What is Variance Analysis?


Variance Analysis is the difference between the actual amount of costs or revenue and the expected amount. Variance analysis compares actual amounts with the standard amounts and calculates efficiency. The analysis also explains the reason behind the difference. Variance analysis helps management in finding the causes for variation. It aids the process of decision-making.

Classification of Variance Analysis

Material variance: The material variance may help companies identify where they may be using more materials than they need. For example, if a company reorders materials because of quality concerns, the additional costs may show variance in their analysis. The company might use this information to determine whether to continue using the same material supplier or search for a new one. This analytical process can require the use of multiple material formulas to find individual and overall variances, which are:

  • (Actual quantity x standard price) – (standard quantity x standard price) = quantity variance
  • (Actual quantity x standard price) – (actual quantity x actual price) = price variance
  • Quantity variance + price variance = overall variance

Labor variance: The labor variance may help companies identify how efficiently they use labor and the effectiveness of their pricing. For example, if a company calculates variance and finds inefficiencies or higher labor pricing, it might consider making changes for the upcoming fiscal year. This information may help the company further streamline its operations and save money.
This analytical process can require the use of multiple material formulas to find individual and overall variances, which are:

  • (Actual hours x actual rate) – (actual hours x standard rate) = rate variance
  • (Actual hours x standard rate) – (standard hours x standard rate) = efficiency variance
  • Rate variance + efficiency variance = overall variance

Fixed overhead variance: The fixed overhead variance may help companies identify differences between their budgeted overhead costs, which they may determine based on production volumes, and the number of used overhead costs. For example, if a company wants to revisit its budget plans, it might use fixed overhead variance to identify if it’s workable to reduce its current allotted budget. This information may help the company save money or allocate that money to other areas of the business.
This analytical process can require the use of multiple material formulas to find individual and overall variances, which are:

  • Denominator level of activity x standard rate = budgeted fixed overhead cost
  • Actual fixed overhead cost – budgeted fixed overhead cost = budget variance
  • Standard hours x standard rate = fixed overhead cost applied to inventory
  • Budgeted fixed overhead cost – fixed overhead cost applied to inventory = volume variance
  • Budget variance + volume variance = overall variance.