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6PERFORMANCE EVALUATION

VARIANCE ANALYSIS

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THE BUDGET PLAN FOR 4TH QUARTER

► Sell in 4th quarter:• 70,000 pants• 25,000 jerseys• 9,000 award jackets

► Control inventory► Manage cash

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WHAT’S UP?

► C&C sold more award jackets than budgeted. Managers thought that would be a good thing.

► Turns out, workers took too long to make the extra jackets. And they were paid overtime to meet customer delivery dates.

► Net income was $144,800 lower than budgeted, even though more jackets were sold.

FLEXIBLE BUDGETSA PERFORMANCE EVALUATION TOOL

Unit 6.1

61.Unit 6.2 Unit 6.3

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Unit 6.4

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TOTAL VARIANCE

Actual results achieved

Budgeted (expected) results

Variance

A variance is any difference between what you expected and what you achieved.

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Actual StaticBudget

Variance

Sales $2,457,525 $2,335,000 $122,525 F

Cost of goods sold 1,724,150 1,582,757 141,393 U

Gross margin 733,375 752,243 (18,868) U

Selling and administrative expenses 385,139 360,753 24,386 U

Operating income 348,236 391,490 (43,254) U

Financing costs 2,256 1,880

376 U

Income before taxes 345,980 389,610 (43,630) U

Income taxes 103,794 116,883 (13,089) F

Net income $242,186 $272,727 ($30,541) U

LET’S LOOK AT SOME VARIANCES

A variance is favorable if it increases net income

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Actual StaticBudget

Variance

Sales $2,457,525 $2,335,000 $122,525 F

Cost of goods sold 1,724,150 1,582,757 141,393 U

Gross margin 733,375 752,243 (18,868) U

Selling and administrative expenses 385,139 360,753 24,386 U

Operating income 348,236 391,490 (43,254) U

Financing costs 2,256 1,880 376 U

Income before taxes 345,980 389,610 (43,630) U

Income taxes 103,794 116,883 (13,089) F

Net income $242,186 $272,727 ($30,541) U

LET’S LOOK AT SOME VARIANCES

A variance is unfavorable if it decreases net income

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YOUR PERFORMANCE REPORT

The month has just ended, and your department has been very productive. You were able to crank out 38,000 units! That’s 3,000 more than were budgeted for the month. You figure this must be good for a bonus, so let’s see how well you did.

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YOUR PERFORMANCE REPORTActual Results Static Budget Variances

Units produced 38,000 35,000 3,000

Variable expenses

Direct labor $86,500 $80,500 $6,000 U

Direct materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed expenses

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total expenses $383,500 $367,500 $16,000 U

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YOUR PERFORMANCE REPORTActual Results Static Budget Variances

Units produced 38,000 35,000 3,000

Variable expenses

Direct labor $86,500 $80,500 $6,000 U

Direct materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed expenses

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total expenses $383,500 $367,500 $16,000 U

These variances are unfavorable because actual expenses were greater than what was budgeted, thus lowering net income.

Do these unfavorable variances mean that you have done a poor job controlling costs?

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THE QUESTION…

Think about it.

By definition, the total variable costs would be higher. Working more machine hours

should result in higher costs. But some of the higher costs could be a result of poor

management as well.

How can we tell the difference?

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THE ANSWER…

We have to…

the budget to match the actual activity level achieved.

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FLEXIBLE BUDGETS

► Present a budget for any level of activity actually achieved.• Variable expenses change with activity level.• Fixed expenses remain constant regardless of

activity level, as long as you remain within the relevant range.

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LET’S PRACTICE: FIX THE FLEXActual Results Static Budget Variances

Units produced 38,000 35,000 3,000

Variable expenses

Direct labor $86,500 $80,500 $6,000 U

Direct materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed expenses

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total expenses $383,500 $367,500 $16,000 U

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COMPONENTS OF THE STATIC BUDGET VARIANCE

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LET’S LOOK AT EXHIBIT 6-4

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SOME GENERAL POINTS…

► Always identify a variance as “favorable” (F) or “unfavorable” (U)

► A favorable variance is not necessarily a good thing, just as an unfavorable variance is not necessarily a bad thing

► Variance analysis provides an opportunity to benchmark against established standards to control operations

VARIANCE ANALYSISDIRECT MATERIALS

Unit 6.1

62.Unit 6.2 Unit 6.3

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Unit 6.4

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ANALYZING THE FLEXIBLE BUDGET VARIANCE

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PRICE VARIANCE CALCULATION

AQ × AP SP × SQ

Flexible Budget Variance

AQ × SP

or

AQ (AP - SP)

Price Variance

Actual Results Flexible Budget

This measures the difference between the actual price of inputs and the standard price of inputs

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QUANTITY VARIANCE CALCULATION

or

SP (AQ - SQ)

AQ × AP SP × SQ

Flexible Budget Variance

AQ × SP

Price Variance

Actual Results Flexible Budget

Quantity Variance

This measures the difference between the actual quantity of inputs used and the standard quantity of inputs that should have been used

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DIRECT MATERIALS VARIANCES

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C&C’S DIRECT MATERIAL VARIANCES

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INTERPRETING DM PRICE VARIANCES

Purchased in bulk and received quantity discount

Purchased lower-quality goods at a cheaper price

Received discount from supplier to get business

Suppliers decreased price

Purchased smaller-than-normal quantity and lost quantity discounts

Purchased higher-quality goods at a higher price

Suppliers increased price

Placed rush order with overnight delivery

FAVORABLE VARIANCE UNFAVORABLE VARIANCE

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INTERPRETING DM QUANTITY VARIANCES

Use of higher-quality goods resulted in reduced waste

Highly-skilled workers generated a lower scrap rate

Use of lower-quality goods resulted in increased waste

Low-skilled worked generated a higher scrap rate

Machine problems ruined some units

Poor supervision allowed extra scrap and waste

Employee theft

FAVORABLE VARIANCE UNFAVORABLE VARIANCE

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THINGS TO CONSIDER ON MATERIAL VARIANCES

► Price variance should be calculated at time of purchase, quantity variance at time of use

► Price and quantity variances may stem from the same cause

VARIANCE ANALYSISDIRECT LABOR

Unit 6.1

63.Unit 6.2 Unit 6.3

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Unit 6.4

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DIRECT LABOR VARIANCES

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C&C’s DIRECT LABOR VARIANCES

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INTERPRETING DL RATE VARIANCES

Used less skilled (lower paid) workers

Market wage rates decreased

Used higher skilled (higher paid) workers

Employees worked overtime and received overtime pay

Market wage rates increased

FAVORABLE VARIANCE UNFAVORABLE VARIANCE

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INTERPRETING DL EFFICIENCY VARIANCES

Used more highly skilled (higher paid) workers than allowed in the standard

Used higher quality materials that needed less handling

New employees were still learning their jobs

Overtime caused fatigue and reduced workers’ efficiency

Low quality materials required longer production time

Poor supervision resulted in employees “goofing off”

Excessive machine downtime

FAVORABLE VARIANCE UNFAVORABLE VARIANCE

VARIANCE ANALYSISMANUFACTURING OVERHEAD

Unit 6.1

64.Unit 6.2 Unit 6.3 Unit 6.4

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VARIABLE OVERHEAD VARIANCES

► Variable overhead variances are calculated just like labor variances• Variable overhead spending variance• Variable overhead efficiency variance

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VARIABLE OVERHEAD VARIANCES

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C&C’s VARIABLE OVERHEAD VARIANCES

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INTERPRETING VOH SPENDING VARIANCES

Paid less than expected for variable overhead items

FAVORABLE VARIANCE

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INTERPRETING VOH EFFICIENCY VARIANCES

Efficient use of activity base

Inefficient use of activity base

FAVORABLE VARIANCE UNFAVORABLE VARIANCE

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FOH SPENDING VARIANCE

► Since fixed costs do not change with changes in volume, the flexible budget amount for FOH is the same as the static budget amount

► FOH spending variance is the difference between the actual amount spent and the budgeted amount.

Actual FOH – Budgeted FOH = FOH Spending Variance

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THIS IS JUST THE BEGINNING…

► The calculation of the variances is the easy part► Unless you investigate the cause of the

variance, the whole process is useless► What variances should you investigate? All of

them?