7.3 Calculating Variances: Totals, Adverse or Favourable, and Percentages

7.3 Calculating Variances: Totals, Adverse or Favourable, and Percentages

Key Concept: A variance is the difference between a budgeted figure and the actual result. PCTN asks you to compare actual results with a fixed budget for a single product and then do four things: calculate the total variance for materials, labour, overheads and income, label each one adverse or favourable, express it as a percentage of the budgeted figure, and decide which variances are significant enough to report.

The PCTN specification (learning outcome 3.1) requires you to understand how to decide whether a variance is adverse or favourable. It also requires you to calculate variances between actual and budgeted total materials, total labour, total overheads and total income, and to express each variance as a percentage of the budgeted cost or income. In AAT's review of the October 2023 examiner reports, "budget calculations and exception reporting using formulas" was one of the three weakest PCTN tasks, so this section is worth practising until it is automatic.

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Adverse or Favourable?

A variance is described by its effect on profit:

Always ask "did this line make profit better or worse than planned?" Students who try to memorise "higher is adverse" get income variances wrong, because higher income is good news.

In a variance report the variance is normally shown as a positive amount with a label. For example, write "£2,880 A". Do not write "−£2,880", unless a task specifically asks for a signed figure.

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The Variance Percentage

The percentage tells management how big the variance is relative to what was planned:

$\text{Variance \%} = \frac{\text{Variance}}{\text{Budgeted figure}} \times 100$

The denominator is always the budgeted figure, never the actual figure. A £900 overspend on a £3,000 budget (30%) is far more alarming than a £900 overspend on a £90,000 budget (1%), and the percentage makes this visible at a glance. Round as the task instructs, commonly to the nearest whole percentage or to one or two decimal places.

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Worked Example: Pennine Pies Ltd

Pennine Pies Ltd makes one product, a boxed steak pie. Its fixed budget and actual results for March are below.

Working through each line:

1. Sales revenue: actual £126,000 is £6,000 more than budget. More income means more profit, so the variance is favourable. £6,000 ÷ £120,000 × 100 = 5.0%.
2. Direct materials: actual £38,880 is £2,880 more than budget, so the variance is adverse. £2,880 ÷ £36,000 × 100 = 8.0%.
3. Direct labour: actual £27,160 is £840 less than budget, so the variance is favourable. £840 ÷ £28,000 × 100 = 3.0%.
4. Fixed overheads: actual £19,800 is £1,800 more than budget, so the variance is adverse. £1,800 ÷ £18,000 × 100 = 10.0%.
5. Total costs: £85,840 − £82,000 = £3,840 adverse, which is 4.68% of budget (4.7% to one decimal place).
6. Profit check: £6,000 F − £2,880 A + £840 F − £1,800 A = £2,160 F, which agrees with £40,160 − £38,000. Always do this cross-check. If the profit variance does not reconcile, one of the line variances has the wrong label.

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Setting the Calculation Out in a Spreadsheet

PCTN often asks for these calculations as spreadsheet formulas. Suppose the budget for direct materials is in cell B5, the actual figure in C5, the variance in D5 and the percentage in E5:

Choose the order of subtraction that gives a positive variance, then add the A or F label in the adjacent column. Section 8.4 explains the formula formats that AAT will and will not credit.

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Why PCTN Uses a Fixed Budget, and Its Limitation

At this level, variances are calculated against the fixed budget, which was set for one planned level of activity. If actual output differs from planned output, part of each cost variance is simply caused by making more or fewer units. For example, if Pennine Pies made 5% more pies than planned, some of the £2,880 adverse materials variance would be expected. Section 7.2 explains how a flexible (flexed) budget removes that volume effect. PCTN requires you to understand the difference between the two budgets. Its calculation tasks, however, compare actual results with the fixed budget.

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Beyond PCTN: Sub-Variances

Standard costing systems split each total variance further. A total materials variance can be split into a price variance and a usage variance, and a total labour variance into a rate variance and an efficiency variance. These splits are not part of the PCTN specification, which asks for total variances. They are useful background when you explain causes in a variance report, though. For example, if a total materials variance is adverse, the cause could be that more material was used, that a higher price was paid, or both.

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Common Exam Traps

• Labelling income variances backwards. Actual income above budget is favourable.
• Dividing by the actual figure. Variance percentages use the budgeted figure as the denominator.
• Netting different lines together. Report each line separately. A favourable labour variance does not cancel an adverse materials variance in the line-by-line report.
• Ignoring rounding instructions. If the task says "to the nearest whole percentage", enter 8, not 8.0 or 7.99.
• Forgetting the profit cross-check. The line variances should reconcile to the difference between budgeted and actual profit.