Friday, 12 July 2013

Material Variances

Standard Costing- Material Variances
Variance Analysis:

          In standard costing, for specified areas of operational activity, the difference between actual & standard costs is known as variances. Calculation & classification of variances is one of the most important features of standard costing. Classification of variances & disclosure of the same to the management is essential so that it becomes possible for the management to take remedial action & allocate responsibility.

         Therefore, the examination of all those influences, as a result of which variances have occurred & identification of the action of the management which is necessary for rectifying matters; constitutes analysis of variances.
         Identification of only variance is of no value by itself-the value lies in determining the   causes of the variances & taking corrective actions. Generally, in accordance with the principles of responsibility accounting, variance analysis operates; as the cause of variances can be personalized, for example: for labour efficiency variance, responsibility will be on the production foremen; for sales price & sales mix variances, , responsibility will be on the marketing management; for material price variance,  responsibility will be on the purchasing department, & so on.
         Depending upon the circumstances, variances may be either adverse (A) or favourable (F). When actual costs are less than the standard costs, to view the variances as favourable is logical, similarly, when actual costs exceeds the standard costs, then to view the variances as adverse is logical. But automatically it does not follow that these terms should be equated with good or bad. Only after the causes of variances are known, such an appraisal should be made.
Cost Variances
Total Cost Variance:
         The difference between the total standard cost of the output that has been achieved in a period & the total actual cost which has been incurred in a period is known as total cost variance. On actual output & not on standard or budgeted output, all cost variances are based.
Material Variances:
Direct Material Cost Variance:
          The difference between the standard cost of direct materials which has been specified for the production that has been achieved & the actual cost of direct materials which are used is known as direct material cost variance.
The formula is:

Standard Cost-Actual Cost
         As a result of changes in the quantities of materials or the price, the variance may arise. Analysis of material cost variance therefore can be done into two components, viz. (i) material price variance, & (ii) material usage variance.
(i)Material Price Variance:
         The difference in cost which has been resulted from price being different to standard is known as material price variance. Therefore, it is the multiplication of actual usage with the difference in price.
The formula is:
Actual quantity * Price Difference
Or, Actual quantity * (Standard price-Actual price)
Or, Actual quantity * Standard price – Actual quantity * Actual price
Or, Standard cost of actual quantity – Actual cost
Reasons of occurrence of Material price variance:
         Material price variance may be caused by:
  1. Materials market price’s fluctuations.
  2. Purchasing in lots which are non-standards.
  3. Purchasing from suppliers who are located unfavorably, as a result of which additional cost of transportation has been incurred.
  4. During transit, excessive shrinkage or losses has arisen.
  5. Purchasing from the suppliers other than those who has offered the most favourable terms.
  6. On account of delay in payments, cash discount cannot be availed.
  7. For the purpose of special handling or faster transportation, additional charges are required to be paid.
  8. Purchases on emergency basis- to place rush orders at any price for immediate delivery.
  9. Fraud is there in purchases.
  10. Due to unavailability of planned materials, substitute material is required to be bought.
(ii) Material Usage Variance:
         The difference arising between actual usage & expected usage (i.e. for producing the actual output, what should have been used) multiplied by the standard price is known as the material variance.
The formula is:
Standard price * Usage difference
Or, Standard price * (Standard Usage-Actual Usage)
Or, Standard price * Standard Usage – Standard price * Actual Usage
Or, Standard cost of standard quantity – Standard cost of actual quantity
Reasons of occurrence of Material usage variance:
         Material usage variance may be caused by:
  1. Substitution of materials which are non-standard.
  2. Materials results in variations in yields.
  3. Changes in product designs, tools, machinery or method of processing which have not yet been recognized in standards.
  4. Excess materials not returned to the stores.
  5. Inspection which is too rigid.
  6. There are no proper tools or machines.
  7. Inadequately trained, poorly supervised, careless or dissatisfied workmen have caused loss or destruction of materials.
  8. Machines & tools are not kept in good working conditions.
Relationship between the variances:
         Total material cost variance = Price variance + Usage variance
Illustration1:
         The following information has been furnished by AB ltd. which has adopted standard costing:
Standard:
            Materials for 150 kg finished products                                   200 Kg
            Price of materials                                                                    $ 4 per kg
Actual:
            Output                                                                                     300000 kg
            Materials used                                                                         360000 kg
            Cost of materials                                                                     $ 684000
         Calculate: (a) Material cost variance; (b) Material price variance & (c) Material usage variance.
Solution:
Standard quantity of material required for actual output:-
                                    =300000 * 200                                                400000 Kg     
Actual quantity of material            150                                                360000 kg
Standard price                                                                                     $ 4 per kg
Actual price                 = 684000                                                         $ 1.90 per kg
                                       360000
(a) Material cost variance: Standard Cost-Actual Cost
= (400000*$4) -$ 684000                                                                   $ 916000 Favourable
(b) Materials price variance: Actual quantity * Price Difference
= 360000 * (4.00-1.90)                                                                       $ 756000 Favourable
(c) Material Usage Variance: Standard price * Usage difference
= $4 * (400000-360000)                                                                     $ 160000 Favourable
Check: Material cost variance = Price + Usage                      $ 916000 Favourable
Illustration2:
         The standard raw material mix for 500 kg of finished product is:
Material K                               250 Kg @ $ 4.00 per kg
Material L                               150 Kg @ $ 11.00 per kg
Material M                              150 Kg @ $ 6.00 per kg
Material N                               50 Kg @ $ 15.00 per kg

During the accounting period, the material used was as follows:

Material K                               600 Kg @ $ 4.40 per kg
Material L                               390 kg @ $ 12.00 per kg
Material M                              400 kg @ $ 5.20 per kg
Material N                               130 kg @ $ 14.00 per kg
         During the period, production was 1250 Kg. Identify & calculates (a) material cost variance; (b) material price variance; & (b) material price variance; & (c) material usage variance.
Solution:
Standard input for material for actual output of 1250 kg = (600/500) * 1250 = 1500 Kg

Standard Material Cost for Actual Output:                $
K (250/500) * 1250    = 625 kg @ $ 4.00 =               2500                                       
L (150/500) * 1250    = 375 kg @ $ 11.00 =             4125
M (150/500) * 1250   = 375 kg @ $   6.00 =             2250
N   (50/500) * 1250   = 125 kg @ $ 15.00=              1875                                                                                       
                                    1500 kg input                        10750
                                  (-) 250 kg loss                          -___
                                    1250 kg output                      10750
Actual Cost:
K                                 600 kg * $ 4.40                       2640
L                                  390 kg * $ 12.00                     4680
M                                 400 kg * $ 5.20                       2080
N                                 130 kg *$ 14.00                      1820
                                   1520 kg input                         11220   
                                (-) 270 kg loss                           _-____  
                                    1250 kg output                      11220   
(a) Material Cost variance: Standard cost for actual output – Actual cost

                                                $ 10750- $ 11220                     $ 470 (Adverse)
(b) Material Price variance: Actual quantity * (Standard Price – Actual Price)
K         ($   4.00-$ 4.40) * 600   = 240 (Adverse)
L          ($ 11.00-$ 12.00) * 390 =390 (Adverse)
M         ($ 6.00-$ 5.20) * 400 =    320 (Favourable)
N         ($ 15.00-$ 14.00) * 130 =130 (Favourable) 

                                                     180 (Adverse)                    $ 180 (Adverse)
(c) Material Usage Variance: Standard Price * (Standard Usage – Actual Usage)
K         (625-600)* $ 4.00 =    100 (Favourable)
L          (375-390) * $11.00=   165 (Adverse)
M         (375-400) * $ 6.00 = 150 (Adverse)
N         (125-130) * $ 15 =     75 (Adverse)
                                             290 (Adverse)                            $ 290 (Adverse)
Check: Material Cost Variance = Price + Usage                  $ 470 (Adverse)         
         The material usage variance can be further divided into material mix variance & material sub-usage variance/ material yield variance, where in combination; two or more materials are used.
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