Variance Analysis in Budgeting (Example, Calculations)

What is Variance Analysis in Budgeting?

Variance analysis is budgeting is the study of deviation of the actual outcome against the forecasted behavior in finance. This is essentially concerned with how the difference between actual and planned behavior indicate and how business performance is being impacted.

Business can often improve their result 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 area 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 result in a direct Labour Variance efficiency.

Explanation of Variance analysis in Budgeting

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
Change in Overhead Cost

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 the beyond the control of 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 cost 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 category i.e Yield and Mix, Yield occurs due to use of inferior material or excess material whereas Mix is due to using of a combination of two material in a different proportion during a production process.

#2 – Labour Variance Analysis

Labour Variance occurs when the actual cost of labor differ from the projected labor Cost

If you paid too much that will 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 Analysis

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

Direct Labour Rate Variance Analysis

(Standard Rate- Actual Rate)*Actual Time

Direct Labour Efficiency Variance Analysis

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 labour.
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 Analysis

Reasons for Overheads Variance Analysis

Under or over absorption of fixed overheads.
Fall in demand/ improper planning.
Breakdowns /Power Failure.
Labour issues.
Inflation.
Lack of planning.
Lack of cost control

#4 – Sales Variances 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 Variance = Budgeted Price (Actual Quantity – Budgeted Quantity)

Reasons for Sales Variance

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

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

Variance Analysis

What is Variance Analysis in Budgeting?