GlossaryKind of term: Cost and economicsVariance analysis
What is variance analysis?
Variance analysis splits the gap between budgeted and actual cost by cause, such as price, usage and volume.
Variance analysis explains the gap between estimate and actuals by splitting it by cause. A price variance arises when material or subcontract work was bought dearer or cheaper than budgeted. An efficiency or usage variance means that more or fewer hours or material were needed than the standard for the quantity produced. A volume variance comes from machines running more or fewer hours in a period than the rate assumed, an expenditure variance from fixed costs that themselves differed. The first two can show per order, where the booking allows it; the last two show only per period.
What does variance analysis depend on?
Under standard costing the variances follow fixed formulas. The price variance is standard price minus actual price, times the actual quantity. The efficiency variance is the standard quantity allowed for actual output minus the actual quantity, times the standard price. The volume variance is actual minus normal activity, times the fixed cost per hour at normal activity. Whether a positive figure is favourable or adverse depends on the sign convention you use.
How does variance analysis work in practice?
An order that comes out dearer than estimated does not yet tell you what to change. A dearer bar makes it a question for purchasing, and for how long a material price in your quote stays fixed. An operation that overran puts that operation's standard up for review, unless a one-off breakdown explains it. If the shop ran fewer hours in a month than the rate assumes, an order costed at the estimating rate will not show it; the period result will. Mix those causes up and you adjust the wrong standard.
What is variance analysis often confused with?
Variance analysis is not the actuals: the actuals establish the gap, variance analysis explains it. And an efficiency variance is not automatically an error in the standard: a one-off incident such as a broken cutter does not belong in the next estimate.
Frequently asked questions
What is variance analysis in job costing?
Splitting the gap between estimate and actuals by cause: price, usage of hours and material, and, per period, volume. In shop terms: bought dearer, took longer, or ran fewer hours than planned.
How do you calculate the efficiency variance?
Per operation, take the standard hours for the quantity actually made minus the actual hours, and multiply by the estimating rate. Positive means faster than standard, negative slower. If hours are booked only per order, you cannot work it out per operation.
Why is the volume variance not part of a single order?
Because it belongs to the period: if the machines run fewer hours in a month than the rate assumes, fixed costs go unrecovered however well each order went. Read it per month or quarter, not per order.