Practical Question 1

The standard product cost card of a product is shown below.

Materials 2 feet length, 1/4 inch thick @ $16 $32
Factory overhead labor 4 hours @ $6 $24
Variable 4 hours @ $2 $8
Fixed 4 hours @ $4 $16 $24
Total standard production cost $80

Fixed overhead was based on 36,000 hours a year.
Total fixed overhead estimated at $144,000 per annum.

Actual data for a month has been ascertained as follows:

  • Actual hours worked = 3,800
  • Units of product produced = 900
  • Material used = 1,900 feet in length
  • Price per foot = $15
  • Actual labor wage rate = $5.80
  • Actual factory overhead: variable = $6,200, fixed = $12,000

Required: Calculate two variances for each of the three elements of the production cost.

Solution

1) Material Cost Variance

Standard quantity of output @ standard price:
900 units x 2 x $16 = $28,800
Actual quantity used @ standard price:
1,900 x $16 = $30,400
Actual quantity used @ actual price:
1,900 x $15 = $28,500
Total material cost variance:
$28,800 – $28,500 = $300 (favorable)

Analysis

Materials usage variance:
28,800 – 30,400 = $1,600 (unfavorable)
Materials price variance:
30,400 – 28,500 = $1,900 (favorable)

2) Labor Cost Variance

Standard hours of output at standard wage rate:
900 units x 4 hours x $6 = $21,600
Actual hours for the output at standard wage rate:
3,800 hours x $6 = $22,800
Actual hours at actaul wage rate:
3,800 hours x $5,80 = $22,040
Total labor cost variance:
$21,600 – $22,040 = $440 (unfavorable)

Analysis

Labor efficiency variance:
$21,600 – $22,800 = $1,200 (unfavorable)
Labor wage rate variance:
$22,800 – $22,040 = $760 (favorable)

3) Factory Overhead Variance

Standard hours of output @ standard overhead rate:
900 units x 4 hours x $6 = $21,600
Budget for standard hours produced = 900 units x 4 hours = 3,600 hours
Variable overhead:
3,600 hours x $2 = $7,200
($144,000 / 12 months = $12,000)
Total = $19,200
Actual overhead = $18,200
Total factory overhead variance:
$21,600 – $18,200 = $3,400
Factory overhead volume variance:
$21,600 – $19,500 = $2,400 (favorable)
Factory overhead controllable variance:
$19,200 – $18,200 = $1,000 (favorable)

Practical Question 2

The data shown below relate to an industrial organization that manufactures household appliances.

Standard quantity required of materials item 0020 1 kg.
Standard price per kg. $10
Product in a month appliances 100 kgs.
Actual quantity of materials used 98 kgs.
Actual price paid $11/kg

The following calculations for variances have been made:

Material usage variance = 2 kgs. @ $11 = $22
Material price variance = 100 kgs. x $1 = $100

Required: Do you agree with these calculations? If not, provide a correct calculation for the variances.

Solution

The above analysis of variances is not correct. The correct calculations are given below:

Material Usage Variance

= Difference between standard quantity for the output x Standard price
= 100 units x 1 kg. x $10 = $1,000
(-) 98 kgs. x $10 = $980 or 2 kgs. x $10 = 20 (favorable variance)

Material Price Variance

= Actual quantity used x Difference between standard price and actual price
= 98 kgs. x $1 = $98 (unfavorable)
Total Variance = $78 (unfavorable)

Practical Question 3

The following data pertains to a company’s first week of operations in June 2011:

Materials:

Actual purchased  = 1,500 units @ $3.80 per unit
Actual usage  = 1,350 units
Standard usage  = 1,020 units @ $4.00 per unit

Direct Labor:

Actual hours  = 310 hours @ $12.10 per hour
Standard hours  = 340 hours @ $12.00 per hour

Required: Compare the following variances to determine whether they are favorable or unfavorable:

  • (A) Material purchase price variance and quantity variance
  • (B) Labor rate efficiency variance.

Answer

Requirement (A)

1) Material Purchase Price Variance

Actual quantity purchased x Actual rate (1,500 units x $3.80)  = $5,700
Actual quantity purchased x Standard rate ( 1,500 units x $4)  = $6,000
Favorable  = $300

2) Material Usage Price Variance

Actual quantity used x Actual rate ( 1,350 units x $3.80)  = $5,130
Actual quantity used x Standard rate (1,350 units x $4)  = $5,400
Favorable  = $270

3) Material Quantity Variance

Actual quantity used x Standard rate (1,350 units x $4)  = $5,400
Standard quantity allowed x Standard rate (1,020 units x $4)  = $4,080
Unfavorable  = $1,320

Requirement (B)

1. Labor Rate Variance

Actual labor hours worked x Actual rate (310 hours x $12.10)  = $3,751
Actual labor hours worked x Standard rate (310 labor hours x $12)  = $3,720
Unfavorable  = $31

 

2. Labor Efficiency Variance

Actual labor hours worked x Standard rate (310 hours x $12)  = $3,720
Standard hours allowed x Standard rate (340 hours x $12)  = $4,080
Favorable  = $360

Frequently Asked Questions

What is a variance analysis?

Variance analysis is a form of performance measurement that provides an explanation for deviations between standards and actual costs or revenues.

What is the importance of a variance analysis?

Variance analysis helps managers focus on possible causes of problems and improve performance. It documents where things are going well and, more importantly, where they need improvement. This information can provide insight into what actions should be taken to meet forecasted targets.

What are the types of variance analysis?

There are three fundamental types of variance analysis: material variance analysis, labor variance analysis, and overhead/labour allocation.

What are the advantages of a variance analysis?

The benefits of variance analysis are providing an early warning system to management by highlighting deviations from planned results, allowing managers to take corrective action at an early stage before the problems start getting out of hand, and helping determine whether or not actual costs are higher or lower than budgeted costs, thereby justifying any price changes.

What are the common business applications for a variance analysis?

Some common business applications include an assessment of cost efficiency in order to determine if management is operating as effectively as possible; identification of those factors resulting in unfavorable variances, so that corrective action can be taken if necessary; and as a tool for management control.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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