8.2 Interpreting Variances: Causes, Interrelationships and Deciding What to Investigate
Key Takeaways
Variances can be caused by operational performance, by poorly set or out-of-date standards, or by measurement errors, so an adverse variance does not automatically mean poor management.
Buying cheaper, lower-quality material can give a favourable price variance but adverse material usage and labour efficiency variances.
Using more highly skilled labour typically gives an adverse labour rate variance with favourable labour efficiency and material usage variances.
Cutting the selling price gives an adverse sales price variance but may create a favourable sales volume variance if demand responds.
Whether to investigate depends on the size of the variance, its trend, whether it is controllable, and whether the benefit of correcting it exceeds the cost of investigation.
Why this topic is examined
Syllabus area C2(d) asks you to explain why variances could have arisen and the inter-relationships between variances. Questions present a scenario (for example, "the purchasing manager switched to a cheaper supplier") and ask which combination of variances is most likely, or give a set of variances and ask for the most plausible explanation. You will not be asked to calculate here, but you must connect causes to the variances calculated in Sections 7.2 to 8.1.
Three sources of variances
Before blaming a manager, ask which kind of cause is behind a variance:
| Source | Explanation | Example |
|---|---|---|
| Operational | Actual performance genuinely differed from what was achievable | Careless handling increased material wastage |
| Planning (standard setting) | The standard itself was unrealistic or has become out of date | The standard material price was set before a general price rise |
| Measurement or recording error | The figures are wrong | Material issued to one job was coded to another |
Only operational variances say something about how well managers performed. A variance caused by an out-of-date standard should lead to revising the standard, not to criticising the manager.
Typical causes of each variance
| Variance | Possible favourable causes | Possible adverse causes |
|---|---|---|
| Material price | Bulk discounts; cheaper supplier; lower-quality material; falling market prices | Price rises; higher-quality material; urgent purchases at premium prices; loss of discounts |
| Material usage | Higher-quality material; more skilled workers; better machinery | Lower-quality material; wastage, theft or spoilage; inexperienced workers; poor machine maintenance |
| Labour rate | Using lower-grade (cheaper) staff; less overtime than planned | Pay rise not in the standard; overtime or shift premiums; using higher-grade staff |
| Labour idle time | Always adverse | Machine breakdowns; material shortages; poor scheduling; power cuts |
| Labour efficiency | Skilled, motivated staff; better methods or equipment; good-quality material | Inexperienced or poorly supervised staff; poor-quality material; machine problems |
| Variable overhead expenditure | Lower prices for power or consumables | Higher tariffs or consumable prices |
| Variable overhead efficiency | Same causes as favourable labour (or machine) efficiency | Same causes as adverse labour (or machine) efficiency |
| Fixed overhead expenditure | Savings on rent, insurance or salaries | Unexpected rises in rent, insurance or supervisory costs |
| Sales price | Stronger demand; less discounting; price rise | Price cuts; discounts; competitor pressure |
| Sales volume | Successful marketing; lower prices; competitor problems | Price rises; weak demand; production shortages; new competitors |
Note
When variable overhead is absorbed on labour hours, the variable overhead efficiency variance has the same cause as the labour efficiency variance, because both measure the same difference between standard and actual hours.
Interrelationships: one decision, several variances
Variances are rarely independent. A decision that improves one variance often worsens another.
| Decision or event | Favourable variance | Adverse variances likely |
|---|---|---|
| Buying cheaper, lower-quality material | Material price | Material usage (more waste); labour efficiency (more rework); possibly variable overhead efficiency |
| Buying higher-quality material | Material usage; labour efficiency | Material price |
| Using more skilled, higher-paid workers | Labour efficiency; material usage | Labour rate |
| Using trainees or lower-grade staff | Labour rate | Labour efficiency; material usage |
| Cutting the selling price | Sales volume (if demand responds) | Sales price |
| Working overtime to meet demand | Sales volume | Labour rate (overtime premium) |
| A major machine breakdown | None | Idle time; labour efficiency; possibly sales volume if orders are lost |
The practical lesson is that responsibility must be assessed across the business. A purchasing manager who earns a favourable price variance by buying poor material may have caused a larger adverse usage variance in production. Rewarding the purchasing manager and blaming the production manager would be unfair and would encourage the wrong behaviour.
Worked interpretation
In Section 8.1, Apex Precision Systems reported these variances for May:
| Variance | $ |
|---|---|
| Sales price | 19,000 F |
| Sales volume (at standard contribution) | 9,500 A |
| Material usage | 2,500 F |
| Labour rate | 5,000 A |
| Labour efficiency | 3,000 F |
| Variable overhead efficiency | 1,000 F |
| Fixed overhead expenditure | 4,000 A |
A coherent explanation:
- Sales: Apex raised its average price from $50 to $52. The price rise earned a $19,000 favourable price variance but probably reduced demand, causing 500 fewer sales than budgeted and a $9,500 adverse volume variance. Overall, the price decision added $9,500 net.
- Labour and materials: The adverse labour rate variance alongside favourable labour efficiency and material usage variances suggests more experienced, higher-paid staff were used. They worked faster (500 hours saved) and wasted less material. The favourable variable overhead efficiency variance follows directly from the hours saved. Together these three favourable variances ($6,500) exceed the adverse rate variance ($5,000).
- Fixed overhead: The $4,000 adverse expenditure variance is unrelated to volume in a marginal costing system; it needs a separate explanation, such as an unbudgeted rent or insurance increase.
Deciding whether to investigate
Investigating every variance would be expensive. Management by exception focuses attention on the variances that matter. Factors to consider:
| Factor | Question to ask |
|---|---|
| Materiality (size) | Is the variance large in absolute terms, or as a percentage of the standard cost? Many organisations set a threshold such as a fixed percentage of standard. |
| Trend | Is a small variance growing month after month? A persistent trend may matter more than a one-off large variance. |
| Controllability | Can a manager act on it? An adverse price variance caused by a global commodity price rise may not be controllable. |
| Cost versus benefit | Will the savings from correcting the problem exceed the cost of investigating it? |
| Type of standard | With an ideal standard, adverse variances are expected and less significant; with an attainable standard, they are more worrying. |
| Interdependence | Is the variance a side effect of a decision that produced a larger favourable variance elsewhere? |
| Favourable variances too | A large favourable variance may reveal an out-of-date standard or cut corners (for example, skipped maintenance) and deserves attention as well. |
Tip
In scenario questions, look for the root cause first, then list every variance that cause would affect. Answer options that include only one variance for a decision that obviously affects several areas are usually incomplete.
A factory replaces experienced operatives with newly recruited trainees paid at a lower hourly rate. Which combination of variances is most likely?
Adverse labour rate, favourable labour efficiency and favourable material usage
Favourable labour rate, adverse labour efficiency and adverse material usage
Favourable labour rate, favourable labour efficiency and favourable material usage
Adverse idle time and favourable sales volume
A company reports a large favourable sales price variance and an adverse sales volume variance for the same period. Which explanation is most consistent with these results?
The company raised its selling price, and demand fell as a result
The company cut its selling price to win market share
A machine breakdown caused abnormal idle time
The purchasing department bought cheaper raw materials
Which factor is least relevant when deciding whether to investigate a variance?
Whether the variance is material relative to the standard cost
Whether the variance shows a worsening trend over several periods
Whether the cost of investigation is likely to exceed the benefit of correcting the cause
Whether the variance is labelled favourable, since favourable variances never need investigating
Sections you finish are checked off in the contents.