Question

Holding down operating costs is an ongoing challenge for managers. The lower the costs a company incurs, the higher its profit will be. But two factors can make a target profit difficult to achieve. First, human error and unexpected machine breakdowns may cause dozens of operating inefficiencies, and each inefficiency will cause costs to rise. Second, a company may control its costs so strictly that it will use cheaper materials or labour, which may cause a decline in the quality of its product or service and in its sales. To control costs and still produce high- quality goods or services, managers must continually assess operating activities by analyzing both financial and nonfinancial data.

Required:

Explain how variance analysis helps managers control costs. Focus on both the financial and nonfinancial data used in standard costing.

Answer 1

Answer:

Mostly people will focus primarily on cost variances because they are all expressed in dollars. Unfavorable cost variances lead to cost overruns, whereas favorable cost variances result in cost savings.

Many variances are based on nonfinancial data, however, and such data can help to pinpoint the causes of variances. Examples include

(1) Direct materials quantity variances, which arise because the actual quantity used differed from the standard quantity that should have been used.

(2) Direct labor efficiency variances, which occur when the standard time allowed for good output differs from the actual time taken.

Because analyses of variances based on nonfinancial data often lead to cost-saving solutions, such variances are a significant part of the cost control process.