One of the keys to a good business is expenses management. Well-run businesses know what it costs to produce an item or service, and can recognize when there are problems that cause higher expense than supposed.
Having well-developed standards and procedures allow a company to establish variances. Two of the most essential variances in production are volume variances and cost.
Establishing Expense Accounting Standards
With the purpose of having useful variance analysis, corporations must first build fine standards. They can be based on the budget, or some different authoritative measure. The standards require identifying the supposed cost and volume for every service that is executed by the business.
For instance, a manufacturing corporation produces golf balls. In a usual year, the corporation will make one thousand balls, and the entire cost of the operation is 100 000 dollars. Consequently, the standard golf ball cost is 100 dollars.
Cost Variance Assessment
In case at the year's end, the corporation has produced one thousand golf balls at the cost of the 100 000 dollars, they have performed precisely at the standard, and no variance estimation is necessary. That is a not likely situation, since things not often turn out precisely as planned.
In case the corporation does make one thousand, but because of an unplanned salary raise, the overall cost is 105 000 dollars, the real cost per golf ball is 105 dollars. The variance of 5 000 dollars is completely explicable by the 5 dollar negative expenses variance per ball.
Volume Variance Assessment
In case the business has an excellent year, and requires making two thousand golf balls, but enhancements in productivity cause cost staying the same at 200 000 dollars, the mean cost per ball is still 100 dollars. The 100 000 dollars increase in expenses is explicable by the volume variance of one thousand units.
The issue turns out to be complicated with there's both a volume and cost variance, as there would probably be in most real-life circumstances. Consider if the business produced 1 500 golf balls, but the overall cost for the operation was 250 000 dollars.
There's a total cost variance of 150 000 dollars. The usual golf ball cost was 100 dollars. It is multiplied by the volume variance. 100 dollars X 500 units = 50 000 dollars. As a result there's a positive volume variance of 50 000 dollars. It is subtracted from the 150 000 dollars to arrive at the negative expenses variance of 100 000 dollars.
It's needed to have positive volume and cost variances, as that shows enhancements in both production and efficiency over standards. These are simple instances, since few businesses make one item, and expenses must be allocated over lots of items, but the basic conception of cost accounting are identical, no matter how big the business.