CAT / FIA FMA Syllabus E. Standard Costing - Factors to consider before investigating - Notes ^{7 / 8}

When deciding which variances to investigate, the following factors should be considered

1. Reliability and accuracy of the figures. 

   Mistakes in calculating budget figures, or in recording actual costs and revenues, could lead to a variance being reported where no problem actually exists (the process is actually ‘in control’).

2. Materiality. 

   The size of the variance may indicate the scale of the problem and the potential benefits arising from its correction.

3. Possible interdependencies of variances. 

   Sometimes a variance in one area is related to a variance in another.

    For example, a favourable raw material price variance resulting from the purchase of a lower grade of material, may cause an adverse labour efficiency variance because the lower grade material is harder to work with.

   These two variances would need to be considered jointly before making an investigation decision.

4. The inherent variability of the cost or revenue. 

   Some costs, by nature, are quite volatile (oil prices, for example) and variances would therefore not be surprising. 

   Other costs, such as labour rates, are far more stable and even a small variance may indicate a problem.

5. Adverse or favourable? 

   Adverse variances tend to attract most attention as they indicate problems. 

   However, there is an argument for the investigation of favourable variances so that a business can learn from its successes.

6. Trends in variances. 

   One adverse variance may be caused by a random event. 

   A series of adverse variances usually indicates that a process is out of control.

7. Controllability/probability of correction. 

   If a cost or revenue is outside the manager’s control (such as the world market price of a raw material) then there is little point in investigating its cause.

8. Costs and benefits of correction. 

   If the cost of correcting the problem is likely to be higher than the benefit, then there is little point in investigating further.

The control action which may be taken will depend on the reason why the variance occurred.

The variance may be a result of a measurement error, e.g. wastage has been unrecorded, scales have been misread or employees may adjust their records to ‘improve’ their performance.

Control action is required to improve the accuracy of the recording system so that measurement errors do not occur.

In periods of high inflation or where operations are subject to technological development, price standards are likely to become out of date.

In such cases, there is the need to frequently review and update standards.

Spoilage and wastage will both negatively affect the efficiency of operations.

It is important to highlight the cause of the inefficiency that will lead to control action to eliminate the efficiency being repeated.

A standard is an average figure, representing the midpoint of different values.

Actual results are likely to deviate from this standard.

As long as the variance falls within this range, it will be classified as a random or chance fluctuation and control action will not be necessary.