Basic Variances: Direct Material, Direct Labour and Idle Time Variances

A paint factory in Ibadan budgets to make 2,000 tins of a product in March. It makes 2,000, but the cost report shows that materials cost ₦316,000 more than the budget and labour ₦366,000 more. The directors ask the obvious question: was it the price we paid, or the quantity we used?

Was it the wage rate, or the speed of the workers, or the hours they stood idle because the mixing machine broke down? A total difference does not tell them where to look. Variance analysis splits it into parts that point to a cause and a person.

This topic starts the study of variances with the flexed budget on which they all rest, then explains the direct material variances (total, price and usage), the direct labour variances (total, rate, efficiency and idle time), the line-by-line layout for them, how idle time is treated when it is built into the standard, the possible causes, and the interrelationships that mean two variances may come from one decision.

It builds on the earlier topic on standard costing: its uses, how standards are set and the types of standard. The next topic covers material mix and yield variances.

The flexed budget and the basic variances

Why the fixed budget is not used

The fixed budget is the original master plan for a stated volume. If actual volume differs, then actual cost compared with the fixed budget looks lower or higher only because less or more was made. A fair comparison needs a flexed budget, drawn up at the end of the period from the actual activity levels but using standard revenue per unit and standard cost per unit.

The difference between fixed and flexed budget is due only to volume; the difference between flexed budget and actual is due to price, quantity and efficiency, and these are what the cost variances explain. The flexed budget is at the heart of variance analysis.

Each variable cost variance is the actual cost of the actual output compared with the standard cost of the same output, split in two parts: a price part (what was paid per unit of the resource) and a quantity part (how much of the resource was used). In a cost accounting system the cost variances adjust profit: favourable ones increase it, adverse ones reduce it.

Variance reports at the end of each control period (a month) show large adverse variances that need control action, and large favourable ones that may be worth repeating.

Direct materials variances

• Total direct material cost variance = standard material cost of the actual output − actual material cost of that output. (Actual units × standard quantity × standard price, against actual quantity × actual price.)
• Price variance = (actual quantity purchased × standard price) − (actual quantity purchased × actual price). It is normally calculated at the point of purchase, so that stock is carried at standard cost. With several materials, calculate each separately.
• Usage variance = (standard quantity for the actual output − actual quantity used) × standard price. Work first in quantity, then convert at standard price.

Direct labour variances

• Total labour cost variance = standard labour cost of the actual output − actual labour cost.
• Rate variance = (hours paid for × standard rate) − actual cost of those hours. With several grades, one for each.
• Efficiency variance = (standard hours for the actual output − actual hours worked) × standard rate. It is also called the productivity variance.
• Idle time variance = (hours paid for − hours worked) × standard rate.

Idle time

Idle time is paid time with no work to do: a machine breakdown, a hold-up at an earlier stage, a material shortage, or a lack of orders. Idle time is recorded and its hours measured. If it is not in the standard it is unexpected, so the idle time variance is always adverse, and the efficiency variance is then calculated on hours worked (not paid).

If idle time is not recorded, it stays inside the efficiency variance.

If a regular amount of idle time is expected (for example because of bottlenecks), it can be built into the standard in two ways: method 1, as a separate element of the standard cost (for example 3.0 hours of work and 0.3 hours of idle time per unit); or method 2, as an allowance inside the standard hours per unit (for example 3.3 hours paid, of which 10% is idle).

Then the idle time variance compares actual idle hours with expected idle hours, and may be favourable or adverse. The two methods give the same total for idle time plus efficiency, but split it differently.

Causes and interrelationships

• Material price, favourable: a different, cheaper supplier; a bulk discount; lower-quality material. Adverse: a dearer supplier; an unexpected price rise or inflation; a shortage; better-quality material.
• Material usage, favourable: less waste; better methods. Adverse: more waste; poor handling and breakages; cheaper material that causes more rejects.
• Labour rate, favourable: less experienced and cheaper employees; a smaller pay rise than expected. Adverse: a pay rise; overtime premium; more skilled and better-paid staff.
• Labour efficiency, favourable: better methods; good morale and management; incentive schemes; more experienced staff. Adverse: less experienced staff; poor morale.

Interrelationships. Two variances may share one cause, so they should be read together. A dearer, better material gives an adverse price variance, but if there is less waste, a favourable usage variance. A lower grade of labour gives a favourable rate variance but, if the work takes longer, an adverse efficiency variance, and inexperienced staff may also waste more material (adverse usage).

A higher price that raises the sales price variance may reduce demand and so the volume variance. Finally, the value of variances depends on reliable standards: if the standard is wrong, a variance reflects the poor standard and not good or bad performance. Variances should also be reported to the manager who can control them.

Layouts for material and labour variances

1. Standard cost of actual output = units × standard cost per unit.
2. Material: AQ purchased × AC; AQ purchased × SC (price variance); AQ used × SC (movement in stock); SQ for actual output × SC (usage variance).
3. Labour: AH paid × AR; AH paid × SR (rate); AH worked × SR (idle time); SH × SR (efficiency).
4. Label each F or A and add to the total variance as a check.

Money is in naira and each answer is rounded once, at the end.

Worked examples

1. Total. Standard cost of 2,000 units = 4,000,000; actual 4,316,000; ₦316,000 A.
2. Price.
   8,300 kg should cost 8,300 × 500 = 4,150,000; did cost 4,316,000; ₦166,000 A (the actual price was ₦520 a kg).
3. Usage.
   2,000 units should use 8,000 kg; did use 8,300; 300 kg A × ₦500 = ₦150,000 A.
4. Check.
   166,000 + 150,000 = 316,000.

1. Total.
   Standard 2,000 × 2,400 = 4,800,000; actual 5,166,000; ₦366,000 A.
2. Rate.
   6,300 × 800 = 5,040,000; actual 5,166,000; ₦126,000 A.
3. Idle time.
   (6,300 − 6,100) = 200 hours × 800 = ₦160,000 A.
4. Efficiency.
   Standard hours 2,000 × 3 = 6,000; worked 6,100; 100 hours A × 800 = ₦80,000 A.
5. Check.
   126,000 + 160,000 + 80,000 = 366,000.

1. Total.
   Standard 2,000 × 2,640 = 5,280,000; actual 5,166,000; ₦114,000 F.
2. Rate. unchanged, ₦126,000 A.
3. Idle time.
   Expected idle time 2,000 × 0.3 = 600 hours; actual 200; 400 hours F × 800 = ₦320,000 F.
4. Efficiency. Standard hours worked 6,000; actual 6,100; ₦80,000 A.
5. Check.
   −126,000 + 320,000 − 80,000 = 114,000 F.
   The idle time is now favourable because less was lost than expected, though the efficiency of the hours worked was still poor.

Expect variants: several materials or grades of labour, opening and closing stock of materials (price on purchases, usage on use), a normal loss in the standard, a question that gives the variances and asks you to work back, or discussion of causes.

Common mistakes

• Comparing with the fixed budget instead of the flexed budget.
• Valuing usage at the actual price. Use the standard price.
• Efficiency on hours paid instead of hours worked when idle time is recorded.
• Calling idle time favourable when it is not in the standard.
• Wrong sign. Costs above standard are adverse.
• Not reading variances together, or blaming a manager for a cause outside his control.

Quick revision

• Flexed budget = actual activity at standard prices and costs.
• Material price (on purchases) + usage (at standard price) = total.
• Labour rate (hours paid) + idle time + efficiency (hours worked) = total.
• Idle time not in standard: always adverse; in standard: actual v expected idle hours.
• Interrelated: price/usage, rate/efficiency.

How the marks are earned

• Layout and correct quantities.
• Sign and check to the total.
• Cause and interrelationship for the case.

Practice questions

These are original questions, written in the style of the Skills examination. Work each one before you open the answer.

Recall check: multiple choice

Section B style: written questions

Model answers

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