Variance Analysis

Variance analysis is a crucial process in management accounting that helps organizations understand and control their costs and revenues. It involves comparing actual results with predetermined standards or budgets and then analyzing the differences (variances) to identify the root causes of any deviations. This allows management to pinpoint areas of strong performance, as well as areas needing improvement, and assign responsibility for those results.

What is Variance Analysis?

Variance analysis is the process of:

Calculating the Variance: Determining the difference between actual results and the established standard or budgeted figures. This is typically done for both costs and revenues.

Analyzing the Variance: Investigating the reasons behind the variance. This involves breaking down the total variance into smaller, more manageable components to isolate the specific factors contributing to the difference. For example, a variance in direct material costs might be due to a change in price or a change in the quantity of materials used.

Assigning Responsibility: Identifying the individuals or departments responsible for the variance. This step is crucial for accountability and allows management to take appropriate corrective actions.

Taking Corrective Action: Implementing changes to address the negative variances and capitalize on positive variances. This might involve revising budgets, improving processes, or providing additional training.

Types of Variances

Variances can be classified in various ways, including:

Favorable vs. Unfavorable: A favorable variance occurs when actual results are better than the standard (e.g., lower costs, higher revenues). An unfavorable variance occurs when actual results are worse than the standard (e.g., higher costs, lower revenues).

Controllable vs. Uncontrollable: Controllable variances are those that can be influenced by management. Uncontrollable variances are those that are outside of management's control (e.g., changes in market prices).

By Cost Element: Variances can be categorized by the specific cost element, such as direct material variances, direct labor variances, overhead variances, and sales variances.

By cost element (Diagram division)