Variance Analysis

Reviewed by Subject Matter Experts

Updated on May 02, 2023

Standard costs (SC) indicate what costs should be for a unit of production. The difference between actual cost (AC) and SC is called a variance.

Accountants can analyze variances to determine why they exist. This analysis can also provide a basis for corrective action. If AC is greater than SC, the variance is unfavorable; if AC is less than SC, the variance is favorable. In other words:

• AC > SC = Unfavorable
• AC < SC = Favorable

Variance analysis helps to identify cost differences between actual performance and desired performance. Hence, it helps to pinpoint efficient and inefficient operating areas.

It also helps when assigning responsibility to individuals and assists in motivating employees and other staff to achieve the organization’s performance targets.

Variance Analysis Technique

The technique of variance analysis enables the investigator to isolate the causes of differences between actual costs and standard costs. For proper control, both favorable and unfavorable variance should be analyzed.

Variance analysis is also used to identify the causes of variances and the individuals responsible for instances of variance. Hence, the system of variance analysis helps management to find answers to the following two questions:

• Is the variance due to loose or tight standards?
• Have the standards been set scientifically?

Variance analysis helps management to rely on the principle of management by exception.

Management is usually not concerned with analyzing every performance report. Instead, the company may decide that performance within ± 3 percent of the budget or standards is acceptable when examining performance reports.

In such cases, the management will only examine more cost areas where differences exceed these limitations. This is a prime example of how variance analysis is used to achieve efficiency.

Types of Variance

Variances can be divided into three main types:

Variance Analysis FAQs

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.