Budgeting Basics and Beyond

8.9. Interrelationship of Variances

With regard to variance analysis for all production costs (direct material, direct labor, and overhead), it is important to note that each variance does not represent a separate and distinct problem to be handled in isolation. All variances in one way or another are interdependent. For example, the labor rate variance may be favorable because lower-paid workers are being used. This could lead to an (1) unfavorable material usage variance because of a higher incidence of waste, (2) unfavorable labor efficiency variance because it takes longer hours to make the equivalent number of products, (3) unfavorable overhead efficiency variance because the substandard work causes more hours to be spent for a specified output, and (4) unfavorable overhead volume variance arising from abnormally high machine breakdowns because of less skilled operators.

A trade-off between variances may be a manager's objective. For example, a material price variance may be favorable because of a bargain purchase opportunity or because of a combination of available resources designed to save overall costs. However, the raw material acquired may be somewhat inferior in quality to that which is usually purchased. In processing, use of this material may lead to greater waste or more labor hours in producing a finished item that will satisfy product quality guidelines. The goal here may be to minimize total production costs through the trade-off of a favorable price variance ...