## Wednesday, 13 February 2013

### STANDARD COSTING AND VARIANCE ANALYSIS

CHAPTER VIII
STANDARD COSTING AND VARIANCE ANALYSIS
Standard costing is a very important system of cost control. Standard costing aims at eliminating the wastage and increasing efficiency in performances through setting up standards for production expenses and production performance.
STANDARD COST AND STANDARD COSTING
Standard cost is a predetermined cost. It is a determination in advance of production, of what should be the cost. When standard costs are used for the purposes of cost-control, the technique is known as the standard costing.
Eric. L. Kohler has defined standard cost as “Standard cost is a forecast or pre-determination of what actual cost should be under projected conditions, serving as a cost control and as a measure of production efficiency or standard of comparison when ultimately aligned actual cost. It furnishes a medium by which the effectiveness of current results can be measured and the responsibility for deviations can be placed”.
The main points in the above definitions are:
(i)                 It is pre-determined calculation of what cost ought to be specific working conditions.
(ii)               It is built up by correlating standard quantity (of machine time, labour time and material) and forecast of future market trend for price standards (i. e., prices for material, wage rates and machine cost per hour etc.)
(iii)             It provides bases for control through variance accounting.
(iv)             It provides bases for valuation of stock and work-in-progress and in some cases for fixing selling price.
Standard costing is the preparation of standard costs and applying them to measure the variations from actual costs and analyzing the causes of variations with a view to maintain maximum efficiency in production. It is a technique which uses standards for cost and revenues for the purpose of control through variance analysis.
From the definition given above, it is clear that the technique of standard costing may comprise:
(i)                 Ascertainment of standard costs under each element of cost i. e., material, labour and overhead.
(ii)               Measurement of actual costs.
(iii)             Comparison of the actual costs with the standard cost to find out the variances.
(iv)             Analysis of variances for the purpose of ascertainment of reasons of variances for taking the appropriate action where necessary so that maximum efficiency may be achieved.
STANDARD COSTING AND BUDGETARY CONTROL
Both standard costing and budgetary achieve the same objective of maximum efficiency and cost reduction by establishing predetermined standards, comparing actual performance with the predetermined standards and taking corrective measures, where necessary. Thus, although both are useful tools to the management in controlling costs, they differ in the following respects:
1.      To be able to establish standard costs, some form of budgeting is essential as there is the need to forecast the level of output and prescribed set of working conditions in the periods in which the standard costs are to be used. On the other hand, budgetary control can be prepared on the basis of past figures adjusted to future trends. But to get the best out of budgetary control, linking of budgetary control with standard costing is recommended.
2.      Standards are based on technical assessments whereas budgets are based on past actual adjusted to future trends.
3.      Budgetary control deals with the operations of department of business as a whole while standard costing is applied to manufacturing of a product, process or processes or providing a service. Thus, budgetary control is extensive whereas standard costing is intensive in its application. For example, budgets are prepared for different functions of the business i. e., production, sales, purchases, cash etc. Standard costs, on the other hand are complied for various elements of cost.
4.      Standards are set mainly for production and production expenses where as budgets are complied for all items of income and expenditure. Therefore, budgeting is a much broader function than standard costing.
5.      Budgets set up maximum limits to expenses above which the actual expenditure should not be normally exceed. Standards set up targets which are to be attained by actual performance. Thus, budgetary control lays emphasis on costs not exceeding the budgets and standard costing gives importance to cost approaching the standard costs.
6.      Budgets are projection of final accounts; standard costs are projection of cost accounts because budgetary control adopts a more general approach of giving service to the management than does standard costing. Final accounting, as we know, is concerned with the overall efficiency of the business whereas cost accounting deals with individual products, ascertain and controlling their costs. Standards cost aim at efficiency at every point; so they are projection of cost accounts. On the other hand, budgetary control aims at overall efficiency (i. e., efficiency of the particular function such as sales function, purchase function, production function etc); so it is a projection of financial accounts.
7.      In budgetary control, variances are not revealed through the accounts but are revealed in total. But in standard costing, variances are analyzed in detail according to their originating cases. Thus, standard costing reveals variances through different accounts.
8.      Budgets are anticipated or expected costs meant to be used for forecasting requirements of material, labour, cash etc. standard costs, on the other hand, do not tell what the costs are expected to be, but rather what the costs should be under specific conditions of production performance and as such cannot be used for the purpose of forecasting.
Both standard costing and budgetary control are complimentary to each other and for maximum efficiency both should be used simultaneously. Both may prove more effective if they are used in conjunction with each other.
STANDARD COSTING AND MARGINAL COSTING
Standard costing is a system of accounting in which all expenses (fixed and variable) are considered for the determination of standard cost for a prescribed set of working conditions. On the other hand, marginal costing is a technique in which only variable expenses are taken to ascertain the marginal costing is a technique in which only variable expenses are taken to ascertain the marginal cost. Both standard costing and marginal costing are completely independent and each other and may be installed jointly. This system of joint installation may be named as Marginal Standard Costing or Standard Marginal Costing System. Variances are calculated in the same way as in standard costing system with the only difference that the volume variances are absent because fixed expenses are charged in totals in each period.
Preliminaries to the Establishment of Standard Costs
The following preliminaries should be gone through before a standard costing system is established:
1. Establishment of cost centers; 2.Type of standard; and 3. Setting the standards.
1.      Establishment of Cost Centers. As defined earlier in this book, a cost centre is a location, person or item of equipment for which costs may be ascertained and used for the purpose of the cost control. Establishment of cost centers in necessary for fixing responsibilities for unfavorable variance.
2.      Types of Standards. They are three types of standards:
a)      Current standard. A standard which is related to current conditions and is established for use over a short period of time.
Ideal Standard: This is a standard which can be attained under the most favorable conditions possibly. In other words, this standard is based upon a very high degree of efficiency which is rather impossible to achieve. In this standard, it is assumed that there will be the most desirable conditions of performance and that there will be no wastage of material or time and no inefficiencies in the manufacturing processes. This standard is not likely to be achieved because ideal conditions of performance will not prevail. It is, therefore, a theoretical standard.
The unity of this standard is that it sets a target which, though not attainable in practice, is always aimed at. The criticism of the standard is that when actual costs are compared with such standard costs, large unfavorable variances are shown and these variances become a permanent feature of the concern. The ideal standard will breed frustration among employees because such standard is never to be attained. Nobody will pay serious attention to such standard and setting up of this standard will become a farce.
Expected or Attainable Standard: This is a standard which is anticipated during a future specified budget period. In fixing this type of standard present conditions and circumstances prevailing with in a particular industry are taken into consideration. Beside due weight age is given to the expected changes in the present circumstance and conditions. In setting up this standard, a reasonable allowance is also made for unavoidable (normal) wastages. This standard is, therefore, considered to be more realistic than the ideal standard because this standard is based on the realities rather than on the most ideal conditions. Hence, this type of standard is best suited from control point of view because this standard reveals real variances from the attainable performance.
b)      Basic Standard. It is a standard which is established for use unaltered over a long period of time. This standard is fixed for long periods so as to help foreword planning. Basic standard is established for some base year and is not changed for a long period of time as material prices, labour rates and other expenses change. Deviations of actual cost from basic standards will not serve any practical purpose because basic standards remain unaltered over a long period of time and are not adjusted to current market conditions. Thus, this type of standard is not suitable from cost control point of view. However variances calculated on the basis of basic standards will help in studying the trends in manufacturing costs over a long period of time.
Comparison of Current and Basic Standard Cost. Current standard relate to current conditions and operate only for a short period before they are revised when conditions change. On the other hand, basic standards are set for a long period and there is no need for constant revision for such standards. Deviation of actual costs from basic standard cost will not serve any practical purpose because standards are not adjusted to current market conditions. However such standards will be helpful in studying the trends of variance over a long period of time which is not possible in case of current standards which go on changing. Current standards will take care of inflationary tendencies because they are adjusted to current market conditions. On the other hand, basic standards are static and do not take care of inflationary tendencies.
c)      Normal Standard. This standard is defined as “the average standard which it is anticipated can be attained over a future period of time, preferable long enough to cover one trade cycle’. Such standards are established on the basis of average estimated performance over a future period of time (say 5 years) covering one trade cycle. It is difficult to follow normal standards in practice as it is not possible to forecast performance with a reasonable degree of accuracy for a long period of time. Such standards are attainable under anticipated normal conditions and are not attainable if anticipated conditions do not prevail over a future period of time. That is why; normal standards may not be a useful device for a purpose of cost control.
3.      Developing or Setting the Standards or Establishment of Standard Cost. Just like a budget committee, there should be Standard Committee which should be entrusted with the work of setting standard costs. The committee will include General Manager, Purchase Officer, Production Engineer, Production Manager, Sales Manager, Cost Account, and other functional heads, if any.
Of all the persons, the cost accountant plays a very important role in setting the standards because he is to supply the necessary costs figures and coordinate the activities of the committee so that standards set are as accurate as possible.
It may be noted that standards set should neither be too high nor too low. Nobody will take interest in the standards if these are too high because such standards are not capable of being achieved and employees will always have an opportunity to excuse the failure to reach standards. Such standards are not realistic and, therefore, cannot be used in inventory valuation, product costing and pricing, planning and control, and capital investment decisions. Low standards, on the other hand, will not induce employees and management to put more efforts because they can be achieved very easily. They defeat the objectives of standard costing and fail o disclose inefficiencies because they can be attained by poor performance. As a general rule, currently attainable standards should be set which can be attained if employees and management become more efficient or put some more efforts. Such standards motivate employees and are most appropriate for performance appraisal, cost control and decision making.
According to the National Association of Accountants (U.S.A) “Such standards provide definite goals which employees can usually be expected to reach and also appear to be fair bases from which to measure deviations for which the employees are held responsible. A standard set at a level which is high at still attainable with reasonable diligent effort and attentive to the correct methods of doing the job may also be effective for stimulating efficiency”.
The success of standard costing depends upon the establishment of correct standards. Thus, every possible care should be taken in the establishment of standard and standards should be established for each element of cost as follows:
(a)    Direct Material Cost. Standard material cost for each product should be predetermined. This will be include:
(i)                 Determination of standard quantity of materials needed for the production.
(ii)               Determination of standard price per unit of material.
In ascertaining standard quantity of materials, the standard specification, of materials should be planned by the engineering department after consulting the past records. While setting standards an allowance should be made for the normal wastage of materials. The purpose of determining standard quantities of materials should be to achieve maximum economies in material usage.
The standard prices of materials should be determined for the various types of material needed for the production. This is done by the cost accountant in collaboration with the purchase officer. Standard price for each item of material is established after carefully studying the market conditions and forecasting the trend of prices for a future period. While setting standard material price, the cost of purchasing and storekeeping should also be include in the price of materials. The object of fixing standard price of materials is to increase efficiency in the purchasing so that price of materials may be kept down. Any difference between standard price and actual; price is to be referred to the Purchasing Department of explanation, so before setting standards for material price, it is advisable to see hat purchasing functions are efficiently managed.
Setting up of standard price of materials required is a difficult task because it depends on so many factors beyond anybody’s control. Generally standard prices are based on current price adjusted to expected changes in future.
(b)   Direct Labour Cost. Determination of standard direct labour cost will include determination of:
(i)                 Standard time
(ii)               Standard rate
It become necessary to standardize the time to be taken for each category of labour and for each operation involved. Time and motion study will determine how much time is to be allowed for each operation involved while fixing the standard time to be taken for each category for labour and for each operation involved. While fixing the standard time, due allowance should be made for fatigue, tool setting, receiving instructions and normal idle time.  Standard time can also be determined on the basis of average of the past performance. Though this method is simple, it is not scientific. Thus standard time is established on the basis of time and motion study and this is done in conjunction with the work study engineers. Standard time established according to time and motion study are independent of previous performances. It is good for the development of objective standards. Standard time can also be set by taking trial runs for new products. This method is not satisfactory as real conditions are not available in such runs.
The fixation of standard labour rates is not so difficult as the fixation of standard prices of materials is because labour rates are usually pre-established. Standard rates of pay should be established for every category of labour. Labour rates in the past may not be reliable basis for determination of rates if the labour rates are subject to fluctuating demand and supply of the labour force. Any expected increase in rates should be considered in the determination of standard rates. Establishment of standard rates of pay do not present any problem in those industries where wage rates have been fixed by contracts, Law, Wages Tribunals and Wages Boards. Fixation of standard rates will depend upon the method of wage payment. Standard rates per hour or pay day will be fixed in wages are paid according to time wages system and when the method of wage payment is piece rate, standard wage per piece will be fixed. Personal department will help the cost accountant in determining standard rates of pay.
Budget production in units or budgeted hours for the budget period
Budget production in units or budgeted hours for the budget period
Standard Hours
Production is generally expressed in physical units such kilos, tons, gallons, units, dozens etc. but it is difficult to express all the products in one common unit when different types of products which are measured in different units are manufactured in a factory. In such a case, it is essential to have a common unit in which all the products can be measured. Time factor is common to all the products, and, therefore, production can be expressed in standard hours. A standard hour can be defined as an hour which measures the amount of work that should be performed in one hour under standard conditions.
ANALYSIS OF VARIANCES
Control is a very important function of management. Through control management ensures that performance of the organization conforms to its plans and objectives.
Analysis of variances is helpful in controlling the performance and achieving the profits that have been planned.
The deviation of the actual cost of profit or sales from the standard cost or profit or sales is known as “variance”. When actual cost is less than standard cost or actual profit is better than standard profit, it is known as favorable variance and such a variance is usually a sign of efficiency of the organization. On the other hand, when actual cost is more than standard cost or actual profit or turnover is less than standard profit or turnover, it is called unfavorable or adverse variance and usually an indicator of inefficiency of the organization. The favorable and unfavorable variances are also known as credit and debit variances respectively. Variances of different items of cost provide the key to cost control because they disclose whether and to what extent standards set have been achieved.
Another way of classifying the variance may be controlled and uncontrollable variances. If a variance is due to inefficiency of a cost centre (i. e., individual or department), it is said to be controllable variance. Such a variance can be corrected by taking a suitable action. For example, if actual quantity of material used is more than the standard quantity, the foreman concerned would be responsible for it. But if excessive use is due to defective supply or materials or wrong setting of standards, the purchasing department or cost accounting department would be responsible for it. On the other hand, an uncontrollable variance does not relate to an individual or department but it arise due to external reasons like increase in price of materials. This type of variance is not controllable and no particular individual can be held responsible for it.
There are a number of reasons which gives rise to variances and the analysis of variances will help to locate the reason and person or department responsible for a particular variance. The management need not pay attention to items or departments proceeding according to standards laid down. It is only in case of unfavorable items that the management has to exercise control. This type of management technique is known as ‘management by exception’. This type of technique is considered as an efficient way of exercising control because management cannot devote their limited time to every item.
The deviation of total actual cost from total standard cost is known as total cost variance. It is a net variance which is the aggregate of all variance relating to various elements of cost, both favorable and unfavorable.
Analysis of variances may be done in respect of each element of cost and sales, viz.,
1.      Direct Material Variances
2.      Direct Labour Variances
4.      Sales Variances
Material Variances
In case of materials, the following may be the variance:
(a)    Material Cost Variance
(b)   Material Price Variance
(c)    Material Usage or Quantity Variance
(d)   Material Mix Variance
(e)    Material Yield Variance
The following chart shows the division and sub-division of material variances:
Material Cost Variance
Material Price Variance                                               Material Usage or Quantity Variance
Material Mix Variance                                    Material Yield Variance
Now, we proceed to define these variances one by one.
(a)    Material Cost Variance (MCV). It is the difference between the standard cost of materials allowed (as per standards laid down) for the output achieved and the actual cost of material used. Thus, it may be expressed as:
Material Cost Variance = Standard Cost of Materials for Actual Output – Actual Cost of Material Used
Or Material Cost Variance = Material Price Variance + Material Usage or Quantity Variance
Or Material Cost Variance = Material Price Variance +Material Mix Variance + Material Yield Variance
In order to calculate material cost variance, it is necessary to know:
1.      Standard quantity of materials which should have been required (as per standards set) to produce actual output. Thus, standard quantity of materials is :
Actual Output x Standard Quantity of Materials per unit.
Note. In order to find out standard quantity of materials specified, actual output (and not standard output) is to be multiplied by standard quantity of materials per unit.
2.      Standard price per unit of materials
3.      Actual quantity of materials used
4.      Actual price per unit of materials
(b)   Material Price Variance (MPV). It is that that portion of the material cost variance which is due to the difference between the standard cost of materials used for the output achieved and the actual cost of materials used. In other words, it can be expressed as:
Material Price Variance:
Actual usage (Standard Unit Price – Actual Unit Price)
Here, Actual Usage     = Actual Quantity of material (in units) used
Standard Unit Price    = Standard price of material per unit
Actual Unit Price        = Actual price of material per unit
(c)    Material Usage (or Quantity) Variance (MQV). It is that portion of the material cost variance which is due to the difference between the standard quantity of materials specified for the actual output and the actual quantity of material used. It may be expressed as:
Material Usage Variance:
Standard Price per unit (Standard Quantity – Actual Quantity)
(d)   Material Mix Variance (MMV). It is that portion of the material usage variance which is due to the difference between standard and the actual composition of a mixture. In other words, this variance arises because the ratio of materials being changed from the standard ratio set. It is calculated as the difference between the standard price of standard mix and standard price of actual mix.
In case of material mix variance, two situations may arise:
(i)                 Actual weight of mix and the standard weight of mix do not differ. In such a case, material mix variance is calculated with the help of the following formula:
Standard Unit Cost (Standard Quantity – Actual Quantity)
Or Standard Cost of Standard Mix – Standard Cost of Actual Mix
If the standard is revised due to shortage of a particular type of material, the material mix variance is calculated as follows:
Standard Unit Cost (Revised Standard Quantity – Actual Quantity)
Or Standard Cost of Revised Standard Mix – Standard Cost of Actual Mix
(e)    Material Yield (or Sub-usage) Variance (MYV). It is that portion of the material usage variance which is due to the difference between the standard yield specified and the actual yield obtained. This variance measures the abnormal loss or saving of materials. This variance is particularly important in case of process industries where certain percentage of loss of materials is inevitable. If the actual loss of materials differs from the standard loss of materials, yield variance will arise. Yield variance is also known as scrap variance. This loss may result in the following two situations:
i)                    When standard and actual mix do not differ. In such a case, yield variance is calculated with the help of the following formula:
Yield Variance = Standard Rate (Actual Yield – Standard Yield)

Where, Standard Rate =               Standard Cost of Standard Mix
Net St. Output (i. e, Gross Output – St. Loss)
ii)                  When actual mix differs from standard mix. In such a case, formula for the calculation of yield variance is almost the same. But since the weight of actual mix differs from that of the standard mix, a revised standard mix is to be calculated to adjust the standard mix in proportion to the actual mix and the standard rate is to be calculated from the revised standard mix as follows:
Standard Rate =    Standard Cost of Revised Standard Mix
Net standard Output
Formula for yield variance in such a case is :
Yield Variance = Standard Rate (Actual Yield – Revised Standard Yield)
Labour Variances
Labour variances can be analyzed as follows:
a)      Labour Cost Variance(LCV)
b)      Labour Rate (of Pay) Variance (LRV)
c)      Total Labour Efficiency Variance (TLEV)
d)     Labour Efficiency Variance (LEV)
e)      Labour Idle Time Variance (LITV)
f)       Labour Mix Variance or Gang Composition Variance (LMV or GCV)
g)      Labour Yield Variance or Labour Efficiency Sub-variance (LYV or LESV)
h)      Substitution Variance.
These variance are like material variance and can be defined as follows:
a)      Labour Cost Variance. It is the difference between the standard cost of labour allowed (as per  standard laid down) for the actual output achieved and the actual cost of labour employed. It is also known as wages variance. This variance is expressed as:
Labour Cost Variance = Standard Cost of Labour – Actual Cost of Labour
b)      Labour Rate (of Pay) Variance. It is that portion of the labour cost variance which arises due to the difference between the standard rate specified and the actual rate paid. It is calculated as follows:
Rate of Pay Variance = Actual Time Taken (Standard Rate – Actual Rate)
c)      Total Labour Efficiency Variance. It is that part of labour cost variance which arises due to the difference between standard labour costs of standard time for actual time paid for. It is calculated as follows:
Total Labour Efficiency Variance (TLEV) = Standard Rate (Standard time for Actual Output – Actual Time Paid for)
Total labour efficiency variance is calculated only when there is abnormal idle time.
d)     Labour Efficiency Variance. It is that portion of labour cost variance which arise due to the difference between the standard labour hours specified for the output achieved and the actual labour hours spent. It is expressed as:
Labour Efficiency Variance = Standard Rate (standard Time for Actual output – Actual Time Worked). Hence standard time for actual output means time which should be allowed for the actual output achieved.
Actual time worked means actual labour hours spent minus abnormal idle hours.
e)      Labour Idle Time Variance. It is calculated only when there is abnormal idle time. It is that portion of labour cost variance which is due to the abnormal idle time of workers. This variance is shown separately to show the effect of abnormal cases affecting production like power failure, breakdown of machinery shortage of materials etc. while calculating labour efficiency variance, abnormal idle time is deducted from actual time expended to ascertain the real efficiency of the workers. Labour idle time variance is expressed as :
Idle Tine Variance = abnormal Idle Time X Standard Rate
Total Labour Cost Variance = Labour Rate of Pay Variance + Total Labour Efficiency Variance
Total Labour Efficiency Variance = Labour Efficiency Variance + Labour Idle Time Variance
f)        Labour Yield Variance. It is like material yield variance and arises due to the difference between yield that should have been obtained by actual time utilized on production and actual yield obtained. It can be calculated as follows:
Standard labour cost per unit (Actual Yield in units – Standard Yield in units expected from the actual time worked on production).
g)      Substitution Variance. This is a variance in labour cost which arises due to substitution of labour when one grade of labour is substituted by another. This is denoted by difference between the actual hours at standard rate of standard worker and the actual hours at standard rate of actual worker. This can be denoted as under:
Substitution variance = (Actual hours X std. rate of std. worker) – Actual hours X Std rate for actual worker)
Overhead cost variance can be defined as the difference between the standard cost of overhead allowed for the actual output achieved and the actual overhead cost incurred. In other words, overhead cost variance is under or over absorption of overheads. The formula for the calculation is:
Actual output X Standard Overhead Rate per Unit – Actual Overhead Cost or Standard Hours for Actual Output X standard Overhead Rate per hour – Actual Overhead Cost
Overhead cost variance can be classified as :
1.      Variable Overhead Variance. It is the difference between the standard variable overhead cost allowed for the actual output achieved and the actual variable overhead cost. This variance is represented by expenditure variance only because variable overhead cost will vary in proportion to production so that only a change in expenditure can cause such variance. It is expressed as:
Actual output X standard variable overhead rate – Actual variable overheads or St. Hours for actual output X St. Variable overhead rate per hour – Actual variable overheads
Some accountants also find out variable overhead efficiency variance just like labour efficiency variance. Variable overhead efficiency variance can be calculated if information relating to actual time taken and time allowed is given. In such a case variable overhead variance can be divided into two part as given below:
a)      Variable overhead expenditure variance = actual hours worked X standard variable overhead rate per hour – actual variable overhead
Or actual hours (Standard variable overhead rate per hour – actual variable overhead rate per hour
Variable overhead expenditure variance is calculated in the same way as labour rate variance is calculated.
b)      Variable overhead efficiency variance = standard time for actual production X standard  variable overhead rate per hour – actual hours worked X standard variable overhead rate per hour
Or standard variable overhead rate per hour (standard hours for actual production actual hours)
Variable overhead efficiency variance resembles labour efficiency variance and calculated like labour efficiency variance.
2.      Fixed overhead variance. It is that portion of total overhead cost variance which is due to the difference between the standard cost of fixed overhead allowed for the actual output achieved and the actual fixed overhead cost incurred. The formula for the calculation of the variance is
Actual output X standard fixed overhead rate per unit – Actual fixed overheads
Or standard hours produced  X standard fixed overhead rate per hour – Actual fixed overheads
(Standard hours produced = time which should be taken for actual output i. e., standard time for actual output)
This variance is further analysed as under:
1.      Expenditure variance: It is that portion of the fixed overhead variance which is due to the difference between the budgeted fixed overheads and the actual fixed overheads incurred during a particular period. It is expressed as:
Expenditure variance = budgeted hours X standard fixed overhead rate per hour – actual fixed overheads.
2.      Volume variance: It is that portion of the fixed overhead variance which arises due to the difference between the standard cost of fixed overhead allowed for the actual output and the budgeted fixed overheads for the period during which the actual output has been achieved. This variance shows the over or under absorption of fixed overheads during a particular period. If the actual output is more than the budgeted output, there is over-recovery of fixed overheads and volume variance is favourable and vice versa if the actual output is less than the budged output. This is so because fixed are not expected to change with the change in output. This variance is expected as:
Volume variance = actual output X standard rate – budgeted fixed overheads
Or standard rate (Actual output – budgeted output)
Or Volume variance = standard rate per hour (standard hours produced – actual hours)
Standards hours produced means number of hours which should have been taken for the actual output as per the standard laid down.
i)          Capacity variance. It is that portion of the volume variance which is due to working at higher or lower             capacity than the budgeted capacity. In other word , this variance is related to the under and over utilization of plant and equipment and arises due to idle time, strikes and lock-output, breakdown of the machinery, power failure, shortage of materials and labour, absenteeism, overtime, changes in number of shifts. In short, the variance arises due to more or less working hours than the budgeted working hours. It is expressed as:
Capacity variance = standard rate ((revised budgeted units – budgeted units)
Or capacity variance = standard rate (revised budgeted hours – budgeted hours)
ii)         Calendar Variance. It is that portion of the volume variance which is due to the difference between the number of working days in the budget period and number of actual working days in the period to which the budget is applicable. If the actual working days are more than the standard working days, the variance will be favorable and vice versa if the actual working days are less than the standard days. It is calculated as:
Calendar variance = Increase or decrease in production due to more or less working days the rate of budgeted capacity X standard rate per unit.
iii)                Efficiency Variance. It is that portion of the volume variance which is due to the difference between the budgeted efficiency of production and the actual efficiency achieved. This variance is related to the efficiency of workers and plant and is calculated as:
Standard rate per unit (Actual production (in units0 – standard production (in units))
Or standard rate per hour  (standard hours produced – actual hours)
Here, standard production or hours means budgeted production or hours adjusted to increase or decrease in production due to capacity or calendar variance.
Two Variance and Three Variance Methods of Analysis of Overhead Variance
Analysis of overhead variance can also be made by two variance and three variance methods. The analysis of overhead variances by expenditure and volume is called two variance analysis. When the volume is further analysed to know the reasons of change in output, it is called three variance analysis. Change in output occurs due to:
i)          Change in capacity i. e., change in work in hours per day giving rise to capacity variance.
ii)         Change in number of working days giving rise to calendar variance.
iii)        Change in the level of efficiency resulting into efficiency variance.
Thus, three variance analysis includes:
i)          Expenditure variance
ii)         Volume variance further analysed into
a)      Capacity variance        b)         Calendar variance, and           c) Efficiency variance
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