What Happened to Variance Analysis

May 21, 2015

A few weeks ago I was talking to a CFO of a publicly traded company about the evolution of cost accounting. We were specifically talking about the change associated with variances. We discussed how variances were once frequently computed, reported and analyzed in detail to help provide management guidance for improvements in production efficiency. Now, this has been virtually put aside for a variety of reasons.

As I think about that change, I’m not surprised management teams of American businesses have not clamored for its reinstatement. Even at the height of its use, I’m not sure how many line production managers actually understood the results of the variances they were creating and how to appropriately manage their departments to minimize the variances and to maximize productivity. The process of creating, calculating, analyzing, and presenting variances is a unique specialty unto itself. Unfortunately, unless the individual departmental managers received specific training related to the variances they were asked to control, I can’t imagine they were very effective. The ability to manage your areas of responsibility with the assistance of properly analyzed variances is a valuable tool. However, if those tools are misunderstood, misused or haphazardly applied, then no favorable results will likely be generated. This will put the entire process in a questionable light as to the benefit to improving the operational efficiencies, and call into question the cost-benefit of maintaining the entire process.

Calculate_VarianceI understand the component of the variance computation and analysis process. It seems reasonable to me. However, the other component of the variance analysis is the ability to properly ascertain that the standards and the rates that are being used and whether or not they represent reality on the shop floor. Companies that have up-to-date standards and rates would very likely create relatively minimal variances related to minor changes in productivity or other fluctuations common in the manufacturing world. However, those companies with out-of-date standards, bills of material, and product routings would have an indication of how far off they are by the magnitude of the variances that are being created.

If standards are being maintained and rates are being updated periodically, and bills of material and routings also concurrently change on the shop floor, then the variances would be relatively minor and would provide assurances that product costing is reasonable with the constraints that the costing system allows it to be.

For instance, overhead application rates may result in the recovery of all the overhead in a fashion sufficient to create a small variance, but does not indicate that the allocation between products, process, customers or plants is accurate and reliable. In today’s world, I see huge discrepancies in product pricing when such assurances would give management at least one level of comfort that what they’re attempting to do is reasonable and prudent in light of total recovery.

In spite of the fact that not all variances are computed in the same fashion as they’ve always been in the past, it would seem prudent that the cost accountant of a company would annually reconcile all variances to actual and look for anomalies that would indicate a fundamental disconnect in the cost model used to cost their products for inventory, for sales, for gross margin analysis, and for other analytical tools important to manage

Categories: Cost Accounting