CHAPTER 7

Variance Analysis and Cost Control

Learning Objectives:
After completing this chapter, you will be able to:
 Deduce whether actual production costs are in conformity with standard (planned)
production costs.
 Enumerate the procedure and precautions observed to determine standards.
 Understand the concept of benchmarking and its periodic review.
 Appreciate variance analysis as a technique of cost control.
 Identify the line manager(s)responsible for higher costs and also the line manager(s) to be
rewarded for better performance.
 Classify total cost variance into various categories, namely, material cost variance, labour
cost variance, variable overhead cost variance and fixed overhead cost variance.
 Prepare a reconciliation statement with a list of factors explaining why actual profits are
different from budgeted profits.

INTRODUCTION

Often, business firms are confronted with the situationactual

in which the co
profits are different from budgeted profits. Evidently, business executives are interested in
determining the factors responsible for such a variance. In broad terms, there are two types of
variances explaining the difference in profits:
(i) Cost Variances
(ii) Sales Variances.
Corresponding to major elements of production cost, cost variances can be categorised into the
following:
(a) Direct material cost variance
(b) Direct labour cost variance

7.1
 (c) Variable overheads cost variance
(d) Fixed overheads cost variance.
Likewise, sales variances can be segregated into:
(a) Sales price variance
(b) Sales quantity variance.
These variances, taken together, explain the difference between the actual profit and
budgeted profit, known as profit the variance. Inter-se, some sub-variances may be
favourable and some may be unfavourable. Thus, these variances enable the chief
executives of companies to know which line manager(s) have performed better and
performance of which line manager(s) is deficient. Understanding these variances
constitutes the subject matter of this chapter.

COST VARIANCES

Cost variance is the difference between the actual cost (AC) and the standard cost (SC). It
is favourable if AC is less than SC and it is unfavourable (adverse) in case AC exceeds SC.
Evidently, favourable variances imply better performance and unfavourable variances are
undesirable and warrant corrective action.
As variances are computed with reference to SC, they will be reliable only if SC figure is
credible. In operational terms, the validity of variance figure is dependent on how well the
standards are set by the business firm. In case, standards are not properly set, conclusions drawn
based on such benchmarks will not be correct.
For instance, if standards set are liberal, that is to say, an inefficient worker is taken as the
sample to determine the time required to make a product. Further, based on the time he takes,
standard time for all other workers is decided. As a result of such standards, the firm is likely to
show favourable variance from the perspective of labour costs. The firm may feel happy at the
good performance of the workers, which is clearly a distorted conclusion. A more serious
situation may take place if standards set are tight (with provision of no waste, no scrap, no
machine break down, no idle time). Obviously, in the real world situations, such standards
cannot be achieved. As a result, the variances determined, vis-à-vis, such perfect/tight standards
are likely to be unfavourable. Based on such a result, the efforts will be made to correct the

7.2
situation, which is not necessarily incorrect one. Therefore, there is a futile waste of time, effort
and energy. Above all, this may have an adverse bearing on morale and motivation of the
personnel in the organisation.
It is apparent from the above, that standards should be set properly in that they should be
attainable (given the working ambience of the organisation) and should be revised from time to
time in the light of changed circumstances. In the absence of proper standards, variance analysis
will not serve any useful purpose as a tool of cost control since conclusions drawn will not be
correct.
You will be eager to know how variance analysis facilitates cost control. It happens like
this. The line managers are aware of the fact that their performance will be judged in relation to
the pre-determined standards (which normally are (should be) set in their consultation). Being
conscious of this fact (as well as party for establishing standards) they strive their best to achieve
them. Thus, there is a built-in motivation, in the system to conform to standard costs. This apart,
they are well aware of the fact that the management will hold them responsible/accountable in
the event of unsatisfactory performance in their sphere of operations.
For instance, production manager will be answerable for excessive consumption of
materials; likewise, for excessive payment for materials purchased, purchase manager will be
held responsible. In operational terms, it implies that one will be held accountable for what one
does. A manager will be held responsible only for those spheres of activities that fall in his
jurisdiction; he will not be held accountable for activities that are outside his control. Thus,
‘passing the buck’ is not possible. Evidently, variance analysis by tracing r
facilitates cost control.
Having understood the importance of variance analysis, we now proceed to determine
various cost variances.

Material Cost Variances (MCV)

The MCV is the difference between the total actual material cost (TAMC) of the actual
output and total standard material cost (TSMC) that should have been incurred for actual units
produced. Symbolically,

TMCV = (TAMC – TSMC) (7.1)

7.3
 For better comprehension, consider Example 7.1
Example 7.1:
From the following data related to a manufacturing company, determine the relevant material
cost variances:
Standard quantity (SQ) required to make a product 10 kgs.
(after making due allowance for normal loss)
Standard price per kg. of material Rs 20
Standard material cost (SMC) per unit of finished output (Rs 20 × 10 kgs.) Rs 200
Actual output (AO) for January 1,000 units
Total actual quantity (TAQ) used as per store ledger 10,500 kgs.
Actual price per kg. of material Rs 21

Solution:
TMCV = TAMC – TSMC
= (TAQ × AP = 10,500 kg. × Rs 21) – (SMC × AO = Rs 200 × 1,000)
= (Rs 2,20,500 – Rs 2,00,000) = Rs 20,500 (unfavourable)
Since TAMC is higher than TSMC allowed, TMCV is evidently unfavourable.
From the above, it is apparent that difference in price paid for materials purchased in
relation to the standard and difference in the quantity of materials used are the two factors
causing this variance. Accordingly, TMCV can be split into two sub-variances:
(i) Material Quantity Variance and (ii) Material Price Variance.
Material Quantity Variance (MQV): It measures the difference between the total actual quantity
(TAQ) used and the total standard quantity (TSQ) of materials allowed for actual output. This
difference in quantity is then multiplied by the price to determine the MQV in financial terms.
The question that arises here is, which price (standard or actual) should be the
multiplying factor? To answer this question, we should know who (production manager or
purchase manager) would be responsible for MQV? Please ponder over. Your answer should be
based on principles of equity and fair play. Obviously, the standard price (SP) will be the
relevant price, as the production manager cannot be held responsible for higher price paid by
the purchase manager. Likewise, the production manager should not be rewarded for
economical purchases made by the purchase manager. Thus, in symbolic terms,

7.4
 MQV = (TAQ – TSQ) × SP (7.2)
= (10,500 kg. – 10,000kgs.*) × Rs 20 = Rs 10,000 (unfavourable)
* = (SQ per unit, i.e., 10 kgs. × Actual Output, 1,000 units)
Material Price Variance (MPV): This measures the difference between the actual price (AP)
paid for materials used and the standard price (SP) at which the materials should have been
purchased. Evidently, it is the responsibility of the purchase manager to procure materials at the
stipulated price. Symbolically,
MPV = (AP – SP) × TAQ (7.3)
= (Rs 21 – Rs 20) × 10,500 kg. = Rs 10,500 (unfavourable)
Confirmation: (MQV + MPV) = TMCV
= Rs 10,000 (unfavourable) + Rs 10,500 (unfavourable) = Rs 20,500 (unfavourable)
It may come to your mind that the multiplying factor should be TSQ (and not TAQ) to
conform to the criterion used in determining MQV. The production manager was not accountable
for the higher price paid; likewise, the purchase manager should be responsible for higher price
paid, and not for the higher quantity used by the production manager. Prima-facie, the
contention merits consideration.
The contention does not hold much water when we look at the primary function of the
purchase manager in a manufacturing organisation. In a manufacturing firm does the purchase
manager, purchase only standard quantity required? Does he not, in general, purchase more than
the normal requirements to take care of exigencies/unforeseen needs (safety stocks)?
Besides, with increased production, requirement of materials to be purchased also goes up. In
Example 7.1, if the actual output were 1,050 units in January, would the purchase manager not
have purchased 10,500 kgs? (1,050 units × 10 kgs.)? Alternatively, if the budgeted production
for January were 1,050 units, the purchased requirement itself would have been 10,500 kgs. In
fact, it is a common practice, in the real business situations that manufacturing firms purchase
more than their normal consumption requirement to avoid stock-out costs, which may inflict
heavy losses in that man and machines may remain idle. Also there may be potential loss of sales
and hence profits.
We hope that you are convinced of the rationale why the multiplying factor is total actual
quantity and not standard quantity.

7.5
 The major reasons for the MQV are: careless handling in use of materials, sub-
standard/defective materials, more wastage due to employment of casual untrained workers,
frequent break-down of machines and so on.
Unanticipated change in custom duties and excise duties, increase in transportation costs
(normally considered part of purchase costs), strikeat thesuppliers’ factoryforcingpurchase
be made from others, sporadic change in production volume forcing the purchases to be made in
uneconomic quantities, etc. are the major factors accountable for the MPV.
Which of these two sub-variances, you feel is controllable? The MPV, by and large, is
caused due to factors beyond the control of the manufacturing firm. It is for this reason, MPV is
referred to as uncontrollable variance. When the purchase manager is assigned responsibility
for such a variance; he states unusual circumstances (enumerated above) in his defence. In the
absence of any such reason, he is obviously responsible. More often than not, unfavourable price
variance gets reflected in the revision of standard price.
In contrast, the material quantity variance is caused due to internal factors and is
appropriately called controllable variance. Therefore, it is this sub-variance, which warrants
immediate remedial measures. For this purpose, there is a need for the training of the existing
work force; the frequency of preventive maintenance in respect of plant and equipment may be
required to be increased; inspection of raw materials purchased may be introduced and so on.
Material Mix Sub-Variance: Example 7.1 was based on a situation when a manufacturing
company was using only one type of material. However, a product may require more than one
type/grade of raw materials or a mix of materials. Obviously, the standard proportion (mix) in
which materials are to be mixed to make a product is pre-determined. It will be of interest to
determine whether the actual proportion of raw materials (mix) employed is in conformity with
the standard proportion. This constitutes the rationale to determine the material mix variance.
It is important to note that the material mix variance is not an additional variance; it is a
part of a material quantity variance; being so, it is appropriate to designate this as a material mix
sub-variance (MMSV). As per the name, this variance will be based on the difference between
the actual mix and standard mix (of actual raw materials/inputs used). Since, material-mix is the
responsibility of the production manager, the multiplying factor will be standard price (and not
the actual price; the reason for the same has been already explained). Symbolically,
MMSV = (Actual mix of TAQ used – Standard mix of TAQ) × SP (7.4)

7.6
 Example 7.2:
A manufacturing company uses the following standard mix in the making of one of its standard
products:
Material A 5 kgs. at the standard price of Rs 10 per kg.
Material B 3 kgs. at the standard price of Rs 20 per kg.
Material C 2 kgs. at the standard price of Rs 50 per kg.
The actual mix (for 1,000 units of output for January) was as follows:
Material A 6,000 kgs. at the actual price of Rs 9 per kg.
Material B 4,000 kgs. at the actual price of Rs 20 per kg.
Material C 1,000 kgs. at the actual price of Rs 60 per kg.

Determine all the relevant material variances.

Solution:
In such a situation, it is useful to prepare a table that indicates total standard material cost
(TSMC) and total actual material cost (TAMC) of actual units produced.
Table 7.1: TAMC and TSMC of 1,000 units
Materials Actual material cost (TAMC) Standard material cost (TSMC)
TAQ AP TAMC TSQ SP TSMC
A 6,000 kgs. Rs 9 Rs 54,000 5,000*kgs. Rs 10 Rs 50,000
B 4,000 20 80,000 3,000 20 60,000
C 1,000 60 60,000 2,000 50 1,00,000
Total 11,000 1,94,000 10,000 2,10,000
* (For one unit, SQ of material A required is 5 kg. and, therefore, for 1,000 units produced, TSQ
of material A would be 5,000 kgs. (5 kgs. × 1,000 units); likewise, for B and C materials needed
are determined.
TMCV: (TAMC – TSMC) = (Rs 1,94,000 – Rs 2,10,000) = Rs 16,000 (favourable)
(i) Material price variance (MPV): (AP – SP) × AQ
Material A (Rs 9 - Rs 10) × 6,000 kgs. = Rs 6,000 (favourable)
B (Rs 20 – Rs 20) × 4,000 kgs. = Nil
C (Rs 60 – Rs 50) × 1,000 kgs. = 10,000 (unfavourable)

7.7
 4,000 (unfavourable)
(ii) Material quantity variance (MQV): (TAQ – TSQ) × SP
Material A (6,000 kgs. – 5,000 kgs.) × Rs 10 = Rs 10,000 (unfavourable)
B (4,000 kgs. – 3,000 kgs.) × Rs 20 = 20,000 (unfavourable)
C (1,000 kgs. – 2,000 kgs.) × Rs 50 = 50,000 (favourable)
20,000 (favourable)
The sum of MQV (Rs 20,000 favourable) and MPV (Rs 4,000 unfavourable) is Rs 16,000
(favourable), which is TMCV.
Now, we need to answer a very important question. Should this organisation appreciate
the performance of its production manager, as the MQV is favourable? If you read closely, the
inputs used, in relation to the standard, you will observe that the production manager has used
more of cheaper materials (A and B) and less of costly material (C). As a result, he could achieve
favourable variance. If such a mix were possible, the management itself would have set such a
standard mix (say 6:4:1 of A, B and C).
On the contrary, by altering the mix, the production manager may affect the quality of the
productanditmayhaveanadversebearingonthebrand/imageofthecompany’spro
long run, sales may decline; there may be heavy returns of goods already sold (manufactured on
such a mix). Therefore, there is a need to isolate the impact of material mix sub-variance (from
MQV); determination of the MMSV involves the following two steps:
 Determination of standard mix (5:3:2 of Materials A, B, C) of total actual quantity used
(11,000 kgs.).
 Prepare a new table which has revised values

Table 7.2: Actual Mix and Standard Mix of 11,000 kgs. Materials used
Materials (Actual mix – standard mix) (×) standard price = Total
A (6,000 kgs. – 11,000 kgs. × 5/10 = 5,500 kgs.) × Rs 10 = Rs 5,000 (unfavourable)
B (4,000 kgs. – 11,000 kgs. × 3/10 = 3,300 kgs.) × Rs 20 = 14,000 (unfavourable)
C 1,000 kgs. – 11,000 kgs. × 2/10 = 2,200 kgs.) × Rs 50 = 60,000 (favourable)
Total 41,000 (favourable)

7.8
 Table 7.2 indicates that there is a favourable MMSV of Rs 41,000; the material quantity variance
(revised) accordingly will be Rs 21,000 (unfavourable) as shown below:
Material quantity variance Rs 20,000 (favourable)
Less MMSV 41,000 (favourable)
MQV (revised) 21,000 (unfavourable)

It is important to stress here that the earlier pseudo conclusion (based on MQV) of the
better performance of the production manager gets reversed. In contrast, he has used more
quantity of raw materials (11,000 kgs.) than was allowed (10,000 kgs.) which gets reflected in
the MQV (revised). It will be more appropriate to designate MQV (revised) as material yield
sub-variance (as explained in the following paragraph).
Material Yield Sub-Variance (MYSV): The word, yield implies output. Being so, in this context,
the objective of computation of MYSV will be to know the difference of the actual output and
the standard output, given the actual usage of materials. Based on the simple arithmetic, it is
possible to determine standard yield. In Example 7.2, we know that 1 unit of finished output
requires 10 kgs. mixture of materials A, B, and C. Since, the total actual quantity used is 11,000
kgs., the standard output/yield is1,100 units of finished output (11,000 kgs./10 kgs. per unit).
Since it is the responsibility of the production manager, the multiplying factor (Please
think on your own) will be standard material cost per unit of finished output. Symbolically,
MYSV = (Actual Yield – Standard Yield) × Standard material cost per finished unit (7.5)
= (1,000 units – 1,100 units) × Rs 210 = Rs 21,000 (unfavourable)
Standard material cost per unit is obtained from Table 7.1. Total standard material cost of
1,000 units produced is Rs 2,10,000 and, hence, SMC per unit is (Rs 2,10,000/1,000 units) = Rs
210 per unit.
The concept of MYSV is particularly useful for process industries such as chemicals and
sugar where a certain specified percentage of yield is expected from a given input of materials.
Exhibit 7.1 shows all the relevant material cost variance at one place for Example 7.2.

TMCV (Rs 16,000 favourable)

MPV (Rs 4,000 unfavourable) MQV (Rs 20,000 favourable)

7.9
 Labour Cost Variance (LCV)
Labour cost variance is the difference between the Total Actual Labour Cost (TALC)
incurred for the Actual Output and Total Standard Labour Cost (TSLC) allowed for such a level
of output. Symbolically,
TLCV = TALC – TSLC (7.6)

Example 7.3:
From the following data relating to a manufacturing firm, which employs labour on time basis,
determine the relevant labour cost variances.
Standard hours (SH) required
(on the basis of motion and time study) per unit 2 Hours
Standard wage rate (SR) per hour Rs 15
Standard labour cost per unit of finished output (2 Hours × Rs 15) Rs 30
Actual output (for the month of January) 1,000 units
Total actual hours (TAH) spent as per time card 2,300 hours
Actual wage rate (AR) per hour paid Rs 16

Solution:

7.10
 At the outset, it is useful to mention that the computation of the labour cost variances, to
a marked extent, is on the pattern of material cost variances. You will observe the same in the
solution that follows.
TLCV = TALC – TSLC
= (TAH × AR) – (TSH × SR)
= (2,300 Hours × Rs 16) – (2 Hours × 1,000 units × Rs 15)
= (Rs 36,800 – Rs 30,000) = Rs 6,800 (unfavourable)
Since total actual labour cost exceeds the total standard labour cost, TLCV is
unfavourable. Since this variance is caused on account of the difference in wage rate and time
taken, it can be segregated into two sub-variances: (i) Labour Rate Variance and (ii) Labour
Efficiency Variance (as difference in time is indicative of efficiency).
Labour Rate Variance (LRV): As the name suggests, it measures the difference between the
actual wage rate paid and the pre-determined standard wage rate. Like the MPV, the difference
in rates is then multiplied by the total actual hours (TAH) workers have been paid for.
Symbolically,
LRV = (AR – SR) × TAH (7.7)
= (Rs 16 – Rs 15) × 2,300 Hours = Rs 2,300 (unfavourable)
Since AR > SR, LRV is unfavourable.
The LRV can be traced to a variety of causes. The three important causes are:
1. Change in the basic wage structure and the dearness allowance as per the new agreement
with trade union not yet reflected in the standard wage rate
2. Employment of casual/temporary workers to meet seasonal demand and are paid at
different wage rate
3. Payment of overtime to meet some special urgent job orders, and so on.
From the causes enumerated above, it is apparent that the LRV is more often an
uncontrollable variance. Being so, standard wage rate normally gets revised for future periods.
Labour Efficiency Variance (LEV): The time taken by workers to give an output is the index of
their efficiency. LEV measures the difference between the total actual hours (TAH) taken by the
labour force to produce the actual output and the total standard hours (TSH) allowed for such an
output. Symbolically,
LEV = (TAH – TSH) × SR per hour (7.8)

7.11
 The rationale for multiplying by SR (and not AR) is that LEV is the responsibility of
the production manager and he cannot be held accountable for difference in wage rates. In
Example, 7.3,
LEV = (2,300 Hours – 2,000 Hours) × Rs 15 = Rs 4,500 (unfavourable)
Since TAH (2,300) are higher than TSH (2 Hours per unit × 1,000 units produced), LEV
is unfavourable.
Improper working conditions, old and defective machines , incompetent supervision,
inadequate training of workers and increase in labour turnover are some of the major reasons
causing labour efficiency variance.
This variance, being controllable in nature, is of prime significance to any manufacturing
organisation. In today’s competitive world, firms may find it very difficult to m
products to be cost competitive with unfavourable LEV. This, therefore, warrants immediate
managerial action. Some concrete actions conceived in this regard could be to provide a
conducive ambience in terms of the proper maintenance of existing machines, replacing obsolete
machines by the new ones, training of workers and good working conditions.
It is important to stress here that the LEV is evaluated on the basis of the total actual
hours paid for and not on the basis of the total actual hours worked. In case, there exists a
difference between these two sets of hours, it implies that the labour force has been idle for some
time. Therefore, to determine true labour efficiency, it is imperative to isolate the impact of idle
time variance.
Idle Time Variance: The labour idle time variance measures idle hours lost due to the factors
beyond the control of workers, say, non-availability of raw materials and power, major
breakdown of machines due to poor maintenance and so on. Symbolically, it is equal to
(Idle labour hours × standard rate) (7.9)
By definition, this variance is unfavourable. You will agree that the presence of idle time
variance will distort the computation of LEV. Therefore, adjustments are to be made to
determine the correct value of LEV.
Assume in Example 7.3, idle hours on account of abnormal circumstances mentioned
above are 400 hours, the true LEV (revised) in fact turns out to be Rs 1,500 favourable as shown
below:
(Total actual hours worked – Total standard hours) × SR

7.12
 = (2,300 Hours – 400 = 1,900 Hours – 2,000) × Rs 15 = Rs 1,500 (favourable)
Idle time variance = (400 Hours × Rs 15) = Rs 6,000 (unfavourable)
Thus, the earlier conclusion that the work force is inefficient gets reversed. These facts
demonstrate that it is very useful to determine idle time variance separately. Exhibit 7.2
enumerate all labour variances at one place for data contained in Example 7.3:

TLCV (Rs 6,800 unfavourable)

Labour Rate Variance Labour Efficiency Variance

(Rs 2,300 unfavourable) (Rs 4,500 unfavourable)

Idle Time Variance True Labour Efficiency Variance or LEV (revised)

(Rs 6,000 unfavourable) (Rs 1,500 favourable)

Exhibit 7.2: Labour Cost Variances

Like MQV, labour efficiency variance (revised) can be segregated into two sub-
variances; namely, Labour Mix Sub-Variance (LMSV) and Labour Yield Sub-Variance (LYSV).
The procedure of computation of these variances parallels the procedure that is adopted for
determining MMSV and MYSV. Symbolically,
LMSV= Actual labour mix – Standard labour mix (×) Standard wage rate per hour (7.10)
of actual total hours of total actual hours

LYSV = (Actual yield/output – Standard yield/output) × Standard labour cost per unit of finished output
(7.11)
Since the procedure is analogous to the one that is used to determine such variances in
respect of materials, further elaboration is not made to avoid repetition.

7.13
 Variable Overhead Cost Variances (VOCV)
At the outset, it may be useful for you to know that the nature of VOCV is also similar to
that of the MCV and LCV. The VOCV measures the difference between the Total Actual
Variable Overhead Costs (TAVOC) incurred for the actual output and the Total Standard
Variable Overheads (TSVOC) allowed. Symbolically,
TVOCV = (TAVOC – TSVOC) (7.12)

Example 7.4:
The following is an extract related to variable overheads for the month of January of a
manufacturing firm
Standard hours (SH) required to make a unit 2 Hours
Standard variable overhead rate (SVOR) per hour Rs 10
Standard variable overhead costs per unit (2 × Rs 10) Rs 20
Actual output 1,000 units
Total actual hours (TAH) spent 2,300 Hours
Actual variable overhead rate (AVOR) per hour Rs 11
Determine the variable overhead cost variances.

Solution:
TVOCV = (TAVOC – TSVOC)
= (TAH × AVOR) – (TSH × SVOR)
= (2,300 × Rs 11) – (2 Hours × 1,000 units × Rs 10)
= (Rs 25,300 – Rs 20,000 = Rs 5,300 (unfavourable)
As the TAVOC is higher than the TSVOC, TVOCV is unfavourable. This difference is
caused due to the difference in time taken and in variable overhead rate. Accordingly, the VOCV
can be divided into two sub-variances: (i) Variable Overhead Efficiency Variance (VOEV) for
the difference in time taken and (ii) Variable Overhead Rate Variance, more popularly
designated as Variable Overhead Spending Variance, VOSV.

7.14
Variable Overhead Efficiency Variance (VOEV): VOEV measures the difference between the
actual hours and standard hours allowed for the actual output. This difference, as in the case of
LEV, is then multiplied by SVOR per hour. Symbolically,
VOEV = (TAH – TSH) × SVOR per hour (7.13)
In Example 7.4, the VOEV is
= (2,300 Hours – 2,000 Hours) × Rs 10 = Rs 3,000 (unfavourable).
Since the actual time taken (2,300 Hours) is higher than the standard time allowed (2
Hours per unit × 1,000 units), the VOEV is unfavourable. The reasons for VOEV are the same as
those of the LEV. In fact, it is important for you to note that for any manufacturing firm, both the
LEV and VOEV and Fixed Overhead Efficiency Variance (to be discussed in the next section)
are of the same type that is either they are favourable or they are unfavourable.
Variable Overhead Spending Variance (VOSV): VOSV is the difference between the Actual
Variable Overheads Incurred (AVOC) and the Standard Variable Overheads incurred for actual
hours taken. In other words, the standard hours are not to be considered for the purpose of
determining standard variable overheads. The reason is simple; actual amount of variable
overheads spent, say power expenses, would be in relation to the actual hours worked, and not
in relation to the standard hours. Symbolically,
VOSV = Total actual variable overheads incurred (TAH ×AVOR) (–)
Total standard variable overheads allowed for actual hours (TAH × SVOR) (7.14)
= (2,300 Hours × Rs 11) – (2,300 Hours × Rs 10)
= (Rs 25,300 – Rs 23,000) = Rs 2,300 (unfavourable)
Since the AVOC > SVOC, VOSV is unfavourable.
Thus, TVOCV = VOEV + VOSV
Rs 5,300 (unfavourable) = Rs 3,000 (unfavourable) + Rs 2,300 (unfavourable)
Fixed Overhead Cost Variances (FOCV)
It is important for you to note that the treatment of the FOCV is different from the three
variances (material, labour and variable overheads) discussed so far. In this context, it will be
useful for you to recapitulate the nature of fixed costs (discussed in chapters 5 and 6). Like fixed
costs, fixed overhead costs will not vary with the changes in the level of production within a
relevant range (in the present context up to the normal output/capacity).

7.15
 These fixed overheads are charged to the production based on a pre-determined standard
fixed overhead rate per unit. This standard fixed overhead rate per unit is determined dividing
Budgeted Fixed Overheads of the period by Normal Capacity (output) of that period. For better
comprehension of determining all relevant FOCV, consider Example 7.5.

Example 7.5:
The following data relate to fixed manufacturing overheads for the month of January:
Budgeted fixed overheads (consisting of factory rent, insurance, lease rent of Rs 50,000
machine, salary of factory manager and so on)
Normal capacity (output), based on the plant capacity and other facilities 1,250 units
available in the factory
Normal capacity (in hours) 2,500 Hours
Standard hours required to make a unit 2 Hours
Standard fixed overhead (SFOR) rated per hour (Rs 50,000/2,500 Hour) Rs 20
Standard fixed overhead rate per unit of output (Rs 20 × 2 Hours) or Rs 40
(Rs 50,000/1,250 units)
Actual output 1,000 units
Actual Hours 2,300 Hours
Actual fixed overheads incurred (TAFOC) Rs 50,600

Determine all the relevant fixed overhead cost variances.

Solution:
TFOCV, like other cost variances, is the difference between the total actual fixed overhead costs
(TAFOC) and the total standard fixed overhead costs (TSFOC) allowed for actual production (in
the present example) at the rate of Rs 40 per unit). Symbolically,
TFOCV = (TAFOC – TSFOC) (7.15)
= Rs 50,600 – (1,000 units produced × Rs 40) = Rs 10,600 (unfavourable)
Like other cost variances, this variance is also to be divided into sub-variances. You are
already aware of the two sub-classifications (i) Fixed Overhead Efficiency Variance and (ii)
Fixed Overhead Spending Variance; (iii) a third category (peculiar to fixed overhead cost
variances only) is capacity variance (explained in detail later).

7.16
Fixed Overhead Efficiency Variance (FOEV): Like other efficiency variances, this variance is
the function of the difference between the total actual hours and total standard hours and the
standard fixed overhead rate (SFOR) per hour. Symbolically,
FOEV = (TAH – TSH) × SFOR per hour (7.16)
= (2,300 Hours – 2,000 Hours) × Rs 20 = Rs 6,000 (unfavourable)

Fixed Overhead Spending Variance (FOSV): It is the difference between the Actual Fixed
Overhead (TAFOC) incurred and the Total Budgeted Fixed Overhead expenditure of the period.
Symbolically,
FOSV = (TAFOC – Budgeted fixed overhead costs) (7.17)
= (Rs 50,600 – Rs 50,000) = Rs 600 (unfavourable)
It is important to note that the budgeted fixed overhead costs, because of the non-varying
nature do not require proportionate adjustment as they are to be spent irrespective of the fact
whether actual output (in the present case 1,000 units) is equal to or less than its normal capacity
(1,250 units).
The reason for the FOSV could be traced to the change in the usage and/or rate of any
one or more of the components of fixed overhead cost items. For instance, factory rent rates,
insurance rates, property taxes may be revised upwards; salary of factory manager, supervisor,
foreman might have been enhanced but have not been incorporated in the budgeted fixed
overheads; a rise in annual repairs and maintenance charges may take place. Obviously, this
variance (like MPV and LRV) is non-controllable in nature.
Capacity Variance: This variance is a function of the difference between the actual hours
worked and the normal capacity hours available and standard fixed overhead rate. Symbolically,
Capacity Variance = (TAH – Normal hours) × SFOR per hour (7.18)
= (2,300 Hours – 2,500 Hours) × Rs 20 = Rs 4,000 (unfavourable)
Capacity variance is unfavourable since the company did not utilise its full capacity (of
2,500 hours). In simple words, capacity variance is indicative of the fact whether the firm is
operating at its full capacity or not; under-utilisation, obviously, is a signal of unfavourable
variance.
Thus, TFOCV = FOEV + FOSV + Capacity Variance

7.17
 Rs 10,600 (unfavourable) = Rs 6,000 (unfavourable) + Rs 600 (unfavourable) + Rs 4,000
(unfavourable).

SALES VARIANCES

Besides cost variances, sales variances provide the other major causes for the difference
of the actual profit and the budgeted profit. It will be useful for you to note that the computation
pattern of sales variances (as a part of profit variance) is similar to that of the cost variances.
Consider Example 7.5.
Example 7.5:
The following is the data related to a manufacturing firm for the month of January:
Budgeted quantity to be sold 10,000 units
Standard (budgeted) selling price per unit Rs 30
Standard cost per unit Rs 20
Actual quantity sold 8,000 units
Actual selling price per unit Rs 32
Actual cost per unit Rs 21

Determine (i) total profit variance, (ii) sales price variance, (iii) sales quantity variance and (iv)
total cost variance.
Solution:
Total Profit Variance = (Total Actual Profit – Total Budgeted Profit) (7.19)
Total actual profit:
Total actual sales revenue (8,000 units × Rs 32) Rs 2,56,000
Less total actual costs (8,000 units × Rs 21) 1,68,000
Total actual profit (8,000 units × Rs 11) 88,000

Total budgeted profit:

Total budgeted sales revenue (10,000 units × Rs 30) Rs 3,00,000

7.18
Less total standard costs (10,000 units × Rs 20) 2,00,000
Total budgeted profit (10,000 units × Rs 10) 1,00,000

Total profit variance = Rs 88,000 – Rs 1,00,000 = Rs 12,000 (unfavourable)

There are three main sub-variances, which explain this difference.
(A) Sales Price Variance (SPV): SPV is a function of the difference between the Actual Selling
Price (ASP) and the Standard Selling Price (SSP), and the basis of its determination is similar to
the material price variance. Symbolically,
SPV = (ASP – SSP) × TAQ sold (7.20)
= (Rs 32 – Rs 30) × 8,000 = Rs 16,000 (favourable).
Since the ASP is higher than the standard/budgeted selling price, SPV is favourable and it
has contributed towards more profits.
Favourable market conditions/unforeseen market competitive conditions, marketing
strategy to tap new markets (in particular export markets) and flexibility provided to the sales
personnel are the chief causes for the sales price variance.
(B) Sales Quantity Variance (SQV): SQV measures the difference between the Total Actual
Quantity (TAQ) sold and the budgeted/standard/planned quantity (in terms of units) to be sold.
Since SQV is a sub-part of profit variance, the multiplying factor to the above difference will be
standard profit per unit and not the standard selling price per unit. This basis of computation
is akin to the material quantity variance. Symbolically,
SQV = (TAQ – TSQ) × standard profit per unit (7.21)
= (8,000 units – 10,000 units) × Rs 10* = Rs 20,000 (unfavourable)
*(Standard selling price per unit (Rs 30) – Actual selling price per unit (Rs 20) = Rs 10)
As the number of units sold is less than the budgeted number of units, SQV is unfavourable in
that it has decreased profits by Rs 20,000. Ineffective sales promotion/ advertising, unforeseen
competition from a new product and recession in the market are some of the major reasons for
such a variance.
In the case of multi-product firm, the SPV and SQV are to be determined product-wise.
(C) Total Cost Variance (TCV): TCV measures the difference between the total actual cost of
actual units sold and the standard/budgeted costs of these units.
Symbolically,

7.19
 TCV = (Total actual cost of units sold – Total standard cost of units sold) (7.22)
= (8,000 units × Rs 21) – (8,000 units × Rs 20)
= Rs 1,68,000 – Rs 1,60,000 = Rs 8,000 (unfavourable)
Alternatively,
TCV = (Actual cost per unit – Standard cost per unit) × TAQ sold (7.23)
= (Rs 21 – Rs 20) × 8,000 = Rs 8,000 (unfavourable)
In practice, this cost variance consists of manufacturing costs (namely, material, labour and
overheads), administrative costs, selling and distribution costs and financial costs. All the
variances then can be reported in a statement form to the management (Table 7.3).
Table 7.3: Budgeted profit and Actual Profit
Budgeted profit Rs 1,00,000
Add favourable variances:
Sales price variance 16,000
Less unfavourable variances:
Sales quantity variance Rs 20,000
Cost variance* 8,000 (28,000)
Actual profit 88,000
*Details of cost variances, some favourable and some unfavourable, for each element of cost, are
required to be shown. This is done to provide a bird’s eye view to the managemen
items/factors responsible for the difference between the actual profit and budgeted profit.
Example 7.6 (comprehensive):
The accounting department of one chemical manufacturing firm has furnished the following
information (standard/budgeted and actual) pertaining to one of its main brand products for the
second quarter of the current year:
Standard cost sheet per unit
Direct material cost (3 kgs. @ Rs 10 per kg.) Rs 30
Direct labour cost (1.5 Hours @ Rs 10 per hour) 15
Variable overheads (1.5 Hours @ Rs 10 per hour) 15
Fixed overheads (1.5 Hours @ Rs 20 per hour) 30
Total standard cost 90
Standard profit per unit 30

7.20
Standard price per unit 120
Budgeted sales 5,000 units; Normal capacity 7,500 Hours or 5,000 units; Budgeted fixed
overheads at normal capacity Rs 1,50,000.

Actual cost, production and sales data:

Direct materials consumed (13,000 kgs, @ Rs 9) Rs 1,17,000
Direct labour cost (6,500 hours @ Rs 11 per hour) 71,500
Variable overheads (6,500 hours @ Rs 10 per hour) 65,000
Fixed overheads (6,500 hours) 1,55,000
Actual selling price per unit Rs 125
Actual production 4,000 units
Actual sales 4,000 units

You are required to compute all possible cost, sales and profit variances and prepare a
reconciliation statement of budgeted profit with actual profit.

Solution:
Total Profit Variance = (Total Actual Profit – Total Budgeted Profit)
Total actual profit:
Actual sales revenue (4,000 units × Rs 125) Rs 5,00,000
Less total actual costs:
Direct material costs Rs 1,17,000
Direct labour cost 71,500
Variable overheads 65,000
Fixed overheads 1,55,000 4,08,500
Actual profit 91,500
Total budgeted profit:
Standard profit per unit Rs 30
(×) Budgeted sales(units) × 5,000 1,50,000

7.21
Thus, Total Profit Variance = (Rs 91,500 – Rs 1,50,000) = Rs 58,500 (unfavourable); the
following variances will explain this difference.
(A) Sales Price Variance: (ASP – SSP) × AQ sold
= (Rs 125 – Rs 120) × 4,000 units = Rs 20,000 (favourable)
(B) Sales Quantity Variance: (AQ – SQ) × Standard Profit Per Unit
= (4,000 – 5,000) × Rs 30 = Rs 30,000 (unfavourable)
(C) Total Cost Variance: (Total Actual Cost – Total standard cost per unit × actual output)
= (Rs 4,08,500 – Rs 3,60,000 i.e. 4,000 units × Rs 90) = Rs 48,500 (unfavourable)
There will be further break-up of cost variance.
(a) Material Cost Variance: (TAMC – TSMC)
= Rs 1,17,000 – (Rs 30 × 4,000 units) = Rs 3,000 (favourable)
(i) Material Price Variance: (AP – SP) × TAQ consumed
= (Rs 9 – Rs 10) × 13,000 kgs. = Rs 13,000 (favourable)
(ii) Material Quantity Variance: (AQ – SQ) × SP per kg.
= [13,000 kgs. – (3 kgs. per unit × 4,000 units)] × Rs 10 = Rs 10,000 (unfavourable)
(b) Labour Cost Variance: (TALC – TSLC)
= Rs 71,500 – (Rs 15 × 4,000 units) = Rs 11,500 (unfavourable)
(i) Labour Rate Variance: (AR – SR) × TAH
= (Rs 11 – Rs 10) × 6,500 Hours = Rs 6,500 (unfavourable)
(ii) Labour Efficiency Variance: (TAH – TSH) × SR per hour
= [6,500 Hours – (1.5 Hours × 4,000 units)] × Rs 10 = Rs 5,000 (unfavourable)

(c) Variable Overhead Cost Variance: (TAVOC – TSVOC)

Rs 65,000 – (Rs 15 × 4,000 units) = Rs 5,000 (unfavourable)
(i) Variable Overhead Spending variance: (AR – SR) × TAH
= (Rs 10 – Rs 10) × 6,500 = Nil
(ii) Variable Overhead Efficiency Variance: (AH – SH) × SVOR per hour
= (6,500 Hours – 6,000 Hours) × Rs 10 = Rs 5,000 (unfavourable)
(d) Fixed Overhead Cost Variance: (TAFOC – TSFOC)
= [Rs 1,55,000 – (Rs 30 per unit × 4,000 units)] = Rs 35,000 (unfavourable)
(i) Fixed Overhead Spending Variance: TAFOC – Total budgeted costs)

7.22
 = (Rs 1,55,000 – Rs 1,50,000) = Rs 5,000 (unfavourable)
(ii) Fixed Overhead Efficiency Variance (TAH – TSH) × SFOR per hour
= (6,500 Hours – 6,000 Hours) × Rs 20 = Rs 10,000 (unfavourable)
(iii) Capacity Variance: (Actual hours – Normal Capacity in hours) ×SFOR per hour
= (6,500 Hours – 7,500 Hours) × Rs 20 = Rs 20,000 (unfavourable)

Statement of Reconciliation of Actual Profit with Budgeted Profit

Budgeted profit Rs 1,50,000
Add favourable variance
Sales price variance Rs 20,000
Material price variance 13,000 33,000
Less unfavourable variances
Sales quantity variance Rs 30,000
Material quantity variance 10,000
Labour rate variance 6,500
Labour efficiency variance 5,000
Variable overhead efficiency variance 5,000
Fixed overhead spending variance 5,000
Fixed overhead efficiency variance 10,000
Capacity variance 20,000 (91,500)
Actual profit 91,500

In practice, the reconciliation statement (as shown above) provides a very useful
summary to the top management regarding factors responsible for the decrease and the increase
in the profit. In fact, in reporting variances to the management (in a report form), it is suggested
that the reconciliation statement should be the first page and all other variances should be shown
as annexures (say annexure 1 for sales variance, annexure 2 for material variance and so on).
These annexures could be referred for details (if desired) by the management.

7.23
 Summary of Key Points
 Cost variance is the difference between the Total Actual Costs (TAC) and the Total Standard
Costs (TSC).
 In case the TAC are lower than the TSC, variance is said to be favourable; conversely,
variance is unfavourable if the TAC are higher than the TSC.
 In order to serve variance analysis, as a useful tool of cost control, it is imperative and also
desired that various cost standards set (in respect of material, labour and overheads) should
be current and attainable. In other words, the management should not opt for setting both
liberal and tight standards, as variances determined on such standards then will not be correct
ones.
 Apart from cost control, variance analysis is a useful tool to explain to the management the
reasons why the actual profits differ from the budgeted profits. The variance between this set
of profit can be explained in terms of three main variances: (i) cost variance, (ii) sales price
variance and (iii) sales quantity variance.
 Corresponding to the major elements of manufacturing costs, cost variances can be
categorised into 4 broad groups, namely, direct material cost variance, direct labour cost
variance, variable overhead cost variance and fixed overhead cost variance.
 Direct material cost variance is the difference between the actual total material cost and the
standard total material cost of actual output. This variance can be sub-divided into two main
variances in the case of manufacturing firms, using only one type of material; there will be
three sub-variances when the firm uses more than one type of material. The computation is
shown as follows:
(a) Using only one type of material:
(i) Material price variance (MPV): (Actual price AP – Standard price, SP) × Total
actual quantity (TAQ) of materials used
(ii) Material quantity variance (MQV): = (Total actual quantity, TAQ – Total standard
quantity, TSQ) × Standard price, SP.
(b) Using more than one type of material
(i) MPV (In the same manner as stated above, except that it is to be computed for each
type of materials used separately.

7.24
 (ii) Materials mix sub-variance: (Actual mix of TAQ used- Standard mix of TAQ) ×
Standard Price (This Variance is to be computed for each material separately).
(iii) Material yield sub-variance: (Actual yield - standard yield) × Standard material cost
of one unit of finished output

 While the material price variance is normally considered uncontrollable as it arises due to
external factors beyond the control of the business firm, the material quantity variance, the
material mix sub-variance and the material yield sub-variance are regarded as controllable
since they are, by and large, due to internal factors.
 Direct labour cost variance is the difference between the total actual labour cost and the
standard labour cost of the actual output. It is bifurcated into two sub-variances when there is
no idle time and only one type of labour is used; the number of such sub-variances is four
when there is idle time and more than one type of labour force is used. The computation is as
follows:

(a) With no idle time and working with only one type of labour:
(i) Labour rate variance (LRV): (Actual wage rate, AR – Standard wage rate, SR) ×
Total actual hours, TAH.
(ii) Labour efficiency variance (LEV): (Total actual hours, TAH – Total standard
hours, TSH) × SR per hour
(b) When there is idle time and more than one grade of labour (say skilled, semi-skilled,
unskilled) is used
(i) LRV (as above; to be computed for each type of labour)
LEV is sub-divided into three categories:
(ii) Idle time variance: (Idle Hours × SR)
(iii) Labour mix sub-variance (LMSV): (Actual labour mix - standard mix of total actual
labour hours worked) × SR (This variance is to be computed separately for each
type of labour force used).
(iv) Labour yield sub-variance (LYSV): (Actual yield – Standard yield) × Standard
labour cost of one unit of finished product

7.25
  Like the material price variance, the labour rate variance is branded as uncontrollable
variance. Since labour efficiency variance and its sub-parts are akin to the material quantity
variance, such variances appropriately fall in the category of controllable variances.
 Variable overhead cost variance is the difference between the actual variable overhead costs
and the standard variable overhead costs of the actual output. It has two sub-variances. These
two sub-variances and their computation is shown as under:
(i) Variable overhead spending variance (VOSV): (AR – SR) × Total actual hours, TAH
(ii) Variable overhead efficiency variance (VOEV): (TAH – TSH) × SR

 Similar to the nature of the MPV and LRV, the VOSV is uncontrollable variance; like the
LEV, the VOEV is controllable variance.
 Fixed overhead cost variance (FOCV) is the difference between the total actual fixed
overhead costs and the total standard fixed overhead costs (SFOC) of the actual output. For
the purpose of determining the SFOC per unit, you are to divide total budgeted fixed
overheads by the normal capacity (output) in units. The FOCV is segregated into three sub-
variances. These variances and their computation is as follows:
(i) Fixed overhead spending variance (FOSV): (Total actual fixed overhead costs –
Total budgeted fixed overhead costs). It is important for you to note that the budgeted
fixed overhead costs will not be proportionately adjusted (when the actual output
differs from the normal or budgeted output) as the nature of fixed costs is that they do
not change with the changes in the level of output.
(ii) Fixed overhead efficiency variance (FOEV): (TAH – TSH) × Standard fixed
overhead rate per hour
(iii) Capacity variance: (Total actual hours – Normal Capacity (measured in hours) ×
Standard fixed overhead rate per hour.

 The FOSV is normally regarded as uncontrollable variance; the capacity variance is pre-
determined (if the management has envisaged to have budgeted output less than the normal
output); the FOEV (like other efficiency variances) is controllable variance.
 The sales price variance (SPV), as the name suggests, measures the difference between the
actual sale price (ASP) and the budgeted/standard-selling price (SSP). In case, the ASP is

7.26
 higher, vis-à-vis, the SSP, the SPV is evidently favourable; it will obviously be unfavourable
if ASP < SSP. Symbolically, SPV = (ASP – SSP) × Total actual quantity sold.
 The sales quantity variance (SQV) is indicative of the difference in the actual quantity sold as
compared to the budgeted quantity. Being a part of the profit variance, this difference is
multiplied by the standard profit per unit.
Symbolically, SQV = (TAQ – TSQ) × Standard profit per unit
 The reconciliation statement of the budgeted profits with the actual profits is prepared to
show all sub-variances at one place. Such a statement provides a bird’s
-view eye
of all the
possible factors causing the difference between the budgeted profits and the actual profits. It
will be useful, if such a statement also contains the names of the managers/people
responsible for such variances. For instance, the purchase manager may be named for the
MPV and the production manager for the MQV and LEV. Being complete in all respects, this
statement can be used to assign responsibility (or to reward for better performance) for the
deviations by the management.

7.27
 OBJECTIVE TYPE QUESTIONS

7.1. Indicatewhetherthefollowingstatementsare‘True’or‘False’.
(i) Business firms should set tight standards to attain cost control.
(ii) Profit variance is explained by total cost variance, sales price variance and sales quantity
variance.
(iii) Idle time variance is always an unfavourable variance.
(iv) Normal loss of materials is ignored while setting standard related to material quantity.
(v) Labour efficiency variance is normally considered as an uncontrollable variance.
(vi) Material price variance is a controllable variance.
(vii) Material mix variance measures whether the total actual quantity of material used is in
conformity with total standard quantity of material to be used.
(viii) Standards are measures of performance expectations.
(ix) If labour efficiency variance is unfavourable, it also implies that the variable as well as
the fixed overhead efficiency variance will also be unfavourable.
(x) Fixed overhead spending variance is a measure of capacity utilisation.
Answers: (i) False, (ii) True, (iii) True, (iv) False, (v) False, (vi) False, (vii) False, (viii) True,
(ix) True, (x) False.

7.2. Fill in the blanks (out of choices provided).

(i) _____________ manager is held accountable for excessive price paid for the material
purchased. (Production/Purchase)
(ii) ______________ manager is held accountable if the actual labour hours taken are more
than the standard labour hours stipulated. (Production/Personnel)
(iii) Standards should be _____________ to be an effective tool of cost control.
(Tight/Loose/Attainable)
(iv) Excess quantity of material used is multiplied by ____________ price to determine
material quantity variance. (Standard/Actual)
(v) ____________ is sub-divided into material mix sub-variance and material yield sub-
variance. (Material cost variance/Material quantity variance)
(vi) ___________ is always an unfavourable variance. (Idle time/Labour efficiency)

7.28
(vii) If actual capacity hours are more than capacity hours utilised, capacity variance is said to
be _____________ (Favourable/Unfavourable)
(viii) Materials yield variance is _________________ when actual yield is higher than standard
yield. (Favourable/unfavourable)
(ix) Management should focus more on _________________ variances.
(Controllable/Uncontrollable).
(x) _______________ is normally unfavourable for new firms (Capacity variance/Efficiency
variance).
Answers: (i) Purchase, (ii) Production, (iii) Attainable, (iv) Standard, (v) Material quantity
variance, (vi) Idle time, (vii) Unfavourable, (viii) Favourable, (ix) Controllable, (x) Capacity
variance.

EXERCISES
7.1: What are the various types of standards? What kind of standards would you like a
company to follow?
7.2: Do you subscribe to the view that standards set should be tight? Explain.
7.3: How does variance analysis help in cost control?
7.4: What are the major causes of material price and quantity variance?
7.5: “Controllablevariancesaremoreimportanttothebusinessfirm.”Elucida
7.6: Distinguish between fixed overhead efficiency variance and capacity variance.
7.7: Why is capacity variance only applicable to fixed manufacturing overheads? Explain.
7.8: Distinguish between:
(i) Labour rate variance and Labour efficiency variance.
(ii) Material mix sub-variance and material yield sub-variance.
(iii) Variable overheads and fixed overheads.
(iv) Sales quantity and sales price variance.
7.9: “The reconciliation statement (of actual profit with budgeted profit
documentfromthepointofviewofmanagement.”Comment.
7.10: How are profit variances explained?

7.29
 Numerical Exercises

7.11: In a manufacturing process, the following standards apply:

Standard price : Raw material A @ Rs 10 per kg.
: Raw material B @ Rs 30 per kg.
Standard mix (by weight) : 70% (A) and 30% (B)
Standard output (yield) : Weight of product as percentage of raw material used (80%)
In the month of January, the actual costs, actual quantity of materials used and actual yield
were as follows:
Quantity used: 8,400 kgs. A costing Rs 9 per kg.
2,600 kgs. B costing Rs 32 per kg.
Actual output: 8,000 kgs. of finished output.
Determine all the relevant material variances.

7.12: A product passes through two operating departments. The standard labour cost card for
this product is as follows:
Departments Standard time Standard rate Standard cost
X 3 Hours Rs 15 Rs 45
Y 2 20 40

The production for the month of December is 2,000 units. The actual labour cost incurred in
Departments X and Y is as follows:
Department Actual time Actual rate Actual cost
X 5,500 Hours Rs 16 Rs 88,000
Y 4,500 19 85,500

Determine various labour variances.

7.30
 7.13: Calculate the relevant cost variances from the following data:
Standard cost per unit:
Material costs (5 kgs. × Rs 20) Rs 100
Labour cost (2 Hours × Rs 15) 30
Variable overheads (2 Hours × Rs 10) 20 Rs 150
Actual cost of (1,000 units produced)
Material costs (4,800 kgs. × Rs 25) Rs 1,20,000
Labour cost (2,200 Hours × Rs 16) 35,200
Variable overheads (2,200 Hours × Rs 9) 19,800 1,75,000

7.14: From the following data of XYZ Ltd. relating to the budgeted and actual performance for
the current month, determine all the relevant variances:
Budgeted/Standard data:
Material costs (2 kg. @ Rs 10 per kg.) Rs 20
Labour costs (2 Hours @ Rs 5 per hour) 10
Variable overheads (2 Hours @ Rs 8 per hour) 16
Fixed overheads (2 Hours @ Rs 7 per hour) 14
Total standard cost per unit 60
Profit per unit 40
Selling price per unit 100
Normal capacity 20,000 Hours (or 10,000 units)
Budgeted sales 10,000 units
Budgeted fixed overheads Rs 1,40,000
Actual data:
Material costs (17,000 kgs. @ Rs 9 per kg.) Rs 1,53,000
Labour costs (15,000 Hours @ Rs 6 per hour) 90,000
Variable overheads (15,000 Hours @ Rs 8.5 per hour) 1,27,500
Fixed overheads Rs 1,50,000
Actual production 7,000 units
Actual sales 7,000 units
Actual selling price per unit Rs 100

You are also required to prepare a reconciliation statement with as many details as possible.

7.31
 Solution to numerical exercises

7.11: Total standard input (in kgs.) required to produce 8,000 kgs. of finished output: (8,000
kgs. × 100/80) = 10,000 kgs.
The standard mix of 10,000 kgs. requirement of total raw material should be in the ratio of 70%
and 30% for materials A and B respectively, that is,
Material A (10,000 kgs. × 70/100) = 7,000 kgs.
Material B (10,000 kgs. × 30/100) -= 3,000 kgs.
Based on the above information, solution table, showing actual material cost and standard
material cost has been prepared.

Table 7.3: Total actual material cost and total standard material cost of 8,000 kgs.
Raw material Actual Standard
AQ (kgs.) AP TAMC SQ (kgs.) SP TASC
A 8,400 Rs 9 Rs 75,600 7,000 Rs 10 Rs 70,000
B 2,600 32 83,200 3,000 30 90,000
11,000 1,58,800 10,000 1,60,000

Total material cost variance (TMCV): (TAMC – TASC)

= Rs 1,58,800 – Rs 1,60,000 = Rs 1,200 (favourable)
TMCV is sub-divided into the following three sub-variances:
(i) Material price variance (MPV): (AP – SP) × TAQ used
Material A (Rs 9 – Rs 10) × 8,400 kgs. = Rs 8,400 (favourable)
B (Rs 32 – Rs 30) × 2,600 kgs. = 5,200 (unfavourable)
3,200 (favourable)
(ii) Material mix sub-variance (MMSV): (Actual mix – Standard mix of AQ used) ×
Standard price per kg.
Material A (8,400 kgs. – 7,700 kgs.*) × Rs 10 = Rs 7,000 (unfavourable)
B (2,600 kgs. – 3,300 kgs.*) × Rs 30 = Rs 21,000 (favourable)
Rs 14,000 (favourable)

7.32
 (* 11,000 kgs. TAQ is to be used in proportion of 70% and 30% for Materials A and B
respectively; 11,000 kgs. × 0.7 = 7,700 kgs. for Material A and 11,000 kgs. × 0.3 for Material B)
(iii) Material yield sub-variance (MYSV): (Actual yield – Standard yield) × standard
material cost of one kg. of final output
Standard yield (in kgs.) = (Total actual quantity used × Standard yield ratio) = 11,000 kgs. ×
80% = 8,800 kgs.
Standard material cost of one kg of final output: Rs 1,60,000/8,000 kgs. = Rs 20
MYSV = (8,000 kgs. – 8,800 kgs.) × Rs 20 = Rs 16,000 unfavourable
Confirmation:
MPV Rs 3,200 (favourable)
MMSV 14,000 (favourable)
MYSV 16,000 (unfavourable)
TMCV 1,200 (favourable)

7.12: Table 7.4: Total actual labour cost and total standard labour cost of 2,000 units,
department-wise
Department Actual Standard
TAH AR TALC TSH AR TSLC
X 5,500 Rs16 Rs 88,000 6,000* Rs 15 Rs 90,000
Y 4,500 19 85,500 4,000** 20 80,000
10,000 1,73,500 10,000 Rs 1,70,000

*(2,000 units × 3 Hours = 6,000) ** (2,000 × 2 Hours per unit) = 4,000

Total labour cost variance (TLCV): (TALC – TSLC)

= (Rs 1,73,500 – Rs 1,70,000) = Rs 3,500 (unfavourable)
TLCV is sub-divided into two sub-variances:
(i) Labour rate variance (LRV): (AR – SR) × TAH
Department X (Rs 16 – Rs 15) × 5,500 Hours = Rs 5,500 (unfavourable)
Y (Rs 19 – Rs 20) × 4,500 Hours = Rs 4,500 (favourable)
Rs1,000 (unfavourable)
(ii) Labour efficiency variance (LEV): (TAH – TSH) × SR per hour

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 Department X (5,500 Hours – 6,000) × Rs 15 = Rs 7,500 (favourable)
Y (4,500 Hours – 4,000) × 20 = 10,000 (unfavourable)
2,500 (unfavourable
Confirmation:
LRV Rs 1,000 (unfavourable)
LEV 2,500 (unfavourable)
TLCV 3,500 (unfavourable)

7.13: Table 7.5: Total actual manufacturing cost and total standard manufacturing cost of
1,000 units
Cost items Actual costs (total) Standard costs (total)
Material 4,800 kgs. × Rs 25 Rs 1,20,000 Rs 100 × 1,000 Rs 1,00,000
Labour 2,200 Hours × Rs 16 35,200 30 × 1,000 30,000
Variable overheads 2,200 Hours × Rs 9 19,800 20 × 1,000 20,000
1,75,000 1,50,000

Total cost variance: (TAC – TSC)

= (Rs 1,75,000 – Rs 1,50,000) = Rs 25,000 (unfavourable)

(a) Total material cost variance (TMCV): (TAMC – TSMC)

= (Rs 1,20,000 – Rs 1,00,000) = Rs 20,000 (unfavourable)
(i) Material price variance (MPV): (AP – SP) × TAQ
= (Rs 25 – Rs 20) × 4,800 kgs. = Rs 24,000 (unfavourable)
(ii) Material quantity variance (MQV): (TAQ – TSQ) × SP per kg.
= (4,800 kgs. – 5,000 kgs.*) × Rs 20 = Rs 4,000 (favourable)
* (SQ per unit is 5 kgs. × 1,000 units output).
(b) Total labour cost variance (TLCV): (TALC – TSLC)
= (Rs 35,200 – Rs 30,000) = Rs 5,200 (unfavourable)
(i) Labour rate variance (LRV): (AR – SR) × TAH
= (Rs 16 – Rs 15) × 2,200 Hours = Rs 2,200 (unfavourable)
(ii) Labour efficiency variance (LEV): (TAH – TSH) × SR per hour
= (2,200 Hours – 2,000 Hours) × Rs 15 = Rs 3,000 (unfavourable)

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 (c) Total variable overhead cost variance (TVOCV): (TAVOC – TSVOC)
= (Rs 19,800 – Rs 20,000) = Rs 200 (favourable)
(i) Variable overhead efficiency variance (VOEV): (TAH – TSH) × SVOR per hour
= (2,200 Hours – 2,000 Hours) × Rs 10 = Rs 2,000 (unfavourable)
(ii) Variable overhead spending variance (VOSV): (AR – SR) ×TAH
= (Rs 9 – Rs 10) × 2,200 Hours = Rs 2,200 (favourable)

Statement reconciling total actual cost and total standard cost

Particulars Amount

Standard costs Rs 1,50,000

Less favourable cost variances
Material quantity variance Rs 4,000
Variable overhead spending variance 2,200 (6,200)
Add unfavourable cost variances
Material price variance Rs 24,000
Labour rate variance 2,200
Labour efficiency variance 3,000
Variable overhead efficiency variance 2,000 31,200
Actual costs 1,75,000

7.14: Total profit variance: (Total actual profit – Total budgeted profit)
Total actual profit:
Sales revenue (7,000 units × Rs 100) Rs 7,00,000
Less total actual costs:
Material costs Rs 1,53,000
Labour costs 90,000
Variable overheads 1,27,500
Fixed overheads 1,50,000 5,20,500
Actual profit 1,79,500

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Total budgeted profit
Standard profit per unit Rs 40
(×) Budgeted sales (units) × 10,000 units Rs 4,00,000
Total profit variance = (Rs 1,79,500 – Rs 4,00,000) = Rs 2,20,500 (unfavourable)

(A) Sales price variance: (ASP – BSP) × TAQ sold

(Rs 100 – Rs 100) × 7,000 units = Nil
(B) Sales quantity variance: (AQ – SQ/BQ) × Standard profit per unit
(7,000 units – 10,000 units) × Rs 40 = Rs 1,20,000 (unfavourable)
(C) Total cost variance: (Total actual cost – Total standard cost)
= (Rs 5,20,500 – Rs 60 × 7,000 units i.e., Rs 4,20,000) = Rs 1,00,500 (unfavourable)
(a) Material cost variance: (TAMC – TSMC)
= (Rs 1,53,000 – Rs 20 × 7,000 units = Rs 1,40,000) = Rs 13,000 (unfavourable)
(i) Material price variance: (AP – SP) ×TAQ in kgs.
= (Rs 9 – Rs 10) × 17,000 kgs. = Rs 17,000 (favourable)
(ii) Material quantity variance: (TAQ – TSQ) × SP per kg.
= (17,000 kgs. – 2 kgs. × 7,000 = 14,000 kgs.) × Rs 10 = Rs 30,000 (unfavourable)
(b) Labour cost variance: (TALC – TSLC)
= (Rs 90,000 – Rs 10 × 7,000 units = Rs 70,000) = Rs 20,000 (unfavourable)
(i) Labour rate variance: (AR – SR) × TAH
= (Rs 6 – Rs 5) ×15,000 Hours = Rs 15,000 (unfavourable)
(ii) Labour efficiency variance: (TAH – TSH) × SR per hour
= (15,000 Hours – 2 Hours × 7,000 units = 14,000) × Rs5 = Rs 5,000
(unfavourable)
(c) Variable overhead cost variance: (TAVOC – TSVOC)
= (Rs 1,27,500 – Rs 16 × 7,000 units = Rs 1,12,000) = Rs 15,500 (unfavourable)
(i) Variable overhead spending variance: (AR – SR) × TAH
= (Rs 8.5 – Rs 8.0) × 15,000 Hours = Rs 7,500 (unfavourable)
(ii) Variable overhead efficiency variance: (TAH – TSH) ×SVOR per hour
= (15,000 Hours – 14,000 Hours) × Rs 8 = Rs 8,000 (unfavourable)
(d) Fixed overhead cost variance: (TAFOC – TSFOC)

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 = (Rs 1,50,000 – Rs 14 × 7,000 = Rs 98,000) = Rs 52,000 (unfavourable)
(i) Fixed overhead spending variance: (TAFOC – Total budgeted fixed overhead
cost)
= (Rs 1,50,000 – Rs 1,40,000) = Rs 10,000 (unfavourable)
(ii) Fixed overhead efficiency variance: (TAH – TSH) × SFOR per hour
= (15,000 Hours – 14,000 Hours) × Rs 7 = Rs 7,000 (unfavourable)
(iii) Capacity variance: (Actual hours – Normal capacity in hours) × SFOR per hour
(15,000 Hours – 20,000 Hours) ×Rs 7 = Rs 35,000 (unfavourable)

Statement of Reconciliation of Actual Profit with Budgeted Profit

Budgeted profits Rs 4,00,000
Add favourable variances:
Material price variance 17,000
Less unfavourable variances:
Sales quantity variance Rs 1,20,000
Material quantity variance 30,000
Labour rate variance 15,000
Labour efficiency variance 5,000
Variable overhead spending variance 7,500
Variable overhead efficiency variance 8,000
Fixed overhead spending variance 10,000
Fixed overhead efficiency variance 7,000
Capacity variance 35,000 (2,37,500)
Actual profit 1,79,500*
* (Rs 4,17,000 – Rs 2,37,500)

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