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Variance Analysis Notes

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This is an extract of our Variance Analysis document, which we sell as part of our Managerial Accounting Notes collection written by the top tier of LSE students.

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Lecture 2: Variance Analysis 15 November 2010

Topics

* Variance Analysis

* Static and Flexible Budgets

* Variance

* Benchmarking

Reading

* Bhimani (Chapter 2)

Key Points

* Variance analysis

* How useful is variance analysis

* Limitations of variance analysis

* Static vs. flexible budgets

Variance Analysis

* 3 elements affect performance: a. Activity b. Cost c. Prices

* Variance Analysis = Separating the effects of the different elements of performance

* Managers can decide how to improve performance based on isolated effects

* Compares actual performance against planned

* Actual vs. planned performance can be favourable or unfavourable

* Favourable = When income exceeds budget and/or expenses are lower than budget

* Unfavourable/Adverse = When income is less than budget and/or expenses are higher than budget

* Interpreting, investigating and taking action over variances is the key activity Process of Variance Analysis

* Determine budget for period

* Report actual performance

* Determine variance between then
* Investigate why variance occurred

* Is the variance significant?

* Is it early or late in the year?

* Is it likely to be repeated

* Can it be explained (and understood)?

* Is it controllable?

* Take corrective action if possible How Useful Is It as an Organisational Tool?
* What can it do (and cannot do?
? Causes of variance
* When should it be used?
? Cost of the examination
* How to interpret the results?
? Tracing the actions responsible for the variances
* What are the limitations of variance analysis?
? Relevance of financial vs. non-financial data
? Benchmarking

* If emphasis on budget and variance is high, managers less likely to use variances for learning and improvement

* Should only be carried out when potential improvements outweigh costs a. Cost of examination b. Cost of actual analysis
* Two basic attributes of variance analysis: c. Effectiveness
? To what degree does the variance affect the achievability of set goals?
d. Efficiency
? How much resources are needed to achieve a certain goal?
How detailed should it be?
* "The analysis should stop any time the next level does not produce useful enough management information to warrant the additional complications" - (Shank & Churchill 1977, p.257) Example of variance analysis

Example of variance analysis from lecture notes

Course Notes Page 3

* Developing flexible budgets

* Types of variance (4)

* Who is responsible for variances?

* Benchmarking Definitions

* Benchmarking = Aligning predictions with comparable organisations

* Favourable = When income exceeds budget and/or expenses are lower than budget

* Flexible Budget = Uses budgeted revenues or cost amounts, but these are adjusted using the actual levels of output, revenue and cost drivers

* Static Budget = Based on a single, predetermined level of output

* Unfavourable = When income is less than budget and/or expenses are higher than budget

* Variance Analysis = Separating the effects of the different elements of performance

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