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What is Variance Analysis?

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Accordingly, Variance Analysis helps the management of the business to:

Understand the amount of variance

Its occurrence and factors responsible for it

Take appropriate action to obviate or reduce such a variance

However, it is pertinent to note that not all variances reported through Variance Analysis are controllable. Some are Uncontrollable as well. An uncontrollable Variance is not amenable to control by individual or departmental action. It is caused by external factors such as a change in market conditions, fluctuations in demand and supply, etc, over which the business doesn’t have any control and, as such, is uncontrollable in nature.

Variance Analysis can be computed under each cost element for which standards have been established. Each such variance can be analyzed to ascertain the causes, and necessary action can be undertaken. For instance, Material Price Variance will help the business to understand the variance caused due to a change in the price of the material. Furthermore, by analyzing the total variances component-wise, a business can determine and isolate the causes of each variance.

Examples of Variance Analysis Example #1

The Standard Cost of Product AB manufactured by Ram International is furnished below:

Material (5 units @ Rs 4 each)

Rs 20

Labor (20 hours @ Rs 1.50 per hour)

Rs 30

Overhead expense

Rs 10

Total Product Cost

Rs 60

Actual Units produced were 8000 units, and Actual Cost is as follows:

Material ( 40500 units @ Rs 5 each)

Rs 202500

Labor ( 150000 hours @ Rs 1.60 per hour)

Rs 240000

Rs 90000

Total Cost

Rs 532500

Based on the above illustration, let’s do the Variance Analysis for each component of the Cost

Particulars

Standard Cost ( in Rs)

Actual Cost ( in Rs)

Variance ( in Rs)

Material 160000 (8000* 20) 202500 42500 (Adverse)

Lab0r 240000 ( 8000* 30) 240000 —

Overhead Expenses 80000 (8000*10) 90000 10000 (Adverse)

Total 480000 532500 52500 (Adverse)

Thus, by using Variance Analysis, Ram International can identify the cost components showing variation and take corrective actions accordingly.

Example #2

The Standard Material input required for 20000 kgs of a finished product is given below:

Material

Quantity ( in Kg)

Standard Rate Per Kg

Total (Quantity * Std Rate)

A 9000 20 180000

B 8000 40 320000

C 5000 60 300000

Total 22000 120 800000

And now, we have to calculate the standard output. We have a standard loss of 2000 kg

Standard Loss 2000

Standard Output 20000

Actual production in the period was 20000 kg. Details of Actual quantities of material used and the prices paid are as under:

Material

Quantity ( in Kg)

Purchase Price per Kg

Total (Quantity * Std Rate)

A 10000 19 190000

B 8500 42 357000

C 4500 65 292500

Total 23000 126 839000

And now, we have to calculate the Actual Cost. We have an actual loss of 3000 kg.

Actual Loss 3000

Actual Output 20000

Minus standard loss from Total Quality kg, we get actual output.

Based on the above illustration, let’s compute Material Cost Variance and Material Price Variance:

Material Cost Variance = Standard Cost – Actual Cost

Material Cost Variance = Rs (800000 – 839000)

Material Cost Variance = Rs 390000 (Adverse)

Now, we will find the Material Price Variance using the Material Price Variance.

Material Price Variance= Actual Quantity ( Standard Price- Actual Price)

Material A = 10000 (Rs 20- Rs 19)

Material A = Rs 10000 (Favorable)

Material B = 8500 (Rs 40- Rs 42)

Material B = Rs 17000 (Adverse)

Material C = 4500 (Rs 60- Rs 65)

Material C = Rs 22500 (Adverse)

Things to Remember About Variance Analysis

Variance Analysis helps identify the reasons for higher costs and deviations from standard costs. It helps management analyze whether the higher cost is justified or requires punitive actions to correct it.

Variances arising out of each factor should be correctly segregated. If a part of the variance due to one factor is wrongly attributed to or merged with that of another, the analysis report submitted to the Management can result in misleading and incorrect inferences.

There should be promptness in reporting Controllable Variances to the Management so that corrective actions can be undertaken timely.

Major Areas of Variance Analysis

Variance Analysis finds its utility in the below-mentioned cost areas of business:

Variance Analysis is suitable for finding Material Price Variances, which can be caused by changes in the market price of the material used in the manufacturing etc.

It is suitable for finding Material Usage Variances, which can be caused by spoilage in the usage of materials, inefficiency in production, etc.

It is useful in finding Labor Variance, subdivided into Labor Efficiency Variance and Labor Rate Variance. By doing such Labor Variance Analysis, reasons for variation can be unearthed.

Conclusion

Variance Analysis is an important measure in Cost Accounting. It involves an examination of variances in detail and evaluating them, which can be either based on cost or Sales and forms an integral part of the Standard Costing System. It is an important tool by which business managers ensure adequate control and undertake corrective action whenever needed (mostly in the case of Adverse Variation). However, it should be used on major cost and revenue items to safeguard the time and cost of analyzing the management.