Efficiency Variance

For any actual level of output, the efficiency variance is the difference between the actual quantity of input used and the budgeted quantity of input allowed for that output level, multiplied by the budgeted input price:

Efficiencyvariance=(Actualquantity ofinput used−Budgeted quantityof input allowedfor actual output)×Budgeted priceof input  

The idea here is that, given a certain output level, a company is inefficient if it uses a larger quantity of input than budgeted. Conversely, a company is efficient if it uses a smaller input quantity than was budgeted for that output level.

The efficiency variances for each of Webb’s direct-cost categories are as follows:

<p>A table shows efficiency variances for Webb’s two direct-cost categories</p>

The table depicts actual quantity of input used minus budgeted quantity of input allowed for actual output times budgeted price of input to reach efficiency variance; this is done for direct materials and direct manufacturing labor. The details of the table are as follows:

1. Direct materials

Minus

Times

Equals

66,000 dollars U

2. Direct manufacturing labor

Minus

Times

Equals

20,000 dollars U

The two manufacturing efficiency variances—the direct materials efficiency variance and the direct manufacturing labor efficiency variance—are each unfavorable. Why? Because given the firm’s actual output, more inputs were used than the budgeted quantity allowed. This lowered Webb’s operating income.

As with price variances, there is a broad range of possible causes for these efficiency variances. For example, Webb’s unfavorable efficiency variance for direct manufacturing labor could be due to one or more of the following:

Suppose Webb’s managers determine that the unfavorable variance is due to poor machine maintenance. They would then establish a team consisting of plant engineers and machine operators to develop a maintenance schedule to reduce future breakdowns and prevent adverse effects on labor time and product quality.*

Exhibit 7-3 provides an alternative way to calculate price and efficiency variances. It shows how the price variance and the efficiency variance subdivide the flexible-budget variance. Consider direct materials. The direct materials flexible-budget variance of $21,600 U is the difference between the actual costs incurred (actual input quantity  ×  actual price) of $621,600 shown in column 1 and the flexible budget (budgeted input quantity allowed for actual output ×  budgeted price) of $600,000 shown in column 3. Column 2 (actual input quantity  ×  budgeted price) is inserted between column 1 and column 3. Then:

Exhibit 7-3 

Columnar Presentation of Variance Analysis: Direct Costs for Webb Company for April 2020a

A table shows the level 3 analysis of the direct costs that depicts the actual costs incurred, actual input quantity times the budgeted price, and flexible budget.

The details of the table are as follows:

Exhibit 7-4 provides a summary of the different variances. Note how the variances at each higher level provide disaggregated and more detailed information for evaluating performance.

Exhibit 7-4 

Summary of Level 1, 2, and 3 Variance Analyses

A flowchart shows the summary of level 1, level 2, and level 3 of variance analyses.

The details of the flowchart are as follows:

We now present Webb’s journal entries under its standard costing system.

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