What does favourable and unfavourable variance mean?

Variance analysis is a known quantitative technique that involves identification and evaluation of causes behind differences between actual costs/revenues and standard (or expected) revenues/costs.

Variances are analysed in terms of being favourable or unfavourable for business and are monetized as a difference given a financial value it is more easier for the relevant authorities to assess its financial impact on business.

Favourable variance means that actual results are different from what was planned or expected but this deviation is in favour of business. For example the difference has resulted in increased profits as the difference have arisen either because actual revenue is more than anticipated revenue or actual cost is less than anticipated cost.

Unfavourable variance means that actual outcomes are not as planned or established standards and this deviation proved unfavourable for the business. For example the deviation has resulted in decreased profits. The decreased profit has resulted either because actual revenue are less than expected revenues or actual costs incurred are found to be more than expected costs.

However it must be understood that profit figure is not a conclusive remark to decide whether variance is favourable or unfavourable. Variance is favourable if it has favoured the business operations and it is unfavourable if it is not good for business.

For ease of understanding differentiating between favourable and unfavourable variances, unfavourable variances are usually reported with figures inside parenthesis that highlights its nature. For example if variance is found to be 2,500 and is unfavourable then it will be written as (2,500). Whereas favourable variances are reported simply without any “highlighters”

It must be understood that variance is favourable or unfavourable on the basis whether it is good for business or not and NOT because of mathematical reason i.e. even if value is negative it does not mean it is unfavourable until it is judged on the grounds of profitability. For example if total expected revenue is 1,000 and actual revenue is 1,200 and variance is calculated as 1,000 – 1,200 result will be -200 but it does not mean it is unfavourable variance rather it is favourable variance as actual revenue is more than expected revenue.

Variance analysis can be conducted on each component of financial information or on totality basis. For example variances can be calcualted and assessed for sales revenue and material cost, labour cost etc. Such analysis are more of an individual analysis whereas variances calculated for gross profit or net profit are more of a totality nature as profit itself is a subtotal of revenue and cost variance of profit figure is dependant on variances in cost and revenue.

Variance computation of such values like profit is a bit tricky and it doesn’t have to have same variance as the revenue or cost i.e. it is not necessary that if revenue is favourable then profit is also favourable. Same applies in case of cost.

Example

An entity introduced a new product in market. At the launch it was expected that product will attract many customer and 2,000 units will be sold in the first month at an expected unit price of $10. The cost production was expected to stand at 15,000 in total.

After a month of effort actual results start coming in and actual units sold were 2600 at a price of $8 per unit. Where as actual production cost was 15,500.

Calculate relevant variances

Solution

Total revenue variance can calculated after computing total expected revenue and total actual revenue.

Total expected revenue = 2,000 x 10 = 20,000

Total actual revenue = 2,600 x 8 = 20,800

Total revenue variance = 20,800 – 20,000 = 800 Favourable because actual revenue is more than anticipated

 

Tota cost variance can be calculated by comparing total expected cost and total actual cost i.e. 15,000 and 15,500 respectively.

Total cost variance = Total expected cost – Total actual cost

Total cost variance = 15,000 – 15,500 = (500) i.e. 500 Unfavourable because actual cost is more than anticipated

 

Total profit variance can be calculated by computing difference between actual profit and expected profit

Expected profit = 20,000 – 15,000 = 5,000

Actual profit = 20,800 – 15,500 = 5,300

Profit variance = 5,000 – 5,300 = 300 Favourable as actual profits are more than expected profits.

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