**Variance Analysis** analyses the difference between planned numbers and actual numbers. The summation of all variances gives a picture of the overall over-performance or under-performance within a certain reporting period. To assess over-performance or under-performance, companies assess their favorability by comparing actual costs to standard costs in the industry.

Generally, companies should perform variance analysis annually to compare their estimated costs of a rate proposal to the actual costs for the given period. Variance analysis helps companies and centers determine their variance between cost estimates and actuals annually.

## Role of Variance Analysis

As seen above, variance analysis helps companies maintain control over their expenses by monitoring planned costs versus actual costs. Effective variance analysis can help a companyâ€™s management spot trends, issues, opportunities, and threats to short-term or long-term success.

In most cases, variances are computed for both the price and quantity of materials, labor, and variable overhead and are reported to the management. Nonetheless, not all variances are important. Thus, a companyâ€™s management should only focus on variances that are unusual or those that are particularly significant. When companies analyze these significant or unusual variances, they can use the information obtained to identify a problem and rectify it if possible, thus improving general company performance.

## Types of Variance

Variance can be categorized according to their effect or nature of the underlying amounts. Where *effect of variance* is concerned, there are two types of variances.

These are named:

**Favorable variance**: – this is where the actual results are better than the expected or planned results. Favorable is usually denoted by the letter F in parentheses**(F).**

**Adverse Variance/Unfavorable Variance**: – this is where the actual results are worse than the expected results. often, the adverse or unfavorable variance is denoted by the letter A or U in parentheses-**(A)**or**(U)**

The second category of variance (according to the *nature of the underlying amount*) is determined by the usersâ€™ needs of the variance information.

These include:

**Variable cost variances**which include direct material variances, direct labor variances, and variable production overhead variances

**Fixed Production Overhead**variances which include volume variance and budget variance

**Sales Variance**where total costs are different from expected

In standard costing and budget control, variance analyses are usually performed when the cost or income variance is divided into sub-variances to establish why there is a difference between the expected costs and the actual results. There are many various types of important sub-variances which include:

### Fixed overhead total variance

The total overhead variance is the difference between the amount that would be absorbed into the total cost of the actual units produced and the actual cost of the fixed overheads. When overheads have been over-absorbed, there is a favorable variance. However, when overheads have been under-absorbed, there is an adverse variance.

*Equation*:

*Fixed overhead total variance= Actual fixed overheads x Absorbed fixed overheads*

* = Actual fixed overheads x actual output x fixed overhead absorption rate*

### Overhead efficiency variance

This is obtained by subtracting the budgeted units of activity on which the overhead variable is charged from the actual units of activity; then, the outcome is multiplied by the standard variable overhead cost per unit.

*Equation*:

*Overhead efficiency variance= ( Standard production hours â€“ actual hours taken) x Standard overhead absorption rate per hour.*

### Direct materials total cost variance

Direct materials total cost variance refers to the difference between the standard cost of direct materials itemized for production and the actual cost of direct materials used in production. This variance gives the management an idea of how much more or less cost has been incurred compared to the standard cost.

*Equation*:

*Direct materials total cost variance= (standard price per unit of material x actual units of materials used) â€“ actual cost of materials*

### Direct materials price variance

This refers to the difference between the actual amount spent on direct material purchases in a given period and the amount total amount that would have been spent if the materials were acquired at the standard price. Direct materials variance is also known as direct materials spending or rate variance.

*Equation*:

*Direct materials price variance= (Actual quantity x actual price) â€“ (actual quantity of materials produced x the standard price)*

### Direct labor efficiency variance

Direct labor efficiency variance is obtained from the difference between the standard quantity of labor consumed and the actual labor consumed. The result is then multiplied by the standard labor rate per hour.

*Equation*:

*Direct labor efficiency variance= (standard production hours â€“ actual hours taken to produce goods) x standard rate per direct labor hour.*

### Direct labor total cost variance

When a company produces a product and compares the actual labor cost to the standard labor cost, the outcome is direct labor total cost variance. If the obtained variance is unfavorable, it means that the actual costs related to labor were more than the standard costs.

*Equation*:

*Direct labor total cost variance= (actual hours worked x Actual rate) â€“(standard hours x standard rate)* or *(Direct labor rate variance + direct labor time variance)*

### Sales margin price variance

Sales margin price variance can be defined as the difference between the standard margin appropriate to the number of sales planned for a given period and the margin between the usual/standard cost and the actual selling price of the sales effected.

*Equation*:

*Sales margin price variance= Actual quantity of sales( actual selling price per unit- standard selling price per unit)*

### Sales margin volume variance

In standard costing, sales margin volume variance is obtained as a result of the difference between the budgeted and actual quantities of a unit product of which the sales mixture is composed, valuing sales at the standard net selling price and cost of each unit of sale at the standard price.

*Equation*:

*Sales margin volume variance= (Units sold- expected units sold)x price per unit*

### Variable overhead total variance

This is the difference between the actual costs for variable overheads and the expected costs based on the standards. The variable overhead total variance is sometimes known as the spending variance.

*Equation*:

*Variable overhead spending variance = Actual costs âˆ’ (Actual Hours Ã— Standard Rate)*

## The Column Method for Variance Analysis

When analyzing variance, the easiest method to follow is the column method, including all the necessary information.

For assistance and easy understanding, refer to the * example *provided below:

ABC limited produces Fridge guards. Overhead is applied to products depending on direct labor hours. The minimum level of activity is 4030 hours. The companyâ€™s standard cost card is as shown below

Materials: 8 pieces per fridge guard @ $7 per piece

Labor: 1.3 hours per fridge guard @ $8 an hour

Variable manufacturing overhead: 1.3 hours per guard @ $4 per hour

Fixed Manufacturing overhead: 1.3 hours per guard @ $6 per hour

In the month of January 2021, ABC limited produced 3000 pieces of fridge guards. The fixed overhead budget was estimated at $24,180. The actuals were as indicated below:

Direct materials: 28,000 pieces purchase at the cost of $6 per piece

Direct Labor: 4000 hours worked at the cost of $36000

Variable manufacturing overhead: the actual cost was $17000

Fixed Manufacturing overhead: the actual cost was $25,000

### Solution:

**Variance analysis for direct materials**

Actual Quantity (AQ)* Actual Price (AP)

28000 pieces* $6 per piece = $168000

Actual quantity*Standard price (SP)

28000 pieces * $7 per piece = $196000

Price variance= $196,000 – $168,000 which is equal to $28,000

This is a favorable variance.

Standard Quantity (SQ)*Standard price (SP)

24,000 pieces * $7 per piece = 168,000

Quantity Variance = $168000-168000 which equals to 0

No variance exists.

Adding price variance to quantity variance, we find a variance totaling to $28,000.

**Labor Variance**

Actual Hours (AH) * Actual Rate (AR)

4000 * $8 per hour= $ 36000

Actual hours x standard rate

4000 hours * $8 per hour = $32000

Standard hours x standard rate

3900 hours * $8 per hour = $31200

Rate Variance= $36000-32000= $4,000. This is an Adverse Variance

Efficiency Variance= $32000-31,200= $800. This is also an Adverse/Unfavorable variance

$4000+ $800= $4800 (unfavorable)

The management should look at this variance because it is significant. They should address why the actual labor cost is higher than the standard labor price and explain why more hours are needed for the production of fridge guards. The column method can also be applied to find variable overhead costs. The format used is similar to the labor format as the variable overhead is applied based on labor hours, as shown in the example.

**Fixed overhead variance analysis**

Actual Fixed Overhead Cost = $25,000

Minimum level of activity*Standard rate

4030hours* $6 an hour= $24,180

Standard hours *standard rate

3900 total hours worked * $6 an hour = $23,400

Therefore,

Budget Variance will be calculated as:

$25000- $24180 = $820 (Adverse Variance)

**To find Volume Variance**

Subtract $24,180 from $23,400 which equals to $780. This is an Unfavorable Variance

The sum of budget variance and volume variance equals a total variance of $1,600. This is a salient variance that the management may want to consider.

## Free Templates

Here are free and customized templates:

## The Role of Standards in Variance Analysis

In Cost and Management Accounting, a standard is defined as a benchmark for measuring performance. Typically, organizations set standards for both the cost and quantity of labor, materials, and overhead needed to provide services or produce goods.

Quantity standards usually indicate how much labor (in hours) or materials (in kgs) should be utilized to manufacture a unit product. On the other hand, cost standards indicate what the actual cost of the labor hour or materials should be. Therefore, in simpler terms, standards refer to the estimated prices or quantities that a company will incur in the production of goods or provision of services.

## Preparing the Variance Analysis Report

Generally, variance reports should be due within six weeks of the permitted rate cycle end date. This is true for most companies that perform variance analyses. To develop an effective variance analysis report that the management can use to identify trends, issues, opportunities, and threats to long-term and short-term success, one is advised to consider including these *critical elements* in the analysis report:

They include:

### Rate cycle dates

This is the date on which the variance analysis report is based. It should be within the approved rate cycle dates.

### Proposal estimates

In this section, write the estimated cost amounts from the proposal. It is essential to note that the estimated revenue is not required here.

### Actual costs and revenues

Include the actual costs or revenues for the period being reported. Once you have included the actual costs and revenues and the proposed estimates, the variance dollar figure and percentage will auto calculate.

Supposing the result is a variance dollar figure that is equal to or greater than $5,000 AND or equal to or greater than 10%, in that case, an explanation must be provided. It is worth noting that the variance needs to meet both these criteria before an explanation is needed.

### Variance explanations

Variance explanations should be provided concisely while ensuring that the actual variance is addressed.

When a company adjusts its rates mid-year, it can still use the initially approved rate proposal for variance analysis reporting purposes. However, if a material variance occurs due to the mid-year rate adjustment, this should be indicated on the final report.

## Frequently Asked Questions (FAQs)

### What is the Variance Analysis Report in Real Estate?

Variance analysis in real estate or property management is the periodic review of actual business results versus the managementâ€™s approved budget. The analysis report should indicate the degree of discrepancy between approved budgets and actual results within the reporting period and provide an explanation for the discrepancies.

### How do you interpret a Variance analysis?

Variance analysis refers to the quantitative examination of the difference between actual costs and planned costs. Variance analysis can be interpreted using a trendline, which enables a company to detect changes in the variance level, which are more apparent, from time to time. Besides, variance analysis can be interpreted using the difference between the actual and planned behavior, such that the result is a statement of the discrepancies and an interpretation of why the discrepancies occurred. If the actual results are better than the expected results, there is a favorable variance. If the actual results are worse than the estimated results, there is an Unfavorable/ Adverse variance.

### How do you write a variance analysis report?

When writing a variance analysis report, one needs to provide a detailed description of the technical events that led to the reported variance. To achieve this, one must provide separate analysis for cost and schedule variances; identify if the variance is usage (that is, more hours required than performed) or rate (i.e., due to rate changes or more/less expensive resources used); and finally, emphasize more on those variances that are unusual or significant.

### Why do we calculate variance?

Calculating variance is important as it helps companies compare each assetâ€™s relative performance in a portfolio to achieve the best resource allocation. Investors may also use variance analysis to determine the level of risk associated with certain investments or if they will be profitable.

### What is the purpose of variance analysis?

Variance analysis is used to measure the price and quantity of materials, labor, and overhead costs. The figures obtained are reported to the management, which becomes a signaling mechanism, especially when the reported variance is salient.