10.15: Favorable versus Unfavorable Variances
Learning Outcomes
- Differentiate between favorable and unfavorable variances
Favorable and unfavorable variances can be confusing. As a manager at a local movie theatre, you notice the expense for popcorn was way higher than budgeted, causing an unfavorable variance in that expense line. But, you also see a much higher revenue line for popcorn! So, the revenue variance is favorable. How can you calculate whether the increase in expense and the increase in revenue make sense?
Let’s go back now to our Simply Yoga example. Remember we have some variances we identified as favorable, and some unfavorable. Here is the flexible budget as a reminder:
| Simply Yoga Flexible and Planning Budget | ||||
|---|---|---|---|---|
| Planning Budget | Flexible Budget | Activity Variance | Favorable or Unfavorable | |
| Classes taken | 500 | 600 | ||
| Revenue ($14/class) | $7,000 | $8400 | $1400 | Favorable |
| Expenses | ||||
| Wages and Salaries | $3500 | $4200 | $700 | Unfavorable |
| Yoga supplies | $250 | $300 | $50 | Unfavorable |
| Utilities | $500 | $600 | $100 | Unfavorable |
| Rent | $500 | $500 | ||
| Insurance | $100 | $100 | ||
| Other Expenses | $250 | $300 | $50 | Unfavorable |
| Total Expense | $5,100 | $6,000 | $900 | Unfavorable |
| Net Operating Income | $1900 | $2400 | $500 | Favorable |
Favorable variances are defined as either generating more revenue than expected or incurring fewer costs than expected. Unfavorable variances are the opposite. Less revenue is generated or more costs incurred. Either may be good or bad, as these variances are based on a budgeted amount.
As an example, when Simply Yoga had more students attend classes, their wages and salaries line went up, creating an unfavorable variance. As you can see, their revenue was substantially higher, so that favorable variance more than offsets the unfavorable variance of the additional wages!
So you can see here, that Simply Yoga showed some unfavorable variances in their expenses, but had an overall favorable change in their net operating income! So favorable or unfavorable variances don’t mean much if you look at them individually. We need to look at the whole picture!
If the number of classes had remained at 500, and we still saw the increase in wages, there would be more cause for concern., right? But, what if the wages had gone up, more than the increase in revenue? Each favorable and unfavorable variance needs to be examined individually, as noted in the popcorn example in the video! Analysis is the key to making sure that increases (favorable variances) in revenue or increases (unfavorable variances) in expenses are appropriate.
We need to review what would be the expected increase in expense, based on the increase in classes, or popcorn sales or item sales. In the Simply Yoga example, for each $14 increase in revenue (one additional class taken), we would expect a $7 increase in payroll expense, since we pay our instructors $7 per student for each class taken. If we would have seen a different increase in expense, it would have been cause for concern, and further review. Thinking back to our example, where each instructor is paid a minimum of $84 per class (12 students), if we had increased our number of classes, thus more classes were attended, but each of those classes was only getting 8 students, we may have seen the following:
| 10 additional classes x 8 students each | $1,120 additional revenue |
| 10 classes x $84/instructor | $840 additional payroll expense |
We would have expected and additional $560 in payroll expense, so we have an unfavorable variance of $280 of additional expense, even adjusting for the additional revenue.
In this case, we would need to examine which classes we would like to keep on the schedule, and which to eliminate. More decisions will need to be made with this new information!
Practice Questions