Variance analysis: material, labour, overhead and sales variances

Cost and Management Accountancy (CMA (ICMAI)) · Management accounting and decisions · free study notes for exams, placements and interviews

In short

Variance analysis compares the standard (pre-set) cost or margin for the output actually achieved with what actually happened, and splits the gap into causes — price paid, quantity used, mix, yield, rate, efficiency, idle time, spending, capacity and volume. Each variance is labelled Favourable (F) when actual is better than standard and Adverse (A) when worse, and the parts must add back to the total so that budgeted profit can be reconciled with actual profit. It is a guaranteed scoring area in CMA Intermediate/Final cost and management accounting papers, in B.Com/MBA cost accounting, and in CA Inter costing; sums are numerically heavy and marks are lost on signs, not on concepts. In practice Indian manufacturers (Tata Steel, Asian Paints, Hindustan Unilever, Maruti suppliers, pharma formulators, sugar and cement units) run monthly variance decks, and cost auditors under section 148 of the Companies Act, 2013 look at variances to separate normal from abnormal cost.

Explained

Framework, sign convention and the golden rule

Standard cost = standard quantity × standard price, pre-determined from technical estimates; actual cost = actual quantity × actual price.
The golden rule: always compute the standard for the actual output, never for the budgeted output. Standard quantity (SQ) = actual output × standard input per unit.
Sign convention: variance = Standard − Actual for *costs*; = Actual − Budget for *sales and profit*. Positive = Favourable.
Additivity: price-type variance + quantity-type variance = total cost variance; every sub-split must reconcile to its parent. If it does not add up, the arithmetic is wrong.
Controllability: price/rate variances usually belong to purchase/HR; usage, efficiency and mix to production; volume and mix of sales to marketing. Variances are interdependent — a cheap substitute material (F price) often causes excess usage and rework (A usage).
Investigation is by exception: absolute size, percentage of standard, trend over months, and a control limit (often ±5%). Not every variance is investigated.
Accounting treatment: under Ind AS 2 / AS 2 standard cost may be used for inventory valuation only if it approximates actual cost and is reviewed regularly; variances are normally written off to the profit and loss account of the period. ICMAI's Cost Accounting Standards — CAS-6 (material cost), CAS-7 (employee cost), CAS-3 (production and operation overheads) — require abnormal and non-recurring costs (abnormal idle time, abnormal wastage) to be excluded from cost of production and shown separately; this is what cost records in form CRA-1 and the cost audit report in CRA-3 are tested against.

Material variances

Material cost variance (MCV) = standard cost of material for actual output − actual cost of material.
Price variance = AQ × (SP − AP). Caused by market rates, GST-inclusive versus exclusive quoting errors, freight, discounts, emergency purchases, exchange rates on imports.
Basis issue: if purchases ≠ consumption, price variance is computed on quantity purchased (purchase-based, the usual exam instruction when stock is valued at standard) while usage variance is on quantity consumed. State the basis you use.
Usage (quantity) variance = SP × (SQ − AQ). Causes: wastage, spoilage, pilferage, machine condition, poor-grade input, operator skill.
Usage splits into mix and yield where two or more materials are substitutable:
- Mix variance = SP × (Revised standard quantity − AQ), where RSQ = total actual input quantity apportioned in the standard mix ratio. Measures departure from the recipe.
- Yield (sub-usage) variance = standard cost per unit of output × (Actual output − Standard output expected from actual input). Measures loss/gain of output from a given input.
- Alternative yield formula = standard cost per unit of input × (Total SQ − Total AQ); both give the same figure when the standard loss percentage is applied consistently.
Revised usage variance is sometimes asked instead of yield: SP × (RSQ − SQ) with the opposite sign, i.e. usage = mix + revised usage.
Normal (standard) loss is already built into the standard input; only abnormal loss shows up as an adverse yield variance.

Labour (employee cost) variances

Labour cost variance = standard labour cost for actual output − actual labour cost (hours paid × actual rate).
Rate of pay variance = Hours paid × (SR − AR). Causes: wage settlements, dearness allowance revision, overtime premium, higher-grade workers deployed, statutory increases in minimum wages notified under the Code on Wages, 2019 (the four Labour Codes are in force from 21 November 2025 and replaced the Minimum Wages, Factories, Industrial Disputes and BOCW Acts).
Idle time variance = Abnormal idle hours × SR. Always adverse (never favourable). Normal idle time is built into the standard rate/time; abnormal idle time (power failure, strike, material shortage) is excluded from cost of production per CAS-7.
Efficiency variance = SR × (Standard hours for actual output − Actual hours worked). Causes: skill, training, learning effect, machine breakdown, quality of material, method change.
Gang composition (labour mix) variance = SR × (Revised standard hours − Actual hours worked), RSH = total actual hours in the standard skill-mix ratio of skilled/semi-skilled/unskilled.
Labour yield (productivity) variance = standard labour cost per unit × (Actual output − Standard output from actual hours worked).
Reconciliation: labour cost variance = rate + idle time + mix + yield; or rate + idle time + efficiency, where efficiency = mix + yield.

Overhead variances

Variable overheads vary with activity; fixed overheads do not — so their variance structures differ fundamentally. Absorption is at a standard rate per hour or per unit.
Variable overhead (2-variance split):
- Total VOH variance = (Standard hours for actual output × SR) − Actual VOH.
- VOH expenditure/spending variance = (Actual hours × SR) − Actual VOH.
- VOH efficiency variance = SR × (Standard hours for actual output − Actual hours).
Fixed overhead:
- Total FOH variance (under/over-absorption) = (Standard hours for actual output × SR) − Actual FOH.
- FOH expenditure (spending) variance = Budgeted FOH − Actual FOH. This is the only genuinely cost-control variance in fixed overhead.
- FOH volume variance = Absorbed FOH − Budgeted FOH = SR × (Standard hours for actual output − Budgeted hours). It exists only because fixed cost is unitised; it measures utilisation, not spending.
- Volume splits into capacity variance = SR × (Actual hours − Budgeted hours), calendar variance = SR × (Actual days − Budgeted days) × standard hours per day, and efficiency variance = SR × (Standard hours for output − Actual hours).
- When calendar variance is separated, capacity variance is computed against the revised budgeted hours for the actual number of days, so that calendar + capacity + efficiency = volume.
Classification names: two-variance analysis (expenditure + volume), three-variance (expenditure + capacity + efficiency), four-variance (expenditure + capacity + calendar + efficiency).
Under marginal costing there is no fixed-overhead volume variance at all — fixed overhead is a period cost, so only the expenditure variance arises. This is a favourite examiner trap.

Sales variances

Two accepted methods; the question must be read for which one is wanted.

Profit (margin) method — explains the profit gap, used when a reconciliation statement is required:
- Total sales margin variance = Actual margin (actual quantity × standard margin, adjusted for actual price) − Budgeted margin.
- Sales price variance = AQ × (AP − SP).
- Sales volume (margin) variance = Standard margin per unit × (AQ − BQ), which splits into sales mix variance = Standard margin × (AQ − RBQ) and sales quantity (sub-volume) variance = Standard margin × (RBQ − BQ), where RBQ = total actual quantity in the budgeted product ratio.
Turnover (value) method — explains the revenue gap: total sales value variance = Actual sales value − Budgeted sales value, split into price variance (same as above) and volume variance valued at standard selling price, further split into mix and quantity at standard selling price.
The price variance is identical in both methods; volume/mix/quantity differ because one values at margin and the other at selling price.
Market size and market share variances (advanced): quantity variance = market size variance (change in total market × budgeted share × standard margin) + market share variance (change in share × actual market × standard margin).

Reconciliation and control ratios

Standard flow of an operating statement: Budgeted profit → ± sales variances → ± material, labour, variable overhead and fixed overhead variances → Actual profit.
Control ratios express the same information as percentages:
- Efficiency ratio = Standard hours for actual output / Actual hours worked.
- Capacity ratio = Actual hours worked / Budgeted hours.
- Activity (volume) ratio = Standard hours for actual output / Budgeted hours = Efficiency ratio × Capacity ratio.
- Calendar ratio = Actual days / Budgeted days. Above 100% is favourable.
Advantages: pinpoints responsibility, enables management by exception, feeds pricing and cost-reduction decisions, supports cost audit and working-capital control.
Limitations: standards go stale with inflation and input substitution; heavy clerical effort; variances are interdependent so blame is hard to assign; favourable variances can be dysfunctional (buying sub-standard material, over-producing to absorb fixed overhead); not suited to one-off jobs or rapidly changing product mixes; backward-looking and weak against JIT/TQM/continuous-improvement philosophies, where planning versus operational variance splits (ex-post standards) are preferred.

Key points

Golden rule - the standard is always flexed to the actual output achieved.
Price variance - AQ × (SP − AP); on quantity purchased if stock is valued at standard.
Usage variance - SP × (SQ − AQ); splits into mix and yield.
Mix variance - SP × (RSQ − AQ); RSQ = total actual input in the standard mix ratio.
Yield variance - std cost per unit of output × (actual output − output expected from actual input).
Rate variance - hours paid × (SR − AR); efficiency uses hours worked.
Idle time variance - abnormal idle hours × SR, and it is always adverse.
Gang (labour mix) variance - deviation from the standard skilled/unskilled composition.
VOH split - expenditure (at actual hours) + efficiency (hours difference).
FOH expenditure variance - budgeted minus actual fixed overhead; the only spending control in fixed overhead.
FOH volume variance - absorbed minus budgeted; arises purely from unitising a fixed cost; nil under marginal costing.
Capacity, calendar, efficiency - the three causes of a volume variance (four-variance analysis).
Sales price variance - AQ × (AP − SP); identical under margin and turnover methods.
Sales mix versus quantity - mix is the product-ratio effect, quantity is the total-volume effect; together they equal the volume variance.
Activity ratio = Efficiency ratio × Capacity ratio, the ratio form of the volume variance.
CAS-6 / CAS-7 / CAS-3 - abnormal wastage and abnormal idle time are excluded from cost of production and shown separately.
Ind AS 2 - standard cost is acceptable for inventory only if it approximates actual; variances go to the profit and loss account.
Interdependence - a favourable price variance is often the cause of an adverse usage variance.

Formulas and examples

Material: MCV = (SQ × SP) − (AQ × AP); MPV = AQ × (SP − AP); MUV = SP × (SQ − AQ)
MMV = SP × (RSQ − AQ), RSQ = Total AQ × standard mix proportion; MYV = SC per unit of output × (Actual output − Standard output from actual input)
*SQ = standard quantity for actual output (kg), SP = standard price (₹/kg), AQ, AP = actual*

Labour: LCV = (SH × SR) − (Hours paid × AR); LRV = Hours paid × (SR − AR); Idle time variance = Idle hours × SR (always A); LEV = SR × (SH − Hours worked); Gang variance = SR × (RSH − Hours worked)
*SH = standard hours for actual output, SR = standard rate (₹/hour)*

Variable overhead: Total = (SH × SR_v) − Actual VOH; Expenditure = (Actual hours × SR_v) − Actual VOH; Efficiency = SR_v × (SH − Actual hours)

Fixed overhead: Total = (SH × SR_f) − Actual FOH; Expenditure = Budgeted FOH − Actual FOH; Volume = SR_f × (SH − Budgeted hours); Capacity = SR_f × (Actual hours − Budgeted hours); Calendar = SR_f × std hours per day × (Actual days − Budgeted days); Efficiency = SR_f × (SH − Actual hours)

Sales (margin method): Price = AQ × (AP − SP); Volume = Std margin × (AQ − BQ); Mix = Std margin × (AQ − RBQ); Quantity = Std margin × (RBQ − BQ), RBQ = Total AQ × budgeted mix proportion
Sales (turnover method): Volume = SP × (AQ − BQ); Mix = SP × (AQ − RBQ); Quantity = SP × (RBQ − BQ)

Control ratios: Efficiency = SH / Actual hours; Capacity = Actual hours / Budgeted hours; Activity = SH / Budgeted hours = Efficiency × Capacity

Example 1 — Single material. Standard: 5 kg @ ₹40/kg per unit. Actual output 1,100 units; 5,750 kg bought and consumed @ ₹42/kg.

SQ = 1,100 × 5 = 5,500 kg; standard cost = 5,500 × 40 = ₹2,20,000. Actual cost = 5,750 × 42 = ₹2,41,500.
MCV = 2,20,000 − 2,41,500 = ₹21,500 (A)
MPV = 5,750 × (40 − 42) = ₹11,500 (A)
MUV = 40 × (5,500 − 5,750) = ₹10,000 (A); check 11,500 + 10,000 = 21,500 (A) ✓

Example 2 — Mix and yield. Standard for 100 kg output: A 60 kg @ ₹50 = ₹3,000; B 50 kg @ ₹30 = ₹1,500; input 110 kg, standard loss 10 kg; standard cost ₹4,500 per 100 kg (₹45/kg output). Actual output 2,000 kg from A 1,300 kg @ ₹52 and B 980 kg @ ₹28.

SQ for 2,000 kg output (20 batches): A 1,200 kg, B 1,000 kg; standard cost = 20 × 4,500 = ₹90,000. Actual = 67,600 + 27,440 = ₹95,040 → MCV ₹5,040 (A)
MPV: A 1,300 × (50 − 52) = 2,600 A; B 980 × (30 − 28) = 1,960 F → ₹640 (A)
MUV: A 50 × (1,200 − 1,300) = 5,000 A; B 30 × (1,000 − 980) = 600 F → ₹4,400 (A); 640 + 4,400 = 5,040 ✓
RSQ (total input 2,280 kg in 60:50): A = 2,280 × 60/110 = 1,243.64 kg; B = 1,036.36 kg.
MMV: A 50 × (1,243.64 − 1,300) = 2,818.18 A; B 30 × (1,036.36 − 980) = 1,690.91 F → ₹1,127.27 (A)
Standard output from 2,280 kg input = 2,280 × 100/110 = 2,072.73 kg; MYV = 45 × (2,000 − 2,072.73) = ₹3,272.73 (A)
Check: 1,127.27 + 3,272.73 = ₹4,400 (A) = usage variance ✓

Example 3 — Labour with idle time. Standard 4 hours @ ₹60 per unit. Actual output 2,500 units; hours paid 10,400 (including 200 hours abnormal idle time from a power cut); rate paid ₹62/hour.

SH = 10,000; standard cost ₹6,00,000. Actual = 10,400 × 62 = ₹6,44,800 → LCV ₹44,800 (A)
LRV = 10,400 × (60 − 62) = ₹20,800 (A)
Idle time = 200 × 60 = ₹12,000 (A)
LEV = 60 × (10,000 − 10,200 worked) = ₹12,000 (A); total 20,800 + 12,000 + 12,000 = 44,800 ✓

Example 4 — Overheads (four-variance fixed, two-variance variable). Budget: output 10,000 units at 2 hours each = 20,000 hours in 25 working days; fixed overhead ₹6,00,000 (SR_f = ₹30/hour, ₹60/unit); variable overhead ₹20/hour (₹40/unit). Actual: output 9,500 units, hours worked 19,400 over 24 days, fixed overhead ₹6,20,000, variable overhead ₹4,00,000. SH = 9,500 × 2 = 19,000 hours.

Variance	Working	Result
FOH total	(19,000 × 30) − 6,20,000	₹50,000 A
FOH expenditure	6,00,000 − 6,20,000	₹20,000 A
FOH volume	30 × (19,000 − 20,000)	₹30,000 A
FOH calendar	30 × 800 hr/day × (24 − 25)	₹24,000 A
FOH capacity (revised: 24 days × 800 = 19,200 hr)	30 × (19,400 − 19,200)	₹6,000 F
FOH efficiency	30 × (19,000 − 19,400)	₹12,000 A
VOH total	(19,000 × 20) − 4,00,000	₹20,000 A
VOH expenditure	(19,400 × 20) − 4,00,000	₹12,000 A
VOH efficiency	20 × (19,000 − 19,400)	₹8,000 A

Checks: calendar + capacity + efficiency = 24,000 A + 6,000 F + 12,000 A = ₹30,000 A = volume ✓; expenditure + volume = ₹50,000 A ✓. Control ratios: efficiency 19,000/19,400 = 97.94%, capacity 19,400/20,000 = 97%, activity 19,000/20,000 = 95% (97.94% × 97% = 95%) ✓.

Example 5 — Sales variances, two products.

	Budget qty	Std price ₹	Std cost ₹	Std margin ₹	Actual qty	Actual price ₹
P	1,000	500	400	100	1,100	510
Q	1,000	300	250	50	800	290

Budgeted profit = 1,00,000 + 50,000 = ₹1,50,000; budgeted sales = ₹8,00,000; actual sales = 5,61,000 + 2,32,000 = ₹7,93,000.
Actual margin at standard cost = 1,100 × 110 + 800 × 40 = ₹1,53,000 → total sales margin variance ₹3,000 F
Price = 1,100 × 10 + 800 × (−10) = ₹3,000 F
Volume (margin) = 100 × 100 + (−200) × 50 = 10,000 F − 10,000 A = Nil; 3,000 + 0 = 3,000 F ✓
RBQ (total actual 1,900 in 1:1) = 950 each. Mix = (1,100 − 950) × 100 + (800 − 950) × 50 = 15,000 F − 7,500 A = ₹7,500 F; Quantity = (950 − 1,000) × 100 + (950 − 1,000) × 50 = ₹7,500 A; mix + quantity = Nil ✓
Turnover method: total value variance = 7,93,000 − 8,00,000 = ₹7,000 A; price ₹3,000 F; volume = 100 × 500 + (−200) × 300 = ₹10,000 A; mix = 150 × 500 + (−150) × 300 = ₹30,000 F; quantity = (−50) × 500 + (−50) × 300 = ₹40,000 A ✓ (Note how the volume figure changes between methods — nil at standard margin, ₹10,000 A at standard selling price, because P's gain and Q's shortfall cancel when valued at margin but not when valued at price, which is exactly why both methods are taught.)

Where it is used

Process and chemical industries (fertilisers, paints, cement, sugar, distilleries): material mix and yield variances are the core monthly KPI, since yield loss directly moves contribution.
Pharmaceutical formulations (Sun, Cipla, Dr. Reddy's): batch yield variance against the master formula record, and overhead volume variance on validated-capacity utilisation.
Auto and auto-component plants (Maruti vendors, Bosch, Bharat Forge): labour efficiency and gang composition variances per shift; standard hours drive incentive schemes.
Textiles, garments and food processing: labour rate variance tracks minimum-wage notifications under the Code on Wages and overtime; idle time variance tracks power and material shortages.
Job roles: cost accountant, plant/management accountant, FP&A analyst, business finance partner, internal auditor, cost auditor signing CRA-3, and SAP CO consultants configuring standard cost estimates (CK11N) and production-order variance calculation (KKS1).
FMCG and pharma sales finance: sales price, mix and quantity variances per SKU and region explain the gross-margin bridge in the monthly management review.

Interview questions

Q: Why must the standard be set for actual output and not budgeted output? A: Otherwise the cost variance would include a pure volume effect; flexing the standard isolates price and efficiency, which is what managers control.
Q: Can an idle time variance ever be favourable? A: No. Abnormal idle hours are either zero or positive, so the variance is nil or adverse; any "favourable" figure means normal idle time was double-counted in the standard.
Q: Which hours do you use for the rate variance and which for the efficiency variance? A: Rate variance uses hours paid, efficiency uses hours actually worked; the difference is the idle time variance.
Q: What does a fixed overhead volume variance really tell you? A: Only that activity differed from the level assumed when the absorption rate was set — it is an under/over-absorption of a cost that did not change, not a spending saving.
Q: Does a volume variance arise under marginal costing? A: No. Fixed overhead is treated as a period cost and not absorbed into units, so only the fixed overhead expenditure variance exists.
Q: A favourable material price variance came with an adverse usage variance. What happened? A: Purchasing likely bought cheaper, lower-grade material; the saving on price was lost in wastage or rework, so the two must be judged together.
Q: Difference between material mix and material yield variance? A: Mix measures the cost effect of departing from the standard proportion of inputs; yield measures the output obtained from the total input compared with the standard loss allowance.
Q: How do the sales margin and sales turnover methods differ? A: Both give the same price variance, but volume/mix/quantity are valued at standard margin in the margin method and at standard selling price in the turnover method, so the margin method ties into the profit reconciliation.
Q: What is the relation between the activity, capacity and efficiency ratios? A: Activity ratio = capacity ratio × efficiency ratio; they are the percentage form of the volume, capacity and efficiency variances.
Q: How are variances treated in the books and in cost records? A: Normally written off to the profit and loss account for the period (standard cost inventory is allowed under Ind AS 2 only if it approximates actual), while abnormal wastage and abnormal idle time are excluded from cost of production under CAS-6 and CAS-7 and disclosed separately.
Q: When is variance analysis a poor control tool? A: When standards are stale, in short-run or bespoke job work, under rapid input-price inflation, and in JIT/continuous-improvement settings where planning versus operational variances or non-financial measures work better.
Q: What is a calendar variance and when do you compute it? A: The fixed overhead effect of actual working days differing from budgeted days; it is computed only in four-variance analysis, and then capacity variance is measured against the hours budgeted for the actual days.

Common mistakes

Using budgeted output instead of actual output to compute the standard quantity or standard hours.
Reversing the sign convention — writing Actual − Standard for costs, which flips every F and A.
Computing the labour rate variance on hours worked, so the idle time variance no longer reconciles.
Mixing bases for material price variance (purchases) and usage variance (consumption) without stating it, then forcing the total to agree.
Taking RSQ or RBQ in the *actual* ratio instead of the *standard/budgeted* ratio — mix variance then comes out as nil.
Treating the fixed overhead volume variance as a cost saving, or computing it at all in a marginal costing question.
Double-counting: reporting usage, mix and yield together as three additions when usage already equals mix plus yield (same error with efficiency = mix + yield).