Common Variances Explained
Common variances in manufacturing include differences in the price and quantity of direct materials, labor cost and efficiency, and overhead cost and efficiency. A direct materials cost variance is the difference between the direct materials' actual costs and their standard costs. A direct materials quantity variance is the difference between the actual amount of direct materials used and the standard amount that the company expected to use.
A company can calculate labor and overhead cost variances based on its spending, its efficiency, or both. A labor cost variance is the difference between the actual cost of labor and the standard cost. A labor efficiency variance is the difference between the actual time used for production and the standard efficiency rate. For example, if the company's labor cost for its hourly workers is much higher than anticipated for the actual quantity of units sold, then the company may have a labor efficiency variance. The company would then want to investigate why its employees took much longer in the production process than expected.Similar variances can also occur in overhead spending. Overhead includes costs such as rent, heating, air conditioning, and taxes. An overhead cost variance is the difference between the actual overhead incurred and the standard budgeted cost. An overhead efficiency variance is the difference between the actual overhead needed for production and the standard overhead that was planned. These variances will have a favorable or unfavorable effect on the company. For instance, a variance in the price of direct materials means that those materials could have cost more or less than expected. If the direct materials cost more than expected, this results in an unfavorable variance. This likely results in higher cost of goods sold and a reduced profit margin. If the materials cost less than expected, this results in a favorable variance.
The company should investigate the reason for the variance and whether it was favorable or unfavorable. Doing so may give the company valuable insight on where it can better use its resources.