Question

Explain price, efficiency, intensity, and volume variances. What do they measure and what impact does the manager have on this aspect of financial operations? How do managers determine which variances should be investigated?

Explain the purpose of financial ratios and what issues should be considered when using them for comparing organizations? Explain the purpose and difference types of benchmarking.

Answer 1

Given variances are explained as follows:

1. Price variance refers to - Difference in actual expenses versus standard expenses due to change in price keeping other factors constant as per standard cost.

Meaning either increase or saving in costs due to changes in prices.

Formula to calculate material price variance -

1. Material price variance

= Actual Qty used * (Actual price - Standard Price)

2. Labour price variance

= Actual Labour Hours used * (Actual labour price/hour - Standard labour price/hour)

Efficiency Variance =

Efficiency variance refers to efficiency with which labours have worked or efficiency in usage of materials keeping other factors constant.

1. Labour Efficiency variance

= Standard labour rate/hour * (Standard Hours - Actual Hours)

2. Material Efficiency Variance

= Standard Rate/Kg * (Standard Qty - Actual Qty)

Material efficiency variance can also be termed as material usage variance.

Intensity variance refers to Intensity with which activities are carried out during any given frame of time. For e.g there may be incentives for production in any given period of time during the day.

4. Volume variance -

This variance is used when absorbing fixed overheads. Change in volume leads to an increase or decrease in absorption rate.

Volume Variance can be calculated as -

Overhead Rate/Unit*(Budgeted Quantity - Actual Quantity)

or

Overhead Rate/Hour*(Budgeted Hours - Actual Hours)

Variances give exact reasons for performance being less than estimated or more than estimated, by looking into variances managers can focus on where to improve. Whichever area managers notice, has an adverse variation analysis they can investigate the same.

For e.g. if there is adverse material price variance, managers can drill down to find out the cause of changes in price of materials.

Financial ratios give very informative and useful information to users of financial statement. Based on financial ratio analysis performance of the organisation can be judged into. Comparison of ratios for the organisation with it's previous year or with those of other organisations in the industry gives the position of the organisation. Where does organisation stands amongst industry players.

Ratios are always mentioned as % figure they are not absolute numbers. Even though ratio of one organisation might be good than the other but when looked into at absolute numbers ratio may turn out to be only deceptive thing. Hence, when using financial ratios equal importance shall be given to absolute numbers.

Benchmarking means setting of standards:

Like in financial world, there may be various benchmarks that can be used. For e.g. benchmarks used in a particular industry i.e. this particular industry gives ROI of 8%, hence 8% ROI is the benchmark set in that industry. Other form of benchmarks can be - employee cost paid to acquire a particular employee in any particular industry.

Benchmarks are set over the period of time and they are not a overnight phenomenon. Over the period of time industry practices are taken into consideration to determine benchmarks.