Adverse Variance (Unfavourable Variance)

Adverse Variance Unfavourable Variance Standard Costing Budgetary Control Budgeted Performance Actual Costs Actual Sales Revenue Financial Analysis
In standard costing and budgetary control, adverse variance indicates discrepancies where actual performance falls short of budgeted expectations, impacting the budgeted profit negatively.
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Definition

Adverse Variance (Unfavourable Variance) refers to the difference between the actual performance and the budgeted or standard performance in an organization, where the actual figures cause a reduction in the estimated profits. This can happen if actual sales revenue is less than what was budgeted, or if actual costs surpass the budgeted costs.

Examples

  • Sales Revenue Adverse Variance: Company ABC anticipated sales revenue of $500,000 in Q1. The actual sales revenue turned out to be $450,000. The adverse variance is $50,000.

  • Cost Adverse Variance: Company XYZ budgeted $200,000 for manufacturing costs, but the actual costs were $220,000. The adverse variance is $20,000.

Frequently Asked Questions

1. What causes an adverse variance?

  • Adverse variance can be caused by lower-than-expected sales, higher-than-expected costs, inefficiencies in production, unexpected market conditions, or errors in budgeting.

2. How can an organization manage adverse variances?

  • Organizations can manage adverse variances by analyzing the causes, implementing cost-control measures, improving operational efficiencies, and adjusting pricing strategies.

3. What is the difference between an adverse variance and a favourable variance?

  • An adverse variance occurs when actual performance is worse than budgeted performance, reducing profit. A favourable variance happens when actual performance is better than budgeted, increasing profit.

4. Are adverse variances always negative?

  • While adverse variances indicate a shortfall in performance, they offer diagnostic value by highlighting areas needing improvement.

5. Can adverse variances be predicted?

  • Adverse variances can sometimes be predicted through trend analysis, market research, and other forecasting techniques.

1. Standard Costing: A costing method where standard costs are assigned to production activities, helping in variance analysis.

2. Budgetary Control: A financial control technique where actual performance is monitored against budgeted figures to manage financial activities effectively.

3. Favourable Variance: The positive difference between actual and budgeted figures where actual performance is better, leading to increased profits.

4. Analysis of Variance (ANOVA): A statistical method used to identify differences among group means, often used in budgeting to compare variances.

5. Variance: The difference between actual and budgeted figures, which can be either favourable or adverse.

Online Resources

  1. Understanding Variances in Accounting
  2. Variance Analysis in Cost Accounting
  3. Budget Variance Analysis

Suggested Books for Further Studies

  1. Cost Accounting: A Managerial Emphasis by Charles T. Horngren
  2. Accounting for Decision Making and Control by Jerold Zimmerman
  3. Budgeting and Financial Management for Nonprofit Organizations by Lynne A. Weikart

Accounting Basics: “Adverse Variance” Fundamentals Quiz

### What is an adverse variance in accounting? - [ ] A positive difference between actual and budgeted figures - [x] A negative difference between actual and budgeted figures - [ ] The balancing of actual and budgeted figures - [ ] A measure used solely in external audits > **Explanation:** An adverse variance is a negative difference between actual and budgeted figures, indicating that actual performance was worse than expected. ### How does an adverse variance affect budgeted profit? - [ ] It increases the budgeted profit - [x] It decreases the budgeted profit - [ ] It has no impact on budgeted profit - [ ] It balances the budgeted profit > **Explanation:** An adverse variance decreases the budgeted profit as it reflects performance that fell short of expectations. ### Which of the following is a cause of adverse variance? - [ ] Greater-than-expected sales revenue - [ ] Lower-than-expected costs - [x] Higher-than-expected costs - [ ] Increased customer base > **Explanation:** Higher-than-expected costs will result in an adverse variance since actual expenses exceed budgeted amounts. ### If a company budgets $400,000 for sales and achieves $350,000, what is the adverse variance? - [x] $50,000 - [ ] $100,000 - [ ] $0 - [ ] $350,000 > **Explanation:** The adverse variance is $50,000, calculated by subtracting the actual sales ($350,000) from the budgeted amount ($400,000). ### How can adverse variances be managed? - [x] By analyzing causes and implementing corrective measures - [ ] By ignoring the variances - [ ] By increasing budgeting figures - [ ] By decreasing actual performance > **Explanation:** Adverse variances can be managed by analyzing their causes and implementing corrective measures to improve performance or reduce costs. ### What is the primary goal of variance analysis in budgetary control? - [ ] To adjust annual budgets - [ ] To penalize departments - [ ] To highlight negative performances only - [x] To monitor and manage financial performance effectively > **Explanation:** The primary goal of variance analysis in budgetary control is to monitor and manage financial performance effectively by identifying areas for improvement. ### What might a consistent adverse variance indicate? - [ ] Overestimated budgets - [ ] Exceptional performance - [x] A need for operational review - [ ] Lower-than-expected profits > **Explanation:** A consistent adverse variance might indicate the need for an operational review to identify and correct inefficiencies and issues. ### Which of the following is true about favourable variance? - [ ] It signifies lower profits - [x] It signifies higher profits - [ ] It has no financial implication - [ ] It must be avoided > **Explanation:** A favourable variance signifies higher profits as it indicates actual performance was better than budgeted. ### Can adverse variances be beneficial? - [ ] Never - [ ] Rarely - [x] As diagnostic tools for areas of improvement - [ ] Only in non-profit organizations > **Explanation:** Adverse variances can be beneficial as they serve as diagnostic tools, helping organizations identify areas that need improvement. ### What type of analysis utilizes adverse variances? - [ ] Liquidity analysis - [ ] Profitability analysis - [ ] Cash flow analysis - [x] Variance analysis > **Explanation:** Variance analysis specifically utilizes adverse variances to compare actual performance against budgeted or standard performance.

Thank you for engaging with this comprehensive guide and quiz on adverse variance. Keep exploring to deepen your understanding of financial and management accounting!

Tuesday, August 6, 2024
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