What is variance Analysis

Variance literally means diference. Variance therefore, means the difference between the actual costs and the standard costs.

Variances can be computed for all the three cost element of production-materials, labor and factory overhead. Once computed, variances are analyzed and evaluated to provide managers with useful information for measuring efficiency and improving performance. Variance analysis is performed to know two things:
  1. The difference between actual and standard costs
  2. The reasons for such difference

    In variance analysis, therefore, it should not just be to know the amount of variance. In fact, it is more important to know the reasons for such variance since these will be the management's basis for making the appropriate economic decisions.

    Variances may be described as either favorable or unfavorable. When the actual costs incurred are less than the standard, the variance is favorable,since this means that the company incurred less than what it is allowed to spend. On the other hand, when the actual cost are greater than standard, the resulting variance is unfavorable, meaning that there was overspending during the period. To be meaningful, the variance should always be presented with the appropriate description. Omitting this description is considered as a very serious oversight.

    To facilitate our discussion of the formulas for variance computation and analysis, we shall use the following codes:

    A = Actual
    S = Standard
    C = Cost
    V = Variance
    Q = Quantity
    T = Time
    P = Price
    R = Rate
    Prod.= Production
    Pur.= Purchase(d)    		 M = Materials
    L = Labor
    FOH = Factory Overhead
    Var = Variable
    Fx = Fixed
    OH = Overhead
    F = Favorable
    UF = Unfavorable
    D = Difference


    TOTAL VARIANCE=Total Materials Variance + Total Labor Variance + Total Overhead Variance
    (TMV + TLV + TOV)
    TOTAL MATERIALS VARIANCE=Materials Price Variance + Materials Quantity Variance
    (MPV + MQV)
    • Materials Price Variance=(Actual Quantity x Actual Price) - (Actual Quantity x Standard Price)
      Alternative: MPV = AQ x (AP - SP)
    • Materials Quantity Varaince=(Actual Quantity x Standard Price) - (Standard Quantity x Standard Price)
      Alternative: MQV = SP x (AQ - SQ)

    Causes of Materials Variances
    The causes may relate to both internal and external factors. The investigation of a material price variance usually begins in the purchasing department.Many factors affect the price paid for raw materials. These include the delivery method used, availability of quantity and cash discounts, and the quality of materials requested.

    The starting point for determining the cause(s) of unfavorablematerials quantity variance is in the production department. If the variances are due to inexperienced workers, faulty machinery, or carelessness, the production department would be responsible. However, if the materials obtained by the purchasing department were of inferior quality, then the purchasing department should be responsible.


    TOTAL LABOR VARIANCE=Labor Rate Variance + Labor Quantity Variance
    (LRV + LQV)
    • Labor Price Variance = (Actual Hours x Actual Rate) - (Actual Hours x Standard Rate)
      Alternative:LPV = AH x (AR - SR)
    • Labor Quantity Variance = (Actual hours x Standard Rate) - (Standard Hours x Standard Rate)
      Alternative: LQV = SR x (AH - SH)

    Causes of labor variances
    Labor price variances usually result from two factors:(1)Paying workers higher wages than expected,and (2)misallocation of workers.

    Labor quantity variances relate to the efficiency of workers.An investigation of the causes of a quantity variance generally focuses on the production department. The causes on an unfavorable variance may be poor training, worker fatigue, faulty machinery, or carelessness. These causes are the responsibility of the production department. However, if the excess time is due to inferior materials, the responsibility falls outside the production department.

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