1
Introduction
This discussion focuses
on financial performance
measures
2
Calculating Variances
• Most companies make a monthly analysis of
the differences between actual and budgeted
revenues and expenses for each business unit
and for the whole organization.
• A more thorough analysis identifies the
causes of the variances and the organization
unit responsible.
• Effective systems identify variances down to
the lowest level of management
• Therefore, it is possible to identify each
variance with with the individual manager
who is responsible for it.
3
Calculating Variances
The analytical framework use
to conduct variance
analysis incorporates the
following ideas :
• Identify the key causal factors
that affects profits
• Break down the overall profit
variances by these key causal
factors
• Focus on the profit impact of
variation in each causal factors
4
Calculating Variances
• Try to calculate the specific, separable
impact of each causal factor by varying only
that factor while holding all other factors
constant
• Add complexity sequentially, one layer at a
time, beginning at a very basic
“commonsense” level (“peel the onion”).
• Stop the process when the added
complexity at a newly created level is not
justified by added useful insights into the
casual factors underlying the overall profit
variance
5
Calculating Variances
Revenue Variances
• The calculation is made for each
product line, and the product line
results are then aggregated to
calculate the total variance.
6
Variations in Practice
Time Period of the Comparison
• Some companies use performance for
the year to date as the basis for
comparison. For period ended June
30, they would use budgeted and
actual amounts for the six months
ending on June, rather than the
amounts for June.
• A comparison for the year to date is
not as much influenced by temporary
aberrations that may be peculiar to
the current month.
7
Variations in Practice
Focus on Gross Margin
• Gross margin = Selling prices – Manufacturing
cost
8
Variations in Practice
Focus on Gross Margin
• Evaluation
The formal standards used in the evaluation of
reports on actual activities are :
1. Predetermined standards
If carefully prepared and coordinated, these
are excellent standards
2. Historical standards
These are records of past actual performance.
Results for the current month may be
compared with the results for last month, or
with results for the same month a year ago.
3. External standards
9
Variations in Practice
Full Cost Systems
• If the company has a full cost system, both
variable and fixed overhead costs are
included in the inventory at the standard
cost per unit
• Variance = Budgeted fixed production cost
at the actual volume – Standard fixed
production costs at that volume
• The important point is that production
variances should be associated with
production volume, not sales volume
10
Variations in Practice
Amount of Detail
We analyzed revenue variances at several levels :
1. In total
2. By volume, mix and price
3. By analyzing the volume and mix variance
4. By industry volume and market share
At each of these levels, we analyzed the
variances by individual products. The process
of going from one level to another is often
referred to as “peeling the onion “.
11
Variations in Practice
Engineered and Discretionary Costs
• A favorable variance in engineered costs is
usually an indication of good performance, that
is the lower the cost, the better the
performance
• By contrast, the performance of a
discretionary expense center is usually judged
to be satisfactory if actual expenses are about
equal to the budgeted amount, neither higher
or lower.
12
Limitations of Variance Analysis
1. Although it identifies where a variance
occurs, it does not tell why the variance
occurred or what is being done about it.
2. To decide whether a variance is significant
3. The performance reports become more
highly aggregated, offsetting variances
might mislead the reader.
Finally, the reports show only what was
happened. They do not show the future
effects of actions that manager has taken.
13
Limitations of Variance Analysis
Management Action
• There is one cardinal principle in
analyzing formal financial reports. The
monthly profit report should contain
no major surprises.
• One of the most important benefits of
formal reporting is that is provides the
desirable pressure on the subordinate
managers to take corrective actions on
their own initiative
• Profit reports are worthless unless
they lead to action