Question

How are managers likely to respond if variances are used to punish them?

Answer 1

Ans-

Companies use variance analysis in different ways. The starting point is the determination of standards against which to compare actual results. Many companies produce variance reports, and the management responsible for the variances must explain any variances outside of a certain range. Some companies only require that unfavorable variances be explained, while many companies require both favorable and unfavorable variances to be explained.

Requiring managers to determine what caused unfavorable variances forces them to identify potential problem areas or consider if the variance was a one-time occurrence. Requiring managers to explain favorable variances allows them to assess whether the favorable variance is sustainable. Knowing what caused the favorable variance allows management to plan for it in the future, depending on whether it was a one-time variance or it will be ongoing.

Another possibility is that management may have built the favorable variance into the standards. Management may overestimate the material price, labor rate, material quantity, or labor hours per unit, for example. This method of overestimation, sometimes called budget slack, is built into the standards so management can still look good even if costs are higher than planned. In either case, managers potentially can help other managers and the company overall by noticing particular problem areas or by sharing knowledge that can improve variances.

Often, management will manage “to the variances,” meaning they will make decisions that may not be advantageous to the company’s best interests over the long run, in order to meet the variance report threshold limits. This can occur when the standards are improperly established, causing significant differences between actual and standard numbers.