Definition of Variance
In accounting, variance refers to the difference between the standard, or budgeted, levels of costs or income for an activity and the actual costs incurred or income achieved. Variance analysis is crucial in cost accounting and budgeting because it provides insight into the reasons behind budget deviations. Variances can either be:
- Favourable Variance: Occurs when actual performance leads to better results than the standard or budgeted amount. This appears as a surplus in income or a savings in costs.
- Adverse Variance: Occurs when actual performance falls short of expectations, resulting in higher costs or lower income than budgeted. Adverse variances warrant further investigation to identify their causes.
Examples
Example 1: Budgeted vs Actual Sales
A company budgeted $50,000 in sales for the month. The actual sales were $55,000. The variance can be calculated as follows:
\[ \text{Variance} = \text{Actual Sales} - \text{Budgeted Sales} = $55,000 - $50,000 = $5,000 (Favourable) \]
Example 2: Budgeted vs Actual Expenses
A department had budgeted $20,000 for office supplies but spent $22,000. The variance is:
\[ \text{Variance} = \text{Actual Expenses} - \text{Budgeted Expenses} = $22,000 - $20,000 = $2,000 (Adverse) \]
Frequently Asked Questions (FAQs)
What is variance analysis?
Variance analysis is the process of examining the deviations between actual financial performance and budgeted figures to understand the reasons behind the differences.
Why are variances important in accounting?
Variances are crucial because they help businesses understand areas where they are overperforming or underperforming relative to their budget or standards, enabling better decision-making.
What causes adverse variances?
Adverse variances can be caused by various factors such as inefficiencies, increased costs, waste, or lower than expected sales.
How can companies address adverse variances?
Companies can address adverse variances by identifying their root causes, correcting inefficiencies, reducing waste, or revising their budget to align more closely with actual performance.
What is a favourable variance in cost accounting?
A favourable variance occurs when the actual costs are less than the budgeted or standard costs, indicating better-than-expected financial performance.
Are all variances negative?
No, variances can be both favourable (positive) and adverse (negative).
How do you calculate a variance?
Variance is calculated by subtracting the budgeted amount from the actual amount. The sign of the result indicates whether it is favourable or adverse: \[ \text{Variance} = \text{Actual Amount} - \text{Budgeted Amount} \]
What are the types of variances in cost accounting?
Types of variances include material variance, labor variance, overhead variance, and sales variance, among others.
What is the role of variance analysis in budgeting?
Variance analysis helps in the control function of budgeting by comparing actual performance with planned performance, thus identifying areas needing attention.
Can variance analysis predict future performance?
While variance analysis primarily assesses past performance, it can provide valuable insights that can inform future budgeting and forecasting efforts.
Related Terms
- Standard Costing: An accounting method that assigns a standard cost rather than actual cost to products for cost control and performance evaluation.
- Budgetary Control: The process of comparing budgeted figures to actual figures to monitor an organization’s financial performance.
- Favourable Variance: A variance that indicates better-than-expected performance according to a budget or standard.
- Adverse Variance: A variance that indicates worse-than-expected performance according to a budget or standard.
- Analysis of Variance (ANOVA): A statistical method used to analyze the differences among group means in a sample.
Online Resources
- Investopedia: Variance Definition: Investopedia - Variance
- AccountingTools: Variance Analysis: AccountingTools - Variance Analysis
- Corporate Finance Institute (CFI): Variance Analysis: CFI - Variance Analysis
Suggested Books for Further Studies
- “Management Accounting” by Anthony A. Atkinson: A comprehensive textbook covering various aspects of management accounting, including variance analysis.
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren: An authoritative book on cost accounting that includes detailed discussions on variance analysis.
- “Budgeting Basics and Beyond” by Jae K. Shim: An accessible guide to budgeting and beyond, ideal for understanding how variances fit into budgetary control.
Accounting Basics: “Variance” Fundamentals Quiz
Thank you for exploring the concept of variance in accounting with our comprehensive guide and quiz. Keep advancing your financial knowledge!
