Variance refers to the difference between planned and actual performance. Planned performance may be quantified in budget or actual performance. Planned performance may be quantified in budget or expressed as standard costs or any other statement. Thus, variance is a general term and not specific to the standard costing system.

Variance Accounting:

It is defined as ‘A technique whereby the planned activities of an undertaking are quanti­fied in budgets, standard cost, standard selling prices and standard profit margins, and the difference between these and the actual results are compared. The procedure is to collect, compare, comment and correct.’ – (CIMA Official Terminology)

This is also a general term and its use is not restricted to the standard costing system.

The variance accounting procedure involves:


(a) Formulating plans and setting standards.

(b) Comparing actual results with plans and/or standards.

(c) Analysing variances and investigating causes.

(d) Taking corrective actions.


Variance accounting, in addition to budgets and standard costs, uses standard selling prices and standard margins to evaluate actual results.

Variance Analysis:

Variance analysis refers to the process of segregating the total variance, arising in a stan­dard costing system, into their constituent parts in order to identify the causes for the total variance.

Standard Cost Variance Analysis-Basic Principles:

The following points must be kept in mind while calculating standard cost variances:


(a) Variances are analysed product by product.

(b) All variances are expressed in monetary terms only.

(c) The total cost variance is the difference between the actual cost and the standard cost of actual output.



Budgeted fixed overhead is CU 40,000 and budgeted production is 4,000 units. Actual result shows production of 4,100 units with fixed overhead of CU 42,000.

The total fixed overhead variance is:

CU 10 × 4,100 – CU 42,000 = CU 1,000 (adverse)

It would be wrong to compare the actual fixed overhead of CU 42,000 with the budget fixed overhead of CU 40,000.


A variance is said to be ‘favourable’ if it results in increase in operating profit and ‘adverse’ if it results in decrease in operating profit.

Direct Material Cost Variance Analysis:

Total material cost variance is decomposed into usage variance and price variance in order to understand the reasons for variance between standard material cost and actual material cost for actual production. Material price variance may arise due to various reasons, such as market fluctuations, poor planning resulting in emergency purchases, loss of discount, high transportation cost etc., change in statutory levies, lack of funds resulting in failure to take advantage of the seasonal purchases, or un-economic size of the purchase order.

Sim­ilarly, material usage variance may arise for various reasons. Mix variance arises due to the inability of managers to maintain the standard mix. This might happen either because the purchase manager could not organize materials in right quantities or because of problems in the production process.


Similarly, yield variance might arise because of poor workman­ship or because of poor quality of materials purchased by the purchase manager. Manag­ers investigate the reasons for variances and report the same to the top management.

Direct Labour Cost Variance Analysis:

Traditional Method:


Methods of calculating labour cost variances are same as those being used to calculate material cost variances with an exception. Some labour hours are wasted as abnormal idle hours. In order to calculate the cost incidence of the difference between standard efficiency and actual efficiency, only productive hours (including unavoidable waste) are considered. Cost incidence of abnormal idle hours is presented separately.

The following list shows ‘Direct material cost variances’ and corresponding ‘Direct labour cost variances’:

Material Cost Variances:

1. Total material cost variance

2. Material usage variance

3. Material price variance


4. Material mix variance

5. Material yield variance

Labour Cost Variances:

1. Total labour cost variance

2. Labour usage variance

3. Labour rate variance

4. Labour mix variance

5. (a) Labour efficiency variance

(b) Labour idle time variance

Direct labour cost variance may occur for various reasons. For example, wage rate variance may arise due to revision in pay scales, overtime working, or use of employees in grades different from what was contemplated at the time of establishing the target.

Direct labour efficiency variance may arise due to poor planning and scheduling, poor supervision, poor maintenance of machines, poor quality of materials, increase in labour turnover, or industrial unrest. Mangers investigate the causes and report the same to the top management.

Variable Overhead Variance:

Usually variable overheads vary in direct proportion to the number of hours worked. For example, consumption of power varies in direct proportion to hours worked. Therefore, standard for variable overhead is established in terms of variable overhead per hour. Standard for variable overhead per unit of production is derived from the standard variable overhead per hour and standard production per hour.

Therefore, variable overhead vari­ance arises for two reasons- variance in efficiency, which has resulted in more or less hours taken to produce the output as compared to standard hours; and because the expense per hour was more or less than the standard.

Variable overhead expenditure may arise due to price fluctuations or variations in the use of resources. Efficiency variance arises due to variations in the machine or employee efficiency. Managers investigate the reasons for taking remedial actions.

Fixed Overhead Variance:

Fixed overhead by definition is fixed and does not change with changes in the activity level within the relevant range.

Fixed overhead per unit is an average cost and is calcu­lated as follows:

Target fixed overhead rate per unit = Budget fixed overhead expenditure/ budgeted production

Therefore, fixed overhead cost variance arises due to variances in budgeted expendi­ture and/or budgeted volume of production. Actual production may be greater or lower as compared to the budgeted production due to variations in the number of days worked, the number of hours worked, and the labour efficiency.

Fixed overhead expenditure variance may occur due to poor planning resulting in improper use of available facilities and price fluctuations. Overhead capacity variance may arise due to poor planning and scheduling, machine breakdown, failures, etc. industrial unrest, shortage of material, or lack of demand for the product. Overhead efficiency vari­ance arises due to change in efficiency of machines or employees. Managers investigate the reasons for taking remedial actions.

Revision Variance:

Revision variance is the difference between an original and a revised standard cost. Revi­sion variance reflects a conscious decision to compare actual costs against revised stan­dard. Standards are revised to take into consideration uncontrollable factors, which have temporarily distorted original standards. Revision variances reflect the difference between original and revised standard cost.

Sales Variances:

Sales Variance with Reference to Profit (Margin):

A variance report prepared under a standard costing system reconciles the budgeted profit and actual profit. The difference between the budgeted profit and actual profit arises because of sales variances and cost variances. Therefore, firms using a standard costing system calculate sales variances, which reflect how profit is affected due to variations in sale quantities and selling prices.

The recognized method is to calculate sales variances with reference to profit or mar­gin. We shall use the terms margin and profit interchangeably. Budget and actual profits are calculated with reference to the standard cost of the product or service because the impact of cost variances are presented separately in the variance report.

A firm establishes sales budget in terms of sales volume and selling price. In order to establish the target for the sales volume, it estimates the market size and its market share. If the firm sells similar products in the same market, it also decides the sales mix.

For example, if a company, which is in the passenger car business, sells more than one model in the same market segment, it decides the proportions of different models in the budgeted volume. Therefore, in reporting variances, volume variance is decomposed into quantity variance and mix variance, and the quantity variance is further decomposed into market size variance and market share variance.