Management Accounting Unit - 2. B.Com(Hons)/B.Com/BBA/MBApdf

Management Accounting B.Com (Hons) Semester 4th
1 | Page Prepared by UMA KANT (Research Scholar “LU”, JRF(Commerce), UGC NET(Management), M.Com, MBA
Management Accounting
B.Com (Hons.) Semester - 4th
Unit -2
University of Lucknow,
Lucknow
Budgetary control
Budgetary control is the process by which budgets are prepared for the future
period and are compared with the actual performance for finding out variances, if
any. The comparison of budgeted figures with actual figures will help the
management to find out variances and take corrective actions without any delay.
The comparison of budgeted and actual figures will enable the management to find
out discrepancies and take remedial measures at a proper time. The budgetary
control is a continuous process which helps in planning and co-ordination. It
provides a method of control too. A budget is a means and budgetary control is the
end-result.
Objectives of Budgetary Control
The main objectives of budgetary control are given below:
1) Defining the objectives of the enterprise.
2) Providing plans for achieving the objectives so defined.

3) Coordinating the activities of various departments.
4) Operating various departments and cost centres economically and
efficiently.
5) :5. Increasing the profitability by eliminating waste.
6) Centralizing the control system.
7) Correcting variances from sit standards.
8) Fixing the responsibility of various individuals in the enterprise.
Essentials of Successful Budgetary Control:
The following are the essential requisites for implementing budgetary control
successfully:
1) Clearly Defined Organisational Structure:- The authority and
responsibilities are to be properly defined to pin-point the responsibility of
specific individuals in key positions.
2) Efficient Accounting System: - The accounting system should provide
the required information in time.
3) Reporting of Deviations:- Efficient system has to be devised to reduce
the differences between the budgets and actual performance.
4) Motivation: - Staff are to be appraised of the budgets and benefits they
are going to derive directly and indirectly.
5) Realistic Targets: - The targets set should be realistic so that they are
achievable and budgets should not frustrate the workers by fixing
unrealistic targets.
6) Participation of All Departments Concerned: - Budgets are to be set for
all the departments so that their participation in implementation will be
effective.

7) Flexibility: - Budgets are prepared on the basis of certain conditions. If
there is change in conditions budgets also should be adjusted to
accommodate the changes.
8) Top Management Support: - The budgetary control system should have
continuous support of top management which can ensure its all-round
acceptance.
Advantages of Budgetary Control
Some of the advantages of budgetary control are:
1) Budgetary control fixes targets. Each and every department is forced to work
efficiently to reach the target. Thus, it is an effective method of controlling
the activities of various departments of a business unit.
2) It secures better co-ordination among various departments.
3) In case the performance is below expectation, budgetary control helps the
management in finding up the responsibility.
4) It helps in reducing the cost of production by eliminating the wasteful
expenditure.
5) By promoting cost consciousness among the employees, budgetary control
brings in efficiency and economy.
6) Budgetary control facilitates centralized control with decentralized
activity.
7) As everything is planned and provided in advance, it helps in smooth
running of business enterprise.
8) It tells the management as to where action is required for solving problems
without delay.

Disadvantages or Limitations of Budgetary Control
The following are the limitations of budgetary control:
1) Budget involves a heavy expenditure which small business concerns cannot
afford.
2) Budgets are prepared for the future period which is always uncertain. In
future, conditions may change which will upset the budgets. Thus, future
uncertainties minimize the utility of budgetary control system.
3) Budgetary control is only a management tool. It cannot replace management
in decision-making because it is not a substitute for management.
4) The success of budgetary control depends upon the support of the top
management. If there is lack of support from top management, then this will
fail.
5) It is really difficult to prepare the budgets accurately under inflationary
conditions.
Types of Budget in Management Accounting
Type # 1. Sales Budget:-
Many of the other budgets are based on the sales budget. It is taken to be the
critical starting point to which all other budgets are adjusted. Its preparation begins
with the prediction of units of each product that will be sold at specific prices. The
work starts with the examination of sales analysis for the current year.
Type # 2. Production Budget:-
The production budget shows the estimates of production planned for the
immediate future period. The production budget should indicate, apart from other

things, targets of production for each product, each department and by each month.
Generally, the production budget is based on the sales budget.
 The production budget is prepared into two parts, namely:
 Production volume budget- It shows the physical units of the product to be
manufactured; and
 Cost of production or manufacturing cost budget- It gives details of the
budgeted cost under material, labour and factory overheads.
The following steps are involved in the preparation of production budget:
1) Production Planning – Production planning plays very important part in
the preparation of production budget. Production planning on sound lines
takes into consideration optimum utilisation of plant capacity by
elimination or reduction of limiting factors and both bottlenecks in
production like shortage of material, labour etc. Proper planning of
production levels out seasonal fluctuations of sales so that optimum
inventory of finished goods, components and work-in-progress is
maintained.
2) Consideration of Plant Capacity – The total quantities of each of the
products or group of products which the firm is capable of producing is
determined. This requires coordination of production budget with plant
utilization budget.
3) Co-ordination with the Sales Budget – Proper coordination between
production and sales budget is necessary to avoid imbalances of sales and
production.
4) Inventory Policy Considerations – The extent to which inventory of
finished goods is to be carried depends upon several factors such as future

sales potential, availability of storage facilities, the risk and cost of stock-
out and cost of carrying inventory.
 The budgeted quantity of production is computed as follows:
 Units to be produced = Desired closing stock of finished goods +
Budgeted sales – Opening stock of finished goods.
5) Policy of the Management – Management policy as to whether certain
components or parts should be produced or procured from outside should
also be taken before finally setting the budget.
Type # 3. Production Cost Budget:
This is the quantity of products to be manufactured expressed in terms of cost.
Basically, there are three element of cost, namely, direct material, direct labour and
overheads. Separate budgets for each of these elements have to be prepared.
1) Direct Materials Budget:- Standard costing greatly facilitates the preparation
of a materials budget. When standard cost records are not available, the details
have to be adjusted to the period when manufacture takes place. Materials are
controlled on the basis of price and usage after allowing for normal wastage.
Technical experts decide on the best and most economical material to use for
each purpose.
2) Direct Labour Budget:- A similar procedure to the above applies to direct
labour. The hours shown in the production budget are used with the wage
rates which are likely to apply during the period of production. Wages are
controlled according to the rates paid and the efficiency of the operator.
3) Overheads Budget:- Overheads budget has to be assembled from a large
amount of detailed information from past records. It has to be updated to
allow for changes in future costs and related activity. It is compiled on the

basis of department overhead expense budgets and cost centre budgets. The
overheads may relate to factory, general administration, selling and
distribution functions. Accordingly, separate budgets are prepared for factory
overheads, administrative overheads and selling and distribution overheads.
o Factory Overheads Budget:
o Administrative Overheads Budget:
o Selling and Distribution Overheads Budget:
Type # 4. Purchase Budget:-
The purchase budget states the purchases which must be made to achieve the
complete budget plan. These include the requirements of direct and indirect
material, and of purchased services as set out in the sales, production cost, capital
expenditure and research and development budgets adjusted in respect of-
o Inventory policy of the firm,
o Purchase orders already placed,
o Materials to be manufactured within the business as distinct from
those to be purchased from outside.
Type # 5. Cash Budget:
The cash budget is a summary of the firm‟s expected cash inflows and outflows
over a particular period of time. In other words, cash budget involves a projection
of future cash receipts and cash disbursements over various time intervals. There
must be a balance between cash and the cash demanding activities/operations,
capital expenditure and so on. Very often, the need for additional cash is not
realised until the situation becomes critical.
The cash budget consists of two parts:

 The projected cash receipts (inflows) and;
 The planned cash disbursements (outflows).
 Cash receipts include collection from debtors, cash sales, dividends
received, sale of assets, loans received and issues of shares and
debentures. Payments include wages and salaries, payment to
creditors and suppliers, rent and rates, taxes, capital expenditure,
dividend payable, commission payable and repayment of loans and
debentures.
Type # 6. Master Budget:
A master budget is a master plan for the entire firm. It is the summary of final plan
for the forthcoming year. When all detailed functional budgets have been
completed, they are integrated into a master budget. According to the Chartered
Institute of Management Accounts, London, Terminology, a master budget is
defined as “The summary budget which is finally approved, adopted and
employed”.
Type # 7. Fixed and Flexible Budgeting:
In the real world, one seldom finds stable operating conditions. Future can never be
predicted with certainty. A fixed or static budget is satisfactory only when a
company‟s activities can be estimated within close limits. According to The
Chartered Institute of Management Accountants, London, Terminology, a fixed
budget is defined as a “budget designed to remain unchanged irrespective of the
level of activity actually attained”.
Cash Budget: Methods of Preparing Cash Budgets
The other name of cash budget is finance budget. This budget is the most

important of all the functional budgets. But, this budget is prepared after the
preparation of all other functional budgets. The cash budget summarizes the
anticipated cash receipts and payments for a specific period. The cash budget
helps the management to makes an arrangement of cash if sufficient amount of
cash is not available at the end of each month. In this way, the company can meet
all the operating expenses and all other commitments. On the other hand, if
excess of cash is available in anytime, the management can take suitable
arrangements can take suitable arrangements for making investment outside the
business.
Information required preparing cash budget:
A cash budget is prepared with the help of following information.
1. The amount of budgeted cash sales and credit sales.
2. The time lag between credit sales and collection period.
3. The amount of selling and distribution expenses.
4. The amount of income tax, property tax and sales tax.
5. The amount of budgeted cash purchase and credit purchases.
6. The period of credit allowed by the suppliers.
7. The amount of salaries and wages to be paid.
8. The amount of overhead expenses.
9. Details of capital expenditure.
10. Details of administration expenses and payment of dividend.
Methods of preparing cash budget:
There are three methods of preparing a cash budget.
1.Receipts and Payments Method

Under this method, cash budget is prepared in columnar basis. There are two parts.
First part is receipts and second part are payments. The total receipts are added
with opening balance of cash and deducted the payments to get closing balance of
cash. If receipts are more than payments, there is a surplus of cash at the end of the
month and vice versa.
2.Adjusted Profit and Loss Method
This method is also called the cash flow statement. This type of budget is prepared
for long period. It gives more details of incomes and expenses in connection with
long term planning. The profit is considered to be equivalent to cash. Even though,
cash receipts and payments are not into consideration but considers only non-cash
transactions to prepare the cash budget under this method. The profit is adjusted
by adding back depreciation, provisions, stock, work in progress, capital receipts,
decrease in debtors, increase in creditors and by deducting dividends, capital
payments, increase in debtors, and increase in stock and decrease in creditors. The
adjusted profit is the closing balance of cash.
The following information is necessary to prepare the cash budget under adjusted
profit and loss method.
1. Expected opening balance.
2. Net profit for the period.
3. Changes in current assets and current liabilities.
4. Capital receipts and capital expenditure.
5. Payment of dividend.
3.Balance Sheet Method
This method is very similar to adjusted profit and loss method. Under this
method, all the items of balance sheet are recorded in respective sides except cash.

Then, the balance sheet is balanced. If the liabilities side is heavier than assets
side, the balancing figure is cash at bank. Likewise, if the assets side is heavier
than liabilities side, the balancing figure is overdraft
1.Receipts and Payments Method:
Under this method, all actual possible items of cash receipts and payments for the
budgeted period are considered. Sources of information are the various other
budgets.
For example, (a) Sales from the sales budget (b) Materials, labour, overhead
expenditure and capital expenditure etc., from the concerned budgets.
Steps to be adopted:
Cash Receipts Forecast:
Cash receipts from sales, debtors, income from sales of assets and investments
and., probable borrowings should be forecast and brought into cash budget. Any
lag in payment by debtors or by others shall be considered for ascertaining further
cash inflows.
Cash requirements forecast:
Total cash outflows are taken out from operating budgets for the elements of cost,
and from capital expenditure budget for the purchase of fixed assets. Adjustments
are to be made for any lag in payments. Care must be taken to ensure that out-
standings or accruals are excluded from the cash budget since this method is
based on the concept of actual cash flows.
Example 1:

A newly started company Quick Co. Ltd., wishes to prepare cash budget from
January. Prepare a cash budget for the first six months from the following
estimated revenue and expenditure:
Cash balance on 1st January 1999 was Rs. 10,000. A new machine is to be
installed at Rs. 30,000 on credit, to be repaid by two equal instalments in March
and April. Sales commission @ 5% on total sales is to be paid within the month
following actual sales. Rs. 10,000 being the amount of 2nd call may be received in
March. Share premium amounting to Rs.2, 000 is also obtainable with 2nd call.
 Period of credit allowed by suppliers 2 months
 Period of credit allowed to customers 1 month
 Delay in payment of overheads 1 month
 Delay in payment of wages 1/2 month
 Assume cash sales to be 50% of total sales.
Solution:

Sometimes, it is required to forecast cash or working capital and this can be
computed in the usual way as described above. Further consideration is
necessary in respect of lag in payment and lag in realisation.
2.Adjusted Profit and Loss Method:
Compared with the previous method, this method is less detailed and more
difficult to comprehend; it is particularly useful for the long-term forecasts, say
for a period of over three years. It is called thus, because it transforms the profit
and loss account into cash forecast.
The basic assumption in this method is that any increase or decrease in cash
balance is due to profit or loss of the business. All non-cash items such as

depreciation, write-offs or write-ups etc., are mainly adjusted to the net profit.
The theory, under this method, is based on the assumption that profit is cash. If
there were no credit transactions or transactions resulting in capital profits, the
balance of profit on the Profit and Loss account should be equal to the balance of
cash in the cash book.
Such a situation however will never exist in practice in any business. Hence all
adjustments with regard to the above items are to be made in the cash forecast.
Sources of information are the firm‟s profit and loss account and balance sheet.
Example 2:
From the following information prepare a cash budget under the adjusted profit
and loss method:

The following are the additional information for the year 1999: Shares were
issued for Rs. 10,000, and debentures were issued for Rs. 2,000. On 31-12-1999,
the accrued expenses were Rs. 500, debtors Rs. 20,000, creditors Rs. 30,000 and
land and buildings, Rs. 40,000.
Solution:

3.Balance Sheet Method:
The same theoretical assumption of the adjusted profit and loss method holds
good in this method also. Under this method, a budgeted balance sheet is
prepared showing all items of assets and liabilities except cash balance.
The balancing figure is considered to represent cash balance. If there is excess of
liabilities over assets, the balance is ordinary cash balance; if there is excess of
assets over liabilities, the balance is assumed to be bank overdraft.
Of these three methods, the first method is mostly preferred because it is a short-
term forecast and is much more detailed than the other two methods which are
normally used as long-term forecasts.
Example 3:

Using the data of Example 2, prepare cash forecast showing cash at bank on 31-12-
1999 under balance sheet method.
Solution:
The balancing figure of Rs. 28,600 represents cash at bank on 31-12-1999. This is
obtained by completing the balance sheet from the information obtained from
example 2, as follows:
Flexible Budget: Importance and Methods of Preparation!
The Chartered Institute of Management Accountants, England, defines a flexible
budget (also called sliding scale budget) as a budget which, by recognizing the
difference in behaviour between fixed and variable costs in relation to fluctuations
in output, turnover, or other variable factors such as number of employees, is
designed to change appropriately with such fluctuations.
Thus, a flexible budget gives different budgeted costs for different levels of
activity. A flexible budget is prepared after making an intelligent classification of
all expenses between fixed, semi-variables and variable because the usefulness of
such a budget depends upon the accuracy with which the expenses can be
classified.

Flexible budgets represent the amount of expense that is reasonably necessary to
achieve each level of output specified. In other words, the allowances given under
flexible budgetary control system serve as standards of what costs should be at
each level of output.
Such a budget is prescribed in the following cases:
1. Where the level of activity during the year varies from period to period,
either due to the seasonal nature of the industry or due to variation in
demand.
2. Where the business is a new one and it is difficult to foresee the demand.
3. Where the undertaking is suffering from shortage of a factor of production
such as materials, labour, plant capacity etc. The level of activity depends
upon the availability of such a factor of production.
4. Where an industry is influenced by changes in fashion.
5. Where there are general changes in sales.
6. Where the business units keep on introducing new products or make changes
in the design of its products frequently.
7. Where the industries are engaged in make to order business like ship-
building.
Utility (or Importance) of Flexible Budget:
Following points show the utility or importance of flexible budget:
1. Flexible budget provides a logical comparison of budgeted allowances with
the actual cost i.e., a comparison with like basis.
2. Flexible budget reckons operational realities and streamlines control
function and profit planning. It gives balanced perspective on comparison.

When flexible budget is prepared, actual cost at actual activity is compared
with budgeted cost at actual activity i.e., two things to a like basis.
3. Flexible budget recognises concept of variability and provides logical
comparison of expenditure with actual expenditure as a means of control.
4. With flexible budget, it is possible to establish budgeted cost for any range
of activity.
5. A flexible budget is very useful for purposes of budgetary control because it
corresponds with changes in the level of activity.
6. It is helpful in assessing the performance of departmental heads because
their performance can be judged in relation to the level of activity attained
by the organisation.
7. Cost ascertainment at different levels of activity is possible because a
flexible budget is prepared for various levels of activity.
8. It is helpful in price fixation and for sending quotations.
9. To conclude, a flexible budget is more useful, elastic and practical.
Preparation of Flexible Budgets:
There are three methods of preparing a flexible budget:
1. Tabular Method or Multi-Activity Method.
2. Charting Method.
3. Formula Method or Ratio Method.

1. Tabular Method:
According to this method, a flexible budget is prepared for different levels of
activity showing different activity or capacity levels in horizontal columns and
budgeted figures against different activity or capacity levels in the vertical
columns. The expenses are usually recorded under three groups, namely, variable,
semi-variable and fixed. Budgeted figures for any level of activity not specifically
covered in the flexible budget can be obtained by interpolation.
A specimen of a flexible budget may be as follows:

2. Charting Method:
Under this method, an estimate of expenses is made for different levels of activity
by classifying the expenses into three categories, namely, variable, semi-variable,
and fixed. The estimated expenses are plotted on a graph paper on Y-axis and level
of activity is plotted on X-axis. The budgeted expenses corresponding to the level
of activity attained can then be read out from the chart and the performance of
departmental heads can be assessed.
3. Formula Method or Ratio Method:
Under this method, a budget is prepared for the expected normal level of activity
and variable cost per unit of activity is ascertained.
Expense budget allowed for a particular level of activity attained will be as
follows:
Fixed cost + (Actual units of activity x variable cost per unit of activity)

For example, the overhead expenses budget for a normal level of 80% activity is
Rs 90,000. Assuming that the expenses budget consists of fixed cost Rs 50,000 and
variable expenses Rs 40,000, then variable cost per 1% activity is Rs 500 (i.e., Rs
40,000/ 80).
Suppose actual level of activity is 75%, the expense budget allowed will be:
50,000 (fixed) + 75 x Rs 500 (variable) = Rs 87,500.
Basic Budgets:
A basic budget has been defined as a budget which is prepared for use unaltered
over a long period of time. This does not take into consideration current conditions
and can be attainable under standard conditions.
Current Budgets:
A current budget can be defined as a budget which is related to the current
conditions and is prepared for use over a short period of time. This budget is more
useful than a basic budget, as a target it lays down will be corrected to current
conditions.
Long-Term Budgets:
A long-term budget can be defined as a budget which is prepared for periods
longer than a year. These budgets help in business forecasting and forward
planning. Capital Expenditure Budget and Research and Development Budget are
examples of long-term budgets.
Short-term Budgets:
This budget is defined as a budget which is prepared for period less than a year and
is very useful to lower levels of management for control purposes. Such budgets

are prepared for those activities, the trend in which is difficult to foresee over
longer periods. Cash budget and material budget are examples of short-term
budgets.
Standard Costing
Meaning of Standard Costing:
It is a method of costing by which standard costs are employed. According to
ICMA, London, Standard Costing is “the preparation and use of standard costs,
their comparison with actual cost and the analysis of variances to their causes
and points of incidence”.
Standard Costing involves:
a) Ascertainment and use of Standard Costs;
b) Recording the actual costs;
c) Comparison of actual costs with standard costs in order to find out the
variance;
d) Analysis of variance; and
e) After analysing the variance, appropriate action may be taken where
necessary.
Process of Standard Costing

1) Establishing Standards: First and foremost, the standards are to be set on
the basis of management‟s estimation, wherein the production engineer
anticipates the cost. In general, while fixing the standard cost, more weight
is given to the past data, the current plan of production and future trends.
Further, the standard is fixed in both quantity and costs.
2) Determination of Actual Cost: After standards are set, the actual cost for
each element, i.e. material, labour and overheads is determined, from
invoices, wage sheets, account books and so forth.
3) Comparison of Actual Costs and Standard Cost: Next step to the process,
is to compare the standard cost with the actual figures, so as to ascertain the
variance.
4) Determination of Causes: Once the comparison is done, the next step is to
find out the reason for the variances, to take corrective actions and also to
evaluate the overall performance.
5) Disposition of Variances: The last step to this process, is the disposition of
variances by transferring it to the costing profit and loss account.
Objectives of Standard Costing:
1) It helps to implement budgetary control system in operation;
2) It helps to ascertain performance evaluation.

3) It supplies the ways to utilise properly material, labour and also overhead
which will be economic in character.
4) It also helps to motivate the employees of a firm to improve their
performance by setting up a „standard‟.
5) It also helps the management to supply necessary data relating to cost
element to submit quotations or to fix up the selling price of a firm.
6) It also helps the management to make proper valuations of inventory (viz.,
Work-in- progress, and finished products).
7) It acts as a control device to the management.
8) It also helps the management to take various corrective decisions viz.,
fixation of price, make-or-buy decisions etc. which will be more
beneficial to the firm.
Advantages of Standard Costing:
The following advantages may be derived from Standard Costing:
1) Standard Costing serves as a guide to the management in several
management functions while formulating prices and production policies
etc.
2) More effective cost control is possible under standard costing if the same
is reviewed and analyzed at regular intervals.
3) Analysis of variance and its measurement helps to detect inefficiencies
and mistakes which enable the management to investigate the reasons.
4) Since standard costs are predetermined costs they are very useful for
planning and budgeting.
5) Once the Standard Costing System is implemented it will lead to saving
cost since most of the costing work can be eliminated.

6) Delegation of authority and responsibility becomes effective by setting up
standards for each cost centre as the supervisors or executives of each cost
centre will know the standard which they have to maintain.
7) Standard costing is also used for inventory valuation purposes. Stock can
be valued at standard cost which can reduce the fluctuation of profit for
different methods of valuation for the same.
8) Efficiency of labour is promoted.
Disadvantages of Standard Costing:
1) Since Standard Costing involves high degree of technical skill, it is,
therefore, costly.
2) The executives are liable for those variances that are found from actions
which are actually controllable by them.
3) Standards are always changing since conditions of the business are equally
changing. So, standards are to be revised in order to make them comparable
with actual results.
4) Standards are either too liberal or rigid since the same are based on average
past results, attainable good performance or theoretical maximum efficiency.
Material Variance:
The following variances constitute materials variances:

Material Cost Variance
The difference between the standard cost of direct materials specified for
production and the actual cost of direct materials used in production is known as
Direct Material Cost Variance. Material Cost Variance gives an idea of how much
more or less cost has been incurred when compared with the standard cost. Thus,
Variance Analysis is an important tool to keep a tab on the deviations from the
standard set by a company.
 Material Cost Variance = (Standard Cost – Actual Cost)
Material Price Variance
Material Price Variance is the difference between the standard price and the actual
price for the actual quantity of materials used for production. The cause for
material price variance can be many including changes in prices, poor purchasing
procedures, deficiencies in price negotiation, etc.
 MPV = (Standard Price – Actual Price) x Actual Quantity
Let us understand this formula with the help of an example.

Standard Actual
Price $ 10 per kg. $ 8 per kg.
Quantity 200 kgs. 150 kgs.
Here, the Material Price Variance can be calculated as follows:
MPV = (10 – 8) x 150
= 300 (F)
Reasons of direct materials price variance:
A favorable or unfavorable material price variance may occur due to one or more
of the following reasons:
1) Order size: Some suppliers allow discount on large orders. The materials
purchased in large quantities may reduce the the unit price and a favorable
price variance may occur.
2) Rise in price: The rise in the general price level may increase the input costs
of the vendor and as a result vendor may increase the price of the materials.
3) Urgent needs: If production department does not indicate the need of
materials on time, the purchasing department may have to order on urgent
basis that may increase the price of materials and other expenses associated
with the order.
4) Quality: A favorable price variance may be the result of purchasing low
quality materials and an unfavorable variance may be the result of
purchasing high quality materials.
5) Inefficient standard setting: Inefficiencies in terms of forecasting and
environmental scanning during standard setting process can be a reason of
huge variances.

6) Transportation: Transportation is a part of total direct materials cost. Any
change in the transportation expenses can change the total and per unit cost
of direct material.
7) Inefficient or unreliable suppliers: A deviation from standard material
costs may be the result of inefficient or unreliable vendors.
Material Usage Variance
Material Usage Variance is the difference between the standard quantity specified
for actual production and the actual quantity used at the standard purchase price.
There can be many reasons for material usage variance including the use of sub-
standard or defective products, pilferage, wastage, the differences in material
quality, etc.
 MUV = (Standard Quantity – Actual Quantity) x Standard Price
With the help of the above example, let us now calculate Material Usage Variance.
MUV = (200 – 150) x 10
= 500 (F)
Causes for Direct Material Usage Variance.
1) Negligence in use of materials.
2) More wastage of materials by untrained workers.
3) Adopting defective or wring or improper production process.
4) Loss due to pilferage.
5) Use of material mix other than the standard mix.
6) Using of poor or bad quality of materials.
7) Carelessness and inefficiency of workers.
8) More or less yield from materials than the standard set.

9) Lack of skill of the employee‟s leads to more consumption of materials.
10) Defective production necessitating the use of additional materials.
11) Improper condition of Plant and Equipment.
12) Bad maintenance and upkeep of plant lead to more scraping materials.
13) Lack of proper inspection and supervision of materials lead to more
consumption of materials.
The materials usage or quantity variance can be separated into mix variance and
yield variance.
For certain products and processing operations, material mix is an important
operating variable, specific grades of materials and quantity are determined before
production begins. A mix variance will result when materials are not actually
placed into production in the same ratio as the standard formula.
Material mix variance is usually found in industries, such as textiles, rubber and
chemicals, etc. A mix variance may arise because of attempts to achieve cost
savings, effective resources utilisation and when the needed raw materials
quantities may not be available at the required time.
a) Materials mix variance
Materials mix variance is that portion of the materials quantity variance which is
due to the difference between the actual composition of a mixture and the standard
mixture.
 MMV= Standard price * (Revised standard quantity-Actual quantity)
(b) Materials Yield Variance:

Materials yield variance explains the remaining portion of the total materials
quantity variance. It is that portion of materials usage variance which is due to the
difference between the actual yield obtained and standard yield specified (in terms
of actual inputs). In other words, yield variance occurs when the output of the final
product does not correspond with the output that could have been obtained by
using the actual inputs. In some industries like sugar, chemicals, steel, etc. actual
yield may differ from expected yield based on actual input resulting into yield
variance.
The formula for computing yield variance is as follows:
 MYV = Standard cost per unit x(Actual yield – Standard Yield specified)
Relationship between the Material variances:
 MCV= MPV + MUV
 MCV= MPV + (MMV+ MYV) Or MPV + (MMV + MRUV/MSUV)
 MUV= (MMV+ MRUV/MSUV) Or MUV= (MMV+ MYV)
 MPV= MCV- MUV
 MUV= MCV- MPV
 MPV=MCV-(MMV+MYV)
Where,
MCV= material cost variance
MPV= Material Price variance
MUV= Material Usage variance
MMV= Material Mix variance
MRUV= Material Revised usage variance
MSUV= Material Sub- usage variance

MYV= Material Yield variance
Labour Variances:
Direct labour variances arise when actual labour costs are different from standard
labour costs. In analysis of labour costs, the emphasis is on labour rates and labour
hours.
Labour variances constitute the following:
Labour Cost Variance:
Labour cost variance denotes the difference between the actual direct wages paid
and the standard direct wages specified for the output achieved.
This variance is calculated by using the following formula:
Labour cost variance = (SH x SR) – (AH x AR)
Where:
AH = Actual hours
AR = Actual rate
SH = Standard hours
SR = Standard rate

1. Labour Efficiency Variance:
The calculation of labour efficiency or usage variance follows the same pattern as
the computation of materials usage variance. Labour efficiency variance occurs
when labour operations are more efficient or less efficient than standard
performance. If actual direct labour hours required to complete a job differ from
the number of standard hours specified, a labour efficiency variance results; it is
the difference between actual hours expended and standard labour hours specified
multiplied by the standard labour rate per hour.
Labour efficiency variance = Std. rate per hour x(Standard hours for the actual
output- Actual hours)
(i) Labour Mix Variance:
Labour mix variance is computed in the same manner as materials mix variance.
Manufacturing or completing a job requires different types or grades of workers
and production will be complete if labour is mixed according to standard
proportion. Standard labour mix may not be adhered to under some circumstances
and substitution will have to be made. There may be changes in the wage rates of
some workers; there may be a need to use more skilled or expensive types of
labour, e.g., employment of men instead of women; sometimes workers and
operators may be absent.
These lead to the emergence of a labour mix variance which is calculated by using
the following formula:
Labour mix variance = (Actual labour mix – Revised standard labour mix in
terms of actual total hours) x Standard rate per hour

Take an example, suppose the following were the standard labour cost data per unit
in a factory:
In a period, many class B workers were absent and it was necessary to substitute
class B workers. Since the class A workers were less experienced with the job,
more labour hours were used.
The recorded costs of a unit were:
Labour mix variance will be calculated as follows:
Labour mix variance = (Actual proportion – Revised standard proportion of actual
total hours) x standard rate per hour
Revised standard proportion:
(ii) Labour Yield Variance:
The final product cost contains not only material cost but also labour cost.
Therefore, gain or loss (higher or lower output than the standard output) should
take into account labour yield variance also. A lower output simply means that

final output does not correspond with the production units that should have been
produced from the hours expended on the inputs.
It can be computed by applying the following formula:
Labour yield variance = (Actual output – Standard output based on actual hours) x
Av. Std. Labour Rate per unit of output.
Or
Labour yield variance = (Actual loss – Standard loss on actual hours) x Average
standard labour rate per unit of output
Labour yield variance is also known as labour efficiency sub-variance which is
computed in terms of inputs, i.e., standard labour hours and revised labour hours
mix (in terms of actual hours).
Labour efficiency sub-variance is computed by using the following formula:
Labour efficiency sub-variance = (Revised standard mix – standard mix) x
Standard rate
2. Labour Rate Variance:
Labour rate variance is computed in the same manner as materials price variance.
When actual direct labour hour rates differ from standard rates, the result is a
labour rate variance. It is that portion of the direct wages variance which is due to
the difference between actual rate paid and standard rate of pay specified.
The formula for its calculation is:
Labour rate variance = (Actual rate – Standard rate) x Actual hours

Using data from the example given above, the labour rate variance is Rs 25,250,
i.e.,
Labour rate variance = (35 – 30) x 5050 hours = 5 x 5050 = Rs 25,250
(unfavourable)
The number of actual hours worked is used in place of the number of the standard
hours specified because the objective is to know the cost difference due to change
in labour hour rates, and not hours worked. Favourable rate variances arise
whenever actual rates are less than standard rates; unfavourable variances occur
when actual rates exceed standard rates.
3. Idle Time Variance:
Idle time variance occurs when workers are not able to do the work due to some
reason during the hours for which they are paid. Idle time can be divided according
to causes responsible for creating idle time, e.g., idle time due to breakdown, lack
of materials or power failures. Idle time variance will be equivalent to the standard
labour cost of the hours during which no work has been done but for which
workers have been paid for unproductive time.
Suppose, in a factory 2,000 workers were idle because of a power failure. As a
result of this, a loss of production of 4,000 units of product A and 8,000 units of
product B occurred. Each employee was paid his normal wage (a rate of? 20 per
hour). A single standard hour is needed to manufacture four units of product A and
eight units of product B.
Idle time variance will be computed in the following manner:
Standard hours lost:
Product A = 4, 000/ 4 = 1,000 hr.
Product B = 8, 000 / 8 = 1,000 hr.

Total hours lost = 2,000 hr.
Idle time variance (power failure)
2,000 hours @ Rs 20 per hour = Rs 40,000 (Adverse)

Management Accounting Unit - 2. B.Com(Hons)/B.Com/BBA/MBApdf

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