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Should Variances Be Investigated Regardless of if they are Favorable or Unfavorable?

Assume that the budgeted cost for a department is $10,000 per week and the standard deviation is $500.00. The decision to investigate a variance requires a comparison of expected benefits with expected costs. Suppose an unfavorable variance of $1,000 is observed. The normal distribution indicates the probability of observing this variance is 0.0228 if the system is in control. Furthermore, assume that the benefits would be $50% of the variance and that investigation costs are $200. Should this variance be investigated? Assume that the variance is still $1,000, but it is favorable. Should it still be investigated?

- What is the difference between favorable and unfavorable variances and how do you calculate them?
- What if $1,000 difference is unfavorable and should that be investigated?
- What if $1,000 difference is favorable and should that be investigated?

Solution Preview

Cost/benefit analysis

First, let's look at the cost/benefit since they provided amounts that make this computation possible (seldom that explicit in a natural business setting). The incremental benefit is 50% of this particular variance, using the amounts given, is 50% of $1,000 or $500. The cost of investigating is $200. So, the incremental benefit of $500 exceeds the incremental cost of $200 by $300. So, the benefits exceed the costs and the variance should be investigated. However, the motive for investigating variances is not just to reduce costs.

What is the difference between favorable and unfavorable variances and how do you calculate them?

A favorable variance is when ...

Solution Summary

Your response is 310 words and includes a discussion and calculation of cost/benefit and a description of favorable and unfavorable variances. Then, the discussion gives one reason to study unfavorable and two reasons to study favorable variances.

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