Why analyze variances?
The budget tells you what you planned, and the journal entries tell you what happened. Variance analysis is what connects the two: it measures the difference between actual and plan for each line, then breaks each difference down into its causes so you know who is responsible and what to correct.
The simple rule: a variance is favorable if it is in favor of profit (higher revenue or lower cost), and unfavorable if it works against it. But the total figure alone is not enough: a drop in sales of 15,000 SAR may be because you sold less, or sold at a lower price, or both, and each cause has a different remedy.
The example we will follow throughout the guide
A fictional confectionery factory sells boxes of sweets. It set a standard cost for each box (what it should cost under normal conditions), and planned to produce and sell 1,200 boxes a month at a price of 100 SAR per box:
| Cost element | Standard per box | Standard cost per box |
|---|---|---|
| Sugar (direct materials) | 2 kg × 10 SAR | 20 |
| Direct labor | Half an hour × 40 SAR | 20 |
| Variable overheads | Half an hour × 20 SAR | 10 |
| Fixed overheads | 30,000 SAR ÷ 1,200 boxes | 25 |
| Standard cost per box | 75 |
At the end of the month, the actual figures were: it produced and sold 1,000 boxes at a price of 105 SAR, used 2,100 kg of sugar at 11 SAR, used 520 hours of labor at a rate of 38 SAR, and variable overheads came to 11,000 SAR and fixed overheads to 31,000 SAR.
Sales variances: price and quantity
- Selling price variance = (actual price − budgeted price) × actual quantity = (105 − 100) × 1,000 = 5,000 SAR favorable.
- Sales quantity variance = (actual quantity − budgeted quantity) × budgeted price = (1,000 − 1,200) × 100 = 20,000 SAR unfavorable.
The total is 15,000 SAR unfavorable, which equals the difference between actual sales of 105,000 and budgeted sales of 120,000. The reading: raising the price worked for each box, but the quantity fell by more. Did raising the price cause the drop in quantity? That is a question for sales management, and the analysis is what made it a clear question.
Note: some references calculate the quantity variance using the standard contribution margin instead of the price (here 100 − 50 variable cost = 50 SAR), so it becomes 200 × 50 = 10,000 SAR unfavorable, which is the effect of the lower quantity on profit rather than on revenue.
Materials variances: price and quantity
- Materials price variance = (actual price − standard price) × actual quantity = (11 − 10) × 2,100 = 2,100 SAR unfavorable. Usually the responsibility of purchasing.
- Materials quantity variance = (actual quantity − standard quantity for actual output) × standard price. The standard quantity for 1,000 boxes = 2,000 kg, so the variance = (2,100 − 2,000) × 10 = 1,000 SAR unfavorable. Usually the responsibility of production (waste, or material quality).
Be careful: the standard quantity is what should have been used for the output actually produced (1,000 boxes), not for the planned output (1,200). This is the most common calculation mistake.
Labor variances: rate and efficiency
- Wage rate variance = (actual rate − standard rate) × actual hours = (38 − 40) × 520 = 1,040 SAR favorable.
- Labor efficiency variance = (actual hours − standard hours for actual output) × standard rate = (520 − 500) × 40 = 800 SAR unfavorable.
Read together: the factory used cheaper labor (a lower rate), but it needed 20 extra hours. Did the cheaper labor really save money? The net labor variance is only 240 SAR favorable, and waste may also rise. This is an example of how a favorable variance is not always good.
Overhead variances
Variable (such as electricity and maintenance linked to labor hours):
- Spending variance = actual − (actual hours × standard rate) = 11,000 − (520 × 20) = 600 SAR unfavorable.
- Efficiency variance = (actual hours − standard hours) × rate = (520 − 500) × 20 = 400 SAR unfavorable, and its cause is the same as that of the labor efficiency variance.
Fixed (such as rent and supervisors' salaries):
- Budget variance = actual − budget = 31,000 − 30,000 = 1,000 SAR unfavorable.
- Volume variance = budget − (actual output × standard rate) = 30,000 − (1,000 × 25) = 5,000 SAR unfavorable. It is not overspending but unused capacity: the same rent was spread over fewer boxes.
The factory summary in one table
| Variance | Amount | Assessment | Usually responsible |
|---|---|---|---|
| Selling price | 5,000 | Favorable | Sales |
| Sales quantity | 20,000 | Unfavorable | Sales and marketing |
| Materials price | 2,100 | Unfavorable | Purchasing |
| Materials quantity | 1,000 | Unfavorable | Production |
| Wage rate | 1,040 | Favorable | Human resources |
| Labor efficiency | 800 | Unfavorable | Production |
| Variable overhead spending | 600 | Unfavorable | Production and maintenance |
| Variable overhead efficiency | 400 | Unfavorable | Production |
| Fixed overhead budget | 1,000 | Unfavorable | Management |
| Fixed overhead volume | 5,000 | Unfavorable | Sales and planning |
Check yourself: the standard cost of 1,000 boxes = 75,000 SAR, and the actual cost = 23,100 + 19,760 + 11,000 + 31,000 = 84,860 SAR. The difference is 9,860 SAR unfavorable, which equals the total of the eight cost variances (3,100 + 6,000 + 1,000 − 240).
The flexible budget: why not compare with the fixed budget?
If you compared the actual cost of 84,860 with the original budget for 1,200 boxes (90,000 SAR), you would see a saving of 5,140 SAR, and that is misleading: the factory produced less, so naturally it spent less. The flexible budget recalculates the budget at actual output: variable costs 50 × 1,000 = 50,000, and fixed 30,000, for a total of 80,000 SAR. The correct comparison is 84,860 against 80,000 = 4,860 SAR unfavorable due to performance, and the volume variance is shown separately.
How to read the result and what to do
- Start with the largest (management by exception): here, sales quantity and fixed overhead volume, both caused by selling less than planned.
- Ask about the cause, not the person: a rise in the price of sugar may come from the market, not from purchasing.
- Examine large favorable variances just as you examine unfavorable ones: the saving on wages was offset by weaker efficiency.
- Set a materiality threshold that your business decides (a percentage or an amount); anything below it does not need investigating every month.
- Update the standards if conditions have really changed, because an outdated standard produces meaningless variances.
Calculate it with your own figures
The free variance analysis calculator compares budget with actual for each line, classifies each as favorable or unfavorable using the materiality threshold you choose, analyzes price and quantity in sales, materials or labor, and gives you a PDF report and an Excel file with real formulas. And every variance in this guide has a page with its example in the Accountant's glossary.