Favorable variance definition
/What is a Favorable Variance?
A favorable variance indicates that a business has either generated more revenue than expected or incurred fewer expenses than expected. For an expense, this is the excess of a standard or budgeted amount over the actual amount incurred. When revenue is involved, a favorable variance is when the actual revenue recognized is greater than the standard or budgeted amount.
The reporting of favorable (and unfavorable) variances is a key component of a command and control system, where the budget is the standard upon which performance is judged, and variances from that budget are either rewarded or penalized.
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The Basis for a Favorable Variance
Obtaining a favorable variance (or, for that matter, an unfavorable variance) does not necessarily mean much, since it is based upon a budgeted or standard amount that may not be an indicator of good performance. In particular, favorable variances related to price (such as the labor rate variance and purchase price variance) are only derived from the difference between actual and expected prices paid, and so have no bearing at all on the underlying efficiency of a company's operations.
When to Investigate a Favorable Variance
Budgets and standards are frequently based on politically-derived wrangling to see who can beat their baseline standards or budgets by the largest amount. Consequently, a large favorable variance may have been manufactured by setting an excessively low budget or standard. The one time when you should take note of a favorable (or unfavorable) variance is when it sharply diverges from the historical trend line, and the divergence was not caused by a change in the budget or standard.