In accounting, variance refers to the difference between the standard variable and the actual variable. For example, you can calculate the selling price variance to find the difference between the actual selling price and the standard selling price.
Broadly speaking, there are 2 types of variances: favourable and adverse. A favourable variance, as the name suggests, is a variance that is beneficial to the firm. If the actual costs are less than the standard costs, the variance is favourable as the company was able to lower its costs and therefore increase its profits.
The other type of variance is an adverse variance. This type of variance is disadvantageous to the firm. For example, if the actual labour rate efficiency is lower than the standard labour rate efficiency, the variance between the two is adverse as the company was spending more than the standard amount on salaries.
Purpose of Variance Analysis
After finding the variance, managers must investigate why the variance occurred so that they know what they did right or wrong. For example, if the company has a favourable direct materials variance because it purchased raw materials from a particular supplier, it will know that it is best to buy from the company again.
One thing you must remember when you are performing variance analysis is that you should compare like with like. For example, if the company doesn’t have figures for the actual level of production, it cannot substitute the budgeted level of production for the actual level when performing variance analysis. This is why the flexed budget is important. Budgeted figures must be flexed to reflect the actual figures (or what the actual figures would have been).
We will be talking about different types of variances. They can be classified as follows:
- Direct material cost variances
- Direct material price variance
- Direct material usage variance
- Direct labour cost variances
- Direct labour rate variance
- Direct labour efficiency variance
- Sales variances
- Sales volume variance
- Sales price variance
- Fixed overhead variances
- Expenditure variance
- Volume variance
- Capacity variance
- Efficiency variance