 4/7 = 440 Kgs. the ratio of SP. i.. By definition. As stated earlier. However. Further.. for the purposes of computing variances. a basic feature is the concept of IDLE-TIME. As a first step. 1200 : 2400 can be applied on Rs. be it Intermediate or Final. In Cost Accounting. 40 = 400 Kgs.(4) = Price = 70 (F) (1) .(1) .(3) = Usage = 320 (A) (3) . .e.SQ of A and B. we will analyse the variances of the other components of cost.(2) = Sub-usage = 360 (A) (2) . y Revised standard quantity = 770 * 3/7 = 330 Kgs. It is the experience of the authors that any type of problem in Variance Analysis can be solved within a time span of 15 mins to 30 mins with the above approach.PART II INTRODUCTION In this article. Idle-time is the number of hours lost due to non-production.360 (A). Chemical A . = 300 Kgs. as the same approach regarding Materials is used for Labour. Replacing the Standard Price with Standard Rate and Standard Quantity with Standard Hours. on comparing this chapter with others. LABOUR VARIANCES Recall back the final figure regarding Material Variances. the Idle-time can be either due to normal or abnormal causes.e.360 (A) to arrive at the individual Sub-usage variances of A and B as Rs. Sales and Sales margin variances.

RSH (3) SR. Hence. it can be included as part of Efficiency variance.(4) = (2) . Conceptually. Idle-time variance can be built in by splitting the Actual Hours into Actual hours taken for production and Actual hours paid.SQ (3) .(4) = Volume (1) . IDLE HOURS CAN BE EXPRESSED AS THE DIFFERENCE BETWEEN HOURS TAKEN FOR PRODUCTION .(5) = Rate (1) .AH (5) (1) .(3) = Quantity (4) SP.HOURS ACTUALLY PAID. (1) . SALES VARIANCES (a) Sales Turnover or Value method : Here we reverse the order of Material variances to analyse the nature of variance.SH AH.(4).(2) = (2) . as applied to the total Actual Hours taken for production.AP (2) AQ. With this analysis. However. This is calculated individually for the various composition of Labour. In our formulation in Step-I.(3) = Sub-Efficiency or Gang-composition Yield or Mix (3) . only the Standard cost is removed for analysing the Margin variances.(2) = Price Mix (3) SP.AR Production Paid Paid (2) SR. Therefore the formulation will be as follows : (1) AQ. Where Idle-time is abnormal.Idle-hours x Standard Rate.(4) = Idle-time (4) . the Efficiency variance will be (1) .e. or Average Standard Rate.AH (4) SR.SP (1) . this variance will always be Unfavourable. i... The Revised Standard Hours will be the ratio of the elements of Labour. Therefore. even from the actual Selling price.(5) = Cost Variance NOTE Where Idle-time is normal. any increase in Selling price increases the profit absolutely. Favourable or Adverse.RSQ (2) . it should be noticed that for a full comprehensive analysis of variances.(3).(4) = Value Variance (b) Profit or Sales Margin method : The basic concept of the above method is to analyse the Profit margin by removing the Standard Cost from the Selling Prices. i.e. the Cost . the Labour variances emerge as follows : (1) SR.

As the entire evaluation is on Output.variances will have to be analysed separately apart from the Sales Margin variances. Hence. FIGURE I . with regard to Overheads. it can be noticed that the same will be computed by comparing the Budgeted volume and Actual volume with the standard recovery as well as actual recovery. (1) AQ. they are not identifiable with respect to a Unit of production. necessitated by the change in the number of days actually worked. Analysing the fundamental causes for variance. viz.(SP-SC) (1) .(3) = Expenditure (1) . Considering the usual Recovery Rates normally used.Based on Standard Recovery per unit AR . the following two figures can be drawn accordingly. Capacity and Calendar. Therefore they are absorbed by a proper Recovery Rate based on number of units produced or labour hours or machine hours. there is no revision of the Standard unlike Materials and Labour. the prefix µMargin¶ will be given.(4) = Margin Volume (1) . OVERHEAD VARIANCES By definition. Indirect labour and Indirect expenses. To derive the formula e for Sales Margin variances. Volume and Price.(4) = Margin Value Variance NOTE As regards Sales variances. Further. namely. there is no concept of Yield. Hence. it should be seen that as regards Overheads.(AP-SC) (2) AQ.SQ (3) . The formulation will then be as follows : (1) Standard Recovery x (2) Standard Recovery x (3) Actual Recovery x Actual production = Standard overhead Budgeted production = Budgeted overhead Actual production = Actual overhead (1) .(2) = Margin Price Margin Mix (3) (SP-SC)RSQ (2) . the terms Budget and Standard are viewed synonymously.(2) = Volume (2) .(4) = (2) . the same figure used for Sales variances on the basis of Turnover will be retained with the removal of the Standard cost from each of the Selling Prices. The concept of Calendar variance arises due to a revision of the Budgeted capacity. This Recovery Rate again is on the basis of a Budget (usually the normal capacity). Overheads constitute Indirect materials. Standard Recovery based on number of units produced or number of labour hours. but there is only a revision of the Budget.(3) = Cost Variance The causes for increase in Volume is due to factors such as Efficiency.(3) = Margin Quantity (4) (SP-SC).

SR 1 2 3 4 5 AQ SQ RBQ BQ AQ .

II.SH .(2) = Idle-time (1) .(5) = Expenditure (1a) . a change has been done with respect to Actual Quantity in the first place (Figure .AR (4) .I) and Actual Hours in the second place (Figure -II).BH (3) .(2) = Efficiency [Idle-time is normal] .FIGURE II .AH.AQ .RBQ SR. i.AR [Actual (1a) SR.SR.. it is possible to split AH into µAH for production¶ and µAH paid¶ for computing the Overhead Idle-time variance. This is to facilitate the Cost variance as well as the Efficiency variance.SH (1) .(4) = Calendar AH. (1) (2) (3) (4) (5) SR.AR.(3) = Capacity SR.SR. As regards Figure .RBH (2) .Based on Standard Recovery per hour AR SR 1 2 3 4 5 SH AH RBH BH AH In the above two figures.SQ in terms of the number of units produced.SH .AQ . By definition.(1a) = Efficiency overheads] SR. Whereas.SQ SR.AQ AQ.AH.AR and SR. the Cost variance is SR. with respect to number of hours.BQ SRAH Production SRAH Paid SR.AQ and the Efficiency variance is SR. the same will be SR.e. a change in the normal order of formulation can be noticed. The full analysis is now given below.

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