# How do you report variances?

Formatting and visualization

The first important point is that you never report positive or negative numbers, and you never write or say that a variance is positive or negative. You need to report absolute values and indicate whether the variance is favorable (F) or unfavorable (U). A variance is favorable (F) if it increases Operating Income compared to the budget. It is unfavorable (U) if it decreases Operating Income compared to the budget.

The reason why you do not report positive or negative numbers is that the meaning of signs reported by the formula depends on whether the variance is a revenue / contribution / profit variance or a cost variance. “Positive” cost variances mean an increase in costs, so a decrease in profit, and are therefore unfavorable. Therefore, to avoid confusion, indicate explicitly whether the number you report is favorable (F) or unfavorable (U). And to determine whether a variance is favorable (F) or unfavorable (U), rely on common sense rather than formulas or signs. The following video shows how you can apply the right format on numbers and cells in Excel.

Another helpful tool to visualize variances is waterfall chart showing how you go from the budgeted Operating Income to the Actual one variance after variance:

The following video shows how you can create such chart in Excel.

Timing of the recognition

Another important point related to variances is when to report them. In prior examples, I assumed that there was no inventory, so the question of timing is inconsequential. But when there is an inventory, you have a choice between an early or a late recognition of the variance.

All the formulas we used are based on the volumes sold, driving the resources consumed, driving the resources bought. But when there is an inventory, everything which is bought is not necessarily consumed (or more than what was bought can be consumed) and everything which is consumed is not necessarily consumed for sales of the current period.

The question is therefore when should a material price variance be recognized: when materials are bought (early recognition) or when materials are sold with the product in which they were incorporated (late recognition)? The latter is more consistent with the matching principle, but considerably complicates the accounting systems and, more importantly, delays the information brought by the variance until it is too late to react. Therefore, many firms opt for early recognition. This allows them not only to have faster signals about departures from budgets, but also to value inventories at their standard costs, facilitating accounting and avoiding unnecessary unit cost fluctuations.

Early recognition means that since you do not know yet how many units will be produced and sold with the resources bought, both volume and usage are still unknown, and the resource price variance must be based on the quantity of resource bought during the period. The same reasoning applies to usage variances, which will be based on the volume produced in the period rather than the sales volume.