Question

A recent review of actual operating results compared to budget indicates an unfavorable cost variance on both direct materials and direct labor. (that is, we are spending more on materials and labor than we expected to). Which departments may be responsible for additional costs? For example, can be blame Human Resources for hiring inexperienced factory workers who have been making many mistakes causing us to waste materials?

Answer 1

Direct materials variance is a combination of price variance as well as quantity variance.

Price variance = (standard price – actual price)*actual quantity.

In this case the variance is due to the fact that actual price is different from standard price. In case of unfavorable variance actual price is more than standard price. Thus the department that is responsible here is the purchase department that purchased the materials at a price that is higher than the standard price. Purchase department may have had to buy materials at increased price due to high inflation or change in economic scenario etc.

Quantity variance = (standard quantity – actual quantity)*standard price.

In this case the variance is due to the fact that actual quantity is different from standard quantity. In case of unfavorable variance actual quantity is more than the standard quantity. Thus the department that is responsible here is the production department that has used quantity more than the estimated amount.

Direct labor variance is a combination of labor rate variance and labor efficiency variance.

Labor rate variance = (standard rate – actual rate)*actual hours.

In this case the variance is due to difference in wage rates. Thus the department that is responsible here is the HR department as it was not able to determine properly what the actual wage rates would be.

Labor efficiency variance = (standard hours – actual hours)*standard rate.

In this case the variance is due to difference in hours of labor (or their efficiency). The departments that are responsible here are the HR department and the production department. HR department may have hired inefficient workers resulting to higher actual hours. Production department may not have provided workers with proper training and guidance which is leading to higher actual hours.