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Variance Analysis in 5 mins

Richard Clarke

Variance Analysis: A Simplified Explanation

What is Variance Analysis?

Variance analysis is a tool used in management accounting to compare actual performance (what really happened) with budgeted or standard performance (what was planned). It helps managers understand why results differ and take corrective actions. Variances can be:

  • Favourable: Better than expected
  • Adverse: Worse than expected

In the ACCA PM exam, variance analysis often focuses on cost variances (e.g., material, labor) and sales variances. Let’s explore Material Cost Variances as an example.

Key Components of Material Cost Variances

Material cost variances explain why the actual cost of materials differs from the budgeted cost. They’re split into:

  1. Material Price Variance: Difference due to paying more or less per unit than planned.
  2. Material Usage Variance: Difference due to using more or fewer units than expected.

Formulae

  • Material Price Variance = (Actual Price - Standard Price) × Actual Quantity
  • Material Usage Variance = (Actual Quantity - Standard Quantity) × Standard Price
  • Total Material Cost Variance = Material Price Variance + Material Usage Variance

Numeric Example

A company budgets to make 1,000 units of a product. The standard cost is:

  • Standard Price: $5 per kg of material
  • Standard Usage: 2 kg per unit (so 2,000 kg total for 1,000 units)

Actual Results:

  • Produced: 1,000 units
  • Used: 2,100 kg of material
  • Paid: $5.20 per kg

Step 1: Calculate Material Price Variance

  • Actual Price = $5.20
  • Standard Price = $5
  • Actual Quantity = 2,100 kg
  • Formula: (5.20 - 5) × 2,100 = 0.20 × 2,100 = $420 Adverse
    (Adverse because they paid more per kg than planned)

Step 2: Calculate Material Usage Variance

  • Actual Quantity = 2,100 kg
  • Standard Quantity = 2,000 kg (1,000 units × 2 kg)
  • Standard Price = $5
  • Formula: (2,100 - 2,000) × 5 = 100 × 5 = $500 Adverse
    (Adverse because they used more material than planned)

Step 3: Total Material Cost Variance

  • Total = Price Variance + Usage Variance = $420 A + $500 A = $920 Adverse

What Does This Mean?

  • Price Variance ($420 A): The company spent $420 more because the material price was higher than budgeted.
  • Usage Variance ($500 A): They used 100 kg more than expected, costing an extra $500.
  • Total ($920 A): Overall, material costs were $920 higher than planned.

Managers might investigate: Was the price increase due to supplier issues? Was usage higher due to waste or inefficiency?

Why It Matters for ACCA PM

Variance analysis tests your ability to:

  • Calculate variances accurately.
  • Interpret results to support decision-making.
  • Understand how costs behave and affect profitability.

Practice with different scenarios (e.g., favourable variances) to get comfortable for the exam!