Variance analysis

A variance is the difference between actual cost and the standard cost allowed for the actual output. Each cost variance splits into a price part (paying more or less per unit of input) and a quantity part (using more or less input than the standard allows).

Sign convention. A variance is favourable (F) when it increases profit compared with standard — actual cost below standard, or actual revenue above. It is adverse (A) (US texts: unfavourable, U) when it reduces profit. Always label the direction; a bare number is ambiguous.

Materials - Price variance = (standard price − actual price) × actual quantity purchased = AQ × SP − actual cost. - Usage variance = (standard quantity allowed for actual output − actual quantity used) × standard price.

Labour - Rate variance = actual hours × standard rate − actual cost. - Efficiency variance = (standard hours allowed − actual hours) × standard rate.

Variable overhead (absorbed per labour hour) - Spending (expenditure) variance = actual hours × standard rate − actual variable overhead. - Efficiency variance = (standard hours allowed − actual hours) × standard variable overhead rate — it moves with labour efficiency.

Fixed overhead (absorption costing) - Spending (expenditure) variance = budgeted fixed overhead − actual fixed overhead. - Volume variance = fixed overhead absorbed (standard hours for actual output × rate) − budgeted fixed overhead. It shows under- or over-absorption caused by producing more or less than budgeted, not a spending problem.

Two disciplines matter. Quantity variances are valued at standard price, so a price change can't leak into the efficiency measure. And the standard quantity is for actual output, never for the original budget.

Interpreting variances. Variances signal where to look; they don't explain themselves. Causes are often interdependent: cheaper, lower-grade material (price F) may cause more waste (usage A) and slower work (labour efficiency A). Investigate when a variance is large, persistent, or controllable — and judge managers on what they control.