Material Mix Variance is a concept that is used in the manufacturing world. Manufacturing companies make a huge amount of R&D spending in determining the optimum mix of materials. This optimum mix is a combination of inputs at which the cost of production is at a minimum while maintaining the desired quality. The companies use this optimum mix of materials as the standard to set their cost and budgetary estimations.
However, this standard cost does not remain the same in the real world as the material cost keeps on fluctuating. And this results in the variance from the standard cost. We call this variance Material Mix Variance. The variance can also be due to the change in the quantity from the optimum combination. We can say that the variance arises because of a change in the ratio in which a company uses the materials in comparison to the set standard.
This variance could either be favorable or unfavorable (or adverse). It is crucial that whenever you calculate any variance, you denote it as favorable or adverse. If the variance is favorable, you can tag it as ‘F,’ and if it is adverse, you can tag it as ‘A.’
Example of Material Mix Variance
An example will help us understand the concept in a better way. A company uses two chemicals, X and Y, to make a third chemical Z. The cost per liter of X and Y is $20 and $25, respectively, while Z sells for $30 per liter.
The company, on the basis of its research, has come up with two optimal combinations. These are:
First: 10 ltr. of X and 10 ltr. of Y will give 18 ltr. of Z
Second: 8 ltr. of X and 12 ltr. of Y will give 19 ltr. of Z
We can determine the optimum mix between the two by calculating the net contribution from each.
First: (18 x $30) less (10 x $20) less (10 x $25) = $90
Second: (19 x $30) less (8 x $20) less (12 x $25) = $110
This means that the second mix is the optimum mix, giving the maximum net contribution.
Now, if the price of X and Y change, or the selling price of Z changes, or if the production uses more materials than the optimum mix, this will result in the variance.
Now, assume that the company produces 1,900 ltr. of Z using 900 ltr. of X and 1,100 ltr. of Y. The cost of X and Y are the same as the standard cost above, i.e., $20 and $25, respectively.
To calculate the variance, we first need to calculate the standard cost of producing 1,850 ltr. of Z using the proportionate optimum mix of X and Y from the Second combination above.
The optimum quantity of X, in this case, will be = (8/20)* 2,000 ltr. = 800 ltr. The 2,000 ltr. Here is the total X and Y used to produce Z.
Similarly, the optimum quantity of Y will be = (12/20)* 2,000 ltr. = 1,200 ltr.
Now, we need to calculate the optimum/standard cost. This will be (800 * $20) + (1,200 * $25) = $46,000
Now let us calculate the actual cost incurred by the company. And this will be = (900 * $20) + (1,100 * $25) = $45,500
The material mix variance in this case will be = $46,000 less $45,500 = $500 F
As the actual cost incurred is less than what was initially estimated. Therefore we have a favorable variance here.
Read Material Variance for more details on other types of material variances.
Material Mix Variance is a tool available to the production managers to gauge the efficiency of the production process. The management can regularly calculate this variance to determine whether or not the actual production is in line with the set standard. In case there is an unfavorable variance, and it is above the acceptable limit, then the management can take corrective actions to minimize or eliminate the variance.