# Cost Variance Analysis

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## Cost Variance Analysis

It is useful for employee motivation, product costing and budgeting. Setting Direct Materials Standards Standard Quantity Industrial engineers develop specification for the kinds and quantities of materials used in producing the goods budgeted. Operation schedules list the materials and quantities required for the expected volume of production. Standard Price – Information from the operation schedule and bills of material established jointly by the engineering department, the manufacturing supervisor and the accountant becomes the basis for the material price standard.

Variance Analysis – Analysis of variances reveals that causes of aviations between standard and actual costs. This feedback aids in planning future goals, controlling costs and evaluating performance. Variances – are the difference between standard and actual costs. A variance is considered FAVORABLE if actual costs are less than the standard costs, UNFAVORABLE if actual costs exceed standard costs. Setting Labor Standards Standard Time Examination of past payroll and production records can reveal the worker-hours used on various jobs and can help determine performance.

Time reports from the workers for a limited period will be a good basis for the standard. If possible, time and motion study should be the basis for the standard The time study seeks to develop time standards and price rates which the average operator can meet daily Standard Labor Rate Labor rates should be determined by considering the current rates as well as the competitive markets. Methods in determining the labor rate standards:

1. A company may establish a standard rate for the job, regardless of who performs the job, the rates stays the same, or

2. A company may establish a rate for an individual worker and the worker receives this rate regardless of the work performed. If labor contracts exist, the wage is relatively fixed and can be used as standard. Setting Overhead Standards Factory overhead cost standards provide a means of allocating factory overhead to cost inventories for pricing decisions and controlling expenses A capacity level is selected as the volume based or denominator capacity. Costs are allocated on a volume related or non-volume related base. Commonly used volume-related basis:

a. Machine hours

b. Direct labor-hours

c. Direct labor costs

d. Direct materials costs

e. Units or production

After expressing volume based on machine hours, number of inspection, or another basis, the factory incurred at this level is estimated. Responsibility: the Purchasing Department is usually responsible for material price variances. However, the Production Department could be responsible for unfavorable price variance occurring (1) because of a request for rush order due to poor scheduling or (2) when they specify certain brand-name materials or materials of certain grade or quality other those initially included in the bill of materials.

The possible causes of materials quantity or usage variance are as follows: Waste and loss of materials in handling and processing Us obstruction of defective or non-standard materials Spoilage or production Of excess scrap because or inexperienced workers or poor supervision Lack of proper tools or machines Variation yields from materials Responsibility. Production line supervisors responsible for materials under their control. Would be held Operating Performance Analysis of Variances Evaluation The variance or difference between actual costs and standard costs can be separated and analyzed into two components: Variance and Efficiency Variance Price DIRECT MATERIALS VARIANCE ANALYSIS Difference between actual costs and standard cost of materials used is called material cost variance This variance is made up of a price variance and a usage or quantity or efficiency variance The possible causes of materials price variance are as follows:

1 .

Fluctuations in market price of materials Purchasing from distant suppliers, which results in additional transportation costs Failure to take cash discounts available purchasing materials of substandard quality or in uneconomical lots unfavorable purchase terms Diagram of Direct Materials Variance Actual AS X AP Inputs at Standard Price ASPS Price variance Flexible Production Budget Quantity variance Total variance

AS = actual quantity AP = actual price SQ standard quantity allowed for actual output SP = standard price FORMULAS: Materials Price Variance Actual price p xx Less: Standard Price xx Difference in Price Multiplied by: Actual Quantity Purchased* Unfavorable (Favorable) p xx Materials Quantity Variance Actual Quantity P xx Less: Standard Quantity Difference in Quantity unfavorable (Favorable) actual quantity used if quantity purchased is not known SAMPLE PROBLEM: MATERIALS VARIANCE BBC Company has budgeted 50,000 units of output using 50,000 units of raw materials at a total material cost of

P 100,000. Actual output was 50,000 units of product that require 45,000 units at a cost of PA. 10 per unit. The direct material price variance and usage variance are: b. D. Price P 4,500 p 4,500 F p 5,000 F POI,oho usage POI,500 POI,ADD p 4,500 SOLUTION: Material Quantity Variance Actual Price Actual Quantity 45,000 50,000 Difference in Sty 5,000 x Standard Price Material Usage P 2. 10 (PAID,oho / 50,000 units) x Actual Sty used Material Price Answer: 2. 00 P 0. 10 45,000 DIRECT LABOR VARIANCE ANALYSIS Labor cost variance is the difference between actual labor cost and standard labor cost.

This variance may be analyzed into two components namely: the labor rate variance and the labor usage or efficiency variance The possible causes of labor rate variance are as follows: Inexperienced workers hired Change in labor rate particularly peak season that has not been incorporated in standard rate Use of an employee having a wage classification other than that assumed when the standard for a job was set use of a greater number of higher-paid employees in the group than anticipated.