Variance Analysis | Standard Costing | Managerial Accounting
Table of Contents
Variance analysis is a task of comparing the Actual Performances with the Predetermined Performance Standards to determine how well the targets have been met. Variances are the deviations or the differences between what should be the (standard) and what has (actually) happened.
If the actual performance meets the standard, then the achievement is considered to be good. But if there exists gap between the Actual Performance and the Standard then the performance is considered to be poor. The difference between standard costs and actual costs is called variance. The expression of this relationship can be seen in the simple formula
Actual cost = Standard cost + Variance
By rearranging the terms in the formula, we can determine the variance if we know standard and
actual costs:
Variance = Actual costs – Standard costs
One needs to be mindful that the gap may exist in both the sides. The difference might favor (“F”) you if the actual cost is less or if the actual output is more. The reverse case is an unfavorable (“U”) variance if the actual cost is more or if the actual output is less. Variance can be either plus or minus, depending on whether actual cost is greater or less than standard cost. Since standard cost is a measurement of what a particular cost ought to be, any deviation from it can be interpreted as good or bad, favorable or unfavorable to the attainment of the company’s profit goals.
Variance = Standard cost – Actual cost
This variance is to be regarded as unfavorable because the company paid Re. 10 more per unit than it should have, and profits were lower as a result. One should be careful that a favorable variance in the paper report does not always mean the operating efficiency. It might happen due to the overstatement of standard costs.
The manipulation of standard with the intention of showing favorable variances in performance report is a big psychological problem, known as the padding problem, in organizations. The setting of standards and the establishment of a standard cost system allow managers to follow the exception principle, which specifies that the manager will maximize his or her efficiency by concentrating on those operational factors, which are deviations from the plan.