Cost Accounting 2

Chapter 6
Measuring Mix and Yield
Variances

Lecturer: Abdirahman Awil

07:14 AM (MBA, BA in Finance & Accounting)
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 VARIANCE ANALYSIS
• Definition of variance and variance analysis
• In accounting, a variance is the difference between an
actual amount and a budgeted, planned or past amount.
• Variance analysis is a Process aimed at computing
variance between actual and budgeted or targeted
levels of performance, and identification of their causes.
• Variance analysis is an analytical tool that managers
can use to compare actual operations to budgeted
estimates. In other words, after a period is over,
managers look at the actual cost and sales figures and
compare them to what was budgeted. Some budgets
will be met and some will not.

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Variance Analysis Cycle

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• Variance can occur for the following
reasons
• The possible reasons for each type of
variances and the suggested course of
action are given
Type of Variance below.
Reasons This Suggestive
of Variance list
Action
is only
Course of

illustrative
MATERIAL and not exhaustive.
Material Price • Change in Basic Price
 
• Fail to purchase the
anticipated standard
quantities at appropriate •
price
• Departmental head
should take necessary
action to purchase at
right point of time
Cash discount or
interest rate for payment
of purchase should be
consider at the time of
such payment

    • Price check on the

purchase of standard
quality materials

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Material Usage • Use of sub-standard • Regular Inspection of
material quality of materials
• Ineffective use of • Proper training of
materials operators
• Non standardized mix • Ensure best utilization of
resources

LABOR
Labor Efficiency • Change in design and • Proper planning
quality standard • Proper training
• Poor working conditions • Healthy working
• Improper scheduling environment
• Timelines for achieving
set targets

Labor Rate • Improper placement of • Time Scheduling for work

labor performance
• Increments / high labor • Proper job allocation
wages according to capabilities
• Overtime of workers

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OVERHEADS
Manufacturing • Improper planning • Efficient planning for
• Under or over absorption better Capacity utilization
of fixed overheads • Check on expenditure
• Reduction of sales
• Breakdowns
• Power failure
• Labor Trouble
Selling and Distribution • Increase in delivery cost • Sales quotas
• Increase in stock holding • Sale Targets
period
• Overtime
Administrative • Over expenditure • Comparison of budgets
with actuals
• Introduction of Operating
costing
• Introduction of cost ratios

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• Selling expenses are those expenses which
are incurred to promote sales and service to
customers. Thus, selling overhead includes
Salesmen’s Salaries, Commission, Travelling
expenses, Cost of advertisement

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• Manufacturing overhead is all indirect costs incurred during
the production process. This overhead is applied to the
units produced within a reporting period. Examples of costs
that are included in the manufacturing overhead category
are:
1. Depreciation on equipment used in the production
process
2. Property taxes on the production facility
3. Rent on the factory building
4. Salaries of maintenance personnel
5. Salaries of manufacturing managers
6. Salaries of the materials management staff
7. Salaries of the quality control staff
8. Supplies not directly associated with products (such as
manufacturing forms)
9. Utilities for the factory
10.Wages of building janitorial staff 8
• 7.3. LIMITATIONS OF VARIANCE ANALYSIS
• The variance analysis is been of large use to
corporations; however it comes with its own set of
limitations as follows:
1. Variance analysis as an activity is based on financial
results which are released much later after quarterly
closing; there may be a time gap which may affect the
remedial action taking an ability to a certain extent.
Also, not all sources of variance may be available in 
accounting data which makes acting upon variances
difficult.
2. If the budgeting is not made taking into consideration
the detailed analysis of each factor, the budgeting
exercise may be loosely done which is bound to
deviate from the actual numbers. Thereafter analyzing
variances may not be a useful activity.

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3. Reporting Delay: Variance analysis is usually
conducted as part of the annual budgeting exercise.
The usefulness of variance analysis as a control
mechanism declines as the duration of reporting
period increases because the delay in the provision of
such information reduces its relevancy for the
decision making needs of management.
4. Behavioral Issues: Standard costing and variance
analysis may encourage short-termism due to their
inherent tendency towards short-term, quantified
objectives and results.

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• Types of variance analysis
• Variance Analysis can be broadly classified into the
following heads:
1. Material Variance
2. Labor Variance
3. Variable Overhead Variance
4. Fixed Overhead Variance
5. Sales Variance
• COMPUTATION OF VARIANCES
• Direct Material Variances
• The total direct material cost variance for actual output
can basically be divided into three types, namely (a)
Material cost variance (b) price variance and (c)
Quantity/usage variance. The method of calculating
these variances is as under:
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1. Material cost variance
= standard cost of martial – actual cost of material
= (standard Quantity × Standard price) – (Actual Quantity ×
Actual price)
2. Material price variance
= (Standard Price – Actual Price) x Actual Quantity
3. Material usage variance
= (Standard Quantity for actual output – Actual Quantity) x
Standard Price
4. Labor variance (actual cost)
= Standard Wages – Actual Wages
= (Standard Hours x Standard Rate per Hour) – (Actual
Hours x Actual rate per Hour)
5. Labor rate variance (
= (Standard Rate per Hour – Actual Rate per Hour) x Actual
Hours
6. Labor efficiency variance (Quantity of labor HR)
= (Standard Hours for Actual Out Put – Actual Hours) x
Standard Rate 12
7. Variable overhead variance
= standard variable overhead – actual variable overhead
= (standard rate – actual rate) x actual output
= 80 (favorable)
8. Variable overhead efficiency variance
= (actual output – standard output) x standard rate
9. Variable overhead expenditure variance
= (standard output x standard rate) – (actual output x actual rate)
10. Fixed overhead variance 
= (actual output x standard rate per unit) – actual fixed overhead
11. Fixed overhead expenditure variance
= standard fixed overhead – actual fixed overhead
12. Fixed overhead volume variance
= (actual output x standard rate per unit) – standard fixed
overhead
 
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Example 1
Standard /
  Budgeted Actual
Price $ 10 per kg. $ 8 per kg.
Quantity 200 kg 150 kg
Hours 250 300
Rate $8 $7
Output 100 kg 80 kg
Required
1. Material cost variance
2. Material price variance
3. Material usage variance
4. Labor variance
5. Labor rate variance
6. Labor efficiency variance 14
7. Variable overhead variance
8. Variable overhead efficiency variance
9. Variable overhead expenditure variance
10.Fixed overhead variance 
11.Fixed overhead expenditure variance
12.Fixed overhead volume variance

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 Exercise
  Standard/ Budgeted Actual
Price $ 10 per kg. $ 8 per kg.
Quantity 190 kg 140 kg
Hours 240 290
Rate $9 $7
Output 120 kg 90 kg

• Required
1. Material cost variance
2. Material price variance
3. Material usage variance
4. Labor variance
5. Labor rate variance
6. Labor efficiency variance 16
7. Variable overhead variance
8. Variable overhead efficiency variance
9. Variable overhead expenditure variance
10.Fixed overhead variance 
11.Fixed overhead expenditure variance
12.Fixed overhead volume variance

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