Cost Variances

Updated January 02, 1998

Accountants calculate cost variances to answer two questions about cost:

Variance Terminology

Accountants calculate two cost variances for each type of cost a company incurs. They compute a PRICE variance and a USAGE variance. Unfortunately, accountants change the names of these variances depending on the kind of cost involved. The following list gives the names of these variances for materials, labor and overhead.

Type of Cost

Price Variance is Called

Usage Variance is Called
Materials Price Variance Usage Variance
Labor Rate Variance Efficiency Variance
Overhead Spending Variance Efficiency Variance

A cost system designed to produce inventory and cost of sales values for external financial reports also produces an overhead variance called a VOLUME variance, a variance that shows the amount of overhead over- or under-absorbed.

Formulas for cost variance computation

Materials Variances

Purchase price variance = (Standard price - Actual price) x Actual quantity

Materials usage variance = (Standard quantity - Actual quantity) x standard price

Labor Variances

Labor rate variance = (Standard rate - Actual rate) x Actual hours

Labor efficiency variance = (Standard hours - Actual hours) x Standard hourly rate

Overhead Variances--Decision Focused Cost System

Overhead spending variance = ((Variable overhead rate x actual hours)+ Budgeted fixed overhead) -Actual overhead cost

Overhead efficiency variance = (Standard hours - Actual hours) x Variable overhead rate

Examples of Variance Calculations

Standards

Materials
Standard price per pound                                      $20
Standard quantity of material per unit produced		        4
pounds

Labor
	Standard wage rate per hour				$15
	Standard labor time per unit produced			   2

Overhead
	Variable amount per direct labor hour			$ 5
	Standard labor time per unit produced			  2
	Fixed overhead per month				$20,000

Actual production and costs for the month
	Actual units produced					 3,000
	Actual purchases (10,000 pounds)		      $215,000
	Actual material used 				    13,100 pounds
	Actual labor cost (6,400 hours)			       $100,000
	Actual overhead cost					$45,000

Materials Variances

Purchase price variance = (Standard price - Actual price) x Actual quantity

$15,000 = $20 - $21.50 x 10,000

Materials usage variance = (Standard quantity - Actual quantity) x standard price

$22,000 = (((3,000 x 4 pounds)- 13,100) x $20

Labor Variances

Labor rate variance = (Standard rate - Actual rate) x Actual hours

$4,000 = $15 - $15.625 x 6,400

Labor efficiency variance = (Standard hours - Actual hours) x Standard hourly rate

$6,000 = ((3,000 x 2 hours) - 6,400) x $15

Overhead Variances--Decision Focused Cost System

Overhead spending variance = ((Variable overhead rate x actual hours)+ Budgeted fixed overhead) -Actual overhead cost

$7,000 = ((($5 x 6,400 hours)+$20,000) - $45,000

Overhead efficiency variance = (Standard hours - Actual hours) x Variable overhead rate

$2,000 = ((3,000 x 2 hours) - 6,400) x $5

For additional material on variances see Neil Fargher's material.