# Variance Analysis in ACCA MA: Step-by-Step Optimisation Approach

In this article, we discuss the art of "variance analysis", a key component of the ACCA Management Accounting syllabus. We provide you with a step-by-step guide.

Meet Johno.

He is what one would call a real numbers geek. We say that with great respect because Johno has a knack for figuring out why things don’t go according to plan.

When the numbers are crunched and they’re not adding up, Johno isn’t a happy lad, and the only thing that makes him feel better is having a solid plan in place to make things more predictable in the future.

Johno’s story is one that many ACCA students and management accountants can relate to.  His passion for numbers and desire for accuracy and predictability are the hallmarks of financial work.

In this article, we discuss the art of ‘variance analysis’, a key component of the ACCA Management Accounting syllabus. We provide you with a step-by-step approach for optimisation, a tried and tested way of reaching important business goals, if you will.

Let’s hop into Johno’s shoes for a moment and look at the fascinating world of analysing variances and all the information you can gain from this process.

## Key Components of Variance Analysis

### Types of Variances

• Sales Volume Variance: Measures the effect on expected profit of a difference between actual and budgeted sales volume. It's calculated by taking the difference between the actual units sold and the budgeted units, and then multiplying this figure by the standard profit per unit.
• Sales Price Variance: The difference between the actual revenue generated from sales and the expected revenue based on budgeted selling prices.
• Fixed Overhead Expenditure Variance: Quantifies the deviation of the actual cost of fixed overheads from the budgeted or planned fixed overhead costs for a given period.
• Fixed Overhead Volume Variance: The difference between the budgeted fixed overheads and the fixed overheads that would have been incurred at actual production levels. Essentially, it shows how changes in production volume impact fixed overhead costs.
• Sales Volume Profit Variance: Arises from the difference in the actual quantity sold or produced compared to the budgeted quantity.
• Material Usage Variance: The difference between the actual quantity of materials used in production and the standard quantity expected to be used, multiplied by the standard price per unit of material.
• Material Price Variance: The difference between the actual price paid for materials and the standard price, multiplied by the actual quantity of materials purchased. It reflects how well the purchasing department is controlling costs.
• Labour Efficiency Variance: Difference between the actual labor hours used and the standard labor hours expected for the production achieved, multiplied by the standard labor rate. It assesses the efficiency of labor use in the production process.
• Variable cost variances: Measures the difference between the actual variable costs incurred and the budgeted variable costs. Variable costs are expenses that vary in proportion to the production volume or business activity level.

### Significance of Each Variance

• Favorable Variances: Indicate better-than-expected performance (e.g., higher revenues or lower costs than budgeted).
• Unfavorable Variances: Reflect worse-than-expected performance (e.g., lower revenues or higher costs than budgeted).

### Calculation and Analysis

• Variances are calculated by subtracting the budgeted figure from the actual figure.
• The analysis involves investigating the reasons behind these variances, which could include changes in market conditions, efficiency variations, or pricing strategies.

### Application in Decision-Making

• Helps in identifying areas of business that are performing well or underperforming.
• Provides insights for budget revisions, cost control measures, and strategic planning.

### Limitations

• Variance analysis mainly focuses on quantitative aspects, potentially overlooking qualitative factors.
• It's often based on historical data, which may not always be a reliable indicator for future planning.

Now that we understand the finer details of variance analysis, let’s examine how this applies in business.

## Step-by-Step Approach to Optimisation

### 1. Set Clear Objectives

Define what you want to achieve (e.g., cost reduction, revenue maximization, efficiency improvement). Ensure these objectives align with the overall business strategy.

### 2. Develop Standard Costs and Budgets

Create detailed budgets and standard costs for different operations. These should be realistic and based on thorough market and internal analysis.

### 3. Implement Tracking and Measurement Systems

Use accounting systems to track actual performance against the standards set. Ensure the data collected is accurate and timely. For example, tracking fixed overhead variance is essential for understanding how fixed costs are controlled and managed in relation to the budget.

### 4. Conduct Regular Variance Analysis

Regularly compare actual performance with the budgeted or standard figures. Identify both favorable and unfavorable variances.

### 5. Investigate Variances

Analyze the reasons behind each significant variance. Look into operational, market, and internal factors that could have contributed.

### 6. Take Corrective Actions

For unfavorable variances, implement measures to correct the deviations. This could involve process improvements, cost control measures, or strategic shifts.

### 7. Revise Plans and Standards

Based on the insights gained, revise budgets and standards to make them more attainable or challenging. Ensure these revisions are communicated across the organisation.

### 8. Continuous Monitoring and Improvement

Keep monitoring performance against revised standards. Continuously look for ways to optimise operations, reduce waste, and improve efficiency.

### 9. Feedback and Learning

Encourage feedback from all levels of the organisation. Use lessons learned for continuous improvement and future planning.

### 10. Alignment with Long-Term Goals

Ensure that the insights and actions derived from variance analysis contribute to the long-term objectives of the business. Periodically review the alignment between short-term operational adjustments and long-term strategic goals.

Ok, we’re getting along nicely and Johno would approve, but no learning is complete until you can practically apply the theory. Here, we provide just one example of how you can work through this process in real life.

## Practical Example for Each Step in the Optimisation Process

A manufacturing company produces electronic gadgets. The standard cost for materials is \$10 per gadget, and the standard labor cost is \$5 per gadget. In a particular month, the company produces 5,000 gadgets. The actual costs were \$52,000 for materials and \$26,000 for labor.

Step 1: Set Clear Objectives

Objective: Reduce production costs by optimising material and labor expenses.

Action: Analyse material and labor variances to identify cost-saving opportunities.

Step 2: Develop Standard Costs and Budgets

Budget for the Month: Materials = 5,000 gadgets * \$10 = \$50,000; Labor = 5,000 gadgets * \$5 = \$25,000.

Step 3: Implement Tracking and Measurement Systems

System Implementation: Use accounting software to track actual costs versus standard costs.

Data Collection: Collect data on actual spending and production output.

Step 4: Conduct Regular Variance Analysis

Material Variance Calculation: Actual - Standard = \$52,000 - \$50,000 = \$2,000 unfavorable.

Labor Variance Calculation: Actual - Standard = \$26,000 - \$25,000 = \$1,000 unfavorable.

Step 5: Investigate Variances

Material Variance Analysis: Explore reasons like price increases or excess usage.

Labor Variance Analysis: Investigate causes such as overtime or inefficiencies.

Step 6: Take Corrective Actions

Material Cost Actions: Negotiate prices, reduce waste, and switch suppliers.

Labor Cost Actions: Improve scheduling, enhance training, and revise work processes.

Step 7: Revise Plans and Standards

Revising Standards: Adjust standards if new suppliers are found or if efficiency improvements are implemented.

Communicating Changes: Ensure all departments are aware of the new standards.

Step 8: Continuous Monitoring and Improvement

Ongoing Monitoring: Regularly review the cost reports.

Seeking Improvements: Continuously look for further cost-saving opportunities.

Step 9: Feedback and Learning

Encouraging Feedback: Seek input from production staff on potential improvements.

Learning from Variance Analysis: Adjust strategies based on feedback and results.

Step 10: Alignment with Long-Term Goals

Strategic Alignment: Ensure cost reductions align with long-term profitability and quality goals.

** Here one more example like this could be included and I believe will be helpful if the client is willing to go over the word count to include it.

## How can you become a variance whizzkid?

We’ve given you a whirlwind tour of variance analysis. But why stop here? Dive into the full course with many more practical examples by visiting our ACCA MA course page.  This course isn't just about numbers and mountains of theory. It’s an interactive journey that will systematically transform you into a financial whizz like Johno.