A cost variance is the difference between the cost actually incurred and the budgeted or planned amount of cost that should have been incurred. Cost variances are most commonly tracked for expense line items, but can also be tracked at the job or project level, as long as there is a budget against which it can be calculated.
Some cost variances are formalized into standard calculations. The following are examples of variances related to specific types of costs:
- Direct material price variance
- Fixed overhead spending variance
- Labor rate variance
- Purchase price variance
- Variable overhead spending variance
There is a negative cost variance when the actual cost incurred is greater than the budgeted amount. There is a positive cost variance when the actual cost incurred is lower than the budgeted amount.
Cost variances are usually tracked, investigated, and reported on by a cost accountant. This person determines the reason why a variance occurred and reports the results to management, possibly along with a recommendation for changing operations to reduce the size of the variance (if negative) in the future.
It is not always useful to bury management with an analysis of every possible variance. Instead, the cost accountant should determine which ones are large enough to be worth their attention, or if there is some action to be taken to improve the situation. Thus, a cost variance report should only include a few items each month.
It is important to note that not all negative cost variances are bad. Spending more money in one area may create a positive cost variance somewhere else. For example, it might be necessary to spend twice as much on preventive maintenance to avoid a much greater total expense associated with replacing fixed assets more frequently. Thus, it is sometimes better to review cost variances from the level of an entire department, facility, or product line, rather than at a more detailed level. This higher level of analysis gives managers room in which to allocate funds in a manner designed to improve total profits.