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Jul 21, 2016

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Sales Variances!

The function of standards in cost accounting is to

reveal variances between standard costs which are

allowed and actual costs which have been recorded.

The Chartered Institute of Management Accountants

(UK) defines variances as the difference between a

standard cost and the comparable actual cost

incurred during a period. Variance analysis can be

defined as the process of computing the amount of,

and isolating the cause of variances between actual

costs and standard costs. Variance analysis involves

two phases:

(1) Computation of individual variances, and

(2) Determination of Cause (s) of each variance.

We now turn to explain below the computation of

material, labour and factory overhead variances:

I. Material Variance:

The following variances constitute materials

variances:

actual cost of direct material used and standard cost

of direct materials specified for the output achieved.

This variance results from differences between

quantities consumed and quantities of materials

allowed for production and from differences between

prices paid and prices predetermined.

This can be computed by using the following

formula:

Material cost variance = (AQ X AP) (SQ X SP)

Where AQ = Actual quantity

AP = Actual price

SQ = Standard quantity for the actual output

SP = Standard price

Material Usage Variance:

The material quantity or usage variance results when

actual quantities of raw materials used in production

used to produce the output achieved. It is that portion

of the direct materials cost variance which is due to

the difference between the actual quantity used and

standard quantity specified.

As a formula, this variance is shown as:

Materials quantity variance = (Actual Quantity

Standard Quantity) x Standard Price

A material usage variance is favourable when the total

actual quantity of direct materials used is less than the

total standard quantity allowed for the actual output.

Example:

Compute the materials usage variance from the

following information:

Standard material cost per unit

Materials issued

Material A 2 pieces @ Rs. 10=20 (Material A 2,050

pieces)

Material B 3 pieces @ Rs. 20 =60 (Material B

2,980 pieces)

Total = 80

Units completed 1,000

Solution:

Material usage variance = (Actual Quantity Standard

Quantity) x Standard Price

Material A = (2,050 2,000) x Rs. 10 = Rs. 500

(unfavourable)

Material B = (2980 3000) x Rs. 20 = Rs. 400

(favourable)

Total = Rs. 100 (unfavourable)

It should be noted that the standard rather than the

actual price is used in computing the usage variance.

Use of an actual price would have introduced a price

factor into a quantity variance. Because different

departments are responsible, these two factors must

be kept separate.

(a) Material Mix Variance:

The materials usage or quantity variance can be

separated into mix variance and yield variance.

For certain products and processing operations,

material mix is an important operating variable,

specific grades of materials and quantity are

determined before production begins. A mix variance

will result when materials are not actually placed into

production in the same ratio as the standard formula.

For instance, if a product is produced by adding 100

kg of raw material A and 200 kg of raw material B, the

standard material mix ratio is 1: 2.

Actual raw materials used must be in this 1: 2 ratio,

otherwise a materials mix variance will be found.

Material mix variance is usually found in industries,

variance may arise because of attempts to achieve

cost savings, effective resources utilisation and when

the needed raw materials quantities may not be

available at the required time.

Materials mix variance is that portion of the materials

quantity variance which is due to the difference

between the actual composition of a mixture and the

standard mixture.

It can be computed by using the following

formula:

Material mix variance = (Standard cost of actual

quantity of the actual mixture Standard cost of

actual quantity of the standard mixture)

Or

Materials mix variance = (Actual mix Revised

standard mix of actual input) x Standard price

Revised standard mix or proportion is calculated

as follows:

Standard mix of a particular material/Total standard

quantity x Actual input

Example:

A product is made from two raw materials, material A

and material B. One unit of finished product requires

10 kg of material.

at the following costs:

Solution:

Material mix variance = (Actual proportion Revised

standard proportion of actual input) x Standard price.

Materials yield variance explains the remaining

portion of the total materials quantity variance. It is

that portion of materials usage variance which is due

to the difference between the actual yield obtained

and standard yield specified (in terms of actual

inputs). In other words, yield variance occurs when

the output of the final product does not correspond

with the output that could have been obtained by

using the actual inputs. In some industries like sugar,

chemicals, steel, etc. actual yield may differ from

yield variance.

The total of materials mix variance and materials yield

variance equals materials quantity or usage variance.

When there is no materials mix variance, the materials

yield variance equals the total materials quantity

variance. Accordingly, mix and yield variances explain

distinct parts of the total materials usage variance and

are additive.

The formula for computing yield variance is as

follows:

Yield Variance = (Actual yield Standard Yield

specified) x Standard cost per unit

Example:

Standard input = 100 kg, standard yield = 90 kg,

standard cost per kg of output = Rs 200

Actual input 200 kg, actual yield 182 kg. Compute the

yield variance.

therefore, the materials usage variance will be equal

to the materials yield variance.

The above formula uses output or loss as the basis of

computing the yield variance. Yield variance can also

be computed on the basis of input factors only. The

fact is that loss in inputs equals loss in output. A lower

yield simply means that a higher quantity of inputs

have been used and the anticipated or standard

output (based on actual inputs) has not been

achieved.

Yield, in such a case, is known as sub-usage

variance (or revised usage variance) which can be

computed by using the following formula:

Sub-usage or revised usage variance = (Revised

Standard Proportion of Actual Input Standard

quantity) x Standard Cost per unit of input

Example:

Standard material and standard price for

manufacturing one unit of a product is given

below:

variance. The difference lies only in terms of

calculation. The former considers the output or loss in

output and the latter considers standard inputs and

actual input used for the actual output. Mix and yield

variance both provide useful information for

production control, performance evaluation and review

of operating efficiency.

Materials Price Variance:

A materials price variance occurs when raw materials

are purchased at a price different from standard price.

It is that portion of the direct materials which is due to

the difference between actual price paid and standard

price specified and cost variance multiplied by the

actual quantity. Expressed as a formula,

Materials price variance = (Actual price Standard

price) x Actual quantity

Materials price variance is un-favourable when the

actual price paid exceeds the predetermined standard

price. It is advisable that materials price variance

should be calculated for materials purchased rather

than materials used. Purchase of materials is an

earlier event than the use of materials.

Therefore, a variance based on quantity purchased is

basically an earlier report than a variance based on

quantity actually used. This is quite beneficial from the

viewpoint of performance measurement and

corrective action. An early report will help the

management in measuring the performance so that

performance can be expanded at an early date.

Recognizing material price variances at the time of

purchase lets the firm carry all units of the same

materials at one pricethe standard cost of the

material, even if the firm did not purchase all units of

the materials at the same price. Using one price for

the same materials facilities management control and

simplifies accounting work.

If a direct materials price variance is not recorded until

the materials are issued to production, the direct

materials are carried on the books at their actual

purchase prices. Deviations of actual purchase prices

from the standard price may not be known until the

direct materials are issued to production.

Example:

Assuming in Example 1 that material A was

purchased at the rate of Rs 10 and material B was

purchased at the rate of Rs 21, the material price

variance will be as follows:

Materials price variance = (Actual Price Standard

Price) x Actual Quantity

Material A = (10 10) x 2,050 = Zero

Material B = (21 20) x 2,980 = 2980 (un-favourable)

Total material price variance = Rs 2980 (un-

favourable)

The total of materials usage variance and price

variance is equal to materials cost variance.

Direct labour variances arise when actual labour costs

are different from standard labour costs. In analysis of

labour costs, the emphasis is on labour rates and

labour hours.

Labour variances constitute the following:

the actual direct wages paid and the standard direct

wages specified for the output achieved.

This variance is calculated by using the following

formula:

Labour cost variance = (AH x AR) (SH x SR)

Where:

AH = Actual hours

AR = Actual rate

SH = Standard hours

SR = Standard rate

1. Labour Efficiency Variance:

The calculation of labour efficiency or usage variance

follows the same pattern as the computation of

materials usage variance. Labour efficiency variance

occurs when labour operations are more efficient or

less efficient than standard performance. If actual

direct labour hours required to complete a job differ

from the number of standard hours specified, a labour

efficiency variance results; it is the difference between

actual hours expended and standard labour hours

specified multiplied by the standard labour rate per

hour.

Labour efficiency variance is computed by

applying the following formula:

Labour efficiency variance = (Actual hours Standard

hours for the actual output) x Std. rate per hour.

Assume the following data:

Standard labour hour per unit = 5 hr

Standard labour rate per hour = Rs 30

Units completed = 1,000

Labour cost recorded = 5,050 hrs @ Rs 35

Labour efficiency variance = (5,050-5,000) x Rs 30 =

Rs 1,500 (unfavourable) It may be noted that the

used in computing labour efficiency variance. If

quantity variances are calculated, changes in

prices/rates are excluded, and when price variances

are calculated, standard quantities are ignored.

(i) Labour Mix Variance:

Labour mix variance is computed in the same manner

as materials mix variance. Manufacturing or

completing a job requires different types or grades of

workers and production will be complete if labour is

mixed according to standard proportion. Standard

labour mix may not be adhered to under some

circumstances and substitution will have to be made.

There may be changes in the wage rates of some

workers; there may be a need to use more skilled or

expensive types of labour, e.g., employment of men

instead of women; sometimes workers and operators

may be absent.

These lead to the emergence of a labour mix

variance which is calculated by using the

following formula:

Labour mix variance = (Actual labour mix Revised

standard labour mix in terms of actual total hours) x

Standard rate per hour

To take an example, suppose the following were

was necessary to substitute class B workers. Since

the class A workers were less experienced with the

job, more labour hours were used.

The recorded costs of a unit were:

Labour mix variance = (Actual proportion Revised

standard proportion of actual total hours) x standard

rate per hour

Revised standard proportion:

The final product cost contains not only material cost

but also labour cost. Therefore, gain or loss (higher or

lower output than the standard output) should take

into account labour yield variance also. A lower output

simply means that final output does not correspond

with the production units that should have been

produced from the hours expended on the inputs.

It can be computed by applying the following

formula:

Labour yield variance = (Actual output Standard

output based on actual hours) x Av. Std. Labour Rate

per unit of output.

Or

Labour yield variance = (Actual loss Standard loss

unit of output

Labour yield variance is also known as labour

efficiency sub-variance which is computed in terms of

inputs, i.e., standard labour hours and revised labour

hours mix (in terms of actual hours).

Labour efficiency sub-variance is computed by

using the following formula:

Labour efficiency sub-variance = (Revised standard

mix standard mix) x Standard rate

2. Labour Rate Variance:

Labour rate variance is computed in the same manner

as materials price variance. When actual direct labour

hour rates differ from standard rates, the result is a

labour rate variance. It is that portion of the direct

wages variance which is due to the difference

between actual rate paid and standard rate of pay

specified.

The formula for its calculation is:

Labour rate variance = (Actual rate Standard rate) x

Actual hours

Using data from the example given above, the labour

rate variance is Rs 25,250, i.e.,

Labour rate variance = (35 30) x 5050 hours = 5 x

5050 = Rs 25,250 (unfavourable)

the number of the standard hours specified because

the objective is to know the cost difference due to

change in labour hour rates, and not hours worked.

Favourable rate variances arise whenever actual rates

are less than standard rates; unfavourable variances

occur when actual rates exceed standard rates.

3. Idle Time Variance:

Idle time variance occurs when workers are not able

to do the work due to some reason during the hours

for which they are paid. Idle time can be divided

according to causes responsible for creating idle time,

e.g., idle time due to breakdown, lack of materials or

power failures. Idle time variance will be equivalent to

the standard labour cost of the hours during which no

work has been done but for which workers have been

paid for unproductive time.

Suppose, in a factory 2,000 workers were idle

because of a power failure. As a result of this, a loss

of production of 4,000 units of product A and 8,000

units of product B occurred. Each employee was paid

his normal wage (a rate of? 20 per hour). A single

standard hour is needed to manufacture four units of

product A and eight units of product B.

Idle time variance will be computed in the

following manner:

Standard hours lost:

Product A = 4, 000/ 4 = 1,000 hr.

Product B = 8, 000 / 8 = 1,000 hr.

Total hours lost = 2,000 hr.

Idle time variance (power failure)

2,000 hours @ Rs 20 per hour = Rs 40,000 (Adverse)

The analysis of factory overhead variances is more

complex than variance analysis for direct materials

and direct labour. There is no standardisation of the

terms or methods used for calculating overhead

variances. For this reason, it is necessary to be

familiar with the different approaches which can be

applied in overhead variances.

Generally, the computation of the following

overhead variances are suggested:

between the actual overhead cost incurred and the

standard cost of overhead for the output achieved.

This can be computed by applying the following

formula:

(Actual overhead incurred) (Standard hours for the

actual output x Standard overhead rate per hour)

Or

(Actual overhead incurred) (Actual output x

Standard overhead rate per unit)

To illustrate the overall overhead variance, assume

that the actual overhead for a department amounts to

Rs 1,00,000 for the month of January and standard

(or allowed) hours for work performed total 4,500

hours, while actual hours used are 5,000.

overhead variance will be the following:

cost and standard variable overhead allowed for the

actual output achieved.

The formula for computing this variance is as

follows:

(Actual Variable Overhead Cost) (Actual Output x

Variable Overhead rate per unit)

Or

(Actual Variable Overhead Cost) (Std. hours for

actual output x Std. Variable overhead rate per hour)

This variance indicates the difference between the

actual fixed overhead cost and standard fixed

overhead cost allowed for the actual output.

This variance is found by using the following

formula:

Fixed Overhead Variance = (Actual Fixed Overhead

Cost Fixed Overhead absorbed)

Or

Fixed Overhead rate per unit)

Or

(Actual fixed overhead cost) (Std. hours for actual

output x Std. fixed overhead rate per hour)

(Spending or Budget) Variance:

This variance indicates the difference between actual

variable overhead and budgeted variable overhead

based on actual hours worked.

This variance is found by using the following:

(Actual variable overhead Budgeted variable

overhead)

Variance:

This variance is like labour efficiency variance and

arises when actual hours worked differ from standard

hours required for good units produced. The actual

quantity produced and standard quantity fixed might

be different because of higher or lower efficiency of

workers employed in the manufacturing of goods.

This variance is found by using the following

formula:

(Actual hours Standard hours for actual output) x

Standard variable overhead rate per hour

(Spending or Budget) Variance:

This variance indicates the difference between actual

fixed overhead and budgeted fixed overhead.

The formula for computing this variance is as

follows:

(Actual fixed overhead Budgeted fixed overhead)

If actual fixed overhead costs are greater than

budgeted fixed costs, an unfavourable variance

results because actual costs exceed the budget.

Actual overhead costs seldom equal budgeted costs

because property tax rates may change, insurance

premiums may increase or equipment changes may

affect depreciation rates. As an illustration, assume

that a company completed 36,000 units (equal to

18,000 standard production hours) in 18,500 hours at

the recorded fixed cost of Rs 7,51,000. The standard

fixed cost rate per hour is Rs 40. Therefore,

Expenditure variance = (Actual fixed overhead costs

Budgeted fixed overhead costs)

That is, = 7,51,000 (18,500 x 40)

= 7,51,000 7,40,000

= Rs 11,000 (Unfavourable)

The expenditure or budget variance provides

management with information which helps in

prepared on a departmental basis and the factors that

cause the budget variances are, therefore,

controllable by departmental managers.

variance arises due to the difference between the

standard fixed overhead cost allowed (absorbed) for

the actual output and the budgeted fixed overhead

based on standard hours allowed for actual output

achieved during the period. The variance shows the

over-or-under-absorption of fixed overheads during a

particular period. If the actual output is more than the

standard output, there is over-absorption and variance

is favourable. If actual output is less than the standard

output, the volume variance is unfavourable.

The formula for computing this variance is as

follows:

(Budgeted fixed overhead applied to actual output

Budgeted fixed overhead based on standard hours

allowed for actual output)

Or

(Actual production Budgeted production) x Std. fixed

overhead rate per unit

Volume variance is further sub-divided into three

variances:

the difference between the number of actual working

days in the period to which the budget is applicable

and budgeted number of days in the budget period.

If actual working days is more than the budgeted

working days, the variance is favourable as work has

been done on days more than budgeted or allowed

and vice-versa.

The formula is as follows:

(No. of actual working days No. of budgeted working

days) x Std. fixed overhead rate per day. Calendar

variance can be computed based on hours or output.

Then the formulae are:

Hours Basis:

Calendar Variance = (Revised Budget Capacity hours

Budget Hours) x Std. Fixed Overhead rate per hour

If revised budgeted capacity hours are more than the

budgeted hours, the variance will be favourable. In the

reverse situation, the variance will be unfavourable.

Output Basis:

Calendar Variance = (Revised budgeted quantity in

terms of actual number of days worked Budgeted

quantity) x Standard fixed overhead rate per unit

budgeted quantity; the variance is favourable; if

revised budgeted quantity is less, the variance will be

unfavourable.

actual hours of production used for actual output differ

from the standard hours specified for that output. If

actual hours worked are less than the standard hours,

the variance is favourable and when actual hours are

more than the standard hours, the variance is

unfavourable.

The formula is:

Fixed Overhead Efficiency Variance = (Actual hours

Standard hours for actual production) x Fixed

overhead rate per hour

Fixed Overhead Efficiency Variance = (Actual

production Standard production as per actual time

available) x Fixed overhead rate per unit

It is that part of fixed overhead volume variance which

is due to the difference between the actual capacity

(in hours) worked during a given period and the

budgeted capacity (expressed in hours). The formula

is

Budgeted Capacity) x Standard fixed overhead rate

per hour

This variance represents idle time also. If actual

capacity hours are more than the budgeted capacity

hours, the variance is favourable and if actual capacity

hours are less than the budgeted capacity hours the

variance will be unfavourable.

In case actual number of days and budgeted number

of days are also given, then budgeted capacity hours

will be calculated in terms of actual number of days

and it will be known as revised budgeted capacity

hours, i.e., budgeted hours in actual days worked.

In this situation, the formula for calculating

capacity variance will be as follows:

Capacity Variance = (Actual Capacity hours Revised

Budgeted Capacity hours) x Standard fixed overhead

rate per hr.

In the above formula, the variance will be favourable if

actual capacity hours are more than the revised

budgeted hours. However, if actual capacity hours are

lesser than the revised budgeted hours, the variance

will be adverse as lesser hours means that lesser

actual hours have been worked taking the actual days

utilised into account.

Variance Analysis:

The above overhead variances are also classified as

Two-way, Three-way and Four-way variance.

The different variances under these categories are

listed below:

(A) Two-way Variance Analysis:

The two-way analysis computes two variances budget

variance (sometimes called flexible budget or

controllable variance) and volume variance, which

means:

(i) Budget variance = Variable spending variance +

Fixed spending (budget) Variance + Variable

efficiency variance

(ii) Volume variance = Fixed volume variance

(B) Three -Way Variance Analysis:

The three-way analysis computes three variances

spending, efficiency and volume variances. Therefore,

(i) Spending variance = Variable spending variance +

Fixed spending (budget) variance

(ii) Efficiency variance = Variable efficiency variance

(iii) Volume variance = Fixed volume variance

(C) Four-way Variance Analysis:

The four-way analysis includes:

(i) Variable spending variance

(iii) Variable efficiency variance

(iv) Fixed volume variance.

Illustrative Problem 1:

Budgeted hours for month of March = 180 hours

Standard rate of article produced per hour = 50units

Budgeted fixed overhead = Rs 27, 000

Actual Production = 9, 2000 units

Actual hours for Production = 175 hours

Actual fixed Overhead Costs = Rs 28, 000

Calculate Overhead Cost Variances.

Solution:

1. Overhead Cost Variance:

(Actual Overhead Cost Standard Overhead of actual

output)

(Rs 28,000-9,200 units x 3)

Rs 28,000 27,600 = Rs 400 (unfavourable)

Standard Overhead rate per unit = Rs 27,000/(180 hrs

x 50) = 27,000/9, 000 = Rs 3

2. Overhead Expenditure Variance:

(Actual Overhead Budgeted Overhead)

(Rs 28,000 27,000) = Rs 1,000 (unfavourable)

3. Overhead Volume Variance:

(Budgeted Overhead for actual output Budgeted

fixed overhead)

(27,600 27,000) = Rs 600 (favourable)

It can be calculated in the following manner also:

(Actual Production Budgeted Production) x Std. rate

per unit

(9,200 9,000) x Rs 3 = Rs 600 (favourable)

Or

(Budgeted hrs for actual production Budgeted

hours) x Std. rate per hour

( 184 hrs-180) x Rs 150

4 x 150 = Rs 600 (favourable)

For 9,000 units standard hours required = 180 hrs.

For 9,200 units standard hours (9, 200 x 180)/9, 000 =

184 hrs

Illustrative Problem 2:

From the following data, calculate overhead

variances:

Solution:

1. Total Overhead Cost Variance:

(Rs 3,05,000 + 4,70,000) (16,000 x Rs 50)

Rs 7,75,000 Rs 8,00,000 = Rs 25,000 (favourable)

Standard rate = Standard Overhead /Standard Output

2. Variable Overheads Variance:

Actual variable cost (Actual units x Std. Rate)

4,70,000 (16,000 x Rs 30)

Rs 4,70,000 Rs 4,80,000 = Rs 10,000 (favourable)

3. Fixed Overhead Variance:

Actual fixed overhead cost (Actual units x Std. Rate

of fixed overhead)

3,05,000-(16,000 x 20)

3,05,000 3,20,000 = Rs 15,000 (favourable)

4. Volume Variance:

(Actual units x St. rate) Budgeted fixed overheads

(16,000 x Rs 20) Rs 3,00,000 = Rs 20,000

(favourable)

5. Expenditure Variance:

Actual fixed overheads Budgeted fixed overheads

Rs 3,05,000 Rs 3,00,000 = Rs 5,000 (unfavourable)

6. Capacity Variance:

Std. Rate x (Revised budget units Budgeted units)

Revised budgeted units = Budgeted units + Increase

in capacity

= 15,000 + 5/100 x 15,000= 15,750 units 100

= Capacity variance

= Rs 20 (15,750 units 15,000 units)

= Rs 20 x 750 = Rs 15,000 (favourable)

7. Calendar Variance:

Increase or decrease in production due to more or

less working days x Std. rate per unit within 25 days,

standard production with increased capacity = 15,750

units within 2 days (27 25),

production will be increased by = (15, 750 x 2)/25 =

1,260 units

Calendar variance = 1,260 units x Rs 20

= Rs 25,200 (favourable)

8. Efficiency Variance:

Std. rate x (Actual production Std. production)

Standard production:

Budgeted production = 15,000 units

Production increased due to increase in capacity 5%

= 750 units

Now budgeted production = 15,000 + 750 = 15,750

units

Production increased due to 2 more working days

Units for 2 days = (15, 750 x 2)/25 days = 1,260 units

Total units = 15,750 + 1,260

= 17,010 units

Efficiency Variance = Rs 20 (16,000 units 17,010

units)

Rs 20 (- 1,010 units) = Rs 20,200 (unfavourable)

Illustrative Problem 3:

In department A the following data is submitted

for the week ending 31st October:

department A:

A. Expenditure variance:

(Actual overhead Budgeted overhead)

Rs 1,50,000 Rs 1,40,000 = Rs 10,000 (Adverse)

B. Volume variance:

Std. fixed overhead rate per unit x (Actual output

Budgeted output)

Rs 100 (1,200 1,400) = Rs 20,000 (Adverse)

C. Total overhead cost variance:

(Actual overhead Overhead recovered by actual

output)

Rs 1,50,000 Rs 1,20,000 = Rs 30,000 (Adverse)

(a) Efficiency variance:

Std. fixed overhead rate per unit x (Actual production

Std. production for actual hours)

Rs 100 (1200 32 x 35) = Rs 8000 (Favourable)

(b) Capacity variance:

Std. fixed overhead rate per hour (Actual hours

Standard hours)

Rs 3,500 (32 40) = Rs 28,000 (Adverse)

Illustrative Problem 4:

A Cost Accountant of a company was given the

following information regarding the overheads for

February, 2012:

(a) Overheads cost variance Rs 1,400 adverse.

(b) Overheads volume variance Rs 1,000 adverse.

(c) Budgeted hours for February 2012, 1,200 hours.

(d) Budgeted overheads for February 2012, Rs 6,000.

(e) Actual rate of recovery of overheads Rs 8 per

hour.

You are required to assist him in computing the

following for February, 2012:

(1) Overheads expenditure variance.

(2) Actual overheads incurred.

(3) Actual hours for actual production.

(5) Overheads efficiency variance.

(6) Standard hours for actual production.

Solution:

Computation of Required Variances

(1) Overheads Expenditure Variance

= Overheads Cost Variance Overheads Volume

Variance

= Rs 1,400 (A) Rs 1,000 (A)

= Rs 400 (A)

(2) Actual Overheads incurred

= Budgeted Overheads + Overhead Expenditure

Variance

= Rs 6,000 + Rs 400 (A)

= 6,400

(3) Actual hours for actual production

Actual overheads incurred/Actual rate of recovery of

overheads per hour

= Rs 6,400/8 = 800 hours

(4) Overheads Capacity Variance

= Standard Overhead x (Actual Hours Budgeted

Hours)

= 5 x (800 hours 1,200 hours)

= Rs 2,000 (A)

= Standard Rate of Overhead = Budgeted overheads /

Budgeted hours

= Rs 6, 000/1, 200 = Rs 5 per hour

(5) Overhead Efficiency Variance

= Overheads Volume variance Overhead Capacity

variance

= Rs 1,000 (A) Rs 2,000 (F)

= Rs 1,000 (F)

(6) Standard Hours for Actual Production

Volume Variance

= Standard Overheads Rate x (Standard hours for

Actual Production Budgeted Hours) or 1,000 (A) = 5

(x- 1,200)

or 1,000 (A) = 5 x 6,000

or -5 x = 5,000

or x = 1,000 hours

Illustrative Problem 5:

New India Company uses a standard costing system.

The company prepared its budget for 2012 at

10,00,000 machine hours for the year. Total budgeted

overhead costs is Rs 12,50,00,000. The variable

overhead rate is Rs 100 per machine hour (Rs 200

per unit).

Actual results for 2012 are as follows:

Required:

(I) Compute for the fixed overhead

(a) Budgeted amount

(b) Budgeted cost per machine hour

(c) Actual cost

(d) Volume variance

(II) Compute variable overhead spending variance

and variable overhead efficiency variance.

Solution:

(I) For fixed overhead:

(a) Budgeted Amount:

Total budgeted overhead = Rs 12,50,00,000

Less: Budgeted variable overhead (10,00,000

machine hrs x Rs 100 budgeted rate per machine

hour) = 10,00,00,000

Budgeted fixed overhead 2,50,00,000

(b) Budgeted (fixed) cost per machine hour:

= Rs 2,50,00,000 budgeted amount/10,00,000

budgeted machine hours

= Rs 25 per machine hour

It is calculated through fixed overhead spending

variance.

Fixed overhead spending variance = Actual cost

incurred Budgeted amount

Actual cost = Budgeted amount + Unfavourable

spending variance

= 2,50,00,000+ 60,00,000 A

= Rs 3,10,00,000

Because fixed overhead spending variance is

unfavourable, the amount of actual costs is higher

than the budgeted amount.

(d) Production Volume Variance:

Budgeted variable overhead per unit = Rs 200

Budgeted variable overhead rate = Rs 100 per

machine hour

Therefore budgeted machine hours allowed per unit =

Rs 200/Rs 100

= 2 machine hours

Formula:

Budgeted fixed overhead Fixed overhead absorbed

or allowed for actual output units

= Rs 2,50,00,000 (Rs 25 per machine hour x 2

machine hours per unit x 4,98,000 units)

= Rs 2,50,00,000 Rs 2,49,00,000 (absorbed fixed

overhead)

= Rs 1,00,000 Adverse

Or

Another formula:

(St hrs for actual production Budgeted hrs) x St.

fixed overhead rate per hr

= (2 x 4,98,000) (10,00,000 hrs) x Rs 25

= (9,96,000 hrs 10,00,000 hrs) x Rs 25

= Rs 1,00,000 Adverse

Or

Another formula:

(Budgeted production Actual production) x St. fixed

overhead rate per unit

Standard fixed overhead rate per unit = Budgeted

fixed overhead/Budgeted units

= Rs 2,50,00,000/5,00,000 units

= Rs 50 per unit

Budgeted units = 2 machine hour needed for 1 unit

In 10,00,000 machine hours, units produced will be

= 10,00,000/2 = 5,00,000 units

Now, applying the formula

(5,00,000 units 4,98,000 units) x Rs 50

= 2,000 units x Rs 50 = Rs 1,00,000 Adverse

(II) For Variable overhead

(a) Variable overhead spending variance:

overhead)

Budgeted variable overhead cost = Actual hrs works x

St. Variable overhead rate per hour

= 9,60,000 hrs x Rs 100

= Rs 9,60,00,000

Now, applying the formula

(Rs 9,60,00,000 Rs 10,08,00,000)

= Rs 48,00,000 Adverse

Or

Another formula:

(St. machine hr rate Actual machine hr rate) x Actual

hrs worked

= (Rs 100 Rs 10, 08, 00, 000/9, 00, 000 hrs) x 9, 60,

000 hrs

= (Rs 100 Rs 105) x 9,60,000 hrs

= Rs 48,00,000 Adverse

(b) Variable overhead efficiency Variance:

(St. hours for actual output Actual hrs) x St. Variable

overhead rate per hour

= ((4,98,000 units x 2 hrs) 9,60,000 hrs) x Rs 100

= (9,96,000 hrs 9,60,000 hrs) x Rs 100

= 36,000 hours x Rs 100

= Rs 36,00,000 Favourable

Note:

question, have been computed as below.

(Ill) For Fixed overhead:

Calender Variance, Efficiency Variance, Capacity

Variance.

(a) Fixed overhead Calender Variance:

= (Budgeted hrs Revised budgeted Capacity hrs) x

St. fixed overhead rate per hour

= (10,00,000 hrs 2 hrs x 4,98,000 units) x Rs 25

= (10,00,000 hrs 9,96,000 hrs) x Rs 25

= 4,000 hrs x 25 = Rs 1,00,000 Adverse

Variance is adverse because of lesser use of hours

available.

(b) Fixed overhead Efficiency Variance:

(st. hr for actual production Actual hrs) x Fixed

overhead rate per hour

= (2 hrs x 4,98,000 units) 9,60,000 hrs ) x 25

= (9,96,000 hrs 9,60,000 hrs) x 25

= 36,000 hrs x Rs 25

= Rs 9,00,000 F

It is favourable because actual hrs are less than

standard hours.

(c) Fixed Overhead Capacity Variance:

(Budgeted Capacity hrs Actual Capacity hours) x St.

fixed overhead rate per hr

= 36,000 hrs x Rs 25

= Rs 9,00,000 Adverse

Since actual hours are less than budgeted hours, in

terms of capacity utilisation, it indicates Adverse

Variance

Fixed Overhead Expenditure Variance:

(also known as Spending or Budget Variance)

(Budgeted fixed overhead Actual fixed overhead)

= Rs 2,50,00,000 Rs 3,10,00,000

= Rs 60,00,000 Adverse

This is already given in the question.

Fixed Overhead Variance:

(budgeted fixed overhead cost Actual fixed overhead

cost)

Budgeted fixed overhead cost =

(i) Actual output units x St. fixed overhead rate per

unit

Or

(ii) St. hours for actual output x St. fixed overhead rate

per hour

Applying the formula:

(i) (4,98,000 units x Rs 50 per unit) Rs 3,10,00,000

= 2,49,00,000-3,10,00,000

= Rs 61,00,000 Adverse

Or

(ii) (9,96,000 hrs x Rs 25 per hr) Rs 3,10,00,000

= Rs 2,49,00,000 Rs 3,10,00,000

= Rs 61,00,000 Adverse

Verification:

Fixed overhead Variance = Fixed overhead

expenditure variance + Fixed overhead volume

variance

Rs 61,00,000 A = Rs 60,00,000 A + Rs 1,00,000 A

Variable Overhead Variance:

(Budgeted variable overhead cost Actual variable

overhead cost) Budgeted variable overhead cost =

(i) Actual output units x St. variable overhead rate per

unit

Or

(ii) St. hours for actual output x St. variable overhead

rate per hour

Applying the formula:

(i) (4,98,000 units x Rs 200 per unit) Rs

10,08,00,000

= Rs 9,96,00,000 Rs 10,08,00,000

= Rs 12,00,000 Adverse

Or

(ii) (9,96,000 hrs x Rs 100) Rs 10,08,00,000

= Rs 9,96,00,000 Rs 10,08,00,000

= Rs 12,00,000 Adverse

Verification:

Variable overhead variance = Variable overhead

expenditure variance + Variable overhead efficiency

variance

Rs 12,00,000 A = Rs 48,00,000 A + Rs 36,00,000 F

Rs 12,00,000 A = Rs 12,00,000 A

Total Overhead Cost Variance:

(Budgeted overhead cost Actual overhead cost)

Budgeted overhead cost =

(i) Actual output units x St. overhead rate per unit

Or

(ii) St. hours for actual output x St. overhead rate per

hour

Applying the formula:

St. overhead rate per unit = Variable overhead rate +

Fixed overhead rate = Rs 200 + Rs 50 = Rs 250

Or

St. overhead rate per hour =

= Variable overhead rate per hour + Fixed overhead

rate per hour

= Rs 100 + Rs 25 = Rs 125

(i) (4,98,000 units x Rs 250) (Rs 3,10,00,000 + Rs

10,08,00,000)

= Rs 12,45,00,000 Rs 13,18,00,000

= Rs 73,00,000 Adverse

Or

(ii) (9,96,000 hrs x Rs 125) (Rs 3,10,00,000 + Rs

10,08,00,000)

= Rs 12,45,00,000-Rs 13,18,00,000

= Rs 73,00,000 Adverse

Verification:

Total overhead cost variance = Fixed overhead cost

variance + Variable overhead cost variance

Rs 73,00,000 A = Rs 61,00,000 A + Rs 12,00,000 A

Rs 73,00,000 A = Rs 73,00,000 A

Illustrative Problem 6:

The following information has been extracted

from the books of Goru Enterprises which is

using standard costing system:

Actual output = 9,000 units

Direct wages paid = 1,10,000 hours at Rs 22 per hour,

of which 5,000 hour, being idle time, were not

recorded in production

Standard hours = 10 hours per unit

Labour efficiency variance = Rs 3,75,000 (A)

Standard variable Overhead = Rs 150 per unit

Actual variable Overhead = Rs 16,00,000

You are required to calculate:

(i) Idle time variance

(iii) Variable overhead expenditure variance

(iv) Variable overhead efficiency variance.

Solution:

Actual output = 9,000 units

Idle time = 5,000 hours

Production time (Actual) = 1,05,000 hours

Standard hours for actual production = 10 hours/unit x

9,000 units = 90,000 hours.

Labour efficiency variance = Rs 3,75,000 (A)

i.e. Standard rate x (Standard Production time

Actual production time) = Rs 3,75,000 (A).

SR (90,000 1,05,000) = 3,75,000

SR = -3,75,000/-15,000 = Rs 25

(i) Idle time variance = 5,000 hours x 25 Rs hour = Rs

1,25,000. (A)

(ii) Standard Variable Overhead = Rs 150/unit

Standard hours = 10 hours/unit

Standard Variable Overhead rate/hour =150/10 =

Rs15/hour

Total Variable Overhead variance = Standard Variable

Overhead Actual Variable Overhead

= Standard Rate x Standard hours Actual rate x

Actual hours

= (15) x (10 x 9,000) 16,00,000

= 13,50,000 -16,00,000

Total Variable Overhead Variance = 2,50,000 (A)

(iii) Variable Overhead Expenditure Variance =

(Standard Rate x Actual Hours) (Actual Rate x

Actual Hours)

= (15 x 1,05,000) 16,00,000

= 15,75,000 16,00,000

= Rs 25,000 (A)

(iv) Variable Overhead Efficiency Variance = Standard

Rate x (Standard Hours for actual output Actual

hours for Actual output)

= 15 (90,000 1,05,000)

= 15 (-15,000)

= Rs 2,25,000 (A)

Alternative Solution:

Actual Output = 9,000 Units

Idle time = 5,000 hrs

Direct Wages Paid = 1,10,000 hours @ Rs 22 output

of which 5,000 hours being idle, were not recorded in

production.

Standard hours = 10 per unit.

Labour efficiency variance = Rs 3,75,000 (A)

Or

Standard Rate (Standard Time Actual Time) =

3,75,000

Or Standard Rate = Rs 25/(i) Idle time variance = Standard Rate x Idle time

25 x 5,000 = Rs 1,25,000 (A)

(ii) Standard Variable Overhead/unit =150

Standard Rate = 150/10 = Rs 15/hour

Standard Quantity = 10 hours

Actual Variable Overhead = 16,00,000

Standard Variable Overhead = 150 x 9,000 =

13,50,000

Actual Variable Overhead = 16,00,000

Total Variable Overhead Variance = 2,50,000 (A)

(iii) Variable Overhead expenditure Variance =

Standard Variable Overhead for actual hours Actual

Variable Overhead

= (150 x 1,05,000)-16,00,000

= 15,75,000-16,00,000

= 25,000 (A)

(iv) Variable overhead efficiency variance = (Standard

Variable Overhead for actual output Standard

Variable Overhead for Actual hours)

= 15 (10 hours x 90,000 units 1,05,000)

= 15 (90,000 1,05,000)

= 15 (- 15,000)

= 2,25,000 (A)

Illustrative Problem 7:

The Norkhill Furniture Company has the following

standard cost per unit of furniture:

produced, the following information is available:

Lumber purchased: 50,000 feet at Rs 390 per 100

feet

Lumber used: 56,000 feet

Direct labour: 3,100 hours @ Rs 105

Variable overhead: Rs 1,55,000

Fixed Overhead: Rs 2,90,000

Any materials price variance is assigned to the

purchasing department at the time of purchase.

You are required to:

(a) Prepare a flexible budget for the actual level of

activity.

(b) Prepare a complete analysis of all variances,

including a three-way analysis of overhead variances.

(i) Spending variance = (Actual Overhead costs

Budgeted overhead costs based on actual hours)

= 4,45,000 (Rs 3,00,000 + 100 x 33,100 hours)

= 4,45,000- 4,55,000

= Rs 10,000 (F)

(ii) Efficiency variance

= (Budgeted overhead costs based on actual hours

Budgeted overhead costs based on Std. hours)

= 4,55,0000 4,65,000

= Rs 10,000 (F)

(iii) Volume variance

= (Budgeted overhead Costs based on Std. hours in

terms of actual units Applied over head costs)

= (Rs 150 x 3300 hrs) (Rs 150 x 3100 hrs)

= Rs 4,95,000 4,65,000

= Rs 30,000 (F)

Illustrative Problem 8:

Jumbo Food Products Ltd. operates a system of

standard costing and in respect of one of its

products which is manufactured within a single

cost centre, data for one week have been

analysed as follows:

changes of stock. You are required to compute:

(i) The actual output;

(ii) Actual profit;

(iii) Actual price per kg of material;

(iv) Actual rate per labour hour;

(vi) Amount of production overhead absorbed;

(vii) Production overhead efficiency variance;

(viii) Selling price variance;

(ix) Sales volume profit variance.

Sales variance is the difference between the actual

value of sales achieved in a given period and

budgeted value of sales. There are many reasons for

the difference in actual sales and budgeted sales

such as selling price, sales volume, sales mix.

Sales variance can be calculated by using any of

the following two methods:

A. Sales variance based on turnover

B. Sales variances based on margin (i.e.,contribution

margin or profit)

The first approach i.e., sales variance based on

turnover, accounts for difference in actual sales and

budgeted sales. The sales variances using margin

approach accounts for difference in actual profit and

budgeted profit. In the margin method, it is assumed

that cost of production is constant, i.e., no difference

is assumed between actual cost of production and

standard cost of production.

The reason for this assumption is that cost variances

are calculated separately to analyse the difference

between actual cost and standard cost of production.

Therefore, cost side of the sales variance is assumed

constant under the margin method.

Sales variances computed under these two methods

The different sales variances under these two

approaches and their formula are given below:

Also known as sales variance, this variance shows the

difference between actual sales value and budgeted

sales value.

The formula is:

Sales Value Variance = (Actual value of sales

Budgeted value of sales)

Actual sales = Actual quantity sold x Actual selling

price

Budgeted sales = Standard quantity x Standard

selling price

Or

Sales value variance = (Actual quantity x Actual

selling price) (Standard quantity x Standard selling

price)

there is favourable variance and if actual sales are

less than the budgeted sales, unfavourable variance

arises.

(ii) Sales Price Variance:

This variance is due to the difference between actual

selling price and standard or budgeted selling price.

The formula is:

Sales price variance = (Actual selling price

Budgeted selling price) x Actual quantity

If actual selling price is less than the budgeted selling

price, variance is favourable and if actual selling price

is more than the budgeted selling price, there will be

unfavourable sales price variance.

(iii) Sales Volume Variance:

Sales volume variance arises when the actual

quantity sold is different from the budgeted quantity. If

actual sales quantity exceeds the budgeted sales

quantity, there is a favourable sales volume variance

and if actual quantity sold is less than the budgeted

quantity, the variance is unfavourable.

The formula is:

Sales volume variance = (Actual quantity Budgeted

quantity) x Budgeted selling price

Sales volume variance is divided into two

variances:

(i) Sales mix variance

(ii) Sales quantity variance

(i) Sales Mix Variance:

Sales mix variance is one part of overall sales volume

variance. This variance shows the difference between

actual mix of goods sold and budgeted mix of goods

sold.

The formula is:

Sales Mix Variance = (Actual Mix of quantity sold

Actual quantity in standard proportion) x Standard

selling price

Or

Sales Mix Variance = (Budgeted price per unit of

actual mix Budgeted price per unit of budgeted mix)

x Total actual quantity.

If actual sales mix are more than the mix in standard

or budgeted proportion, the variance is favourable and

if actual mix sales are less than the standard mix (of

actual sales), the variance is unfavourable. Similarly, if

budgeted price per unit of actual mix is more than the

budgeted price per unit of budgeted mix, favourable

variance will arise. In the reverse situation, variance

will be unfavourable.

(ii) Sales Quantity Variance:

This variance shows the difference between total

actual sales quantity and total budgeted sales

quantity. If total actual quantity is more than the total

budgeted quantity, variance will be favourable and if

total actual quantity is less than the total budgeted

quantity, there will be unfavourable sales quantity

variance.

The formula is:

Sales quantity variance = (Total actual quantity Total

budgeted quantity) x Budgeted price per unit of

budgeted mix

The total of sales mix variance and sales quantity

variance will be equal to sales volume variance.

Contribution Margin or Profit):

The sales variances using margin approach show the

difference in actual profit and budgeted profit only

whereas sales variances based on turnover show the

difference between total actual sales and total

budgeted sales.

The following sales variances are calculated if

margin or profit is the basis of calculation:

Sales Variances based on Margin or Profit

under the margin method. This variance shows the

difference between actual profit and budgeted profit.

The formula is:

Total sales margin variance = Actual Profit Budgeted

profit

If actual profit is more than the budgeted profit,

variance will be favourable and if actual profit is less

than the budgeted profit, unfavourable variance will

arise.

This variance is one part of total sales margin

variance and arises due to the difference between

actual margin per unit and budgeted margin per unit.

It is significant to note that, assuming cost of

production being constant, the difference in the actual

margin and budgeted margin will only be because of

the difference between actual selling price and

budgeted selling price. The formula for calculating

Sales Margin Price Variance = (Actual Margin per unit

Budgeted Margin per unit) x Actual quantity

If actual margin per unit is more than the budgeted

margin per unit, favourable variance will be found and

if actual margin is less than the budgeted margin,

variance will be unfavourable.

sales units and budgeted sales units.

The formula is:

Sales Margin Volume Variance = (Actual quantity

Budgeted quantity) x Budgeted Margin per unit.

If actual sales units are more than the budgeted sales

units, variance will be favourable and if actual sales

units are less than the budgeted sales units,

unfavourable variance will arise.

Sales margin volume variance can be calculated

using another formula which is:

Sales margin volume variance = (Standard profit on

actual quantity of sales Budgeted profit)

If standard profit exceeds budgeted profit, variance

will be favourable and if standard profit is less than the

budgeted profit, unfavourable variance will emerge.

Sales margin volume variance consists of:

(ii) Sales margin quantity variance.

(i) Sales Margin Mix Variance:

This variance shows the difference between actual

mix of goods and budgeted (standard) mix of goods

sold.

The formula is:

Sales Margin Mix Variance = (Actual sales mix

Standard proportion of actual sales mix) x Budgeted

margin per unit.

If budgeted margin per unit on actual sales mix is

more than the budgeted margin per unit on budgeted

mix, variance will be favourable. In the reverse

situation, unfavourable variance will arise.

(ii) Sales Margin Quantity Variance:

This variance will be found when the total actual sales

quantity in standard proportion is different from the

total budgeted sales quantity.

The formula is:

Sales Margin Quantity Variance = (Actual sales in

standard proportion Budgeted sales) x Budgeted

margin per unit on budgeted mix

If actual sales (in standard proportion) are more than

the budgeted sales, variance will be favourable and if

actual sales are less than the budgeted sales,

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