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How To Calculate Cost Variances? [8 Types] Published

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There are many types of cost variance, which fall into the two general categories of price and efficiency variances. The price variance is the difference between the standard and actual price paid for anything, multiplied by the number of units of each item purchased. The derivations of price variances for materials, wages, variable overhead, and fixed overhead are as follows:

Materials Price Variance

This is based on the actual price paid for materials used in the production process, minus their standard cost, multiplied by the number of units used. It is typically reported to the purchasing manager. This calculation is a bit more complicated than it at first seems, since the actual cost is probably either the, FIFO, or average cost of an item (LIFO is no longer allowed).

Here are some additional areas to investigate if there is a materials price variance:

1. The standard price is based on a different purchase volume.
2. The standard price is incorrectly derived from a different component.
3. The materials were purchased on a rush basis.
4. The materials were purchased at a premium, due to a supply shortage.

Labor Price Variance

This is based on the actual price paid for the direct labor used in the production process, minus its standard cost, multiplied by the number of units used. It is typically reported to the managers of both production and human resources—the production manager because this person is responsible for staffing jobs with personnel at the correct wage rates, and the human resources manager because this person is responsible for setting the allowable wage rates that employees are paid. This tends to be a relatively small variance, as long as the standard labor rate is regularly revised to match actual labor rates in the production facility. Since most job categories tend to be clustered into relatively small pay ranges, there is not much chance that a labor price variance will become excessive.

Here are some areas to investigate if there is a labor price variance:

1. The standard labor rate has not been recently adjusted to reflect actual pay changes.
2. The actual labor rate includes overtime or shift differentials that were not included in the standard.
3. The staffing of jobs is with employees whose pay levels are different from those used to develop standards for those jobs.

To calculate this variance, subtract the standard variable overhead cost per unit from the actual cost incurred, and multiply the remainder by the total unit quantity of output. This is very similar to the material and labor price variances, since there are some overhead costs that are directly related to the volume of production, as is the case for materials and labor. The detailed report on this variance is usually sent to the production manager, who is responsible for all overhead incurred in the production area. This variance can require considerable analysis, for there may be a number of costs that fall into this category, all of which may be hiding significant variances.

Here are some areas to investigate if there is a variable overhead spending variance:

1. The cost of activities in any of the variable overhead accounts has been altered by the supplier.
2. The company has altered its purchasing methods for the variable overhead costs to or from the use of blanket purchase orders (which tend to result in lower prices due to higher purchase volumes).
3. Costs are being misclassified between the accounts, so that the spending variance appears too low in one account and too high in another.

This is the total amount by which fixed overhead costs exceed their total standard cost for the reporting period. Notice that, unlike the preceding price variance definitions, this one is not multiplied by any type of production volume. There is no way to relate this price variance to volume, since it is not directly tied to any sort of activity volume. The detailed variance report on this topic may be distributed to a number of people, depending on who is responsible for each general ledger account number that it contains. Investigation of variances in this area generally centers on a period-to-period comparison of prices charged to suppliers, with particular attention to those experiencing recent price increases. It may be beneficial to link this investigation to a summary of all contractual agreements with suppliers, since these documents will reveal any allowable pricing changes; only those not allowed by such agreements will still require further investigation.

The Efficiency Variance

The Efficiency Variance is the difference between the actual and standard usage of a resource, multiplied by the standard price of that resource. The efficiency variance applies to materials, labor, and variable overhead. It does not apply to fixed overhead costs, since these costs are incurred independently from any resource usage. Here is a closer examination of the efficiency variance. Here are variances under the “Effeciency Variance“:

Materials Yield Variance

Though its traditional name is slightly different, this is still an efficiency variance. It measures the ability of a company to manufacture a product using the exact amount of materials allowed by the standard. A variance will arise if the quantity of materials used differs from the preset standard. It is calculated by subtracting the total standard quantity of materials that are supposed to be used from the actual level of usage, and multiplying the remainder by the standard price per unit. This information is usually issued to the production manager.

Here are some of the areas to investigate to correct the material yield variance:

1. Excessive machine-related scrap rates
2. Poor material quality levels
3. Excessively tight tolerance for product rejections
4. Improper machine setup
5. Substitute materials that cause high reject rates

Labor Efficiency Variance

This measures the ability of a company’s direct labor staff to create products with the exact amount of labor set forth in the standard. A variance will arise if the quantity of labor used is different from the standard; note that this variance has nothing to do with the cost per unit of labor (which is the price variance), only the quantity of it that is consumed. It is calculated by subtracting the standard quantity of labor consumed from the actual amount, and multiplying the remainder times the standard labor rate per hour. As was the case for the material yield variance, it is most commonly reported to the production manager.

Here are the likely causes of the labor efficiency variance:

1. Employees have poor work instructions.
2. Employees are not adequately trained.
3. Too many employees are staffing a workstation.
4. The wrong mix of employees is staffing a workstation.
5. The labor standard used as a comparison is incorrect.

This measures the quantity of variable overhead required to produce a unit of production. For example, if the machine used to run a batch of product requires extra time to produce each product, there will be an additional charge to the product’s cost that is based on the price of the machine, multiplied by its cost per minute. This variance is not concerned with the machine’s cost per minute (which would be examined through a price variance analysis), but with the number of minutes required for the production of each unit. It is calculated by subtracting the budgeted units of activity on which the variable overhead is charged from the actual units of activity, times the standard variable overhead cost per unit. Depending on the nature of the costs that make up the pool of variable overhead costs, this variance may be reported to several managers, particularly the production manager. The causes of this variance will be tied to the unit of activity on which it is based. For example, if the variable overhead rate varies directly with the quantity of machine time used, then the main causes will be any action that changes the rate of machine usage. If the basis is the amount of materials used, then the causes will be those just noted for the materials yield variance.

Cost Variance Calculatin Summary and Its Connection

To sum-up, here is a set of cost variance calculation figure where actual and budgeted costs are extracted from the general ledger and posted in the upper-left corner, with all variance calculations details in the figure being derived from that information. 