Variance analysis looks at two important factors. The first is the difference between actual and standard costs. The second factor is the reason that the difference occurred. It can be difficult to determine the reasons behind the variances. Once the reasons are found, a plan of action must be put in place to avoid the same problem in the future.
Companies figure variances for the three basic cost elements of manufacturing: direct labor, direct materials, and manufacturing overhead. There are two types of direct material variances. These are material price variances and material quantity variances. The material price variance is the difference between the actual cost of material and the standard cost anticipated to be paid for the material. The material quantity variance is the difference between the actual quantity of material used and the standard quantity that was expected to be used to make the product. This variance is sometimes called the material use variance.
There are two types of direct labor variances. They are the labor rate variance and the labor efficiency variance. The labor rate variance is the difference between the actual hours worked multiplied by the standard rate, and the actual hours worked multiplied by the actual rate. When workers are paid at higher than the standard rate, an unfavorable variance exists, and vice versa. The labor efficiency variance is the difference between the standard hours multiplied by the standard rate, and the actual hours worked multiplied by the standard rate. When the actual hours worked are less than the standard hours, a favorable variance exists.
Manufacturing overhead variances are more complicated to analyze than the direct labor and direct materials variances. The reason for this is that overhead costs are indirect costs that include both fixed and variable components. The variance for total overhead is the difference between the value of overhead applied to production for the period and the actual overhead cost incurred throughout the period. There are various methods of analyzing manufacturing overhead variances, including the two-variance method and the three-variance method. Under the two-variance method, the total overhead variance is broken down into a controllable variance and a volume variance. Under the three-variance method, the controllable variance is further broken down into a spending variance and an overhead efficiency variance.
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