Unfavorable variances certainly need to be investigated, but favorable variances can be revealing as well. A favorable labor quantity variance can indicate that your employees don't need as long as standards allow to complete a process. The standard may be too high. Favorable material price variances could indicate a less expensive source of materials and the standard could be adjusted accordingly. Failure to investigate could lead to wasteful spending, as standards provide employees with guidelines. Too much extra room and they may be less cost conscious.
Prior year's average cost is a fine place to start but other factors need to be considered, such as forecasted prices, required quantities, and alternative sources or materials.
Without distinguishing between fixed and variable costs Company A will be unable to pinpoint areas for improvement or favorable areas that should be capitalized upon.
Economic conditions and production requirements are continually changing within the company and the world. Through continued revisions, analysis and scrutiny Company D is in the best position to create meaningful guidelines and information from the standards and variance analysis process.
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