Organizations must closely monitor their spending in order to ensure they remain within budget and that their resources are being used in the most cost-effective manner. This is true for both operating and capital expenses. As such, it is important to understand and analyze the spending variance, or the difference between the amounts budgeted for a specific item and the actual amount spent. It is critical for an organization to pay attention to spending variances in order to identify a problem before it becomes too large. In this blog post, we will explore the implications of spending variance and how organizations can best manage and prevent it. We will review the causes of spending variance, how it can be calculated, and the importance of actively monitoring it. Additionally, we will cover best practices for dealing with spending variances and how organizations can leverage technology to help them manage and monitor spending. By the end of this blog post, readers will have a better understanding of spending variance and the impact it can have on an organization.
- Actual cost – expected cost = spending variance.
- (Actual variable overhead rate – expected variable overhead rate) x hours worked = variable overhead spending variance.
For which expenses can you calculate spending variance?
Applying the spending variance calculation to many costs your client might incur while running their business is fairly simple. Here is a closer look at some of the more typical expense categories that you can use to determine spending variance for:
Variable overhead
The total cost of running a business that is unrelated to the goods and services it offers is referred to as variable overhead. To show your client the cost of overhead expenses based on the number of hours their employees or equipment work to complete overhead operations, you can compute the variable overhead spending variance. The formula for calculating variable overhead is:
Variable overhead spending variance = (Actual variable overhead rate – Expected variable overhead rate) x hours worked.
Fixed overhead
Operating expenses without the variable of labor hours are referred to as fixed overhead costs. This fixed amount includes recurring costs like building rent or employee salaries within a company. Using this fixed overhead spending variance formula, you can assess whether your client knows where their expenses are going on a regular basis and how they can produce more positive variances:
Fixed overhead spending variance is equal to the difference between actual and expected fixed overhead costs.
Administrative overhead
Taxes, office supplies, and other administrative costs that support a business’ operations are included in administrative overhead expenses. To adjust administrative spending and make sure the proper amount of money is allocated to these crucial operating expenses, it is crucial to calculate administrative overhead spending variance. Usually, you can calculate the individual spending variances for each item within the administrative overhead expenses using the basic spending variance formula.
Purchase price
The actual and anticipated costs of direct materials, which are the materials used to produce the goods or provide the services that your client company sells, are taken into account when calculating the purchase price spending variance. Your client must comprehend their purchase price spending variance in order to maximize their direct material cost savings and profit. Calculate the purchase price spending variance with the following formula:
(Actual price per material – Expected price per material) x the quantity of materials bought equals the variance in the purchase price.
Labor rate
The cost of hiring labor to produce the goods or provide the services for your client’s business to sell is another expense for many businesses. Your client can decide whether they can negotiate better rates or change their production to maximize profit for their business by being aware of the spending variance for labor rates. Calculate the labor rate spending variance for your clients using the following formula:
The labor rate spending variance is equal to (Actual labor rate – Expected labor rate) x the number of hours worked.
What is spending variance?
Spending variance is the difference between what someone actually paid for something (the actual cost) and what they anticipated it would cost (the expected cost). The spending variance of a company aids in determining whether it is operating effectively or whether its standards for budgeting and calculation are reliable. This enables you and your client to reevaluate the production costs and how much they spend on operating.
There are numerous ways to calculate spending variance for various types of expenses, but the fundamental formula is as follows:
Actual cost – expected cost = spending variance
How to calculate spending variance
Take into account the following steps to assist you in calculating spending variance for your clients’ expenses:
1. Determine which expenses youre calculating
Choosing which of your clients’ expenses you want to review is the first step in calculating spending variance. Knowing early which expenses you want to calculate spending variance for is important because the formulas for each type of expense may differ slightly. Find the information for those expenses to aid in your calculations by taking into account the information you hope to learn from the spending variance calculation.
2. Define the actual cost
Define the actual cost for those expenses, or the sum your client paid for a good or service, after choosing the category of expenses for which you want to calculate spending variance. This sum may represent the total cost or just a single expense, such as the hourly wage or the cost of a single item. Typically, your clients’ financial records contain this information, which you can use to begin your spending variance calculations.
3. Define the expected cost
The expected cost is the amount your client anticipated paying for a good or service, which could indicate that they made a financial estimate or budgeted a certain sum of money. Similar to actual cost, expected cost may represent the total cost of a number of goods or services or a single unit. Talk with your client and examine their financial records and budgets to learn how much they anticipated an item or service would cost them in order to determine the expected cost.
4. Find out any additional variables
To give you a more complete picture of the cost difference between what your client anticipated and what they actually paid, some expenses call for variables in their spending variance calculations. These factors can be specifics like the quantity of items purchased or the number of hours worked, as in the calculation of the labor rate spending variance or the purchase price spending variance, respectively. When deciding whether to include more variables in your calculations, take into account the type of expense you are reviewing.
5. Perform the calculation for your chosen expense
Calculate the discrepancy between the actual cost and the expected cost of the services or items using the specific spending variance formula for your chosen expense. If the outcome is positive, your client is staying within their budget and spending less than they had anticipated. If the result is negative, however, they might want to reevaluate how they are spending their money. With this knowledge, you can support your client in making wise financial decisions for their business to increase profits.
Examples of spending variance
You can learn how to use spending variance to your client’s company’s advantage by studying the spending variance examples below:
Example 1
Your client creates a budget for their office building’s renovations, utilities, and rent. The total budget, or anticipated cost, for these items for the year is $58,000. The actual cost of these items at the end of the year is $56,000. You calculate the spending variance using the formula below and the fixed overhead spending variance:
$58,000 – $56,000 = $2,000
Example 2
Your client increases factory staff during the busy season to increase production. When they finally hire the employees to work 40 hours per week for eight weeks, they find that the actual cost of their pay is $18 per hour, even though they budgeted for the employees to cost $15 per hour. Using the purchase price spending variance formula, you can calculate the spending variance as follows:
($15 – $18) x 320 = -$960
Example 3
You evaluate the administrative expenses your clients incurred as a result of purchasing new office equipment at the conclusion of their fiscal year. They anticipated a new printer to cost $500, a new copier to cost $400, and a set of new computers to cost $2,000 when you look at their budget. The printer, copier, and computers actually cost $600, $300, and $2,500 respectively. Here is how to calculate their spending variance using the administrative overhead spending variance formula:
$500 – $600 = -$100 for the printer
$400 – $300 = $100 for the copier
$2,000 – $2,500 = -$500 for the computers
How to Calculate a Spending Variance (Example)
FAQ
How do you determine if a spending variance is favorable or unfavorable?
A favorable variance is when revenues exceed expectations or actual expenses fall short of expectations. Unfavorable variances are times when costs exceed what was anticipated in your budget.
Is spending variance the same as rate variance?
A spending variance, also referred to as a rate variance, is the discrepancy between an expense’s actual and budgeted amounts. If a company spends more than anticipated on utilities in January ($250 instead of $150), there is a $100 negative spending variance.
What is revenue and spending variance?
The difference between the flexible budget and the actual results—often referred to as revenue and spending variances—results from variations in revenue per unit, cost per unit, and/or the total amount of costs incurred
What does a favorable spending variance mean?
A variance should be indicated appropriately as “favorable” or “unfavorable. “A favorable variance occurs when revenue exceeds budget or when expenses are less than anticipated. The result could be greater income than originally forecast.
