Variance Analysis

What is variance analysis?

In accounting, a variance is the difference between an expected or planned amount and an actual amount.

Advantages
Performance Measurement

Responsibility Accounting

Management By Exemption

Variable-Overhead Spending Variance

Variable-overhead spending variance

=AH x (AVR SVR)

Where: AH = actual machine hours AVR = actual variable-overhead rate SVR = standard variable-overhead rate

Variable-Overhead Efficiency Variance

Variable-Overhead Efficiency Variance

=SVR x (AH - SH)

Where: AH = actual machine hours SH = standard machine hours SVR = standard variable-overhead rate

Interpreting Variable Variance

The variable-overhead efficiency variance does not indicate inefficient use of variable-overhead. An unfavorable variable-overhead spending variance The spending variance can alert managers if variable overhead costs are exceeding expectations.

Fixed-Overhead Variances
Fixed-Overhead Budget Variance =
Actual fixed overhead - Budgeted fixed overhead The budget variance is the real control variance for fixed overhead, because it compares actual expenditures with budgeted fixed-overhead costs.

Fixed-Overhead Volume Variance =

Budgeted fixed overhead - Applied fixed overhead
Applied fixed overhead = Predetermined fixed overhead rate x Standard allowed hours

Material Price Variance

MPV = (AP SP) AQ

Where: MPV = Material price variance AP = Actual unit price of materials SP = Standard unit price of materials AQ = Actual quantity of materials purchased Decision Rule: AP > SP AP < SP Unfavorable Favorable

Material Quantity Variance

MQV = (AQ SQ) SP
where: MQV = Material quantity variance AQ = Actual quantity of materials put into production SQ = Standard quantity allowed for the output produced SP = Standard unit price of materials Decision Rule: AQ > SQ AQ < SQ Unfavorable Favorable

Labor Rate Variance

LRV = (AR SR) AH

where: LRV = Labor rate variance AR = Actual labor rate SR = Standard labor rate AH = Actual labor hours worked Decision Rule: AR > SR AR < SR Unfavorable Favorable

Labor Efficiency Variance

LEV = (AH SH) SR

where: LEV = Labor efficiency variance AH = Actual labor hours worked SH = Standard hours allowed for the output produced SR = Standard labor rate Decision Rule: AH > SH AH < SH Unfavorable Favorable

Example: Suppose that 2,000 units have been produced during the period and 5,400 direct labor hours have been worked at a rate of $13.75 per direct labor hour. Standard rate per direct labor hour is $14.00.

Calculate labor rate variance.

Calculation of direct labor rate variance. Labor rate variance = (Actual hours worked Actual rate) (Actual hours worked Standard rate) = (5,400 $13.75) (5,400 $14.00 )

= 74,250 75,600
Labor rate variance = $(1,350) Favorable

Disposition of Variances
Variances are temporary accounts and most companies close them directly into Cost of Goods Sold at the end of each accounting period.

Disadvantages
The monitoring cycle can be so long that it renders the application of control impossible.
Typically, by the time a problem has been identified through variance analysis it is too late to take corrective action.