How to calculate activity variance Accounting

What is a Spending Variance?

A spending variance is the difference between the actual and expected (or budgeted) amount of an expense. Thus, if a company incurs a $500 expense for utilities in January and expected to incur a $400 expense, there is a $100 unfavorable spending variance. This concept is commonly applied to the areas noted below.

Direct Materials

The spending variance for direct materials is known as the purchase price variance, and is the actual price per unit minus the standard price per unit, multiplied by the number of units purchased.

Direct Labor

The spending variance for direct labor is known as the labor rate variance, and is the actual labor rate per hour minus the standard rate per hour, multiplied by the number of hours worked.

Fixed Overhead

The spending variance for fixed overhead is known as the fixed overhead spending variance, and is the actual expense incurred minus the budgeted expense.

Variable Overhead

The spending variance for variable overhead is known as the variable overhead spending variance, and is the actual overhead rate minus the standard overhead rate, multiplied by the number of units of the basis of allocation (such as hours worked or machine hours used).

Administrative Overhead

The variance calculation is normally applied to each individual line item within this general category of expense.

Favorable and Unfavorable Spending Variances

Whenever the actual expense is greater than the budgeted or standard expense, the difference is called an unfavorable variance. The reverse is called a favorable variance.

An unfavorable spending variance does not necessarily mean that a company is performing poorly. It could mean that the standard used as the basis for the calculation was too aggressive. For example, the purchasing department may have set a standard price of $2.00 per widget, but that price may only be achievable if the company purchases in bulk. If it instead purchases in small quantities, the company will likely pay a higher price per unit and incur an unfavorable spending variance, but will also have a smaller investment in inventory and a lower risk of inventory obsolescence.

Thus, any spending variance should be evaluated in light of the assumptions used to develop the underlying expense standard or budget.

Terms Similar to Spending Variance

A spending variance may also be known as a rate variance.

Analysis of the difference between planned and actual numbers

What is Variance Analysis?

Variance analysis can be summarized as an analysis of the difference between planned and actual numbers. The sum of all variances gives a picture of the overall over-performance or under-performance for a particular reporting period. For each item, companies assess their favorability by comparing actual costs to standard costs in the industry.

For example, if the actual cost is lower than the standard cost for raw materials, assuming the same volume of materials, it would lead to a favorable price variance (i.e., cost savings). However, if the standard quantity was 10,000 pieces of material and 15,000 pieces were required in production, this would be an unfavorable quantity variance because more materials were used than anticipated.

Learn variance analysis step by step in CFI’s Budgeting and Forecasting course.

The Role of Variance Analysis

When standards are compared to actual performance numbers, the difference is what we call a “variance.” Variances are computed for both the price and quantity of materials, labor, and variable overhead and are reported to management. However, not all variances are important.

Management should only pay attention to those that are unusual or particularly significant. Often, by analyzing these variances, companies are able to use the information to identify a problem so that it can be fixed or simply to improve overall company performance.

Types of Variances

As mentioned above, materials, labor, and variable overhead consist of price and quantity/efficiency variances. Fixed overhead, however, includes a volume variance and a budget variance.

Learn variance analysis step by step in CFI’s Budgeting and Forecasting course.

The Column Method for Variance Analysis

When calculating for variances, the simplest way is to follow the column method and input all the relevant information. This method is best shown through the example below:

XYZ Company produces gadgets. Overhead is applied to products based on direct labor hours. The denominator level of activity is 4,030 hours. The company’s standard cost card is below:

Direct materials: 6 pieces per gadget at $0.50 per piece

Direct labor: 1.3 hours per gadget at $8 per hour

Variable manufacturing overhead: 1.3 hours per gadget at $4 per hour

Fixed manufacturing overhead: 1.3 hours per gadget at $6 per hour

In January, the company produced 3,000 gadgets. The fixed overhead expense budget was $24,180. Actual costs in January were as follows:

Direct materials: 25,000 pieces purchased at the cost of $0.48 per piece

Direct labor: 4,000 hours were worked at the cost of $36,000

Variable manufacturing overhead: Actual cost was $17,000

Fixed manufacturing overhead: Actual cost was $25,000

Materials Variance

Adding these two variables together, we get an overall variance of $3,000 (unfavorable). It is a variance that management should look at and seek to improve. Although price variance is favorable, management may want to consider why the company needs more materials than the standard of 18,000 pieces. It may be due to the company acquiring defective materials or having problems/malfunctions with machinery.

Labor Variance

Adding the two variables together, we get an overall variance of $4,800 (Unfavorable). This is another variance that management should look at. Management should address why the actual labor price is a dollar higher than the standard and why 1,000 more hours are required for production. The same column method can also be applied to variable overhead costs. It is similar to the labor format because the variable overhead is applied based on labor hours in this example.

Learn variance analysis step by step in CFI’s Budgeting and Forecasting course.

Fixed Overhead Variance

Adding the budget variance and volume variance, we get a total unfavorable variance of $1,600. Once again, this is something that management may want to look at.

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The Role of Standards in Variance Analysis

In cost accounting, a standard is a benchmark or a “norm” used in measuring performance. In many organizations, standards are set for both the cost and quantity of materials, labor, and overhead needed to produce goods or provide services.

Quantity standards indicate how much labor (i.e., in hours) or materials (i.e., in kilograms) should be used in manufacturing a unit of a product. In contrast, cost standards indicate what the actual cost of the labor hour or material should be. Standards, in essence, are estimated prices or quantities that a company will incur.

This has been CFI’s guide to Variance Analysis. To help you advance your career, check out the additional CFI resources below:

Analysis of Financial Statements
Financial Statement Normalization
Financial Accounting Theory
Revenue Recognition Principle

What is activity variance in accounting?

Activity variances are the differences between the static/planning budget and the flexible budget and are caused by the difference between planned and actual activity levels.

Why do we calculate variance in accounting?

Variance analysis helps management to understand the present costs and then to control future costs. Variance calculation should always be calculated by taking the planned or budgeted amount and subtracting the actual/forecasted value. Thus a positive number is favorable and a negative number is unfavorable.

What is activity volume variance?

A volume variance is the difference between the actual quantity sold or consumed and the budgeted amount expected to be sold or consumed, multiplied by the standard price per unit. This variance is used as a general measure of whether a business is generating the amount of unit volume for which it had planned.

What is activity variance in project management?

Activity variance can be described as the difference between what is planned and what has actually transpired in a project. Activity variance may also be defined as the difference between actual progress of a project and its expected progress.