Flexible Budgets

Common Flexible Budget Variances in Manufacturing

Common Variances Explained

There are common variances that many manufacturers use.

Common variances in manufacturing include differences in the price and quantity of direct materials, labor cost and efficiency, and overhead cost and efficiency. A direct materials cost variance is the difference between the direct materials' actual costs and their standard costs. A direct materials quantity variance is the difference between the actual amount of direct materials used and the standard amount that the company expected to use.

A company can calculate labor and overhead cost variances based on its spending, its efficiency, or both. A labor cost variance is the difference between the actual cost of labor and the standard cost. A labor efficiency variance is the difference between the actual time used for production and the standard efficiency rate. For example, if the company's labor cost for its hourly workers is much higher than anticipated for the actual quantity of units sold, then the company may have a labor efficiency variance. The company would then want to investigate why its employees took much longer in the production process than expected.

Similar variances can also occur in overhead spending. Overhead includes costs such as rent, heating, air conditioning, and taxes. An overhead cost variance is the difference between the actual overhead incurred and the standard budgeted cost. An overhead efficiency variance is the difference between the actual overhead needed for production and the standard overhead that was planned.
The common variances that occur in manufacturing include labor, direct materials, and overhead. Within each of these categories, companies can evaluate costs as well as a combination of quantity and efficiency.
These variances will have a favorable or unfavorable effect on the company. For instance, a variance in the price of direct materials means that those materials could have cost more or less than expected. If the direct materials cost more than expected, this results in an unfavorable variance. This likely results in higher cost of goods sold and a reduced profit margin. If the materials cost less than expected, this results in a favorable variance.

The company should investigate the reason for the variance and whether it was favorable or unfavorable. Doing so may give the company valuable insight on where it can better use its resources.

Calculation of Common Variances

Variances in manufacturing can be calculated to give insight into the company's efficiency.
Companies calculate variances in manufacturing so they can figure out how to become more efficient. Variances they might calculate include direct materials cost variance, direct materials amount variance, and total variance. Each calculation compares the standard factor (cost, quantity, or both cost and quantity) with the actual factor.
Direct Materials Cost Variance=(Standard CostActual Cost)×Number of Units Sold\text{Direct Materials Cost Variance}=(\text{Standard Cost}-\text{Actual Cost})\times\text{Number of Units Sold}
Direct Materials Amount Variance=(Standard QuantityActual Quantity)×Standard Cost\text{Direct Materials Amount Variance}=(\text{Standard Quantity}-\text{Actual Quantity})\times\text{Standard Cost}
After calculating these two types of variances, the company will likely want to determine the total variance for direct materials as a category. The total variance can be determined through the use of an equation.
Total Variance=(Standard Cost×Standard Quantity)(Actual Cost×Actual Quantity){\text{Total Variance}=(\text{Standard Cost}\times\text{Standard Quantity})-(\text{Actual Cost}\times\text{Actual Quantity}})
A coffee bean company buys its coffee beans for $10 per pound, which means $10 is the standard cost per unit. The company prepackages the coffee beans into containers that weigh about 3.5 pounds each. In the last budget period, the company sold 500 containers of coffee beans. Thus, the standard quantity of coffee beans (the quantity of pounds the company should have used for 500 containers) is 1,750 pounds (500Containers×3.5Pounds per Container500\;\text{Containers}\times3.5\;\text{Pounds per Container}). The company's records show that it actually used 2,000 pounds of coffee during that budget period, at an actual cost of $8 per pound. This means that the company used more pounds of coffee than the standard quantity (2,000 instead of 1,750) but that it bought each pound at a smaller cost per unit than the standard cost per unit ($8 instead of $10). So the company needs to determine whether the overall direct material cost variance was favorable or unfavorable. To do this, the company uses the direct materials cost variance equation.
Direct Materials Cost Variance=(Standard CostActual Cost)×Number of Units Sold=($10$8)×2,000=$4,000\begin{aligned}{\text{Direct Materials Cost Variance}}&=(\text{Standard Cost}-\text{Actual Cost})\times\text{Number of Units Sold}\\\\&=(\$10-\$8)\times2{,}000\\\\&=\$4{,}000\end{aligned}
The direct materials price variance results in a favorable variance of $4,000. Next, the company wants to know the direct material amount variance. To determine whether the direct material amount variance is favorable or unfavorable, the company uses the direct materials amount variance equation.
Direct Materials Amount Variance=(Standard QuantityActual Quantity)×Standard Cost=(1,7502,000)×$10=$2,500\begin{aligned}\text{Direct Materials Amount Variance}&=(\text{Standard Quantity}-\text{Actual Quantity})\times\text{Standard Cost}\\\\&=(1{,}750-2{,}000)\times\$10\\\\&=-\$2{,}500\end{aligned}
The direct materials amount variance results in an unfavorable variance of $2,500. This shows that the company used an extra 250 pounds, which increased its costs by $2,500. Again, the company had predicted that it would use 1,750 of coffee beans if it sold 500 containers (500Containers×3.5Pounds Per Container500\;\text{Containers}\times3.5\;\text{Pounds Per Container}), but it actually used 2,000 pounds of coffee during that budget period. Managers at the company want to find out whether direct materials overall resulted in a favorable or unfavorable variance. To determine this, they use the total variance equation.
Total Variance=(Standard Cost×Standard Quantity)(Actual Cost×Actual Quantity)=($10×1,750)($8×2,000)=$17,500$16,000=$1,500\begin{aligned}\text{Total Variance}&=(\text{Standard Cost}\times\text{Standard Quantity})-(\text{Actual Cost}\times\text{Actual Quantity})\\\\&=(\$10\times1{,}750)-(\$8\times2{,}000)\\\\&=\$17{,}500-\$16{,}000\\\\&=\$1{,}500\end{aligned}
The company has a favorable total variance of $1,500.