Calculating Labour and Material Variances – Level 4 study tips

When a budget is constructed, essentially an educated guess is being made as to what the actual production/labour, costs/material costs will be. 

In reality it is unlikely (not impossible) that the budgeted and actual figures will be exactly the same.  As an Accounting Technician you will be expected to have the ability to compare the differences between budgeted and actual figures.  Analysis takes place in the form of calculating variances.

Here is a table showing some budgeted and actual figures for a business that produces Teddy Bears.  The table shows output for one month, 1 unit of production is 1 teddy bear and the direct material is the fabric required to make the teddy bears.

It would be easy to simply compare each row of data in terms of cost and assume this was the variance.  This is not the case and it is imperative that you are well versed in analysing the data in a more detailed manner.  Here is one way of systematically working through the data and calculating all the variances.

A good approach to analysing data such as this is to start off by taking some time to calculate your standards.  If you calculate your standards now, then it helps when it comes to calculating the variances.

Calculation of standards using the budgeted data

Labour:           200 hours / 1,000 units = 0.2 hours per unit
£2,000 / 200 hours = £10 per hour
0.2 x £10 = £2 per unit of output in terms of labour
Materials: 5000kg / 1,000 units = 5kg per unit
£2,500 / 5,000kg = £0.50 per kg
5 x £0.5 = £2.50 per unit of output in terms of materials
Total standard cost per unit:    = £4.50 per unit (£2 + £2.50)

The following guide will show how to calculate each individual variance and also how different variances can be reconciled with one another.

Direct Labour Variances

There are 3 questions which should be asked about labour in terms of variances:
1. How much more/less did the hours worked cost us than standard rate?

2. How efficient were the work force in making the actual output?

3. What is the total variance for direct labour?

Calculations

1. Actual hours = 228

Standard rate per hour = £10

Standard cost for actual hours = 228 x £10 = £2,280

Actual cost = £2,850

Difference = £2,280 – £2,850 = £570 more than standard

This variance is called the Labour Rate Variance.  As the actual cost was more expensive than standard we call it an adverse variance (think of the connotations of the word adverse, more expensive = bad/adverse).

The Labour Rate Variance = 570 ADVERSE

2. Actual output = 1,200 units

Standard hours per unit = 0.2 hours

Standard hours for actual output = 1,200 x 0.2 = 240

Actual hours = 228

Difference = 240 – 228 = 12 hours less than standard

In monetary terms = 12 hours x £10 (standard rate per hour) = £120

This variance is called Labour Efficiency Variance.  As the workforce took less time than standard to make the actual output, the variance will be favourable (think about this logically, a more efficient workforce is a good/favourable thing).

The Labour Efficiency Variance = 120 FAVOURABLE

3. Actual output = 1,200 units

Standard cost per unit = £2

Standard cost for actual output = £2,400

Actual cost for actual output = £2,850

Difference = 2,400 – 2,850 = £450 more than standard (therefore Adverse)

Total labour variance = 450 ADVERSE

Tip:  The total variance for labour can be reconciled with the labour rate and labour efficiency variances; this is a good way of checking the calculations.

Labour Rate Variance + Labour Efficiency Variance = Total Labour Variance

570 adverse + 120 favourable = 450 adverse (an indication our variance calculations are correct)

Direct Material Variances

There are 3 questions which should be asked about labour in terms of variances:

1. How much more/less did the materials used cost us compared to standard rate?

2. How much more/less material did we use producing the actual output than standard?

3. What is the total variance for direct material?

Calculations

1. Actual usage = 6120kg

Standard price per kg = £0.50

Standard cost for actual usage = 6120 x £0.50 = £3060

Actual cost = £2,754

Difference = £3,060 – £2,754 = £306 less than standard

This variance is called the Material Price Variance.  As the actual cost was less expensive than standard then it is a favourable variance.

The Material Price Variance = 306 FAVOURABLE

2. Actual output = 1,200 units

Standard usage per unit = 5kg

Standard usage for actual output = 1,200 x 5 = 6000kg

Actual usage = 6120kg

Difference = 6000 – 6120 = 120 kg more than standard

In monetary terms = 120 kg x £0.50 (standard rate per kg) = £60

This variance is called Material Usage Variance.  We used more material than our standard, therefore this variance is adverse.

The Material Usage Variance = 60 ADVERSE

3. Actual output = 1,200 units

Standard cost per unit = £2.50

Standard cost for actual output = £3,000

Actual cost for actual output = £2,754

Difference = 3,000 – 2,754 = £246 less than standard (therefore                   Favourable)

Total labour variance = 246 FAVOURABLE

Tip:  The total variance for materials can be reconciled with the material price variance and material usage variance; this is a good way of checking the calculations.

Material Price Variance + Material Usage Variance = Total Material Variance

306 favourable + 60 adverse = 246 favourable (an indication our variance calculations are correct)

Reconciliation of all variances (Standard cost + adverse variances – favourable variances)

Total standard cost for actual production             = £5400 (1200 x £4.50)
Labour Rate Variance                                       = 570 ADVERSE
Labour Efficiency Variance                             = 120 FAVOURABLE
Material Price Variance                                   = 306 FAVOURABLE
Material Usage Variance                                 = 60 ADVERSE
Total Variance = 204 ADVERSE
Actual cost of actual production                 = £5604

 

The reconciliation is successful, the calculations are correct.  Investigation into the variances can now commence.  In a workplace this would be an important process because any significant variance would need to be investigated, causes would need to be established and where possible eradicated.  If the cause of a variance is an internal issue, the company may look at revising how it derives its standards.

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Mathew Pickering is an AAT lecturer at The Sheffield College, part of the team which won Training Provider of the year (medium size provider) in 2015.

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