Unfavorable Variance

An unfavorable variance is a difference between an actual result and a budgeted, forecast or standard amount that makes profit lower than expected. For costs, it arises when actual spending exceeds the budget or standard; for revenue, when actual revenue falls short. In British and international usage it is usually called an adverse variance. Variances are commonly labeled U for unfavorable or F for favorable in management reports.

Variance analysis is a core part of managerial accounting. Comparing actual results with the budget or with standard costs shows managers where performance differed from plan, so they can investigate causes and take action. The opposite outcome, which increases profit, is a favorable variance.

• Revenue: actual revenue below budget, for example because of lower volumes or lower selling prices.
• Costs: actual costs above budget or standard, for example because of higher input prices, more materials or labor used, or higher manufacturing overhead spending.
• Profit: actual operating income below budget, the combined effect of revenue and cost variances.

For a cost item:

Here a positive result is unfavorable because more was spent than planned, and a negative result is favorable. For revenue, the sign is reversed: actual revenue below budget is unfavorable.

A furniture maker's standard for one table is 20 board feet of walnut, its main direct material, at $9.00 per board foot, or $180. In March it makes 400 tables, so the standard cost of walnut is $72,000. It actually uses 8,600 board feet bought at $9.40, costing $80,840. The total materials variance is $8,840 unfavorable. Breaking it down:

• Price variance: ($9.40 minus $9.00) times 8,600 is $3,440 unfavorable, because walnut cost more per board foot.
• Quantity variance: (8,600 minus 8,000) times $9.00 is $5,400 unfavorable, because 600 more board feet were used than the standard allows.

The purchasing manager is asked about the price rise, which turns out to reflect a market-wide shortage. The production manager is asked about the extra usage, which is traced to a new employee cutting inefficiently. Different causes call for different responses: renegotiating supply or adjusting prices for the first, training for the second.

An unfavorable variance is a signal to investigate, not proof of poor performance. Possible explanations include:

• Higher activity: costs naturally rise when output exceeds the plan. Comparing actual costs with a flexible budget for the actual output removes this effect.
• Outside factors: inflation, supplier price rises, exchange rate movements or new regulations may be beyond managers' control.
• Unrealistic standards: ideal standards that assume perfect conditions produce unfavorable variances almost every month.
• Trade-offs: an unfavorable labor variance may result from using more skilled staff, who in turn produce a favorable materials variance through less waste.
• Recording errors: misposted invoices or cut-off mistakes can create variances that are not real.

Managers focus on variances that are large in amount or percentage, persist over several periods, or relate to costs they control. This management-by-exception approach saves time but depends on setting sensible thresholds, such as investigating any variance over 5 percent or $10,000.

In a standard costing system, unfavorable variances are recorded as debits in variance accounts. At the period end they are usually closed to cost of goods sold, increasing it, or prorated among inventory and cost of goods sold if they are material. For external financial statements, inventory must reflect approximately actual cost, so large variances cannot simply be left out. Overall budget variance reports summarize favorable and unfavorable variances for each department, helping senior management see whether problems are isolated or widespread. Persistent unfavorable variances may also indicate budgetary slack in other areas or a need to revise standards.