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23.7 Describe How Companies Use Variance Analysis

Variance Analysis Overview​

Variance analysis compares actual costs to standard (or budgeted) costs to identify differences. It helps managers understand why actual results differ from expectations.

Materials Variances​

Total Materials Variance: Total Variance = Actual Cost - Standard Cost Total Variance = MPV + MQV

  1. Materials Price Variance (MPV)

    • Formula: (Actual Price - Standard Price) × Actual Quantity
    • Measures purchase price differences
    • Responsibility: Purchasing department
    • Causes: Supplier price changes, quality differences, purchasing efficiency

  2. Materials Quantity Variance (MQV)

    • Formula: (Actual Quantity - Standard Quantity) × Standard Price
    • Measures efficiency of material usage
    • Responsibility: Production department
    • Causes: Waste, theft, quality issues, production inefficiency

Example:

  • Standard price: €2 per kg
  • Standard quantity: 1,000 kg (for 1,000 units)
  • Actual price: €2.20 per kg
  • Actual quantity: 1,100 kg (for 1,000 units)

Calculations:

  • Actual cost: 1,100 × €2.20 = €2,420
  • Standard cost: 1,000 × €2.00 = €2,000
  • Total variance: €2,420 - €2,000 = €420 U

Variance Breakdown:

  • MPV = (€2.20 - €2.00) × 1,100 = €220 U (unfavorable)
  • MQV = (1,100 - 1,000) × €2.00 = €200 U (unfavorable)
  • Total: €220 + €200 = €420 U ✓

Analysis:

  • Price variance: Paid more than expected (supplier price increase or poor purchasing)
  • Quantity variance: Used more materials than expected (waste, quality issues, inefficiency)
  • Both need investigation

Labor Variances​

Total Labor Variance: Total Variance = Actual Labor Cost - Standard Labor Cost Total Variance = LRV + LEV

  1. Labor Rate Variance (LRV)

    • Formula: (Actual Rate - Standard Rate) × Actual Hours
    • Measures wage rate differences
    • Responsibility: HR/Payroll
    • Causes: Wage increases, overtime premiums, skill level differences

  2. Labor Efficiency Variance (LEV)

    • Formula: (Actual Hours - Standard Hours) × Standard Rate
    • Measures productivity differences
    • Responsibility: Production/Supervision
    • Causes: Inefficiency, training issues, equipment problems, worker skill

Example:

  • Standard rate: €25/hour
  • Standard hours: 200 hours (for 1,000 units)
  • Actual rate: €26/hour
  • Actual hours: 220 hours (for 1,000 units)

Calculations:

  • Actual cost: 220 × €26 = €5,720
  • Standard cost: 200 × €25 = €5,000
  • Total variance: €5,720 - €5,000 = €720 U

Variance Breakdown:

  • LRV = (€26 - €25) × 220 = €220 U (unfavorable)
  • LEV = (220 - 200) × €25 = €500 U (unfavorable)
  • Total: €220 + €500 = €720 U ✓

Analysis:

  • Rate variance: Paid higher wages (overtime, wage increase, different workers)
  • Efficiency variance: Took more hours than expected (inefficiency, training needed, equipment issues)
  • Both need investigation

Luxembourg Consideration:

  • Social charges affect total labor cost but are typically included in overhead
  • LRV should consider Luxembourg wage regulations
  • LEV may be affected by cross-border worker regulations

Overhead Variances​

Variable Overhead Variances:

  1. Variable Overhead Spending Variance

    • Formula: Actual VOH - (Actual Hours × Standard VOH Rate)
    • Measures spending differences
    • Responsibility: Department managers
    • Causes: Price changes, inefficient spending

  2. Variable Overhead Efficiency Variance

    • Formula: (Actual Hours - Standard Hours) × Standard VOH Rate
    • Measures efficiency (same as labor efficiency)
    • Responsibility: Production
    • Causes: Same as labor efficiency issues

Example:

  • Standard VOH rate: €5 per labor hour
  • Standard hours: 200
  • Actual VOH: €1,150
  • Actual hours: 220

Calculations:

  • Spending Variance: €1,150 - (220 × €5) = €1,150 - €1,100 = €50 U
  • Efficiency Variance: (220 - 200) × €5 = €100 U
  • Total VOH Variance: €50 + €100 = €150 U

Fixed Overhead Variances:

  1. Fixed Overhead Budget Variance

    • Formula: Actual Fixed Overhead - Budgeted Fixed Overhead
    • Measures spending control
    • Responsibility: Management
    • Causes: Unexpected costs, cost control issues

  2. Fixed Overhead Volume Variance

    • Formula: Budgeted Fixed Overhead - Applied Fixed Overhead
    • Measures capacity utilization
    • Responsibility: Sales/Production planning
    • Causes: Underutilization or overutilization of capacity

Example:

  • Budgeted fixed overhead: €30,000
  • Actual fixed overhead: €31,000
  • Standard hours: 200
  • Actual hours: 180
  • Predetermined rate: €30,000 ÷ 2,000 standard hours = €15 per hour

Calculations:

  • Budget Variance: €31,000 - €30,000 = €1,000 U
  • Applied Overhead: 200 × €15 = €3,000 (for this production)
  • Volume Variance: €30,000 - (2,000 × €15) = €0 (if at capacity)
    • Or: (Budgeted hours - Actual hours) × Rate
    • If budgeted 2,000 hours but only used 1,800: (2,000 - 1,800) × €15 = €3,000 U

Interpreting Variances​

  • Investigate significant variances (based on percentage or amount thresholds)
  • Determine causes (price changes, inefficiencies, errors)
  • Take corrective action if needed
  • Update standards/budgets if necessary

Behavioral Impact​

Variance analysis should focus on learning and improvement, not blame. Consider uncontrollable factors (market prices, regulations).

Luxembourg Compliance Note​

Variance analysis in Luxembourg SMEs helps identify cost increases (e.g., raw materials, energy). Variances should consider VAT-adjusted costs. Documentation may be needed for discussions with banks or investors.

Think It Through​

How can variance analysis help managers take proactive actions? What risks arise if variances are ignored?