Variance Analysis – Part 1

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If you find variance analysis to be a confusing topic, then you are not alone in this world. I’ve been teaching P1 for a while and most students I find tend to get muddled up when calculating the different variances. It also doesn’t help that there are just so many of them to remember.

But in my years of teaching, I’ve discovered a general model that’s used by many tutors and students alike to understand variances better. I’d like to share this with you today and I hope this helps you in some little way.

Below is a visual tip on what you need to remember when looking at variances. Please memorise. It will become useful in a second once we start using it.

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So we have a lot of different variances – sales variances, material variances, labour variances, and overhead variances. We also have price variances, usage variances, efficiency variances, expenditure variances, yield variances, mix variances, volume variances, etc. See how it can easily get confusing?

Do you still remember the table a couple of minutes ago? Good! Let’s try it on some Sales Variances. We have 2 main ones we will do today. One is called the selling price variance and the other is the sales volume profit variance.

Let’s bring back our table and determine which difference yields which variance. If we look at the first 2 columns, we have the same actual quantity. The price is the difference here. We have an actual price and a standard price. If we multiply the quantity and the price, and then subtract column 1’s result to column 2, we will get the price variance.

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Example information: Actual quantity sold was 500 at £5 per piece. It was originally forecast as £2 per piece.

So we will do the calculations as follows:
Actual quantity = 500 x actual price at £5 = £2500
Actual quantity = 500 x standard price at £2 = £1000
The difference of £1500 is a price difference (because we are calculating the difference between price rather than quantity). This is the selling price variance and it is a favourable variance.

Why did I say that? Well, the actual total sold in terms of quantity and price was a lot higher than what we were half expecting. If we look at the 3 columns, we could classify them as:

Column 1 – Actuals (because it is actual quantity and actual price)
Column 2 – Half Expected (because it is actual quantity but with standard price)
Column 3 – Budgeted (because it is standard quantity and standard price)

A simpler way to remember is, if the first column’s total (the actuals) is higher than the second (the half expected), then it is a favourable selling price variance. If it’s the other way around, then it is an adverse selling price variance.

Of course, this only works if the table and the cell descriptions do not change in any way.

Now let’s try the other side of the table where the quantities are the ones that’s changing. That is column 2 and 3 – see below table.

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Example information: Actual quantity sold was 500. It was originally forecast to sell 400 at £2 per piece.

So we will do the calculations as follows:
Actual quantity = 500 x standard price at £2 = £1000
Standard quantity = 400 x standard price at £2 = £800
The difference of £200 is a volume difference (because we are calculating the difference between quantities rather than the price). This is a sales volume profit variance. And it is a favourable one.

Again, as per prior explanation, if the second column’s total (the half expected) is higher than the third (the budgeted), then it is a favourable selling price variance. If it’s the other way around, then it is an adverse selling price variance.

Still with me on this? Ready for the next lot?

So let’s do Direct Material Variances this time. And let’s not overly complicate our example. We will use the same example as above except now instead of being sold, it is being used in production.

Example information: Actual quantity used was 500 with cost price of £5 per piece. It was originally forecast with cost of £2 per piece.

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The calculations would be as follows:
Actual quantity = 500 x actual price at £5 = £2500
Actual quantity = 500 x standard price at £2 = £1000
The difference of £1500 is a price difference. Because this pertains to direct material, the difference is referred to as direct material price variance.

So here’s the kicker. With regards being adverse or favourable, the direct material price variance in this case is an adverse one. You may wonder why it is the other way around compared to the selling price variance. The simple reason is that the selling price variance deals with income and so if the actuals are higher than the half expected and budgeted, that means we are getting more income. With direct material, it is an expense. So if the actuals are higher, this would mean we are spending more.

Let’s go onto our second direct material variance – the direct material usage variance. Again, let’s tweak the same example.

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Example information: Actual quantity used was 500. It was originally budgeted to use 400 at cost price of £2 per piece.

The calculations would be as follows:
Actual quantity = 500 x standard price at £2 = £1000
Standard quantity = 400 x standard price at £2 = £800
The difference of £200 is usage difference and is commonly referred to as direct material usage variance. It is an adverse one.

The sum of direct material price variance and direct material usage variance makes up direct material total variance.

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We have a few more variances to deal with, and I’ll put more up in the coming weeks. I’ll let you mull these variances and calculations over for now.

I hope you’ve gained a better understanding of the topic.

See you next week!

Operational OT course available here.

2 thoughts on “Variance Analysis – Part 1

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