Lecture 3 - National Income Determination: Two Sector Model | Macroeconomics- Learning and Analysis PDF Download

 Page 1


Analysis of Variance 
  
  
 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Course:   Discipline 1-Commerce and BMS 
Subject:  Accounting for Managers 
Lesson:   Analysis of Variance 
Lesson Developer: Deepika Dewan 
College/ Department: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page 2


Analysis of Variance 
  
  
 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Course:   Discipline 1-Commerce and BMS 
Subject:  Accounting for Managers 
Lesson:   Analysis of Variance 
Lesson Developer: Deepika Dewan 
College/ Department: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Analysis of Variance 
  
  
 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Lesson: Analysis of Variance 
 
Table of Contents 
 
1: Learning Outcomes 
2: Introduction 
3: Concept of Variance and Variance Analysis 
   3.1: Rationality of Variance Analysis 
   3.2: Variants of Variances 
   3.3: Role of Standard and Standard Costing in Variance Analysis 
4: Process of Variance Analysis 
5: Computation of Variances 
5.1: Material Cost Variances 
5.2: Labour Cost Variances 
 
Summary 
Glossary 
Exercises  
References 
 
 
 
1. Learning Outcomes: 
 
 After you have read this lesson you should be able to: 
? understand the concept of variance and variance analysis, 
? identify the existence of variance and the type of variances, 
? explain the implications of various variances, 
? appreciate the role of variance analysis in the managerial process, 
? apply the knowledge to find the variances and deal with it, 
? comprehend the inter-relationship among various variances, 
? explain how standards are established, 
? compute and interpret the variances. 
Page 3


Analysis of Variance 
  
  
 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Course:   Discipline 1-Commerce and BMS 
Subject:  Accounting for Managers 
Lesson:   Analysis of Variance 
Lesson Developer: Deepika Dewan 
College/ Department: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Analysis of Variance 
  
  
 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Lesson: Analysis of Variance 
 
Table of Contents 
 
1: Learning Outcomes 
2: Introduction 
3: Concept of Variance and Variance Analysis 
   3.1: Rationality of Variance Analysis 
   3.2: Variants of Variances 
   3.3: Role of Standard and Standard Costing in Variance Analysis 
4: Process of Variance Analysis 
5: Computation of Variances 
5.1: Material Cost Variances 
5.2: Labour Cost Variances 
 
Summary 
Glossary 
Exercises  
References 
 
 
 
1. Learning Outcomes: 
 
 After you have read this lesson you should be able to: 
? understand the concept of variance and variance analysis, 
? identify the existence of variance and the type of variances, 
? explain the implications of various variances, 
? appreciate the role of variance analysis in the managerial process, 
? apply the knowledge to find the variances and deal with it, 
? comprehend the inter-relationship among various variances, 
? explain how standards are established, 
? compute and interpret the variances. 
Analysis of Variance 
  
  
 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
2. Introduction: 
 
Analysis of variance is one of the important techniques of control. And control is the most 
significant function of management. This function assists the management to measure and 
ascertain the performance of the organisation as a whole. The presence and successful 
implementation of control ensures the achievement of pre-determined targets and required 
efficiency. Under planning, the organisation decides on what, how and when the actions 
have to be implemented. But under control one evaluates if the planning has been 
executed. If it is executed whether it is implemented in the manner it was planned. One 
needs to identify the difference(s) in the planned and achieved targets for evaluating the 
managerial efficiencies and be more cost effective. This calls for analysis and measurement 
of differences between the planned and achieved targets. The analysis helps to determine 
the unplanned effects on the achieved results. The managers can correct effects if they are 
detrimental for the organisation or to enhance it if effects are beneficial. 
 
3. Concept of Variance and Variance Analysis: 
 
The variance is the quantified difference between the actual results achieved and expected 
performance. 
 
 Variance(s) = Expected or Estimated - Actual  
  
An illustration 
Suppose you are travelling and expect to reach your destination in normal traffic and 
normal conditions around in an hour. The time estimations and time keeping are done with 
all the considerations of the prevalence of normal conditions. But it took one and a half hour 
to reach the destination.  
 
The difference of half an hour that exists between the expected time frame of one hour and 
the actual time taken is called “variance”. In our example variance is adverse because 
actual time taken was more than expected. This boils down to the fact that there can be a 
favourable variance too. If the actual time taken would have been less than the expected, 
the difference would be favourable and enjoyed by everyone. 
 
Figure 1: Nature of Variance 
 
 
 
Variance 
 
Favourable Unfavourable or Adverse 
Page 4


Analysis of Variance 
  
  
 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Course:   Discipline 1-Commerce and BMS 
Subject:  Accounting for Managers 
Lesson:   Analysis of Variance 
Lesson Developer: Deepika Dewan 
College/ Department: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Analysis of Variance 
  
  
 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Lesson: Analysis of Variance 
 
Table of Contents 
 
1: Learning Outcomes 
2: Introduction 
3: Concept of Variance and Variance Analysis 
   3.1: Rationality of Variance Analysis 
   3.2: Variants of Variances 
   3.3: Role of Standard and Standard Costing in Variance Analysis 
4: Process of Variance Analysis 
5: Computation of Variances 
5.1: Material Cost Variances 
5.2: Labour Cost Variances 
 
Summary 
Glossary 
Exercises  
References 
 
 
 
1. Learning Outcomes: 
 
 After you have read this lesson you should be able to: 
? understand the concept of variance and variance analysis, 
? identify the existence of variance and the type of variances, 
? explain the implications of various variances, 
? appreciate the role of variance analysis in the managerial process, 
? apply the knowledge to find the variances and deal with it, 
? comprehend the inter-relationship among various variances, 
? explain how standards are established, 
? compute and interpret the variances. 
Analysis of Variance 
  
  
 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
2. Introduction: 
 
Analysis of variance is one of the important techniques of control. And control is the most 
significant function of management. This function assists the management to measure and 
ascertain the performance of the organisation as a whole. The presence and successful 
implementation of control ensures the achievement of pre-determined targets and required 
efficiency. Under planning, the organisation decides on what, how and when the actions 
have to be implemented. But under control one evaluates if the planning has been 
executed. If it is executed whether it is implemented in the manner it was planned. One 
needs to identify the difference(s) in the planned and achieved targets for evaluating the 
managerial efficiencies and be more cost effective. This calls for analysis and measurement 
of differences between the planned and achieved targets. The analysis helps to determine 
the unplanned effects on the achieved results. The managers can correct effects if they are 
detrimental for the organisation or to enhance it if effects are beneficial. 
 
3. Concept of Variance and Variance Analysis: 
 
The variance is the quantified difference between the actual results achieved and expected 
performance. 
 
 Variance(s) = Expected or Estimated - Actual  
  
An illustration 
Suppose you are travelling and expect to reach your destination in normal traffic and 
normal conditions around in an hour. The time estimations and time keeping are done with 
all the considerations of the prevalence of normal conditions. But it took one and a half hour 
to reach the destination.  
 
The difference of half an hour that exists between the expected time frame of one hour and 
the actual time taken is called “variance”. In our example variance is adverse because 
actual time taken was more than expected. This boils down to the fact that there can be a 
favourable variance too. If the actual time taken would have been less than the expected, 
the difference would be favourable and enjoyed by everyone. 
 
Figure 1: Nature of Variance 
 
 
 
Variance 
 
Favourable Unfavourable or Adverse 
Analysis of Variance 
  
  
 
4 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
  
 
 
 
 
 
 
 
The favourable variance is positive and adverse variance is negative. The expected input, if 
is greater than the actual achievement, that suggests that the efforts were expected to be 
more but the target is achieved in the lesser effort therefore, it is a matter of favour and if 
the effort put in for achieving the target is more than the expected or estimated amount, it 
is an adverse condition. Hence, this situation is referred to as the adverse variance.  
 
But, simply the identification of the quantum of variance is meaningless, if it is not 
analyzed. If one does not strive for knowing the reasons behind favourable or adverse 
variances the whole exercise of determining the variances is futile. 
 
Variance Analysis 
 
The exercise of analyzing the variances is referred to as Variance Analysis. Variance analysis 
is part of control process that involves calculation of variance and interpretation of results 
so as to find out various factors that are responsible for the variances. Variance analysis is a 
tool that helps the organizations to look into the causes of the discrepancies that arise or 
occur during the working of an organization. Besides identifying the differences between the 
desired or planned objectives or targets set for the particular period and the targets actually 
achieved, the variance analysis assists in identifying the causes for such discrepancies.  
 
Illustration Co nti nue d….. 
 
It is a known fact that there is bound to be a difference between the expected time and the 
actual time taken for reaching a particular destination, continuing with the same example of 
reaching a destination in a specified time. 
This difference may be due to several factors 
    i)  differences in the assumptions made while estimating the expected time to reach the  
destination with regard to the traffic, weather etc. and the actual conditions and  
assumptions; 
    ii) the process of determining and comparing actual time taken with the expected time; 
   iii) speed maintained to reach the destination, and 
   iv) the mode of travelling etc.  
 
The variance analysis tends to help in locating the reasons for such variances. The variances 
can exist in any field; wherever the estimation is done the variance analysis can be applied. 
The parameters of measurement can be time, cost, profit, yield, sales, revenue or any other 
thing. The discussion, here in this chapter is limited to variance analysis of cost. Cost has 
different components like material, labour and overhead. But, again this chapter is 
restricted to discuss only two major components of cost i.e. labour and material. In 
Page 5


Analysis of Variance 
  
  
 
1 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Course:   Discipline 1-Commerce and BMS 
Subject:  Accounting for Managers 
Lesson:   Analysis of Variance 
Lesson Developer: Deepika Dewan 
College/ Department: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Analysis of Variance 
  
  
 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Lesson: Analysis of Variance 
 
Table of Contents 
 
1: Learning Outcomes 
2: Introduction 
3: Concept of Variance and Variance Analysis 
   3.1: Rationality of Variance Analysis 
   3.2: Variants of Variances 
   3.3: Role of Standard and Standard Costing in Variance Analysis 
4: Process of Variance Analysis 
5: Computation of Variances 
5.1: Material Cost Variances 
5.2: Labour Cost Variances 
 
Summary 
Glossary 
Exercises  
References 
 
 
 
1. Learning Outcomes: 
 
 After you have read this lesson you should be able to: 
? understand the concept of variance and variance analysis, 
? identify the existence of variance and the type of variances, 
? explain the implications of various variances, 
? appreciate the role of variance analysis in the managerial process, 
? apply the knowledge to find the variances and deal with it, 
? comprehend the inter-relationship among various variances, 
? explain how standards are established, 
? compute and interpret the variances. 
Analysis of Variance 
  
  
 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
 
2. Introduction: 
 
Analysis of variance is one of the important techniques of control. And control is the most 
significant function of management. This function assists the management to measure and 
ascertain the performance of the organisation as a whole. The presence and successful 
implementation of control ensures the achievement of pre-determined targets and required 
efficiency. Under planning, the organisation decides on what, how and when the actions 
have to be implemented. But under control one evaluates if the planning has been 
executed. If it is executed whether it is implemented in the manner it was planned. One 
needs to identify the difference(s) in the planned and achieved targets for evaluating the 
managerial efficiencies and be more cost effective. This calls for analysis and measurement 
of differences between the planned and achieved targets. The analysis helps to determine 
the unplanned effects on the achieved results. The managers can correct effects if they are 
detrimental for the organisation or to enhance it if effects are beneficial. 
 
3. Concept of Variance and Variance Analysis: 
 
The variance is the quantified difference between the actual results achieved and expected 
performance. 
 
 Variance(s) = Expected or Estimated - Actual  
  
An illustration 
Suppose you are travelling and expect to reach your destination in normal traffic and 
normal conditions around in an hour. The time estimations and time keeping are done with 
all the considerations of the prevalence of normal conditions. But it took one and a half hour 
to reach the destination.  
 
The difference of half an hour that exists between the expected time frame of one hour and 
the actual time taken is called “variance”. In our example variance is adverse because 
actual time taken was more than expected. This boils down to the fact that there can be a 
favourable variance too. If the actual time taken would have been less than the expected, 
the difference would be favourable and enjoyed by everyone. 
 
Figure 1: Nature of Variance 
 
 
 
Variance 
 
Favourable Unfavourable or Adverse 
Analysis of Variance 
  
  
 
4 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
  
 
 
 
 
 
 
 
The favourable variance is positive and adverse variance is negative. The expected input, if 
is greater than the actual achievement, that suggests that the efforts were expected to be 
more but the target is achieved in the lesser effort therefore, it is a matter of favour and if 
the effort put in for achieving the target is more than the expected or estimated amount, it 
is an adverse condition. Hence, this situation is referred to as the adverse variance.  
 
But, simply the identification of the quantum of variance is meaningless, if it is not 
analyzed. If one does not strive for knowing the reasons behind favourable or adverse 
variances the whole exercise of determining the variances is futile. 
 
Variance Analysis 
 
The exercise of analyzing the variances is referred to as Variance Analysis. Variance analysis 
is part of control process that involves calculation of variance and interpretation of results 
so as to find out various factors that are responsible for the variances. Variance analysis is a 
tool that helps the organizations to look into the causes of the discrepancies that arise or 
occur during the working of an organization. Besides identifying the differences between the 
desired or planned objectives or targets set for the particular period and the targets actually 
achieved, the variance analysis assists in identifying the causes for such discrepancies.  
 
Illustration Co nti nue d….. 
 
It is a known fact that there is bound to be a difference between the expected time and the 
actual time taken for reaching a particular destination, continuing with the same example of 
reaching a destination in a specified time. 
This difference may be due to several factors 
    i)  differences in the assumptions made while estimating the expected time to reach the  
destination with regard to the traffic, weather etc. and the actual conditions and  
assumptions; 
    ii) the process of determining and comparing actual time taken with the expected time; 
   iii) speed maintained to reach the destination, and 
   iv) the mode of travelling etc.  
 
The variance analysis tends to help in locating the reasons for such variances. The variances 
can exist in any field; wherever the estimation is done the variance analysis can be applied. 
The parameters of measurement can be time, cost, profit, yield, sales, revenue or any other 
thing. The discussion, here in this chapter is limited to variance analysis of cost. Cost has 
different components like material, labour and overhead. But, again this chapter is 
restricted to discuss only two major components of cost i.e. labour and material. In 
Analysis of Variance 
  
  
 
5 
Institute of Lifelong Learning, University of Delhi 
management accounting the variances are computed on the basis of the benchmarks known 
as standards. 
Let’s understand the concept of variance analysis in terms of cost.  
 
The figure given below shows the basic concept of variance analysis that variance(s) can be 
favorable as well as unfavourable. It is clear that any inefficiency in production process 
leads to higher actual cost because of which unfavourable variance arises and amount of 
profit decreases. This occurs because pre-determined standards or benchmarks were too 
high and not viable or feasible to achieve in the present situation. 
Conversely, efficiencies in production lead to lower actual costs and that results in 
favourable variance and higher profits. This situation arises when benchmarks are either too 
low or understated and the present environment or scenario is more favourable. 
 
Figure 2: Concept of Variance 
 
 
 
Whenever actual cost matches with the standard cost it shows absence of any variance. But 
this happens very rarely in the actual practice. The assumptions on which the norms or the 
standards are based seldom go together with the actual scenario. To comprehend the 
concept of variance analysis clearly the understanding of the standard and standard costing 
is necessary that is discussed in the later section of the chapter. 
 
3.1 Rationality of Variance Analysis: 
 
Only the planning or setting the benchmarks do not serve any purpose unless actual results 
are matched with the standards. It is a well-known fact that the difference or variance 
between the planned and the actual is bound to occur. Need of variance analysis arises from 
this fact that in any organization there is a difference between the planned outcomes and 
the actual outcomes. So, it is necessary to check why these differences/variances arise. It is 
Inefficiency in 
Production  
Actual cost > 
Standard Cost  
Unfavourable 
Variance  
Reduction in Profit 
Dr. Balance   
Indicated by A i.e 
adverse 
When 
Neither Efficiency 
Nor Inefficiency 
Actual Cost= 
Standard Cost 
No Variance 
Efficiency in 
Production 
Actual Cost< 
Standard Cost 
Favorable Variance 
Increase in Profit 
Cr. Balance 
Indicated by F i.e 
favourable