EVALUATING PERFORMANCE
VARIANCE ANALYSES
A QUICK REVIEW
DEFINITIONS
Standard cost: CIMA Official Terminology defines standard cost as planned unit cost of a product, component or service.
Standard Costing: CIMA Official Terminology standard costing is a control technique that reports variances by comparing actual costs to pre-set standards so facilitating action through management by exception.
Management by Exception: CIMA Official Terminology defines management by exception as ‘the practice of concentrating on activities that require attention and ignoring those which appear to be conforming to expectations. Typically, standard cost variances or variances from budget are used to identify those activities that require attention.’
Variance: CIMA Official Terminology defines Variance as the difference between a planned, budgeted, or standard cost and the actual cost incurred. The same comparisons may be made for revenues.
Variances are, as such, either:
Favourable: A favourable variance is achieved when the actual performance is better than the expected results.
Adverse: An adverse variance is achieved when the actual performance is worse than the expected results.
Variance Analysis: CIMA Official Terminology defines Variance analysis as the evaluation of performance by means of variances, whose timely reporting should maximize the opportunity for managerial action.
THE ADVANTAGES OF STANDARD COSTING
1. Carefully planned standards aids the budgeting process.
2. Standard costs provide a yardstick against which actual costs can be measured.
5.2
SECTION A : STRATEGIC COST MANAGEMENT FOR DECISION MAKING
3. The setting of standards involves determining the best materials and methods which may lead to cost economies.
4. A target of ef ciency is set for employees to reach and cost consciousness is stimulated.
5. Variances can be calculated which enable the principle of ‘management by exception’ to be operated.
6. Only the variances which exceed acceptable tolerance limits need to be investigated by management with a view to control action.
7. Standard costs simplify the process of bookkeeping in cost accounting, because they are easier to use than LIFO, FIFO and weighted average costs.
8. Standard times simplify the process of production scheduling.
9. Standard performance levels might provide an incentive for individuals to achieve targets for themselves at work.
TYPES OF STANDARDS
Ideal Standard:
Some companies set their standards at the maximum degree of efficiency. Using such an ideal standard, they determine costs by considering estimated materials, labour, and overhead costs; the condition of the factory and machinery; and time for rest periods, holidays, and vacations—but make no allowances for inefficient conditions such as lost time, waste, or spoilage. This ideal standard can be achieved only under the most efficient operating conditions; therefore, it is practically unattainable, generally giving rise to unfavourable variances.
Attainable Standards:
From the potential problems of the ideal standard as discussed in the previous paragraph most companies set attainable standards that include such factors as lost time and normal waste and spoilage. These companies realize that some inefficiencies cannot be completely eliminated, so they design standards that can be met or even bettered in efficient production situations.
Criticisms of Standard Costing
(a) The use of standard costing relies on the existence of repetitive operations and relatively homogeneous output. Nowadays many organisations are forced continually to respond to customers’ changing requirements, with the result that output and operations are not so repetitive.
(
b) Standard costing systems were developed when the business environment was more stable and less prone to change. The current business environment is more dynamic and it is not possible to assume stable conditions.
(
(
c) Standard costing systems assume that performance to standard is acceptable. Today’s business environment is more focused on continuous improvement.
d) Standard costing was developed in an environment of predominantly mass production and repetitive assembly work. It is not particularly useful in today’s growing service sector of the economy.
USE OF STANDARD COSTING
1. Even when output is not standardized, it may be possible to identify a number of standard components and activities whose costs may be controlled effectively by the setting of standard costs and identi cation of variances.
2. The use of computer power enables standards to be updated rapidly and more frequently, so that they remain useful for the purposes of control by comparison.
3. The use of ideal standards and more demanding performance levels can combine the bene ts of continuous improvement and standard costing control.
4. Standard costing can be applied in service industries, where a measurable cost unit can be established.
STANDARD COSTING AND BUDGETARY CONTROL
Budgetary control and standard costing have the common objective of cost control by establishing pre-determined targets. These two techniques are similar in certain respects but differ in respect of other points.
Budgetary control is a system of planning and controlling costs. It involves the establishment of budgets, measurement of actual performance, comparison of actual performance with budgeted performance to develop the deviations and the analysis of the causes of variations for taking appropriate remedial steps.
Points of similarity between standard costing and budgetary control:
1. The establishment of predetermined targets of performance.
2. The measurement of actual performance.
3. The comparison of actual performance with the predetermined targets to nd out variations, if any.
4. Analysis of variations between actual and predetermined performance.
5. To take remedial action, where necessary.
Conceptual difference between standard costing and budgetary control:
1. Budgetary control deals with the operation of a department or business as a whole while standard costing mainly applies to manufacturing of a product or providing a service. As such budgetary control system is more extensive as it relates to the operations of the business as a whole and covers capital, sales and nancial expenses in addition to production. But standard costing is more intensive and is concerned with controlling amount involved in various elements of cost.
2. Standard costing can be adopted in a business without any particular policy. Sole object of standard costing is to maximise ef ciency in operation by determining standard costs before the start of operations. But in case of budgetary control, it is necessary to lay down the objective or the policy of the rm for the period for which budgets are being laid down.
3. Budgetary control is exercised by putting the budgets and actuals side by side. Variances are not revealed through the accounts. Under the Standard Costing system, actuals are recorded in accounts and the variances are revealed through different accounts.
5.4 SECTION A : STRATEGIC COST MANAGEMENT FOR DECISION MAKING
4. Budgetary control system can be employed in parts such as budget for cash, selling and distribution expenses, research and development expenses, but partial application of standard costing system is not possible.
IMPORTANT FORMULAS
Material Variances:
(
a) Total material cost variances = Standard cost – Actual cost
(
b) Materials Price Variance = (Std. Price – Actual Price) × Actual Quantity
(
(
c) Material Mix Variance = (Revised Standard Quantity – Actual Quantity) × Std. Price
d) Material Yield Variance = (Standard Quantity – Revised Standard Quantity) × Std. Price
(
e) Material Usage variance = (Standard Quantity – Actual Quantity) × Std. Price
(
f) Revised Standard Quantity = Actual Total Quantity divided in standard proportion
Labour Variances:
(
a) Labour Cost variance = Standard cost – Actual cost
(
(
b) Labour rate Variance = (Std. rate – Actual rate) × Actual Hours paid
c) Labour Ef ciency Variance = (Standard Hours – Actual Hours worked) × Std. rate
(
d) Labour Mix Variance = (Revised Standard Hours – Actual hours) × Std. rate
(
e) Labour Sub-Ef ciency Variance = (Standard Hours – Revised Standard Hours) × Std. rate
(
f) Idle time Variance = (Actual hours paid – Actual hours worked) × Std. rate
(
g) Revised standards hrs (RSH) = Actual total hours in standard proportion
Variable Overhead Variances:
(
a) Total Variable Overhead variance = Standard cost – Actual cost
(b) Variable Overhead Expenditure Variance = (Std. rate per hour – Actual rate per hour) × Actual hours
Or
Variable Overhead Expenditure Variance = (Std. rate per unit – Actual rate per unit) × Actual Units
(
c) Variable Overhead Ef ciency Variance = (Standard hours – Actual hours) × Std. rate per hour
Or
(d) Variable Overhead Ef ciency Variance = (Standard units – Actual units) × Std. rate per unit
Fixed Overhead Variances:
(
a) Fixed Overhead Cost Variance = Recovered Fixed Overheads – Actual Fixed Overheads
(b) Fixed Overhead Expenditure Variance = Budgeted xed overhead – Actual xed overhead
(
c) Fixed Overhead Volume Variance = Recovered Fixed Overheads – Budgeted Fixed Overheads
(d) Fixed Overhead Ef ciency Variance = Recovered Fixed Overheads – Standard Fixed Overheads
(
e) Fixed Overhead Calendar Variance = Revised Budgeted Fixed Overheads –Budgeted Fixed Overheads
(
(
f) Fixed Overhead Capacity Variance = Standard Overheads – Revised Budgeted Fixed Overheads
g) Recovered Fixed Overheads = Standard xed overhead rate per hours × Standard hours for actual production Or
Recovered Fixed Overheads = Standard xed overhead rate per unit × Standard units for actual production
(
h) Standard Fixed Overheads = Standard xed overhead rate per hour × Actual hour Or
Standard Fixed Overheads = Standard xed overhead rate per unit × Actual units
(i) Revised Budgeted Fixed Overheads = Budgeted Fixed overheads × Budgeted Days/Actual Days
Ratios relating to Fixed Overhead Variances:
(a) Ef ciency Ratio = (Standard hours for actual output ÷ Actual hours worked) × 100
(
b) Activity Ratio = (Standard hours for actual output ÷ Budgeted hours) × 100
(
c) Capacity Ratio = (Actual hours worked ÷ Budgeted hours) × 100
(d) Idle Capacity Ratio = (Budgeted hours – Actual hours worked) ÷ Budgeted hours × 100
Sales Variances:
(
a) Sales Value variance = Actual Sales – Standard Sales
(b) Sales Price Variance = (Actual Price – Std. Price) × Actual Quantity
(c) Sales Volume variance = (Actual Quantity – Std. Quantity) × Std. Price
(d) Sales Mix Variance = (Actual Quantity – Revised Standard Quantity) × Std. Price
(
e) Sales Sub-Volume Variance = (Revised Standard Quantity – Standard Quantity) × Std. Price
(f) Revised Standard Quantity = Actual Total Quantity divided in standard proportion
Sales Variances based on profit margin:
(a) Sales Margin Value variance = Actual Pro t – Standard Pro t
(b) Sales Margin Price Variance = (Actual Pro t per unit – Std. pro t per unit) × Actual Quantity
5.6 SECTION A : STRATEGIC COST MANAGEMENT FOR DECISION MAKING
(
(
c) Sales Margin Volume variance = (Actual Quantity – Std. Quantity) × Std. Pro t per unit
d) Sales Margin Mix Variance = (Actual Quantity – Revised Standard Quantity) × Std. Pro t per unit
(
e) Sales Margin Sub-Volume Variance = (Revised Standard Quantity – Standard Quantity) × Std. Pro t per unit
(
f) Revised Standard Quantity = Actual Total Quantity divided in standard proportion
(
h) Standard pro t = Standard Selling Price – Standard Cost
(i) Actual Pro t = Actual Selling Price – Standard Cost
PAST EXAMINATION QUESTIONS
OBJECTIVE QUESTIONS
Q. 1 The budgeted fixed overhead for the year 2015 amounted to ` 14,400. It is anticipated that 288 days would be worked during the year. During the month of February, 2015 only 20 days were worked. Find out Calendar Variance.
[Dec. 2015, 2 Marks]
Ans. Budgeted Fixed Overheads = 14,400/12 = ` 1,200
Budgeted Days = 288/12 = 24
Revised Budgeted Fixed Overheads = Budgeted Fixed overheads × Budgeted Days/Actual Days = 1,200 × 20/24 = ` 1,000
Fixed Overhead Calendar Variance = Revised Budgeted Fixed Overheads –Budgeted Fixed Overheads = 1,000 – 1,200 = 200 (A).
Q. 2 The information relating to the direct material cost of a company is as follows:
Standard price per unit ` 7.20
Actual quantity purchased in units 1600
Standard quantity allowed for actual production in units 1450
Material price variance on purchase (Favourable) ` 480
What is the actual purchase price per unit?
(a) ` 7.50 (b) ` 6.40
(c) ` 6.50 (d) ` 6.90
[June 2017, 2 Marks; Similar Question in June 2024, 2 Marks]
Ans. (d) ` 6.90
Working Note:
Material Price Variance (MPV) = Standard cost of Actual Quantity – Actual Cost
480 = 7.20 × 1,600 – Actual Cost
or, Actual Cost = 11,520 - 480 = 11,040
Actual Price/Unit = 11,040 ÷ 1,600 = ` 6.90.
Q. 3 The preparation and use of standard cost, their comparison with actual costs and the measurement and analysis of variances to originating causes is defined as:
(a) Marginal Costing
(b) Standard Costing
(c) Throughput Costing
(d) Kaizen Costing
[June 2017, 2 Marks]
Ans. (b) Standard Costing
Q. 4 The following figures are extracted from the books of a company:
Budgeted O/H ` 10,000 (Fixed ` 6,000, Variable ` 4,000)
Budgeted Hours 2,000
Actual O/H ` 10,400 (Fixed ` 6,100, Variable ` 4,300) Actual Hours 2,100
Variable O/H cost variance and Fixed O/H cost variance will be:
(a) 100 (A) and 200 (A)
(b) 100 (F) and 200 (F)
(c) 100 (A) and 200 (F)
(d) 200 (A) and 100 (F)
[Dec. 2017, 2 Marks]
Ans. (c) 100 (A) and 200 (F)
Working Note:
VOH per hour = 4,000/2,000 = ` 2 per hour
FOH per hour = 6,000/2,000 = ` 3 per hour
Variable O/H Cost variance = (2,100 × 2) – 4,300 = 4,200 – 4,300 = 100(A)
Fixed O/H Cost variance = (2,100 × 3) –6,100 = 6,300 – 6,100 = 200 (F)
Q. 5 In a factory where standard costing system is followed, the production department consumed 1,100 kgs of a material @ ` 8 per kg for product X resulting in material price variance of ` 2,200 (Fav) and material usage variance of ` 1,000 (Adv). What is the standard material cost of actual production of product X?
(a) 11,000 (b) 20,000
(c) 14,000 (d) 10,000
[June 2018, 2 Marks; Dec. 2024, 2 Marks; June 2025, 2 Marks]
Ans. (d) 10,000
Working Note:
Actual Cost + Favourable Cost Variance = Standard Cost
(1,100 × 8) + (2,200 – 1,000) = Standard Cost
8,800 + 1,200 = Standard Cost
Standard Cost = ` 10,000.
Q. 6 A company operates a standard absorption costing system. The budgeted fixed production overheads for the company for last year were ` 3,30,000 and budgeted output was 2,20,000 units. At the end of the company’s financial year, the total of the fixed production overheads debited to the Fixed Production Overhead Control Account was ` 2,60,000 and the actual output achieved was 2,00,000 units. The under/over absorption of overhead was
(a) ` 40,000 over absorbed.
(b) ` 40,000 under absorbed.
(c) ` 50,000 over absorbed.
(d) ` 50,000 under absorbed.
[Dec. 2018, 2 Marks]
Ans. (a) ` 40,000 over absorbed.
Working Note:
Overhead Absorption Rate = (3,30,000/ 2,20,000) = ` 1.50/unit
Overhead absorbed: 2,00,000 @ ` 1.50
Actual overhead
Over absorbed overhead 3,00,000 (2,60,000)
40,000
Q. 7 AB Ltd. uses standard cost system. The following information pertains to direct labour for Product X for the month of March, 2019:
Standard rate per hour ` 8
Actual rate per hour ` 8.40
Standard hours allowed for actual production 2,000 hours Labour Efficiency variance ` 1,600 (Adverse) What were the actual hours worked?
(a) 1,800
(b) 1,810
5.8
SECTION A : STRATEGIC COST MANAGEMENT FOR DECISION MAKING
(c) 2,200
(d) 2,190 [June 2019, 2 Marks]
Ans. (c) 2,200
Working Note:
Labour Efficiency Variance = (SH – AH) × SR
(2,000 – AH) × ` 8 = –` 1,600
(2,000 – AH) = –200
AH = 2,200 hours
Q. 8 The higher the actual hours worked,
(
a) The lower the capacity usage ratio.
(b) The higher the capacity usage ratio.
(
c) The lower the capacity utilization ratio.
(d) The higher the capacity utilization ratio. [Dec. 2019, 2 Marks]
Ans. (d) The higher the capacity utilization ratio.
Q. 9 A manufacturing company uses two types of materials. X and Y, for manufacture of a standard product. The following information is given:
Mix
Direct Materials Mix Variance is:
(a) ` 40 (fav.)
(b) ` 40 (unfav.)
(c) ` 80 (fav.)
(d) ` 80 (unfav.) [Dec. 2019, 2 Marks]
Ans. (b) ` 40 (unfav.)
Working Note:
RSQ for X = 200 3/5 = 120
RSQ for Y = 200 2/5 = 80
Material Mix Variance
A = 5 (120 – 112) = 40 (fav.)
B = 10 (80 – 88) = 80 (unfav.) = 40 (unfav.)
Q.10 A manufacturing company has the following information pertaining to a normal monthly production of 10,000 units of a product.
Standard factory overhead rates are based on a normal monthly volume of one standard direct hour per unit. Standard factory overhead rates per direct labor hour are: Fixed ` 6.00
Units actually produced in current month 9,000 units
Actual factory overhead costs incurred (Includes ` 70,000 fixed) ` 156,000
Actual direct labour hours 9,000 hours
The variable overhead spending variance is:
(a) ` 0 (b) ` 10,000 (F)
(c) ` 4,000 (F) (d) ` 86,000 (A)
[Dec. 2021, 1 Mark; Similar Question in Dec. 2023, 2 Marks]
Ans. (c) ` 4,000 (F)
Working Note:
Actual VOH = 1,56,000 – 70,000 = ` 86,000
Standard Hours for Actual Output = 9,000 1 = 9,000
VOH Spending Variance = AH (SR – AR) = (9,000 10) – 86,000 = ` 4,000 (F)
Q. 11 A factory is trying to establish standard time for a certain job. Workers arrive at 8:00 am, during the day take tea and lunch breaks for 1 ½ hours, machines need set up for ½ an hour and workers leave by 4 p.m. A worker can ideally produce a unit of output if he is at his job for two hours. How much is the standard labour hour per unit? [Dec. 2021, 1 Mark]
Ans. 2.67 hours
Working Note:
Time available at job = 8 hours (8:00 am to 4:00 pm)
Working Time = 8 – 1.50 – 0.50 = 6 hours
In a day 3 units can be made in 6 hours. (1 unit in 2 hours)
So Standard time = 8/3 = 2.67 hours.
Q. 12 RON Ltd., a manufacturer of product CEMO using a standard costing system provides the following information pertaining to the Direct Materials for the month of November, 2022:
1 tonne of material input yields standard output of (units) 1,00,000
Standard price of material per kg (`) 20
The Actual quantity of material used (Tonnes) 10
Actual price of material per kg (`) 21
Actual output obtained for the month (units) 9,00,000
Material Cost Variance will be:
(a) 40,000 (Adv)
(b) 40,000 (Fav)
(c) 30,000 (Adv)
(d) ` 25,000 (Adv) [Dec. 2022, 2 Marks]
Ans. (c) 30,000 (Adv)
Working Note:
Standard quantity for actual output = 9,00,000 1/1,00,000 = 9 tonnes
SP per tonne = 20 1,000 = ` 20,000
Standard Cost = 20,000 x 9 = ` 1,80,000
Actual Cost = 10 21 1,000 = ` 2,10,000
Material Cost Variance = 1,80,000 –2,10,000 = ` 30,000 (Adv)
Q. 13 BOSAN Ltd. using standard costing system provides the following information pertaining to Direct Labour for its product JUM for the month of May, 2023:
Standard Direct Labour Rate per hour: ` 16
Actual Direct Labour Rate per hour ` 14.50
Labour Rate variance ` 15,000 (Fav)
Standard hours allowed for Actual production 8,000 hours
Actual output is 800 units. How many Direct Labour hours were worked during the month of May, 2023?
(a) 12,000 hours
(b) 11,000 hours
(c) 10,000 hours
(d) None of the above [June 2023, 2 Marks]
Ans. (c) 10,000 hours
Working Note:
Labour rate Variance = AH (SR – AR) 15,000 = AH (16 – 14.50)
5.10 SECTION A : STRATEGIC COST MANAGEMENT FOR DECISION MAKING
15,000 = 1.50 AH
AH = 10,000
Q. 14 A Co. producing output X and Y uses standard costing. The standard overhead contents of each product is: X: ` 3 per unit and Y: ` 2.25 per unit. The budgeted overhead is ` 860 and budgeted time is 3,440 hours.
Actual Output:
X 200 units and Y 100 units.
Actual time: 3,200 hours
Actual overhead: ` 875. Compute Overhead Volume variance.
(a) ` 35 (A) (b) ` 35 (F) (c) ` 25 (F) (d) ` 15 (A)
[Dec. 2023, 2 Marks]
Ans. (a) ` 35 (A)
Working Note:
Recovered Fixed Overheads = (200 3) + (2.25 × 100) = ` 825
Fixed OH Volume Variance = 825 – 860 = ` 35 (A)
THEORY QUESTIONS
Q. 1 Mention four important Budget Ratios, which are used by the management to measure development from budgeted figure. [Dec. 2015, 2 Marks]
Ans. Budget Ratios provide information about the performance level. The following important Budget Ratios are usually used by the management to measure development from budget: (any four)
(i) Ef ciency ratio: Ef ciency ratio summarizes the relationship between output expressed in standard hours and actual hours spent for that output.
(ii) Activity ratio/Production volume ratio: This ratio refers to the relationship between output expressed in terms of standard hours and the budgeted standard hours.
(
iii) Calendar ratio: It refers to the relationship between actual number of working days in a period and the number of working days in the related budget period.
(iv) Actual capacity usage ratio: This ratio refers to the relationship between actual number of working hours and the maximum possible number of working hours in a period as per budget.
(
v) Actual usage of budgeted capacity ratio: This ratio refers to the relationship between actual number of working hours and the budgeted number of working hours for that period.
(vi) Standard capacity usage ratio: This ratio refers to the relationship between budgeted hours and maximum possible working hours in a budget period.
Q. 2 Write a short note on Differences between Standard Costing and Kaizen Costing. [Dec. 2018, 4 Marks]
Ans.
Standard Costing
Kaizen Costing
It is used for cost control. It is used for cost reduction. It is assumed that current manufacturing conditions remain unchanged. It assumes continuous improvement.
