In budgeting, and management accounting in general, a variance is the difference between a budgeted, planned, or standard cost and the actual amount incurred/sold. Variances can be computed for both costs and revenues.
The concept of variance is intrinsically connected with planned and actual results and effects of the difference between those two on the performance of the entity or company.
Types of variances
Variances can be divided according to their effect or nature of the underlying amounts.
When effect of variance is concerned, there are two types of variances:
- When actual results are better than expected results given variance is described as favorable variance. In common use favorable variance is denoted by the letter F—usually in parentheses (F).
- When actual results are worse than expected results given variance is described as adverse variance, or unfavourable variance. In common use adverse variance is denoted by the letter U or the letter A—usually in parentheses (A).
The second typology (according to the nature of the underlying amount) is determined by the needs of users of the variance information and may include e.g.:
- Variable cost variances
- Direct material variances
- Direct labour variances
- Variable production overhead variances
- Fixed production overhead variances
- Sales variances
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Example
Let us assume that standard direct material cost of production is as follows:
:2 kg of Kevlar at € 60 per kg = € 120 per unit of fuselage unit
Let us assume further that during the given period, 200 units of fuselage were manufactured, using X kg of Kevlar which cost Y
Direct material total variance can be calculated as