F5 – Performance management

Advanced variances

Advanced variance analysis presents deeper picture as to what is the actual reason behind occurring
variances. They provide an alternative view and present comprehensive analysis of basic variances. They
include:

 Mix and yield variance

 Sales mix and sales quantity variance
 Planning and operational variances

Mix and Yield variances

These variances are calculated when product requires more than one type of raw materials in
production process and when their mix can be changed without effecting the quality of final product.

If a company uses two or more raw materials, basic variances used to calculate material price and
material usage variance for each product individually and net them off to get total material price and
total material usage variance. Whereas, in advance variance analysis, in case of multiple raw materials,
material usage is sub-divided into Mix and Yield variances. Material price variance is calculated the
same way as in basic variances:

 Mix variance is of the view that, usage variance arises when; raw materials are not input
according to standard mix. Mix variance is the difference between standard mix and actual mix.
 Yield variance is of the view that, usage variance arises when; actual output received from
actual material input is different than expected output. It highlights the way material input is
being used to generate output.

Formulas:

Mix variance:

Actual quantity is Actual Difference Std material Variance

actual mix quantity in price per kg
standard mix
Material A
Material B

Yield variance:

Actual quantity in Std quantity in Difference Std material Variance

standard mix standard mix price per kg
Material A
Material B

Farrukh Abbas
SKANS School of Accountancy Page 1
F5 – Performance management

Reason for Mix and yield variances:

Mix Variance Yield variance

For individual materials: adverse mix variance For individual material: Reasons for yield variance
implies that actual quantity in actual mix is more are same as that of material usage variances for
than what quantity should have been as per example,
standard mix and vice versa. Favorable mix  Quality of material
variance for one material will always result in  Efficiency of workforce
adverse material mix variance for the other  Machine efficiency
material.  Production process
 Losses
For total variance: if material mix variance is For total yield variance: favorable total yield
adverse in total it implies that input of expensive variance implies that either both or only expensive
material is more than what input should have been material is used efficiently creating a larger
according to standard mix, that caused a larger favorable yield variance to counter a lower
adverse mix variance to cover the counter adverse material yield variance of a cheaper
favorable variance caused by lower input of material.
cheaper material than what input should have
been according to standard mix causing a smaller
favorable material mix variance.

Sales Mix and sales quantity variances

These variances are calculated when company is selling more than two types of products or services to
the customers and when their standard mix can be changed by changing advertising policy.
In basic variance analysis, in case of multiple products, sales price and sales volume variances are
calculated individually for each product. However, in advanced variance analysis, sales price variance is
calculated in the same way as in basic variances but sales volume variances is sub-analyzed into sales
mix and sales quantity variances, where:

 Sales mix variance is of the view that sales volume arises when products are not sold according
to standard mix. It is the difference between standard mix of sales and actual mix of sales.
 Sales quantity variance is of the view that sales volume variance arises when company sold
more or lower quantity of products than expected. It is the difference between, actual quantity
and standard quantity.

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SKANS School of Accountancy Page 2
F5 – Performance management

Formulas:

Sales Mix variance:

Actual sales in Actual sales in Difference Std profit or Variance

actual mix standard mix contribution
price per unit
Product A
Product B

Sales quantity variance:

Actual sales in Std sales in Difference Std profit or Variance

standard mix standard mix contribution
price per unit
Product A
Product B

Reason for sales mix and sales quantity variances:

Sales Mix variance Sales quantity variance

For individual products: adverse sales mix For individual products: reasons are same as
variance implies that company sold lesser units that of sales volume variance. For example:
of product than what should have been sold  Quality of product
according to standard mix. Favorable sales mix  Marketing strategy
variance for one product will always result in  Price level and competitor’s price
adverse sales mix variance for the other  Brand recognition
product.
For total variance: adverse total sales mix For total variance: favorable total sales quantity
variance implies that product with higher profit variance implies that either both or sales
or contribution is sold lesser than standard and quantity variance of more profitable product is
product with lower profit or contribution is sold favorable to counter adverse quantity variance
more than standard. of a product with lower profit or contribution.

Farrukh Abbas
SKANS School of Accountancy Page 3
F5 – Performance management

Planning and operational variances

Traditional variance analysis does not realize that reasons for any variance can be categorized into two
types, planning reasons and operational variances. For example if material price variance is adverse it
could be due to poor negotiations by procurement department or it could be due to higher quality
material being purchased, both of these reasons are operational reasons. However, another possible
cause could be rise in world-wide prices or inflation being more than expected. Both of these reasons
are planning reasons. In variance analysis philosophy, the point to calculate variance is to investigate the
problem and get to the root cause of it to take appropriate control action.

Planning and operational variances are of the view that, control actions will be different in case of
planning and operational reasons altogether. In case of planning reasons, no one could be held
accountable or responsible because these are caused by external factors beyond the control of
management and appropriate control action would be to revise the standard along with improving
planning process. Whereas in case of operational variances, individuals will be held responsible because
operations are under control of management and appropriate action is taken depending upon the
reason for example if material price variance is adverse due to poor negotiation of purchasing
department, possible control action could be hiring of a new team or conducting trainings for employees
to improve their negotiation skills. The point is control action is different for planning and operational
reasons therefore; the solution is to sub-analyze each basic variance into its components of planning
and operational variances.

Advantages:

 Helps to identify controllable and uncontrollable variances.

 Manager’s acceptance and their motivation level are likely to rise as they will not be held
responsible for uncontrollable variances.
 Standard setting and budgeting process will improve because they will be accurate and up-to-
date.
 Operational variances will provide true and fair picture about performance of the company.

Limitations:

 It is always difficult to set a realistic standard in hindsight.

 Managers may actually use planning variances as a justification for operational variances that
variance appeared simply due to planning error.
 It could be a time consuming process because whenever there is a change in environment,
management will need to revise standards and in-turn budgets.

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SKANS School of Accountancy Page 4
F5 – Performance management

Variances and accountability:

Variance Accountability
Sales price variance Sales or marketing management
Sales volume variance Normally sales or marketing management
However, if sales are less than budget due to problems with
production, the production manager is responsible
Material price variance The manager responsible for purchasing materials
Material usage variance Normally the production manager
Labor rate variance The manager responsible for pay rates. This may be senior
Management or Human Resources management. However, the
production manager will be responsible for any adverse rate
variances
caused by working overtime and paying employees a premium rate
per hour
Labour efficiency variance Normally the production manager
Idle time variance This depends on the cause of the idle time. It may be caused by lack
of sales orders (sales management responsibility), inefficient
production management (production management responsibility)
or
delays in deliveries of key raw material (buying manager
responsibility)

Exception reporting:

It is an approach which is of the view that no matter how carefully a standard is set, there will always a
difference between standard and actual. It implies that there will always be variances t every period end
and company cannot afford to investigate each and every variance. Therefore, company must identify
few selected exceptional variance that need investigation and need to be reported to senior
management. Following factors may use company to select exceptional variances:

 Size of variance (Rule of thumb) (5000)

 Controllability (Principle of controllability)
 Interdependence of variances (Material PV adverse, Material usage variance favo, sales price
variance favorable, sales volume variances favorable)
 Trend of variance (2008 4800 Adverse, 2009 4900 Adverse, 2010: 4950 Adverse, 2011: 4900
Adverse)
 Cost vs benefit analysis (Cost of investigation vs benefits of investigation)

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SKANS School of Accountancy Page 5
F5 – Performance management

Can standard costing co-exist with TQM?

TOTAL QUALITY MANAGEMENT: According to TQM, quality of products or services has to improve
continuously in every area of the business.
 Continuous improvement
 Zero error tolerance policy
 Every individual is responsible for his area of responsibility.

Standard costing and TQM cannot be used simultaneously because of following reasons:

 Standard costing uses pre-determined standards whereas; TQM focuses on a philosophy of

continuous improvement.
 Continual improvement will involve looking for alternates or changes to existing system
whereas; standard costing works in a stable and repetitive environment.
 Standard costing uses attainable standards which keeps an allowance for normal losses, idle
time and other inefficiencies whereas; TQM works on zero-defect policy and accepts no losses,
idle times or any other inefficiencies.
 Standard costing makes individual managers responsible for variances for area under their
control whereas; in TQM every individual is held responsible and is made aware of importance
of supplying the customer with high quality product.

Planning and operational variances:

Reasons for any variances can be two types:
 Planning reasons
 Operational reasons

Material price variance = (Std material price – Actual material price) * Actual quantity purchased/used

80,000 Adverse

Reasons:
 Change in supplier. (Operational reason)
 Higher quality material purchased. (Operational reason)
 Discounts lower than expected or no discounts at all. (Planning reason: Unreal discounts
expected, Negotiation problem: Operational reason)
 Inflation higher than expected. (Planning reason)
 Shortage of material lead to increase in price. (Planning reason)
 Standard was incorrect. (Planning reason)
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SKANS School of Accountancy Page 6
F5 – Performance management

 Purchase of alternate material. (Operational reason)

 Inefficient purchasing department. (Operational reason)

Planning and operational variances are of the view that reasons for any variances are of two types; a
variance is either caused due to errors in planning process that leads to inaccurate standards being set
or variance is caused due to errors in operations. A variance can also arise due to planning and
operational errors together. It is vital for organizations to get to the root cause of the variance so that
the problem can be properly resolved. However, traditional variances do not take highlight that whether
a variance is caused due to planning errors or operational. It would however be very beneficial for the
companies if they could pin-point the actual reason behind every variance and its impact. Therefore, to
help companies understand the reasons behind variance and devise a proper control action, every
variance is sub-divided into two categories; planning variance and operational variance.

Formula’s for planning and operational variances:

Original standard Revised std Actual data

Traditional variance compares Original standard vs actual data.

Planning variance compares Original std Vs Revised Standard
Operational variance compares Revised std VS Actual data.

Material price planning variances (Original std vs Revised std)

(Standard material price per kg – Revised std material price per kg) * Actual quantity used

Material price operational variance (Revised std VS Actual data)

(Revised standard material price per kg – Actual material price per kg) * Actual quantity used

Material usage variance (planning and operational)

Material usage planning variance

(Standard quantity for actual production – Revised standard quantity) * Std material price

Material usage operational variance

(Revised standard quantity – Actual quantity used) * Std material price

Labor rate variance (Planning and operational)

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F5 – Performance management

Labor rate planning variance

(Std labor rate per hour – Revised std labor rate per hour) * Actual hours paid

Labor rate operational variance

(Revised std labor rate per hour – Actual lab rate per hour) * Actual hours paid

Labor efficiency variance (Planning and operational variances)

Labor efficiency planning variance

(Std hours for actual production – Revised std hours) * Std lab rate per hour

Labor efficiency operational variance

(Revised std hours – Actual hours worked) * Std lab rate per hour

Sales price variance (Planning and operational variances)

Sales price planning variance

(Std selling price – Revised std selling price) * Actual units sold

Sales price operational variance

(Revised std selling price – Actual selling price) * Actual units sold

Sales volume variances (Planning and operational variances)

Sales volume planning variance (Market size variance)

(Budgeted sales in units – Revised sales in units) * Std profit or Std Contribution per unit

Sales volume operational variance (Market share variance)

(Revised sales in units – Actual sales in units) * Std profit or std contribution per unit

Farrukh Abbas
SKANS School of Accountancy Page 8