Updated July 29, 2023
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. It provides the key to cost control which enables management to correct adverse tendencies and understand the areas of concern and improvement. In short, Variance Analysis involves the computation of Individual Variances and the determination of the causes of each such variance.
When the 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 the Actual Cost is less than the Standard Cost, Variance Analysis is said to be Favorable. It is a sign of improvement in efficiency, or it may be due to a substandard production 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 that not all variances reported through Variance Analysis are controllable. Some are Uncontrollable as well. An uncontrollable Variance is not amenable to control by individual or departmental action. It 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, is uncontrollable in nature.
Variance Analysis can be computed under each cost element for which standards have been established. 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 of each variance.
Examples of Variance Analysis
Example #1
The Standard Cost of Product AB manufactured by Ram International is furnished below:
| Material (5 units @ Rs 4 each) |
Rs 20 |
| Labor (20 hours @ Rs 1.50 per hour) |
Rs 30 |
| Overhead expense |
Rs 10 |
| Total Product Cost |
Rs 60 |
Actual Units produced were 8000 units, and Actual Cost is as follows:
| Material ( 40500 units @ Rs 5 each) |
Rs 202500 |
| Labor ( 150000 hours @ Rs 1.60 per hour) |
Rs 240000 |
|
Overhead expense |
Rs 90000 |
|
Total Cost |
Rs 532500 |
Based on the above illustration, let’s do the Variance Analysis for each component of the 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) |
| Total | 480000 | 532500 | 52500 (Adverse) |
Thus, by using Variance Analysis, Ram International can identify the cost components showing variation and take corrective actions accordingly.
Example #2
The Standard Material input required for 20000 kgs of a finished product is given below:
| Material | Quantity ( in Kg) | Standard Rate Per Kg | Total (Quantity * Std Rate) |
| A | 9000 | 20 | 180000 |
| B | 8000 | 40 | 320000 |
| C | 5000 | 60 | 300000 |
| Total | 22000 | 120 | 800000 |
And now, we have to calculate the standard output. We have a standard loss of 2000 kg
| Standard Loss | 2000 |
| Standard Output | 20000 |
Minus standard loss from Total Quality kg, 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) |
| A | 10000 | 19 | 190000 |
| B | 8500 | 42 | 357000 |
| C | 4500 | 65 | 292500 |
| Total | 23000 | 126 | 839000 |
And now, we have to calculate the Actual Cost. We have an actual loss of 3000 kg.
| Actual Loss | 3000 |
| Actual Output | 20000 |
Minus standard loss from Total Quality kg, 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 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 identify the reasons for higher costs and deviations from standard costs. It helps management analyze whether the higher cost is justified or requires punitive actions to correct it.
- Variances arising out of each factor should be correctly segregated. If a part of the 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 by changes in the market price of the material used in the manufacturing etc.
- It is suitable for finding Material Usage Variances, which can be caused by spoilage in the usage of materials, inefficiency in production, etc.
- It is useful in finding Labor Variance, subdivided into Labor Efficiency Variance and Labor Rate Variance. By doing such Labor Variance Analysis, reasons for variation can be unearthed.
Conclusion
Variance Analysis is an important measure in Cost Accounting. It involves an examination of variances in detail and evaluating them, which can be either based on cost or Sales and forms an integral part of the Standard Costing System. It is an important tool by which business managers ensure adequate control and undertake corrective action whenever needed (mostly in the case of Adverse Variation). However, it should be used on major cost and revenue items to safeguard the time and cost of analyzing the management.
Recommended Articles
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 –
