explain the effect of an adverse variance on (a) costs (b) profit
Explain the effect of an adverse variance on (a) costs (b) profit
Answer:
An adverse variance occurs when actual figures deviate negatively from the expected or budgeted figures. Let’s break down the effects on costs and profit:
(a) Costs
- Increased Costs: An adverse variance indicates that the actual costs are higher than budgeted. This could be due to unforeseen expenses, higher prices for materials, or inefficiencies in production.
- Impact on Budgeting: Regular adverse variances may suggest the need for better budgeting techniques or cost control measures.
(b) Profit
- Reduced Profit: If costs are higher than anticipated without a corresponding increase in revenue, profits will decrease. Adverse variances can directly diminish net income.
- Strategic Analysis: Businesses might need to analyze and revise pricing strategies, reduce costs, or improve operational efficiency to mitigate the impact on profit.
Summary: An adverse variance in costs implies higher expenses than planned, while for profit, it signifies a decrease in earnings. Businesses must investigate and adapt to manage these variances effectively.