The reason we use the words favorable and unfavorable when evaluating variances

Question

The reason we use the words favorable and unfavorable when evaluating variances is made clear when we look at the closing of accounts. To see this, consider that: All variance accounts are closed at the end of each period (temporary accounts) A favorable cost variance is always a credit balance An unfavorable cost variance is always a debit balance Write a one page memorandum to your instructor with three parts that answers the three following requirements. (Assume that variance accounts are closed to Cost of Goods Sold.) Does Cost of Goods Sold increase or decrease when closing a favorable variance? Does gross margin increase or decrease when a favorable variance is closed to Cost of Goods Sold? Explain. Does Cost of Goods Sold increase or decrease when closing an unfavorable variance? Does gross margin increase or decrease when an unfavorable variance is closed to Cost of Goods Sold? Explain. Explain the meaning of a favorable variance and an unfavorable variance.

Explanation / Answer

cost of goods sold increase when there is a favorable variance say op stock is 100

cosg is 50 and sale is 150 then there is nil balance but if there is a closing stock of 10 and sale is 100 and op stock is 100 then cosg will be 40

opstock+cosg=sales + clo stock

100+50=150+0

in 2nd situation

100+x=150+10

or x=150+10-100

x=60

gross margin will increase when favorable variance is close to cost of goods sold

when cosg=100 then gross margin=50

if cosg down to 50 then margin will be=50+50=100 cause cosg will down but sale price remain same

if closing in unfavorable then cosg will decrease

suppose cosg=100 and closing is50 op =100 sale=150

now if closin will 0then

op stock+cosg=sales+clo stock

100+x=150+0

or x=50

so cosg will down

gross margin will down if there is unfavorable balance

cause if closing maintain a debit or sort balance then there will be a negativity that is why gross margin will decrease

favourable variance means a credit balance means account has a surface in credir

unfavorable variance means a debit balance means account has a surface in debit

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