Chapter 8

1. Chapter 8 Financial and Non-Financial Measures of Operating Efficiency

2. Compare budgeted and actual results to isolate the impact of individual input and output factors Used to Revise plan assumptions Evaluate employee performance Profit Variance Analysis LO1: Understand how companies use budgets for control.

3. Benchmark for computing variances As you know, the master budget specifies in detail Sales volumes and prices Input quantities and costs Planned efficiencies and prices Capacity costs Also termed overhead cost The master budget is like picking a point on the profit line in the CVP graph The Master Budget LO1: Understand how companies use budgets for control.

4. Cindy’s Master Budget LO1: Understand how companies use budgets for control.

5. Actual Results Differ LO1: Understand how companies use budgets for control.

6. Variance could be due to Output quantities and/or prices Input efficiencies and/or prices Errors in estimated overhead costs Variance analysis Linear decomposition of overall profit variance into above factors Turns “one dial” at a time Many Possible Sources LO1: Understand how companies use budgets for control.

7. $20.95 $14.30 1 $6.65 2 $19,950 3 $14,000 4 $3,75 in materials + $10.00* in labor + $0.55 in variable overhead *($10.00 = $20 per hour x 0.50hours per cake) 1 $20.95 - $14.30 2 $3,000 x $6.65 3 $19,950 - $14,000 4

8. Variance Conventions LO2: Perform variance analysis.

9. Conceptual Approach LO2: Perform variance analysis.

10. Structure of Variances LO2: Perform variance analysis.

11. $58,660 $79,610 $40,040 $45,760 $21,280 $25,270 $14,000 $14,000

12. Difference between income / contribution in master and flexible budgets  units × Budgeted UCM = revenue × Budgeted CMR Flexible budget is at actual output quantity Sales volume is only change in plan assumption  Profit difference is due to change in sales volume Focus on change in CM / income & not revenue Change in volume changes revenues and variable costs Fixed costs do not change if volume changes Sales Volume Variance LO2: Perform variance analysis.

13. Profit Line (per CVP model) Budgeted Profit Profit or Loss ($) Profit Variance Actual Profit 0 Volume of Activity Actual volume Budgeted volume (Fixed Cost) Budgeted and Actual Results LO2: Perform variance analysis.

14. Profit ($) Master Budget Profit Flexible Budget Profit Sales Volume Variance + FlexibleBudgetVariance = Total Profit Variance Actual Profit Profit Line (per CVP relation) B A C 0 Volume of Activity Budgeted volume Actual volume (Fixed Costs) Sales Volume Variance Profit ($) Volume of Activity LO2: Perform variance analysis.

15. Sales Volume Variance - Concept TotalProfitVariance SalesVolumeVariance FlexibleBudgetVariance Master budgetprofit Profitinflexiblebudget Actual profit Sales volume variance Flexiblebudgetvariance Totalprofitvariance LO2: Perform variance analysis.

16. Tabular Format F F U LO2: Perform variance analysis.

17. 300 1 $8.15 $2,445 2 1 3,800 cakes – 3,500 cakes 300 x $8.15 2

18. Flexible Budget Variance LO2: Perform variance analysis.

19. Cost in flexible budget is the right benchmark Activity volume the same in flexible budget and actual operations Can compare line items Materials Labor Overhead costs Cost Variances LO2: Perform variance analysis.

20. Look Back to the Previous Step F F U LO2: Perform variance analysis.

21. Flexible Budget Variances LO2: Perform variance analysis.

22. Variable Cost Variance Quantity Variances Price Variances Cost Variances - Concept Cost item in actual results “as if” cost item Cost item in flexible budget Price variance Quantity variance Flexible budget variance for given cost LO2: Perform variance analysis.

23. Tabular Format LO2: Perform variance analysis.

24. Actual Cost Budgeted Cost Variances are Linear LO2: Perform variance analysis.

25. Profit Reconciliation LO2: Perform variance analysis.

26. Test Your Knowledge! For what purpose is a flexible budget used? • To provide various possible outcomes for management to consider • To adjust input prices so that future variances are eliminated • To insure that profit does not drop below a predetermined level • To identify the sources of variances A flexible budget helps identify what caused any differences between the budgeted amount allowed at the actual level of sales and the actual amounts incurred.

27. $19.95 1 $20.95 3,800 2 $75,810 actual revenue / 3,800 cakes actually sold 1 ($19.95 - $20.95) x 3,800 = $3,800 U 2

28. Investigate all significant variances Large variance shows poor plan / execution Examine trends Consistent sign may be related to plan assumptions Consider the total picture Variances ignore interactions Price-quantity, input substitution Interpreting Variances LO3: Interpret variances to determine possible corrective actions.

29. $0.14 $0.12 18,600 19,000 1 2 3 5 eggs per cake x 3,800 cakes 1 $372 U = [($0.12 - $0.14) x 18,600] 2 $48 F = [(19,000 – 18,600) x $0.12] 3

30. Non financial measures better on Timeliness Specificity Non-financial measures used for Process control Provide localized feedback for immediate action Agency control (Chapter 12 & 13) Non-financial Controls LO4: Explain how nonfinancial measures complement variance analysis.

31. Test Your Knowledge! The controller for Navia, Inc. created a budget prior to the current period. At the end of the period, the controller compared the budget with the actual results. For what purpose is the controller using budgets? • Coordination • Control • Variances • Planning Having a good plan alone is not sufficient. The budget must be compared to actual performance, with any significant differences investigated and changes made as necessary.

32. (Appendix A) PURCHASE PRICE VARIANCE Appendix A

33. We calculated materials price variance based on quantity of materials used This can differ from quantity purchased Firms want to know a variance sooner than later Thus, many calculate the materials price variance on the quantity of materials purchased. Which approach is better? “Quantity purchased” is the pure approach and is consistent with a traditional accounting view We continue to employ “quantity used” Helps with profit reconciliation Rationale Appendix A

34. MARKETING VARIANCES (Appendix B and C) Appendix B and C

35. Appendix B: Market Size and Share • This is a drill down of sales volume variance • Similar in principle to breaking down labor variance into labor rate and labor quantity variances. • Volume (in units or $) = Size × Share • Sales Volume Variance turns both dials • The decomposition turns one dial at a time Appendix B and C

36. Actual market size x Planned market share x Planned UCM Market share variance Market size variance Sales volume variance Planned market size x Planned market share x Planned UCM Static budget profit Actual market size x Actual market share x Planned UCM Flexible budget profit Decomposition: Graphical Appendix B and C

37. Example 17,500 cakes x 20% share x $6,65/cake = $28,525 Static budget profit (3,500 cakes) Flexible budget profit (3,800 cakes) 20,000 x 19% share x $6.65/cake = $30,970 20,000 cakes x 20% share x $6.65/cake = $32,600 Market share variance Market size variance $3,325 F $1,330 U Sales volume variance $1,995 F Appendix B and C

38. Appendix C: Multiple Products • Thus, far we have considered a 1- product case • Budget was budgeted quantity and UCM. Flexible budget based on actual quantity and budgeted UCM. Thus. • Sales volume variance = (Actual quantity – budgeted quantity) * budgeted UCM • With Multi-product case • Budget at budgeted quantity and budgeted UCM for each product • Flexible budget at actual quantity and budgeted UCM for each product • We can perform analysis in two ways • Analyze each product separately • Appropriate when products are independent • Consider each product as a (total quantity * % share of product) • Useful when products are substitutes / complements Appendix B and C

39. Multi-product Variance Analysis • Focus on second type of analysis • Recall that in CVP, when we considered multiple products, we used sales mix (% sales of each kind) to calculate Weighted Average Contribution Margin (WACM). • Identical concept used here • Use budgeted total sales (in units) and budgeted WACM to compute master budget • Use actual total sales (in units) and actual WACM in flexible budget • But, this turns two dials – total sales and WACM • Can decompose into a mix effect and a quantity (mix-adjusted total sales) effect • Introduce a “as if” column between master and flexible budget Appendix B and C

40. Mix and Quantity Variances Actual total sales x Planned mix x Planned UCM Profit in flexible budget Actual total sales x Actual mix x Planned UCM Sales mix variance Sales quantity variance Sales volume variance Planned total sales x Planned mix x Planned UCM Static budget profit Appendix B and C

41. Pacific Telephones Appendix B and C

42. 201,000 Actual units x $25.075 Plan WACM Profit in flexible budget 201,000 Actual units x $24.841 WACM in flexible budget Sales mix variance Sales quantity variance Sales volume variance 200,000 plan units x $25.075 plan WACM Static budget profit Sales Volume Variance $25,075 F $47,125 U $22,050 U Appendix B and C

43. Exercise 8.34 Calculating materials and labor price and quantity variances (LO2). The Glass Vessel Company has established the following budget for producing one of its hand-blown vases: In March of the most recent year, Glass Vessel produced 300 vases using 650 pounds of materials. Glass Vessel purchased the 650 pounds of materials for $845. Labor costs for March were $7,200 for 480 hours worked. • Required: • What were Glass Vessel’s materials price and materials quantity variances for March? • What were Glass Vessel’s labor price and labor quantity variances for March?

44. Exercise 8.34 (Continued) • What were Glass Vessel’s materials price and materials quantity variances for March? To calculate the materials price and quantity variances, we need to know: (1) the flexible budget for materials; (2) the “as if” budget for materials with actual efficiencies; and (3) the actual results. The table below provides the required computations and accompanying variances.

45. Exercise 8.34 (Continued) • What were Glass Vessel’s materials price and materials quantity variances for March? Thus, Glass Vessel’s materials price and quantity variances were $32.50 U and $62.50U, respectively, for March.

46. Exercise 8.34 (Continued) • What were Glass Vessel’s labor price and labor quantity variances for March? As in part [a], to calculate the labor price and quantity variances, we need to know: (1) the flexible budget for labor; (2) the “as if” budget; and (3) the actual results. The table below provides the required computations and accompanying variances.

47. Exercise 8.34 (Continued) • What were Glass Vessel’s labor price and labor quantity variances for March? Thus, Glass Vessel’s labor price and quantity varianceswere $0 and $450 U, respectively, for March.