Variances

Definition

Variances refer to the differences between actual and expected or budgeted amounts in managerial accounting. They are used to analyze and understand the reasons for deviations from planned performance, enabling managers to make informed decisions and take corrective actions.

5 Must Know Facts For Your Next Test

1. Variances are a key tool in managerial accounting for performance evaluation and decision-making.
2. Analyzing variances helps managers identify areas of efficiency or inefficiency within the organization.
3. Variances can be classified as either favorable (positive) or unfavorable (negative) based on their impact on the organization's performance.
4. Cost variances are commonly used to analyze the differences between actual and budgeted costs, such as material, labor, or overhead costs.
5. Variances can be further broken down into different components, such as price and quantity variances, to pinpoint the specific sources of deviations.

Review Questions

• Explain how variances are used to distinguish between financial and managerial accounting.
  • In financial accounting, the focus is on reporting historical financial information to external stakeholders, such as investors and regulators. Variances are not typically reported in financial statements, as the emphasis is on presenting the final results. In contrast, managerial accounting utilizes variances to provide internal managers with insights into the organization's performance. By analyzing variances between actual and budgeted figures, managers can identify areas for improvement, make informed decisions, and take corrective actions to enhance the organization's efficiency and profitability.
• Describe the different types of variances and their implications for managerial decision-making.
  • Variances can be classified as either favorable or unfavorable. Favorable variances, where the actual amount is less than the expected or budgeted amount, indicate better-than-planned performance and can provide insights into areas of efficiency. Unfavorable variances, where the actual amount is greater than the expected or budgeted amount, suggest worse-than-planned performance and can highlight areas for improvement. Managers can use this information to identify the root causes of variances, make adjustments to budgets or processes, and implement strategies to enhance the organization's overall performance.
• Analyze how variances can be used to evaluate the effectiveness of an organization's cost management strategies.
  • Variances, particularly cost variances, are crucial for evaluating the effectiveness of an organization's cost management strategies. By comparing actual costs to budgeted or expected costs, managers can identify areas where costs are being effectively controlled, as well as areas where costs are exceeding expectations. This information can then be used to refine budgeting processes, implement cost-cutting measures, or identify opportunities for cost savings through process improvements or technological advancements. Analyzing variances over time can also help managers track the long-term impact of their cost management strategies and make adjustments as needed to optimize the organization's financial performance.

Related terms

Favorable Variance: A variance where the actual amount is less than the expected or budgeted amount, indicating better-than-planned performance.

Unfavorable Variance: A variance where the actual amount is greater than the expected or budgeted amount, indicating worse-than-planned performance.

Cost Variance: A variance that compares the actual cost of an activity or resource to the expected or budgeted cost.