Part of writing and developing good variance analyses requires an understanding and identifying of the primary drivers of variances. You can break down variances into to two key buckets: variances driven by technical issues and variances driven by rate issues. These can be defined further:
- Rate vs. Usage variance in Labor – A rate variance results from incurring labor costs at a rate per hour that is different from the value budgeted for the labor found in the control account plan. Rate variances are calculated by comparing the actual labor rate incurred to the budgeted labor rate and extending the difference by the actual number of hours expended. A usage variance is attributable to utilizing more or less labor than was budgeted. This type of variance is calculated by subtracting the actual labor hours incurred from the budgeted hours and extending the difference by the budgeted labor rate.
- Rate vs Usage variance in Material – A price variance results from incurring a cost for material that is different from the value budgeted for that material found in the control account plan. Price variances are calculated by extending consumed quantities (by part number) by the unit price deltas (budgeted value of the part less the actual incurred cost). A usage variance is attributable to consuming quantities of parts that are different from the earned quantities. This type of variance is calculated (by part number) by subtracting consumed quantities from the earned quantities and extending the difference by the budgeted unit value of the part number.
Simply put, the first thing that needs to be identified is whether or not variance is cause by rates or how much resources were used to accomplish the work. There are various reasons for both causes of variances, which we’ll get into next.
Reasons for a Rate Variance in Labor
- Many companies use a government-approved rate to plan and forecast the program but bill using actual resource rates. This will likely lead to some rate variance across the board, although usually on larger scale programs this will come out as a wash.
- Changes in corporate burdens (Overhead, Fringe, etc).
- Decision to use a higher priced or lower priced resource than originally thought for technical purposes. It’s possible that during the initial planning it was thought a more junior person could complete the required work in a particular control account but due to learning curves, changes in the technical environment or even availability a more senior or in the inverse a junior resource was needed.
- Using a higher priced resource to “crash the schedule’. Depending on the needs of the customer there might be a greater need for earlier delivery or recovery from an incurred schedule slip. In this case a more senior person might be brought in to accomplish the work in quicker fashion.
Reasons for a Usage Variance in Labor
- This could be the result of unexpected technical difficulties (Fill in technical explanation). You anticipated using x hours to build the hull of the ship but needed y hours due to XYZ. Things like greater than expected learning curves, complexity of technical requirements different than assumptions, etc. The key is to explain what these technical causes are. You can’t just say greater learning curve or more complex than originally anticipated. You need to provide the customer why this is the case.
- You could “crash the schedule” using additional resources as opposed to more senior resources. This would result in more hours being needed as opposed to a higher rate resource.
Reasons for a Rate Variance in Materials
- This could be caused by the availability of resources or vendor supply.
- Taxes have changed since original budgeting.
- Change in type of material that was needed.
Reasons for a Usage Variance in Material
- Could be the result of unskilled labor handling the material, i.e. damage to the material.
- Purchase of material of lower or higher quality than the standard.
The first thing when preparing a variance analysis is to determine whether or not the variance was caused by a rate or usage. Once that is done you can begin the process of discovering the root cause of the variance. You can then develop a variance analysis report that provides management and the customer with a clear story as to the cause, impact and potential corrective actions to the issue.