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.