Variance - What is variance?
Variance is the difference between the budgeted/planned costs and the actual costs incurred.
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Analysing variance helps businesses understand current outgoings and helps them budget for future expenses. Businesses often carry out variance analysis - a quantitative investigation into the differences between planned and actual costs and revenues.
Variance analysis can be applied to both revenues and expenses. When actual results are better than planned, variance is referred to as ‘favourable’. If results are worse than expected, variance is referred to as ‘adverse’ or ‘unfavourable’.
There are four main forms of variance:
Direct material variance
Direct labour variance
Sales variance is the difference between planned or expected sales and actual sales made. Analysing sales variance helps to measure sales performance, understand market conditions and evaluate business results.
The main two types of sales variance are:
Sales price variance: when sales are made at a price higher or lower than expected
Sales volume variance: a difference between the expected volume of sales and the planned volume of sales
Direct material variance is the difference between the expected cost and quantity of inventory materials used in production compared to the actual cost and quantity of materials used in production. Direct material variance can result from two conditions:
Purchase price variance: a discrepancy between the expected and actual prices paid for materials
Material yield variance: a difference between the quantity of materials expected to be used for the standard number of units produced, and the actual quantity of materials used
Direct labour variance is the difference between the standard or expected cost for labour related to production, and the actual cost incurred. Direct labour variance is made up of two components:
Labour rate variance: the difference between the expected cost and the actual cost paid for the number of labour hours
Labour efficiency variance: the difference in the number of units expected to be produced in a standard hour of labour, and the actual number of units produced
All businesses have ongoing business expenses or overheads. Some overheads are fixed, meaning that the cost doesn’t change depending on the level of production, whereas other overheads are variable, meaning that the cost varies according to the level of business activity.
Overhead variance occurs when the day-to-day costs of running a business differ from the amount budgeted and can occur with both variable and fixed overheads.