Basic Cost Accounting Variance Analysis
Examples of Cost and Volume Variances from Standards
Nov 3, 2009
One of the keys to a successful business is cost management. Well-run companies know what it costs to make a product or service, and can identify when there are issues that result in higher expense than expected.
Having well developed processes and standards allow a business to determine variances. Two of the most important variances in production are cost and volume variances.
Establishing Cost Accounting Standards
In order to have useful variance analysis, businesses must first build good standards. These can be based on the budget, or some other valid measure. The standards need to identify the expected volume and cost for each service that is performed by the business.
As an example, a manufacturing company makes golf balls. In a normal year, the company will make 1,000 balls, and the total cost of the operation is $100,000. Therefore, the standard cost of a golf ball is $100.
Cost Variance Analysis
If, at the end of the year, the company has produced 1.000 golf balls at the cost of the $100,000, they have performed exactly at the standard, and no variance calculation is necessary. This is an unlikely situation, since things rarely turn out exactly as planned.
If the company does make 1,000, but due to an unplanned salary increase, the total cost is $105,000, the actual cost per golf ball is $105. The variance of $5,000 is completely explainable by the $5 negative cost variance per ball.
Volume Variance Analysis
If the business has a good year, and need to make 2,000 golf balls, but improvements in productivity result in cost staying the same at $200,000, the average cost per ball is still $100. The cost increase of $100,000 is explainable by the volume variance of 1,000 units.
The issue becomes complicated with there is both a cost and volume variance, as there would likely be in most real-life situations. Consider if the company made 1,500 golf balls, but the total cost for the operation was $250,000.
There is a total expense variance of $150,000. The standard cost for a golf ball was $100. This is multiplied times the volume variance in units. $100 times 500 units equals $50,000. Therefore there is a positive volume variance of $50,000. This is subtracted from the $150,000 to arrive at the negative cost variance of $100,000.
It is desirable to have positive cost and volume variances, since that shows improvements in both efficiency and production over standards. These are simple examples, since few companies make one item, and cost must be allocated over many items, but the basic concepts of cost accounting are the same, no matter how large the business.
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