Cost variance (CV) is difference between planned cost (or budgeted cost) and actual cost incurred. It is a very important tool for managers or accountants to identify over expenditure and further investigate the reason of it to take necessary measures. It can be used in any cases where it is feasible to calculate budgeted cost. Here, planned cost or budget cost is a cost that can be pre-determined based on previous data on cost of product and services.
Cost variance can be favorable or unfavorable both. When CV < 0, it’s unfavorable and when CV > 0, it’s favorable. In language, whenever actual cost is more than the planned cost, cost variance is unfavorable. Otherwise, it’s favorable. All unfavorable CV might not be bad as an expense may be necessary to avoid bigger expenses e.g. maintenance may avoid replacement of a whole machine.
It is also advisable not to consider some CVs that are too small as too many CVs can make analysis very complex.
Suppose a project require Rs 100,000 and a year time to complete. But after 6 months, it’s only 50% completed at a cost of Rs 60,000. In that case,
Actual cost = Rs 60,000, Budgeted cost = 50% of Rs 100,000 =Rs 50,000 for 6 months time
And cost variance (CV) = budgeted cost (BC) – Actual cost (AC) = Rs 50,000 – Rs 60,000 = - Rs 10,000. As the cost variance is negative, costs are running over budget and hence, unfavorable.