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?

Answer 1

An unfavorable variance is when costs are greater than what has been expected.

The sooner these variances can be detected, the sooner management can address the problem and avoid a loss of profit. Unfavorable variances often indicate that something did not go according to plan, financially.

Favorable variances are defined as either generating more revenue than expected or incurring fewer costs than expected.

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.

Remember, variances are expressed at the absolute values meaning we do not show negative or positive numbers. We express variances in terms of FAVORABLE or UNFAVORABLE and negative is not always bad or unfavorable and positive is not always good or favorable.

Keep these in mind:

• When actual materials are more than standard (or budgeted), we have an UNFAVORABLE variance.
• When actual materials are less than the standard, we have a FAVORABLE variance.
• Same rule applies for direct labor. If actual direct labor (either hours or dollars) is more than the standard, we have an UNFAVORABLE variance. A FAVORABLE variance occurs when actual direct labor is less than the standard.