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Variance Analysis Model in Accounting

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  • 0:03 Variance Analysis Modeling
  • 0:56 Direct Materials Variances
  • 1:56 Direct Labor Variances
  • 2:34 Overhead Variances
  • 3:20 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Budgets and variances are useful, but if you really want to see just how effective your organization is at making use of that information, then you're going to want to learn about variance analysis modeling.

Variance Analysis Modeling

By now, there's probably a pretty good chance that you know what a variance is in accounting. In case you forgot, a variance is the difference between the budgeted amount and the actual amount that was spent on a good, service, or action. As you probably also know, variances are a big deal to businesses, because they help you figure out where budgets go wrong. As anyone knows who has ever tried to manage a household budget and found that the electricity bill was twice as much as planned, being able to track variances is a valuable skill.

You can do this more effectively with variance analysis modeling, by which we track variances over time to notice any trends that are developing. In this lesson, we'll apply variance analysis modeling to three different categories of variances, providing examples of where each can happen along the way.

Direct Materials Variances

First of all, let's start with variance analysis modeling of direct materials variances. Remember that direct materials variances occur when the budgeted amount for materials differs from what was actually spent. To do this, we first of all need our variances. To keep things simple, let's only track three different times, and we'll look at total materials as a whole. Here's our chart:

Quarter Variance
Q1 -$1,000
Q2 -$500
Q3 $100

Notice how each time the variance gets more and more favorable, until it is once again positive. Remember that a positive number is a favorable variance, in which the company saved money, while a negative number is an unfavorable variance, in which the company lost money. The bigger the number, the further off your budget was. As you move towards zero, you are becoming more accurate and are better able to allocate resources to get more done.

If you wanted to, you could graph this knowledge, but I think it's pretty apparent that whoever is doing the budgeting for the direct materials is mindful of limiting variances and providing the best information possible.

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