During the budgeting process, a company does its best to estimate the sales revenues and expenses it will incur during the upcoming accounting period. After the period is over, management will compare budgeted figures with actual ones and determine variances. If revenues were higher than expected, or expenses were lower, the variance is favorable. If revenues were lower than budgeted or expenses were higher, the variance is unfavorable.
Revenue and Expense Variances
A typical business calculates a variety of expense and revenue variances, including:
- Purchase price variance
- Materials usage variance
- Labor efficiency variance
- Labor rate variance
- Sales volume variance
- Selling price variance
- Overhead efficiency variance
- Overhead spending variance
Sales volume variance and selling price variance are revenue variances, while the rest are expense variances.
Variances are either favorable or unfavorable. A favorable variance occurs when net income is higher than originally expected or budgeted. For example, when actual expenses are lower than projected expenses, the variance is favorable. Likewise, if actual revenues are higher than expected, the variance is favorable.
Suppose a company expected to pay $9 a pound for 100 pounds of raw material but was able to contract a price of $7 a pound. The purchase price variance is 100 pounds at $2 a pound, or $200. Since the company spent less than expected, the $200 is a favorable variance.
This variance would be presented on paper as either $200 favorable or simply $200.
When revenues are lower than expected, or expenses are higher than expected, the variance is unfavorable. For example, if the expected price of raw materials was $7 a pound but the company was forced to pay $9 a pound, the $200 variance would be unfavorable instead of favorable.
Unfavorable variances are labeled as such or expressed as a negative number. This variance would be presented on paper as either $200 unfavorable, -$200 or ($200).
During the course of variance analysis, the company may calculate net income variance. Net income variance is the sum of revenue variances and expense variances. For example, say a company has a positive revenue variance of $500 and an unfavorable expense variance of $300. The netted variance would be presented as:
- Revenue variance = $500
- Expense variance = ($200)
- Net income variance = $300
This means that the combination of all revenue and expense variances created a $300 favorable variance for net income.