Management Accounting (MA) competency area is tough. Most of us haven’t worked in the manufacturing industry, so understanding terms like “joint costing” and “cost driver” is challenging. Of all concepts in MA, the variance analysis (VA) comes up most often in the CPA exams.
If you’ve ever thought: “How do I solve variance analysis? How do I memorize all the formulas?”, you’re not alone. This is one of the top questions CPA students ask me when studying for Core 2, PM and CFE exams. Lets dive in and learn how to tackle VA.
Understanding Variance Analysis (VA)
Mastering VA is not not about memorizing 20+ formulas, it’s about understanding the why behind them. What actually works when studying VA is understanding the logic. Think of variances as telling a story:
- What did we plan?
- What actually happened?
- Why is there a difference?
- Who caused it?
Once you understand the story, the formulas are easier to build, even if you forget the exact one.
Static vs Flexible
The backbone of VA is static and flexible budgets. Here’s how they work:
- Static Budget:
- This is the original plan, based on expected volume.
- Formula: Static Budget Variance = Actual Result – Static Budget
- Why we use it: Checks if sales revenue or fixed costs met expectations. It doesn’t adjust if you sell more/less units than expected, which is why it’s called “static.”
- Example: Company A budgeted $1,000 travel expenses. Actual were $1,500. The static variance is $500 unfavourable.
- Flexible Budget:
- This adjusts the budget to the actual volume of sales or production.
- Formula: Flexible Budget Variance = Actual Result – Flexible Budget
- Why we use it: It shows whether price or quantity changed. It’s most often used in manufacturing where price and quantity drive the costs.
- Example: Company B budgeted to pay $4 per metal sheet but ended up paying $5 per sheet. They used 2,000 sheets in production. Using the formula (AP – SP) × AQ, we get $2,000 unfavorable variance (= ($5 – $4) × 2,000).
Focus on “Big 6” variances
There are 6 core variances that come up with most on MA questions. Here they are:
|
Variance |
Formula (Actual – Standard) |
Interpretation |
|
Price (DM) |
(AP – SP) × AQ |
Paid more/less for materials |
|
Quantity (DM) |
(AQ – SQ) × SP |
Used more/less materials |
|
Rate (DL) |
(AR – SR) × AH |
Labour cost more/less per hour |
|
Efficiency (DL) |
(AH – SH) × SR |
Took more/less time than planned |
|
Sales Mix Variance (SMV) |
(Actual Sales Mix % – Budgeted Sales Mix %) x Total Actual Sales x Budgeted CM per unit |
Impact on CM from selling a different mix of products than planned. |
|
Sales Quantity Variance (SQV) |
(Actual Qty Sold−Budgeted Qty Sold) × Budgeted CM per unit |
Impact on CM from selling a different total quantity of products than planned. |
Above, the “P” stands for “Price”, the “Q” for “Quantity”, the “R” for “Rate” and “H” for “Hours”. The “CM” means contribution margin. The terms “Standard” and “Budgeted” mean the same thing: the planned cost.
Here are my top tips to help you understand and remember these formulas.
Tip#1: The 3 Buckets
Variances can be sorted into three categories: (1) Price/Rate, (2) Quantity/Efficiency, (3) Volume. Every time you see a variance, ask yourself: “Is this about price, quantity, or volume?”
-
- Price/Rate: This measures how much you paid per unit/hour.
- Quantity/Efficiency: Measures on how much material/labour you used
- Volume: How many units you produced/sold.
Tip#2: Same Patterns
Notice that the above formulas follow the same pattern. Inside the parentheses, we always deduct Actual and Standard. The name of the variance is always what’s inside the parentheses. For example, let’s say you get a Core 2 MCQ that asks: “Calculate the direct material price variance.” Since it’s asking for “Price” variance, this tells you that inside the parentheses, you’re gonna use “P”.
Outside the parentheses, we multiply by the opposite. For example, when we have “price” in the parentheses, we multiple by “quantity”. When we have “quantity” in the parentheses, we multiple by “price.” This is true for the first four, but the SMV and SQV involve the CM.
Tip#3: Explain the Cause
Calculating the variance is not the end. Once you calculate the variances, you must then determine the root cause of the variance. Once that’s done you can then make a recommendation. Common causes include:
- For efficiency variance:
- Higher scrappage due to lower quality materials, resulting in unfavourable variance.
- Extra training time for unskilled workers resulted in unfavourable efficiency variance.
- Increased usage of materials due to poor fit/install issues with low-quality product.
- Manual labour increased due to equipment downtime.
- For price/rate variance:
- Lower quality materials purchased, leading to favorable variance (ie, better price than expected)
- Use of unskilled workers at lower wage rates led to favourable rate variance.
- Overtime and higher hourly wage rates due to rework caused by low-quality materials.
Extra resources
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