Planning and Operational Variances for Direct Materials and Direct Labour

A plastics factory in Kaduna budgets 3 hours of labour for each unit of a new product, on the assumption that a new moulding machine will speed the work. The machine breaks down in the first week and is sent back to the supplier. For the whole month the work is done by hand, and every unit takes more than 3 hours.

At the month end the production manager receives a large adverse labour efficiency variance. Was the manager inefficient, or was the standard wrong? The answer is both, in different amounts, and planning and operational variances show how much of each. The previous topic explained the idea and applied it to sales.

This topic applies it to direct labour and direct materials: how an ex post standard is set, how the operational variances are recalculated against it, how the planning variance is found when the usage, the price or both have been revised, how the planning variance can be analysed into price and usage parts (and why the split depends on the order), and the line-by-line method.

It builds on the earlier topic on planning and operational variances: sales, market size and share. The next topic covers overhead variances and reconciling budgeted and actual profit.

Planning and operational variances for materials and labour

Setting the ex post standard

The ex post standard is the standard that, with hindsight, should have applied during the period. It may revise the usage (kilograms or hours per unit), the price or rate, or both.

Examples: a machine failed and its planned efficiency could not be achieved (usage revised); a pay agreement or a sudden fall in the exchange rate changed the price of imported material (price revised); a supplier changed the specification (both). The revision must be justified, and it is made for the period that has passed.

Variances are then separated into those caused by the planning error and those arising from how the work was done compared with a realistic standard.

Operational variances

Operational variances use exactly the same formulae as the ordinary variances; only the standard changes to the ex post figure.

• Material price (operational) = AQ purchased × (ex post standard price − actual price).
• Material usage (operational) = (ex post standard quantity for the actual output − actual quantity used) × ex post standard price.
• Labour rate (operational) = hours paid × (ex post standard rate − actual rate).
• Labour efficiency (operational) = (ex post standard hours for the actual output − actual hours worked) × ex post standard rate.

The planning variance

The planning variance in total is the ex ante standard cost of the actual output minus the ex post standard cost of the actual output (adverse if the ex post cost is higher). Because material and labour are variable costs, it is calculated on the actual units made.

If only one factor was revised, the calculation is simple: for hours only, it is (ex post hours per unit − ex ante hours per unit) × units × the standard rate, adverse if the revised time is longer. If both usage and price were revised, it is the difference between two total costs, and may be analysed into a planning price element and a planning usage element.

The line-by-line method

Start with the actual cost and change one factor at a time:

1. Actual quantity × actual price (the actual cost).
2. Actual quantity × ex post standard price; the difference from line 1 is the operational price (or rate) variance.
3. Ex post standard quantity for the actual output × ex post standard price; the difference from line 2 is the operational usage (or efficiency) variance.
4. Ex ante standard quantity for the actual output × ex ante standard price; the difference from line 3 is the planning variance.

Splitting the planning variance, and using the results

When both price and usage were revised, the planning variance can be analysed into a planning price variance and a planning usage variance. This is done by changing one factor between the ex ante cost and the ex post cost.

If price is changed first: planning price = (ex post quantity × ex post price) − (ex post quantity × ex ante price); planning usage = (ex post quantity × ex ante price) − (ex ante quantity × ex ante price). If usage is changed first: planning usage = (ex post quantity × ex post price) − (ex ante quantity × ex post price); planning price = (ex ante quantity × ex post price) − (ex ante quantity × ex ante price).

The two orders give different splits, but the same total, which shows that the individual parts are not reliable figures. They are of little use for control, since the planning variance as a whole is uncontrollable.

The traditional price and usage variances can also be compared with the operational ones: the traditional usage variance may be a large adverse figure, and the operational one favourable, which would change the judgement of the manager completely.

Use in management. Operational variances show who did well or badly against a realistic standard, and are the basis for rewards and control action. The planning variance shows the cost of the planning error and the lesson for the next budget (for example, do not budget for the benefits of new equipment until it is working).

The risk is that managers may use planning variances as an excuse: revisions to the standard should be justified, approved by someone senior who is not the manager concerned, and made only for causes outside the manager’s control.

Layouts for planning and operational variances

1. Ex ante and ex post standard cost per unit and for the actual output.
2. Operational variances against the ex post standard.
3. Planning variance = ex ante cost of actual output − ex post cost of actual output.
4. Check: operational price + operational usage + planning = actual cost − ex ante standard cost of actual output (the total traditional variance).
5. Split the planning variance only if asked, stating the order.

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

Worked examples

1. Traditional.
   Rate: 1,980 × 600 = 1,188,000 against 1,208,000, ₦20,000 A.
   Efficiency: standard hours 1,600; actual 1,980; 380 A × 600 = ₦228,000 A.
   Total ₦248,000 A (standard cost 800 × 1,200 = 960,000; actual 1,208,000).
2. Operational efficiency.
   Ex post standard hours 800 × 2.5 = 2,000; actual 1,980; 20 hours F × 600 = ₦12,000 F.
   Operational rate is unchanged: ₦20,000 A.
3. Planning.
   (2.5 − 2.0) × 800 = 400 hours A × 600 = ₦240,000 A.
4. Check.
   20,000 A + 12,000 F + 240,000 A = ₦248,000 A.
5. Comment. The traditional report blames the manager for ₦228,000. In fact the manager did slightly better than the realistic standard (₦12,000 F); the ₦240,000 is the cost of an over-optimistic plan.

1. Line 1. Actual quantity × actual price = 1,987,200.
2. Line 2.
   13,800 × 140 = 1,932,000.
   Operational price ₦55,200 A.
3. Line 3.
   Ex post SQ = 3,000 × 4.5 = 13,500 kg × 140 = 1,890,000.
   Operational usage ₦42,000 A (300 kg).
4. Line 4.
   Ex ante SQ = 3,000 × 5 = 15,000 kg × 120 = 1,800,000.
   Planning ₦90,000 A.
5. Check.
   55,200 + 42,000 + 90,000 = ₦187,200 A = 1,987,200 − 1,800,000.
6. Split, price first.
   Ex post quantity at the ex ante price: 13,500 × 120 = 1,620,000.
   Planning price = 1,890,000 − 1,620,000 = ₦270,000 A; planning usage = 1,620,000 − 1,800,000 = ₦180,000 F; net 90,000 A.
7. Split, usage first.
   Ex ante quantity at the ex post price: 15,000 × 140 = 2,100,000.
   Planning usage = 1,890,000 − 2,100,000 = ₦210,000 F; planning price = 2,100,000 − 1,800,000 = ₦300,000 A; net 90,000 A.
   The two splits differ, though the total is the same.

Expect variants: planning and operational variances for rate and usage together, a requirement to comment on which managers should be held responsible, and variances reported with fixed overhead as well.

Labour variances when temporary labour is used

If permanent staff cannot cover the work, the extra work is done by temporary workers at a higher rate and often more slowly, so the variances relate only to them. Example. Standard hours for actual output 1,200; permanent capacity 1,000 hours, fully efficient; the extra 200 standard hours are done by temporary workers who take 1.5 times as long: 300 hours. Standard rate ₦100, temporary rate ₦130.

Rate variance = (100 − 130) × 300 = ₦9,000 A. Efficiency variance = (200 − 300) × 100 = ₦10,000 A. Total ₦19,000 A = actual cost 300 × 130 = 39,000 less standard cost 200 × 100 = 20,000. The same split applies to a material price: the planning variance is the standard price against the market price at purchase (uncontrollable); the operational variance is the market price against the price actually paid (the buyer’s performance).

Together they equal the total price variance, but each tells management something different: planning shows how good the estimates were; operational shows how well purchasing performed in the conditions of the time.

Common mistakes

• Using the ex ante standard in the operational variances.
• Forgetting to value the planning variance on the actual output.
• Wrong sign on the planning variance: adverse when the ex post cost is higher.
• Not checking to the total variance.
• Presenting the price/usage split of the planning variance as a precise figure.
• Accepting any revision. It must be justified and independent of the manager.

Quick revision

• Operational = actual v ex post, same formulae. Planning = ex ante cost − ex post cost of actual output.
• Four lines: AQ×AP; AQ×ex post price; ex post SQ×ex post price; ex ante SQ×ex ante price.
• Total = operational price + usage + planning. Split of planning depends on the order.

How the marks are earned

• Ex post figures and operational variances.
• Planning variance and check.
• Comment on responsibility.

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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