A variance, in accounting, is the difference between a pre-established measure and an actual measure: what a standard, a budget or a plan said, set against what the books recorded. Variance accounting is computing those differences and explaining what caused them, work that also travels under the name variance analysis.
That definition is written into a federal standard rather than left to industry habit. Variance is defined in the Cost Accounting Standards as exactly that difference, alongside standard cost, meaning any cost computed with the use of pre-established measures (section 9904.407-30 of the Cost Accounting Standards). The recorded side of the pair is actuals, the planned side budgeted, which comes out of budgetary planning.
The Formula and the Sign Convention
Every variance is one subtraction, run on one item for one period.
Variance = actual measure - pre-established measureThe definition names the two measures and does not label a direction, so which way round the subtraction runs is a reporting choice that has to be stated. On a cost, an actual measure above the pre-established one is conventionally unfavorable and one below it favorable. On revenue the labels attach to the opposite signs.
Positive is not a synonym for favorable, and the tax rules for the standard cost method are where that bites. A net positive overhead variance there means total standard, or estimated, indirect production costs in excess of total actual, and a net negative one the reverse (Treasury Regulation 1.471-11(d)(3)(i)). Run the subtraction above on a cost and the favorable case, actual below standard, comes out negative, while that regulation calls the same fact a net positive overhead variance, so the two vocabularies attach opposite signs to one thing and a pack mixing them stops being readable.
The Variance Families
A total says little until it is split, and the splits follow the measures the cost was built from. Direct costs carry four of those measures in two matched pairs: a price standard and a quantity standard for material, set out in purchase price variance, and a rate standard and a time standard for labor, set out alongside the budget-versus-standard split in budgeted. One of each pair is expressed in money and the other in physical or temporal units (section 9904.407-30 of the Cost Accounting Standards), and that is the line the family map runs along.
So direct cost variances come in a price half and a quantity half, each holding the other measure constant. On material they are the price variance and the quantity, or usage, variance. On labor they are the rate variance and the time variance, also called the efficiency variance.
Overhead splits on a different axis, because no single unit consumes it directly. The gap between overhead incurred and overhead applied carves into a budget piece, also called the controllable piece, what the pool cost against what the flexible budget allowed for the work actually done, and a volume piece, the activity level the fixed rate was built on against the standard hours that output earned. The arithmetic is in 2-way variance analysis, the rate and base behind it in costing overheads.
Variance in Accounting Versus Variance in Statistics
These are unrelated computations sharing a word. In statistics the variance measures spread inside one data set, roughly the arithmetic average of the squared distance from the mean (NIST/SEMATECH e-Handbook of Statistical Methods, 1.3.5.6, Measures of Scale), while nothing is squared in an accounting variance and there is no data set behind it, only two figures for one item. Two-way variance analysis and the two-way analysis of variance collide the same way, and are pulled apart in 2-way variance analysis.
Where Variance Review Lands in a Firm’s Work
Variance review is a close step rather than a special project, run on the month-end close calendar. What gets written up is decided by a threshold rather than by every difference, because a threshold that catches everything produces a review nobody finishes, and that threshold is an internal reporting choice, not the materiality judgment that governs what a financial report may leave out. What gets compared, and on what basis, is the manager’s choice rather than a framework’s, a freedom worked through in managerial accounting.
Common Questions
No standard fixes a numbered list. The grouping usually meant is by cost element: material, labor and overhead. Split instead by what moved and the three become price, quantity and, on overhead, volume.
Subtract the pre-established measure from the actual measure for one item and one period, then say on the report which direction you are calling favorable. Where the item has a rate and a quantity, run it twice and hold one of them constant each time, which is what separates a price variance from a quantity variance.
In budgeting and reporting it carries the accounting meaning, a planned or standard figure against a recorded one. In quantitative work it carries the statistical meaning, a measure of spread. Only the first has a favorable direction.
Say a client’s approved budget and its posted ledger produce the figures below.
Budgeted software cost $8,000
Actual software cost $9,100
Variance 9,100 - 8,000 = $1,100 unfavorableUnfavorable because it is a cost and the recorded amount came in above the plan.
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