5_variance_analysis

Question 1

What is Standard Costing?

Answer 1

A costing system that uses predetermined or target costs (standards) for products or services. These standards are set in advance and used as benchmarks to measure actual performance.

Question 2

What is a Standard Cost?

Answer 2

A predetermined or target cost for a unit of product or service. It represents what a cost SHOULD be under efficient operating conditions. Standards are set for materials, labour, and overheads.

Question 3

What is a Variance?

Answer 3

The difference between a standard (budgeted) cost and the actual cost incurred. Variances highlight where performance differs from expectations and require investigation.

Question 4

What is a Favourable (F) Variance?

Answer 4

A variance where actual results are BETTER than standard/budget:
- Actual costs are LOWER than standard (good)
- Actual revenue is HIGHER than standard (good)
- Actual profit is HIGHER than standard (good)
Favourable variances INCREASE profit.

Question 5

What is an Adverse (A) Variance?

Answer 5

A variance where actual results are WORSE than standard/budget:
- Actual costs are HIGHER than standard (bad)
- Actual revenue is LOWER than standard (bad)
- Actual profit is LOWER than standard (bad)
Adverse variances DECREASE profit.

Question 6

What is Material Price Variance (MPV)?

Answer 6

Measures the effect of paying a DIFFERENT PRICE for materials than the standard price. It isolates the impact of price changes from usage changes.

Question 7

Material Price Variance Formula

Answer 7

MPV = (Standard Price - Actual Price) × Actual Quantity Purchased/Used

Where:
- Standard Price = budgeted price per kg/unit
- Actual Price = actual price paid per kg/unit
- Actual Quantity = quantity purchased or used

Favourable if Standard Price > Actual Price (paid less than expected)
Adverse if Standard Price < Actual Price (paid more than expected)

Question 8

Material Price Variance Example 1

Answer 8

Standard price = £5 per kg
Actual price = £4.80 per kg
Actual quantity purchased = 1,000 kg

MPV = (£5 - £4.80) × 1,000 = £0.20 × 1,000 = £200 Favourable

We paid £0.20 less per kg, saving £200 total.

Question 9

Material Price Variance Example 2

Answer 9

Standard price = £8 per metre
Actual price = £8.50 per metre
Actual quantity = 2,500 metres

MPV = (£8 - £8.50) × 2,500 = -£0.50 × 2,500 = £1,250 Adverse

We paid £0.50 more per metre, costing £1,250 extra.

Question 10

What causes Material Price Variance?

Answer 10

Favourable MPV:
- Bulk discounts obtained
- Cheaper suppliers found
- Lower market prices
- Effective negotiation

Adverse MPV:
- Price increases from suppliers
- Buying higher quality materials
- Urgent purchases without negotiation
- Inflation

Question 11

What is Material Usage Variance (MUV)?

Answer 11

Measures the effect of using MORE or LESS material than the standard quantity for the actual output achieved. It isolates the impact of efficiency/waste from price changes.

Question 12

Material Usage Variance Formula

Answer 12

MUV = (Standard Quantity for Actual Output - Actual Quantity Used) × Standard Price

Where:
- Standard Quantity for Actual Output = standard usage per unit × actual units produced
- Actual Quantity Used = actual material used
- Standard Price = budgeted price per unit

Favourable if Standard Quantity > Actual Quantity (used less material)
Adverse if Standard Quantity < Actual Quantity (used more material)

Question 13

Material Usage Variance Example 1

Answer 13

Standard usage = 5 kg per unit, Standard price = £6 per kg
Actual production = 800 units
Actual quantity used = 3,800 kg

Standard quantity for 800 units = 5 kg × 800 = 4,000 kg
MUV = (4,000 - 3,800) × £6 = 200 kg × £6 = £1,200 Favourable

Used 200 kg less than expected, saving £1,200.

Question 14

Material Usage Variance Example 2

Answer 14

Standard usage = 3 metres per unit, Standard price = £10 per metre
Actual production = 1,000 units
Actual quantity used = 3,200 metres

Standard quantity for 1,000 units = 3 metres × 1,000 = 3,000 metres
MUV = (3,000 - 3,200) × £10 = -200 metres × £10 = £2,000 Adverse

Used 200 metres more than expected, costing £2,000 extra.

Question 15

What causes Material Usage Variance?

Answer 15

Favourable MUV:
- Less waste/scrap
- Better quality materials
- Skilled workers
- Efficient processes
- Better supervision

Adverse MUV:
- More waste/scrap
- Poor quality materials
- Inexperienced workers
- Machine breakdowns
- Poor supervision

Question 16

Total Material Variance Formula

Answer 16

Total Material Variance = Material Price Variance + Material Usage Variance

Or calculated directly:
Total Material Variance = (Standard Cost - Actual Cost) for actual output

Question 17

Total Material Variance Example

Answer 17

MPV = £200 Favourable
MUV = £2,000 Adverse
Total Material Variance = £200 F + £2,000 A = £1,800 Adverse

Overall, materials cost £1,800 more than standard for the output achieved.

Question 18

What is Labour Rate Variance (LRV)?

Answer 18

Measures the effect of paying a DIFFERENT HOURLY RATE to labour than the standard rate. It isolates the impact of wage rate changes from efficiency changes.

Question 19

Labour Rate Variance Formula

Answer 19

LRV = (Standard Rate - Actual Rate) × Actual Hours Worked

Where:
- Standard Rate = budgeted hourly wage rate
- Actual Rate = actual hourly wage rate paid
- Actual Hours Worked = total hours actually worked

Favourable if Standard Rate > Actual Rate (paid less per hour)
Adverse if Standard Rate < Actual Rate (paid more per hour)

Question 20

Labour Rate Variance Example 1

Answer 20

Standard rate = £12 per hour
Actual rate = £11.50 per hour
Actual hours worked = 2,000 hours

LRV = (£12 - £11.50) × 2,000 = £0.50 × 2,000 = £1,000 Favourable

Paid £0.50 less per hour, saving £1,000 total.

Question 21

Labour Rate Variance Example 2

Answer 21

Standard rate = £15 per hour
Actual rate = £16 per hour
Actual hours worked = 1,500 hours

LRV = (£15 - £16) × 1,500 = -£1 × 1,500 = £1,500 Adverse

Paid £1 more per hour, costing £1,500 extra.

Question 22

What causes Labour Rate Variance?

Answer 22

Favourable LRV:
- Using lower-grade workers
- Wage rate decreases
- Less overtime
- Efficient rostering

Adverse LRV:
- Using higher-grade workers
- Wage rate increases
- Overtime premiums
- Skilled labour shortage

Question 23

What is Labour Efficiency Variance (LEV)?

Answer 23

Measures the effect of labour taking MORE or LESS TIME than the standard hours for the actual output achieved. It isolates the impact of productivity from wage rate changes.

Question 24

Labour Efficiency Variance Formula

Answer 24

LEV = (Standard Hours for Actual Output - Actual Hours Worked) × Standard Rate

Where:
- Standard Hours for Actual Output = standard hours per unit × actual units produced
- Actual Hours Worked = actual hours worked
- Standard Rate = budgeted hourly rate

Favourable if Standard Hours > Actual Hours (took less time)
Adverse if Standard Hours < Actual Hours (took more time)

Question 25

Labour Efficiency Variance Example 1

Answer 25

Standard time = 2 hours per unit, Standard rate = £10 per hour Actual production = 500 units Actual hours worked = 950 hours Standard hours for 500 units = 2 hours × 500 = 1,000 hours LEV = (1,000 - 950) × £10 = 50 hours × £10 = £500 Favourable Workers were faster, taking 50 hours less, saving £500.

Question 26

Labour Efficiency Variance Example 2

Answer 26

Standard time = 3 hours per unit, Standard rate = £14 per hour Actual production = 400 units Actual hours worked = 1,300 hours Standard hours for 400 units = 3 hours × 400 = 1,200 hours LEV = (1,200 - 1,300) × £14 = -100 hours × £14 = £1,400 Adverse Workers took 100 hours more than expected, costing £1,400 extra.

Question 27

What causes Labour Efficiency Variance?

Answer 27

Favourable LEV: - Skilled/experienced workers - Good training - Better equipment/tools - Improved processes - Effective supervision - High motivation Adverse LEV: - Inexperienced workers - Poor training - Equipment breakdowns - Material quality issues - Poor supervision - Low motivation

Question 28

Total Labour Variance Formula

Answer 28

Total Labour Variance = Labour Rate Variance + Labour Efficiency Variance Or calculated directly: Total Labour Variance = (Standard Cost - Actual Cost) for actual output

Question 29

Total Labour Variance Example

Answer 29

LRV = £1,500 Adverse LEV = £500 Favourable Total Labour Variance = £1,500 A + £500 F = £1,000 Adverse Overall, labour cost £1,000 more than standard for the output achieved.

Question 30

What is Fixed Overhead Expenditure Variance?

Answer 30

Measures the difference between the budgeted fixed overhead costs and the actual fixed overhead costs incurred. This is a spending variance.

Question 31

Fixed Overhead Expenditure Variance Formula

Answer 31

Fixed Overhead Expenditure Variance = Budgeted Fixed Overheads - Actual Fixed Overheads Favourable if Budgeted > Actual (spent less than budgeted) Adverse if Budgeted < Actual (spent more than budgeted)

Question 32

Fixed Overhead Expenditure Variance Example 1

Answer 32

Budgeted fixed overheads = £50,000 Actual fixed overheads = £48,000 FO Expenditure Variance = £50,000 - £48,000 = £2,000 Favourable Spent £2,000 less than budgeted on fixed overheads.

Question 33

Fixed Overhead Expenditure Variance Example 2

Answer 33

Budgeted fixed overheads = £80,000 Actual fixed overheads = £85,000 FO Expenditure Variance = £80,000 - £85,000 = £5,000 Adverse Spent £5,000 more than budgeted on fixed overheads.

Question 34

What causes Fixed Overhead Expenditure Variance?

Answer 34

Favourable variance: - Rent reductions/negotiations - Lower insurance premiums - Reduced supervision costs - Energy efficiency savings Adverse variance: - Rent increases - Higher insurance costs - Additional supervision - Unexpected repairs

Question 35

What is Fixed Overhead Volume Variance?

Answer 35

Measures the difference between the standard cost of actual production and the budgeted cost. It arises because actual production volume differs from budgeted volume (only in absorption costing).

Question 36

Fixed Overhead Volume Variance Formula

Answer 36

FO Volume Variance = (Actual Units Produced - Budgeted Units) × OAR per unit Where OAR per unit = Budgeted Fixed Overheads / Budgeted Units Favourable if Actual Units > Budgeted Units (produced more) Adverse if Actual Units < Budgeted Units (produced less)

Question 37

Fixed Overhead Volume Variance Example 1

Answer 37

Budgeted production = 10,000 units Budgeted fixed overheads = £120,000 OAR per unit = £120,000 / 10,000 = £12 per unit Actual production = 10,500 units FO Volume Variance = (10,500 - 10,000) × £12 = 500 × £12 = £6,000 Favourable Produced 500 more units, absorbing £6,000 more fixed overhead.

Question 38

Fixed Overhead Volume Variance Example 2

Answer 38

Budgeted production = 5,000 units Budgeted fixed overheads = £75,000 OAR per unit = £75,000 / 5,000 = £15 per unit Actual production = 4,600 units FO Volume Variance = (4,600 - 5,000) × £15 = -400 × £15 = £6,000 Adverse Produced 400 fewer units, under-absorbing £6,000 fixed overhead.

Question 39

What causes Fixed Overhead Volume Variance?

Answer 39

Favourable variance: - Higher demand than expected - Better production efficiency - Fewer breakdowns - Improved capacity utilization Adverse variance: - Lower demand than expected - Production delays - Machine breakdowns - Material shortages - Labour issues

Question 40

Why investigate variances?

Answer 40

1. Identify problems early and take corrective action 2. Learn from favorable variances and replicate success 3. Improve future standards and budgets 4. Assess performance of managers and departments 5. Ensure standards remain realistic and achievable 6. Maintain control over operations

Question 41

When should variances be investigated?

Answer 41

1. When variance is SIGNIFICANT in monetary value 2. When variance exceeds a certain percentage threshold 3. When variance shows a trend (consistently adverse/favourable) 4. When variance is CONTROLLABLE by management 5. When investigation cost is justified by potential benefits

Question 42

What is Management by Exception?

Answer 42

A principle where managers focus attention on significant variances (exceptions) rather than routine items. This saves time and directs effort where it's most needed.