What is Variance Analysis? 

In layman's terms, variance analysis is an analysis of a difference between planned and actual behavior. Variance analysis is mainly used by the companies to maintain a control over a business. After analyzing differences, companies find the reasons for the variance so that the necessary steps should be taken to correct that variance. 

For example – Suppose the company planned sales to be $40,000 but the actual sales take place in the company for $35,000. So, this $5000 difference is known as variance analysis yield. 

Types of Variances 

Before measuring the level of variances, it is necessary for the business to know about the types of variances. Classification of variances is done on the following basis: 

On the basis of element of cost: 

• Material cost variance – Material cost variance is the difference between the standard and planned cost of material. If the actual cost is more than the standard cost, then it’s called unfavorable variance whereas if the actual cost of material is less than standard cost then, it’s a favorable variance.The formula for calculating material cost variance is: 

MCV = Standard cost – actual cost

Or,

MCV = (SQ × SP) – (AQ × AP)

Whereas,

SQ = standard quantity

SP = standard price

AQ = actual quantity

AP = Actual price

• Labor cost variance – It is the difference between the actual direct wages paid and the planned direct labor cost for the actual output to be achieved. The formula for calculating labor cost variance : 

LCV = Standard cost – Actual cost

Whereas,

Standard cost = Actual output × standard rate

Actual cost = actual hours × Actual hourly rate

• Overhead variance – overhead variance is the difference between the planned cost of overhead (fixed and variable overhead) and the actual overhead cost incurred. The formula for calculating overhead variance: 

OC = standard cost – Actual cost

Standard cost = Actual output × standard rate

  On the basis of Controllability: 

• Controllable Variance - Controllable variance refers to that variance which could be influenced by the action of a department or by an individual.  For example, excessive usage of raw materials or if the workers take excess time to do the work etc. 
• Uncontrollable variance -  Uncontrollable variance is mainly due to the external factors which are beyond the control of the department hand. No particular group or a particular department will be held responsible for these variances. 

Examples of uncontrollable variances like because of government restrictions, due to the strike wages increases or may be due to the change in price in the market.  

On the basis of Impact: 

• Favorable Variance - Favorable variance refers to a situation when the actual cost incurred is less than the standard cost.  Favorable variance helps in determining the efficiency of the business operation. 
• Unfavorable variance - When the actual cost incurred is more than the planned actual cost, then it is known as an unfavorable variance. If the company is in the situation of an unfavorable variance, then it indicates that business operation is inefficient. 

On the basis of nature: 

• Basic Variances - Basic Variances arise due to the changes in the monetary rates like changes in the price of the raw materials or may be due to the change in the price of the labor rate. 

• Sub- Basic variances - The variance which arises due to the non- monetary factors is known as Sub-basic variances. 

Advantages of Variance Analysis 

The following are the advantages of variance analysis: 

• The variance analysis helps in analyzing variances which helps in taking appropriate action to correct those variances. 
• Variance analysis also helps in giving responsibility to a group or to a department, particularly for their variances. 
• Variance analysis helps in determining favorable and unfavorable variance which helps the management to consider the reason for unfavorable variances so that necessary steps should be taken to avoid that variance. 
• After the variance analysis, it helps the management in profit planning properly. 
• One of the important advantages of variance analysis is that it helps in cost reduction and cost control. 

Disadvantages of Variance Analysis 

Some disadvantages of variance analysis are as follows : 

• It may be possible that variances may be manipulated by the employees for their own benefits. Sometimes, it happens that management may take some inappropriate measures to get a favorable variance. For example, When a company needs higher units of product, the employees, just to make the material usage variance, they use low quality products at a cheaper rate. 
• The variance analysis is not suitable for the companies who follow the changing technology in their business very rapidly. 

Process of Variance Analysis 

Followings are the steps that are included in the process of variance Analysis: 

Step 1: Collect all data 

In the first step, the companies collect all the data of which the companies like to compare the results with. Companies must ensure that the data that they used for comparison must belong to the same business and similar time period. 

Step 2: Creation of variance report 

After the comparison of data, a variance report is created by the companies. The variance that is found while comparison is all noted in the report. 

Step 3: Evaluate the variance 

After knowing what the variance is, the company needs to evaluate the variance and find the reason for the variance so that the appropriate action should be taken to correct the variance or else to avoid any miserable condition that may happen in near future because of this variance. 

Step 4: Recommendation from senior management 

After the evaluation, there is a need to show the variance to the senior management and get recommendations about what to do whether to capitalize the favorable variance or to correct an unfavorable variance. 

Step 5: Plan for future 

Lastly, in the final step before implementation, make assumptions about the effect of these variances in the future so that you can be well prepared for the next variance analysis exercise. 

Context and Applications 

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for       

• B.Sc. 
• M.Sc.