Module V: Budgets, Budgeting, and Budgetary Control PDF

# Chapter 1: Budgets, Budgeting and Budgetary Control The two important functions of management are planning and control. Planning relates to the future and control relates to the past. In today's competitive environment, a business enterprise can succeed only with planning. If a business fails to...

# Chapter 1: Budgets, Budgeting and Budgetary Control The two important functions of management are planning and control. Planning relates to the future and control relates to the past. In today's competitive environment, a business enterprise can succeed only with planning. If a business fails to plan, it means the business is planning to fail. For planning and control, two techniques are used. They are standard costing and budgetary control. This chapter deals with budget and budgetary control. ## Meaning and Definition of Budget The term 'budget' has been derived from the French word 'Bougette'. It means a leather bag into which funds are appropriated to meet the anticipated expenses. A budget simply means a financial plan. It is a plan expressed in money. It is a detailed plan of action of the business for a definite period of time. In business, a budget may be defined as a statement showing the expected income and expenditure for a definite future period. ## Meaning and Definition of Budgeting Budgeting simply means preparing budgets. It is a process of preparation, implementation, and the operation of budgets. J. Batty says, "The entire process preparing budgets is known as budgeting." Thus, budgeting is the process of formulating budgets. The National Association of Accountants (USA) defines budgeting as, "the process of planning all flows of financial resources into, within, and from an entity during some specified future period." In short, budgeting is the act of preparing budgets. ## Meaning and Definition of Budgetary Control Budgetary control is a system of using budgets for planning and controlling costs. "It is a system of controlling costs which includes the preparation of budgets, coordinating the departments and establishing responsibilities, comparing actual performance with that budgeted and acting upon the results to achieve maximum profitability." According to Rowland and Harr, "budgetary control is a tool of management used to plan, carry out and control the operations of business." ## Budgetary Control Budgetary control contains two different processes. One is the preparation of the budget. The other is the control of the prepared budget. Thus, the preparation and use of budgets to control a firm's activities is known as budgetary control. In short, budgetary control is a system of controlling a firm's activities through budgets. ## Difference between Budget, Budgeting, and Budgetary Control - Budget and budgeting are narrower concepts while budgetary control is a wider concept. If there is a budget or budgeting, it is not necessary that there should be budgetary control as well. But if there is budgetary control, then a budget and budgeting are necessary. - Budgets are business estimates for a future period, budgeting is the process of preparing these estimates while budgetary control is a system of achieving performance on the basis of budgets. - Budget and budgeting are the parts of planning whereas budgetary control is linked with coordination and control. In other words, budget is a financial plan while budgetary control results from the administration of a financial plan. Rowland and William Harr have stated the difference among budget, budgeting and budgetary control thus, "budgets are the individual objectives of a department etc., whereas budgeting may be said to be the act of building budgets. Budgetary control embraces all this and in addition includes the science of planning the budgets themselves and the utilization of such budgets to effect an overall management tool for the business planning and control." In short, budget is the means, budgeting is the procedure, and budgetary control is the end result. ## Objectives of Budgets and Budgetary Control The basic objective of budgeting and budgetary control is to achieve the objectives of management. The subsidiary objectives are summarized as below: 1. To coordinate the activities of different departments of an organization. 2. To reduce uncertainties. 3. To direct individuals and departments to achieve goals. 4. To plan and control income and expense so as to attain maximum profitability. 5. To fix the responsibility of various individuals in the organization. 6. To direct the capital expenditure in the most profitable manner. 7. To improve the operational efficiency of the departments and cost centers. 8. To eliminate wastes of all kinds to improve economy and efficiency. 9. To ensure that sufficient working capital is available for the efficient operation of the business. 10. To provide a yardstick against which actual results can be compared. 11. To show the management where action needed to correct inefficiency. ## Essentials of Effective Budgetary Control Some preliminary steps are to be taken for a successful and sound budgetary system. The following are the essential conditions or requirements or pre-requisites of a good budgetary system: 1. **Support of top management:** Budgetary control system should have the full support and the wholehearted cooperation of every member in the organization. In this regard, the initiative must come from the top management. 2. **Clear and realistic goals:** For the successful budgeting and its systematic implementation, it is essential that the goals should be clear and realistic. They should be reasonably attainable as well. 3. **Adequate accounting system:** The accounting system should provide the required information in time. 4. **Minimum cost of operation:** The system should not cost more than its worth. The ultimate object of the budgetary control system should always be maximization of profit. 5. **Effective communication:** The employees must be given continuous budget education and orientation. For the successful budgeting, there should be a free communication throughout the organization in order to make them actively interested in the budgetary control programme. 6. **Timely reporting:** A sound and successful budgetary control system requires a timely and prompt reporting system. This enables management to take remedial action in time. 7. **Flexibility:** A budgetary control system should be kept flexible. This is done through continuous review and revision in the light of changed circumstances. 8. **Sound organization:** A sound organization is needed for successful budgetary control. The authority responsibility of each manager should be clearly fixed. A budget committee may be constituted. ## Steps in the Installation of Budgetary Control System (Organization for Budgetary Control) A sound and efficient organization is a pre-requisite of a budgetary control system. The following steps are involved in setting up a sound organization or in the installation of a system of budgetary control: 1. **Establishment of budget centers:** Budget centers or departments should be established for the purpose of defining responsibility and also for the cost control. A budget center is that part of the organization for which the budget is prepared. According to ICMA, "budget center is a section of the organization of an undertaking defined for the purpose of budgetary control." For each budget center or department, a separate budget is prepared. 2. **Introduction of adequate accounting records:** The accounting system should be such that it should be able to add and analyze the information required for the operation of the system. A chart of accounts corresponding to the budget center should be maintained. 3. **Budget training and education:** All personnel should be trained in operating the system of budgetary control. Each person must be informed of the various aspects and benefits of budgetary control. There must be proper orientation of employees in the utility and principles of budgeting. 4. **Preparation of an organizational chart:** There should be a well defined organizational chart for budgetary control. The organizational chart defines the functions and responsibilities of each member of the management team. It ensures that each one knows his position in the organization and his relationship with other members. 5. **Establishment of a budget committee:** In small concerns, a budget officer or the accountant may perform all the work connected with the preparation of the budget. But in large concerns, a budget committee is appointed to formulate a general program for preparing budgets and exercising overall control. The budget committee consists of the chief executive or managing director, budget officers, and the managers of various departments. The budget committee performs the following functions: - To provide historical information to help departmental managers in forecasting. - To assist and advise in the preparation of departmental budgets. - To issue necessary instructions regarding budget requirements. - To define the general policies of management in relation to the budget. - To fix the final date for the submission of functional budgets. - To review budgets. - To approve budgets. - To prepare a master budget. - To prepare budget summaries wherever necessary. - To suggest remedial actions wherever needed. 6. **Preparation of a budget manual:** A budget manual serves as a basic document relating to the budgetary control system. It is a document which specifies the responsibilities of the persons engaged in the routine of and the forms and records required for budgetary control. It is considered to be the "Magna Carta" of the budgetary control. It is usually maintained in a loose-leaf form so that alteration can easily be made as an when required. It is the responsibility of the budget officer to prepare and maintain this manual. A budget manual usually includes the following: - Objects and policies of the concern. - Description of the system and its objectives. - Procedure to be adopted in operating the system. - Definition of responsibilities and duties. - Instructions and forms to be used. - Steps in the preparation of budgets. - The accounts code in use. - Deadline date by which data are to be submitted. - Functions and duties of the budget committee. 7. **Fixation of budget period:** Another step is the determination of the budget period. A budget period is the length of time for which a budget is prepared and employed. There is no right period for any budget. It may be weekly or monthly or quarterly. The budget period may be long term which is extended for three to five years. This is suitable for expansion, modernization, and diversification. The budget period depends upon the nature of the budget to be prepared. 8. **Determination of the key factor:** In the preparation of the budgets, it is necessary to consider the key factor/factors. A key factor is one which limits the activities of an undertaking It is a factor which affects all other budgets Therefore, the budget relating to the key factor is prepared before other budgets are framed. It is also known as "limiting," "governing," or "principal" budget factor. The key factor may be sales, raw material, labor, machinery etc. Sales is most often the key factor in an industry. 9. **Determination of the level of activity:** It is necessary to establish the normal level of activity of the business. Normal level of activity is the level that the company is expected to achieve under the present conditions. This level of activity is essential in production planning because it decides the material and labor requirements. ## Need for the Preparation of Budgets (Advantages of Budgets and Budgetary Control) Budgets play an important role in the effective use of resources. Budgets are needed for achieving overall organizational goals. They help management in the allocation of responsibility and authority. The need for the preparation of budgets arises due to the fact that budgets bring so many benefits to a business organization. The following are some of the important benefits of budgets and budgetary control: 1. **Tool of Planning:** Budgeting compels the management to plan for the future. It makes planning precise and purposeful. 2. **Promotes profitability:** It minimizes wastage of all kinds and promotes efficiency, productivity, and profitability. 3. **Evaluates managerial performance:** It is a tool for measuring the managerial performance. 4. **Optimum utilization of resources:** It ensures optimum utilization of both human and non-human resources. 5. **Coordination:** It ensures coordination of activities of various departments and facilitates smooth running of the business enterprise. 6. **Tool of control:** It is an important tool to control income and expenditure. Through budgetary control, the management can find out the deviation from the plan and take remedial actions. 7. **Improves communication:** It improves communication throughout the organization. 8. **Motivates executives:** It motivates executives to attain the given goals. 9. **Management by exception:** It facilitates management by exception. In this way, it saves management's time and energy. 10. **Facilitates delegation:** It assists in the delegation of authority and assignment of responsibility. It permits participation of employees at all levels in the preparation of budgets. 11. **Measures performance of departments:** It provides a tool for measuring the performance of various departments. Thus, the most important advantage of budgets and budgetary control is that they enable management to conduct business in the most efficient manner. ## Classification of Budgets Budgets can be classified in many ways. The following are the most important among them: - Classification according to time factors. - Classification according to flexibility factors. - Classification according to function. ### Classification According to Time Factor: On the basis of time, budgets can be of the following three types: 1. **Long-term budgets:** These budgets are related to planning the operation of a firm for a period of 5 to 10 years. For example, capital expenditure budgets, research & development budgets, etc. 2. **Short-term budgets:** These budgets are drawn usually for a period of one or two years. For example, Cash budgets, Material budgets, etc. 3. **Current budgets:** These budgets cover a period of one month or so. These are related to current conditions. ### Classification According to Flexibility Factor: On the basis of flexibility, budgets are classified into the following two types: 1. **Flexible budgets:** Flexible budget is a dynamic budget. CIMA defined flexible budgets as "a budget designed to change in accordance with the level of activity actually attained." It shows estimated costs and profits at different levels of output. In flexible budgets, costs are analyzed according to behavior such as fixed and variable. A flexible budget is also called a variable or sliding scale budget. 2. **Fixed budgets:** A fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity attained. It doesn't change with the change in the level of activity. It is prepared for one level of activity for a definite time period. This type of budget is most suited for fixed expenses. It is also called a static budget. ### Features of Flexible Budgets: Following are the important features of flexible budgets: - It is prepared for different levels of activity. - It provides a basis for comparison. - It provides a readymade budget for a particular volume. - It is based upon adequate knowledge of cost behavior patterns. ### Advantages of Flexible Budgets: The advantages of flexible budgets are summarized as below: - It is a very useful device for controlling costs. - It is very useful in an uncertain and unpredictable environment. - It shows the impact of varying levels of activity on profits. - It is made to get adjusted automatically to the actual level of activity. - The performance of any department can be judged at various levels of activity. - It facilitates production planning and profit planning. ### Steps in Preparing Flexible Budget 1. Identify the relevant range of activity. 2. Classify costs according to variability (i.e., variable, fixed, and semi variable costs). 3. Determine variable costs. 4. Determine fixed costs. 5. Determine semi-variable costs. 6. Prepare the budget for selected levels of activity. ### Limitations of Fixed Budgets: Fixed budgets have the following limitations: 1. It cannot be used for comparing actual cost and budgeted cost. 2. It cannot be used as a tool for effective cost control. 3. It cannot be used for cost ascertainment and price fixation. 4. It does not involve detailed analysis of cost into fixed, variable, and semi-variable elements. 5. Generally, the actual level of activity is different from the expected level of activity. So, a fixed budget has no value. ### Difference between Fixed and Flexible Budgets | | **Fixed Budget** | **Flexible Budget** | |------------------------|------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------| | **Assumption** | Based on the assumption that business conditions do not change. | Based on the assumption that business conditions change. | | **Comparison** | Comparison between actual and budgeted costs is not possible. | Comparison between actual and budgeted costs is possible. | | **Cost Classification**| Costs are not classified according to variability. | Costs are classified according to variability. | | **Purpose** | Prepared for a specific level of activity. | Prepared for different levels of activities. | | **Control & Pricing** | Not useful for control, price fixation, etc. | Useful for cost control, pricing decisions, etc. | ### Classification According to Function: On the basis of functions, budgets can be of the following two types: 1. **Functional budgets:** Functional budgets are those which are prepared by heads of functional departments for their respective departments. A functional budget is one which relates to the function of a business. Functional budgets are prepared for each function. These are subsidiary to the master budget. Examples of functional budgets include sales budgets, production budgets, production cost budgets, material budgets, purchase budgets, labor budgets, cash budgets, etc. Functional budgets may be further classified into two - operating budgets and financial budgets. 2. **Master budgets:** The managers of various departments prepare their budgets (functional budgets) and submit them to the budget committee. The committee will make necessary adjustments, incorporate all the functional budgets. Then it prepares a master budget. A master budget is a summary of all functional budgets. It summarizes sales, production, purchase, labor, finance and plant and equipment budgets. Thus, a master budget is the overall budget. ## Preparation of Financial Budgets Financial budgets include cash budgets, capital budgets, etc. Here, we discuss only cash budgets. ### Cash Budget: Cash budget is the most important of all the functional budgets. It is prepared only after all the other functional budgets are prepared. A cash budget is also called the financial budget or the ways and means budget. It is a statement showing estimated cash inflows and cash outflows for a future period of time. Thus, it shows the periodical cash position. It is prepared to ensure that there will be just sufficient cash in hand to cope adequately with budgeted activities. ### Advantages of Cash Budget: The advantages of a cash budget are as follows: - It ensures that sufficient cash is available when required. - It helps to ascertain expected shortage of cash so that steps can be taken in time for making up the deficiency by arranging a bank loan or overdraft. - It helps to ascertain excess of cash so that the surplus cash can be invested for a short period. - It is useful for financial planning. - It enables the management to formulate a suitable dividend policy. ### Methods of Preparation of a Cash Budget: There are three ways of preparing a cash budget. They are: 1. The receipts and payments method. 2. The adjusted profit and loss method. 3. The balance sheet method. Here we discuss only the first method. ### Receipts and Payments Method: Under this method, all actual possible cash receipts and payments for the budgetary period are considered. This method is widely used. ## Standard Costing One of the most important functions of cost accounting is cost control. For the purpose of cost control, it is essential to have planned costs. Standard costing is one of the ways of planning costs. Standard costing is an effective technique of cost control. It has been developed due to the limitations of historical costing (or actual costing). ### Meaning and Definition of Standard Cost: A standard is a "norm" or "yardstick" with which comparison can be made. According to E.L. Kohler, "a standard is a desired attainable objective, a performance, a goal, a model." In short, a standard is a predetermined estimate of quantities. Standard cost is a pre-determined cost for evaluating the actual performance. It is the expected cost of producing one unit. A standard cost is a target cost which should be attained. The costing terminology of CIMA, London, defines standard cost as "pre-determined cost based on a technical estimate for material, labor, and overhead for a selected period of time and for a prescribed set of working conditions." Standard cost may be described as "commonsense cost." In short, standard cost is a pre-determined cost. ### Definition of Standard Costing: When standard costs are used for the purpose of cost control, the technique is known as standard costing. Thus, standard costing is a technique of cost ascertainment and cost control. It is the preparation of standard costs and applying them to measure variations from standard costs and analyzing causes of variations with a view to maintain maximum efficiency. According to CIMA, London, standard costing is "a technique which uses standards for costs and revenues for the purpose of control through variance analysis." In short, when costing is used for the purpose of cost control, the technique is called standard costing. Standard costs are established for each element of cost. ### Difference between Budgetary Control and Standard Costing Following are the differences between budgetary control and standard costing: 1. Budgetary control is related to all types of business activities; but standard costing is related to production and production costs. Thus budgetary control is more extensive while standard costing is more intensive. 2. Budget is based on past experience, while standard is established on the basis of technical estimates. 3. Budgetary control is related to financial accounts; but standard costing is related to cost accounts. 4. Budgets consider both income and expenditure whereas standards are for expenditure only. 5. In standard costing, variances are analyzed in detail, but such a detailed analysis of variance is not possible in budgetary control. 6. Budgets fix maximum limits, while standards fix targets. 7. The standards are expressed in per unit of production, whereas budgets are specific periods and are expressed in total. 8. Budgetary control can be applied in parts. For example, cash, capital expenditure, research, and development. But there can be no partial application of standard costing. 9. Budgetary control does not require standardization of product. But standard costing requires standardization of product. 10. Budgets are for specific periods. They have to be revised when the period is over. Standards need not be changed unless and until essential conditions change. ### Uses or Advantages of Standard Costing: The uses or advantages of standard costing are as follows: 1. **Cost control:** Standard costing is an effective tool of cost control. Cost control can be achieved by comparing actual cost with standard cost and taking corrective action through analysis of variance. 2. **Valuable aid to management:** Standard costing is a valuable aid to management in formulating price and product policies. It also helps in discharging managerial functions. 3. **Measurement of performance:** Standard costing provides a yardstick against which actual cost can be compared to measure efficiency. 4. **Management by exception:** Standard costing facilitates the application of management by exception. By studying the variances, management can pay more attention to weak areas that require control. 5. **Quick reporting:** Standard costing facilitates timely presentation of cost reports to management for the purpose of decision making. 6. **Utilization of resources:** Standard costing ensures the effective utilization of men, material, and machinery by eliminating wastes. 7. **Economy:** Standard costing reduces clerical labor. It does not require the maintenance of detailed cost records. 8. **Coordination:** While establishing standard costs, different functions such as purchasing, selling, production, accounting etc. are co-ordinated. 9. **Inventory valuation:** Standard costing simplifies the valuation of stock because stock is valued at standard cost. The difference between standard cost and actual cost is transferred to a variance account. 10. **Delegation of authority:** Top management can easily delegate work to lower levels because "remote control" becomes possible through standard costing. 11. **Cost consciousness:** Standard costing creates cost consciousness among the personnel by fixing responsibilities. 12. **Motivation:** Standard costing helps in introducing incentives to employees. It provides a basis for motivating them. 13. **Fixation of prices:** Standard costing helps in fixing selling price in advance of production. This enables to prepare quotations and to secure orders. ### Steps involved in Standard Costing The procedure for establishing standard costing is summarized as follows: 1. **Establishment of cost centres:** The first step involved in the installation and operation of standard costing is the establishment of cost centres. A cost centre is a location, person, or item of equipment (or all of these) for which costs may be ascertained and used for the purpose of cost control. Cost centres are set up for cost ascertainment and cost control. 2. **Classification and codification of accounts:** Different items of expenses are classified under suitable headings. Codes and symbols are given to each class of expenditure. Coding facilitates quick collection and analysis of cost information. 3. **Establishment of standards:** One of the most important and difficult tasks in standard costing is setting of standards for each element of cost. The success of the standard costing system depends upon the reliability and accuracy of standards. Standards are established scientifically after studying all details of elements of cost. In big concerns, a committee is formed for this purpose. 4. **Ascertainment of actual cost:** Another step in the standard costing system is the recording of actual costs incurred. 5. **Comparison of standard cost and actual cost:** Standard cost and actual cost are compared and variance is calculated. 6. **Analysis of variance:** Variance analysis is the process of analyzing variances by subdividing the total variances in such a way that management can assign responsibility for poor performance. 7. **Reporting of variance to management:** As soon as variances are analyzed and investigated, they are reported to management. The management takes appropriate action where necessary. ### Analysis of Variance: Variance means difference or deviation. In standard costing variance means the difference between the standard cost and the actual cost. It is the deviation of actual cost from the standard. According to ICMA, London, "Variance is the difference between a standard cost and the comparable actual cost incurred during a period." Variance may be favorable or unfavorable. If the actual cost is less than the standard, the difference is known as favorable or positive variance which is a sign of efficiency. If the actual cost is more than the standard cost, the difference is known as unfavorable or adverse variance which is a sign of inefficiency. In short, positive variance indicates a favorable variance and negative variance indicates unfavorable or adverse variance. The utility of standard costing lies in the analysis of variance. Analysis of variance means carrying out the appropriate investigations to identify the reasons for the variance. On the basis of analysis of variance, remedial action can be taken. Variance analysis indicates to the management whether the costs are under control or not. ### Managerial Uses (or Benefits) of Variance Analysis The benefits or managerial uses of variance analysis may be outlined as below: 1. It identifies the areas where variance arises. This facilitates management by exception. 2. It indicates the causes for variances. This helps to assign the responsibility for the variance to a particular department. In other words, it helps to pinpoint responsibilities for the variance. 3. It can be used as an effective tool of cost control. In other words, it helps to ensure cost control. 4. It helps to compare the performance of different departments. 5. It helps in future planning and in formulating policies. 6. It helps in creating and maintaining cost consciousness among personnel. 7. It helps in developing team spirit among the managerial personnel. ### Types or Classes of Variance Normally, there are two classes of variance - cost variances and sales variances. ### Cost Variances: There are three types of cost variances - material variances, labor variances, and overhead variances. Here, we discuss only labor variances and overhead variances. ### Material Variances: Material variances are popularly known as material cost variances. Material variances are of three types, namely, material cost variance, material price variance, and material usage variance. - **Material Cost Variance:** Material cost variance is the difference between standard cost of material specified for the output achieved and the actual cost of material used. The formula for its computation is as follows: Material cost variance = Standard cost of material - Actual cost of material Standard cost of material = Std. quantity x Std. price per unit Actual cost of material = Actual quantity x Actual price per unit. The material cost variance is further analyzed into material price variance and material usage variance. - **Material Price Variance:** It is that part of material cost variance which is due to the difference between standard price and the actual price paid. The following is the formula for its computation:- Material price variance = Actual qty x (Std. price - Actual price) Material price variance arises due to the following reasons: - Changes in the price of material. - Uneconomical quantity of material purchased. - High transport, storage and handling costs. - Failure to obtain cash discount. - Failure to purchase materials at the proper time. - Emergency purchase at high price. - **Material Usage Variance**: It is that part of material cost variance which is due to the difference between standard quantity and actual quantity used. It is also known as material quantity variance. The following is the formula for its computation:- Material usage variance = Std. Price x (Std. quantity - Actual quantity) Thus, material cost variance = Material price variance + Material usage variance. Material usage variance may arise due to: - Carelessness in material handling. - Loss due to pilferage. - Faulty workmanship. - Defect in plant and machinery causing excessive consumption of material. - Purchase of inferior quality material. - Changes in method of production. - **Material Mix Variance:** Material mix variance arises only when different materials are mixed to manufacture a product, e.g., chemicals, paint, etc. It is that part of material usage variance which is due to the difference between standard and actual composition of a mixture. In the case of material mix variance, there can be two situations: * **When the actual weight of the mix and standard weight of the mix do not differ:** In such a case, material mix variance is calculated by applying the following formula: Material mix variance = Std. price x (Std. qty. - Actual qty.) In this case, the same formula for calculating usage variance is used. In this situation there is no need to revise standard quantity. * **When the actual weight of the Mix and standard weight of the Mix Differ:** In this case, the material mix variance is calculated by applying the following formula: Material Mix Variance = (Total Weight of Actual Mix / Total Weight of Std. Mix) x (Std. Cost of Std. Mix / Std. Cost of Actual Mix) Revised Std. qty = Std. qty x (Total Weight of Actual Mix / Total Weight of Standard Mix) Material mix variance can also be calculated by using the revised standard qty. It is calculated as follows: MMV = Std. price x (Revised Std. qty - Actual qty.) - **Material Sub-usage Variance:** It is that part of total material variance which arises due to the difference between standard quantity for actual production and revised standard quantity. It is also called material revised usage variance. It is computed as follows: MSUV = SP (SQ-RSQ) or MUV = MMV + MSUV or MYV = MMV+MSUV - **Material Yield Variance:** This variance is calculated on the basis of output. Material yield variance is that part of material usage variance which is due to the difference between standard yield and actual yield. The word "yield" denotes "output." This variance is particularly important in the case of process industries. Here also two situations may arise: * **When the total weight of actual mix and total weight of standard mix do not differ:** In this case, the material yield variance is computed by applying the following formula: MYV = Std. rate x (Actual yield - Std. yield) or Std. rate x (Standard loss - Actual loss) Std. rate = (Std Cost of Std. Mix) / (Net Std. Output or Std. Yield) Net std. output or std. yield = (Gross Output - Std. Loss) * **When the total weight of actual mix and total weight of standard mix differ:** In this case, the material yield variance is calculated by applying the following formula: MYV = Standard rate x (Actual yield - Revised Std. yield) Std. rate = (Std. cost of revised std. mix) / (Net std. output, i.e., revised std. yield) MUV = MMV + MYV ### Labour Variances The labour variance or wage variance is similar to material variance. When standard cost of labour differs from actual wage cost, the labour variance arises. The following are the important labor variances: 1. **Labor Cost Variance** 2. **Labor Rate Variance** 3. **Labor Efficiency Variance** 4. **Idle Time Variance** 5. **Labor Mix Variance** 6. **Labor Yield Variance** - **Labor Cost Variance:** Labor cost variance is also called wage variance. It is the difference between standard cost of labor allowed for actual output achieved and the actual cost of labor. The formula for computation of labor cost variance is as follows: LCV = Std. cost of labor - Actual cost of labour or actual wages. - **Labor Rate Variance (Labor Rate of Pay Variance):** This is similar to material price variance It is that part of the labor cost variance, which arises due to the difference between standard rate specified and the actual rate paid. The formula for the calculation of the labor rate variance is as follows: LRV = Actual time x (Std. rate - Actual rate. Labor rate variance arises due to: - change in the basic wage rate - use of different methods of wage payment - unscheduled overtime etc. - **Labor Efficiency Variance:** It is also called labor usage or quantity variance. It is that portion of labor cost variance which arises due to the difference between standard hours specified for the actual output and the actual hours spent. The formula for the computation of LEV is as follows: LEV = Std. rate x (Std. time - Actual time) Here, actual time means actual hours paid minus abnormal idle time. This variance arises due to: - Lack of proper supervision. - Lack of sufficient training - Poor working conditions. - Increase in labor turnover. - Failure to maintain machinery in proper condition. - Change in the production process. - **Idle Time Variance:** Idle time variance is that portion of labor cost variance which arises due to the abnormal idle time of workers on account of sickness, power failure, machine breakdown etc. It is computed as under: ITV = (Idle time variance) Abnormal idle time * Std. rate. It should be noted that idle time variance would always be unfavorable. Verification: LCV = LRV + LEV + ITV - **Labor Mix Variance (LMV):** When different types or grades of labor are used in the production process, two more variances are computed. One is labor mix variance and the other is labor yield variance. Labor mix variance is a part of labor efficiency variance It arises when there is a change in the composition of labor force. It is calculated as follows:- * **Where there is no change in the standard composition of labor and total time spent is equal to the standard time:** LMV = Std. cost of std. composition - Std. cost of actual composition * **When there is change in the labor composition due to shortage of one grade of labor, but there is no change in the total standard time and total actual time.** Labor mix variance (LMV) = Std. cost of revised std. composition - std. cost of actual composition * **When total actual time of labor differs from total standard time of labor:** LMV = (Total time of actual composition / Total time of std.composition) x (Std composition Std. cost of labor / Actual composition Std. cost of labor) or, Std. rate x (Revised std. time - Actual time) Total time of actual workers Revised std. time = Std. time x (Total time of std. workers / Total time of actual workers) - **Labor Yield Variance (LYV):** This is like material yield variance. It is the difference between standard labor output and actual output or yield. It is calculated as follows: LYV = Std. labor cost per unit x (actual yield - Std. yield) or, Labour sub usage variance = SR (ST-RST)