Wednesday, December 24, 2008


Variance Analysis.
A variance is the difference between planned, budgeted, or standard cost & actual cost; and similarly for revenue.
The process by which the total difference between standard & actual results is analyzed is known as variance analysis.
Variance can be divided into three(3) main groups.
  • Variable cost variances,
  • Sales variances,
  • Fixed production overhead variances,
Direct Material Cost Variances.
The Direct material total variance (The difference between what the output actually cost and what it should have cost , in terms of material) can be divided into two sub-variances.
  • The direct material price variance,
This is difference between the standard cost and the actual cost for the actual quantity of material used or purchased. In other words it analysis the difference between what the did cost and what it should have cost.
  • The direct material usage variance,
This is the difference between the standard quantity of materials that should have been used for the number of units actually produced and the actual quantity of materials used, valued at the standard cost per unit of material. In other words it is the difference between how much material should have been used and how much material was used, valued at standard cost.
When a production requires two or more raw materials in its make-up , it is after possible to sub-analyze the materials usage variance into materials mix and materials yield variances,
  • Direct materials mix and yield variances,
The mix variance is calculated as the difference between the actual total quantity used in the standards mix and the actual quantities used in the actual mix, valued at standards prices. If a greater proportion of the more expensive materials is used, there will be and adverse mix variance.
A yield variance is calculated as the difference between the standard output form what was actually input, and the actual output, valued at the standard cost per unit of output.
Mix & yield variances have not meaning and should never be calculated, unless they are a guide to control action. They are only appropriate in the following situation,
  1. Where proportions of materials in a mix are changeable & controllable,
  2. Where the usage variance of individual materials is of limited value because of the variability of the mix, and a combined yield variance for all the materials together is more helpful for control.
Materials variances and opening and closing stock--
In variance analysis , the problem is to decided the material price variance. Should it be calculated on the basis of materials purchased or on the basis of materials used.
The answer to this problem depend on how closing stocks of the raw materials will be valued.
  • If they are valued at standard cost, the price variance is calculated on material purchases in the period.
  • If they are valued at actual cost (FIFO) the price variance is calculated on materials used in production in the period.
A full standard costing system is usually in operation and therefore the price variance is usually calculated on purchases in the period.
There are main advantages in extracting the material price variance at the time of receipt,
  • If variance are extracted at the time of receipt they will be brought to the attention of managers earlier than if they are extracted as the material is used if it is necessary to correct any variances than management action can be more timely,
  • Since variances are detracted at the time of receipt , all stocks will be valued at standard price. This is administratively easier & it means that all issues from stocks can be made at standard price. If stocks are held at actual cost is necessary to made in a number of small batches this can be a time-consuming task, especially with a manual system.

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