What is Variance Analysis?
Variance Analysis is defined as an analysis of the performance of a business or process by means of variances which involves the process of computing the amount and isolating the cause of variances between actual cost and standard cost. Variance Analysis helps in analyzing the difference between Actual Cost and Standard Cost and provides the key to cost control which enables management to correct adverse tendencies as well as understand the areas of concern and improvement. In short Variance Analysis involves the computation of Individual Variances and determination of causes of each such variance.
When Actual Cost is higher than the Standard Cost, Variance Analysis is said to be Unfavorable or Adverse which is a sign of inefficiency and thereby reduces the profit of the business. Similarly, when Actual Cost is less than the Standard Cost, Variance Analysis is said to be Favorable and is a sign of improvement in efficiency or it may be due to the production substandard product or an incorrect standard.
Accordingly, Variance Analysis helps the management of the business to:
- Understand the amount of variance
- Its occurrence and factors responsible for it
- Take appropriate action to obviate or reduce such a variance
However it is pertinent to note here that not all variances which are reported through Variance Analysis are controllable, some are Uncontrollable as well. An uncontrollable Variance is one that is not amenable to control by individual or departmental action and is caused by external factors such as a change in market conditions, fluctuations in demand and supply, etc over which the business doesn’t have any control and as such are uncontrollable in nature.
Variance Analysis can be computed under each element of cost for which standards have been established and each such variance can be analyzed to ascertain the causes and necessary action can be undertaken. For instance, Material Price Variance will help the business to understand the variance caused due to a change in the price of the material. Furthermore, by analyzing the total variances component-wise, a business can determine and isolate the causes giving rise to each variance.
Examples of Variance Analysis
Let’s understand the Variance Analysis with the help of few examples:
Standard Cost of Product AB manufactured by Ram International is furnished below:
|Material (5 units @ Rs 4 each)||
|Labor (20 hours @ Rs 1.50 per hour)||
|Total Product Cost||
Actual Units produced were 8000 units and Actual Cost is as follows:
|Material ( 40500 units @ Rs 5 each)||
|Labor ( 150000 hours @ Rs 1.60 per hour)||
Based on the above illustration let’s do the Variance Analysis for each component of Cost
|Particulars||Standard Cost ( in Rs)||Actual Cost ( in Rs)||Variance ( in Rs)|
|Material||160000 (8000* 20)||202500||42500 (Adverse)|
|Lab0r||240000 ( 8000* 30)||240000||—|
|Overhead Expenses||80000 (8000*10)||90000||10000 (Adverse)|
Thus by using Variance Analysis Ram International can identify the cost components which are showing variation and accordingly can take corrective actions.
The Standard Material input required for 20000 kgs of a finished product are given below:
|Material||Quantity ( in Kg)||Standard Rate Per Kg||Total (Quantity * Std Rate)|
And now we have to calculate the standard output we have a standard loss of 2000 kg
Minus standard loss from Total Quality kg to we get the standard output
Actual production in the period was 20000 kg. Details of Actual quantities of material used and the prices paid are as under:
|Material||Quantity ( in Kg)||Purchase Price per Kg||Total (Quantity * Std Rate)|
And now we have to calculate the Actual Cost we have an Actual loss of 3000 kg.
Minus standard loss from Total Quality kg to we get actual output.
Based on the above illustration let’s compute Material Cost Variance and Material Price Variance:
- Material Cost Variance = Standard Cost – Actual Cost
- Material Cost Variance = Rs (800000 – 839000)
- Material Cost Variance = Rs 390000 (Adverse)
Now, we will find the Material Price Variance by using the Material Price Variance.
- Material Price Variance= Actual Quantity ( Standard Price- Actual Price)
- Material A = 10000 (Rs 20- Rs 19)
- Material A = Rs 10000 (Favorable)
- Material B = 8500 (Rs 40- Rs 42)
- Material B = Rs 17000 (Adverse)
- Material C = 4500 (Rs 60- Rs 65)
- Material C = Rs 22500 (Adverse)
Things to Remember About Variance Analysis
- Variance Analysis helps in identifying the reasons for higher cost and deviations from standard cost and helps management to analyze whether the higher cost is well justified or requires punitive actions for correcting the same.
- Variances arising out of each factor should be correctly segregated. If a part of variance due to one factor is wrongly attributed to or merged with that of another, the analysis report submitted to the Management can result in misleading and incorrect inferences.
- There should be promptness in reporting Controllable Variances to the Management so that corrective actions can be undertaken timely.
Major Areas of Variance Analysis
Variance Analysis finds its utility in the below-mentioned cost areas of business:
- Variance Analysis is suitable for finding Material Price Variances which can be caused as a result of changes in the market price of the material used in the manufacturing etc.
- Variance Analysis is suitable for finding Material Usage Variances which can be caused as a result of spoilage in the usage of materials, inefficiency in production, etc.
- Variance Analysis is useful in finding Labor Variance which is further subdivided into Labor Efficiency Variance and Labor Rate Variance. By doing such Labor Variance Analysis reasons for variation can be unearthed.
Variance Analysis is an important measure in Cost Accounting and involves an examination of variances in detail and evaluation of them which can be either based on cost or based on Sales and forms an integral part of the Standard Costing System. It serves as an important tool by which business managers ensure adequate control and undertake corrective action whenever the need arises (mostly in the case of Adverse Variation). However, it should be used on major cost and revenue items to safeguard the time and cost involved in doing such an analysis of the management.
This has been a guide to Variance Analysis. Here we look at the calculation and examples of variance analysis including Material Price Variances and Material Cost Variances. You may also take a look at the following articles to learn more –
- Contribution Margin vs Gross Margin
- Direct cost and Indirect Cost
- Costs vs Expenses
- Variance vs Covariance