Definition: A spending variance is the difference between the budgeted cost and actual cost paid for an item. In other words, it’s the difference between what management thought it was going to pay for a good and the amount it actually paid for it.
What Does Spending Variance Mean?
A spending variance occurs because budgeted numbers were not met. Remember, budgets are only estimates based on future projections. These plans are laid out by management in prior periods to set goals and maintain the progress of the company. Actual income and expenses rarely match budged numbers identically. There is usually at least a slight variance.
When the budgeted expenses are less than the actual expenses, the difference is considered an unfavorable variance because this results in fewer profits for the period. This is typically referred to as coming in over budget.
Likewise, when the budgeted expenses are more than the actual expenses, the difference is considered a favorable variance because actual expenses were decreased relative to expected ones resulting in greater net income. This is usually called coming in under budget.
Higher-level management uses spending variances to evaluate managers and departments on their ability to set and meet expense goals. These expenses could be anything from direct labor to materials. Spending variances include all types of expenses.
Take factory overhead for example. At the beginning of the period, the cost accountants estimate how much will be spent on rent, insurance, electricity, and other utilities. These estimates are used to prepare financial goals in the form of a budget. For example, a manufacturer might estimate its overhead to be $10,000 a month. At the end of the year, management adds up all of the actual overhead expenditures to $100,000. This means that the factory had a $20,000 favorable overhead spending variance because the actual numbers were $20,000 less than the predicted numbers.