Calculate and interpret cost variances - direct material price and usage, direct labour rate and efficiency, variable and fixed overhead variances, and sales variances - and reconcile budgeted profit or cost to actual through a statement of variances.

What this dot point is asking

The SQA wants you to set standard costs (cost targets), compare them with actual results, and explain the differences as variances. You must compute the standard set of variances, label each adverse or favourable, and reconcile budgeted profit or cost to actual. The SQA provides a formulae sheet for the variance formulae in the exam, so the marks are for using them correctly and interpreting the result, not memorising them.

Standard costing and the purpose of variances

A standard cost is built from expected quantities and prices, agreed before the period. Comparing it with actual is a control tool.

The point is management by exception: rather than scrutinise every figure, managers focus on the variances large enough to matter, ask why they arose, and decide whether to act. A variance is only useful if it is interpreted, so always pair a figure with a possible cause.

Material and labour variances

These are the variances examined most often, and each total splits into a price (or rate) effect and a quantity (or efficiency) effect.

The rule that prevents sign errors is that a price or rate variance is valued at the actual quantity or hours, while a usage or efficiency variance is valued at the standard price or rate. When the bracket is positive the variance is favourable; when negative it is adverse.

Overhead and sales variances

Beyond material and labour, the SQA examines overhead and sales variances.

Variable overhead splits into an expenditure variance (the rate paid) and an efficiency variance (driven by the labour hours, like the labour efficiency variance). Fixed overhead has an expenditure variance (actual versus budgeted fixed cost) and, under absorption costing, a volume variance (because fixed overhead is absorbed on output, producing more or fewer units than budgeted over- or under-absorbs fixed cost). Sales variances compare actual with budget: a sales price variance (selling above or below standard price) and a sales volume variance (selling more or fewer units, valued at standard profit or contribution).

Interpreting variances

A figure is only half the answer; the SQA awards marks for plausible causes and for noting that variances can be linked. An adverse material price variance might be a supplier price rise or buying a higher grade; a favourable material usage variance might be that higher grade reducing waste. A favourable labour rate variance (cheaper, less skilled staff) can cause an adverse efficiency variance (they work slower). Recognising these interdependencies is what marks a strong answer.

Why this matters later

Variance analysis is the control half of management accounting, complementing the planning done in budgeting. The standard costs it relies on come from the costing methods, and the contribution figures used in sales volume variances connect to marginal costing. In a real business the variance report is what turns a budget into a management tool, which is why interpretation, not just calculation, is examined.

Try this

Q1. Standard price is GBP 6 per kg; actual quantity used is 2,000 kg at an actual price of GBP 5.70. Calculate the material price variance and label it. [3 marks]

• Cue. $(6 - 5.70) \times 2{,}000 = +600$ favourable.

Q2. Standard hours for actual output are 900; actual hours are 950; standard rate is GBP 10. Calculate the labour efficiency variance and label it. [3 marks]

• Cue. $(900 - 950) \times 10 = -500$ adverse.