Analysis of Variances

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Variance and Variance Analysis

Variance is the difference between actual performance and budgeted or expected performance. It helps organizations evaluate how well they are doing compared to their plans. Variance Analysis involves examining these differences to identify reasons and make informed decisions.

Types of Variances

Material Variances

Price Variance:
  • Definition: Measures the difference between the actual cost of materials and the standard cost.
  • Calculation:
    • Formula: Price Variance = (Actual Quantity×Actual Price)−(Actual Quantity×Standard Price)
    • Components:
      • Actual Quantity: The quantity of materials actually used.
      • Actual Price: The actual price paid per unit of material.
      • Standard Price: The budgeted or expected price per unit of material.
Usage Variance:
  • Definition: Measures the difference between the actual quantity of materials used and the standard quantity.
  • Calculation:
    • Formula: Usage Variance=(Actual Quantity×Standard Price)−(Standard Quantity×Standard Price)
    • Components:
      • Actual Quantity: The quantity of materials actually used.
      • Standard Quantity: The expected quantity of materials needed based on standards.
      • Standard Price: The budgeted or expected price per unit of material.
  • Function:
    • Identifies cost overruns in material procurement and usage.
    • Helps improve material purchasing and usage efficiency.
Labour Variances

Rate Variance:
  • Definition: Measures the difference between the actual labor cost per hour and the standard labor cost per hour.
  • Calculation:
    • Formula: Rate Variance=(Actual Hours×Actual Rate)−(Actual Hours×Standard Rate)
    • Components:
      • Actual Hours: The number of labor hours worked.
      • Actual Rate: The actual hourly wage paid.
      • Standard Rate: The budgeted or expected hourly wage.
Efficiency Variance:
  • Definition: Measures the difference between the actual hours worked and the standard hours expected.
  • Calculation:
    • Formula: Efficiency Variance=(Actual Hours×Standard Rate)−(Standard Hours×Standard Rate)
    • Components:
      • Actual Hours: The number of hours worked.
      • Standard Hours: The expected number of hours based on standards.
      • Standard Rate: The budgeted or expected hourly wage.
  • Function:
    • Identifies issues related to labor costs and productivity.
    • Helps in optimizing labor usage and wage structures.
Overheads Variances

Spending Variance:
  • Definition: Measures the difference between actual overhead costs incurred and the budgeted overhead.
  • Calculation:
    • Formula: Spending Variance=Actual Overhead−(Actual Hours×Standard Overhead Rate)
    • Components:
      • Actual Overhead: The total overhead costs incurred.
      • Actual Hours: The number of hours worked.
      • Standard Overhead Rate: The budgeted overhead rate per hour.
Efficiency Variance:
  • Definition: Measures the difference between the actual overhead costs based on actual hours and the overhead costs based on standard hours.
  • Calculation:
    • Formula: Efficiency Variance=(Actual Hours×Standard Overhead Rate)−(Standard Hours×Standard Overhead Rate)
    • Components:
      • Actual Hours: The number of hours worked.
      • Standard Hours: The expected number of hours based on standards.
      • Standard Overhead Rate: The budgeted overhead rate per hour.
  • Function:
    • Identifies discrepancies in overhead costs.
    • Helps in managing and controlling overhead expenses.
Sales Variances

Price Variance:
  • Definition: Measures the difference between the actual selling price and the standard or budgeted selling price.
  • Calculation:
    • Formula: Price Variance=Actual Sales−(Actual Volume×Standard Selling Price)
    • Components:
      • Actual Sales: The revenue generated from sales.
      • Actual Volume: The number of units sold.
      • Standard Selling Price: The budgeted or expected selling price per unit.
Volume Variance:
  • Definition: Measures the difference between the actual number of units sold and the standard or budgeted number of units sold.
  • Calculation:
    • Formula: Volume Variance=(Actual Volume×Standard Selling Price)−(Standard Volume×Standard Selling Price)
    • Components:
      • Actual Volume: The number of units sold.
      • Standard Volume: The expected or budgeted number of units.
      • Standard Selling Price: The budgeted or expected selling price per unit.
  • Function:
    • Identifies changes in sales revenue and pricing strategies.
    • Helps in adjusting pricing strategies and sales targets.

Advantages of Variance Analysis

  • Identifies Improvement Areas: Highlights deviations from expected performance, guiding improvements.
  • Provides Feedback: Offers insights to employees about their performance, fostering motivation and development.
  • Facilitates Decision-Making: Informs better resource allocation and strategic choices.
  • Supports Budget Control: Helps in staying within budget by pinpointing areas of overspending.

Disadvantages of Variance Analysis

  • Time-Consuming: Requires significant time and resources to analyze multiple variances.
  • Limited Insight: Only reveals deviations without explaining their causes or broader factors affecting performance.
  • Short-Term Focus: May lead to prioritizing immediate cost-cutting over long-term strategic goals.
  • Relies on Assumptions: Effectiveness depends on the accuracy of budget assumptions, which might not always hold true.