Question

What is a favorable variance and what is an unfavorable variance? How do you calculate them? Is a favorable variance always a bad thing and is an unfavorable variance always a good thing? Why or why not? Laurie: Make sure you talk about the formulas here. Give actual examples of variances to support your position.

Answer 1

1.

variance is the differement from the actuals, it the difference from what is expected and what is actuals, it may be favourable and unfavourable depends upon the nature and type of data or components we are looking at.

Favourable variances arises in case where the actual cost is less than expected and actual profit is more than expected. Here the crux is that favourable means beneficial for the entity, less cost and more profit is always favourable.

on Contrary Unfavourable variance arises in case where the actual costs is more than expected and actual profit is less than expected. Here unfavourable means the loss to the entityi.e more cost and less profits are always unfavourable.

2. Variance is calculated as the difference of the actual costs vs expected cost , or actual profit v/s expected profits. For each cost components the variance can be calculated using various formula

for eg.Material Variance : It has Material price variance and material efficiency variance , combining both will give the material cost variance . The formula for material cost variance = Standard material cost - Actual material cost.

3 The favourable variance is not always a bad thing, but is a goods thing as it will involve lesser cost to the entity and higher profit. In the same way unfavourable variance is not always good thing but it is bad thing as it involves higher costs and lesser profits.

4. Example : Let ABC company makes a product which required 5 kg of raw material at price of $10 per kg , during the period the company makes, 10 units , and used material of 55kg which it bought at $9 per kg.

Now in the given example the data of 1 unit is given as standard, and actual 10 units are produced so first standard data for 10 units needs to be calculated,

standard material requirement for 10 units : for 1 unit 5 kg , thus for 10 units = 50 kg material required. standard rate is given as $ 10 per kg.

Thus standard Material cost = Standard units * standard rate = 50 kg* $10 per kg = $ 500 .

Actuals Material cost = Actual units * Actual rate = 55 kg * $ 9 per kg = $ 495

Here The variance for material cost = Standard cost - Actual cost = $ 500 - $495 = $ 5 Favourable.

In this case the variance is $ 5 which is favourable as actual cost is less than standard cost.