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Examples of Cost VariancesThe following are examples of variances related to specific types of costs: Direct Material Price VarianceThe direct material price variance is the difference between the actual price paid to acquire a direct materials item and its budgeted price, multiplied by the actual number of units acquired. This information is needed to monitor the costs incurred to produce goods. The formula follows: (Actual price - Budgeted price) x Actual quantity = Direct material price variance Fixed Overhead Spending VarianceThe fixed overhead spending variance is the difference between the actual fixed overhead expense incurred and the budgeted fixed overhead expense. To calculate the fixed overhead spending variance, subtract budgeted fixed overhead from actual fixed overhead. The formula for this variance is as follows: Actual fixed overhead - Budgeted fixed overhead = Fixed overhead spending variance Labor Rate VarianceThe labor rate variance measures the difference between the actual and expected cost of labor. It is calculated as the difference between the actual labor rate paid and the standard rate, multiplied by the number of actual hours worked. The formula is: (Actual rate - Standard rate) x Actual hours worked = Labor rate variance Purchase Price VarianceThe purchase price variance is the difference between the actual price paid to buy an item and its standard price, multiplied by the actual number of units purchased. The formula is: (Actual price - Standard price) x Actual quantity = Purchase price variance Variable Overhead Spending VarianceThe variable overhead spending variance is the difference between the actual and budgeted rates of spending on variable overhead. The variance is used to focus attention on those overhead costs that vary from expectations. The formula is: Actual hours worked x (Actual overhead rate - standard overhead rate) Favorable and Unfavorable VariancesThere is an unfavorable variance when the actual cost incurred is greater than the budgeted amount. There is a favorable variance when the actual cost incurred is lower than the budgeted amount. Whether a variance ends up being positive or negative is partially due to the care with which the original budget was assembled. If there is no reasonable foundation for a budgeted cost, then the resulting variance may be irrelevant from a management perspective. Not all unfavorable variances are bad. Spending more money in one area may create a favorable variance somewhere else. For example, it might be necessary to spend twice as much on preventive maintenance to avoid a much greater total expense associated with replacing fixed assets more frequently. Thus, it is sometimes better to review cost variances from the level of an entire department, facility, or product line, rather than at a more detailed level. This higher level of analysis gives managers room in which to allocate funds in a manner designed to improve total profits. Reporting of Cost VariancesCost variances are usually tracked, investigated, and reported on by a cost accountant. This person determines the reason why a variance occurred and reports the results to management, possibly along with a recommendation for changing operations to reduce the size of the variance (if unfavorable) in the future. It is not always useful to bury management with an analysis of every possible cost variance. Instead, the cost accountant should determine which variances are large enough to be worth their attention, or if there is some action to be taken to improve the situation. Thus, a cost variance report should only include a few items each month, preferably with recommended actions to be taken. Today we will take a more detailed look at Variance Analysis. In this article, we will deal with the theory, and in next week’s article, we will build an Excel model to look more practically at the subject. Variance AnalysisVariance analysis looks at the differences between planned and actual numbers. This method is used a lot in management accounting as a way to maintain control over the business. When we perform variance analysis, we compare the actual amount incurred/sold to either budgeted amount, planned amount, or standard amount. Types of VariancesVariances can be two types based on their effect:
A specific level of variance analysis allows the management to understand why discrepancies and fluctuations occur in the business and how to control them better. When calculating variances, we should always take the planned or budgeted amount and subtract the actual value. This way, we ensure that a positive number means a favorable variance, and a negative number – adverse variance. The most common variances used in financial analysis are:
Variable Cost VariancesDirect Material VariancesThe Total Direct Material Variance shows the difference between the standard and actual cost of materials for production activities. It consists of two variances: Purchase Price VarianceThe Purchase Price Variance, also known as Material Price Variance, calculates the difference between the actual price to buy an item and its expected standard price, multiplied by the actual number of units purchased. A positive variance means actual costs have increased, and vice versa. Purchase Price Variance = (Actual Price – Standard Price) x Actual Quantity Material Yield VarianceThe Material Yield Variance, also known as Material Usage Variance, illustrates the difference between standard quantity expected to be used and the actual quantity of materials used, multiplied by the expected standard cost of materials. Unfavorable variance means that usage was higher than expected. Material Yield Variance = (Actual Usage – Standard Usage) x Standard Cost Per Unit Direct Labour Cost VariancesThe Total Direct Labour Variance looks at the effect of the combination of labor rates and worked hours. The total variance can be broken down to the Direct Labour Price Variance and the Direct Labour Quantity Variance. Direct Labour Price VarianceThe Direct Labour Price Variance, also known as the Direct Labour Rate Variance, is calculated by taking the difference between the Standard Rate and the Actual Rate for labor cost, multiplied by the Actual Hours worked. It shows the effect on the labor costs by the change in the hourly labor rate, between the expected and the actual. Direct Labour Price Variance = (Standard Rate – Actual Rate) x Actual Hours Most common drivers for the variance can be:
Direct Labour Quantity VarianceWe calculate the Direct Labour Quantity Variance, also known as the Direct Labour Efficiency Variance, by taking the difference between the expected Standard Hours and Actual Hours worked, multiplied by the Standard Rate expected for hired labor. Direct Labour Quantity Variance = (Standard Hours – Actual Hours) x Standard Rate Some drivers for this variance can be:
Variable Production Overhead VariancesWe calculate the Total Variable Production Overhead Variance in two parts. Variable Overhead Spending VarianceWe calculate the Variable Overhead Spending Variance by subtracting the Actual Hours valued at the Standard Rate for the absorption of variable production costs from the Actual Costs incurred. Actual Rate is not used here, as we do not ‘purchase’ the variable overhead costs per direct labor hours. Variable Overhead Spending Variance = Actual Costs – (Actual Hours x Standard Rate) Some causes for this variance can be account misclassification, changed prices by suppliers, and outsourcing of various tasks. Variable Overhead Efficiency VarianceWe calculate the Variable Overhead Efficiency Variance by subtracting the Standard Hours value at the Standard Rate from the Actual Hours valued at the Standard Rate. The variance calculation assumes that variable overhead costs are genuinely driven by direct labor hours. It shows us the effect on costs from the change between the expected Standard Hours to the Actual Hours. Variable Overhead Efficiency Variance = (Actual Hours x Standard Rate) – (Standard Hours x Standard Rate) The calculation of the variance can be simplified as follows: Variable Overhead Efficiency Variance = (Actual Hours – Standard Hours) x Standard Rate Fixed Production Overhead VariancesThere are two Fixed Production Overhead Variances. First, we have the Budget Variance, also known as the Fixed Overhead Expenditure Variance. Second, we have the Fixed Overhead Volume Variance. Based on the costing model, we can calculate both variances in the case of Absorption Costing. When applying Marginal Costing fixed production overheads are not absorbed in the cost of output, budgeted overheads and flexed overheads (fixed overheads absorbed) are the same. Therefore only the Budget Variance is calculated. Budget VarianceThe Budget Variance, also known as Fixed Overhead Expenditure Variance or Fixed Overhead Spending Variance, is calculated to illustrate the deviation from the budget in the fixed production costs. We derive it the same way under the Absorption and Marginal costing system. Fixed Overhead Expenditure Variance = Actual Fixed Overheads – Budgeted Fixed Overheads Drivers of this variance can be the seasonality in fixed costs or when manufacturing reaches a new step cost trigger point, where we will incur a whole further expense. Volume VarianceThe Fixed Overheads Volume Variance is the difference between budgeted and actual absorbed fixed production costs. A seasonal business can cause it if the allocation base is the number of sold units. If the allocation base is labor hours, the cause can be optimizations of manual labor. Moreover, if the allocation base is machine hours, the variance can be caused by outsourcing some aspects of the production process. We can further analyze the variance into two sub-variances. Fixed Overhead Capacity VarianceThe Fixed Overhead Capacity Variance calculates the variation in absorbed fixed production overheads attributable to changes in the manufacturing hours, as compared to the budget. Fixed Overhead Capacity Variance = (Budgeted Production Hours – Actual Production Hours) x Fixed Overheads Absorption Rate Fixed Overhead Efficiency VarianceThe Fixed Overhead Efficiency Variance shows the variation attributable to the change in the manufacturing efficiency, i.e., manufacturing hours being more or less than what we expected. Fixed Overhead Efficiency Variance = (Standard Production Hours – Actual Production Hours) x Fixed Overheads Absorption Rate Sales VariancesThe primary sales variance that can be calculated as Budgeted Sales less Actual Sales is the Sales Value Variance. To further analyze it, we can break it down into two sub-variances. Sales Price VarianceSales Price Variance = (Actual price – Standard price) * Actual sold quantity This variance shows us a comparison between the actual sales realized and the actual sales at standard prices. Sales Volume VarianceThe Sales Volume variance shows the deviation from budgeted sales to actual sales at actual prices. We calculate it as follows: Sales Volume Variance = (Actual quantity sold – Budgeted quantity sold) * Budgeted price per unit Calculated that way, the sales volume variance is unfavorable, or averse, when fewer items were sold than initially budgeted. Some of the reasons for the volume variance can include:
We can further break down the Sales Volume variance into the Sales Mix variance and the Sales Quantity variance. Sales Mix VarianceWe use the sales mix variance to evaluate how much of the sales volume variance was due to a difference between actual and budgeted sales mix. Sales mix variance = (Actual sales quantity – Actual sales volume at budgeted mix) * Standard price It can also be calculated as Standard Sales – Revised Standard Sales. The mix variance is favorable if the actual volume is higher than the actual volume at the budgeted (standard) mix, and vice versa. Sales Quantity VarianceThe quantity variance shows the effect of the unit volume that varies from the budget. It shows how much of the volume variance is due to the difference between the actual quantity sold at the budgeted mix and the planned quantity. We calculate it as follows: Sales quantity variance = (Actual sales quantity at budgeted mix – Budgeted sales quantity) * Standard price We can represent this as Revised Standard Sales – Budgeted Sales. A favorable variance means that the actual volume at the budgeted sales mix is higher than the budgeted volume. If the actual volume at the budgeted mix is lower than the budgeted sales volume, the formula gives an adverse variance. Limitations of Variance AnalysisWe have to note that there are some problems with variance analysis that keep companies from overusing it. This type of analysis is mostly based on financial results that are sometimes released much later. In a fast-paced environment, management might need such information much faster and more regular than the usual once a month calculation after closing the financial accounts. Variance calculations require more data than what is available in the accounting records, so the accounting staff usually has to go through other information such as bills of material, and overtime records to evaluate the causes of variances. The extra labor cost is only reasonable when management can correct problems based on the calculated deviations. Also, loosely done or political budgeting is bound to deviate a lot from the actual results. Comparing to such unrealistic expectations may provide misleading signals and not be useful at all. ConclusionWe do not need to analyze all variances. When we make our selection, we need to take into consideration the company’s profile, the nature of the industry, and the life cycle of the business. Also, it is essential to remember that not all unfavorable variances are bad, and vice versa. The management of a company faces a challenge to take variance information, evaluate the underlying reasons and causes, and take necessary corrective measures to optimize the business processes. However, one must be mindful, that variance analysis is essentially a comparison between standard (budgeted) values and actual results, and if the budget was unrealistic, then the resulting signals from the variance analysis might turn out to be very misleading. Thank you for reading! Please tune in next week, when we will take a more practical look at variances by applying all this knowledge in building a variance analysis model in Excel. Dobromir DikovFCCA, FMVAHi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with. In my spare time, I am into skiing, hiking and running. I am also active on Instagram and YouTube, where I try different ways to express my creative side. The information and views set out in this publication are those of the author(s) and do not necessarily reflect the official opinion of Magnimetrics. Neither Magnimetrics nor any person acting on their behalf may be held responsible for the use which may be made of the information contained herein. The information in this article is for educational purposes only and should not be treated as professional advice. Magnimetrics and the author of this publication accept no responsibility for any damages or losses sustained in the result of using the information presented in the publication. What is the difference between the actual price and the standard price multiplied by the actual quantity of materials purchased?Hence material price variance is the difference between standard price and actual price multiplied by actual quantity. When there is a difference between the actual quantity and the standard quantity This is called a?2. Quantity variance. The quantity variance is the difference between the actual quantity of inputs used at the standard price and the standard quantity of inputs allowed for the actual output at the standard price. When calculating variances from standard costs the difference between actual and standard price multiplied by actual quantity gives a?23. The difference between the actual price and the standard price, multiplied by the actual quantity of materials purchased is the material price variance. When computing standard cost variances the difference between actual and standard price multiplied by actual quantity yields a N?When computing variances from standard costs, the difference between actual and standard price multiplied by actual quantity yields: Price variance. When computing standard cost variances the difference between actual and standard price multiplied by actual quantity yields a?When computing variances from standard costs, the difference between actual and standard price multiplied by actual quantity yields: Price variance.
When there is a difference between the actual quantity and the standard quantity This is called a?A quantity variance is the difference between the actual usage of something and its expected usage. For example, if a standard quantity of 10 pounds of iron is needed to construct a widget, but 11 pounds are actually used, then there is a quantity variance of one pound of iron.
What variance is the difference between the actual price per unit and the standard price per unit?The correct answer is direct materials price variance. If the company's actual price and standard price on direct materials are compared, the company is evaluating the price variance of the direct materials.
What is the difference between the standard cost of materials for the actual output and the actual cost of materials used for producing actual output?The direct material variance is the difference between the standard cost of materials resulting from production activities and the actual costs incurred.
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When computing standard cost variances the difference between actual and standard price multiplied by actual quantity yields an?
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