Variance reports compare an expectation with what actually
occurred. They can be based on any factor necessary for
tracking an expectation. Some factors are dollars, labor, consumption rates, lines/pieces per hour, or trucks per day.
Three main sections with two subsections each:
1. Materials price variance & materials quantity variance
(If the company is paying too much for materials or using too much materials for a product, that is an unfavorable variance.
If the company is getting materials for less than the standard cost or is using less than the standard materials for a product, that would be favorable).
2. Labor rate variance & labor efficiency variance.
Labor rate variance measures deviation from standard in the average hourly rate paid to direct labor workers.
Labor efficiency variance attempts to measure the productivity of direct labor.
3. Variable overhead spending variance & variable overhead efficiency variance.
A typical threshold is 10% and $5,000, although this may differ substantially for larger departments. Using this as an example, the supply expense above would not require an explanation.
The percent variance is 10%, but the dollar variance is only $1,000. This eliminates the need for unnecessary work in researching and identifying small variances. Similarly, if an item was off budget by $10,000, but was off a small percent, there would be no need for explanation. Some companies only require an explanation if there is a negative variance.
If the variance meets both conditions, the manager needs to research and explain why. It may be things have changed from the budget. Volume may have changed increased, or there may have been unexpected price increases.
The manager should be the best judge of what differs from the budget. If the budget was prepared by someone else, consult any notes there may be. If there are none, the manager’s opinion is still likely to be better than an accountant’s.
Creating a sensible, well-documented budget provides for better explanations of variances. Detailed, accurate explanations demonstrate credibility to administration.