What is a Spending Variance?

A spending variance is the difference between the actual and expected (or budgeted) amount of an expense. By calculating this variance, you can gain a better understanding of your organization’s level of purchasing and operating efficiency. This is useful information for managing and budgeting for a business. For example, if a company incurs a $500 expense for utilities in January and expected to incur a $400 expense, there is a $100 unfavorable spending variance. The spending variance concept is commonly applied to the areas noted below.

Direct Materials Spending Variance

The spending variance for direct materials is known as the purchase price variance, and is the actual price per unit minus the standard price per unit, multiplied by the number of units purchased. The formula is:

(Actual price - Standard price) x Actual quantity = Purchase price variance

Direct Labor Spending Variance

The spending variance for direct labor is known as the labor rate variance, and is the actual labor rate per hour minus the standard rate per hour, multiplied by the number of hours worked. The formula is as follows:

(Actual rate - Standard rate) x Actual hours worked = Labor rate variance

Fixed Overhead Spending Variance

The spending variance for fixed overhead is known as the fixed overhead spending variance, and is the actual expense incurred minus the budgeted expense. The formula for this variance is as follows:

Actual fixed overhead - Budgeted fixed overhead = Fixed overhead spending variance

Variable Overhead Spending Variance

The spending variance for variable overhead is known as the variable overhead spending variance, and is the actual overhead rate minus the standard overhead rate, multiplied by the number of units of the basis of allocation (such as hours worked or machine hours used). The formula is as follows:

Actual hours worked x (Actual overhead rate - standard overhead rate)
= Variable overhead spending variance

Administrative Overhead Spending Variance

The variance calculation is normally applied to each individual line item within this general category of expense.

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Favorable and Unfavorable Spending Variances

Whenever the actual expense is greater than the budgeted or standard expense, the difference is called an unfavorable variance. The reverse is called a favorable variance.

An unfavorable spending variance does not necessarily mean that a company is performing poorly. It could mean that the standard used as the basis for the calculation was too aggressive. For example, the purchasing department may have set a standard price of $2.00 per widget, but that price may only be achievable if the company purchases in bulk. If it instead purchases in small quantities, the company will likely pay a higher price per unit and incur an unfavorable spending variance, but will also have a smaller investment in inventory and a lower risk of inventory obsolescence.

Thus, any spending variance should be evaluated in light of the assumptions used to develop the underlying expense standard or budget.