We constantly seek explanations for everything that we do to ensure that we are not just wasting our precious time and resources. Good management practice requires that managers understand the reasons for variance analysis just like every other aspects of business management.
We have previously discussed the benefits and drawbacks of variance analysis so now is therefore the time for us to explore the reasons for variance analysis.
Accountants solve problems by making sense of a process and not just crunching the numbers. So we must understand the reasons for variance analysis before undertaking one.
7 Reasons for Variance Analysis
Cost control purpose:
One of the most importance reasons for variance analysis is to understand the cost components of a product or services and then take action that will subsequently control the cost. Managers will for example change supplier if it is discovered through variance analysis that budget is over run and that this was as a result of using a more expensive supplier of raw materials.
Planning gaps which is the difference between desired and projected results are reconciled through a well-executed variance analysis. Variance analysis provides a reconciliatory statement as to why our best estimate is different from our projected figures. This again boils down to control and planning.
Quantification of Losses, Wastages and Errors
By comparing actual results to some sorts of budgeted results, losses are wastages are quantified. Line managers make better decision when they can attach monetary value to resources.
To gain insight into the reason why we performed good or badly
Variance analysis helps managers find answer to good or bad performance. A company or division that is constantly achieving their budgeted figure could be using inferior goods or using less expensive workforce which may harm a company’s strategic competitive advantage if quality is compromised as a result of this.
The investigative process that is involved after an event has occurred helps management understand why things has happened the way they did. A division that reports a negative fixed expenditure variance may have invested in machinery that will benefit the company for years to come.
A major function of budgeting is to motivate responsible officers into taking actions that will ensure that the ultimate goal of a company is achieved.
One way of motivating managers is to give them feedback through a performance measurement system. Variance analysis provides integrated information that is feedback to managers with the aim of motivating them into taking corrective action(s) to correct any reported discrepancies.
Variance analysis is not a process that is designed to punish managers as many believe is the case. Rather, it is intended to motivate managers. Whether or not this actually happens depends of some factors which include the experience of the manager administering the whole process.
To Help in Improvement Planning:
A wise man once said that there is always room for improvement. We benchmark a process for example to see if there is need for any modification that would ultimately lead to better performance.
Changes are made to areas where weaknesses are spotted through the lens of variance analysis.
Managers and decision makers rely heavily on managerial accounting reports for planning purposes. This report even in today’s business environment still includes sections that identify discrepancies and an attempt is afterwards made to explain those variances.
A division that always report negative material usage variance for example might plan to invest in modern equipment or arrange for further staff training. Similarly, investment should be made in acquiring new IT infrastructure when reported latency that is associated with slow system is more than budgeted.