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Cost variance reporting is the calculation and reporting of costs that are different than what was expected by the budget or standard.

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Quick reference

Cost Variance Reporting

Cost variance reporting is the calculation and reporting of costs that are different than what was expected by the budget or standard.

When to Use Cost Variance Reporting

Most businesses provide a monthly cost report for each department that will include variances from the OpPlan.  Some companies also provide a monthly cost report for projects that show the variances from the project budget baseline.

Instructions

Monthly cost reports are generated by finance that indicate how much money was spent in a department or on a project.  The report will typically show how much was spent in the preceding month and how much has been spent since the beginning of the year or project.  These reports will often include a planned or standard amount that the actual costs can be compared to.  When these are compared, the difference is the cost variance.

  • The standard for a department cost report is normally the OpPlan, although occasionally the standard will be the previous year’s costs.
  • The standard for projects is the project budget baseline.
  • Variances are reported in two ways: 1) the current period (month) variance which is the variance that occurred in that month, and 2) the cumulative variance which is the variance that has occurred since the fiscal year or project start.
  • The current period variance is helpful to understand current issues and problems.  However, it is very susceptible to timing issues since if a cost occurs the day before or the day after the period in which it was scheduled, it will show as a current period variance. 
  • The cumulative variance will help to identify trends because it minimizes the effects of timing issues.  However it is not good for identifying recent problems because the long term effects will outweigh the near term effects.
  • There are always minor variances.  Variance reporting starts when the variance exceeds thresholds that are usually set at either an absolute value or a percentage of the costs.   
  • When a variance occurs, there are three potential causes.  The actual cause could be a combination of these.
    • Timing – the variance occurred because a cost happened in a different month than expected.  This variance will disappear over time.
    • The amount of work – this variance occurs because the assumed activity that was in the plan was in error.  The actual activity that is needed is higher or lower and therefore an overrun or underrun will occur.
    • The cost of the resource – this variance occurs when the cost of the resource is different than the assumed cost in the plan.  For instance you planned to have your most senior person do the work, and instead you used a summer intern.  This could create an overrun or underrun.
  • Beware, sometimes the potential causes will cancel each other out in a given period.  This is OK for that period, but if one of the causes was timing, it will eventually be reconciled and then the other variances will be evident.

 

Hints and Tips

  • Most variances are a combination of effects so check each potential type of variance.
  • A variance is not necessarily bad; it just means that it is different than planned.  Analyse and understand the variance to determine its impact.
  • Beware of underruns, they are sometimes due to optimistic “underwork” and that activity will need to be re-accomplished at some later time – potentially causing an overrun.
  • Don’t get too deep or too shallow in your variance reporting.  Report what happened at a level that is appropriate for whoever reads the variance reports.
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  • 00:04 Hello, I'm Ray Sheen.
  • 00:05 I'd like to talk with you about cost variances.
  • 00:08 This is what happens when the actual costs are different than the expected costs.
  • 00:12 Let's take a look at this.
  • 00:15 >> Let's first make sure we are clear on what I mean by variance.
  • 00:18 Variance is the difference between the actual financial performance and
  • 00:21 the standard, or target, performance.
  • 00:24 In the case of financial variance, the standard is normally the budget.
  • 00:27 It is the measure of difference between what actually happened and
  • 00:30 what was expected to happen.
  • 00:31 This is a different definition of variance than what the statistician and
  • 00:35 Six Sigma blackbelts use.
  • 00:37 Variance helps the manager recognize what parts of the business are operating
  • 00:40 as expected from a financial perspective in what parts are different.
  • 00:45 The finance portion of a variance report will typically show the absolute value of
  • 00:48 a variance, and express the variance as a percentage of the total spending.
  • 00:53 I find both helpful.
  • 00:55 Also, the finance portion of the variance report will typically show
  • 00:58 the variance for the current month, and a cumulative variance.
  • 01:01 For a department budget, there's a year-to-date cumulative variance,
  • 01:04 based upon the fiscal year, such as January through July.
  • 01:08 For a project report, it is a project stack to date cumulative variance for
  • 01:12 the entire project.
  • 01:14 This helps the manager understand if a current month variance is a one time event
  • 01:18 or an ongoing trend.
  • 01:21 While finance provides the numbers,
  • 01:22 the operating manager must provide the reasons for the variance.
  • 01:26 Most organizations require that the operational manager provide
  • 01:29 an explanation of the variance as part of the variance report.
  • 01:32 Generally, the organization will have some threshold for
  • 01:35 when a variance analysis is required.
  • 01:37 That threshold could be one of a combination of three approaches.
  • 01:41 First, it could be a fixed money threshold such as $5,000.
  • 01:45 Or it could be a percentage variance, such as 5%.
  • 01:47 In some cases, there is a specific total amount for an account.
  • 01:51 And if the account exceeds that value by even a penny, a variance must be prepared.
  • 01:56 Many companies or business units have external variance thresholds
  • 02:00 when they need to report variances to external stakeholders.
  • 02:03 When that is the case, the company will often set tighter internal thresholds, so
  • 02:07 that the business unit manager can get an early warning of problems.
  • 02:11 And can help resolve the problem before it becomes an externally reportable item.
  • 02:16 Variance reports are often viewed as a burden, but I find them very useful.
  • 02:20 The operational manager is forced to think through what is causing the issue and
  • 02:24 is more likely to take appropriate action.
  • 02:26 Otherwise, there can be a tendency to just shoot from the hip and
  • 02:29 make a bad financial decision.
  • 02:31 So let's look at the reasons for variance.
  • 02:34 Variance comes in three forms.
  • 02:36 The first type is easy to understand.
  • 02:38 Basically, there was a bad estimate concerning the cost of the activity.
  • 02:42 The actual effort was significantly different than what was estimated.
  • 02:45 This variance is likely permanent.
  • 02:47 You can't undo the activity, so you're stuck with the variance.
  • 02:51 If it is isolated to one activity, it's not likely to be repeated.
  • 02:55 The second type is not an effort estimating issue,
  • 02:57 it is a resource assignment issue.
  • 03:00 The resource doing the work costs much more or much less than planned.
  • 03:04 You planned on having your senior subject matter expert do the work,
  • 03:06 and it was actually done by the summer intern.
  • 03:09 The rate of pay is much different.
  • 03:11 This type of variance is also permanent.
  • 03:13 If the different resource will continue to be used,
  • 03:16 this variance is likely to grow over time and become a trend.
  • 03:20 A third type of variance is a timing issue.
  • 03:22 An activity that was scheduled to happen in one month actually occurs in
  • 03:25 a different month.
  • 03:26 The variance normally is not permanent.
  • 03:28 Once the schedules catch up, the variance will go away.
  • 03:32 Let me illustrate how variances can offset and hide a problem.
  • 03:35 Let's say it's the month of May.
  • 03:37 You receive the variance numbers from finance, and
  • 03:39 it looks like everything is good.
  • 03:41 But you know that you had a major activity that was supposed to occur in May, but
  • 03:45 was postponed until June.
  • 03:47 So when you look closer, you find that there is an under-run for
  • 03:49 the activity that didn't happen.
  • 03:51 However, there is a big over-run in a different part of your organization
  • 03:55 that offset that under-run.
  • 03:56 This over-run is due to the use of a very high cost
  • 03:59 contractor to do basic administrator work.
  • 04:02 When the postponed activity occurs in June, the under-run will go away,
  • 04:06 and this over-run will be exposed.
  • 04:09 But if you wait until June, you have an extra month of over-run that
  • 04:12 could have been curtailed if you had done a thorough variance analysis.
  • 04:15 Let's look at an example report.
  • 04:18 As you can see, we have both current month and year-to-date numbers from finance.
  • 04:21 It is common for the current month to have higher percentage variances, and
  • 04:25 year-to-date to have higher actual variances.
  • 04:28 Personnel costs are underrun by about the same percentage in both current month and
  • 04:33 year-to-date.
  • 04:33 This is likely a resource cost issue.
  • 04:36 Travel is overrun in the current month, but underrun for year to date.
  • 04:40 This is likely a timing issue.
  • 04:42 Computers are overrun by large and
  • 04:44 different amounts in the current month and year-to-date.
  • 04:46 This is likely a bad estimate issue.
  • 04:50 Overall, while the department was overrun for
  • 04:52 the month, it is underrun for the year.
  • 04:56 >> So what did we discuss?
  • 04:58 Cost variances will occur.
  • 05:00 To manage the department or a project,
  • 05:02 the manager must understand the sources of those variances.
  • 05:06 Could be a bad estimate, could be a wrong resource, or it could be timing.

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