Cost variance

Cost variance
See also
Direct expense Cost classification Costs of production Absorbed costs Cost of production Conversion cost Indirect labor Applied overhead Cost

Cost variance is the difference between the expenditure actually incurred and the planned cost. Cost variances mainly relate to the costs of manufacturing enterprises. We classify cost variances into three types:

• Material variances (Material Cost Variances, MCV)
• Labour variances
• Overhead variances

Variance analysis

According to The Institute of Cost and Management Accountants (UK) variance is the difference between standard cost and actual cost incurred during a period. Variance analysis examines the quantitative difference between actual and planned behavior. There are two phases of Variance analysis:

1. Computation of individual variances (material, labour, and factory overhead variances)
2. Determination of the cause of each variance

The amount of variances is not the only important thing to know in variance analysis, but also where the variances originated, who was responsible for them and why they arise.

Material variances

Material variances also known as Material cost Variances (MCV) is the difference between actual expenses spent for materials and planned cost of those materials.

$MCV=Stanadard\ Cost\ -Actual\ Cost\$

We distinguish material variances into:

• Material price variance (MPV) - is the difference between standard price and actual price for the purchase of materials.

$MPV=(Standard\ Price\ -Actual\ Price)\cdot Actual\ Quantity$

• Material usage (quantity) variance (MUV) - is the difference between standard usage and actual usage of materials.

$MUV=(Standard\ Quantity\ -Actual\ Quantity)\cdot Standard\ Price$

Material usage variance is divided into:

• Material mix sub-variance (MMSV) - it is the difference between the standard mix and the actual mix of different raw materials actually used and their corresponding standard price

$MMSV=Standard\ Cost\ of\ Actual\ Mix-Standard\ Cost\ of\ Standard\ Mix\$

• Material yield sub-variance (MYSV) - the difference between actual cost and standard cost of the output.

$MYSV=(Actual\ Yield\ -Standard\ Yield)\cdot Standard\ Cost\ Per\ Unit\$

Labour variances

Labour variance is the second type of cost variance. Labour cost variance (LCV) is the difference between standard labour cost and the actual labour cost. The Labour variance has two types:

• Labour rate variance (LRV) - the difference between the standard piece-wage rate and the actual piece-wage rate
• Labour efficiency variance (LEV) - the difference between the actual labour hours and the standard labour hours used to produce a product.

Overhead variances

Overhead variance is divided into:

• Variable overhead cost variance (VOCV) - the difference between the actual and the standard variable overheads cost for actual output. Variable overhead cost variance divide into two types:
• Variable factory overhead efficiency variance
• Variable factory overhead spending variance
• Fixed overhead cost variance (FOCV) - FOCV's components are:
• Fixed overhead spending variance
• Fixed overhead efficiency variance
• Volume variance - calendar variance, capacity variance, fixed overhead efficiency variance

$Volume\ variance=calendar\ variance+capacity\ variance+efficiency\ variance$

Examples of Cost variance

• Material Cost Variance: This is the difference between the actual cost of materials used in production and the budgeted cost of the materials used. For example, if a company budgeted to spend $10,000 on materials for a production run but ended up spending $12,000 due to an increase in the cost of raw materials, this would be a material cost variance of $2,000.
• Labor Cost Variance: This is the difference between the actual cost of labor used in production and the budgeted cost of the labor used. For example, if a company budgeted to spend $20,000 on labor for a production run but ended up spending $25,000 due to an increase in wages, this would be a labor cost variance of $5,000.
• Overhead Cost Variance: This is the difference between the actual cost of overhead used in production and the budgeted cost of the overhead used. For example, if a company budgeted to spend $30,000 on overhead for a production run but ended up spending $35,000 due to an increase in utilities, this would be an overhead cost variance of $5,000.

Advantages of Cost variance

The advantages of cost variance are:

• It helps to identify potential cost savings for future projects. It helps to identify where the budget was overspent and why, which can lead to better planning for future projects.
• It can help to identify areas of inefficiency in an organization, allowing for more efficient use of resources.
• It also helps to understand the causes of cost overruns, which can help in preventing similar issues in the future.
• Cost variance analysis also provides valuable feedback to stakeholders, allowing them to make better decisions when it comes to budgeting and resource allocation.
• Finally, it can be used to monitor progress and make sure the project is on track and that the expected results are achieved.

Limitations of Cost variance

• Cost variance does not take into account factors that could affect the actual costs of a project, such as inflation, labor market conditions, and other external factors.
• Cost variance does not consider the impact of changes in the quality of products or services, which can affect the ultimate cost of a project.
• Cost variance does not account for changes in the quantity of resources used, which can also affect the cost of a project.
• Cost variance does not consider the effect of unexpected events or unforeseen circumstances on costs, which can have a significant impact on the cost of a project.
• Cost variance also does not take into account the cost of rework or corrections, which can add to the overall cost of a project.

Other approaches related to Cost variance

Cost variance can be analyzed from different perspectives. These include:

• Cost of quality – this is the difference between the cost of producing a good quality product and the cost of producing a poor quality product.
• Cost of materials – this is the difference between the expected cost of materials and the actual cost of materials used in production.
• Cost of labor – this is the difference between the cost of wages that was planned and the actual wages paid to workers.
• Cost of overhead – this is the difference between the expected cost of overhead and the actual cost of overhead incurred during production.
• Cost of rework – this is the difference between the cost of performing the task correctly and the cost of reworking the task or product.

In summary, cost variance is the difference between the planned and actual cost of producing a product. It can be analyzed from different perspectives such as cost of quality, cost of materials, cost of labor, cost of overhead, and cost of rework.

References

• Jain P.K. (2000) Cost Accounting, Tata McGraw-Hill Publishing Company Limited
• Lal J., Srivastava S. (2009) Cost Accounting 4E, Tata McGraw-Hill Publishing Company Limited
• Rajasekaran V., Lalitha R. (2011) Cost Accounting, Dorling Kindersley (India) Pvt. Ltd.

Author: Emilia Zapart