Variance Analysis

What is the Variance Analysis?

Variance analysis refers to identifying and examining the difference between the standard numbers expected by the business to achieve and the actual numbers achieved by them, which helps the company analyze favourable or unfavourable outcomes.

In simple words, variance analysis is the study of the deviation of the actual outcome against the forecasted behavior in finance. This is essentially concerned with how the difference between actual and planned behavior indicates and how business performance is being impacted.

Businesses can often improve their results if they will first plan their standards for their performance, but sometimes, their actual result doesn’t match their expected standard results. When the actual result comes in, Management can focus on variances from the standards to find areas needing improvement.

For Example, let’s assume that Taj Hotel pays housekeeping crew $5 per hour. Did the Housekeeping crew take longer to clean the room then that management planned? This results in a direct Labour Variance efficiency.

Understanding Variance Analysis

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For eg:
Source: Variance Analysis (wallstreetmojo.com)

Suppose a company set a target to make a profit of an amount of $100 million by selling good worth $200 million and the total production cost is $100 million.

But at the end of the year, the company observed that the profit is $50 million instead of $100 million, which is not a good fit for an organization, so the company has to think about the reason for not achieving the target set by the company. There are certain factors that affect the profit of the company by analyzing the facts they came to know that the production cost changes from $100 million to $120 million. Production cost changes due to the following factors

Change in Material cost.
Change in Labour Cost
And, Change in Overhead CostOverhead Cost Overhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more

So the difference from the Actual output to the Standard output is called as variance

Types of Variance

Controllable variance can be controlled by taking necessary action.
Uncontrollable Variance (UV) is beyond the control of the Departmental head.
If UV is standard in nature and persistent, the standard may require revision
It is very important to know the cause of variance analysis so that one can approach for corrective measure

Top 4 Types of Variance analysis in Budgeting

Given below are the Top 4 types of Variance Analysis

#1 – Material Variance Analysis

If you pay too much then the purchasing cost increases
If you use too many materials then the production cost increase

Both purchasing and production costs are dependent on each other, so we have to look into not only the purchasing cost but also the Production Cost to know the total variance as well.

Example of Material Variance Analysis

Given below is the example of material variance

Cost Variance

A: (Standard Quantity: 800 Kg)* (Standard Price: Rs.6/-) – (Actual Quantity: 750kg)*(Actual Price: Rs.7/-)

B: (Standard Quantity: 400 Kg)* (Standard Price: Rs.4/-)– (Actual Quantity: 750kg)*(Actual Price: Rs.5/-)

The Impact of the variance of Cost of Material is due to Price and Quantity.

Impact of Price on Material Variance Analysis

The Variation of Price for Type A is (Rs.7/- minus Rs.6/-) for 750 Kg

Impact of Price on Material A : ( Rs.1/-)*(750Kg) = Rs.750 (A)

The Variation of Price for Type B is (Rs.5/- minus Rs.4/-) for 750 Kg

Impact of Price on Material B : ( Rs.1/-)*(500Kg) = Rs.500(A)

Total impact of Price = Rs.750 (A) + Rs.500 (A)= Rs.1250 (A)

*F stands for Favourable
*A stands for Adverse.

Impact of Quantity on Material Variance analysis

Variation of Quantity Used in Type A material is (800 Kg- 750Kg)*6

Price due to change in Quantity or Type A is: 300(F)

Variation of Quantity Used in Type B material is (400 Kg- 500Kg)*4

Price due to change in Quantity or Type A is: 400(A)

Impact of Quantity on Cost Variance is 300(F)-400(A) = 100(A)

Quantity further can be analyzed into two categories i.e., Yield and Mix. Yield occurs due to the use of inferior material or excess material. In comparison, Mix is due to using a combination of two materials in a different proportion during the production process.

#2 – Labour Variance Analysis

Labour Variance occurs when the actual cost of laborCost Of Labor Cost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more differs from the projected labor Cost

If you paid too much, that would be personal
If you use too many hours which is called efficiency of the Labour that will affects the production

Example of Labour Variance Analysis

Standard (4 pieces production for 1 Hour)

Skilled: 2workers@20/
Semiskilled: 4 workers@ 12/-
Unskilled: 4 Workers@ 8/-

Actual Output

Skilled: 2workers@20/
Semiskilled: 3 workers@ 14/-
Unskilled: 5 Workers@ 10/-
200 Hours Work
12 Hours Idle time
810 Pieces Production

Actual Time for Skilled Worker: 200*2(No .of Employee) = 400 Hours
Actual Time Work for Skilled Worker: (200 Hrs- 12(Idle Time)*2(No of Employee) = 376 Hours

Standard Time for Skilled Worker

To produce 4 Pieces (Standard time) a skilled worker needed 2 Hours so to produce 810 pieces standard time required
4/2 *(810)= 405 Hours

Direct Labour Cost Variance

(Standard time* Standard Rate)- (Actual Time*Actual Rate)

Direct Labour Rate Variance Analysis

(Standard Rate- Actual Rate)*Actual Time

Direct Labour Efficiency Variance

Standard Rate*(Standard Time – Actual Time)

Reasons for Labour Variance

Time-Related Issues.
Change in design and quality standard.
Low Motivation.
Poor working conditions.
Improper scheduling/placement of labor;
Inadequate Training.
Rate Related Issues.
Increments / high labor wages.
Overtime.
Labour shortage leading to higher rates.
Union agreement.

#3 – Variable Overheads (OH) Variance Analysis

Variable overheads include costs such as

Patents that have to be paid on units produced
Power Cost per unit produced

The total overhead variance is the difference between

The actual Variable Overhead incurred for the actual output of the business
The standard variable overhead we should have incurred for the actual output
Variable OH Variance=(SH*SR)-(AH*AR)

Example of Variable Overheads Variance

Reasons for Overheads Variance

Under or over absorption of fixed overheads;
Fall in demand/ improper planning.
Breakdowns /Power Failure.
Labour issues.
Inflation.
Lack of planning.
Lack of cost controlCost Control Cost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies.read more

#4 – Sales Variance Analysis

Sales Value Variance = Budgeted Sales – Actual Sales

Further Sales Variance is due to either change in sales price or Change in Sales Volume

Sales Price Variance = Actual Quantity (Actual Price – Budgeted Price)
Sales Volume VarianceVolume Variance Volume Variance is an assessment tool that checks if there is a difference in actual quantity consumed or sold and its budgeted quantities. It is usually expressed in monetary terms by multiplying the difference between the two with the standard price per unit.read more = Budgeted Price (Actual Quantity – Budgeted Quantity)

Reasons for Sales Variance

Change in Price.
Change in Market Size.
Inflation
Change in Market Share
Change in Customer Behaviour

Thus Variance analysis helps to minimize the Risk by comparing the actual performance to Standards.

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Variance Analysis