welcome to module 9 of our management accounting course this has us looking at variance analysis so to explain variance analysis i'm going to give an example that is based on a true story i have a friend named bill and he was thinking of opening a hamburger restaurant and one of the things he was worried about was beef well he did open the hamburger restaurant and in fact after a few weeks in business he said i blew my beef budget and as you'll know beef is like the main ingredient in a hamburger and it's the most expensive ingredient so he was worried right his whole business model was precipitated on a certain level of beef costs and he started the business and it looked like he had blown it completely and that had him of understandably quite worried so he knew i was an accountant he was like can you help me with some of the numbers so we worked together and we did some variance analysis for him to figure out what was going wrong if anything with his beef and that's what this module is about but i think this personal and fairly straightforward example will give you some illustration into how it works so beef of course is a direct material and again the account in me the management account and me was thinking okay we are going to have some direct materials variances that we're going to have to deal with here and so i asked what was the game plan here now though i asked him what the plan was but of course as an accountant i was thinking these are what we would call standard costs and so here was his plan each burger takes 200 grams of beef if you're not familiar with metric that's 0.2 kilograms of beef uh and beef costs eight dollars per kilogram so each burger should cost a dollar sixty in beef that's that's the number that was kind of triggering him he's like each burger is supposed to cost a dollar sixty and he was spending more than a dollar sixty burger uh burger and beef as we will soon see so uh this goes on what actually happened well i purchased 20 kilograms of beef for 750 per kilogram so that's 150 dollars worth of beef 20 times 750. i used 19 kilograms of beef and made and sold 80 burgers and so this is what kind of this is early days for him just his first you know 80 burgers uh he wants help he says you know making 80 burgers supposed to cost 80 times 1.6 you know this number up here uh it should cost me 128 but i spent 150. and you might think these are small numbers you know he's only over by 22 bucks what's the big deal but of course this is his main thing and if his main thing he's blowing the budget a lot of his projections are just going to go out the window so he's i think justifiably justifiably worried and so he's asking me for a little bit of help and i thought well this is a great situation for variance analysis and we can get to the bottom of what's causing uh the issue so uh here's how we do a variance analysis and i use these little tables so we'll start with this one i'm going to just bring it over oh i had it all ready to go i thought this is going to save me time and it's probably costing me time uh in any event uh so we'll start with his purchases right did he blow the budget by making bad purchases so let's start there with his purchases so what did he actually purchase now now here's the the way this little variance table works and you'll see me fill it in i think it'll help aq stands for actual quantity that's the again when we're talking about materials we're talking about grams kilograms pounds liters ounces you know these types of units of measure is what's going in here the actual quantity of beef purchased okay what was the actual quantity of beef purchase well worried about what actually happened again a q the a stands for actual so the actual quantity of beef purchased was 20 ap is the actual price paid per unit per kilogram in this case so the actual price paid per kilogram was 750 aq times ap is just the actual amount you paid for your raw material whatever that material was in this case it was beef in the burger so again 20 kilograms times 750 per kilogram gives us 150 actually spent on the beef okay the other prong says okay given the actual quantity so given the actual quantity was uh 20 kilograms that's the actual quantity purchased well if i'd if i told bill before the month started before he started work how much he would have thought he'd have spent and to do it we used something called the sp the standard price so i told him before the period he was going to buy 20 kilograms of beef how much would it have cost he would have said well it would cost 20 times eight because that's his cost per kilogram he thinks beef costs eight dollars a kilogram according to his plan so 20 times eight is 160 the difference here between 160 and 150 is 10 dollars now that's the variance now we've computed a variance the name of this variance is the direct materials price variance and with every variance we need to say if it's a good variance or a bad variance except for we're fancy accountants we don't say good variance or bad variance we use very specific jargon here we say is the variance favorable or unfavorable favorable gets an f unfavorable get to you again favorable means good unfavorable means bad so just looking at this in a vacuum obviously there's some bad news for bill but looking at this in a vacuum was the price variance favorable or unfavorable well it's favorable he saved money he thought he was supposed to spend eight dollars per kilogram he spent 750 this is good news this is a favorable variance so i'm just going to mark that with an f so as direct materials price variance is 10 dollars favorable but that's not the only variance there's also other causes of this and we're going to get into direct materials he used now obviously i think we're headed for some bad news but let's see how we do so in terms of direct materials used uh we take actual quantity times standard price now you might think oh i just take this same number no no no because the direct materials purchased is different from direct materials used he purchased 20 kilograms but he only used 19 of them so we take actual quantity used 19 kilograms times standard price oops i put an underline there i don't know why let's try again oh my goodness things are falling apart ctrl z there we go uh actual quantity uh used was 19 kilograms now i'm worried my american audience is gonna it'll be revealed i'm a canadian i said control z instead of control z uh 19 kilograms the standard price per kilogram is eight dollars 19 times eight is 152. 19 times eight is 152. okay so that's that prong the final prong is probably the trickiest of the bunch standard quantity times standard price our standard price remains eight the standard quantity we need to answer this question given the actual output in this case the actual number of burgers made how much direct material should should have been used so given the fact that i made how many burgers 80 burgers how much material should have been used well we know our standard quantity was 200 grams per burger or 0.2 kilograms for burger so given that i made 80 burgers and burgers are supposed to take 0.2 kilograms it should have taken 80 times 0.2 uh that is 16 kilograms of beef okay so 16 kilograms of beef times 8 16 times 8 48 128 okay so what's the difference here 152 minus 128 the difference is twenty four dollars is this variance favorable or unfavorable well the the price is the same between the two but the quantity is different i used 19 kilograms to do work that should have taken 16 kilograms this is an unfavorable variance i overused the beef this is a direct materials quantity variance so once bill and i had gotten to the bottom of this uh and i said okay well you're right you blew the budget you know you spent you overspent now he had sort of overrated the overspending he thought he was 22 dollars unfavorable overall indeed if you combine these two variants he's only 14 unfavorable what's the difference well he's still got a kilogram of beef that hasn't blown the budget he's still got some beef left over here but this is unfavorable now he got a good price so it wasn't down to price either maybe he got the good price because he got lower quality beef and used more or maybe it was that they spoiled some maybe he you know he's learning how maybe he had to throw some beef in the garbage because he overcooked or undercooked some burgers or had some customers send it back and he had to make a new burger with fresh beef uh or yeah it could be a lower standard of beef but the issue here isn't the price the issue here is he's using more beef than he planned to so a few options one you can just change the budget you can say you know what i'm actually using 250 grams of beef or two he can change something in the kitchen maybe it's not him maybe it's an employee but somebody is not using the beef as efficiently as they should be there's a direct materials quantity variance we've gotten to the bottom of it and again the number seems small but if you're just starting a new business and you're blowing your budget you're worried and bill was worried all right well i hope you don't worry too much how's that for a segway as we work through this module on variance analysis we're going to learn material labor and overhead variances and i hope you'll stay with me talk to you soon everybody have a great day bye for now