Variance analysis

The purpose of variance analysis is to ascertain the quantitative deviation between budgeted, forecasted or otherwise estimated figures and accounting actuals and analyze this deviation into bigger detail. It is a valuable control mechanism.

Factors to consider when deciding whether it is worth to investigate the variance:

• materiality – small variances are usually either not analyzed or analyzed only to lower extent. Materiality levels can be defined:
  • in absolute figures – e.g. variances over € 100 are investigated
  • in % - e.g. variances over x% from budgeted figure are investigated  
  • are not defined and analysts evaluate their significance subjectively
• controllability –uncontrollable variances shall be given lower care than to controllable
• whether the variance is favorable or unfavorable – investigation is more about unfavorable variances
• trend – if the monthly (or other period) variances keep showing a trend, it is certainly worth further analyses
• standards used in budget preparation – if for example ideal standard is used, the variances are expected to be unfavorable
• the cost of variance investigation should not exceed the benefits resulting from the possible remedial action (28)
• interrelationship of variances – one variance can be related with another and it therefore depends on their cumulative effect. For example:
  • using poor-quality material can cause:
    • favorable direct material price variance
    • unfavorable direct material quantity variance (more wastage)
    • unfavorable direct labor quantity variance (worse handling)
  • more qualified staff can result in:
    • unfavorable direct labor rate variance (higher wages)
    • favorable direct material quantity variance (less wastage)
    • favorable direct labor quantity variance (less hours necessary to produce the same output)

In general, direct costs, revenues and margin variances can be split into:

• price variance

Calculation:  (actual unit price – budgeted unit price) x actual quantity

Interpretation: reveals how much the costs/revenues/margin changed as the consequence of the changed price (unit margin).

• quantity (or volume or usage) variance

Calculation:  (actual quantity – budgeted quantity) x budgeted unit price

Interpretation: reveals how much the costs/revenues/margin changed as the consequence of the changed quantity sold/produced. 

More detailed variance calculations can be found here:

Direct material cost variance

Direct labor cost variance

Variable production overheads variance

Fixed production overheads variance