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Chapter 10
Advanced variances
Chapter learning objectives: Lead Component Indicative syllabus content A.1 Discuss costing methods and their results. (c) Apply standard costing methods including the reconciliation of budgeted and actual profit margins, distinguishing between planning and operational variances.
- Manufacturing standards for material, labour, variable overhead and fixed overhead.
- Standards and variances in service industries, public services (e.g. health and law enforcement) and the professions (e.g. labour mix variances in consultancies).
- Price/rate and usage/efficiency variances for materials, labour and variable overhead.
- Subdivision of total usage/efficiency variances into mix and yield variances.
- Note: The calculation of mix variances on both individual and average valuation bases is required.
- Fixed overhead expenditure and volume variances.
- Subdivision of the fixed overhead volume variance into capacity and efficiency variances.
- Sales price and sales volume variances (calculation of the latter on a unit basis related to revenue, gross profit and contribution).
- Sales mix and sales quantity variances. Application of these variances to all sectors including professional services and retail.
- Planning and operational variances.
- Variance analysis in an activity-based costing system.
1. Reasons for variances
- Many industries and processes require a variety of input materials.
- Furthermore, it is possible to vary this mix of materials.
2. Advanced material variances
- The mix variance represents the financial impact of using a different proportion of raw materials to the standard.
- The yield variance represents the financial impact of the input yielding a different level of output to the standard.
Material mix variance
- Material mix variance occurs when the actual mix of materials varies from the standard mix.
- If the mix changes so that a greater quantity of an expensive material is used, there will be an adverse variance.
- If the mix includes more of a cheaper material, there will be a favourable variance.
- Material mix variance can be calculated by two methods: o Individual units method o Weighted average method
- Individual units method:
- Identify the actual mix (actual proportion; actual total quantity).
- Divide the actual total quantity into the standard proportions.
- Calculate the difference for every type of material (the total of these differences should be 0).
- Multiply by the standard cost per kg of input material (this is the variance in money terms).
3. Advanced labour variances
- When a variety of labour is employed, the following advanced variances are calculated:
- Advanced labour variances are most relevant in the service sector.
- Most service industries employ different grades of labour.
- For example, an audit firm would have grades ranging from trainee to senior partner.
Labour mix variance
- Labour mix indicates the different types/grades of labour employed.
- Similar to the material mix, different grades of labour have different costs.
- When the standard mix of labour is different from the actual mix of labour, a variance arises.
- If more higher-grade labour is used, it will be costly, and hence, there will be an adverse variance.
- When more lower-grade labour is used, it will show up as a favourable variance.
- This is calculated by two methods, as with the material mix variance.
- Individual units method:
- Determine the actual hours in actual proportion of the grades of labour (the actual mix).
- Divide the actual total hours into the standard proportions.
- Calculate the difference between the actual (step 1) and standard mix (step 2).
- Multiply by the standard hourly rate.
- Get the mix variance in money terms.
- Weighted average method:
- Determine the actual hours in actual proportion to the grades of labour (the actual mix).
- Divide the actual total hours into the standard proportions.
- Calculate the difference between the actual (step 1) and standard mix (step 2).
- Calculate the standard weighted average cost of labour.
- Calculate the difference between the individual cost of each grade of labour and the weighted average cost of labour.
- Multiply the hours by the individual differences from the weighted average rate (step 3 x step 5).
Labour yield variance
- This variance measures the output from labour (working hours input).
- It measures the efficiency of the whole team of workers employed.
- When the actual output differs from the standard output from a specific number of hours input, a yield variance arises.
- Again, it is calculated as the material yield variance.
- Calculate the standard output expected from the actual hours input (the standard yield).
- Calculate the difference of the standard yield from the actual yield (i.e. the actual output from actual hours input).
- This gives the yield in terms of hours.
- Multiply these hours by the standard rate of labour to get the yield variance in money terms.
Mix and yield variances
- Mix and yield variances should only be calculated when the mix (material and labour) is deemed to be controllable by the management.
- When the mix is not controllable, only usage and efficiency variances are appropriate.
- The weighted average method provides a clearer picture, e.g. by showing which material is more expensive than the average.
- Limitations include:
- Cannot be analysed separately from one another.
- If the same yield can be attained from a cheaper mix, the standard would need revision.
- Trying to get a cheaper mix (favourable mix variance) would likely result in adverse yield variance.
Test Your Understanding 2 – Labour mix
Red Inc makes a single product for which the standard labour input per unit is: Skilled labour 6 hours @ $12 per hour Unskilled labour 4 hours @ $7 per hour
Advantages and disadvantages of advanced sales variances
Advantages Disadvantages
- The mix variance highlights individual product trends
- The mix variance helps strategies to be shaped by exploiting favourable variances
- Success of limited-edition products or new market launches can be evaluated through mix variance
- The quantity variance can identify changes in the market size or share
- Better accountability of managers handling different product lines - Cannot be useful in isolation (interdependence on other aspects, e.g. quality of material) - Sales mix variance is not useful for unrelated products in different markets - Difficult for companies to derive value when they have a wide range of products - Need to consider which factors are controllable for the variance to be beneficial
Test Your Understanding 3 – Sales mix
A business sells two products, X & Y. The following details are available for them: Standard mix (units) Standard profit ($ per unit) Average profit ($ per unit) X 2 5 Y 3 6 Total 5 (2×5)+(3×6)/5 5. Budgeted sales: 200 units X and 300 units Y Actual sales: 180 units X and 310 units Y A. Calculate the sales quantity profit variance and enter it in the blank __________ B. Calculate the sales mix profit variance using the individual units method and enter it in the blank ___________
5. Planning and operational variance
- Variances may also arise due to planning miscalculations.
- When this occurs, the variance is sub-divided into: o The planning variance: caused by an inaccurate original plan. o The operational variance: due to business decisions that caused a change in the actual results.
B. Calculate the operational variances in terms of price and usage and enter them in the given boxes: Operational material price variance Operational material usage variance
Causes of planning variances
- Planning variance means that the standard cost should have been different.
- It effectively implies improper estimation.
- It means shifting the responsibility for variance from operations to estimation.
- Therefore, there should be a strong case for revision of the standard cost.
- Some valid reasons may be: o Change in the main component/input material o Unforeseen events leading to substantial changes in material/labour rates o A radical new change/technology that changes working times
- Where planning variances are caused by multiple factors, there would consequently be multiple revisions.
- The operational variances are calculated with the most recent revision.
- And the total planning revision is split between multiple factors, showing the variance for each factor separately. Advantages Disadvantages More relevant in the fast-changing economies of today Time-consuming to keep calculating up-to-date standards Operational variances are more up- to-date with updated efficiency levels More data is required; where does it come from? Incorporating planning variance is more motivating for operational employees There is an element of subjectivity in deciding which factors should be accommodated in the ex-post standard Focuses and helps to improve the initial planning Can be manipulated to blame uncontrollable factors Planning and operational departments would conflict as to how much of the variance is their responsibility
6. Solutions to Test Your Understanding
Test Your Understanding 1 – Material mix
Material mix variance 501 F Material yield variance 13,999 F Material mix variance Material Std Mix Actual Material Usage (kg) Actual usage @ std mix (kg) Mix variance (kg) Std cost per kg ($) Mix Variance ($) A 10/30 1,000 833 167 (A) 5 835 (A) B 20/30 1,500 1,667 167 (F) 8 1,336 (F) 2,500 2,500 Mix variance 501 (F) Material yield variance Material Standard usage for actual output (kg) Actual usage at standard mix (kg) Yield variance (kg) Standard cost per kg ($) Yield variance ($) A 150 × 10 = 1,500 833 667 (F) 5 3 ,335 (F) B 150 × 20 = 3,000 1,667 1,333 (F) 8 10,664 (F) 4,500 2,500 Yield variance 13,999 (F)
Test Your Understanding 2 – Labour mix
Weighted average mix variance $5,250 F Yield variance $5,000 A Weighted average method Weighted average standard rate = !×$"#!!×$" ! !!"#$!! !!"#$ Weighted average standard rate = $10 per hour
Please note that the standard mix is the total unit sales (490) multiplied by 2/5 to give X and 3/5 to give Y.
Test Your Understanding 4 – Planning and operational variances
Solution to A Planning material price variance $2,240 F Planning material usage variance $5,600 A RSQ × RSP = 1,400 × 8 × $3.80 = $42, RSQ × SP = 1,400 × 8 × $4 = $44, Price variance = $2,240 F RSQ × SP = 1,400 × 8 × $4 = $44, SQ ×SQ = 1,400 × 7 × $4 = $39, Usage variance = $5,600 A Solution to B Operational material price variance $300 F Operational material usage variance $760 F AQ × AP = $41, AQ × RSP = 11,000 × $3.80 = $41, Operational price variance = $300 F AQ × RSP = 11,000 × $3.80 = $41, RSQ × RSP = 1,400 × 8 × $3.80 = $42, Operational usage variance = $760 F
8. Chapter summary
