Budget variances refer to the unpredictable factors that cause a company to spend more or less than it expects to spend in its budget. The company separates out labor costs and material costs when it calculates its budget variances. Each of these factors is separate, so a company can spend more than it expects on wages and less than it expects for materials, still spending less money than it budgeted for.
Labor costs are affected both by the budgeted pay rate and the number of hours that employees work. The budget includes an average wage rate for production workers, such as $12 per hour. If the company uses more experienced employees, it may end up paying an average of $13 per hour. If employees take longer than expected to perform their job, the company will also end up paying more wages. The company budgets for overtime; so if workers receive more or less overtime than usual, this also causes a budget variance.
The cost of materials is the other major factor in the budget variance. The company budgets for a certain price of raw materials that it expects to use to make each product. For example, it may use $20 of raw materials to produce a product that it sells for $80. If the suppliers charge $25 for the materials, this produces a budget variance. The budget can also vary because workers waste materials or are more efficient and use less materials than the company expects.
To avoid variance because a company made more or less products than normal, a company creates a flexible budget. According to Oregon State University, a standard budget sets costs based on the amount of products the company plans to produce, and the flexible budget assigns costs based on the amount of products that the company actually makes. The flexible budget eliminates variances that occur because the company makes more or less goods than usual, helping the company determine how efficient its manufacturing processes are.
Cost and Efficiency
Both materials and labor are split into a cost and an efficiency variable. For labor, the cost per hour of each employee is separated from the amount of products each employee makes per hour. For materials, the cost of raw materials is separated from the amount of raw materials the workers use to make each product. The company can control the efficiency of its factory, but it can't control the price it pays for raw materials or the amount of money workers demand.