Prerequisites of a sound variances analysis system
A variance analysis system would be good enough in controlling costs and evaluation performances if the following requirements are satisfied:
1) Accuracy of standards: variances must be based upon scientifically established standards. if the standard of performance is not meaningful, variance can hardly be a meaningful measure of performance. Sometime variances may be guesses (though carefully made) variance will simply indicate how correct the guesses were. Variances calculated from meaningful and attainable standards show how closely actual costs correspond to costs of desired performance. Scientifically determined standards are. An unfavorable variance may not convey much meaning if is based on an unattainable extremely tight standard.
2) Controllable operating conditions: standards are set on the assumption of efficient operating controllable by those whose performances have to be evaluated by standards. For example to be efficient in his operation an individual would like that goods quality of materials necessary equipment and other facilities are made available. Variances will fail reflect inefficient performance of individuals do not have any control over operating conditions.
3) Objective measurement of performance: third important prerequisite for the success of variances analysis is that some objective criteria must exist for measuring inputs and output. This implies that cost should be classified and recorded in an unbiased and systematic manner. The quality of output should be clearly defined the quantitative measurement of output should be accurate. What constitutes poor quality output should be defined.
4) Responsibility assignment: variances will help in controlling cost if they are analyzed to assign responsibilities. Variance analysis system, therefore, should be designed to pinpoint the responsibilities standards should be set and variance should be anodized for each responsibility centre. When variances are analyzed to assign responsibility a distinction should be drawn between controllable variances and non controllable variances. If a variance arises due to those condition or causes which could be influenced by an individual the variance is controllable. Many time variances arise due to external factors such as non variability of good quality material general increase in wage rates or material price labor disputes etc., which are beyond the control of individuals. No responsibility can be assigned for those variance and they are known as non controllable variances.
5) Separation of forecasting error: standards differ in their tightness. For example quantity standard are more scientifically determined than price standard; price standard are based on forecasts than on a desired performance. Variance analysis system therefore should clearly separate variance are help responsive for forecasting errors standard cost system will not be a true measure of performance evaluation.