Part 1 of this article deals with Direct Material & Direct Labour Variances.

Overhead variances
will be dealt with in a follow-up article.
Variance analysis is the comparison of actual costs with standard costs. The purpose of this
article is not to discuss the principles of standard costing as a technique but to consider the
calculation of variances and their interpretation.
A standard cost can be deemed to be the expected cost for a given activity. As a general rule
production costs can be sub-divided into three main elements – material, labour and overheads.
For each of these elements it is possible to set standard costs.
Consider Company A, who say, manufacture highly specialised plastic containers (Product X72)
for the chemical industry. Each of the containers will require a certain amount of raw material,
they will require a certain amount of labour time to produce and will incur certain production
overhead costs.
SETTING STANDARD COSTS
Direct material
The standard cost for the material content of a product will consist of two parts – the standard
(expected) quantity of material that will be needed and the standard (expected) price of that
material.
Assume that the container referred to above requires a standard of 4 kilograms of raw material
and that the price of the material is expected to be £3 per kilogram.
Standard Material Cost = Standard Quantity x Standard Price = 4 kilograms x £3 per kilogram =
£12
Direct labour
The standard cost for the labour cost of a product will consist of two parts – the standard
(expected) time required to make the items and the standard (expected) rate of pay for the
operatives.
Assume that the container referred to above requires a standard of 5 hours to make and that the
rate of pay is expected to be £3.60 per hour
Standard Labour Cost = Standard Time x Standard Rate of Pay = 5 hours x £4 per hour = £20
Production overheads
Production overheads whether they are variable or fixed in nature are normally absorbed into the
cost of a product on some predetermined basis.
For example, labour hours, machine hours or as a percentage of prime cost.
Assume that in the case of Company A variable overhead is absorbed at a rate of £1 per labour
hour and fixed overhead is absorbed at a rate of £3 per labour hour.
The standard variable overhead cost of the container would be = 5 hours at £1 per hour = £5 and
the standard fixed overhead cost of the container would be = 5 hours at £3 per hour = £15.
STANDARD COST CARD
From the above information the following standard cost card could be constructed:
Standard Cost Card
Product: Plastic Container X72 £
Direct material 4 kilograms @ £3 per kilogram 12
Direct labour 5 hours @ £4 per hour 20
Variable overhead 5 hours @ £1 per hour 5
Fixed overhead 5 hours @ £3 per hour 15
Standard production cost 52
CAUSATION OF VARIANCES
Variances will occur if in any given production period the actual costs vary from the standard
costs. For example, if the price paid for material bought during a given production period,
differed from the standard (expected) price for that material, a material price variance will arise.
Similarly if the amount of material actually used exceeded the standard (expected) usage a
material usage variance will arise.
COMPANY A PRODUCTION DATA FOR MONTH 1
Assume that in Month 1, Company A produced and sold 9,500 Containers and that the following
cost information applied:

Direct Material used: 37,000 kilograms at a total cost of £119,880

Direct Labour hours paid for: 49,200 hours at a total cost of £200,736

Variable overhead incurred: £47,000

Fixed overhead incurred: £145,000
Fixed overheads are budgeted at £150,000 per month

CALCULATION OF VARIANCES – DIRECT MATERIALS

Total material cost variance
The total standard material cost of 9,500 containers should have been £114,000 (that is
9,500containers x 4 kilograms @ £3 per kilogram).
The actual cost was in fact £119,880, so an overall adverse direct material variance of £5,880
arose during Month 1.
Material price variance
Examination of the data reveals that the amount paid for material differed to the standard price.
The price actually paid was £3.24 per kilo (£119,880 / 37,000). This was £0.24 greater than the
standard price. As the quantity actually used was 37,000 kilos and there was an additional cost of
£0.24 per kilo the material price variance was £8,880 adverse. (37,000 x £0.24) This only
accounts for part of the overall material variance.
Material usage variance
The other part of the overall variance is accounted for by the material usage variance. In
producing 400 containers the total standard amount of material that should have been used was
38,000 kilograms (that is 9,500 x 4 kilograms). In fact during Month 1, only 37,000 kilograms
were used. This was below the standard usage. This saving in material at the standard material
price equates with a favourable material usage of £3,000 (1,000 kilograms @ £3 per kilo).
Adding the two variances together equates with the total material variance of £5,880 adverse
( £8,880 adverse price variance + £3,000 favourable usage variance).
CALCULATION OF VARIANCES – DIRECT LABOUR
Total direct labour variance
The total standard labour cost of 9,500 containers should have been £190,000 (that is 9,500
containers x 5 hours @ £4 per hour).
The actual cost was in fact £200,736, so an overall adverse direct labour variance of £10,736
arose during Month 1.
Direct labour rate variance
Examination of the data reveals that the amount paid per hour differed to the standard rate. The
rate actually paid was £4.08 per hour (£200,736 / 49,200).
This was £0.08 higher than the standard price. As the hours actually paid for were 49,200 hours
and there was an additional cost of £0.08 per hour the labour rate variance was £3,936 adverse.
This only accounts for part of the overall labour variance.
Direct labour efficiency variance
The other part of the overall variance is accounted for by the labour efficiency variance and
labour idle time variance. This measures how quickly the work was undertaken. In producing
9,500 containers the total standard time that should have been taken was 47,500 hours . In fact
during Month 1, the work took 49,200 hours. This meant the work took 1,700 hours longer than
expected.. This additional time at standard labour rates equates with an adverse labour efficiency
variance of £6,800 (1,700 hours @ £4 per hour).
Summarising the labour variances would give:
The adverse rate variance of £3,936 adverse, plus the adverse efficiency variance of £6,800 = the
total adverse labour variance of £10,736..
OVERHEAD VARIANCES
These will be discussed in part 2 of this article, which will appear in a later bulletin.
USEFULNESS OF VARIANCES TO MANAGEMENT
Variances highlight to management that everything has not gone to plan. They highlight that
problems may exist and direct management attention to them. If management are aware that
there have been departures from standards (expectations) they will be in a position to take action
to correct such departures. Significant adverse variances will, if left unchecked, have an adverse
effect on profitability. If favourable variance arise, they too should be investigated. It is possible
that a favourable variance has arisen because of some unknown factor that could in the future be
used to the advantage of the business.
POSSIBLE REASONS FOR DIRECT MATERIAL & DIRECT LABOUR VARIANCES
Material price: Lower or higher quality than standard quality
Change in price by supplier
Shortage of material
Material usage: Lower or higher quality than standard quality
Theft
Inexperienced operators
Labour rate: Unexpected wage increase
Using higher or lower grade labour than normal on the work undertaken
Labour efficiency: Using higher or lower grade labour than normal on the work undertaken
Standard of training
Quality of material
 Quality of equipment
INTER-RELATIONSHIP OF VARIANCES
Variances should not be viewed in isolation from each other. For example, an adverse material
price variance may be due to the fact that the material purchased was of a higher standard that
normal. This may mean that the usage variance for that material will be favourable because the
higher quality may result in less wastage than normal