What Is a Variance in Accounting?
Accounting variance is the difference between planned and actual financial results. Variance analysis includes understanding the reasons for this difference and implementing measures to bring actual and planned results closer together. Management uses variance data to assess changes in performance compared to prior periods and for decision-making purposes.
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Facts
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Companies use variance analysis in standard costing and budgeting processes. Standard costing involves estimating labor, raw materials and overhead costs for production activities under normal operating conditions. The variance is the difference between the standard or estimated costs and the actual costs, which companies charge to cost of goods sold. Companies prepare operating budgets to project sales, plan marketing and other expenses and estimate monthly and annual cash flows. The difference between budgeted and actual results is the budget variance.
Types
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The different variance types include cost, overhead, selling price and selling volume. Cost variance is the difference between the estimated costs of raw materials and the actual prices paid. In a normal inflationary environment, a company might pay more for supplies and labor than the budget. During a recession, when supply outpaces demand, actual expenses might be less than planned expenses. Overhead variance includes fixed and variable overhead variance. Variable overhead variance is the per-unit difference in actual and standard overhead costs, while fixed overhead variance applies to a period. Selling price and volume variances refer to the differences between budgeted and actual average selling prices and volumes, respectively.
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Calculation
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Variance calculations usually involve a dollar amount, a quantity or both. For example, a company may incur higher labor costs because of higher labor rates or because it needs more hours to complete a job. Similarly, a company may generate higher sales because of higher average selling prices, higher volumes at the budgeted selling price or a combination. For example, if the budgeted labor rate is $10 an hour and labor shortages increase that rate to $12 an hour, there is a negative variance of $2 an hour in labor rates. If a company estimates sales of one million units but sells 1.2 million units, the positive sales variance is 200,000 units.
Issues
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The problems with variance analysis include time lag, inadequate record-keeping and changing business conditions. Management may not receive the variance information in time to take corrective action. Although sophisticated enterprise resource planning software makes variance and other operational data more readily available, a small business might not have the financial flexibility to implement these tools, which might make it difficult to evaluate the reasons for different variances. Companies may not be able to adjust their estimates and forecasts to rapidly changing business conditions, which might skew the variance data.
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