Variance Analysis

Variance Analysis Overview

  • Variance Analysis is a vital technique used in Management Accountancy, providing a bridge between planning, controlling, and decision-making.
  • It involves the comparison of actual results with budgeted results.
  • It highlights the differences, or variances, between actual and expected results.
  • Variances can be favourable (F), where the actual cost is less than the budgeted cost or unfavourable (U), where the actual cost is more than the budgeted cost.
  • The main types of variances analysed are sales variance, material variance, labour variance, overhead variance, variable cost variance, and fixed cost variance.

Purpose of Variance Analysis

  • The main purpose of variance analysis is to control costs within an organisation.
  • It helps in performance measurement by showing where the company performed better or worse than planned.
  • It assists managers in understanding the cause and effect relationships between different business activities.
  • Variance analysis aids decision-making by providing insights into areas of overperformance or underperformance.
  • It can highlight where future planning and budgeting may need to be adjusted to be more accurate.

Calculation of Variances

  • Calculation of variances involves subtracting the budgeted costs from actual costs for each type of variance.
  • Every type of variance involves different formulas for calculation, e.g., sales variance can be calculated as (Budgeted Sales - Actual sales).
  • Unfavourable variances might indicate a need for corrective action – for instance, reducing costs or increasing sales volumes.

Use of Variance Analysis

  • Variances are typically reported in regular management reports, to help track and control performance.
  • Managers use this information to address areas of weakness or inefficiency and reinforce areas of strength.
  • Variances also serve as a diagnostic tool, to identify where the company’s strategy is working, or needs adjustment.
  • Lastly, they contribute to continuous improvement by identifying trends and providing insights into where changes can be made for better future results.