What are the purposes of variance analysis?

Variance analysis provides a feedback about whether managers are achieving their goals in terms of profitability (evaluating performance). But just knowing whether actual Operating Income is at the expected level is not enough; it is also important to understand how actual Operating Income was obtained. Note that this is true whether objectives are met or not. It is entirely possible to achieve the same level of profit through different ways, and often the way profit was achieved matters.

Accordingly, variance analysis also decomposes systematically variances to suggests beginnings of more detailed explanations. It provides feedback concerning what works and what does not, showing managers whether their actions led to the desired outcomes (organizational learning). One of the most important tasks in variance analysis is indeed to understand why variances arise and then to use that knowledge to promote learning and improve performance.

By showing the magnitude of the impact on Operating Income of specific departures from budgeted estimates, variance analysis also directs managers’ limited attention towards the most influential factors affecting performance (attention directing). If actual results do not conform to the budget and to standards, the management accounting system sends a signal to managers indicating that an exception has occurred which needs their attention and might require corrective actions. In other words, variance analysis enables management by exception. It also suggests and orients towards the persons most able to explain what happened or most able to act on the observed drift.

Management by exception is a practice of concentrating managers’ attention on on areas which are not operating as expected, i.e. deviating from the plan, and placing less attention on areas operating as expected, assuming that they are running properly. It is a way to allocate a limited resource, managers’ attention, to what really requires it.

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