Economic Variances in Engineering Economics

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Types of Economic Variances

There are mainly 4 types of variances in engineering economics, namely

  1. Direct material cost variance
  2. Direct wages/labor cost variance
  3. Variable overhead variance
  4. Fixed overhead variance

Negative (-) variance is always favorable ie actual cost (-) << standard cost (+).

1. Direct material cost variance

This is the difference between standard cost of direct material specified for the o/p and the actual cost of direct materials used. Is the aggregate of direct material price variance and direct material usage variance ie

DMCV = material price variance + material usage variance

  1. Direct material price variance:
    i. cost varies due to difference between standard price specified and actual price paid for
    ii. DMPV = (actual quantity consumed * actual rate) – (actual quantity consumed * standard rate) = (AQ * AR)-(AQ * SR) = AQ (AR – SR) = Actual qty (actual rate – std rate)
  2. Direct material usage variance:
    i. cost variance due to difference between standard qty specified and actual qty variance
    ii. DMUV = (actual qty consumed * std rate) – (std qty consumed * std rate) = (AQ * SR)-(SQ * SR) = SR (AQ – SQ)


2. Direct labor/wage rate variance

Variance between std direct wages specified for the activity achieved and actual direct wages paid
Aggregate of direct wage rate variance and direct labor efficiency

a. Direct wage/labor rate variance:
i. variance due to difference between std rate of pay specified and actual rate paid
ii. DLRV = (actual hours worked at actual rate)-(actual hours worked at standard rate) = AH * AR – AH * SR = AH (AR-SR)

b. Labor efficiency variance:
i. variance due to difference between std labor hour specified for the activities achieved and the actual labor hour expanded
ii. LEV = (actual hours worked @ std rate) – (std hour * std rate) = (AH * SR) – (SH * SR) = SR (AH-SH)


3. Variable Overhead variance

Is the difference between the actual variance overhead and std variable overhead cost for the production

The aggregare of variable overhead, expenditure variance and the variable overhead efficiency variance

a. Variable overhead expenditure variance = (AH * AR) – (AH * SR) = AH (AR –SR)

b. Variable overhead efficiency = (AH * AR) – (AP * SH/UNIT * SR)

where AH = actual hours, SH = std hours, AP = actual production, unit = std production unit


4. Fixed overhead variance

Is the difference between actual fixed overhead and the standard cost of fixed overhead observed in the actual o/p

Is the aggregate of the following 3 variances

a. Fixed overhead expenditure variance = actual fixed overhead – budgeted overhead

b. Fixed overhead capacity variance = budgeted fixed overhead – AH * SR/UNIT

c. Fixed overhead efficiency variance = (AH *SR/UNIT) – (AP * SH/UNIT *SR)

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