Accounting for variances
/What is a Variance?
A variance is the difference between an actual measured result and a basis, such as a budgeted amount. In many accounting applications, a variance is considered to be the difference between an actual cost and a standard cost. There are a multitude of possible variances that can be reported to management, so the person reporting this information should be selective in only forwarding those variances that management can take action to correct. If a variance is insignificant or cannot be corrected in the future, there is less reason to present the information.
What is the Accounting for Variances?
There is usually no need to account for variances. A variance arises when actual results differ from expected results. There are detailed procedures available for reporting variances to management, along with the reasons for the variances. But this is simply internal reporting that does not impact the general ledger. This type of reporting is considered to be managerial reporting, as opposed to financial reporting.
For nearly all transactions, actual revenues and expenditures are being recorded, and accounting standards require that the actual monetary amounts associated with transactions be recorded and reported. When there is a variance from a budgeted amount, there is no need to record this variance, since the only number that matters is the one relating to the actual transaction, not the budget being used for comparison purposes.
Related AccountingTools Course
Standard Costs and Variance Analysis
Accounting for Inventory Variances
The exception is when transactions are initially recorded at their standard costs in the accounting records. This only happens when inventory is recorded at its standard cost, rather than its actual cost. If such is the case, and there is a variance from the standard cost, how do you account for the variance? The answer depends upon how well standard costs have been constructed. If the standards are well-researched and have been updated recently, any variances should be outside of the costing expectations of the business, and so should be recognized in the current period. Since the original transaction was already recorded at its standard cost, this means that there is no need to account for the variance.
What about the alternative, where the standard cost used to record a transaction is likely incorrect? If so, it is entirely possible that the standard should be adjusted to reflect recent conditions, which means that there should be no variance. If the accountant recognizes that this type of variance is based on an incorrect standard, then there should be a journal entry to adjust the standard cost of the inventory item. This type of adjustment is only likely to arise if there is an ongoing program of actively investigating why variances are occurring.