Two-Way Variance Analysis Post 1
In my opinion, many Finance and Accounting textbooks present the mechanics of variance analysis as being way too complicated. The analysis is usually presented as a series of different formulas depending on which textbook you read. Although at a detailed level the formulas are the same, algebraically they're presented in different manners which can lead to confusion. Below are three examples from the textbooks:
Example 1:
Example 2:
Example 3:
Why can't it be as easy as this?
First calculate the actual vs. standard total sales (cells E9 and F9). Second, calculate the percentage change between the actuals and standards (cells G9 - G11). Finally, perform the analysis as presented in the yellow highlighted cells.
In the example below, total actual vs. standard sales increased $20,000. There are two components of variance -> price / unit (rate) and quantity. At the component level, the actual vs. standard price / unit (rate) is identified as going up 20%. The actual vs. standard quantity is identified as going up by 50%.
The advantages of using the last method are:
- Intuitively it makes more sense because the presentation is simple. You can easily see that if the price / unit increases 20%, the dollars component of variance needs to reflect that increase. Likewise, if the quantity component increases 50% the dollars component needs to reflect it.
- You don't need to remember formulas.
- The method can be easily applied to any number of variances. For example, in the Healthcare industry gross revenue variances may include five or more components of variance (work days, fees, volume, payer mix, acuity, etc.). If remembering the formulas for two or three components of variance is difficult, try memorizing the formulas for a five or more components.
