a) Explain what is meant by the term variances and distinguish between favourable and adverse variances

Variances are differences between actual performance and budgeted performance. Variances occur when actual costs and revenues differ from budget and can be categorised as either favourable or adverse.

• Favourable variances occur where actual performance is better than budgeted. For example actual sales is greater than budgeted or actual labour costs are less than budgeted. Both these variances result in actual profit being greater than budgeted and thus are considered favourable.
• Adverse variances occur where actual performance is worse than budgeted performance. For example actual sales is less than budgeted sales or actual labour costs are greater than budgeted labour costs. Both these variances result in actual profit being less than budgeted and thus are considered adverse

b) Explain the three variances that can be applied to the analysis of sales 

Variance analysis is the processes of breaking down variances to find the true cause for the deviation with a view to improving efficiencies within the business. For example the overall sales variances can be analysed into 3 sub-variances namely.

• Sales volume variance which identifies the difference between actual and budgeted sales caused by differences in sales volume. If actual sales volume is greater than budgeted this will lead to a favourable sales volume variance and may lead to an overall favourable sales variance.
• The sales price variance. This identifies the difference between actual sales and budgeted sales caused by differences between the price set in the fixed budgeted and actual price charged. If actual sales price achieved is greater than budgeted this will lead to a favourable sales price variance and may lead to an overall favourable sales variance.
• The sales mix variances: Sales mix is the term used to describe the mix of products / services that a business sells. Many of these different products have different prices and profit margins. For example in a hotel, accommodation would average a gross margin of 90 per cent with food closer to 64 per cent and beverages around 60 per cent. Thus if sales volumes increase, (a favourable volume variance) but actual accommodation sales have fallen compared to food and beverages, (leading to an adverse sales mix variance) then the overall sales variance could be adverse.