83 12: 7: Determining Which Cost Variances to Investigate
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Last updated
- Dec 28, 2020
Learning Objectives
- Determine which variances to investigate.
Question: Companies rarely investigate all variances because there is a cost associated with identifying the causes of variances. This cost involves employees who spend time talking with personnel from areas including purchasing and production to determine why variances occurred and how to control costs in the future. What can managers do to reduce the cost of investigating variances?
Question: Figure 12.14 summarizes the cost variances calculated for Jerry’s Ice Cream. If you were in charge of investigating variances at Jerry’s Ice Cream, how would you determine which variances to focus on and which to ignore?
*From Figure 12.4.
**From Figure 12.6.
† From Figure 12.8.
Another approach might be to investigate all favorable and unfavorable variances above a certain minimum level, calculated as a percent of the flexible budget amount. For example, management could establish a policy to investigate all variances at or above 10 percent of the flexible budget amount for each cost. At Jerry’s Ice Cream, this would mean investigating all variances at or above $42,000 for direct materials (= 10 percent × $420,000), $27,300 for direct labor (= 10 percent × $273,000), and $10,500 for variable overhead (= 10 percent × $105,000). Based on this policy, the following variances would be investigated:
- Unfavorable direct materials price variance of $88,000 (≥ $42,000 minimum)
- Unfavorable direct labor rate variance of $37,800 (≥ $27,300 minimum)
- Favorable direct labor efficiency variance of $(27,300) (≥ $27,300 minimum)
- Favorable variable overhead efficiency variance of $(10,500) (≥ $10,500 minimum)
Many companies calculate and investigate variances weekly, monthly, or quarterly and focus on trends. In this case, they may only investigate variances that are unfavorable and increasing over time.
Whatever the approach, managers understand that investigating variances requires resources. Thus managers must establish an efficient and cost-effective approach to analyzing variances by weighing the benefits derived from investigating variances against the costs incurred to perform the analysis.
Business in action 12.5 – Using Cost Variances to Detect Fraud
© Thinkstock
The most common types of fraud allegations reviewed by Dow’s FIS include expense report fraud, kickback schemes, and embezzlement. Paul Zikmund, the director of FIS, states that “unexplainable cost variances between budget and actual amounts” are among the warning signs he looks for in identifying fraud.
For example, suppose the actual cost for direct materials is significantly higher than the budgeted cost. The cost accountant at Dow would begin investigating the cause of the variance by talking with the company’s purchasing agent. The purchasing agent might be unable (or unwilling) to explain why actual costs are Chapter 12 How Do Managers Evaluate Performance Using Cost Variance Analysis? 12.6 Determining Which Cost Variances to Investigate 789 so high. Further investigation might indicate that the purchasing agent was intentionally overbilling the vendor and receiving a kickback from the vendor.
Zikmund states that for every $1 that Dow spends on investigating fraud, the company recovers nearly $4. He also notes that Dow’s loss per employee is far below the industry average of $9 per employee per day. For a company with 46,000 employees, every dollar in savings per employee adds up to a significant amount.
Sources: Paul Zikmund, “Ferreting out Fraud,” Strategic Finance, April 2003, 1–4; Dow Chemical Company, “Home Page,” http://www.dow.com.
Key Takeaway
Companies often establish criteria to use in determining which variances to investigate. Some might investigate all variances above a certain dollar amount. Others might investigate variances that are above a certain percentage of the flexible budget. Or management might combine the two and investigate variances above a certain dollar amount and above a certain percentage of the flexible budget.
Review problem 12.6
Use the solutions to Note 12.30 “Review Problem 12.3”, Note 12.40 “Review Problem 12.4”, and Note 12.49 “Review Problem 12.5” to complete the following:
- Calculate the total variable production cost variance for Carol’s Cookies using the format shown in Figure 12.10.
- Assume management investigates all variances at or above 15 percent of the flexible budget amount (e.g., all direct materials variances at or above 15 percent of the direct materials
flexible budget are investigated). Identify which of the six variances calculated for direct materials, direct labor, and variable manufacturing overhead management should investigate.
- Answer
Definition
- A term used to describe managers who focus solely on variances showing actual results that are significantly different than expected results.
