A variance is the difference between standard amounts and actual amounts. Whenever actual amounts are lower than the standard amounts, there is a favourable variance. However, if the actual amounts are higher than the standard amounts, there is an unfavourable balance. Variance accounting is an aspect of cost and managerial accounting, and is not typically used in financial accounting.
- Skill level:
Multiply actual purchased materials by the difference of the actual price and the standard price to arrive at direct materials price variance. For example, a company buys 1000 widgets in direct materials, for £1.90 per widget but budgets £1.60 for each widget. The formula is 1000 widgets * (£1.90 - £1.60), which equals £300 unfavourable.
Multiply standard price by the difference between actual quantity used and standard quantity used to arrive at direct materials quantity variance. For example, a company plans to spend £1.60 per widget and estimates it will use 1000 widgets; however, actual production needed only 800 widgets. The formula is £1.60 * (1000 - 800) which equals £320 favourable.
Multiply actual hours worked by the difference between actual amount paid per hour and standard paid per hour to calculate direct labour rate variance. For example, a company needed 1000 hours of work and planned to pay £6 an hour, but due to overtime actually paid £9 an hour. The formula is 1000 hours * (£9 - £6), which equals £3,000 unfavourable.
Multiply the standard rate a company will pay employees by the difference between actual hours worked and the standard planned hours of work to arrive at direct labour efficiency variance. For example, a company plans to pay employees an average of £6 an hour and plans 1000 hours of work, but only 800 hours were needed. The formula would be £6 * (1,000 - 800), which equals £1,200 favourable.
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