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## Variance Analysis Notes

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

* 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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