GROSS PROFIT VARIANCE ANALYSIS
Gross Profit Analysis
• is designed to pick apart the reasons why the gross profit
margin changes from period to period, so that
management can take steps to bring the gross margin in
line with expectations. A decline in gross profits can be an
indicator of serious problems, so the figure is closely
watched.
• Profit, whether it is “gross profit” or “contribution
margin”, is affected by at least three basic items: sales
price, sales volume,and costs. In addition, in a multi
product firm, if not all products are equally profitable,
profit is affected by the mix of products sold.
A change in gross profit can be caused by any of the
following events:
• Sales prices have changed
• The unit volume of items sold have changed
• The mix of products sold has changed (which alters the
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gross profit if different products have different gross
margins)
The purchase price of direct materials have changed
The amount of direct materials required has changed
The amount of direct labor has changed, due to altered
efficiency levels
The cost of direct labor has changed
• The preceding list is not comprehensive, since gross profit
analysis may also uncover problems in such as areas as
late or double-counted inventory, incorrect units of
measure, and theft. Also, the broad scope of this list of
events should make it clear that controlling gross margin
requires the input of many parts of a business, including
the engineering, materials management, sales, and
production departments.
• A gross profit analysis involves comparing the gross profit
for the period being reviewed to either the budgeted level
or the historical average.
• The gross profit analysis reported to management should
describe the total variance from expectations, and then
itemize the exact reasons for the differences. The report
should contain actionable items, so that management can
identify specifically what is wrong and proceed to fix it. An
even better gross profit analysis is one that clusters
identified problems into categories and shows the
frequency of occurrence of the categories over time.
Doing so shows management which problems are
causing the most trouble on a repetitive basis, and which
are therefore most worthy of attention.
• While gross profit analysis is important, it only covers
product-related costs. Thus, if you want a comprehensive
review of all aspects of a company's financial results, you
must also evaluate all costs of selling and administration,
as well as all financing and other non-operational
expenses.
• Gross profit analysis also ignores the amount of
investment in working capital and fixed assets in
proportion to sales. That is, it does not account for the
efficiency of asset usage in creating gross profits.
The difference between budgeted and actual
profits is due to one or more of the following:
• Changes in unit sales price or Sales Price Variance
• Changes in unit cost price or Cost Price Variance
• The difference between sales price variance and cost
price variance is often called a “contribution-marginper-unit variance” or a “gross-profit-per-unit
variance”
• Changes in the volume of products sold summarized as
the “sales volume variance“ and the “cost volume
variance“. The difference between the two is called the
“total volume variance“.
• Changes in the volume of the more profitable or less
profitable items referred to as the “sales mix variance“.
Types Of Standards In Profit Variance
Analysis
• To
determine the various causes for a favorable
variance (an increase) or an unfavorable variance (a
decrease) in profit, we need some kind of yardstick to
compare against the actual results. The yardstick may be
based on the prices and costs of the previous year, or any
year selected as the base period. Some companies
summarize profit variance analysis data in their annual
report by showing departures from the previous year’s
reported income.
• However, one can establish a more effective control and
budgetary method rather than the previous year’s data.
Standard or budgeted mix can be determined using such
sophisticated techniques as linear and goal programming.
How To Calculate Profit Variances For
Single-Product Firms?
• Profit variance analysis is simplest in a single-product
firm, for there is only one sales price, one set of costs (or
cost price), and a unitary sales volume. An unfavorable
profit variance can be broken down into four components:
a sales price variance, a cost price variance, a sales
volume variance, and a cost volume variance.
• The sales price variance measures the impact on the
firm’s contribution margin (or gross profit) of changes in
the unit selling price. It is computed as:
• Sales price variance = (Actual price – Budget price) ×
Actual sales
• If the actual price is lower than the budgeted price, for
example, this variance is unfavorable; it tends to reduce
profit. The cost price variance, however, is simply the
summary of price variances for materials, labor, and
overhead. (This is the sum of material price, labor rate,
and factory overhead spending variances.) It is computed
as:
• Cost price variance = (Actual cost – Budget cost) ×
Actual sales
• If the actual unit cost is lower than budgeted cost, for example,
this variance is favorable; it tends to increase profit. We simplify
the computation of price variances by taking the sales price
variance less the cost price variance and call it the gross-profitper-unit variance or contribution-margin-per-unit variance.
• The sales volume variance indicates the impact on the firm’s
profit of changes in the unit sales volume. This is the amount
by which sales would have varied from the budget if nothing
but sales volume had changed. It is computed as:
• Sales volume variance = (Actual sales – Budget sales) ×
Budget price
• If actual sales volume is greater than budgeted sales
volume, this is favorable; it tends to increase profit. The
cost volume variance has the same interpretation. It is:
• Cost volume variance = (Actual sales – Budget Sales) ×
Budget cost per unit
• The difference between the sales volume variance and
the cost volume variance is called the “total volume
variance“.
Sample Problem:
Sales in Units
Selling Price
Sales Revenue
Cost of Goods Sold
Gross Profit
2017
97,500
9
877,500
585,000
292,500
2018
110,000
8.8
968,000
704,000
264,000
PROFIT VARIANCE ANALYSIS FORMULAS
3-way analysis formulas (R. Roque)
1. Volume or Quantity Factor = (Difference in units) X
(Last year’s gross profit per unit)
2. Price Factor = (Difference in selling prices) X (Current
year’s units
3. Cost Factor = (Difference in cost prices) X (Current
year’s units)
PROFIT VARIANCE ANALYSIS FORMULAS
4-way analysis formulas (R. Roque) or 2-way analysis (F.
Agamata)
Sales Variance:
1. Price Factor = (Difference in selling prices) X (Current year’s
units)
2. Volume or QuantityFactor = (Difference in units) X (Last
year’s selling price)
Cost Variance:
1. Price Factor = (Difference in Cost Prices) X (Current year’s
units)
2. Volume or Quantity Factor = (Difference in units) X (Last
year’s cost price)
PROFIT VARIANCE ANALYSIS FORMULAS
Sales Variances:
1. Price Factor = (Difference in selling prices) X (Last year’s
units)
2. Volume or Quantity Factor = (Difference in units) X (Last
year’s selling price)
3. Price-Volume Factor (R. Roque) or Joint Variance Factor
(F. Agamata) = (Difference in selling prices) X (Difference in
units)
Cost Variances:
1. Price Factor = (Difference in cost prices) X (Last year’s units)
2. Volume or Quantity Factor = (Difference in units) X (Last
year’s cost price)
3. Price-Volume Factor (R. Roque) or Joint Variance Factor
(F. Agamata) = (Difference in cost prices) X (Difference in units)