P&L Variance analysis

Variance analysis is the quantitative investigation of the difference between actual and
planned behavior. This analysis is used to maintain control over a business.
Here are the most commonly-derived variances used in variance analysis (they are linked to
more complete descriptions, as well as examples):

 Purchase price variance. (Actual price - Standard price) x Actual quantity = Purchase price
variance

The standard price is the price that engineers believe the company should pay for an item,
given a certain quality level, purchasing quantity, and speed of delivery. Thus, the variance is
really based on a standard price that was the collective opinion of several employees based on
a number of assumptions that may no longer match a company's current purchasing situation.
The result can be excessively high or low variances that are really caused by incorrect
assumptions.

There are a number of possible causes of a purchase price variance. For example:

o Layering issue. The actual cost may have been taken from an inventory layering
system, such as a first-in first-out system, where the actual cost varies from the
current market price by a substantial margin.
o Materials shortage. There is an industry shortage of a commodity item, which is
driving up the cost.
o New supplier. The company has changed suppliers for any number of reasons,
resulting in a new cost structure that is not yet reflected in the standard.
o Rush basis. The company incurred excessive shipping charges to obtain materials on
short notice from suppliers.
o Volume assumption. The standard cost of an item was derived based on a different
purchasing volume than the amount at which the company now buys.

 Labor rate variance. (Actual rate - Standard rate) x Actual hours worked = Labor rate
variance

There are a number of possible causes of a labor rate variance. For example:

o Incorrect standards. The labor standard may not reflect recent changes in the rates
paid to employees. For example, the standard may not reflect the changes imposed by
a new union contract.
o Pay premiums. The actual amounts paid may include extra payments for shift
differentials or overtime. For example, a rush order may require the payment of
overtime in order to meet an aggressive delivery date.
o Staffing variances. A labor standard may assume that a certain job classification will
perform a designated task, when in fact a different position with a different pay rate
may be performing the work. For example, the only person available to do the work
may be very skilled, and therefore highly compensated, even though the underlying
standard assumes that a lower-level person (at a lower pay rate) should be doing the
work. Thus, this issue is caused by a scheduling problem.
 o Component tradeoffs. The engineering staff may have decided to alter the components
of a product that requires manual processing, thereby altering the amount of labor
needed in the production process. For example, a business may use a subassembly
that is provided by a supplier, rather than using in-house labor to assemble several
components.
o Benefits changes. If the cost of labor includes benefits, and the cost of benefits has
changed, then this impacts the variance. If a company brings in outside labor, such as
temporary workers, this can create a favorable labor rate variance because the
company is presumably not paying their benefits.

 Variable overhead spending variance. Actual hours worked x (Actual overhead rate -
standard overhead rate)
= Variable overhead spending variance

There are a number of possible causes of a variable overhead spending variance. For
example:

o Account misclassification. The variable overhead category includes a number of

accounts, some of which may have been incorrectly classified and so do not appear as
part of variable overhead (or vice versa).
o Outsourcing. Some activities that had been sourced in-house have now been shifted to
a supplier, or vice versa.
o Supplier pricing. Suppliers have changed their prices, which have not yet been
reflected in updated standards.

 Fixed overhead spending variance. The total amount by which fixed overhead costs exceed
their total standard cost for the reporting period.

 Selling price variance. (Actual price - Budgeted price) x Actual unit sales = Selling price
variance

An unfavorable variance means that the actual price was lower than the budgeted price. If the
actual price is lower than the budgeted price, the result may actually be favorable to the
company, as long as the price decline spurs demand to such an extent that the company
generates an incremental profit as a result of the price decline.

 Material yield variance. Subtract the total standard quantity of materials that are supposed to
be used from the actual level of use and multiply the remainder by the standard price per unit.

An unfavorable variance means that the unit usage was greater than anticipated. There are a
number of possible causes of a material yield variance. For example:

o Scrap. Unusual amounts of scrap may be generated by changes in machine setups, or

because changes in acceptable tolerance levels are altering the amount of scrap
produced. A change in the pattern of quality inspections can also alter the amount of
scrap.
 o Material quality. If the material quality level changes, this can alter the amount of
quality rejections. If an entirely different material is substituted, this can also alter the
amount of rejections.
o Spoilage. The amount of spoilage may change in concert with alterations in inventory
handling and storage.
o Freight in issues. The transport service that ships materials to the company may have
damaged them in transit, rendering them unusable.
o The standard unit usage is developed by the engineering staff, and is based on
expected scrap rates in a production process, the quality of raw materials, losses
during equipment setup, and related factors.

 Labor efficiency variance. (Actual hours - Standard hours) x Standard rate = Labor efficiency
variance

There are a number of possible causes of a labor efficiency variance. For example:

o Instructions. The employees may not have received written work instructions.
o Mix. The standard assumes a certain mix of employees involving different skill levels,
which does not match the actual staffing.
o Training. The standard may be based on an assumption of a minimum amount of
training that employees have not received.
o Workstation configuration. A work center may have been reconfigured since the
standard was created, so the standard is now incorrect.

Tracking this variance is only useful for operations that are conducted on a repetitive basis;
there is little point in tracking it in situations where goods are only being produced a small
number of times, or at long intervals.

 Variable overhead efficiency variance. Standard overhead rate x (Actual hours - Standard
hours)
= Variable overhead efficiency variance

Subtract the budgeted units of activity on which the variable overhead is charged from the
actual units of activity, multiplied by the standard variable overhead cost per unit.

A favorable variance means that the actual hours worked were less than the budgeted hours,
resulting in the application of the standard overhead rate across fewer hours, resulting in less
expense being incurred. However, a favorable variance does not necessarily mean that a
company has incurred less actual overhead, it simply means that there was an improvement in
the allocation base that was used to apply overhead.