Unknown Variances Can Be Disastrous

Apr 30, 2015

One of the issues, we occasionally come across involves variances computed by computer systems. Many times new software systems produce large variances every month and without review by the accounting team that is supervising the operations, this becomes a critical issue.

This is not uncommon when a business implements a new system, particularly an ERP system, that is highly integrated and comprehensively measures all elements of the business. Many times the system provides intended controls in the form of variances which require investigation and management to reduce or eliminate reoccurrence. Our experience has revealed many inexperienced cost managers will allow huge unexplained variances to continue for long periods of time without any attention being devoted to their analysis or reduction. The result is at the end of the accounting period, the ledger has a very large variance, which should be identified to some segment of the business but has become more of a problem. This problem has been accumulating for so long it is now difficult or impossible to analyze.

We have collaborated with $50 million businesses in similar situations with unexplained variances that have reached seven-figure proportions! The business had a huge expense on their income statement which they could not identify, did not understand, and did not have a plan to control in the future.

Logic would say that some of that variance should be allocated to one inventory account or another and that this is an indication of miscalculations occurring within the system.

The one lesson I have learned concerning unexplained variances over a number of years is that there is a flaw within the cost accounting system that needs to be identified and corrected. Many times there are multiple flaws sometimes offsetting one another which add to the ever-increasing variance. If no study is undertaken to figure out what is causing the problem and how to fix it, then the miscalculation will likely cause other misinformation. This will continue to mislead managers and undermine the accuracy of the system. In the end, management will react to information that is inaccurate and disastrous events may unravel

If you are operating in an environment that is creating huge costing variances that you do not understand and cannot correct, spend the time to figure out what is wrong and fix it before it becomes a problem that can no longer be an easy fix.

Categories: Cost Accounting