Question

You have been immersed in the world of managerial accounting variances for the past couple of weeks. At this point, what is your assessment of direct cost variances compared to overhead cost variances from a manufacturer perspective? Please provide examples. Now imagine that you are the shareholder and not management. As a shareholder, describe how you would use two (2) of the variances calculated to make better investing decisions. Assume one is Unfavorable and the other Favorable.

Answer 1

From the management point of view, while both Direct cost variance and Overhead variances are important the former would assume a special place of priority for certain specific reasons.

The management is set to operate within a given capacity limit and, more or less, given expense/overhead structure. From the functional point of view, an overhead variance is likely to be small unless control/compliance factors are seriously lacking. An adequate control of the direct cost variance would thus mean a generation of good steady margin which can then get translated into a smart bottomline.

For the shareholder, on the other hand, the long-tern concerns would matter greatly for taking proper investment decisions. If we have a situation that the direct cost variance are positive and overhead variances are adverse, it would mean the assessment/practices re direct cost (and thus margin) computation are reasonably in place. However, an adverse overhead variance would mean the capacity and supporting cost structure is not upto the standard or place as could be expected. A due investment for capacity enhancement or correction of operational variable with a long-term impact can be considered.