Chapter – 12

Advanced Variances
 Sales Variances

Total Sales Variance

Sales Price Variance Sales Volume Variance

= AQ × (AP – SP) = SM × (AQ – BQ)

Where,

SM = Standard Margin
&
Margin = Contribution per unit (in
case of marginal costing)
Or
Profit per unit (in case of
absorption costing)
 Causes of sales variances

Total Sales Variance

Sales Price Variance Sales Volume Variance

 Sales Volume Variances

Sales Volume Variance

Sales Mix/ Sales Mix Profit Variance Sales Quantity/ Sales Quantity Profit Variance

= (AQAM – AQSM) × Std = (AQSM – BQSM) × Std

contribution per unit contribution per unit

Where,
AQAM = AQ in actual mix
AQSM = AQ in standard mix
BQSM = Budgeted Quantity in standard mix
 Material Variances

Total Material Variance

Material Price Variance Material Usage Variance

= AQ × (SP – AP) = SP × (SQ – AQ)

Where,

SQ = Standard Quantity used for

actual production
 Causes of material variances

Total Material Variance

Material Price Variance Material Usage Variance

 Material Usage Variance
Material mix and yield variances are calculated if:
• A product contains more than one type of
Material Usage Variance material.
• These materials are interchangeable.
• There was a change in the proportions of the
input materials

Material Mix Variance Material Yield Variance

= (AQSM – AQAM) × SR = (SQSM – AQSM) × SR

Where,
AQSM = Total AQ used in the ratio Where,
of standard mix SQSM = SQ used in the ratio of
standard mix to produce
actual units
 Labour Variances

Total Labour Variance

Labour Rate Variance Labour Efficiency Variance

= AH × (SR – AR) = SR × (SH – AH)

Productive Efficiency Variance Idle Time Variance

= SR × (SH – AHw) = SR × (AHP – AHW)

Where,
SH = Standard hours worked for actual production
 Causes of labour variances

Total Labour Variance

Labour Rate Variance Labour Efficiency Variance

 Controlling idle time and waste

Idle time can be reduced by:

(1) Proper maintenance of machinery
(2) Advanced production planning
(3) Timely procurement of stores
(4) Assurance of supply of power
(5) Advance planning for machine utilisation.

Material waste - Material waste can happen by evaporation, scrapping, testing etc.

Materials waste can be controlled by:

(1) Ordering the right quantity and quality of materials at the most favourable price
(2) Ensuring the material arrives at the right time in the production process
(3) Taking correct measures against theft, deterioration, breakage.
 Variable Overhead Variances

Total Variable Overhead Variance

Variable Overhead Expenditure Variance Variable Overhead Efficiency Variance

= AH × (SR – AR) = SR × (SH – AH)

Where,
SH = Standard hours worked for
actual production
 Causes of variable overhead variances

Total Variable Overhead Variance

Variable Overhead Expenditure Variance Variable Overhead Efficiency Variance

 Fixed Overhead Variances

Total Fixed Overhead Variance

Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

= SR × (SH – BH)

= (BH × SR) - (AH × AR)

Point to not: In a marginal costing system, as

the amount of overheads is written off to the Fixed Overhead Capacity Fixed Overhead Efficiency
Statement of Profit or Loss rather than getting Variance Variance
absorbed to units, the only fixed overhead = SR × (AH – BH) = SR × (SH – AH)
variance is the fixed overhead expenditure
variance.
Where,
SH = Standard hours for actual production
BH = Standard hours for budgeted production
 Causes of fixed overhead variances

Total Fixed Overhead Variance

Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

Fixed Overhead Capacity Variance Fixed Overhead Efficiency Variance

 When should a variance be investigated?

Factors to consider include:

1. Size of variations between the actual and the standard - Uncontrollable and small variances should not be investigated.

2. Further, a business may decide to only investigate variances above a certain amount. The following techniques could be used
here:
• Fixed size of variance, e.g. investigate all variances over $5,000
• Fixed percentage rule, e.g. investigate all variances over 10% of the budget
• Statistical decision rule, e.g. investigate all variances of which there is a likelihood of less than 5% that it could have
arisen randomly.

3. Favourable or adverse variance - Firms often carry on investigation on adverse variances rather than favourable ones.

4. Cost of investigation

5. Past pattern - A firm may investigate on any steadily worsening trends over the past years.

6. An unreliable or unrealistic budget - In such a case, the variances would be uncontrollable and the firm need a change in the
budgeting process, not an investigation of the variance.

7. Reliability of figures - If the system for measuring and recording the figures is unreliable, then calculating variances will be of no
use.
 Controlling production processes in manufacturing environments

Performance measures used by organizations for controlling production processes:

▪ quality measures for e.g. reject rate, % waste, % yield

▪ average cost of inputs
▪ average cost of outputs
▪ average prices achieved for finished products
▪ average margins
▪ % on-time deliveries
▪ customer satisfaction ratings
▪ detailed timesheets
▪ % idle time
 Planning and operational variances

✓ A difference between the standard set and

actual results may arise partly due to an
unrealistic budget and partly due to operational
factors.
✓ In such a case, the budget may need to be
revised so that actual performance can be
compared with the standard which truly reflects
the changed conditions.
 Benefits of planning and operating variances

❖ In volatile and changing environments, standard costing and variance analysis are more useful
when this approach is used.

❖ Operational variances provide up to date information about current levels of efficiency.

❖ Operational variances make the standard costing system more acceptable and is likely to have
a positive effect on motivation.

❖ It emphasises the importance of the planning function in the preparation of standards and helps
to identify planning deficiencies.
 Problems of planning and operating variances

❖ There is an element of subjectivity in determining as to what are

'realistic’ standards

❖ It’s a time taking activity to establish up to date standards and then

calculating variances

❖ The employees and managers are more tempted to put as much

as possible of the total variances to uncontrollable factors, i.e.
planning variances. This can lead to a conflict between operating
and planning staff.

❖ Data collection for the revised analysis is another problem under

its ambit
 When should a budget be revised?

A good reason for a change in the standard can be:

• a change in one of the main materials used in production

• an unexpected increase in the price of materials
• a change in working methods that in turn changes the direct
labour hours required to make a product or render a service
• an unexpected change in the labour pay rate

Point to note: Planning and operational variances must be reported

occasionally, rather than as a regular event, as the reasons leading to
their calculation are also non routine and occasional.
 Disadvantages of revising the budget

• Managers whose performance is reported to be poor using

such a budget are unlikely to accept them as performance
measures
• A considerable amount of administrative work is involved in
revising the budgets and then analysing the reasons for the
variances
• Poor performance is often excused as being the fault of a
badly set budget.
• Frequent budget revisions can lead to biasness
 Variance analysis in the modern manufacturing environment

Variance analysis may not be appropriate in a modern manufacturing environment because of the following reasons:

• Non-standard and customized products manufactured to customer specifications

• Standard costs become outdated quickly because of shorter product life cycles in the modern business environment

• Extra work and time involved in maintaining up-to-date standards

• Highly automated production as standard costing is based on an assumption that control can be exercised by
concentrating on the efficiency of the workforce. But, where manufacturing systems are highly automated, the
production is controlled by the machinery rather than the workforce.

• Emphasis on continuous improvement under the JIT and TQM - Standard costing and adherence to a preset standard
is inconsistent with the concept of continuous improvement applied within TQM and JIT environments.

• Detailed information requirement for variance analysis in a complex and constantly changing business environment
 Dysfunctional variances in a JIT & TQM environment

Some variances are not useful in JIT or TQM environment, for example:

(1) The material price variance: Because in a JIT and TQM environment, the business is ready to pay a higher price for materials,
to get raw material with no defects and to ensure that production will 'get it right first time’.

(2) The labour, variable overhead and fixed overhead efficiency variances: in a TQM production environment, labour is working
toward minimizing waste and improving quality, which in case leads to adverse variance, is considered as acceptable if the
final product meets customers’ expectations.

(3) The material usage variance: in a JIT and TQM environment, as the workforce needs to be fast in the production process,
more wastage could occur provided the final product sent to customer is absolutely fault-free
 Types of ‘standards’ set for managers to achieve

The type of standard set to which individuals may respond in different ways. They are segregated according to the
difficulty level of achieving the standard

Ideal standard: When a standard level of performance is too high, leading to managers not even trying to get near it.

Current standard: When the standard of performance is not challenging leading to the managers achieving the
standard without trying to improve their performance.

Attainable standard: A standard which challenges employees and their managers to improve their performance.
Some employees will be motivated by it and will work harder to achieve it. But there can be some employees who
may prefer standards to be set at a low level of performance also.

Basic standard: This type of standard may motivate employees since it gives them a long-term target to aim for.
However, the standard may become out of date quickly and, as result, may actually demotivate employees.
 Standard costs in changing environments

Variance analysis can be misleading in organisations using JIT and TQM. The following problems may arise in such a situation:

(1) Standard costing focuses on reducing costs, and ignores quality and customer satisfaction, which is the main consideration
in a TQM environment.

(2) A standard costing system puts too much emphasis on direct labour costs, while modern business environment production is
largely automated, thereby making direct labour cost only a small proportion of total costs.

(3) A standard costing system puts too much emphasis on the control of short-term, variable costs. While, in the modern
environment, most costs (including direct labour costs), are fixed costs – or are fixed at least in the short term.

(4) Standard costing is appropriate in a stable environment. The modern business environment is dynamic and unstable and
operations are also more complex, which makes standard costing not always suitable for it.

(5) Achieving standards is acceptable in standard costing, while the modern business environment insists more on continuous
improvement.

(6) Standard costing systems produce control statements weekly or monthly, but in a dynamic business environment, managers
need more prompt control information in order to deal with any changes.
 Participation in standard setting

Arguments in favour of participation Arguments against participation

• It could motivate employees to set higher standards for • Senior management might be reluctant to share
achievement. responsibilities for budgeting

• Staff are expected to accept the standards that they • The standard-setting process could be time consuming
themselves have set or agreed upon
• Staff might want to set standards that they are likely to
• Morale and actual performance levels might be achieve, rather than more challenging targets. They
improved. might try to build some ‘slack’ into the budget

• Staff will understand more clearly what is expected of • The standard-setting process could result in conflicts
them. rather than cooperation and collaboration

• Staff might feel that their suggestions have been ignored

Thank You