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Variance investigation

Variance investigation is the decision process for determining whether a reported variance is significant enough to justify the cost of identifying its cause; frameworks include a simple materiality threshold, statistical control charts.

ByHoang TruongUpdated

FrameworkManagement by exception

See it move

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Variance investigation weighs two dimensions: size and pattern. A small but systematic variance is monitored; a large, systematic one is investigated without much debate. A small random variance is ordinary noise and is ignored, while a large random variance calls for a cost-benefit comparison between the expected saving from correction and the cost of investigating it.

Where it fits
TopicResponsibility Accounting & DecentralisationAdvancedSubjectManagerial AccountingAdvancedTopicStandard Costing & Variance AnalysisAdvanced

The formula

LaTeX
P×(MCc)>CiP \times (M - C_c) > C_i

Variables

estimated probability that the process is genuinely out of control and the variance reflects a correctable problem (decimal)
present value of the total loss that will accumulate if the out-of-control process is left uncorrected ()
cost of corrective action once the root cause is identified ()
cost of the investigation itself ()

The left side is the expected net saving from correction; the right side is the certain cost of investigating. When the expected saving exceeds the investigation cost, investigation is worthwhile. In practice P is difficult to estimate, so organisations use materiality thresholds or statistical control charts as proxies.

Check yourself

PracticeCORE

A management accountant receives a variance report showing that the direct materials price variance for March is €2,100 adverse — equal to 2.3% of standard materials cost for the period. The company's policy states: 'Investigate any variance that exceeds 5% of standard cost or falls outside the statistical control limits calculated from twelve months of historical data.' No investigation is initiated. Which principle best explains the decision not to investigate?

Select an answer to check your understanding.
Variance investigation — Edlintics Glossary