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**Term Paper on Variance Analysis **

**Term Paper Contents:**

- Term Paper on the Meaning and Definition of Variance Analysis
- Term Paper on Favourable and Unfavourable Variance
- Term Paper on the Utility of Variance Analysis
- Term Paper on the Types of Variance Analysis

Term Paper # 1. Meaning and Definition of Variance Analysis

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Variance analysis is the process of analysing variance by subdividing the total variance in such a way that management can assign responsibility for off-standard performance. It, thus, involves the measurement of the deviation of actual performance from the intended performance.

That is, variance analysis is a tool to measure performances and based on the principle of management by exception. In variance analysis, the attention of management is drawn not only to the monetary value of unfavourable and favourable managerial performance but also to the responsibility and causes for the same.

After the standard costs have been fixed, the next stage in the operation of standard costing is to ascertain the actual cost of each element and compare them with the standard already set. Computation and analysis of variances is the main objective of standard costing. Actual cost and the standard cost is known as the ‘cost variance’.

Variance is the difference between standard and actual performance. If the standard cost is more than the actual cost, then this variance is called favourable variance else unfavourable variance. Material cost variance is the difference between standard material cost and actual material cost. Material cost variance arise due to change in price of material or change in usage of material. Labour variance is the difference between standard wage fixed and actual wage paid.

As per I.C.M.A, Variance Analysis is **“the resolution into constituent parts and explanation of variances”**. The definition indicates two aspects-resolutions into constituent parts is the first aspect which is nothing but subdivision of the total cost variance. Explanation of variance includes the probing and inquiry for causes and responsible persons.

Term Paper # 2. Favourable and Unfavourable Variance

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Variances may be favourable or unfavourable depending upon whether the actual resulting cost is less or more than the standard cost.

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**i. Favourable Variance****: **

When the actual cost incurred is less than the standard cost, the deviation is known as favourable variance. The effect of the favourable variance increases the profit. Again, favourable variance would result when the actual cost is lower than the standard cost. It is also known as positive or credit variance and viewed only as savings.

**ii. Unfavourable Variance****: **

When the actual cost incurred is more than the standard cost, there is a variance, known as unfavourable or adverse variance; unfavourable variance refers to deviation to the loss of the business. It is also known as negative or debit variance and viewed as additional costs or losses.

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When the profit is greater than the standard profit, it is known as favourable variance. When the profit is less than the standard profit, it is known as unfavourable variance. This favourable variance is a sign or efficiency of the organisation and the unfacourable variance is a sign of inefficiency of the organisation.

Term Paper # 3. Utility of Variance Analysis

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Variance analysis is a tool to measure performances and based on the principle of management by exception. In variance analysis, the attention of management is drawn not only to the monetary value of unfavourable and favourable managerial performance but also to the responsibility and causes for the same.

(i) Variance analysis subdivides the total variance based on difference contributory causes. This gives a clear picture of the different reasons for the overall variance.

(ii) The sub division of variance establishes and highlights the interrelationship between different variances.

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(iii) Variance analysis ‘explains’ the causes for each variance. It paves way for fixing responsibility for all variances.

(iv) It highlights all inefficient performances and the extent of inefficiency.

(v) It is a powerful tool leading to cost control.

(vi) It enables the top management to practice ‘management by exception’ by focusing on the problem areas.

(vii) It segregates variance into controllable and uncontrollable, thereby indicating where action is warranted.

(viii) It acts as the basis for profit planning

(ix) By revealing each and every deviation, along with the causes, variance analysis creates and nurtures ‘cost consciousness’ among the employees.

Term Paper # 4. Types of Variance Analysis

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**The following are the different types of variances: **

**A. Direct Material Cost Variance (MCV)****: **

It is the difference between standard materials cost and actual materials cost. If the actual cost is less than the standard cost, the variance is favourable and vice versa. MCV arises due to change in the price of the materials or a change in the usage of materials,

MCV = (SQ × SP) – (AQ × AP)

SQ = Standard Quantity

AQ = Actual Price

SP = Standard Price

AP = Actual Price

**The following chart show the components of material cost variance: **

**1. Material Price Variance (MPV): **

It is that part of material cost variance which is due to the difference between the standard price specified and the actual price paid.

**MPV = (SP – AP) AQ MPV arises due to the following reasons: **

(a) Changes in the market prices of materials

(b) Uneconomical size of purchase orders

(c) Uneconomical transport cost

(d) Failure to obtain cash discount

(e) Failure to purchase materials at proper time.

MPV is mainly the responsibility of the purchase manager. However, a general increase in prices would be uncontrollable.

**2. ****Material Usage Variance (MUV): **

It is the difference between the standard quantity specified and the actual quantity used.

MUV = (SQ – AQ) SP

MUV may arise due to

(a) Carelessness in use of materials

(b) Loss due to pilferage

(c) Faulty workmanship

(d) Defect in plant and machinery causing excessive consumption of materials. Production manager will be responsible for material usage variance.

**(i) ****Material Mix Variance (MMV): **

It is that part of material usage variance which arises due to change in standard and actual composition of mix.

MMV = (RSQ – AQ) SP;

RSQ – Revised Standard Quantity

This variance arises in industries like chemical, rubber etc. where definite proportions of different raw materials are mixed to get a product. Variations may arise due to general shortage or non-purchase of materials at the proper time.

**(ii) ****Material Yield Variance (MYV): **

It is a part of material usage variance. It is the difference between standard yield specified and actual yield obtained.

MYV = (Standard yield – Actual yield) Average standard price p.u. Or (Standard loss on actual input – Actual loss) Average standard price p.u.

**B. Labour Cost Variance (LCV): **

This is the difference between the standard wages specified and the actual wages paid.

LCV – (SH × SR) – (AH × AR).

**This is further divided into the following variances: **

**(i) ****Labour Rate Variance (LRV): **

It is the difference between the standard rate of wage specified and the actual rate paid.

LRV = (SR – AR) AH

Labour rate variance arises due to (a) changes in the basic wage rates (b) use of different methods of wage payment (c) unscheduled overtime.

**(ii) ****Labour Efficiency Variance (LEV): **

It is a part of labour cost variance. It is the difference between standard labour hours specified and actual labour hours spent.

LEV = (SH – AH) SR

This variance arises due to (a) lack of proper supervision (b) insufficient training (c) poor working conditions (d) increase in labour grades utilized

**(iii) ****Labour Mix Variance (LM V): **

This is the difference between the standard labour grade specified and the actual labour grade utilised.

LMV = (RSH – AH) SR

SH = Standard Hour

SR = Standard Rate

AH = Actual Hours

AR = Actual Rate

RSH = Revised Standard Hour.

**(iv) ****Labour Yield Variance (LYV): **

It is a part of labour efficiency variance. It arises due to the difference between standard yield and actual yield.

LYV = (Standard yield – Actual yield) Average Standard Rate p.u. Or (Standard loss on actual input – Actual loss) Average Standard Rate p.u.

**C. Overhead Cost Variance: **

This is the difference between the standard overhead specified and the actual overhead incurred.

Overhead Cost Variance = Standard overhead – Actual overhead. Generally, variances in overhead costs are divided into Variable overhead variance and fixed overhead variance.

**(a) ****Variable Overhead Variance: **

Variable overheads variance is the difference between the standard and actual variable overheads.

**(b) ****Fixed Overhead Variance: **

Fixed overheads variance is the difference between the standard and actual fixed overheads.

**Overheads variance is further divided into the following categories: **

**(i) ****Budget Variance or Expenditure Variance: **

This represents the difference between the budgeted expenses and the actual expenses incurred.

Budget Variance = Budgeted overhead – Actual overhead.

**This variance arises due to: **

(a) Inflation

(b) Lack of control over expenditure and

(c) Change in production method.

**(ii) ****Volume Variance: **

It is caused due to the difference between the budgeted outputs. In other words, this is the difference between the standard cost of overhead absorbed in actual output and the standard allowance allowed for the output.

Volume variance = (Actual production – Budgeted production) SR

**(iii) ****Efficiency Variance: **

It is that portion of volume variance which is due to the difference between the budgeted efficiency (in standard units) and the actual efficiency attained.

Efficiency variance = (Actual production – Standard production) SR

**(iv) ****Capacity Variance: **

It is the portion of volume variance which arises on account of over or under utilization of plant and equipment. It may be caused by idle time, strike and lock out, failure of power, machine break-down etc.

Capacity variance = (Standard production – Budgeted production) SR

**(v) ****Calendar Variance: **

It is a part of capacity variance. This variance arises due to the difference actual working days and the budgeted working days.

Calendar variance = (Revised budgeted production – Budgeted production) SR.

**Note:** SR refers to standard overhead rate per unit.

**D. Sales Variance****: **

**Sales variance may be sub-divided into the following variances: **

**(1) ****Sales Value Variance: **

The difference between actual sales and budgeted sales is termed as sales value variance.

Sales value variance = Actual sales – Standard sales

**(2) ****Sales Price Variance: **

It is the difference between the actual price and standard price, for actual quantity sold.

Sales price variance = (AP – SP) Actual Quantity sold.

**(3) ****Sales Volume Variance: **

It is the difference between the actual quantity of sales and the budgeted quantity of sales at standard price.

Sales volume variance = (Actual Qty. – Standard Qty.) SP

**(4) ****Sales Mix Variance: **

Mix variance represents that portion of volume variance which is due to a change in the proportion (or mix) of the various goods sold. This variance may arise only when more than one commodity is sold.

Sales mix variance = (Actual Qty. – Revised standard Qty.) SP