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VARIANCE ANALYSIS
Definitions and purpose of variance analysis; The mechanics of variance analysis; The interpretation of variance analysis.
Purposes of a standard costing system is:To provide management with a yardstick for the evaluation of performance.
Purpose of variance analysis: To give information on those aspects of business operations which are not proceeding according to plan. Recognizes the importance of controlling both actual results and planning procedures.
Purpose of variance analysis: To generate information which may be useful for future planning (e.g.for the setting of future standards). Important in a changing environment, for example in times of rapid technological change or high inflation.
The information produced by a standard costing system will be virtually worthless if the RESULTING variances are caused by inefficient standard setting.
Such a standard would be unrealistic, because it is rare for ideal conditions to prevail.
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direct labour;
variable overhead; fixed overhead. In turn, each element comprises two factors, quantity;
price.
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The standard unit cost is calculated firstly on the basis on total absorption costing.
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Considerations
Profits Sales Materials Labour - ???
TAXES, Inflation and currency variations.
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Stock Variance
If stocks of materials are left over at the end of the period: Part of the variance in costs would be transferred to the next period if the stocks were valued at their actual rather than standard value.
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Stock Variance
Consequently, stocks are valued at the standard cost rather than the actual cost of production.
Therefore any difference in costs directly effects current months profit statement and allows the difference in profits to be directly compared with the variances.
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Sales Variances
Example: The standard projections of Z units allows for sales of 10,000 units @ 20 per unit. But actual monthly sales are only 7,000 units. Lower profits can be expected because of the 3,000 shortfall in sales.
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Sales Variances
Price also has an impact if it is lower than the standard budgeted figures, i.e. 19.50 rather than 20. Taking into consideration both divergences from set standards, what will be the total sales variance?
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Sales Variances.
The fall in profit from the reduced price on the actual units sold,
Plus The profit that would have been made on the 3,000 units not sold.
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Labour Variance
Labour variances are considered in an identical manner to material variances. Two elements are examined: Wages; Productivity.
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Labour Variance
Example:
The set standard wage is 5 per hour and it is estimated that 0.4 hours of labour is needed for each unit. However, if labour is 6 per hour and each unit takes 0.5 hours of Labour, the impact will be?
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Labour Variance
Then standard cost for 10,000 units would be:Standard costing 0.4 x 5 x 10,000 = 20,000
Actual costing 0.5 x 6 x 10,000 = 30,000
Variance is ????
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Budgeted fixed costs must be compared to actual fixed costs, as fixed costs do not vary with the output level.
This identifies the change in fixed costs for all parts of the business.
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5. Finally, and quite commonly, the reality that an inflexible plan has proved to be unrealistic in the light of changed circumstances.
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It could be due to external changes in the market place which are beyond the control of the company such as changing consumer preferences and changing competition.
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It may due: to the wrong standards of work; untrained employees; inefficient machinery; efficiency of machine operators; changes in the material mix and non-standard production scheduling.
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Responsibility for these variances depends partly upon the conditions prevailing in the labour market.
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the actual costs and revenues must be compared with the realistic standards existing at the time of incurring the costs and revenues;
If this is not done, individual managers may be unfairly advantaged or disadvantaged by being assessed on the basis of obsolete standards.
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Investigating variances
One aspect of good management is knowing when to investigate a variance. The need to know when to investigate a variance is not always clear;
An important point to bear in mind is the cost of any investigation. Although it may be possible to quantify with reasonable accuracy the costs of investigation, it is far less easy to put a value on the benefits.
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Investigating variances
The importance of investigating only material or significant variances is frequently stressed. This presents measurement problems.
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Summary
Standard cost = planned cost of a particular unit or process and is based on what is reasonably attainable. In variance analysis actual costs are compared with standard costs, and corrective action is taken if there are any unplanned trends. Variance analysis enables differences between actual and standard costs to be broken down into cost elements and thus measure performance. VARIANCE is always expressed as a %age of the standard:e.g. + or 5%
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Summary
The degree of analysis will vary, but a total cost variance will be examined in terms of: direct material; direct labour; variable overhead; fixed overhead variances. In turn, these will be scrutinised in terms of quantity and expenditure variances.
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Summary
Sales variances will also be calculated. There are two principal types:
The former are based on total absorption costing whereas the latter is based on marginal costing.
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Summary
The variances help in tracing the main causes of differences between actual and budgeted results. They do not explain what has actually happened.
Managers should investigate variances when: benefits of investigation outweigh the costs; the variances are significant.
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Summary
VARIANCE ANALYSIS IS BEST ILLUSTRATED AS A PERCENTAGE DEVIATION FROM NORMAL. FOR EXAMPLE:PLANNED EXPENDITURE = 10,000 ACTUAL EXPENDITURE = 15,000 VARIANCE = ? NEGATIVE OR ADVERSE 50%.
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Summary
VARIANCE ANALYSIS IS USUALLY THE FIRST ITEM DISCUSSED AT ANY MANAGEMENT MEETING, WITH THE EMPHASIS ON ANY PERCENTAGE CHANGES.
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Summary
It is important to realise that all aspects of a business to have a competitive focus;
Any changes from the NORM must be recognised immediately, evaluated and where necessary acted upon;
Management must have good knowledge and understanding of competitors and their strategies for a competitive focus to be effective; The companys own strengths and weaknesses must be critically evaluated in relation to the strengths and weakness of your competitors.
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Summary
A company must try to know as much about its competitors strategy as it does about its own! It must be established why they have made certain moves, predict what they are planning for the future and estimate the likely reactions to the companies strategy. In this way a winning strategy can be developed.
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ANALYSIS OF COMPETITORS
The information required includes: WHO ARE THEY? WHAT ARE THEIR OBJECTIVES WHAT ARE THEIR STRATEGIES? HOW SUCCESSFUL ARE THEY? WHAT ARE THEIR STRENGTHS? WHAT ARE THEIR WEAKNESSES?
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CONCLUSION
FINANCIAL COMPETITION IS WARFARE.
The strong and ruthless survive and prosper. The weak and badly organised wither and perish.
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