An important part of running a business is comparing how you actually performed to how you expected to perform. 

When you initially start producing something, you make up an estimate of how much it’s going to cost you. You estimate your direct labor costs, your direct materials costs, and your overhead costs. Then you actually produce the product and you see how much it’s going to cost you. Then you go back to analyzing to see whether or not you need to change the amount that you charge for your actual product.

Variance Analysis Usage

We use variance analysis to see what changed between our estimated costs and actual costs. 

Let’s say that our direct labor costs us more than we estimated it would. Variance analysis asks, “Why does it cost more?” Is it because it took more direct labor hours to create each car? Or because each direct labor hour costs you more than you expected it to?”In other words, the direct labor hours per car would be the direct labor efficiency variance. The direct labor costs would be the direct labor price variance.

Remember, our product costs include direct materials, direct labor, and overhead. For variance analysis, we split up overhead into variable overhead and fixed overhead. We have four different types of product costs, and for each of these costs, we have two different variances. Therefore, we have a total of eight types of variance analysis

1. Direct Labor Variance Analysis

• Price Variance Analysis

• Efficiency Variance Analysis

2. Direct Materials Variance Analysis

• Price Variance Analysis

• Efficiency Variance Analysis

3. Variable Overhead Variance Analysis

• Price Variance Analysis

• Efficiency Variance Analysis

4. Fixed Overhead Variance Analysis

• Spending Variance Analysis

• Production Volume Variance Analysis

For direct materials, direct labor, and variable overhead, each has a price variance analysis and an efficiency variance analysis. Fixed overhead is different because it has what is called spending variance analysis and production variance analysis.

Study Tip 😀  

For direct materials, direct labor, and variable overhead, each has a price variance analysis and an efficiency variance analysis. Fixed overhead is different because it has what is called spending variance analysis and production variance analysis.

Key To Remember

Some problems might call price variance the rate variance, but it’s the exact same thing. Some problems might call the efficiency variance the usage variance, but they’re the exact same.

You’re going to see the word “standard” a lot in these sections, and “standard” simply means estimated. If it says the standard price per direct labor hour is $15, that means that the company estimated that their direct labor would cost them $15 per hour. 

The next key to remember is that with variance analysis questions, the number of units that we expected to make is irrelevant to us. For example, if we are expecting to make 200 cars and we actually make 300 cars, the 200 cars we expected to make are irrelevant to us. Each type of variance analysis is either going to be favorable or unfavorable.

A favorable variance means we actually performed better than we expected. Favorable variances are great for the company. A favorable variance results in a credit to the work-in-process account. An unfavorable variance is not great for a company. An unfavorable variance results in a debit to the work-in-process account. 

For example, if we expected to pay our factory workers $16 per hour, but we actually paid them $17 per hour, that would be an unfavorable variance. Because the company spent more than it expected.

In another example, if we estimated that it would take us 25 hours to create each car, but then it actually only took 22 hours, which is a favorable variance because used less labor hours and therefore save money.