ORIE 3150 Variance Analysis handout Dec 1 2009

ORIE 3150 Variance Analysis handout Dec 1 2009 - ORIE 3150...

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ORIE 3150 Variance Analysis A variance is a difference between an actual cost figure and a budgeted (standard) cost figure. The difference is either favorable or unfavorable . Favorable variances have a positive effect on operating income, by reducing expenses or increasing revenue. Unfavorable variances have a negative effect on operating income, by increasing expenses or decreasing revenue. This method can actually be used by any type of company or non-profit organization. Most of the time we determine whether a variance is “favorable” or “unfavorable” intuitively. The premise is that management is too busy to track the minutia of a business, and they should instead pay attention to exceptional events alone. Another is that the variances are going to be in our favorite units. Joules? Kilograms? No, dollars. This way, it is easy to see if a variance is large or not. Standard Costs First, standards must be set for each element of production cost. Materials (each type), labor (each type), variable overhead, and fixed overhead. Each cost element has two standards, price and quantity. Price is how much you pay for a fixed quantity of something (e.g., $3.19 per gallon of milk at Pete’s, versus $1.99 at Wegman’s). Quantity is how much of the cost element that you use to make a fixed quantity of something (e.g., use 1/3 of a can of tuna to make a tuna sandwich, or 3 sandwiches per can). Standards should be set at a reasonably achievable level, taking normal waste, spoilage, goofing off time, rework time, and time to go to the bathroom into account. Standards are unitized in whatever unit of measure the cost element is in (e.g., labor is in hours,
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ORIE 3150 Variance Analysis handout Dec 1 2009 - ORIE 3150...

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