Unfavorable Variance Definition Types Causes and Example
Unfavorable Variance: Definition, Types, Causes, and Example
Contents
What Is Unfavorable Variance?
Unfavorable variance is an accounting term that describes instances where actual costs exceed the standard or projected costs. It alerts management that the company’s profit will be lower than expected. Detecting an unfavorable variance early allows for prompt problem-solving.
Key Takeaways
- Unfavorable variance refers to instances where actual costs are higher than standard or projected costs.
- It alerts management that the company’s profit will be less than expected.
- An unfavorable variance can result from lower revenue, higher expenses, or a combination of both.
Understanding Unfavorable Variance
A budget forecasts revenue and expenses, including fixed and variable costs. Budgets help corporations plan for the future by projecting revenue generated from sales. This enables companies to allocate spending for projects and investments.
Companies create sales budgets to forecast sales from new products and services. Based on this forecast, the company determines revenue and the associated costs. Net income or profit is projected by subtracting fixed and variable costs from total revenue. If the actual net income is lower than projected, an unfavorable variance occurs.
An unfavorable variance indicates a lower net income than anticipated, but not necessarily a loss. Factors contributing to an unfavorable variance can include higher expenses, lower revenue, or a combination of both. For example, an increase in the cost of raw materials or lower sales numbers can contribute to an unfavorable variance.
Types of Unfavorable Variances
Unfavorable variances take different forms or definitions, but they all describe deviations from plan. For financial planning and analysis scenarios, unplanned deviations invite the same managerial reactions as in other business applications.
In finance, unfavorable variance occurs when an actual outcome is less favorable than the projected outcome. Companies that fail to meet their earnings forecasts experience this unfavorable variance due to higher costs, lower revenue, or lower sales.
A sales variance occurs when projected sales volumes do not meet goals. In manufacturing, an unfavorable variance is the result of rising costs for direct materials or inefficient production operations.
Causes of Unfavorable Variances
Unfavorable variances can stem from changing economic conditions, such as lower economic growth or lower consumer spending. Market conditions can change with the entry of new competitors or advancements in technology, making products obsolete.
It is crucial for management teams to analyze unfavorable variances and identify their causes. This allows companies to make necessary changes and realign with their plans.
Example of Unfavorable Variance
For example, a company projected sales of $200,000 for a period but only generated $180,000. This creates an unfavorable variance of $20,000 or 10%.
In a similar case, if projected expenses were $200,000 but actual expenses reached $250,000, an unfavorable variance of $50,000 or 25% occurs.
