Explain the meaning of a favorable variance and an unfavorable variance.

Memorandum for Managerial Accounting

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.) (Should be in the format of a memo)

  1. 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.
  2. 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.
  3. Explain the meaning of a favorable variance and an unfavorable variance.

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