PERFORMANCE EVALUATION
VARIANCE ANALYSIS

6
THE BUDGET PLAN FOR 4 TH QUARTER
►
Sell in 4 th quarter:
• 70,000 pants
• 25,000 jerseys
• 9,000 award jackets
►
Control inventory
►
Manage cash

6
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 BUDGETS
A PERFORMANCE EVALUATION TOOL
Unit 6.1
Unit 6.2 Unit 6.3
Unit 6.4

6
TOTAL VARIANCE
Actual results achieved
Variance
Budgeted
(expected) results
A variance is any difference between what you expected and what you achieved.

LET’S LOOK AT SOME VARIANCES
Sales
Cost of goods sold
Gross margin
Selling and administrative expenses
Operating income
Financing costs
Income before taxes
Income taxes
Net income
Actual
$2,457,525
1,724,150
733,375
385,139
348,236
2,256
345,980
103,794
$242,186
Static
Budget
$2,335,000
1,582,757
752,243
360,753
391,490
1,880
389,610
116,883
$272,727
A variance is favorable if it increases net income
Variance
$122,525 F
141,393 U
(18,868) U
24,386 U
(43,254) U
376 U
(43,630) U
(13,089) F
($30,541) U
6

LET’S LOOK AT SOME VARIANCES
Sales
Cost of goods sold
Gross margin
Selling and administrative expenses
Operating income
Financing costs
Income before taxes
Income taxes
Net income
Actual
$2,457,525
1,724,150
733,375
385,139
348,236
2,256
345,980
103,794
$242,186
Static
Budget
$2,335,000
1,582,757
752,243
360,753
391,490
1,880
389,610
116,883
$272,727
Variance
$122,525 F
141,393 U
(18,868) U
24,386 U
(43,254) U
376 U
(43,630) U
(13,089) F
($30,541) U
A variance is unfavorable if it decreases net income
6

6
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.

YOUR PERFORMANCE REPORT
Actual Results
38,000
Static Budget
35,000
6
Units produced
Variable expenses
Direct labor
Direct materials
Power
Maintenance
Fixed expenses
Depreciation
Maintenance
Supervision
Total expenses
$86,500
26,000
15,700
44,900
80,000
92,400
38,000
$383,500
$80,500
21,000
14,000
42,000
80,000
92,000
38,000
$367,500
Variances
3,000
$6,000 U
5,000 U
1,700 U
2,900 U
---
400 U
---
$16,000 U

YOUR PERFORMANCE REPORT
6
Actual Results Static Budget
Units produced
Variable expenses
38,000 35,000
$86,500
26,000
15,700
$80,500
21,000
14,000
Maintenance 44,900 42,000
Do these unfavorable variances mean that you
Fixed expenses have done a poor job controlling costs?
Depreciation 80,000 80,000
Maintenance
Supervision
Total expenses
92,400
38,000
$383,500
92,000
38,000
$367,500
Variances
3,000
$6,000 U
5,000 U
1,700 U
2,900 U
---
400 U
---
$16,000 U

THE QUESTION…
6
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?

6
THE ANSWER…
We have to… the budget to match the actual activity level achieved.

6
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.

LET’S PRACTICE: FIX THE FLEX
Actual Results
38,000
Static Budget
35,000
6
Units produced
Variable expenses
Direct labor
Direct materials
Power
Maintenance
Fixed expenses
Depreciation
Maintenance
Supervision
Total expenses
$86,500
26,000
15,700
44,900
80,000
92,400
38,000
$383,500
$80,500
21,000
14,000
42,000
80,000
92,000
38,000
$367,500
Variances
3,000
$6,000 U
5,000 U
1,700 U
2,900 U
---
400 U
---
$16,000 U

6
COMPONENTS OF THE STATIC BUDGET VARIANCE

6
LET’S LOOK AT EXHIBIT 6-4

SOME GENERAL POINTS…
6
►
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 ANALYSIS
DIRECT MATERIALS
Unit 6.1
Unit 6.2
Unit 6.3
Unit 6.4

ANALYZING THE FLEXIBLE BUDGET VARIANCE
6

PRICE VARIANCE CALCULATION
Actual Results
AQ × AP AQ × SP
Flexible Budget
SP × SQ
Price Variance
6
Flexible Budget Variance or
AQ (AP - SP)
This measures the difference between the actual price of inputs and the standard price of inputs

QUANTITY VARIANCE CALCULATION
Actual Results
AQ × AP AQ × SP
Flexible Budget
SP × SQ
Quantity Variance Price Variance
6
Flexible Budget Variance or
SP (AQ - SQ)
This measures the difference between the actual quantity of inputs used and the standard quantity of inputs that should have been used

6
DIRECT MATERIALS VARIANCES

6
C&C’S DIRECT MATERIAL VARIANCES

INTERPRETING DM PRICE VARIANCES
6
FAVORABLE VARIANCE
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
UNFAVORABLE VARIANCE
Purchased smaller-thannormal quantity and lost quantity discounts
Purchased higher-quality goods at a higher price
Suppliers increased price
Placed rush order with overnight delivery

6
FAVORABLE VARIANCE
Use of higher-quality goods resulted in reduced waste
Highly-skilled workers generated a lower scrap rate
UNFAVORABLE VARIANCE
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

6
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 ANALYSIS
DIRECT LABOR
Unit 6.1
Unit 6.2
Unit 6.3
Unit 6.4

6
DIRECT LABOR VARIANCES

6
C&C’s DIRECT LABOR VARIANCES

FAVORABLE VARIANCE
Used less skilled (lower paid) workers
Market wage rates decreased
UNFAVORABLE VARIANCE
Used higher skilled (higher paid) workers
Employees worked overtime and received overtime pay
Market wage rates increased
6

INTERPRETING DL EFFICIENCY VARIANCES
6
FAVORABLE VARIANCE
Used more highly skilled
(higher paid) workers than allowed in the standard
Used higher quality materials that needed less handling
UNFAVORABLE VARIANCE
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

VARIANCE ANALYSIS
MANUFACTURING OVERHEAD
Unit 6.1
Unit 6.2 Unit 6.3
Unit 6.4

6
VARIABLE OVERHEAD VARIANCES
►
Variable overhead variances are calculated just like labor variances
• Variable overhead spending variance
• Variable overhead efficiency variance

6
VARIABLE OVERHEAD VARIANCES

C&C’s VARIABLE OVERHEAD VARIANCES
6

FAVORABLE VARIANCE
Paid less than expected for variable overhead items
6

INTERPRETING VOH EFFICIENCY VARIANCES
FAVORABLE VARIANCE
Efficient use of activity base
UNFAVORABLE VARIANCE
Inefficient use of activity base
6

6
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

6
THIS IS JUST THE BEGINNING…
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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?