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.