definitionVariance means difference while analysis means breakdown. In Cost or Management Accounting, variance would relate to difference between Standard and Actual Costs. Analysis would break this difference into various parts like quantity, price and capacity. Any wide variation would be thoroughly investigated and persons responsible (purchase manager, human resource manager, factory manager or marketing manager) would be asked to explain. If it proved avoidable or controllable, someone would be penalized or reprimanded else measures would be taken to avoid in future as far as possible.
In short, variance analysis helps the management in decision-making. In addition (i) it is used in cost-control,
(ii) gives early warning for corrective action and
(iii) is useful in accountability.
What is a standard cost?It is a planned cost or a target cost. It is a realistic estimate based on historical data or experiments like time and motion studies. Standard costs give an indication of probable cost of performing an operation or producing a good or service in normal conditions. Later, such estimates serve as a bench marks against which actual data is compared.
What is actual cost?Actual amount paid or incurred, as opposed to estimated cost or standard cost.
Why compare Actual Costs with Standard Costs
• It gives an idea of efficiency. Other things remaining the same, if actual cost increases estimated cost, there may be either in-efficiency or dishonesty.
• It is used for accountability. Comparison may reveal weak areas and corrective action can be taken against the manager before it is too late.
• Since in-efficiencies or dis-honesties are revealed by comparison on regular basis, top managers can relax and intervene only when wide variations are highlighted. This is known as management by exception.
• It is help in cost control. Whenever the comparison reveals wide and persistent differences, the matter is investigated and efforts are made to avoid its repetition.
Cost varianceCost Variance (CV) is very important factor to measure project performance. Cost Variance (CV) indicates how much over or under budget the project is.
Cost Variance can be calculated as using the following formula
Cost Variance (CV) = Earned Value (EV) - Actual Cost (AC)
Cost Variance (CV) = BCWP - ACWP
The formula mentioned above gives the variance in terms of cost which will indicate how less or more cost has been to complete the work as of date.
Positive Cost Variance Indicates the project is under budget
Negative Cost Variance Indicates the project is over budget
Cost Variance %Cost Variance % indicates how much over or under budget the project is in terms of percentage.
Cost Variance % can be calculated as using the following formula
CV % = Cost Variance (CV) / Earned Value (EV)
CV % = CV / BCWP
The formula mentioned above gives the variance in terms of percentage which will indicate how much less or more money has been used to complete the work as planned in terms of percentage.
Positive Variance % indicates % under Budget.
Negative Variance % indicates % over Budget.
Labour varianceLabour variances can be analyzed as follows:
a) Labour cost variance:It is the difference between the standard cost of labour allowed (as per standard laid down) for the actual output achieved and the actual cost of labour employed. It is also known as wages variance.
Labour cost variance= standard cost of labour – actual cost of labour.
b) Labour rate variance:It is that portion of the labour cost variance which arises due to the difference between the standard rate specified and the actual rate paid.
It is calculated as follows:
Rate of pay variance = actual time taken (standard rate – actual rate)
overhead varianceOverhead variances arise due to differences between the actual overheads and the absorbed overheads. Thus, if we have to calculate an overhead variance, we have to know the amount of the actual overheads and that of the absorbed overheads.
The actual overheads can be known only at the end of the accounting period when the expense accounts are finalized. The absorbed overheads are the overheads charged to each unit of production on the basis of pre-determined overhead rate. This pre-determined rate is also known as standard overhead recovery rate, standard overhead absorption rate or standard burden rate.
To calculate the standard overhead recovery rate, we have to first make an estimate of the likely overhead expenses or each department for the next year. The estimate of the overheads is to be divided into fixed and variable elements. An estimate of the level of normal capacity utilization is then made either in terms of production or machine hours or direct labor hours.
The estimated overheads are divided by the estimated capacity level to calculate the pre-determined overhead absorption rate as shown below:
Standard Fixed Overhead Rate = Budgeted Fixed Overheads/Normal Volume
Standard Variable Overhead Rate = budgeted Variable Overhead/Normal Volume
Overhead Variances can be classified in the following two major categories:
1. Variable overhead variances
2. Fixed overhead variances
Variable Overhead VariancesThese variance arise due to the difference between the standard overhead variance overhead for the actual output and the actual variable overhead. If the standard variable overhead exceeds the actual variable overhead, the variance is favorable and vice-versa.
Mathematically it may be expressed as follows
Variable Overhead Variance = Standard * (Actual Variable Overhead – Variable Overhead)
Variable overheads are usually measured in relation to output if the details of the input quantities on which these variable overheads have been incurred are not readily available. In such circumstances, only the variable overhead variance is calculated.
Fixed Overhead VariancesFixed overhead variances maybe broadly classified into
a) Expenditure variance : It represents the difference between the fixed overheads as per budget and the actual fixed overheads incurred
b) Volume Variance: this variance represents the unabsorbed portion of the fixed costs because of the underutilization of capacity. In case a firm exceeds capacity, this variance is favorable in nature.
sales varianceFor doing sales variance analysis, we have to understand the meaning of sales variance. Sales variance or sales variance variance is the difference between actual value of sales and stand value sales. Value sales means the multiplication of sales price and quantity of sales. Following is its formula
SVV = Actual value of sales – standard value of sales.
If actual value of sales is $ 10000 and standard value of sales is $ 20000, at that time, its is unfavorable variance. It shows that our performance is less than our planning in the form of sales budget. It also tell us market conditions are not favorable for us. For knowing exact reason, we have to divide sales value variance in to two part
1. Sales price Variance
Sales price variance is the difference between actual sales price and standard sales price.
SPV = Actual Quantity of sales X ( Actual price – standard price )
For more detail of sales price variance, you can study at here .
2. Sales Volume Variance
Sales volume variance is the difference between actual quantity of sales and standard quantity of sales.
SVV = Standard price X ( Actual quantity of sales – Standard quantity of sales )
For more study of sales volume variance, you can read at here .
Sales value variance will always equal to the sales price variance and sales volume variance
Sale value variance = Sales price variance + sales volume variance
Direct Material Quantity Variance:
Direct materials quantity variance is also known as Direct materials efficiency variance and Direct materials usage variance. It measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard that has been set. Although the variance is concerned with the physical usage of materials, it is generally stated in dollar terms to help gauge its importance.
Materials quantity | Usage variance Formula:
Following formula is used to calculate materials quantity variance or direct materials usage variance:
[Materials quantity variance = (Actual quantity used × Standard price) - (Standard quantity allowed × Standard Price)]
The variance in the price of materials i.e the actual cost of materials differing from the standard cost of materials for a level of activity or production is referred to as "Material Price Variance".
material price variance
The process of computing this variance is to first compare the standard cost per unit of material with the actual cost paid to purchase the same. The difference is the variance in price and can be favorable or unfavorable. But in order to assess the actual impact of this difference, we must multiply this difference with the actual quantity of materials used in the production. This because, if the quantity of materials used is less or minimal, the variance may be of little consequence. If however, a large quantity of materials is used, the effect of price difference may be large.
Materials Price Variance is therefore computed as the difference between the standard price (SP) and the actual Price (AP) per unit of material multiplied by the quantity of material purchased (QP).
The formula for Material Price Variance is:
(SP – AP) * QP
The variance is generally expressed as a number that is either 'favorable' or 'unfavorable' or 'adverse'. If the actual price paid for the materials is lesser than the standard price, the variance is favorable. In the other case, we refer to the variance as unfavorable.