A Monthly Budget Variance Report This is representative of what a department manager may receive at the end of each month (accounting period). The Budget and Actual values can be used to analyze spending and volume variances The manager must contact the accounting department and get the following information: The volumes (labor hours) used to calculate labor The volumes (units) used to calculate materials The volumes (labor hours) used to calculate overhead For Variance Reports: A Positive value = Favorable (increases Net Income) A Negative value = Unfavorable (decreases Net Income)

Variance Analysis There are two sources of Variance between BUDGETS and ACTUALS. Spending differences Variance due to the COST paid for resources (price or rate) AQ (AP – SP) Volume differences Variance in the QUANTITY used (volume or level of activity) SP (AQ – SQ) Applying Overhead costs will almost always result in Over absorption or Under absorption of Overhead. The reasons for this are: Spending differences due to: Variances in the cost of resources and Indirect resources utilized more or less efficiently than expected. Volume difference when: The volume of activity is different than the budget. Therefore the absorption of the fixed Overhead expenses change.

The Variance Format ACTUAL QUANTITY AT STANDARD PRICE AQ x SP ACTUAL QUANTITY AT ACTUAL PRICE (ACTUALS) AQ x A P STANDARD QUANTITY AT STANDARD PRICE SQ x S P 1 2 3 1 – 2 = PRICE VARIANCE AQ(AP-SP) 2 – 3 = QUANTITY VARIANCE SP(AQ-SQ) TOTAL VARIANCE (1 - 2) + (2 - 3) This is a convenient and model to help calculate the Spending, Volume and Total Variances. The choice of terms, such as Price vs. Rate, will depending on whether the analysis is for materials, labor, or overhead, but the model is the same. The difference between 1 and 2 is the Actual Quantity times the difference between Actual Prices and Standard Prices. This is called: Price Variance for materials ($/unit); Rate Variance for labor ($/hour); and Spending Variance for Fixed and Variable Overhead ($/unit). The difference between 2 and 3 is the Standard Prices times the difference between Actual Quantity and Standard Quantity. It is therefore called: Quantity Variance for materials; Efficiency Variance for labor and Variable Overhead; and Volume Variance for Fixed Overhead Negative variances are credits and are Favorable This is easy to remember for Spending Variance. If the actual price (AP) is greater than the budgeted standard price (SP) then AQ(AP-SP) will be a positive result. This is a debit variance. Also, since actual spending was greater than planned, expenses were greater than planned and, by definition, this is Unfavorable. Negative Variances are Favorable (a credit to Overhead Variance) Positive Variances are Unfavorable (a debit to Overhead Variance) AQ = Actual Quantity or Actual Volume or Actual Hours AP = Actual Price or Actual Rate SQ = Standard Quantity or Standard Volume or Standard Hours

Where is the information found? (1) Actual $$$ given on monthly Variance Analysis report (3) Budgeted $$$ given on monthly Variance Analysis report (2) Calculated by getting AQ and SP from Accounting or other source of budget information = AQ x AP = AQ x SP = SQ x SP ACTUAL COSTS (PROVIDED BY ACCOUNTING) ACTUAL AMOUNT OF RESOURCE AT STANDARD PRICE (CALCULATED) BUDGETED COSTS (PROVIDED BY ACCOUNTING) This is a powerful, and easy to apply model in the real world. When a manager receives a Variance Analysis Report each period it will include Actual and Budget amounts. These become #1 and #3 directly. #2 must be calculated. The values for actual volume (AQ) and standard price (SP) can be found by the accountant. Actual volume was used to calculate Actuals Standard prices are known from the budget when it was prepared. 1 2 3 1 - 2 SPENDING VARIANCE 2 - 3 VOLUME VARIANCE TOTAL VARIANCE (1 - 2) + (2 - 3)

Graphical Analysis OH $$ Activity Level Spending Variance due to Price (rate) Volume Variance due to activity (quantity) 2 Expected $$ @ Actual volume 1 Actual $$ 3 Budgeted $$ This graph shows the the amount of budget overhead per unit of activity level Activity level is the Overhead Driver (cost-allocation base), often it is Direct Labor $/hr. When budgeting, management selects a volume they expect to achieve and the budgeted amount of Overhead costs at this volume. The reality is that the total Overhead costs will not meet the budget due to 1) changes in the activity level, or volume and 2) the price, or rate, paid for the resources that are included in the Overhead costs. The “Actual Volume” line indicates the expected variance due to changes in volume; this is “Expected OH$$ @ Actual Volume”. But the actual Overhead costs (as printed on a Variance Report) will probably be a different value, in this cas the “Actual OH $$”. The difference is due to the price paid for Overhead resources. The Total Variance is the sum of the Spending Variance and the Volume Variance. This is used for: Labor Variance analysis Material Variance analysis Variable Overhead Variance analysis Budgeted Resource ($$ per unit resource) Activity Level Budgeted Volume Actual Volume

Full-absorption Overhead Variance Analysis Variance due to Price (rate) OH $$ Variance due to Volume (quantity) Actual Applied OH $$ 1 ALLOCATED OVERHEAD 2 Volume-adjusted OH $$ BUDGETED OVERHEAD Y=mx + b 3 Budgeted OH $$ The same logic is applied to the Full-absorption OH costing model with a slight variation. Activity Level Budgeted Volume Actual Volume

Overhead Variances under Full-absorption Costing Variation for Y = mx + b Where Y = applied overhead m = Variable Overhead rate (budgeted) x = actual quantity of overhead vehicle (i.e. hours) b = Fixed Overhead expenses (budgeted) 2 When calculating overhead variances under full-absorption costing it must be remembered that this include components of fixed and variable overhead. #2 must be calculated using the slope-intercept equation. ACTUAL QUANTITY AT ACTUAL PRICE (ACTUALS) AQ x A P ACTUAL QUANTITY AT STANDARD PRICE Y = mx + b STANDARD QUANTITY AT STANDARD PRICE SQ x S P 1 2 3 1 – 2 = PRICE VARIANCE AQ(AP-SP) 2 – 3 = QUANTITY VARIANCE SP(AQ-SQ) TOTAL VARIANCE (1 - 2) + (2 - 3)