Cost Variance Analysis: Essential for Expense Management
In the realm of financial management, variance analysis plays a crucial role in uncovering deviations from budgeted performance. Two types of variances that are particularly important are Spending Variance and Activity Variance.
Difference between Spending Variance and Activity Variance
Spending Variance, also known as cost or price variance, measures the difference between the actual cost incurred and the cost that should have been incurred for the actual level of activity. It highlights whether costs were higher or lower than expected for the volume of output actually achieved. On the other hand, Activity Variance measures the effect of the difference between the budgeted level of activity and the actual level of activity on costs or revenues. It shows the financial impact solely due to doing more or fewer units or activity than planned, assuming costs per unit/activity remain as budgeted.
How they are calculated
Activity Variance
The calculation for Activity Variance is as follows:
This variance reflects how much of the total variance is due to having different levels of activity than planned.
Spending Variance
The calculation for Spending Variance, sometimes called flexible budget variance, is as follows:
This compares what was actually spent to what should have been spent at the actual level of activity, indicating cost control effectiveness.
How they are analyzed
Activity Variance
An favorable Activity Variance means more activity was undertaken (e.g., more units sold or produced), usually resulting in higher revenue or costs, while an adverse variance means less activity than planned.
Spending Variance
Spending Variance explains if costs per unit/activity were higher or lower than expected. It can be further analyzed into price/rate variance and efficiency variance to understand if price changes or inefficient resource usage caused differences.
Summary table
| Variance Type | Measures | Calculation | Interpretation | |-----------------|------------------------------------------------|-----------------------------------------------------|------------------------------------------------| | Activity Variance| Effect of difference in volume/activity | (Actual Activity - Budgeted Activity) × Standard Cost | Shows cost/revenue impact of activity level differences | | Spending Variance| Cost difference controlling for activity level | Actual Cost - (Actual Activity × Standard Cost) | Shows efficiency or price control effectiveness |
Example
Consider a company that budgeted to produce 1,000 units at $5 each (budgeted cost $5,000), but actually produced 1,200 units.
- Activity variance = (1,200 - 1,000) × $5 = $1,000 (favorable if revenue, or increased cost if cost variance)
- If actual cost was $6,300, spending variance = $6,300 - (1,200 × $5) = $6,300 - $6,000 = $300 adverse (indicating cost control issues).
This distinction allows managers to separate cost changes due to volume differences from those due to costing inefficiencies or pricing differences, which is critical for effective budgetary control and performance analysis.
Activity variance is a tool for cost management, helping to identify areas of overspending or underutilization of resources. Variance analysis, in essence, serves as a financial GPS, guiding through company performance.
In the context of financial management, Spending Variance, also known as cost or price variance, is a valuable tool for identifying whether costs were higher or lower than expected for the actual volume of output achieved. On the other hand, Activity Variance, calculated by comparing actual activity to budgeted activity and measuring the effect on costs or revenues, reveals the financial impact of doing more or fewer units or activities than planned, assuming costs per unit/activity remain as budgeted. These variances are integral to both business and education-and-self-development, particularly in the realm of finance, as they provide insights into managing costs, resources, and performance effectively.
