Analysis Of Variances
Control is a very important function of management. Through control management ensures that performance of the organization conforms to its plans and objectives. Analysis of variances is helpful in controlling the performance and achieving the profits that have been planned. The deviation of the actual cost or profit or sales from the standard cost or profit or sales is known as “variance”. When actual cost is less than standard cost or actual profit is better than standard profit, it is known as favourable variance and such a variance is usually a sign of efficiency of the organization. On the other hand, when actual cost is more than standard cost or actual profit or turnover is less than standard profit or turnover, it is called unfavourable or adverse variance and is usually an indicator of inefficiency of the organization. The favourable and unfavourable variances are also known as credit and debit variances respectively. Variances of different items of cost provide the key to cost control because they disclose whether and to what extent standards set have been achieved.
Another way of classifying the variances may be controllable and uncontrollable variances. If a variance is due to inefficiency of a cost centre (i.e. individual or department), it is said to be controllable variance. Such a variance can be corrected by taking a suitable action. For example, if actual quantity of material used is more than the standard quantity, the foreman concerned would be responsible for it. But if excessive use is due to defective supply of materials or wrong setting of standards, the purchasing department or cost accounting department would be responsible for it. On the other hand, an uncontrollable variance does not relate to an individual or department but it arises due to external reasons like increase in prices of materials. This type of variance is not controllable and to particular individual can be held responsible for it.
There are a number of reasons which give rise to variances and the analysis of variances will help to locate the reason and person or department responsible for a particular variance. The management need not pay attention to items or departments proceeding according to standards laid down. It is only in case of unfavourable items that the management has to exercise control. This type of management technique is known as ‘management by exception’. This type of technique is considered as an efficient way of exercising control because management cannot devote their limited time to every item. The deviation of total actual costs from total standard cost is known as total cost variance. It is a net variance which is the aggregate of all variances relating to various elements of cost, both favourable and unfavourable.