What is a variance analysis?

The variance analysis is present in managerial accounting and it refers to the investigations of differences between actual and planned behavior.

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.

Types of variances

These are the main types of variances in use:

  • Purchase price variance. It is the actual price paid for the materials used in production minus the standard cost, multiplied by the number of units used.
  • Labor rate variance. The actual price paid for the direct labor used in the production process, minus the standard cost, multiplied by the number of units used.
  • Variable overhead spending variance. Subtract the standard variable overhead cost per unit from the actual cost incurred and multiply the result by the total unit quantity of output.
  • Fixed overhead spending variance. The total amount of fixed overhead cost minus their standard cost for the period.
  • Selling price variance. The actual selling price, minus the standard price, multiplied by the number of units sold.
  • Material yield variance. The total standard quantity of materials that are supposed to be used is subtracted from the actual level of use and then multiplied by the standard cost per unit.
  • Labor efficiency variance. Subtract the standard quantity of labor used from the actual amount and multiply it by the standard labor rate per hour.
  • Variable overhead efficiency variance. Subtract the budgeted unit of activity on which the variable overhead is charged from the actual units of activity, multiplied by the standard variable overhead cost per unit.

Basis of calculation

A variance analysis highlights the causes of the variation in income and expenses during a period that is then compared to the budget.

In order to make variances important, the concept of a “flexed budget” is used when the variances are calculated. The flexed budget acts as a bridge between the original budget and the actual results.

A flexed budget is prepared based on the actual income and expenditures of a business. Sales volume variance accounts for the difference between budgeted profit and the actual profit on the flexed budget. All the remaining variances are calculated as the difference between actual results and the flexed budget.

Functions and importance

The variance analysis is an important part of an organization’s information system.
Functions of the variance analysis include the following:

Planning, standards and benchmarks

Standards and budgetary targets have to be set in advance against which the organization’s performance can be compared against it, in order to calculate variances. This encourages forward thinking and a proactive approach towards setting performance benchmarks.

Control mechanism

A variance analysis facilitates “management by exception”. and deviations from standards are highlighted which affect the financial performance of an organization. If a variance analysis is not performed on a regular basis, these exceptions may go about undetected which can result in a delay in management action necessary in the situation.

Responsibility accounting

The variance analysis facilitates performance measurement and control at the level of responsibility centers.