Question

What is the relationship among the product cost variances, and who is responsible for them? Explain your answer.

Answer 1

A cost variance basically is a variance resulting from the actual expenses incurred and the standard costs expected to be incurred at the beginning of the period. Any company and its management, generally use this system to track, analyze and retrospect on their results.

Cost variances generally include variances amount Direct Materials, Direct Labor and Factory overheads. Before starting the activities, management, based on the past estimates, inflation and the current market conditions would setup a budget/forecast to estimate these expenses. This then becomes the Standard cost expected to be incurred for the production which is later compared with the Actual cost to know the Cost variance.

Direct Material cost variance - This is the variance resulting from the difference in Standard cost estimated and actual cost incurred in the cost of direct materials. This may result due to the better and efficient production methods used and also better quality of raw materials used in production. A favorable variance means that the actual expense was lesser than the estimated expense while an unfavorable variance means that the actual expense was higher than the estimated expense.

Labor Cost variance - This is the variance resulting from the difference in standard labor cost estimated and the actual cost incurred in the cost of the labor. This may result due to the fact that labor work is more effective and efficient because of highly skilled labor. A favorable variance means that the actual expense was lesser than the estimated expense while an unfavorable variance means that the actual expense was higher than the estimated expense.

Overheads Variance - This is the variance resulting from the difference in standard overheads cost estimated and the actual cost incurred in the overheads for production. Overheads basically includes fees, rent, repairs, etc that are incurred during the production process. A favorable variance means that the actual expense was lesser than the estimated expense while an unfavorable variance means that the actual expense was higher than the estimated expense.

With respect to the variances, it becomes important to note , that during most of the times, the variances are interdependent and represent an inherent relationship with each other. All variances in one way or the other are interdependent. For example :-

1.) Labor rate variance may be favorable because lower skilled workers are used for lesser wages; however because of the unskilled labor involved, it will lead to :-

a.) Unfavorable materials variance because of an increased wastage involved,

b.) Unfavorable labor efficiency variance because it would result in an increased number of the hours to produce to the same amount of output.

2.) Material variance may be favorable because of the bargain purchase opportuniy or a combination of available resources to save overall costs. But the resultant product may be of poor quality which will result in unfavorable labor , wastage of the materials and unfavourable overheads cost.

Hence , it becomes really important for a business manager to find a trade off between various costs involved in an efficient way to attain the busines goals.