Bbma3203 T5

Topic X Variance
5 Analysis
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Interpret cost variance analysis result;
2. Explain the uses and importance of direct material variance
and direct labour varience;
3. Calculate direct material varience and direct labour varience;
4. Compute overhead variance; and
5. Examine the uses and importance of cost variance in decision
making.
X INTRODUCTION
The previous topic exposed students to standard costing as a measurement of
productivity and quality in an organisation. Productivity and quality can be
measured by comparing actual cost and standard cost. It then becomes
information that can be used by the management to conduct a performance
evaluation during a specific period.
However, in this topic, you will be exposed to variance analysis which is one of
the tools used in standard costing in conducting performance evaluation.
Following that, students will also be exposed to the uses and advantages of cost
variance other than examining in further detail, types of variance including price
variance and efficiency variance (quantity).
Copyright © Open University Malaysia (OUM)

144 X TOPIC 5 VARIANCE ANALYSIS
5.1 COST VARIANCE ANALYSIS

As explained, standard cost is often used as a benchmark for analysing or
evaluating the performance of an organisation. In cost control, actual cost will be
compared with standard cost in evaluating the performance of an organisation.
This can be achieved by conducting a variance analysis. From the result of this
analysis, we can conclude in general whether the achievement of the organisation
is satisfactory or otherwise.
This section will discuss cost variance analysis, specifically for the manufacturing
industry. In general, cost variance analysis for production cost is divided into
two types, which are price variance and efficiency variance or quantity variance.
It is calculated by multiplying the price difference with actual of input quantity.
Refer to Figure 5.1.
Figure 5.1: Two types of variance cost analysis
What is meant by price variance?
Price variance measures the extent a business can afford to maintain the price
of one unit of raw material input and labour within the standard price.
If a company pays less than the standard price, thus the price variance is
favourable. Conversely, if the company pays more than the standard price, the
price variance is regarded as unfavourable.
Price Variance = (Actual Price ă Standard Price) x Actual Quantity

TOPIC 5 VARIANCE ANALYSIS W 145
What is meant by efficiency variance?
Efficiency variance measures whether the quantity of material or labour used

to produce actual output is within the standard quantity allowed to produce
the amount of actual output.
Efficiency variance refers to the difference in quantity multiplied by the price of

one unit of input.
Efficiency Variance (Quantity) = (Actual Quantity ă Standard Quantity) x

Standard Price
If a company uses input quantity less than the standard input allowed, therefore
the efficiency variance is said to be favourable. Conversely, if a company uses
input more than the standard input, efficiency variance is regarded as
unfavourable.
Therefore, efficiency variance is calculated based on standard price. This is to

enable the company to view how the use of materials and labour affects the
profitability of the company. The efficiency aspect in using materials and labour
is within the control of the company.
Meanwhile, price variance illustrates how changes in the price of materials and
labour wage rate affects the profitability of the company. However, change in
price of materials and labour wage rate caused by changes in the current market
are beyond the control of the company.
Next, let us apply variance analysis. For the purpose of illustration, we will focus
on an example of a company that produces school uniforms.

Example 5.1
Uniform Expert Sdn. Bhd. takes orders and supplies school uniforms to most
supermarkets and clothing stores throughout Malaysia. The production
process is divided into two stages, which are the cutting process and the
stitching process. The production section supervisor together with the
management accountant have set the standards for direct materials and direct
labour as demonstrated in Table 5.1.
Table 5.1: Uniform Expert: Material and Direct Labour Standards
Standard Material Price:

Purchase Price Per Metre Cloth....................................... RM4.00
Carriage Cost Per Metre............................................... RM0.20
Total Standard Price Per Metre Cloth.............................. RM4.20
Standard Material Quantity:
Cloth in Finished Product..............................................
2.7 metres
Surplus of Material (normal)..........................................
0.3 metres
Total Standard Quantity Needed Per Unit Product..........
3.0 metres
Standard Wage Rate:

Wage Rate Per Hour................................................... RM4.00
Additional Allowance (15% of wage)........................ RM0.60
Total Standard Wage Rate Per Hour............................... RM4.60
Standard Quantity of Direct Labour Hours:
Direct Labour Required Per Unit Product......................... 4 hour
Standard quantity of direct materials constitutes the normal amount of direct

materials needed to produce one unit of the finished product. It also takes into
account or allows inefficiency and normal materials surplus.
Standard price of direct materials has taken into account all incurrable costs in
obtaining materials and transporting them to the factory. Material purchase
price is derived after deducting purchase discount, if any. Whereas carriage
inward cost will be added to the purchase price.
Standard quantity of direct labour hours refers to the normal direct labour
hours required to produce one unit of the final product. Meanwhile, the
standard rate of direct labour is the amount of wage and salary costs,
including additional allowances.

Look at Table 5.2. This table demonstrates actual costs incurred by the
production department throughout the month of March. Throughout the month
of March, the company has produced 4,000 school uniforms. Now, let us
compare the total actual cost with the total standard cost by applying variance
analysis.
Table 5.2: Uniform Expert: Actual Cost for the Month of March
Quantity of Direct Materials Bought................................15,000 metres

Price of Direct Materials Per Metre...................................RM3.90
Quantity of Direct Materials Used ...................................14,500 metres
Direct Labour Hours Used.................................................11,400 hours Wage Rate
Direct Labour Per Hour .....................................................RM4.40
SELF-CHECK 5.1
Elaborate what you have understood in relation to cost variance and

its functions.
5.2 DIRECT MATERIALS VARIANCE

You will want to know the value of what has been spent by the purchasing
manager for materials and most importantly, whether the manager has spent
more than necessary. The answer will be known by applying the variance
formulas as follows. Abbreviation for the following terms can be used to facilitate
the variance formula as follows.
QP = Quantity Purchased
AP = Actual Price
SP = Standard Price
AQ = Actual Quantity Used
SQ = Standard Quantity
Direct Materials Quantity Variance Direct Materials Price Variance

(AQ x SP) ă (SQ x SP) (QP x AP) ă (QP x SP)
= SP (AQ ă SQ) = QP (AP ă SP)

The calculation of direct material variance for the production of uniforms for the
month of March can be calculated by adding relevant information from Table 5.1
and Table 5.2 as follows:
Direct Materials Price Variance Direct Materials Quantity Variance

QP (AP ă SP) SP (AQ ă SQ)
= 15,000 (RM3.90 ă RM4.20) = RM4.20 [14,500 ă (4,000 x 3)]
= (RM4,500) Favourable = RM10,500 Unfavourable
A positive variance amount means that the actual cost exceeds the standard cost,
therefore, is unfavourable. Conversely, a variance amount that is negative means
the actual cost is less than the standard cost, therefore is said to be favourable.
Direct material price variance is said to be favourable because the actual
purchase price is less than the standard price.
This price variance explains why revenue from the operations of the company
will be RM4,500 higher because the company has paid less than the standard
price. This can be explained further by comparing the total actual cost with
standard cost for raw materials in the following calculations.
Standard Cost Actual Cost

Total Cost of Direct Materials Purchased RM63,000a RM58,000b
Total Cost of Direct Materials Used RM50,400c RM56,550d
Calculation:
(a) RM4.20 x 15,000 metres (b) RM3.90 x 15,000 metres

(c) RM4.20 x (3 metres x 4,000 units) (d) RM3.90 x 14,500 metres
You can observe that the standard cost amount above is calculated based on
actual output (4,000 units). With that, the purchasing department is estimated to
incur cost amounting RM63,000 only to produce 4,000 units of uniforms. But the
actual cost of direct material purchased is much lower, that is RM58,500. This
means that the purchase of materials was managed efficiently, that is without
spending more than is budgeted.
Meanwhile, direct materials quantity or efficiency variance is unfavourable. This

means that income from the operations of the company will be RM10,500 lower
because workers have used amount of cloth in excess of the standard. The
comparison information shows that the total actual cost of direct materials used
(RM56,550) is higher than the amount budgeted, which is RM50,400. As a whole,

the total variance for direct materials is not favourable, amounting to

RM6,000 (- 4,500 + 10,500).
Variance analysis does not provide related information on the cause of a

particular variance. It only states whether the variance is favourable or
unfavourable. The variances derived must be translated so that we will know
the causes of such variances. Thus, the managers involved must sit down to
discuss and take steps to investigate the causes of significant variances.
For material price variance, it is usually the manager or purchasing clerk who
will be responsible because they should know what causes the change in price. In
the previous example, a favourable price variance may be due to factors such as a
lower price offered by suppliers, purchase of materials per specifications,
company obtaining trade discount or cash discount for buying wholesale or
paying within the credit period, and perhaps carriage cost has fallen.
The production manager is usually the one responsible for material quantity
variance. Unfavourable quantity variance means that the company has used
more materials than required. This could be caused by machine failure, unskilled
labour or worker, materials that do not meet specification or are low in quality
and weak preparation. Sometimes, the purchasing manager has to be responsible
for the material quantity variance. This may be caused by the purchasing
manager buying poor quality materials to save cost.
ACTIVITY 5.1
Through your readings, explain what you have understood if the result of
the analysis showed a positive variance for direct material efficiency and
who will be held responsible for it.
Note that price variance is based on quantity purchased (QP) and quantity
variance is calculated using standard price (SP). For price variance, the
purchasing manager purchases materials not only for what is supposed to be
used, but for the actual amount used. So the price variance is the difference in
price multiplied by the actual quantity purchased.
Price Variance = Price Difference x Actual Quantity Purchased (AQ)

More so, based on the quantity bought, the purchasing manager will know at an
earlier stage, when purchasing, the difference between actual price and standard
price. Therefore, corrective or improvement measures can be identified
immediately for subsequent purchases.
Whereas the purchasing manager would prioritise production efficiency, thus

efficiency variance is calculated by multiplying the difference in quantity with
standard price. With that, the efficiency level of materials used will be known
after the completion of production, that is, after the actual amount of material
used is known.
Efficiency Variance (Quantity) = Quantity Difference x Standard Price (SP)
Often in the manufacturing industry, it involves various types of direct material.

In cases like this, price variance and direct material quantity is calculated for each
material. After that, the amount of variances will be combined to derive the
overall total variance.
5.3 DIRECT LABOUR VARIANCE

The calculation of Actual Cost and Standard Cost of Direct Labour for Uniform
Expert is shown in Table 5.3.
Table 5.3: Calculation of Actual Cost and Standard Cost of Direct Labour for
Uniform Expert
Type of Cost Cost Evaluation

Actual Cost of Direct Material RM4.40 x 11,400 hours
= RM50,160
Standard Cost of Direct Labour RM4.60 x (4 hours x 4,000 units)

= RM73,600
Based on Table 5.3, a comparison of the total actual cost of direct labour used,
that is RM50,160 (RM4.40 x 11,400 hours) is far much lower than the standard
cost for direct labour amounting RM73,600 (RM4.60 x (4 hours x 4,000 units). This
is due to two factors, the actual wage rate is lower than the standard rate and the
number of actual labour is only 11,400 hours. This is much lower than the
standard labour quantity of 16,000 hours. Both these factors will be shown more
clearly by calculating the direct labour rate variance and direct labour efficiency
variance. The formulas are as follows:

Direct Labour Efficiency Variance Direct Labour Rate Variance

(AH x SR) ă (SH x SR) (AH x AR) ă (AH x SR)
= SR (AH ă SH) = AH (AR − SR)
Abbreviation for the following terms will be used to facilitate the variance
formula.
AH = Actual hours used
AR = Actual rate per hour
SR = Standard rate per hour
SH = Standard hours allowed
Direct labour rate and efficiency variance for the production of uniforms in the
month of March can be calculated as follows based on the information in Table
5.1 and Table 5.2.
Direct Labour Rate Variance - RM 2,280 Favourable

Direct Labour Efficiency Variance - RM21,160 Favourable
Total Direct Labour Variance - RM23,440 Favourable
This means that the operating income of the company will be RM23,440 higher
because the company has paid a lower wage compared to the standard rate. This
is also caused by skilled workers which enabled labour hours needed for
production to be lower than the standard labour hours.
Normally, it is the personnel or human resources department which is responsible

in recruiting workers, providing industrial training and determining the workersÊ
wage and salary rates.
A favourable wage rate variance may be due to factors such as the recruitment of
unskilled workers, surplus of skilled workforce in the particular field in the
employment market and efficient supervision. The factors mentioned may result in
lower wages, or it may still be under control.
Efficiency variance is favourable as the direct labour hours used are lower than
standard hours. Rate variance is also favourable because the company pays
labourers at a lower wage rate compared to the standard rate. Both variances if
combined, will become the total variance for direct labour.

Try to recall the type of conditions which create positive or unfavourable direct
labour efficiency variance.
Should the production process involves several categories of labour or workers,

the labour rate and efficiency variance must be calculated for each category
separately. Following that, the variances amounts will be combined to derive the
overall total variance.
ACTIVITY 5.2
The following information was obtained from Syarikat Mila:

Actual direct labour hours 1,275
Actual direct labour cost RM16,605
Actual units produced 1,255 units
Direct labour standard rate RM12
Direct labour efficiency standard rate 1 hour per unit
Budgeted production 1,200 units
Required:
1. Determine direct labour rate variance.
2. Determine direct labour efficiency variance.
5.4 MANUFACTURING OVERHEADS

VARIANCE
Next, we will discuss the third variance, namely the manufacturing overhead
variance.
What is meant by overhead cost?
Overhead cost comprises expenses other than direct materials and direct
labour, such as indirect materials, supplies, utilities, wages of plant managers
and supervisors etc.
Because there is no relationship or direct involvement between the use of

overhead and product, the process of determining the standard cost for overhead
is quite complicated. So is the process of allocating overhead cost to production.

Before we continue our discussion on overhead variance, let us first examine

how manufacturing overhead is divided or allocated to production. For the same
reason, which is the absence of direct relation between input and output for
overhead cost, it is unreasonable to use only one basis to distribute all overhead
expenses. Alternatively, the company can distribute overhead cost to products
using basic activities such as direct labour hours, machine hours, actual output
units and others.
Assuming direct labour hours is made the basis of allocation, the requirement on
overhead is similar to the requirement towards direct labour hours. As soon as
the basis for allocation is chosen, the pre-determined rate or overhead standard
cost can be set for direct labour per hour and those similar to it. This standard
overhead is then used as a benchmark to monitor actual overhead expenses.
In general, you should know that there are two types of variance overheads:
(a) Flexible Budget Variance or Spending Variance

Shows how a manager can control or maintain total overhead expenses within
the amount budgeted, with or based on the total of actual output in the
corresponding period.
(b) Production Volume Variance (or Efficiency)
Is found when the actual quantity of output is different from the quantity of
expected output as noted in the master budgets or static budgets.
Both variances for this overhead is then combined to explain the difference
between standard overhead cost and actual overhead cost.
For the purpose of illustration of overhead variance analysis, you can refer to the
information for Uniform Expert Sdn. Bhd., a school uniform manufacturer. This
company allocates overhead cost based on the machine hours used. Standard
cost information, budgeted cost and actual cost of fixed and variable overheads
for the month of March, and production units are as demonstrated in Table 5.4.

Table 5.4: Uniform Expert: Overhead Cost Information
Standard Machine Hours Per Unit Product................................. 3.5 hours

Total Standard Machine Hours
(based on actual output = 3.5 x 4,000)........................................... 14,000 hours
Budgeted Variable Overhead Cost................................................ RM22,500
Budgeted Fixed Overhead Cost..................................................... RM16,400
Estimated Machine Hours.............................................................. 12,000 hours
Actual Machine Hours Used.......................................................... 13,800 hours
Actual Variable Overhead Cost..................................................... RM20,300
Actual Fixed Overhead Cost.......................................................... RM15,050
Normal Production Capacity Per Month..................................... 6,000 units
Actual Production (March)............................................................ 4,000 units
5.5 OVERHEAD VARIANCE

We will discuss in detail about overhead variance. Overhead variance can be
divided into two, namely:
Rajah 5.2: Two types of overhead variance
(a) Variable Overhead Variance (VOV)

Variable overhead variance can be described in detail as expense variance
and efficiency variance. The formula for the calculation for both variances
are as follows:
Spending Variance = Actual VOV ă (Budgeted VOV x Actual Basis)

= Actual Basis (Actual Rate ă Standard Rate)

Efficiency Variance = Standard Rate (Actual Basis ă Standard Basis on Actual

Output)
Variable overhead spending variance is the difference between variable

overhead cost and standard variable overhead cost at actual basis.
What is meant by actual basis?
Actual basis is the basis that is used to allocate overhead and for the stated
illustration, actual basis is the actual machine hours utilised.
Variable overhead efficiency variance meanwhile refers to the difference

between standard variable overhead cost at an actual basis and standard
variable overhead cost at a standard basis (based on actual output).
To understand further, let us calculate the variance for variable overhead

by adding the relevant Uniform Expert information (refer to Table 5.4) in
the formula provided.
Variance = Actual VOV ă (Budgeted VOV x Actual Basis)

= RM20,300 ă (RM1.07* x 13,800 hours)
= RM20,300 ă RM14,766
= + RM5,534 (Unfavourable)
Efficiency = Standard Rate (Actual Basis ă Standard Basis at

Variance Actual Output)
= RM1.07* [ 13,800 ă (3.5 hours x 4,000 units) ]
= RM214 (Favourable)
* Standard variable overhead rate per machine hour = RM22,500/(6,000 units

x 3.5 hours)
= RM1.07
Unfavourable expense variance illustrates that the actual rate of variable
overhead, that is RM1.47 per machine hour (RM20,300/13,800 hours)
exceeds the standard rate (RM1.07 machine hours). While efficiency
variance is favourable due to actual basis (13,800 machine hours) being
lower than the allowed basis at actual output (14,000 machine hours).
Variance analysis for variable overhead can be illustrated in the chart
shown in Figure 5.3.
Figure 5.3: Variable overhead variance analysis
If you would like to examine the causes of differences in the rates for
variable overhead, you will need to examine the price or rate for each item
combined in the variable overheads such as electricity supply, telephone,
water, indirect materials, indirect labour and so on. A higher rate may be
caused by surplus or wastage in using these items or there is a price
increase.
For a favourable variable overhead efficiency variance, it is directly related

to the basis used to absorp overhead. In the Figure 5.3 illustration, actual
machine hours used is said to be efficient or favourable, thus the company
is regarded as efficient in using its variable overheads. Because both
variances have a direct relationship, the company has to be careful in its
choice of basis activities for the allocation of overhead cost to production.
(a) Fixed Overhead Variance (FOV)

Now, let us look at the second variance overhead, which is the fixed
overhead variance. Fixed overhead variance can be divided into two types,
namely:
(i) Budget variance; and
(ii) Production volume variance.
Calculation for both variances is by using the following formula.
Budget Variance = Actual FOV ă Budgeted FOV
Production Volume Variance = Budgeted FOV ă Absorbed FOV
= Standard Rate (pre-determined) x

(Forecast Basis ă Standard Basis)
= Budgeted FOV ă (Standard Rate x

Standard Basis at Actual Output)
Fixed overhead budget variance is the difference between the total of actual fixed
overhead and budgeted fixed overhead. Whereas production volume variance
will exist due to total fixed overhead budgeted, is not the same as total overhead
absorbed into product. Overhead will be absorbed to the product at standard
basis based on actual output. In the illustration before this, the standard basis is
standard machine hours (5.5 hours per product unit) at actual output which is
4,000 units.
Returning to Uniform Expert, we will calculate fixed overhead variance by taking

the relevant information from Table 5.4 and incorporating it into the following
formula. Absorbed FOV
Budget Variance = Actual FOV ă Budgeted FOV

= RM15,050 ă RM16,400
= ă RM1,350 (Favourable)
Production Volume V a r i a n c e = Estimated FOV ă Absorbed FOV

= RM16,400 ă (RM1.37* x 3.5 hours x 4,000 units)
= RM16,400 ă RM19,180
= ă RM2,780 (Favourable)
* Standard fixed overhead rate (pre-determined) = RM16,400/12,000 = RM1.37.

This analysis can be demonstrated in Figure 5.4. Analysis results demonstrate

both variances as favourable. Fixed overhead budget variance is almost the same
as variable overhead expenses variance, of which actual overhead expenses is
usually difficult to control by managers.
Figure 5.4: Fixed overhead analysis variance
Production volume variance demonstrates how a company uses existing facilities

and amenities in a factory or manufacturing plant. Therefore, it bears no relation
to expenses. A favourable production volume variance means the company is
operating at its capacity. On the other hand, if the variance is unfavourable, this
means the company is operating below its existing capacity.
Based on the corresponding discussion with regard to both variances mentioned,

we can summarise the following. First, there are two categories of cost variance,
namely:
(a) Price variance; and
(b) Efficiency variance (quantity).
The separation between these two variances is important because different
managers are responsible for purchase and input usage and both of these two
activities occur at different times.
Second, price variance and efficiency variance (quantity) can be calculated for all
three cost elements (materials, direct labour and variable overhead), even though
this variance is not known by the same term. For example, for direct materials, it
is known as direct materials price variance, but it is called direct labour rate
variance for direct labour cost and is known as variable overhead expense
variance for variable overhead cost.
Third, even though price variance is known by a different term, it is calculated in

the same way. The same goes for efficiency variance (quantity).
Fourth, actual cost variance analysis is an analysis in the form of input-output.

Input stands for actual quantity of direct materials, direct labour and
overheads.Whereas, output represents product manufactured during that period.
This output is stated in terms of standard quantity allowed based on actual
output, which means amount of materials, labour and overheads that should
have been used to produce actual output for that period.
ACTIVITY 5.3
1. Syarikat Ebi adopts variable overhead for its production at a basis of

RM22 per direct labour hour. Standard labour efficiency rate is 0.5
hours per unit. Last month, the company produced 14,500 units and
used 7,300 direct labour hours. Actual variable overhead cost is
RM162,000.
Required:
(a) Determine the variable overhead expense variance.
(b) Determine the variable overhead efficiency variance.
2. Syarikat Manjalara uses fixed overhead at a rate of RM4.60 per direct

labour hour. Fixed overhead is budgeted at RM910,800 per month.
Direct labour efficiency rate is 3 hours per unit. Even though the unit
budgeted is 66,000, the company has managed to produce 67,800
units. Actual direct labour hours for production is 203,000 and
overhead cost incurred is RM920,000.
Required:
(a) Determine fixed overhead budget variance.
(b) What is the difference between planned units and actual units
produced.
(c) Determine fixed overhead volume variance.

5.6 USES AND IMPORTANCE OF COST

VARIANCE
You must remember that cost variances do not identify the source of the
problem, but rather raise questions and direct attention or focus of the manager.
As such, the source for the existence of variance probably may or may not be
controlled by the manager. In your opinion, would it be approriate for all
variances found be given attention and investigated for its causes?
Variances can occur all the time. Small variances are usually regarded as normal
and managers will not conduct further investigation. Significant and
unfavourable amount of variances are probably indicating that there are
problems which may obstruct the company from achieving its targets as per
budgeted. While significant and favourable variances may illustrate that there is
space and opportunity to implement continuous cost reduction methods.
However, there are cases where favourable variances can indicate a situation
which is worse than that attributed to unfavourable variances. For example, a
favourable variance for the amount of meat in a slice of burger means that a
lesser amount of meat is used compared to what is determined by the standard.
The effect, complaints may come from customers who are not satisfied with the
quality of the burger.
A summary of categories of variances can be seen in Figure 5.5.
Figure 5.5: Categories of variances and its importance

When is a variance considered large or significant? The significance of a variance

depends on the judgement of the management. No specific rules interpret how a
variance is considered to be significant. Normally, a company will set their own
criteria whether the source of the said variance should be investigated or not.
After setting the criteria, the manager will investigate all variances included in
the significant category, not counting whether the variances are favourable or
otherwise.
When should a variance be brought to the attention of the management?
Before significant variances are investigated further, the manager must also
compare between the expected benefit and incurrable cost of the investigation
(cost-benefit analysis). Assuming the cost of investigating is larger than its
benefit, it will not be profitable to continue with the investigation. Following that,
after the investigation is conducted, it will be evaluated and corrective measures
and improvement actions will be taken. Figure 5.6 simplifies the steps that must
be taken by a company when conducting an investigation on any variance.
Figure 5.6: Steps that must be taken by a company when conducting variance
investigation

A variance which is significant can be measured through its relative size, that is
in the amount of RM or in the form of percentages. A basis value will be used to
measure the size of variance, for instance, standard cost or targetted profit.
For example, a manager may neglect a variance which is less than 8% of standard
cost, because he believes that such variances are normal. Among the normal
practices of a company is to invetigate all variances exceeding RM10,000 or
investigate all similar variances or those exceeding 8% of standard cost.
In a previous illustration, Uniform Expert incurred only 11,400 direct labour

hours compared to 16,000 standard hours allowed. The labour hours
consumption variance which is favourable, almost 29% [(11,400 ă 16,000)/16,000]
less than standard hours may be due to trained and skilled workers. This
variance or difference of 29% can be considered as significant and the
management should investigate further.
There is a probability that the standard labour hour rates determined is too low,
while in normal conditions, a worker can prepare a product in faster time than
the standard time. If this actually occurs, a revision in standard labour hours
must be made to realistically demonstrate the capacity of workers.
You must understand that favourable labour efficiency variance can also occur
when the manager recruits workers that are too skilled or possess qualifications
beyond the required level. Surely workers such as these are more efficient, but
the wage rate may exceed the standard rate. The impact is, the company will face
wage rate variance that is unfavourable.
Materials of good quality and machines that runs smoothly also contributes to
favourable labour efficiency variance. Quality materials may be acquired at a
much higher price, which will be demonstrated in the materials price variance. In
short, we must carefully understand variance because variances that are
favourable sometimes give an adverse effect to other variances and also to the
profitability of the company as a whole.
You should also know repeated variances may need further investigation. With
variance, we can study its trend or direction. Variances that constantly occur and
can be forecasted probably shows that the standard cost which was determined is
not suitable or realistic. If that is the reason, the manager must revise the
standard cost used.

When and How Often Should Variances be Calculated?
Usually, variance analysis is conducted at the end of a certain period, for

example monthly, quarterly or daily according to requirement. If the company
has a business contract with suppliers, and has a good relationship and
understanding with the workers union, the tendency for significant price
variances are less.
Thus comparison between actual cost and standard cost is performed monthly or
quarterly is sufficient. On the other hand, if efficiency variance occurs repeatedly,
the manager may monitor the use of raw materials and direct labour hours every
day, perhaps even every hour. Continuous monitoring is not burdensome, in fact
it is an easy process if systems such as computerised input of data and a bar
coding system are available.
Senior management has to be very careful when using cost variance in evaluating
performance. This is because some source of variances are beyond the control of
managers, for example price increase in the market. You must also understand
that price and efficiency variances are inter-related. For example, a personnel
manager may decide to only employ skilled workers to guarantee the quality of
the product produced. Surely then, wage and salary rate will be more costly. In a
case like this, price variance which is unfavourable may not be balanced wholly
by an efficiency variance which is favourable.
Senior management too must not evaluate the performance of managers based
on one benchmark only. Evaluation based on a single variance will encourage
managers to take actions towards making the relevant variance look good, but
this may lead to an adverse impact on the company in the long-term.
Example 5.5
For example, to reduce cost, the purchasing manager may buy poor quality
materials. As a result, more expenses may be incurred when more products
are defective or returned. The purchasing manager may have bought a large
quantity, more than is needed for the purpose of obtaining a good price and a
discount. The impact is that the company will have to bear a higher inventory
storage cost, and the possibility of materials becoming obsolete, defective and
pilfering will also increase. Due to this, performance evaluation must be based
on several basis or other factors including financial and non-financial
methods.
In addition, the managers also have to shift their focus from positive matters and
to be wary of unexpected impacts or consequences.

ACTIVITY 5.4
Based on your understanding, when should a cost variance be

investigated further?
• From the topic that we have discussed, it can be summarised that a variance
analysis can assist in controlling costs.
• Variances for direct materials, direct labour and overheads can be calculated
through variance analysis using the formulas given.
• Moreover, the manager will also be able to identify significant variances

guided by company and industryÊs best practices, and following their own
respective judgements and criteria.
• Significant variances are usually investigated to pinpoint its causes.
• The following factors are taken into account in determining whether a

variance requires further investigation or not; size of variance, frequency of
varience occurence, trend or direction of variance and controllability of
variances.
• The senior management must exercise caution when using variances for
whatever purposes to prevent any unexpected negative consequences.
Direct materials quantity standard Price variance

Efficiency variance Variable overhead efficiency variance
Fixed overhead budget variance Variable overhead spending variance
Overhead cost

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Topic X Variance

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5.1 COST VARIANCE ANALYSIS

Figure 5.1: Two types of variance cost analysis

What is meant by price variance?

Price Variance = (Actual Price ă Standard Price) x Actual Quantity

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What is meant by efficiency variance?

Efficiency variance measures whether the quantity of material or labour used

Efficiency variance refers to the difference in quantity multiplied by the price of

Efficiency Variance (Quantity) = (Actual Quantity ă Standard Quantity) x

Therefore, efficiency variance is calculated based on standard price. This is to

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Standard Material Price:

Standard Wage Rate:

Standard quantity of direct materials constitutes the normal amount of direct

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Quantity of Direct Materials Bought................................15,000 metres

Elaborate what you have understood in relation to cost variance and

5.2 DIRECT MATERIALS VARIANCE

Direct Materials Quantity Variance Direct Materials Price Variance

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Direct Materials Price Variance Direct Materials Quantity Variance

Standard Cost Actual Cost

(a) RM4.20 x 15,000 metres (b) RM3.90 x 15,000 metres

Meanwhile, direct materials quantity or efficiency variance is unfavourable. This

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the total variance for direct materials is not favourable, amounting to

Variance analysis does not provide related information on the cause of a

Price Variance = Price Difference x Actual Quantity Purchased (AQ)

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Whereas the purchasing manager would prioritise production efficiency, thus

Efficiency Variance (Quantity) = Quantity Difference x Standard Price (SP)

Often in the manufacturing industry, it involves various types of direct material.

5.3 DIRECT LABOUR VARIANCE

Type of Cost Cost Evaluation

Standard Cost of Direct Labour RM4.60 x (4 hours x 4,000 units)

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Direct Labour Efficiency Variance Direct Labour Rate Variance

Direct Labour Rate Variance - RM 2,280 Favourable

Total Direct Labour Variance - RM23,440 Favourable

Normally, it is the personnel or human resources department which is responsible

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Should the production process involves several categories of labour or workers,

The following information was obtained from Syarikat Mila:

5.4 MANUFACTURING OVERHEADS

What is meant by overhead cost?

Because there is no relationship or direct involvement between the use of

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Before we continue our discussion on overhead variance, let us first examine

(a) Flexible Budget Variance or Spending Variance

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Table 5.4: Uniform Expert: Overhead Cost Information

Standard Machine Hours Per Unit Product................................. 3.5 hours

5.5 OVERHEAD VARIANCE

Rajah 5.2: Two types of overhead variance

(a) Variable Overhead Variance (VOV)

Spending Variance = Actual VOV ă (Budgeted VOV x Actual Basis)

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Efficiency Variance = Standard Rate (Actual Basis ă Standard Basis on Actual

Variable overhead spending variance is the difference between variable

What is meant by actual basis?

Variable overhead efficiency variance meanwhile refers to the difference