What Is a Favorable Variance in Accounting?

A variance represents the difference between a planned or budgeted financial amount and the actual amount achieved. Businesses regularly compare these figures to understand their financial performance and operational efficiency. Analyzing these differences helps management identify areas performing as expected or requiring closer attention.

Defining Favorable Variance

A favorable variance occurs when actual financial results are better than what was initially budgeted or expected. This positive outcome can arise in two primary ways, both indicating a beneficial impact on a company’s financial standing. One common scenario is when actual revenue collected exceeds the amount that was projected. For instance, if a company planned to sell 1,000 units but sold 1,200 units, the higher sales volume would create a favorable revenue variance.

The other situation for a favorable variance involves actual expenses being less than the budgeted amount. An example might be a manufacturing firm that budgeted $50,000 for raw materials but only spent $45,000 due to efficient purchasing or a price reduction from suppliers. In both revenue and expense scenarios, a favorable variance generally contributes to higher net income or improved profitability.

Calculating and Interpreting Favorable Variances

Calculating a variance typically involves subtracting the budgeted amount from the actual amount. For revenue, if actual sales were $12,000 and budgeted sales were $10,000, the calculation would be $12,000 – $10,000, resulting in a favorable variance of $2,000. Similarly, for expenses, if actual utility costs were $400 and budgeted utility costs were $500, the calculation would be $400 – $500, yielding a favorable variance of negative $100.

This negative result for expenses is favorable, as spending less money is desirable. While a favorable variance generally signals positive performance, understanding its underlying cause is important for proper interpretation. For example, a favorable labor cost variance might stem from increased employee efficiency or, conversely, from using fewer skilled, lower-paid workers, which could affect product quality.

Favorable Versus Unfavorable Variances

The concept of a favorable variance is often contrasted with an unfavorable variance, which signifies that actual results are worse than what was planned. An unfavorable variance occurs when actual revenue falls short of the budget or when actual expenses exceed the budget. For example, if a company budgeted for $8,000 in sales but only achieved $7,000, that $1,000 shortfall would represent an unfavorable revenue variance.

Conversely, spending more than planned, such as actual advertising costs of $3,000 against a budget of $2,000, would result in an unfavorable expense variance of $1,000. These terms, “favorable” and “unfavorable,” are accounting conventions used to describe the financial impact of the variance on a company’s profitability. They indicate whether the deviation from the budget improved or worsened the financial outcome, guiding management’s decisions and future planning.