Friday, August 15, 2014

Management Accounting - Variance Analysis

Variance and Variance analysis
Control is a very important function of management. Through control, management ensures that performance of the organisation conforms to its plans and objectives. Analysis of variances is helpful in controlling the performance and achieving the profits that have been planned.

The deviation of the actual cost or profit or sales from the standard cost or profit or sales is known as “Variance”. When actual cost is less than standard cost or actual profit is better than standard profit it is known as favourable variance and such a variance is usually a sign of efficiency of the organisation. On the other hand, when actual cost is more than the standard cost or actual profit or turnover is less than standard profit or turnover it is called unfavourable or adverse variance and is usually an indicator of inefficiency of the organisation. Variance of different items of cost provide the key to cost control because they disclose whether and to what extent standards set have been achieved.

Variance analysis is the process of analysing variance by sub-dividing the total variance in such a way that management can assign responsibility for off standard performance. It, thus, involves the measurement of the deviation of actual performance from the intended performance. That is, variance analysis is a tool to measure performances and based on the principle of management by exception. In variance analysis, the attention of management is drawn not only to the monetary value of unfavourable and favourable managerial performance but also to the responsibility and causes for the same.
After the standard costs have been fixed, the next stage in the operation of standard costing is to ascertain the actual cost of each element and compare them with the standard already set. Computation and analysis of variances is the main objective of standard costing. Actual cost and the standard cost is known as the ‘cost variance’.

As per I.C.M.A, Variance Analysis is “the resolution into constituent parts and explanation of variances”. The definition indicates two aspects-resolutions into constituent parts is the first aspect which is nothing but subdivision of the total cost variance. Explanation of variance includes the probing and inquiry for causes and responsible persons”.

a.       Variances are analysed to find out the causes or circumstances leading to it so that management can exercise proper control. Variance analysis sub divides the total variance based on difference contributory causes. This gives a clear picture of the different reasons for the overall variance.

b.      The sub division of variance establishes and highlights the interrelationship between different variances.

c.       Variance analysis ‘explains’ the causes for each variance. It paves way for fixing responsibility for all variances.

d.      It highlights all inefficient performances and the extent of inefficiency.

e.      It is a powerful tool leading to cost control. Analysis of variances is helpful in controlling the performance and achieving the profits that have been planned.

f.        It enables the top management to practice ‘management by exception’ by focusing on the problem areas. It helps the management to concentrate only on operations and segments of an enterprise where deviations are there from targeted performance.

g.       It segregates variance into controllable and uncontrollable, thereby indicating where action is warranted. This division of variance into controllable and uncontrollable is extremely important because the attention of the management is drawn particularly towards controllable variance.

h.      It acts as the basis for profit planning.

i.         By revealing each and every deviation, along with the causes, variance analysis creates and nurtures ‘cost consciousnesses among the employees.