Variance Analysis WACE Accounting and Finance Unit 4
“Calculate budget variances for revenue and expenses, classify them as favourable or unfavourable, and explain how variance analysis supports control and decision-making”
A variance is the difference between an actual result and the budgeted figure. A favourable variance improves profit (higher revenue or lower expense than budgeted); an unfavourable variance reduces profit (lower revenue or higher expense). Variance analysis is the control half of budgeting: it tells managers where reality departed from the plan, by how much, and which areas need investigation. Only material variances are normally investigated.
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What this dot point is asking
SCSA wants you to calculate variances, label them favourable or unfavourable using the effect on profit, and explain how they drive corrective action.
What a variance is
A variance is the difference between an actual amount and the corresponding budgeted amount for the same period. Budgeting is the planning phase; variance analysis is the control phase, where actual performance is measured against the plan so management can respond to differences.
Favourable versus unfavourable
The label depends on the effect on profit, not on whether the number went up or down.
For revenue, actual above budget is favourable and actual below budget is unfavourable, because higher revenue lifts profit. For expenses, the logic reverses: actual below budget is favourable (you spent less than planned) and actual above budget is unfavourable (you overspent). The test is always the same: did the difference increase or decrease profit?
Investigating variances
Not every variance matters. Managers apply the principle of management by exception, investigating only variances large enough to be material. A variance prompts questions about its cause: was the budget unrealistic, did input prices change, was efficiency better or worse than expected? The answer guides corrective action, such as renegotiating supply prices or revising the next budget.
Why variances arise
A variance can stem from any of several causes, and identifying the cause is what makes the analysis useful. The budget itself may have been unrealistic, set too optimistically or too cautiously, in which case the fix is a better plan rather than action on operations. Input prices may have changed, so a materials cost overrun could reflect a supplier price rise rather than wasteful use. Efficiency may differ from plan, with more or fewer units produced per hour or per dollar of input. Volume may differ, since selling more or fewer units than budgeted moves both revenue and variable costs. A strong answer does not just label a variance; it suggests a plausible cause and the corrective action it points to, such as renegotiating supply contracts, retraining staff, or revising the next budget. This is the feedback loop at the heart of management accounting.
A variance is not automatically a sign of poor management. A favourable variance can be just as worth investigating as an unfavourable one, because it may reveal that the budget was set too cautiously, or that quality was cut to save cost. Variances should also be read together rather than in isolation, since a favourable expense variance achieved by underspending on maintenance may cause larger unfavourable variances in later periods. Used well, variance analysis closes the loop between planning and control: the budget sets the target, the variance measures the gap, and the response feeds back into the next budget so that future plans become more realistic.
Orin Ltd budgeted sales of $400 000 and total expenses of $310 000, for a budgeted profit of $90 000. Actual sales came in at $385 000 and actual expenses at $300 000.
Sales variance: actual $385 000 less budget $400 000 is $15 000 below budget. Because lower revenue reduces profit, this is a $15 000 unfavourable variance.
Expense variance: actual $300 000 less budget $310 000 is $10 000 below budget. Because spending less raises profit, this is a $10 000 favourable variance.
Actual profit is , against budgeted $90 000, a $5 000 unfavourable profit variance. This reconciles: the $15 000 unfavourable sales variance partly offset by the $10 000 favourable expense variance nets to $5 000 unfavourable, telling management the shortfall came from weaker sales rather than cost control.
Students often call any increase favourable and any decrease unfavourable, which is correct for revenue but backwards for expenses. Spending more than budgeted is unfavourable because it reduces profit, even though the number rose. Always classify by the effect on profit: higher revenue or lower expense is favourable.
Exam-style questions
Questions in the style of SCSA exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
WACE 2022-style7 marksSelby Ltd budgeted sales of $500 000 and total expenses of $380 000. Actual sales were $520 000 and actual expenses $400 000. Calculate the sales variance, the expense variance and the profit variance, classify each as favourable or unfavourable, and show how they reconcile.Show worked answer →
A 7 mark response needs all three variances, correct labels, and the reconciliation.
Sales variance. Actual 500,000 above budget. Higher revenue raises profit, so this is $20,000 favourable.
Expense variance. Actual 380,000 above budget. Spending more reduces profit, so this is $20,000 unfavourable.
Profit variance. Budgeted profit . Actual profit . Profit variance is nil.
Reconciliation. The 20,000 unfavourable expense variance, netting to zero, which is why actual profit equals budgeted profit despite both lines differing. Markers reward correct labels (favourable for higher sales, unfavourable for higher expenses) and the netting reconciliation.
WACE 2023-style5 marksExplain the principle of management by exception in variance analysis, and explain why a favourable variance may still be worth investigating.Show worked answer →
A 5 mark response needs the principle and the favourable-variance point.
Management by exception. Managers do not investigate every variance, only those large enough to be material. Small, expected fluctuations are ignored so attention and resources focus on the significant departures from plan that are most likely to need corrective action.
Favourable variances. A favourable variance is not automatically good news. It may reveal that the budget was set too cautiously and needs revising, or that a cost was cut in a way that harms the business, for example underspending on maintenance now causing larger unfavourable variances later, or cutting quality to save cost. Investigating favourable variances can therefore protect future performance. Markers reward the materiality-based exception principle and a valid reason a favourable variance deserves scrutiny.