What is Variance?

Definition

Variance Analysis, in managerial accounting, refers to the investigation of deviations in financial performance from the standards defined in organizational budgets. Variance analysis also serves as a tool of budgetary control by evaluation of performance by means of variances between budgeted amount, planned amount or standard amount and the actual amount incurred/sold. Variance analysis can be carried out for both costs and revenues.

Variance analysis is usually associated with explaining the difference (or variance) between actual costs and the standard costs allowed for the good output. For example, the difference in materials costs can be divided into a materials price variance and a materials usage variance. The difference between the actual direct labor costs and the standard direct labor costs can be divided into a rate variance and an efficiency variance. The difference in manufacturing overhead can be divided into spending, efficiency, and volume variances. Mix and yield variances can also be calculated.

Variance analysis helps management to understand the present costs and then to control future costs.

Explanation

Variance analysis typically involves the isolation of different causes for the variation in income and expenses over a given period from the budgeted standards.

So for example, if direct wages had been budgeted to cost N100,000 actually cost N200,000 during a period, variance analysis shall aim to identify how much of the increase in direct wages is attributable to:

Increase in the wage rate (adverse labor rate variance);

Decline in the productivity of workforce (adverse labor efficiency variance);

Unanticipated idle time (labor idle time variance);

More wages incurred due to higher production than the budget (favorable sales volume variance).

Types of Variances

Main types of variances are as follows:

1. Sales Variance

2. Direct material total variance

3. Direct labor cost variance

4. Variable production overhead variances

5. Fixed production overhead variances