Definition of Variance Analysis
In accounting, a variance is the difference between an actual amount and a budgeted, planned or past amount. Variance analysis is one step in the process of identifying and explaining the reasons for different outcomes.
Variance analysis is usually associated with a manufacturer's product costs. In this setting, variance analysis attempts to identify the causes of the differences between a manufacturer's 1) standard or planned costs of the inputs that should have occurred for the actual products manufactured, and 2) the actual costs of the inputs used for the actual products manufactured.
Example of Variance Analysis
Assume that a company manufactured 10,000 units of product (output). The company's standards indicate that it should have used $40,000 of materials (an input), but it actually used $48,000 of materials. The variance analysis may include the following:
- There is an $8,000 unfavorable variance which needs to be analyzed
- The $8,000 variance can be separated into a price variance and a quantity variance
- The price variance identifies whether the actual cost per pound of the input was more or less than the planned or standard cost per pound
- The quantity variance identifies whether the actual quantity of the input used was more or less than the planned or standard quantity for the actual output
The variance analysis of manufacturing overhead costs is more complicated than the variance analysis for materials. However, the variance analysis of manufacturing overhead costs is important since these costs have become a large percentage of manufacturing costs.