Offsetting material and labour variances
Halden Foods produces a single product using a standard cost system. The standard material content is 2 kg per unit at £5 per kg. The standard labour content is 0.5 hours per unit at £18 per hour. Last month output was 9,000 units. Actual material purchased and used was 19,500 kg at £4.80 per kg. Actual labour was 4,300 hours at £19 per hour. The purchasing manager negotiated a lower material price with a new supplier. The production manager reports that the new material is more difficult to handle and has caused extra waste. The personnel manager says the higher labour rate reflects the use of more experienced temporary staff, who completed the work faster than standard. The monthly report shows a net material variance of £3,600 adverse and a net labour variance of £700 adverse. The production director says that, because the net variances are small, no further action is needed. The cost of a formal investigation is estimated at £6,000. A supplier quality review could be completed for £2,500.
1. Calculate the material and labour variances, showing price/rate and usage/efficiency variances.
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Material variances:
- Actual output = 9,000 units.
- Standard quantity allowed = 9,000 × 2 kg = 18,000 kg.
- Material price variance = (standard price − actual price) × actual quantity = (£5.00 − £4.80) × 19,500 = £3,900 favourable.
- Material usage variance = (standard quantity − actual quantity) × standard price = (18,000 − 19,500) × £5 = £7,500 adverse.
- Total material variance = £7,500 adverse − £3,900 favourable = £3,600 adverse.
Labour variances:
- Standard hours allowed = 9,000 × 0.5 = 4,500 hours.
- Labour rate variance = (standard rate − actual rate) × actual hours = (£18 − £19) × 4,300 = £4,300 adverse.
- Labour efficiency variance = (standard hours − actual hours) × standard rate = (4,500 − 4,300) × £18 = £3,600 favourable.
- Total labour variance = £4,300 adverse − £3,600 favourable = £700 adverse.
The net figures hide substantial offsetting variances. The material price saving is more than outweighed by extra waste, and the labour rate increase is more than offset by faster working. The variances cannot be interpreted properly unless they are separated by cause and responsibility.
2. Advise whether the production director is right that no action is needed. Include the investigation cost and responsibility.
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The production director is wrong to rely on the net variances. Netting is dangerous because it combines variances with different causes and different responsible managers.
Material: the company paid £4.80 instead of £5.00, saving £3,900, but used 19,500 kg instead of 18,000 kg, costing £7,500 extra at standard price. Actual material cost was 19,500 × £4.80 = £93,600, against a standard cost of 18,000 × £5 = £90,000, so the new supplier has increased total material cost by £3,600 in the month. The usage variance is 1,500 kg, or 8.3% above standard usage, a large operational deviation. A supplier quality review at £2,500 is likely to be worthwhile: if the waste could be eliminated, the monthly saving would be £3,600, or £43,200 annualised, before any change in price. The purchasing manager is responsible for the price, but the production manager bears the usage variance; the decision to buy cheaper material was a joint trade-off, so blame should not be assigned to production alone.
Labour: actual labour cost was 4,300 × £19 = £81,700, against standard 4,500 × £18 = £81,000, so the net overspend is only £700, or 0.86%. The higher rate bought faster working, and the net effect is small. A £6,000 formal investigation is not justified on this evidence unless the temporary staff are causing quality problems or the rate increase is expected to continue. The personnel manager should monitor the use of temporary staff.
Recommendation: investigate the material usage/supplier issue first, because the cost is large and the review is cheap; do not net it against the price saving. Monitor labour rather than formally investigate.
3. What behavioural problems can arise from reporting only net variances, and what reporting would you recommend?
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Reporting only net variances can create several dysfunctional behaviours. It hides offsetting performance, so a manager who makes a poor trade-off can appear to have performed adequately. In this case, purchasing can claim credit for a favourable price variance while production absorbs an adverse usage variance; the two managers may argue rather than solve the total-cost problem. Netting also weakens accountability because no single manager owns the combined result. It can encourage local optimisation: purchasing buys cheap material to improve its own variance, even if total cost rises, and production may use more material or more expensive labour to protect its own efficiency measure.
A better report should:
- Show price and usage variances separately, and rate and efficiency variances separately.
- Identify the manager or function best placed to control each variance.
- Report the total cost effect of related decisions, such as the new supplier's price plus waste, so trade-offs are visible.
- Include explanations and corrective actions, not just numbers.
- Distinguish controllable from uncontrollable causes and separate one-off items.
- Use flexible budgets so that volume effects are removed before performance is judged.
The aim is to support learning and total cost reduction, not to produce a single net figure that can be used to blame or excuse a manager.