In cost accounting, variances refer to a difference between the actual value and the standard value. For example, a direct material cost variance means that the actual cost of direct materials used to produce a particular number of units is different from the standard (or expected) cost.
Variances can either be favourable or adverse. There are four main types of variances: direct material cost, direct labour cost, sales and fixed overheads.
It is important that managers investigate the reasons behind variances as it informs their decisions. For example, if the firm managed to obtain a favourable direct material variance by purchasing raw materials in bulk, the manager would come to know that this is an effective technique.
Some common causes of variances:
- Material price variance:
- The higher or lower price charged by suppliers
- (Adverse) Delivery costs are higher than usual
- (Favourable) The supplier offered bulk discounts
- Material usage variance:
- Higher or lower quality of the material was purchased (for instance, high-quality material would reduce the amount of direct material that needs to be used, creating a favourable variance)
- (Adverse) Any unexpected incidents such as theft or natural calamities that damaged your raw materials
- (Favourable) An efficient labour force that was able to produce using a smaller amount of materials per unit
- Labour rate variance:
- Higher or lower overtime being paid
- (Adverse) Providing bonuses to employees
- (Favourable) Employees not being proficient in their job
- Labour efficiency:
- High-skilled or low-skilled employees
- (Adverse) Lack of training provided to employees
- (Favourable) High-quality technology available to employees (this way, they can get the task done faster)
- Sales price variance:
- Increase or decrease in the level of competition in the market (higher competition would result in lower prices)
- Changes in the level of demand for the product (higher demand would lead to an increase in prices)
- Sales volume variance:
- Changes in the company’s market share (a lower market share would reduce sales volume)
- Changes in the demand for the company’s product
From the above, it is clear that causes of variance vary according to nature of activity in the particular department.