Explain the effect of an adverse variance on (a) costs (b) profit

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.

@Ozkanx