UPI Study › Courses › Project Management › Free lessons › Lesson 10.3 Free with a free account
Cost Variance: Definition, Calculation, and Interpretation
Project Management · Chapter 10: Project Closure and Post-Completion ReviewSection 10.3 · lesson 65 of 7313 min · free with a free account
Free preview
Create a free account to keep watching
It takes a minute and costs nothing. Your free account unlocks all of Chapter 1 and 3 more lessons of Project Management.
Lesson complete
Earn the 3 college credits for Project Management
Enrolling adds a quiz after each lesson, the graded work and the official transcript. Recommended for credit by NCCRS.
Next lesson: Post-Project Customer Evaluations and Implementation Reviews →← Developing a Thorough Project Closure ReportNext lesson: Post-Project Customer Evaluations and Implementation Reviews →
In this lesson
Calculate final cost variance, explain its causes, and turn it into lessons.
- Calculate final cost variance and percent variance with a stated sign convention
- Identify which costs belong in the final actual cost
- Classify variance causes by type and as controllable or not controllable
- Recognize offsetting variances and padded estimates behind a near-zero result
Free study notes
Get this lesson's notes by email
The key points and 4 practice questions with answers, in your inbox. One email, free.
One email. Unsubscribe in one click.
Transcript
Everything said in the video, section by section (1,492 words). Read along, or search it.
Opening Question
Did Rising Prices Cause the Overrun
Priya has closed out another Willowbrook project: the renovation of the Northside clinic's east wing. The figures are made up. It finished $21,000 over its $300,000 budget. The finance committee wants a single explanation, and one board member says rising prices explain all of it. Is that right? And how should the result be calculated, and reported?
Definitions
Approved Budget and Final Actual Cost
The approved budget is the total the sponsor authorized for the project's work, including any formally approved changes to it. The final actual cost is what the project actually cost, when all work and closeout were finished. The final cost variance is the difference. It answers one question: how did the project end against the approved budget? It's calculated once, when all costs are known, and summarized in the closure report.
Formula
Sign Convention and Percent Variance
The formula: final cost variance equals the approved budget, minus the final actual cost. The sign convention says what the sign means. Here, positive means the project finished under budget, and negative means over. Always state it, because readers may assume the opposite. Percent variance is the variance divided by the approved budget, times 100, with the sign carried through. A variance of $5,000 means little until you know whether the budget was $20,000, or $2,000,000.
Worked Examples
One Project Under, One Over Budget
Two cases. First, a budget of $200,000 and a final actual cost of $184,000. 200,000 - 184,000 = +16,000. 16,000 / 200,000 = 0.08, or +8%. Positive, so the project finished under budget. Second, a budget of $150,000 and a final actual cost of $163,500. 150,000 - 163,500 = -13,500. -13,500 / 150,000 = -0.09, or -9%. Negative, so it finished over budget.
Quick Check
Computing an 8 Percent Overrun
Quick check. A project's approved budget was $120,000, and its final actual cost is $129,600. Is the final cost variance +8%, -8%, or -7.4%? And is that over or under budget? Pause and predict. -8%, over budget. 120,000 - 129,600 = -9,600. Divided by 120,000, that's -0.08. +8% reverses the subtraction. And -7.4% divides by the actual cost instead of the budget, which is the wrong base.
What Counts
Costs Included and Excluded
The final actual figure must include every cost that belongs to the project, and only those. In: direct labor, materials, equipment and services; allocated indirect costs; closeout costs, like final training and the archive; and accrued costs, for work done but not yet invoiced. Out: the cost of running the result after handover, which belongs to the operating budget, and charges wrongly coded to the project. So the final figure can't be completed until contract closeout has settled every claim and final payment. That's why the cost position comes late in closure.
Link to Earned Value
When Earned Value Variance Becomes Final
How does this relate to earned value? During the project, cost variance compares the value of work done with what it cost. Before completion, the value of work done is less than the full budget. At completion, it equals the approved budget. So the earned value cost variance becomes budget minus actual: the final cost variance. The two agree at the end. One caution, for a project that ends early or is canceled. If scope was cut, comparing the final cost with the original, full budget mixes a change of scope with a change of cost. Compare with the budget as approved after the scope change, or report the value of the completed work separately, and state which basis you used.
Cause Categories
Five Common Causes of Variance
A variance is a result. Its value comes from knowing why. Five categories cover most causes. An estimating error: the budget was wrong when it was set. Evidence: the original estimate shows what was assumed. A scope change. Approved with a matching budget change, it causes no variance. Added informally, it does. Evidence: the change log. A price movement: labor, materials or services cost more after the budget was set. Evidence: invoices compared with quotations. Productivity: work took more or less effort than planned for the same output. And rework: work done again because it was defective. Evidence: the issue log and inspection records.
Controllability
Controllable Causes Versus Outside Forces
A controllable cause is one the team or its organization could have influenced. One that isn't controllable comes from outside their influence. Estimating errors and rework are generally controllable. Informal scope growth is controllable, through change control. Productivity falls in between. A market-wide price rise generally isn't controllable, though buying early, or a fixed-price contract, can change how much of it the project bears. The classification is a judgment from evidence, so record the reasoning. It decides the lesson. Controllable: improve the practice, like estimating, change control or inspection. Not controllable: improve forecasting and protection, like allowances, reserves, or contract terms that share the risk. Blaming the team for everything discourages honest reporting. Calling everything bad luck prevents learning.
Worked Example
The Northside Line-by-Line Worksheet
Here's the Northside worksheet. Labor: budget 120,000, actual 132,000. That's -12,000, or -10%. Materials: 100,000 against 111,000: -11,000, -11%. Equipment: 40,000 against 36,000: +4,000, +10%. Contracted services: 30,000 against 31,500: -1,500, -5%. Training and other: 10,000 against 10,500: -500, -5%. In total, 300,000 against 321,000: -21,000, or -7.0%. Over budget. Only one line finished under, and the percentages vary widely. The total alone hides which estimates were wrong.
Hidden Problems
Offsetting Variances and Padded Estimates
A variance near zero looks like success, but it can hide two problems. First, offsetting variances: overruns in some lines offset by underruns in others. Equipment came in 4,000 under, while labor ran 12,000 over. With a bigger equipment saving, the total could have hit zero, with two estimating problems still hidden. Second, a padded estimate: a budget deliberately set above the expected cost, so the project looks on budget. It ties up money other projects could use, and makes the estimate useless for the next one. So a close result is good news only when the lines agree too, and the budget was honest.
Quick Check
A Zero Variance That Hides Errors
Quick check. A $500,000 clinic project finishes at exactly $500,000. Labor ran $40,000 over, and materials came in $40,000 under. Should the review conclude the estimates were accurate, check each line's estimate, or call the project over budget? Pause and predict. Check each line's estimate. Zero here comes from offsetting variances: one estimate was too low, and another too high, or padded. The project wasn't over budget, but calling the estimates accurate would carry two bad numbers into the next budget.
Using Results
Feeding Estimates and Reviewing Reserves
Two uses turn the result into improvement. First, feed it back into estimating: lines that ran over or under are noted, so the next estimate for similar work uses the actual cost, not the old guess. Second, review how reserves were used: reserve used, divided by reserve approved. A contingency reserve of 12,000, with 9,000 spent, gives 9,000 / 12,000 = 75%. Across projects, reserves left almost unused may suggest padding, and reserves always exhausted may suggest under-estimating. Either is a question to examine, not a conclusion.
Common Mistakes
Reversed Signs, Wrong Bases, Mixed Budgets
Four mistakes recur. Reversing the subtraction flips the sign, and turns an overrun into a saving. Write the formula in words each time: a project that spent more than it was given must show a negative number. Dividing by the wrong base. In the first case, 16,000 divided by the actual cost of 184,000 gives about 8.7%, not the correct 8%. Mixing budgets: comparing with the original budget when approved changes raised it makes an authorized increase look like an overrun. And leaving out accrued or closeout costs makes the project look cheaper than it was. A quick check: budget minus variance should give back the actual cost. 200,000 - 16,000 = 184,000.
Reporting
The Cost Statement in the Closure Report
In the closure report, the cost result is a short statement in three parts: the figures; the sign convention and percent; and the causes, with the largest contributors and the evidence behind each. Causes that records can't support are marked as judgment. And the statement says whether the result was foreseen: matching the last forecasts shows tracking worked, while a sharp surprise is itself a finding. Finance will want the accrued costs reconciled. The sponsor will want to know whether an overrun needs more funding, or fits within an approved reserve.
Case Resolved
Separating Price Rises From Rework
Back to the board member's claim. Priya separates the causes from the records. Supplier invoices against the original quotes show materials cost 11,000 more from price rises: not controllable. Inspection records show a ceiling section failed inspection and was rebuilt: the 12,000 labor overrun, controllable. The 1,500 was an estimating error, and the 500 a small request absorbed. Overruns of 12,000 + 11,000 + 1,500 + 500 = 25,000, less the 4,000 equipment saving: 21,000. Of the 25,000 in overruns, 12,000 + 1,500 + 500 = 14,000 was controllable. So prices explain only part of it. Priya reports the uncomfortable finding, and two accurate lessons: tighten inspection before closing walls, and consider fixed-price terms for materials.
Key Takeaways
Calculating and Explaining Final Variance
To recap. Final cost variance is the approved budget minus the final actual cost. Positive is under, negative is over. Percent variance divides by the approved budget, with the sign carried through. Count every project cost, including closeout and accruals, and check the lines, not just the total. Then classify each cause as controllable or not, because that decides the lesson.
About Project Management at UPI Study
Project Management (Business 230) is a self-paced online course of 73 video lessons in 12 chapters, from starting and defining a project to planning, budgets, scheduling tools, proposals, contracts, execution, monitoring, closure, teams and certification. It carries a NCCRS credit recommendation for 3 semester credits.
Every lesson transcript is free on pages like this one, and the videos are free with a free UPI Study account. Enrolling adds a practice quiz after each lesson, the graded work and final exam that earn the credit, lifetime access, and an official transcript on completion. UPI Study has helped over 130,000 students with college credits. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.
Enroll now → Course details Download the syllabus All Business courses Every course with PRO →
Why take it here
Why students take Project Management with UPI Study
Where the credit goes
Universities that work with NCCRS
Project Management carries a NCCRS credit recommendation. These universities work with NCCRS; some are UPI Study's signed partners. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.
Thomas Edison State UniversitySigned partner
University of the PeopleSigned partner
Charter Oak State CollegeSigned partner
Strayer UniversitySigned partner
Columbia Southern UniversitySigned partner
Indiana TechSigned partner
Penn StateWorks with NCCRS
Southern New Hampshire UniversityWorks with NCCRS
SUNYWorks with NCCRS
+many more cooperating universitiesFind my college →Find my college → Not listed? Ask Athena in the corner of this page, or book a 15-minute call.
FAQ
Questions students ask us
About Cost Variance: Definition, Calculation, and Interpretation
How do you calculate final cost variance and percent variance?
What costs should be included in a project's final actual cost?
Why can a project with zero cost variance still have bad estimates?
What is the difference between controllable and uncontrollable causes of a cost overrun?
About the Project Management course
How many college credits is Project Management?
How much does Project Management cost and what is included?
Which universities accept UPI Study credits?
How long does Project Management take?
How are the exams done?
How do my credits reach my college?
Ready for the full course? Earn 3 credits in Project Management.
73 video lessons, a quiz after each one, and the graded work that earns the credit. Recommended for credit by NCCRS.
3 credits · NCCRSEnroll →