Variance Analysis, Material and Labour Variance

Variance analysis is a method of analyzing the difference between actual results and expected or standard results. The purpose of variance analysis is to identify the reasons for the differences and take appropriate corrective action. Variance analysis is commonly used in budgeting and cost accounting to evaluate performance and control costs.

Variance analysis is a powerful tool for evaluating performance and controlling costs. By identifying variances and taking corrective action, businesses can improve their profitability and competitiveness in the marketplace. Variance analysis can be used for both financial and non-financial metrics, and can be applied in a variety of settings, including manufacturing, services, and healthcare.

Here are the key steps in variance analysis:

• Identify the standard: The first step in variance analysis is to identify the expected or standard result. This could be the budgeted amount, the expected cost, or the expected level of performance.
• Calculate the actual result: The actual result is calculated based on actual data, such as actual costs or actual performance.
• Calculate the variance: The variance is the difference between the actual result and the expected result. Variance can be calculated in absolute terms or as a percentage.
• Analyze the variance: The variance should be analyzed to determine the reasons for the difference between actual and expected results. This could involve comparing actual and expected costs, reviewing production processes, or evaluating performance metrics.
• Take corrective action: Based on the analysis of the variance, appropriate corrective action should be taken to address the underlying causes of the difference between actual and expected results. This could involve reducing costs, improving production processes, or setting new performance targets.

Material and labor variances are two types of variances commonly used in cost accounting to evaluate performance and control costs. Here’s an explanation of each variance, along with the formulas used to calculate them:

Material variance:

The material variance is the difference between the actual cost of materials used and the expected cost of materials used. It is calculated by subtracting the standard cost of materials used from the actual cost of materials used. The formula for material variance is:

Material variance = Actual cost of materials used – (Standard price x Actual quantity of materials used)

This formula can be broken down into two components:

Material price variance: This measures the difference between the actual price paid for materials and the expected price of materials. The formula for material price variance is:

Material price Variance = Actual quantity of materials used x (Actual price – Standard price)

Material usage variance: This measures the difference between the actual quantity of materials used and the expected quantity of materials used. The formula for material usage variance is:

Material usage Variance = Standard price x (Actual quantity of materials used – Standard quantity)

Labor variance:

The labor variance is the difference between the actual cost of labor and the expected cost of labor. It is calculated by subtracting the standard cost of labor from the actual cost of labor. The formula for labor variance is:

Labor Variance = Actual cost of labor – (Standard rate x Actual hours worked)

This formula can also be broken down into two components:

Labor rate variance: This measures the difference between the actual rate paid for labor and the expected rate of labor. The formula for labor rate variance is:

Labor rate variance = Actual hours worked x (Actual rate – Standard rate)

Labor efficiency variance: This measures the difference between the actual hours worked and the expected hours worked. The formula for labor efficiency variance is:

Labor efficiency Variance = Standard rate x (Actual hours worked – Standard hours allowed)

By calculating and analyzing material and labor variances, businesses can identify areas where costs are higher than expected and take corrective action to improve performance and profitability.

Question:

A manufacturing company produces 10,000 units of a product. The standard cost per unit for direct materials is $5 and the standard cost per unit for direct labor is $10. The actual cost per unit for direct materials is $6 and the actual cost per unit for direct labor is $11. The company used 100,000 pounds of direct materials at a cost of $600,000, and 50,000 hours of direct labor at a cost of $550,000. Calculate the material and labor variances.

Answer:

Material variance:

Actual cost of materials used = $600,000

Standard price per unit of direct materials = $5

Actual quantity of materials used = 100,000 pounds

Material variance = Actual cost of materials used – (Standard price x Actual quantity of materials used)

Material variance = $600,000 – ($5 x 100,000)

Material variance = $100,000 (Favorable)

Material price variance:

Actual quantity of materials used = 100,000 pounds

Actual price per unit of direct materials = $6

Standard price per unit of direct materials = $5

Material price variance = Actual quantity of materials used x (Actual price – Standard price)

Material price variance = 100,000 x ($6 – $5)

Material price variance = $100,000 (Unfavorable)

Material usage variance:

Standard price per unit of direct materials = $5

Actual quantity of materials used = 100,000 pounds

Standard quantity of materials allowed = (10,000 units x 10 pounds per unit) = 100,000 pounds

Material usage variance = Standard price x (Actual quantity of materials used – Standard quantity)

Material usage variance = $5 x (100,000 – 100,000)

Material usage variance = $0 (Favorable)

Labor variance:

Actual cost of labor = $550,000

Standard rate per hour of direct labor = $10

Actual hours worked = 50,000 hours

Labor variance = Actual cost of labor – (Standard rate x Actual hours worked)

Labor variance = $550,000 – ($10 x 50,000)

Labor variance = $50,000 (Unfavorable)

Labor rate variance:

Actual hours worked = 50,000 hours

Actual rate per hour of direct labor = $11

Standard rate per hour of direct labor = $10

Labor rate variance = Actual hours worked x (Actual rate – Standard rate)

Labor rate variance = 50,000 x ($11 – $10)

Labor rate variance = $50,000 (Unfavorable)

Labor efficiency variance:

Standard rate per hour of direct labor = $10

Actual hours worked = 50,000 hours

Standard hours allowed = (10,000 units x 5 hours per unit) = 50,000 hours

Labor efficiency variance = Standard rate x (Actual hours worked – Standard hours allowed)

Labor efficiency variance = $10 x (50,000 – 50,000)

Labor efficiency variance = $0 (Favorable)

In summary, the company had a favorable material usage variance of $0, a favorable material variance of $100,000, an unfavorable material price variance of $100,000, a favorable labor efficiency variance of $0, an unfavorable labor rate variance of $50,000, and an unfavorable labor variance of $50,000.