Variance Analysis Introduction Variance analysis compares both actual performance and standards (Zimmerman, ). Standards serve as guides for the line and staff employees. Favorable or unfavorable outcomes occur. The important variance analysis management tool enhances performance.
Price Variance Analysis
As an example of materials’ price variance analysis, the Obama Company sets the standard purchase price for each raw material Ziplock piece at $ 2.50 (Zimmerman, 2014). Consequently, the purchasing department strives to find a supplier having a raw material price of $2.50 or even lower. If the Obama Company purchases from Bush Company offering Ziplock at $ 2.65 per piece, an unfavorable variance arises. An unfavorable variance arises when the actual price paid ($ 2.65) for the raw material is higher than the preset standard price ($2.50).
Going further, the Obama Company receives lowest bid ($2.45) from Washington Company. Obama Company finally buys the Ziplock raw material from Washington Company, a favorable variance. Favorable variance crops up when the actual price paid is lower than the prescribed standard price. For clarity, Obama purchases 300 pieces of the Ziplock raw materials at $2.45. Consequently, the company’s favorable price variance is: ($ 2.50 – $2.45) x 300 pcs = $ 1,500.
Labor Efficiency variance
The Obama Company’s production department receives an order from the sales department requiring the production of 120 pieces of Cyborg Product model X592 (Zimmerman, 2014). Each piece requires 4 hours to produce. The standard usage for the 120 pieces is: 4hours x 120 pieces, 480 hours.
If the greenhorn production department staff actually uses 490 hours to produce the 120 pieces of the Cyborg product model, there is an unfavorable labor efficiency variance of 10 hours (490 actual hours used less 480 standard hours prescribed). On the other hand, the same company’s expert production staff employees are able to complete the 120 cyborg product model at only 3.85 hours per cyborg product model. The company is able to generate a favorable labor efficiency variance of: (4 hours – 3.85 hours) x 120 pieces, 18 hours. The total actual hours used to produce the 120 cyborg product model is 462 hours.
Analyzing, one of the best benefits of variance analysis is to control future costs and expenses (MarieRao, 2010). By setting the standard price of each Ziplock raw material at $2.50 per piece, the purchasing department must go out of its way to ensure all future Ziplock raw material purchases are paid at $ 2.50 or lower. Consequently, controlling the costs or expenses of all future Ziplock raw materials will contribute to higher Obama Company net profits. Similarly, by prescribing the standard 4 hours for each cyborg product model piece at only 4 hours, the production employees must strive to comply with the standard.
Unfavorable performance prods management to take intervention measures. One intervention measure is to reprimand the low performing employee (stick management method). A third intervention method is to reward high performing production staff (carrot management method). Both methods help improve the production employees’ production outputs (Zimmerman, 2014).
Variance analysis helps the Obama management compare both actual performance and standards. Management can reward excelling employees, favorable variance performers, and penalize low performing employees, unfavorable variance performers. Indeed, variance analysis is an important management tool to improve actual performance.
Marie, A., Rao, A. (2010). Is Standard Costing Still Relevant? Evidence from Dubai. Management Accounting Quarterly , 11 (2), 1-10.
Zimmerman, J. (2014). Accounting for Decision Making and Control. New York: McGraw-Hill.