Unfavourable variance, also known as adverse variance, occurs when the actual financial performance is worse than the budgeted or planned performance. This concept is crucial in budgeting, financial analysis, and management accounting as it helps organizations understand deviations from their financial goals.
Historical Context
The concept of variance analysis, including unfavourable variance, has been used since the early 20th century. Initially, it was employed in manufacturing industries to control costs and improve operational efficiency. Over time, it has become a standard practice in various industries for financial performance measurement.
Types/Categories
Unfavourable variances can be categorized into:
1. Sales Variance
When actual sales revenue falls below the budgeted sales revenue.
2. Cost Variance
Occurs when actual costs exceed the budgeted costs. Subcategories include:
- Material Cost Variance
- Labor Cost Variance
- Overhead Variance
3. Profit Variance
Occurs when actual profit is less than the budgeted profit.
Key Events
Formation of Standard Costing
Standard costing was formalized in the early 1900s, which laid the foundation for variance analysis.
Introduction of Management Accounting
In the mid-20th century, management accounting practices, including variance analysis, gained popularity for internal financial control.
Detailed Explanation
Formula and Calculation
The basic formula for calculating variance is:
Variance = Actual Value - Budgeted Value
For unfavourable variance, the result is a negative value indicating a shortfall.
Importance
Understanding unfavourable variance is critical for:
- Financial Control: Helps in identifying areas where the organization is not performing as expected.
- Decision Making: Informs management to take corrective actions.
- Performance Measurement: Essential for evaluating the efficiency and effectiveness of operations.
Applicability
Unfavourable variance analysis is applicable in various domains such as:
- Manufacturing: Monitoring production costs.
- Sales: Evaluating sales performance.
- Service Industry: Controlling operational costs.
Example
If a company budgeted for $500,000 in sales revenue but only achieved $450,000, the sales variance would be:
Sales Variance = Actual Sales - Budgeted Sales
= $450,000 - $500,000
= -$50,000 (Unfavourable)
Considerations
Root Cause Analysis
Identifying the reasons behind the variance is crucial for taking corrective actions. Possible causes include market conditions, operational inefficiencies, or inaccurate budgeting.
Response Strategy
Organizations should have strategies in place to respond to unfavourable variances, such as cost-cutting measures or revising sales strategies.
Related Terms with Definitions
- Favourable Variance: A positive variance where actual performance is better than budgeted performance.
- Budget: A financial plan outlining expected revenues and expenditures.
- Standard Costing: A method of cost accounting that uses standard costs for products.
Comparisons
- Favourable vs. Unfavourable Variance: Favourable indicates better-than-expected performance, whereas unfavourable indicates worse-than-expected performance.
Interesting Facts
- Variance analysis is not just limited to accounting; it’s also used in project management and quality control.
Inspirational Stories
- A manufacturing company once discovered through variance analysis that inefficiencies in their supply chain were costing them millions. By addressing these issues, they turned an unfavourable variance into a favourable one within a year.
Famous Quotes
- “However beautiful the strategy, you should occasionally look at the results.” – Winston Churchill
Proverbs and Clichés
- “Numbers don’t lie.”
Expressions
- “In the red” refers to financial losses, which can be linked to unfavourable variances.
Jargon and Slang
- Overhead Bust: Slang for an unfavourable variance in overhead costs.
FAQs
Q: What is the main cause of unfavourable variance?
Q: How can unfavourable variances be minimized?
Q: Is unfavourable variance always a sign of poor management?
References
- Horngren, C. T., Datar, S. M., & Rajan, M. V. (2012). Cost Accounting: A Managerial Emphasis.
- Drury, C. (2013). Management and Cost Accounting.
Summary
Unfavourable variance is a vital concept in financial analysis and management accounting, highlighting discrepancies between actual and budgeted performance. By understanding and addressing these variances, organizations can improve their financial control, enhance decision-making, and ensure better alignment with their financial goals.
