Question No. 3 - MMPC-004 Accounting for Managers

Solutions to Assignments 

MMPC - 004 - Accounting for Managers

Solutions to Question No. 3

Variance analysis can be summarized as an analysis of the difference between planned and actual numbers. The sum of all variances gives a picture of the overall over-performance or under-performance for a particular reporting period. For each item, companies assess their favorability by comparing actual costs to standard costs in the industry.

For example, if the actual cost is lower than the standard cost for raw materials, assuming the same volume of materials, it would lead to a favorable price variance (i.e., cost savings). However, if the standard quantity was 10,000 pieces of material and 15,000 pieces were required in production, this would be an unfavorable quantity variance because more materials were used than anticipated.

When standards are compared to actual performance numbers, the difference is what we call a “variance.” Variances are computed for both the price and quantity of materials, labor, and variable overhead, and are reported to management. However, not all variances are important.

Management should only pay attention to those that are unusual or particularly significant. Often, by analyzing these variances, companies are able to use the information to identify a problem so that it can be fixed or simply to improve overall company performance.

There are several types of variance analysis that companies can use. For example, companies can use sales or cost variances to examine specific areas of interest. Similarly, companies may further divide variances into those caused by prices and those caused by usage or efficiency. Some companies may also use variance analysis to investigate product mixes, yields, or for planning variances.

The variance analysis process starts with establishing standards or preparing forecasts. Once companies do so, they must monitor their actual performance closely and identify any inefficiencies. Sometimes, the process may not be as straightforward, though. Therefore, companies will have to wait until the end of their accounting periods to obtain actual performance results.

Need and Importance of Variance Control

Variance analysis plays a significant role in management and cost accounting. These are both areas in accounting that relate to controlling, monitoring and decision-making. Companies primarily use variance analysis to monitor actual costs and control them when needed. However, there is much more to that process apart from the basics.

Variance analysis can be of significant importance to companies for the following reasons.

1. Acts As A Monitoring And Control Tool

Technically, variance analysis isn’t a monitoring tool. Instead, forecasts and budgets provide a basis for analyzing costs. However, companies cannot actually monitor their costs if they don’t compare them with actual results. It is where variance analysis is helpful. Companies can use variance analysis to calculate any differences between budgets and actual results. Through this process, companies can actively identify any efficiencies and eliminate them on time. This way, companies can control any deviations from the set plans for performance. Similarly, companies can also accumulate all the information and perform variance analysis at the end of each period. Based on this process, they can make changes that can help avoid any inefficiencies in the future.

2. Focuses On Favourable And Adverse Variances

Unlike some other tools, variance analysis focuses on both favorable and adverse variances. Although favorable variances are beneficial for companies, they still need to the reason behind it. Sometimes, these variances may come from miscalculations or improper budgeting, which companies should investigate. If that is not the case, companies still need to understand how these variances generated so they can build on the favorable performance. Adverse variances, on the other hand, are harmful to the company. By analyzing these, companies can identify problem areas within their processes. By doing so, they can eliminate any problems which can be beneficial in the future. Some companies may only focus on adverse variances, though. However, variance analysis provides a tool to identify both favorable and adverse variances.

3. Considers Significant Variances

Variance analysis is a great tool to catch and rectify significant variances. Companies can suffer variances in actual performance due to several reasons. Sometimes, these reasons may be random or seasonal. However, variance analysis allows companies to adjust for these variances and allows a better performance analysis. Similarly, variance analysis allows companies to consider material variances only. During the process, companies can set a threshold for the difference that they want to investigate. If any variance does not meet this threshold, companies can ignore that. This way, the process is much straightforward.

4. Detects Inefficiencies In Planning Or Operations

Variance analysis takes a budget and compares actual performances with it. However, it doesn’t focus on operational inefficiencies only. It also allows companies to examine their budgets for any unrealistic expectations. This way, companies can identify any problems with their forecasts and rectify them for the future. Most of the time, however, variance analysis catches operational inefficiencies. It is one of the reasons why companies use it. Operational anomalies are common in every business environment. By identifying these, companies can uncover any problematic areas within their process and correct any errors.

5. Provides A Basis For Accountability

As mentioned, companies may focus on variance analysis toward specific areas. This way, variance analysis can allow companies to hold their managers accountable for their performance. Furthermore, companies can differentiate between controllable and uncontrollable variance. Through this process, they can further identify the departments or managers responsible for variances. Some companies may also use variance analysis as a part of their performance appraisal. Similarly, companies may also reward managers for favorable variances. This way, variance analysis can provide an accountability tool for companies. Likewise, if the expectations are reasonable, companies can use variance analysis as a motivation tool.