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Summary topic variance analysis
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Summary variance analyis
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What is variance analysis ?Budgets are financial syntheses representing mangers’ expectations about their future activity. To
build them, mangers relies on forecasts, estimates, and decisions they make. Variance analysis is
designed to help managers identify which departures from budget explain most of the observed
difference in Operating Income
Variance analysis consists in systematically comparing actual with planned results for the
period. It relies on the systematic assessment of the impact on Operating Income of
differences between actual and budgeted performances.
What are the purposes and principles of variance analysis ?
Variance analysis serves three of the management accounting functions
- Directing attention
- Organizational learning
- Performance evaluation and reward
Variance analysis provides a feedback about whether mangers are achieving their goals in terms of
profitability (performance evaluation and reward). However, often the way profit was achieved
matters as well. Variance analysis systematically decomposes variances to suggest detailed
explanations of how profit was achieved (or not) by comparison to what was initially planned.
Management by exception is a practice of concentrating managers’ attention on areas which
are not operating as expected, i.e. deviating from the plan, and placing less attention on
areas operating as expected, assuming that they are running properly. It is a way to allocate a
limited resource, managers’ attention, to what really requires it.
The principles of variance analysis can be summarized in one sentence: switch from budget to
actual, one assumption at a time, in the order to which these assumptions were established during
the budgeting process, and look at the resulting change in operating income.
The first key principle is that the best way to isolate and assess the impact on Operating Income of a
departure from budget on one specific estimate is to change that estimate only and see how
Operating Income is affected.
The second key principle is that to reconcile budgeted and actual Operating income, you must switch
one by one all the parameters from their budgeted to their actual values.
The third principle is that parameters are switched in the order in which they were set during the
budgeting process: first sales volumes, then usages of resources in production, and finally price of
resources purchased for production
Volume variances are changes in Operating
Income due to differences between actual and budgeted volumes of output (products,
services, or more generally cost drivers)
Usage variances are changes in Operating Income
due to differences between actual and budgeted consumption of resources per unit of
output
Price variances are changes in Operating Income due to the differences between actual and
budgeted prices of either outputs or resources
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