# Variance Analysis

## What is Variance Analysis?

Variance Analysis deals with an analysis of deviations in the budgeted and actual financial performance of a company. The causes of the difference between the actual outcome and the budgeted numbers are analyzed to showcase the areas of improvement for the company. At times, it is also a sign of unrealistic budgets; therefore, budgets can be revised in such cases.

In other words, variance analysis is a process of identifying causes of variation in the income and expenses of the current year from the budgeted values. It helps to understand why fluctuations happen and what can / should be done to reduce the adverse variance. This eventually helps in better budgeting activity.

A variance in management accounting may be favorable (costs lower than expected or revenues higher than expected) or adverse (costs higher than anticipated or revenues lower than expected). Either positive variance or negative variance reflects negatively on the budgeting efficiency unless caused by extreme events.

## Variance Analysis Formula

Variance = Actual Income/Expense – Budgeted Income/Expense

Read more at Variance Analysis Formula with Example

Now, let us look at the need and importance of variance analysis:

## Need and Importance of Variance Analysis

• Variance analysis aids efficient budgeting activity as management wishes to have lower deviations from the planned budgets. Wanting a lower deviation usually leads managers to make detailed and forward-looking budgetary decisions.
• Variance analysis acts as a control mechanism. Analysis of significant deviations on essential items helps the company know the causes, and it allows management to look into possible ways of how much deviation can be avoided.
• Variance analysis facilitates assigning responsibility and engages control mechanisms in departments where required. For example, suppose labor efficiency variance is seen to be unfavorable, or procurement of raw material cost variance is unfavorable. In that case, the management can enhance control of these departments to increase efficiency.

## Limitations of Variance Analysis

The variance analysis is of immense use to corporations; however, it comes with its own set of limitations as follows:

• Variance analysis as an activity is based on financial results, which are released much later after quarterly closing; there may be a time gap that may affect the remedial action-taking ability to a certain extent. Also, not all sources of variance may be available in accounting data, which makes acting upon variances difficult.
• Suppose the budgeting is not made, considering the detailed analysis of each factor. In that case, the budgeting exercise may be loosely done, which is bound to deviate from the actual numbers—after that, analyzing variances may not be a useful activity.

## Forms of Variances

Variances could occur due to changes in one or many items of the budgeted list, and hence we can have various types of variance to be analyzed. Let us look at some of the common types of variances as tabulated below:

## Conclusion

The widely used types of variances that are analyzed by management are given above. Apart from these, the management may also use the variance analysis on other variables like direct cost yield variance, fixed overhead efficiency variance, variable overhead efficiency variance, fixed overhead capacity variance, fixed overhead calendar variance, and fixed overhead total variance, among many others. However, it is important to understand that it is not necessary to track all variances; it may be sufficient to track a few important ones depending upon the nature of the company, the life cycle, and the industry profile.

Quiz on Variance Analysis

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Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

### 1 thought on “Variance Analysis”

1. This is more helpful. Assuming we have a positive variable overhead expenditure variance. Is there any need for one to post it in the general ledger. or should it affect our cost of sales.