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Budgeting
Variance Analysis
Variance Analysis deals with an analysis of deviations in the budgeted and actual financial
performance of a company. The causes of the difference between the actual outcome and the
budgeted numbers are analyzed to showcase the areas of improvement for the company. At
times, it is also a sign of unrealistic budgets, and therefore, in such cases, budgets can be revised.
In other words, variance analysis is a process of identifying causes of variation in the income
and expenses of the current year from the budgeted values. It helps to understand why
fluctuations happen and what can / should be done to reduce the adverse variance. This
eventually helps in better budgeting activity.
A variance in management accounting may be favorable (costs lower than expected or revenues
higher than expected) or adverse (costs higher than anticipated or revenues lower than expected).
Either positive variance or negative variance is reflected negatively on the budgeting efficiency
unless caused by extreme events.
 Table of Contents [show]

VARIANCE ANALYSIS FORMULA

Variance = Actual Income/Expense – Budgeted Income/Expense
Let us look at the need and importance of variance analysis:

NEED AND IMPORTANCE OF VARIANCE ANALYSIS

 Variance analysis aids efficient budgeting activity as management wishes to have lower
deviations from the planned budgets.  Wanting a lower deviation usually leads managers to make
detailed and forward-looking budgetary decisions.
 Variance analysis acts as a control mechanism. Analysis of significant deviation on
essential items helps the company in knowing the causes, and it helps management look into
possible ways of how much deviation can be avoided.
 Variance analysis facilitates assigning responsibility and engages control mechanisms on
departments where it is required. For example, if labor efficiency variance is seen to be
unfavorable or procurement of raw material cost variance is unfavorable, the management can
enhance control of these departments to increase efficiency.
LIMITATIONS OF VARIANCE ANALYSIS
The variance analysis is of immense use to corporations; however, it comes with its own set of
limitations as follows:
 Variance analysis as an activity is based on financial results, which are released much
later after quarterly closing; there may be a time gap which may affect the remedial action taking
the ability to a certain extent. Also, not all sources of variance may be available
in accounting data, which makes acting upon variances difficult.
 If the budgeting is not made, taking into consideration the detailed analysis of each
factor, the budgeting exercise may be loosely done, which is bound to deviate from the actual
numbers. After that analyzing variances may not be a useful activity.
LIST OF VARIANCES
Variances could occur due to change in one or many items of the budgeted list, and hence we can have
various types of variance to be analyzed. Let us look at some of the common types of variances as
tabulated below:

Sr.
No Type of Variance Variance in Special Note / Formula

(Actual Quantity Sold – Budgeted

The quantum of sales. Quantity) X Profit per Unit

This is directly affected

by sudden rise/fall in
demand for the products
SALES QUANTITY or services offered by
1 VARIANCE the company.
 The proportion of various
products sold i.e., the Sales
mix.

This may happen due to

SALES MIX shifting in the demand
2 VARIANCE curve.

The selling price of the

products. This may happen
due to higher competition/
SALES PRICE achievement of higher (Actual Selling Price – Standard Selling
3 VARIANCE market share. Price) X Quantity Sold

(Standard quantity Of Raw Material *

Standard Cost Per Unit) – (Actual
RAW MATERIAL The direct cost of raw Quantity Of Raw Material *Actual Cost
4 PRICE VARIANCE materials used. Per Unit)

This may happen due to

changes in external
factors e.g., cheaper
imports due to changes
in taxation, etc.

The quantity of raw materials(Budgeted Quantity – Actual Quantity)

used up. * Standard Price

Many reasons could

RAW MATERIAL cause this deviation,
5 USAGE VARIANCE including sales volume.

The cost of the standard

proportion of raw materials
RAW MATERIAL used by the company to
6 MIX VARIANCE produce goods.

Costs of labor paid to

produce the goods. This may Labour rate variance helps the
happen due to economies of management in optimization labor cost
LABOUR RATE scale or due to unplanned which is one of the key components of
7 VARIANCE recruitments. direct cost

LABOUR The number of hours utilized (Standard/Budgeted Hours –Actual

EFFICIENCY by the labor resource of the Number of Hours) * Budgeted Hourly
8 VARIANCE company. Rate

9 FIXED OVERHEAD Fixed cost expenditure Usually, these do not deviate much

 unless expansion plans to come up or
expansion plans which were planned
incurred by the company like gets delayed or halted due to some
EXPENDITURE rent, electricity, machinery, problem, or some unplanned losses
VARIANCE land, etc. happen, or natural calamity occurs.

Deviation in this measure could be on

the favorable side if costs reduce due to
VARIABLE economies of scale or could be on the
OVERHEAD unfavorable side due to reasons such as
EXPENDITURE Variable costs like indirect an increase in idle time, reduction in
10 VARIANCE material cost sales, etc.
Conclusion
The widely used types of variances that are analyzed by management are given above. Apart
from these, the management may also use the variance analysis on other variables like direct cost
yield variance, fixed overhead efficiency variance, variable overhead efficiency variance, fixed
overhead capacity variance, fixed overhead total variance, among many others. However, it is
important to understand that it is not necessary to track all variances; it may be sufficient to track
a few important ones depending upon the nature of the company, the life cycle and industry
profile.1–3
References
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Last updated on : May 14th, 2020
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About The Author

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping
and making things simple and easy. Running this blog since 2009 and trying to explain
"Financial Management Concepts in Layman's Terms".

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