Variance Analysis in Management Accounting: Merits and Demerits

This article discusses the merits and demerits of variance analysis in management accounting and its role in determining managers' performance. It also provides a practical example of variance analysis in a case study.

Management
Accounting

Table of Contents
INTRODUCTION...........................................................................................................................3
PART A...........................................................................................................................................3
(i) Sales price variance and sales volume contribution variance:................................................3
(ii). Material price planning variance and material price operational variance:..........................4
(iii). Critical and effective analysis of all the merits and demerits linked with variances use in
determining managers performance:...........................................................................................5
PART B...........................................................................................................................................8
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................12

INTRODUCTION
Present competitive environment has increased the need of adoption of a specific
framework model that can help businesses to survive, stay competitive and achieve targeted
business goals. Management accounting is most useful mechanism that can help businesses to
deal within competitive business environment, as this proposes massive range of strategies and
tactics to support business decision-making. Variance analysis is also a technique of MA that is
crucial for business to its self evaluation (Youssef, Moustafa and Mahama, 2020). The study-
assessment comprises practical sum of finding out different variances based on given
information of XLG which is Britain's cleaning-products making corporation; and a critical
analysis of merits and drawbacks of variance analysis in ascertaining managers performing
status. Further, study discuss about risks may occur due to importing a patent product fama Q
and entent to which this impacted XLG during lock-down focused on the given case study of
XLG.
PART A
(i) Sales price variance and sales volume contribution variance:
As per case study following is a summary of information provided:
Aggregate units sold: 1600 units
Material price variance: £27000 F
Sales and Contribution:
Chemical X Chemical Y
Budgeted total sales 595 units 595 units
Actual Sales Volume 850 units 750 units
standard sales price £ 35 £ 30
Actual sales price £ 45 £ 37
Standard margin £ 25 £ 20
Sales price variance = (Actual Price – Standard Price) * Actual Unit

Chemicals X
Sales Price Variance (X) = (45 – 35) * 850
= 8500F
Chemicals Y
Sales Price Variance (Y) = (37 – 30) * 750
= 5250F
Sales volume contribution variance = (Actual number of units sold × Budgeted price per
unit) – (budgeted number of units sold × Budgeted price per unit)
Chemicals X
Sales volume contribution variance (X) = (850 * 35) – (595 * 35)
= 8925F
Chemicals Y
Sales volume contribution variance (Y) = (750 * 30) – (595 * 30)
= 4650F
(ii). Material price planning variance and material price operational variance:
Based on case study following information provided, as follows:
original standard price £2.50 per-unit
Increased(revised) unit price £4.50
Material price operational variance:
Chemicals X
(A) Original budgeted sales x Standard Margin = 595 * 2.5 * 25 = 37187.5
(B) Revised budgeted sales x Standard Margin = 595 * 4.5 * 25 = 66937.5
Material price operational variance (A – B) = -29750

Chemicals Y
(A) Original budgeted sales x Standard Margin = 595 * 2.5 * 20 = 29750
(B) Revised budgeted sales x Standard Margin = 595 * 4.5 * 20 = 53550
Material price operational variance (A – B) = -23800
Material price planning variance:
Chemicals X
(A) Revised budgeted sales x Standard Margin
= 595 * 4.5 * 25 = 66937.5
(B) Actual Sales Quantity x Standard Margin 850 * 25 21250
Material price planning variance (A – B) = 45687.5
Chemicals X
(A) Revised budgeted sales x Standard Margin
= 595 * 4.5 * 20 = 53550
(B) Actual Sales Quantity x Standard Margin 750 * 20 15000
Material price planning variance (A – B) = 38550
(iii). Critical and effective analysis of all the merits and demerits linked with variances use in
determining managers performance:
Analysis/Evaluation of variances is a procedure through which multiple budgets of
different enterprises can be governed. The review of variances that be carried out on daily ,
weekly or perhaps even monthly base where actual performance results for the entity 's budget
are reported. These participated performance estimates are being used in conjunction with the
already planned estimates for the assessment of discrepancies that are unavoidable. Such
discrepancy is termed as variance as well as the entire procedure is often called as

variances analysis (variance Equal to standard budget-actual budget). In a case that sum
budgeted exceeded the actual sum, the difference found is positive, meaning that amount spent
was lower than budgeted amount (Fleischman and McLean, 2020). An Unfavourable variations
arise whenever actual output sum exceeds the budgeted sum. This should be remembered that
different budgets are developed for primary purpose that they provide a benchmark by
which performance of every company is assessed. at other hand , review of variances determines
the efficiency of the business organization in relation to budgets. There are several variables that
the management team should acknowledge when conducting variance analysis. There's several
situations wherein variances exist and each situation needs to be handled uniquely in attempt to
prevent errors. Planning variance analyses and the process of reviewing results are very critical
activities for the company. Variance analysis assists a good deal in decision-making process
in enterprise. This analysis allows management to formulate various operating strategies in order
to enhance efficiency and also to delegate specific activities to various employees (Frick, Birt
and Waters, 2020). This analysis is also important as it allows management to determine the
reasons of variances and therefore to undertake effective corrective steps to cope with variations.
The decisions made by management after reviewing variance reports can include the following.
Cost variances provide hints to a probable issue and can trigger it. Analysis of variance can be
used for timely detection as well as prevention. Management can find manner to determine if
such variances are actually due to circumstance or to real problem which requires to be
addressed. Favourable variance is defined as predicted cost is greater than actual cost or expected
revenue is less than actual revenue. If estimated cost outweighs the estimated benefits, that's an
unacceptable variance. The choice to examine is taken by balancing the anticipated benefits
with anticipated costs (Asuquo, 2020). Managers are directly concerned with variance results as
an adverse variance in specific area like material , labour etc. indicates that manager who handle
such area is not performing as per the expectation or he is not capable to handle such specific
area's operations. Here in this regard following are certain key merits and demerits of variance
analysis in relation to assessing managers' performance, as follows:
Merits:
 The causes for total variances could be conveniently identified for taking corrective
action. The subsection of the evaluation of variances reveals the key relationship that

prevails between the multiple variations. It is very useful to decide the obligation of the
person or unit separately towards each identified variance.
 It points out or underlines all ineffective performance as well as the level of
ineffectiveness thus also employed for cost controlling purposes. Upper management
may, by exception, adopt the principles of management and only undesirable variances
are reported to top mangers (Sohl, Vroom and Fitza, 2020).
 Often variances may be categorized as controllable or uncontrollable variations.
Controllable variations are put into account in this scenario for further review. The
preparation of profits should be carried out efficiently by top management. The outcomes
of the management action could be a decrease in costs. It induces cost-consciousness
in minds of every staff within a business organisation.
 Effective analysis of all the variance allow managers to efficient allocation of all the
business resources and thereby increase overall productivity of business. Further
managers can also assess the over or any under utilisation of different resources.
 Variance analysis also form a base for preparation of annual financial budget as this
present actual efficiency and operational level of organisation by showing variance in
performance.
 Further this allow managing personnel to focus on weak areas of business organisation
and also act as alarming framework by exhibiting variances in particular areas which
ultimately supports decision-making within entity (Chang, van Witteloostuijn and Eden,
2020).
Demerits:
 Accounting personnel compile all variances at month end before presenting the reports to
the managers. In fast-paced environment, managers require input much quicker than once
in a month, therefore tends to dependent on other measures or indicator markers which
are obtained on-site (particularly in production area).
 Some of the factors for variances generally not appear in accounting reports, and
accounting personnel will dig through details like inventory costs, labour, and payroll
data to identify the sources of the issues. additional analysis is only cost-effective if
managers can systematically fix issues on the basis of such information.

 The analysing variance is necessary in comparison of actual findings with arbitrary
standards which may have been extracted from political agreements. Consequentially, the
eventual variance could not provide any effective information (Wen and Siqin, 2020).
 Variance analysis can promote short-termism owing to its inherent orientation towards
shorter-term, quantitative targets and outcomes. Negative views of the
corporation's variance analysis method that also promote other suboptimal actions among
personnel, like attempts to implement budgeting slacks.
 Accountability is a central feature of variance analysis. Variations may occur for a range
of reasons varying from unrealistic objectives/targets (e.g. failure to consider the
anticipated rise in wages rates) to operational factors ( e.g. change in the direct-material
usage attributable to the hiring of less skilled labour). Planning shortfalls that might have
generated significant variances owing to setting of incorrect standards/budgets could be
resolved retrospectively through measuring planning and operating variations. However,
this may be more complicated to determine the precise reasons and delegate the duties
of organizational variances to a particular individual, division or task within an entity
(Lanzolla and Markides, 2019).
PART B
Evaluation of risks before making a major decisions is crucial for business as this allow
to recognise any potential risks and their effects on business associated with such decision
(Salles, Rocha and Gonçalves, 2020). As presented in XLG's particular scenario, because of the
lock-down, there's a substantial rise in sales prices because as standard sale price every
single unit of the chemical X is being enhanced from £ 35 to £45, as well as in that case chemical
Y's the sale price has also been enhanced from £ 30 to £37. The main consequence of such a rise
in the sales prices is the significant rise in the price of the fama-Q, the superior effective cleaning
item of the corporation that is combined in company's products. Consequence of the lock-down,
and also the restraints and limitations on overseas travels, it is essential for the corporation to
import the fama-Q from the air transit system. It has considerably enhanced the costs of imports,
as air transit is too costly especially in comparison to sea transit. As a consequence of one such
rise in transportation costs, the sales prices of chemicals X and Y have been risen. Fama Q's
standard rate is £2.50 each unit, which was raised to £4.50 but £3.70 is actually charged by XLG.
Here, the significant effect is that the total profitability of the corporation would be influenced.

In addition to sales rates, a drastic rise in demands and use of chemicals X and Y has also been
recorded. The rise is beneficial for the organization because this boost in the net revenue of its
main products. That's one major impacts of lock-down. The reason for this large rise in demand
for household cleaners is that people are now becoming more conscientious of sanitation and
hygiene. Therefore here major risk for company is to drop down in sales due to non fulfilment of
customer's demand on time.
Further, additional information given in the scenario that if the corporation tends to
make single unit of a fama-Q, this will cost the organization £ 3 for every unit, including a
decrease in shipping period of 15 days. This is also given that the demand for chemicals X and Y
expanded about 45 % and is projected to continue. Therefore, focused on additional details and
case scenario, there are major two options available to the XLG, as set out below:
Alternative 1- Importing of fama-Q at the increased rates:
In this alternative, actual demands for chemicals X and Y are: 850-units and 750, as well
as there's a rise in costs of chemicals X and Y owing to imports at a increased average price
of 1.2 each unit (3.7 - 2.5). There will be margin in this situation as shown below:
If Imports:
Chemi
cal X
Chemi
cal Y
Budge
ted
Per
unit Actual
Varian
ce
Budge
ted
Per
unit
Varian
ce
Selling Price 35 20825 45 38250 17425 35 20825 37 27750 6925
Cost of
Chemicals 10 5950 20 17000 11050 10 5950 17 12750 6800
Increase in
cost due to
import of
Fama Q - 1.2 1020 1020 - 1.2 900 900
Total Cost 10 5950 21.2 18020 12070 10 5950 18.2 13650 7700

Profit Margin 25 14875 23.8 20230 5355 25 14875 18.8 14100 -775
Alternative 2- Making fama-Q in house:
In this alternative, demands has risen by 45 per cent and delivery/shipment time has
decreased by 15 days, whereas the cost of developing fama-Q is £3. Premised on this
information, following is evaluation of the product margin, as stated below:
If making
fama Q
Chemi
cal X
Chemi
cal Y
Per
unit
Budge
ted
Per
unit
Varian
ce
Budge
ted
Per
unit
Varian
ce
Selling Price 45 26775 45
38823.
75
12048.
75 35 20825 37
31921.
75
11096.
75
Cost of
Chemicals 20 11900 20 17255 5355 10 5950 17
14666.
75
8716.7
5
Increase in
cost due to
import of
Fama Q 0.5 1.2
431.37
5
431.37
5 - 0.5
431.37
5
431.37
5
Total Cost 20.5
12197.
5 21.2
17686.
375
5488.8
75 10 5950 17.5
15098.
125
9148.1
25
Profit Margin 24.5
14577.
5 23.8
21137.
375
6559.8
75 25 14875 19.5
16823.
625
1948.6
25

Demand according to such new scenario would
have been risen by 45 %
Therefore, new demands for both Chemical X
& Y will be:
Chemical - X 595 + 595 x 45% = 862.75
Chemical - Y 595 + 595 x 45% = 862.75
Through the analysis of both alternatives, this is evaluated that producing in-house fama
Q will be more feasible for the organization. Because, in this case for both Chemical X and Y,
overall margin is greater if the organization makes famaQ itself rather than importing it. It was
also evaluated in contrast with the planned budgeted sum that the alternative of creating famaQ
will be more worthwhile to the company (Merkin and Schweiz, 2020). But here notable aspect is
that if company start making fama Q which is patent product there would be chances of claims
and litigations against company thus company should consider this fact while making product
fama Q. Also, company is operating in highly competitive business environment thus delay in
availability of fama-Q can affect company's sales. Thus here company in order to minimise
delivery by 15 days, should start making fama Q.
CONCLUSION
It has been analysed from the above report that managerial-accounting aspect is of value
to companies to organize their operational activities. This incorporates valuable methodologies,
implementations, reporting techniques and other procedures that finally aid in decision-making
functions within a corporation. This is not mandatory for corporate entities to implement
management accounting structures, however in practical life this is not feasible for a corporation
without it, functioning in a competitive atmosphere and dealing with distinct concerns . This also
advocates a number of techniques that not only strengthen key personnel managerial decisions
and actions, but also provide an aid conceptual model for implementation of strategies.

REFERENCES
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progress of business organizations. International Journal of Scientific and technology
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performance? A variance decomposition analysis. Academy of Management
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Chang, S.J., van Witteloostuijn, A. and Eden, L., 2020. Common method variance in
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Salles, T., Rocha, L. and Gonçalves, M., 2020. A bias-variance analysis of state-of-the-art
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support the execution of a business process. U.S. Patent 10,540,072.