Disposition of variances is the process of determining what actions should be taken in response to the variances identified through variance analysis. Variances can be either favorable or unfavorable, and their disposition depends on a variety of factors, including the magnitude of the variance, the cause of the variance, and the strategic priorities of the organization.
Types of Variances
There are several types of variances that can occur in an organization, including:
- Material variances: Material variances occur when the actual cost of materials used in production differs from the expected cost. Material variances can be further broken down into price variances and usage variances.
- Labor variances: Labor variances occur when the actual cost of labor used in production differs from the expected cost. Labor variances can be further broken down into rate variances and efficiency variances.
- Overhead variances: Overhead variances occur when the actual overhead costs incurred by an organization differ from the expected overhead costs. Overhead variances can be further broken down into fixed overhead variances and variable overhead variances.
- Sales variances: Sales variances occur when actual sales revenue differs from expected sales revenue. Sales variances can be further broken down into price variances and volume variances.
Factors that Influence Disposition of Variances
The disposition of variances depends on a variety of factors, including:
- Magnitude of the variance: The magnitude of the variance is an important factor in determining its disposition. Small variances may not require any action, while larger variances may require more significant action.
- Cause of the variance: The cause of the variance is also an important factor in determining its disposition. Variances caused by external factors may be beyond the control of the organization, while variances caused by internal factors may require corrective action.
- Strategic priorities: The strategic priorities of the organization are also important in determining the disposition of variances. For example, if the organization’s strategic priority is to reduce costs, then variances that result in cost savings may be viewed more favorably than variances that result in increased costs.
- Timeframe: The timeframe in which the variance occurred is also important in determining its disposition. Variances that occur in the short-term may require immediate action, while variances that occur in the long-term may require more strategic action.
Disposition of Material Variances
Material variances can be either favorable or unfavorable, and their disposition depends on the factors listed above. If the variance is favorable, it may be viewed as an opportunity to reduce costs or increase profits. In this case, the organization may take steps to replicate the favorable variance in the future. If the variance is unfavorable, the organization may need to take corrective action to reduce costs or increase efficiency. This may involve renegotiating contracts with suppliers, improving inventory management processes, or re-evaluating product design.
Material variances can arise due to several factors, including changes in material prices, changes in material quantities, and changes in material quality. The disposition of material variances involves analyzing each variance to determine its cause and deciding how to respond to it.
There are two types of material variances: favorable and unfavorable.
- Favorable Material Variances: A favorable material variance occurs when the actual material cost is less than the budgeted material cost. A favorable material variance is a desirable outcome as it indicates that the business has been able to control its material costs. If the variance is material and replicable, the business may choose to investigate the cause of the favorable variance to determine if it can be replicated in future periods. In some cases, the business may choose to invest in new technology or training programs to sustain the favorable variance.
- Unfavorable Material Variances: An unfavorable material variance occurs when the actual material cost is more than the budgeted material cost. An unfavorable material variance is an undesirable outcome as it indicates that the business has not been able to control its material costs. In this case, the variance should be investigated to determine the cause of the variance. The business may choose to take corrective action to reduce material costs in future periods, such as renegotiating contracts with suppliers, reducing waste, or improving inventory management.
The disposition of material variances can also be categorized as controllable and non-controllable variances.
- Controllable Material Variances: A controllable material variance is a variance that can be attributed to a specific person or department within the business. For example, a controllable material variance may be caused by a department that is overusing its budgeted resources. In this case, the department may be held accountable for the variance and may be required to take corrective action to reduce the variance in future periods.
- Non-Controllable Material Variances: A non-controllable material variance is a variance that is beyond the control of a specific person or department within the business. For example, a non-controllable material variance may be caused by changes in market prices or by unexpected events such as natural disasters. In this case, the business may need to adjust its budgeted material costs to reflect the changes in market prices or unexpected events.
Disposition of Labor Variances
Labor variances can also be either favorable or unfavorable, and their disposition depends on the factors listed above. If the variance is favorable, it may be viewed as an opportunity to reward employees for their efficiency or to invest in additional training to further improve efficiency. If the variance is unfavorable, the organization may need to take corrective action to improve efficiency. This may involve re-evaluating job design, implementing incentive programs, or investing in additional training.
Labor variances can arise due to several factors, including changes in labor rates, changes in productivity, changes in the number of hours worked, and changes in labor mix. The disposition of labor variances involves analyzing each variance to determine its cause and deciding how to respond to it.
There are two types of labor variances: favorable and unfavorable.
- Favorable Labor Variances: A favorable labor variance occurs when the actual labor cost is less than the budgeted labor cost. A favorable labor variance is a desirable outcome as it indicates that the business has been able to control its labor costs. If the variance is material and replicable, the business may choose to investigate the cause of the favorable variance to determine if it can be replicated in future periods. In some cases, the business may choose to invest in new technology or training programs to sustain the favorable variance.
- Unfavorable Labor Variances: An unfavorable labor variance occurs when the actual labor cost is more than the budgeted labor cost. An unfavorable labor variance is an undesirable outcome as it indicates that the business has not been able to control its labor costs. In this case, the variance should be investigated to determine the cause of the variance. The business may choose to take corrective action to reduce labor costs in future periods, such as renegotiating contracts with suppliers, reducing the use of labor-intensive activities, or improving productivity.
The disposition of labor variances can also be categorized as controllable and non-controllable variances.
- Controllable Labor Variances: A controllable labor variance is a variance that can be attributed to a specific person or department within the business. For example, a controllable labor variance may be caused by a department that is overusing its budgeted resources. In this case, the department may be held accountable for the variance and may be required to take corrective action to reduce the variance in future periods.
- Non-Controllable Labor Variances: A non-controllable labor variance is a variance that is beyond the control of a specific person or department within the business. For example, a non-controllable labor variance may be caused by changes in labor laws or collective bargaining agreements. In this case, the business may need to adjust its budgeted labor costs to reflect the changes in labor laws or collective bargaining agreements.
Disposition of Overhead Variances
The disposition of overhead variances is a critical aspect of variance analysis. Overhead variances can arise from various sources, such as a change in the volume of production, a change in the prices of inputs, or a change in the efficiency of the production process. The disposition of overhead variances involves determining the appropriate response to each variance that has been identified.
The disposition of overhead variances can be classified into three categories: favourable, adverse, and controllable.
- Favourable Overhead Variances: A favourable overhead variance occurs when the actual overhead cost is lower than the budgeted overhead cost. Favourable overhead variances are desirable because they indicate that the business has been able to control its overhead costs effectively. In this case, the variance may be accepted, or the business may decide to investigate the cause of the variance to determine if it can be replicated in future periods. In some cases, the business may choose to take action to exploit the favourable variance, such as investing in new technology or increasing marketing efforts.
- Adverse Overhead Variances: An adverse overhead variance occurs when the actual overhead cost is higher than the budgeted overhead cost. Adverse overhead variances are undesirable because they indicate that the business has not been able to control its overhead costs effectively. In this case, the variance should be investigated to determine the cause of the variance. The business may decide to take corrective action to reduce the overhead costs in future periods, such as renegotiating contracts with suppliers, reducing the use of overhead-intensive activities, or improving the efficiency of the production process.
- Controllable Overhead Variances: A controllable overhead variance is a variance that can be directly attributed to a specific person or department within the business. For example, a controllable overhead variance may be caused by a department that is overusing its budgeted resources. In this case, the department may be held accountable for the variance and may be required to take corrective action to reduce the variance in future periods.
After identifying the variances, the next step in variance analysis is to decide on the appropriate disposition of each variance. The disposition of variances refers to the actions that will be taken in response to the variances that have been identified. This is a crucial step because it determines whether the variances will be addressed or ignored, and whether any corrective action is needed to achieve the desired results.
The disposition of variances can be broadly classified into three categories: action, investigation, and acceptance.
- Action: When a variance is significant and outside the acceptable range, action is taken to correct it. This may involve changing the way the business operates or adjusting the budget for future periods. For example, if there is a significant adverse variance in the material cost, the business may decide to look for alternative suppliers, negotiate better prices, or change the production process to reduce the material usage.
- Investigation: When a variance is not significant, but outside the acceptable range, further investigation is needed to determine the cause and whether action is required. This may involve reviewing the assumptions used in the budgeting process, or conducting a detailed analysis of the operations to identify the root cause of the variance. For example, if there is a small favourable variance in the labour cost, the business may decide to investigate whether this is due to more efficient operations, or whether there are other factors contributing to the variance.
- Acceptance: When a variance is within the acceptable range, it may be deemed acceptable and no action is required. This may be the case for variances that are within the range of normal business fluctuations, or where the cost of correcting the variance exceeds the benefit. For example, if there is a small favourable variance in the overhead cost, the business may decide that the cost of investigating and correcting the variance outweighs the benefit, and may choose to accept the variance.
The disposition of variances is not a one-time decision, but a continuous process that requires ongoing monitoring and evaluation. As the business environment changes, the acceptable range for variances may also change, and the disposition of variances may need to be re-evaluated. Similarly, the disposition of variances may need to be adjusted based on the results of previous actions taken to address variances.
Pros of Disposition of variances:
- Improved Control: The disposition of variances helps businesses to identify areas where they have lost control over their budget. By analyzing the root cause of the variances, businesses can develop corrective actions to regain control over their budget, improving their overall financial management.
- Improved Decision Making: By analyzing variances and identifying trends over time, businesses can make better-informed decisions on future budgets. The analysis can also provide insight into areas where investments may need to be made to improve the business’s performance.
- Increased Accountability: The disposition of variances helps to increase accountability for budget holders. When budget holders are made aware of variances and the impact they have on the business, they are more likely to take ownership of their budget and implement corrective actions to address variances in the future.
- Better Resource Allocation: By identifying the root cause of variances, businesses can make better decisions on resource allocation. This can help to ensure that resources are allocated to areas where they are most needed, improving the overall performance of the business.
Disadvantages of Disposition of variances:
- Time-Consuming: The process of analyzing variances and developing corrective actions can be time-consuming. This can be a challenge for businesses with limited resources, and the time required may delay other important business activities.
- Limited Scope: The disposition of variances may only focus on specific areas of the business, such as materials, labor, and overheads. This means that other areas that may impact budgetary performance, such as marketing and sales, may be overlooked.
- Limited Accuracy: The accuracy of the disposition of variances may be limited by the quality of data available. If data is inaccurate or incomplete, it may be challenging to identify the root cause of variances accurately.
- Disruption: The process of developing and implementing corrective actions may disrupt day-to-day operations. This can have a negative impact on the business’s ability to meet its goals and objectives.