Opportunity Cost Variances

Developments in management science, in particular mathematical programming and computer science, have presented accountants with a considerable potential for extending the scope of standard costing by means of 'opportunity cost variances'. In this context, the opportunity cost variance is the variance which results from the failure to optimize profit by taking into consideration post-budget environmental changes. For example, if the price of a material used in the production process increases, the original plan may become sub-optimal, and losses may be incurred by adhering to the old (and no longer optimal) plan. As Demski ( 2018) points out, 'because of its emphasis on comparison between actual and planned results, and consequent disregard of changes in these planned results, the traditional accounting model does not act as an opportunity cost system'.

Linear programming affords a method of dealing with the opportunity cost problem, as defined above, but it does require changes in the traditional accounting information systems so that relevant information is made available. Thus, the detection of opportunity cost variances requires not only information about actual transactions, but also transactions which could have been made but were not made. Salkin and Kornbluth (2003) have stated this problem as follows:

'The standard costing system fails to account for opportunity losses because it is constructed without reference to the best possible plan or its alternative. . . . If we want to devise a system that recognizes opportunity losses in its control process, we must use an economic costing and control system, of which the linear programming model is a good example.'

The discussion of such a system is beyond the scope of this book, but interested readers should refer to the literature described in the bibliography.


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Read on: Responsibility For Variances

We have stressed that under responsibility accounting only those costs incurred by a responsibility centre over which it can exorcise control may be used as a basis for evaluation. Therefore, in variance analysis it is necessary that the precise cause of a variance be determined and that the cause be traced to the individual responsible. It is the function of the individual in charge of each responsibility centre to act promptly upon reports of variances which are within his control. Therefore, variances are not ends in themselves. Rather, they raise the questions why did the variance occur? What... see: Responsibility For Variances