- Variance is disparity between standard and real cost
- Variance affect performance
- Variances relate to revenues and cost
- Types of variances : Favorable , Unfavorable, Materials, Labor, Overheads (Church, 1995)
In management accounting, variance refers to the differences between standard (planned or budgeted) costs and the real (actual) costs that are sold or incurred. The differences affect organizations’ or businesses’ performances. Variances calculated for revenues as well as costs. When the real results outweigh the expected ones, the variance is said to be favorable. When the expected results outweigh the actual, the variance is said to be unfavorable. Variances are also categorized according to user needs: variable or invariable. Variable cost variables relate to materials and labor while fixed cost variables relate to overheads.
What is meant by budget variance?
Budget variances are the differences between baseline (budgeted) revenues or expenses and their real (actual) amounts. Favorable budget variance is when real revenue outweigh budgeted revenue or budgeted expense outweigh real expense. At times, budget variances are the differences between budgeted and real liabilities as well as assets. Budget variance stem from poor assumptions or inappropriate budgeting. Some budget variances are controllable while others are uncontrollable. Strictly controllable budget variances are those relating to discertionary expenses.
What is an effective way to incorporate variance analysis into the budget process?
Variance analysis refers to the examination of the differences between budgeted amounts and the real amounts.
The best avenue of incorporating variance analysis into the process of budgeting is connecting cost management to the process strategically.
Variance analysis is used in identifying weaknesses by managers to make out areas and processes that require adjustments or improvements.
Managers should zero in on variances whose impacts on performance are significant.
Focusing on variances with insignificant impacts bogs budgeting down in inconsequential detail.
What are the differences between labor and material variances?
- Both are price variances
- Direct labor rate variance means the disparity between what a business actually pays for labor and the amount it has budgeted for labor
- Direct material price rate variance means the disparity between what a business actually pays for raw materials and the amount it has budgeted for labor
- Both variances are either unfavorable or favorable
Both are calculated in the same way.
variance = (actual price – standard price) * real input quantity
With regard to direct material variance, the real input quantity is the real quantity of bought materials while in the case of direct labor variance the real input quantity is the real amount of procured labor.
Direct Materials Price Variance = (Actual Price – Standard Price) * Quantity Purchased
Direct Labor Price Variance = (Actual Price – Standard Price) * (Actual Hours Used)
How is a quantity variance different from a rate variance?
Businesses should use materials and time efficiently.
Quantity and rate variances are analyzed and compared over time.
Quantity variances relate to either direct materials’ utilization or direct labor’s efficiencies.
Quantity variances are the products of the differences between the input amounts used and ones budgeted for as regards given manufacturing durations prices and actual input amounts.
Rate variances are the products of the differences between the prices actually paid for given items or acts or efforts and the budgeted prices and actual amounts of items or acts or efforts (Church, 1995).
What are the subcomponents of fixed overhead?
Fixed Overhead Volume Variance (FOVV) has various subcomponents: fixed overhead (FOH) volume efficiency variance along with FOH volume capacity variance.
FOVV refers to the disparity between fixed expenses relating to good units made in a given duration and the total set expenses budgeted for the same duration.
FOVV happens when real production volume is dissimilar to the budgeted production.
FOVV is either unfavorable or favorable.
FOVV = (Actual Activity – Normal Activity) × Fixed Overhead Application Rate
Variable Overhead Subcomponents
Variable overheads (VOH) are manufacturing expenses, or costs, that differ approximately with respect to production output changes. The VOH model is used in modeling businesses’ future levels of expenditure and determining the Lowest Possible Prices (LPPs) at which goods ought to be sold. There are various VOHs in a business: production supplies, equipment utilities, and wages for handling materials. There are two types of VOH variances: VOH efficiency variance and VOH spending variance.
VOH efficiency variance refers to the disparity between the budgeted and real hours worked that are then set hourly overhead rate. VOH spending variance refers to the disparity between the preset spending rate and real spending on VOH. Commonly, the VOH is as well applied in business administration. In business administration, VOH refers to administrative expenses varying with business activity level. Notably most administrative costs are actually fixed.
Lowest Possible Price
The VOH model is used in modeling businesses’ future levels of expenditure and determining the Lowest Possible Prices (LPPs) at which goods ought to be sold. A product’s LPP is the least probable price for which it can be sold. In the present case, the LPP per unit is the sum of the direct material cost per unit, direct labor cost per unit, variable overhead per cost, and fixed overhead per unit.
LPP = direct material cost per unit + direct labor cost per unit + variable overhead per cost + fixed overhead per unit
= 1400 + 400 + 200 + 200
The LPP per unit is $2,200
Capacity and Poor LPP Decision
With regard to capacity, there are particular conditions in which the offering of given LPPs is a poor decision.
The conditions include:
- When capacity determination zeroes in on the realizable volume rather than realizable output.
- When planning capacity utilization is focused on fleeting sales goals rather than lasting sales needs.
- When businesses are not running optimally.
- When businesses have underused or unused capacities (McNair, 1994).
Automation Investment and LPP
In the present case, the technology advancement cost per unit will be the cost of the technology divided by the number of units
100,000/ 5,000 = $20 per unit
The technology will increase the LPP per unit by $20.
The new labor cost per unit will be 0.5 of the initial labor cost per unit
0.5*400 = $200 per unit
The new labor cost per unit will reduce the LPP per unit by $200
The new LPP per unit will be
$2,200 + $20 -$200 = $2,020