Unfavorable variance is an important accounting concept describing instances where actual costs exceed standard or projected costs. Identifying an unfavorable variance early can signal management to take corrective actions to protect the company’s profitability.
Key Takeaways
- Unfavorable variance occurs when actual costs surpass standard or projected costs.
- This variance warns management that the company’s profit may be lower than expected.
- It can result from lower revenue, higher expenses, or both.
Comprehending Unfavorable Variance
A budget represents a forecast of revenue and expenses, encompassing both fixed and variable costs. Budgets are crucial for planning future revenue and expenditure, allowing companies to allocate resources effectively.
Companies develop sales budgets, predicting the number of new customers and new product sales. From there, revenue projections and corresponding costs are planned. Upon subtracting fixed and variable costs from total revenue, companies derive net income. If net income falls short of forecasts, it indicates an unfavorable variance.
In simplified terms, an unfavorable variance means the company’s profits did not meet its expectations. The shortfall may stem from increased variable costs or lower-than-anticipated sales figures.
Types of Unfavorable Variances
Unfavorable variances can appear in various contexts such as budgeting or financial planning. When actual results deviate from expectations, the variance can manifest in many ways, but the core fact remains: outcomes did not align with the plan.
For instance, public companies listed on exchanges like the NYSE forecast earnings. Falling short of these forecasts results in unfavorable variance, suggesting higher costs, lower revenue, or subpar sales.
In sales, variance occurs when actual sales volumes fail to meet targets. The management may respond by adjusting staffing, offering performance incentives to the sales team, or enhancing marketing strategies.
In manufacturing, the standard cost of a finished product includes direct material, labor, and overhead costs. Unfavorable variance arises if actual costs exceed these standard costs, often due to rising material costs or inefficient production.
Causes of Unfavorable Variances
Unfavorable variance can result from various economic factors like lower growth, reduced consumer spending, or recessions leading to higher unemployment. Market shifts, such as new competitors or technological advancements rendering products obsolete, can also impact revenue and sales.
Effective management requires analyzing the causes of unfavorable variances. Once pinpointed, essential corrective actions can be taken to realign with the target plan.
Example of Unfavorable Variance
Consider a company that budgeted sales of $200,000 for a period but achieved only $180,000. The unfavorable variance here would be $20,000 or 10%.
Similarly, if expenses were budgeted at $200,000 but actual spending included $250,000, the unfavorable variance would be $50,000 or 25%.
Related Terms: budget variance, fixed costs, variable costs, net income, financial planning.
