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Analyzing Variance: Tips, Examples & Calculations

written by: tomdon•edited by: Linda Richter•updated: 7/5/2010

The concept of variance analysis has far-reaching consequences when it comes to monitoring and analyzing productivity in a business. Learn how diverse managerial cycles have an effect.

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    Comparing Actual vs. Plan

    A variance is defined as the difference between the actual amounts and the standard amounts. Variance can be calculated for both costs and revenues. Variance analysis in managerial accounting is basically associated with the outcome of the planned and actual results and the effects of their differences among the routine performance of a person, article, or a company. Therefore it is very useful in management and accounts and also in calculating labor and materials costs.

    Variance is usually caused when the standard amounts are higher than the actual amounts. Variance accounting is a concept of managerial and cost accounting. It is not used for financial accounting.

    Variance analysis is also used in other fields to measure the accurate performance of machines in the industries. Certain instruments are available that consist of the plant nodes that have LED displays to output the variances as they happen. The information or the variances displayed in the LCD display will be seen and examined by a supervisor who investigates the problem and finds a suitable solution to the problem.

    The Real Time Variance Analysis keeps all personnel informed about the problem as soon as it occurs. In addition, by seeking help from the employees and using the appropriate empowerment tools, the solutions can be further implemented.

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    Types of Variance

    Variance is divided into two types based on the outcome or nature of the fundamental amount

    Favorable Variance

    When the actual results are better than the expected results, then the given variance is described as a favorable variance. In general, the favorable variance is denoted by the letter F. It is also represented within the parentheses (F).

    Adverse Variance or Unfavorable Variance

    When there is a huge difference between the actual results and expected results, then the given variance is described as an adverse variance or unfavorable variance. Generally adverse variance is denoted by the letter A or U and can also be represented within the parentheses (A).

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    Calculating Labor and Material Variances in Managerial Accounting

    Accounting Variances Use the formulas mentioned in this section to calculate variances in managerial accounting.

    Step Number One: Calculating the Direct Material Price Variance

    Find the difference between the standard price and the actual price and multiply the actual materials purchased by this difference to get the direct material price variance.

    For example: A company purchases 1,000 widgets as direct materials. Each widget is purchased for $5 and the budget of each widget was $4.5. The formula for calculating the direct material price variance is 1,000*($5-$4.5), which is equal to $500--an unfavorable variance.

    Step Number Two: Calculating the Direct Material Quantity Variance

    Calculate the difference between the standard quantity and the actual quantity and multiply this value by the standard price to get the direct material quantity variance.

    For example: A company spends $3.5 per widget and plans to use 800 widgets. The actual quantity needed is only 1,000 widgets for the production. The formula will be $3.5*(1,000-800) which equals $700--a favorable variance.

    Step Number Three: Calculating the Direct Labor Rate Variance

    Calculate the difference between the standard amount paid and the actual amount paid per hour. Multiply this difference with the actual hours worked by a laborer to get the direct labor rate variance.

    For Example: A company needs 1,000 hours of work and plans to pay $15 an hour, but actually paid $20. The formula is 1,000*($20-$15) which equals $5,000--and that is unfavorable.

    Step Number Four: Calculating Direct Labor Efficiency Variance

    Find the difference between the standard hours planned to work and the actual hours worked and multiply this difference with the standard rate paid by a company to its employees to get the direct labor efficiency variance.

    For Example: A company decides to pay its employees $20 an hour for 1,000 hours of work, but only 800 hours are needed. The formula is $20*(800-1,000) which equals $4,000--a favorable variance.

    Image Credit: sxc.hu/lusi