International Institute of Hotel Management

Topic = Variance analysis

Name = Shivanshu Maurya

Year = 3rd
Roll no = IIHM20DL113

Submitted to Sachin Singhwal.

 Bibliography
https://www.accountingtools.com/
https://www.wikipedia.org/
https://www.investopedia.com/
https://in.indeed.com/m/
https://www.financestrategists.com/financial-
advisor/financial-plan/financial-strategy/
https://www.accountingnotes.net/cost-
accounting/cost-variances/sales-variance/17796
https://www.linkedin.com
What is Variance Analysis?
Variance analysis is the quantitative investigation of the difference between
actual and planned behaviour. This analysis is used to maintain control over a
business through the investigation of areas in which performance was
unexpectedly poor. For example, if you budget for sales to be $10,000 and actual
sales are $8,000, variance analysis yields a difference of $2,000. Variance analysis
is especially effective when you review the amount of a variance on a trend line,
so that sudden changes in the variance level from month to month are more
readily apparent. Variance analysis also involves the investigation of these
differences, so that the outcome is a statement of the difference from
expectations, and an interpretation of why the variance occurred. To continue
with the example, a complete analysis of the sales variance would be:
Sales during the month were $2,000 lower than the budget of $10,000. This
variance was primarily caused by the loss of ABC customer at the end of the
preceding month, which usually buys $1,800 per month from the company. We
lost ABC customer because we had several instances of late deliveries to it over
the past few months.
This level of detailed variance analysis allows management to understand why
fluctuations occur in its business, and what it can do to change the situation.

Problems with Variance Analysis

There are several problems with variance analysis that keep many companies
from using it. They are as follows:
Time delay. The accounting staff compiles the variances at the end of the month
before issuing the results to the management team. In a fast-paced environment,
management needs feedback much faster than once a month, and so tends to
rely upon other measurements or warning flags that are generated on the spot
(especially in the production area).
Variance source information. Many of the reasons for variances are not located
in the accounting records, so the accounting staff has to sort through such
information as bills of material, labour routings, and overtime records to
determine the causes of problems. The extra work is only cost-effective when
management can actively correct problems based on this information.
Standard setting. Variance analysis is essentially a comparison of actual results to
an arbitrary standard that may have been derived from political bargaining.
Consequently, the resulting variance may not yield any useful information.

Types of Variances
There is a need of knowing types of variances before measuring the variances.
Generally, the variances are classified on the following basis.

On the basis of Controllability

1. Controllable Variance.
2. Uncontrollable Variance.

On the basis of Impact

1. Favourable Variance.
2. Unfavourable Variance

On the basis of Nature

1. Basic Variance.
2. Sub-variance.

Controllable Variance
A variance is controllable whenever an individual or a department or section or
division may be held responsible for that variance.
Uncontrollable Variance
External factors are responsible for uncontrollable variances. The management
has no power or is unable to control the external factors. Variances for which a
particular person or a specific department or section or division cannot be held
responsible are known as uncontrollable variances.

Favourable Variances
Whenever the actual costs are lower than the standard costs at per-determined
level of activity, such variances termed as favourable variances. The management
is concentrating to get actual results at costs lower than the standard costs. It
shows the efficiency of business operation.

Unfavourable Variances
Whenever the actual costs are more than the standard costs at predetermined
level of activity, such variances termed as unfavourable variances. These
variances indicate the inefficiency of business operation and need deeper analysis
of these variances.

Basic Variances
Basic variances are those variances which arise on account of monetary rates (i.e.
price of raw materials or labour rate) and also on account of non-monetary
factors (such as physical units in quantity or time). Basic variances due to
monetary factors are material price variance, labour rate variance and
expenditure variance. Similarly, basic variance due to non-monetary factors are
material quantity variance, labour efficiency variance and volume variance.

Sub Variance
Basic variances arising due to non-monetary factors are further analysed and
classified into sub-variances taking into account the factors responsible for them.
Such sub variances are material usage variance and material mix variance of
material quantity variance.
What is a Standard Cost?
Standard cost is an estimated cost determined by the company for the production
of the goods and services or operating under normal circumstances and is derived
by the company from the historical analysis of the data or from the time and the
motion studies. Such costs pre-determined by the company are used as the target
costs
By the company for comparing it with actual costs, and the difference will be the
variance.

The variance derived is then used by the company’s management for knowing
and correcting the cause, making a further estimation for the coming years, and
decision making related to business. It almost always varies from the actual costs
because the situation keeps changing, involving different unpredictable factors.
Therefore, it is also known as the normal cost.

In manufacturing setup, there are three main components which include the
following:
Direct Materials – It is derived by multiplying the quantity of each material with
the per-unit material cost.
Direct Labour – It is derived by multiplying the quantity of each labour with the
per hour labour cost.
Direct Materials fixed overhead cost and variable overhead, calculated by
multiplying standard quantity with the standard rate of variable overhead.

What is cost variance?

Cost variance is the difference between the planned cost of a project and its
actual cost after accounting for any extra expenses or unexpected savings. The
formula for calculating cost variance is:
Projected cost – actual cost = cost variance
A positive cost variance indicates that a project is coming in under budget, while a
negative cost variance means that the project is over budget. If the cost variance
is zero, it means that the actual cost of the project is equal to the expected cost of
the project.

What is the importance of cost variance?

Cost variance is important because it allows you to track the financial progression
of your project. It is an indicator of how well you monitor and mitigate potential
risks and how well you analyze data related to the project. You can also evaluate
your cost variance to make comparisons between the budget and actual cost
throughout a project your team completes, giving you the opportunity to make
improvements to your budget approaches that align with your goals. Another
helpful aspect is that you can use historical data from similar projects to create a
more accurate projection for the budget.

What is a Material Variance?

Material variance has two definitions, one relating to direct materials and the
other to the size of a variance. They are noted below.
Material Variance Related to Materials
This is the difference between the actual cost incurred for direct materials and the
expected (or standard) cost of those materials. It is useful for determining the
ability of a business to incur materials costs close to the levels at which it had
planned to incur them. However, the expected (or standard) cost of materials can
be a negotiated figure or only based on a certain purchase volume, which renders
this variance less usable. The variance can be further subdivided into the
purchase price variance and the material yield variance.
Purchase price variance. This is concerned solely with the price at which direct
materials were acquired. The calculation is: (Actual price – Standard price) x
Actual quantity
Material yield variance. This is concerned solely with the number of units of the
materials used in the production process. The calculation is: (Actual unit usage –
Standard unit usage) x Standard cost per unit

What is a Labour Rate Variance?

The labour rate variance measures the difference between the actual and
expected cost of labour. It is calculated as the difference between the actual
labour rate paid and the standard rate, multiplied by the number of actual hours
worked. The formula is:
(Actual rate – Standard rate) x Actual hours worked = Labour rate variance
An unfavourable variance means that the cost of labour was more expensive than
anticipated, while a favourable variance indicates that the cost of labour was less
expensive than planned. This information can be used for planning purposes in
the development of budgets for future periods, as well as a feedback loop back to
those employees responsible for the direct labour component of a business. For
example, the variance can be used to evaluate the performance of a company’s
bargaining staff in setting hourly rates with the company union for the next
contract period.

How Standard Labour Rates are Created

The standard labour rate is developed by the human resources and industrial
engineering employees, and is based on such factors as:

 The expected mix of pay levels among the production staff

 The amount of overtime likely to be incurred
 The amount of new hiring at different pay rates
 The number of employees retiring
 The number of promotions into higher pay levels
  The outcome of contract negotiations with any unions representing the
production staff.

Overhead Variance
The difference between actual and applied overhead is referred to as overhead
variance. The overhead variance is the difference between the standard overhead
costs allowed for the actual output achieved and the actual overhead costs
incurred. In budgeting or management accounting, variance analysis is the study
of deviations between actual and forecasted or planned behaviour. Overhead
variance can only be calculated after you have determined the actual overhead
costs for the period. This is primarily concerned with how the difference between
actual and planned behaviours affects business performance.

Overhead is calculated using a fixed rate and a cost driver. This is essentially a
method of estimating overhead costs prior to incurring them. At the end of the
fiscal period, the actual overhead costs can be compared to the predetermined
estimates. The overhead variance is the difference between the actual overhead
costs and the applied overhead costs. It is defined as the sum of indirect material,
labour, and expense costs. Overhead variances may occur as a result of a
discrepancy between the standard overhead costs budgeted and the actual
overheads incurred.

KEY TAKEAWAYS
 Variable Overhead Spending Variance is the difference between what the
variable production overheads actually cost and what they should have cost
given the level of activity during a period.
 The standard variable overhead rate is typically expressed in terms of
machine hours or labour hours.
 Variable overhead spending variance is favourable if the actual costs of
indirect materials are lower than the standard or budgeted variable
overheads.
  Variable overhead spending variance is unfavourable if the actual costs are
higher than the budgeted costs.

What is the Fixed Overhead Volume Variance?

The fixed overhead volume variance is the difference between the amount of
fixed overhead actually applied to produced goods based on production volume,
and the amount that was budgeted to be applied to produced goods. This
variance is reviewed as part of the period-end cost accounting reporting package.
The fixed overhead costs that are a part of this variance are usually comprised of
only those fixed costs incurred in the production process. Examples of fixed
overhead costs are factory rent, equipment depreciation, the salaries of
production supervisors and support staff, the insurance on production facilities,
and utilities.
Being fixed within a certain range of activity, fixed overhead costs are relatively
easy to predict. Because of the simplicity of prediction, some companies create a
fixed overhead allocation rate that they continue to use throughout the year. This
allocation rate is the expected monthly amount of fixed overhead costs, divided
by the number of units produced (or some similar measure of activity level).
Conversely, if a company is experiencing rapid changes in its production systems,
as may be caused by the introduction of automation, cellular manufacturing, just-
in-time production, and so forth, it may need to revise the fixed overhead
allocation rate much more frequently, perhaps on a monthly basis.
Example of the Fixed Overhead Volume Variance
A company budgets for the allocation of $25,000 of fixed overhead costs to
produced goods at the rate of $50 per unit produced, with the expectation that
500 units will be produced. However, the actual number of units produced is
600, so a total of $30,000 of fixed overhead costs are allocated. This creates a
fixed overhead volume variance of $5,000.
What Is Sales Price Variance?
Sales price variance is the difference between the price at which a business
expects to sell its products or services and what it actually sells them for. Sales
price variances are said to be either “favourable,” or sold for a higher-than-
targeted price, or “unfavourable” when they sell for less than the targeted or
standard price.

KEY TAKEAWAYS
 Sales price variance refers to the difference between a business’s expected
price of a product or service and its actual sales price.
 It can be used to determine which products contribute most to the total
sales revenue and shed insight on other products that may need to be
reduced in price or discontinued.
 A favourable sales price variance means a company received a higher-than-
expected selling price, often due to fewer competitors, aggressive sales and
marketing campaigns, or improved product differentiation.
 Unfavourable sales price variances, selling for less than the targeted price,
can stem from increased competition, falling demand for a given product,
or a price decrease mandated by some type of regulatory authority.