Chapter 17 – Additional Topics in Variance Analysis Accounting 4310 Chapter 17 – Additional Topics in Variance Analysis

Profit Variance Analysis Comparison of actual results to budgeted results Actual results vary based on production When company produces more than sold, there is no effect on the sales activity variance BUT the profit variance is affected Variable production costs need to be adjusted

Profit Variance Analysis Variable production cost variance: Actual variable cost – estimated variable cost X Actual units produced Actual variable production costs = flexible budget variable production costs +/- variable production cost variances Can be treated as a period cost or it can be prorated between units sold and inventory

Absorption costing vs. Variable Costing All manufacturing costs – DM, DL, Variable and fixed OH included in unit inventory cost Variable costing Only variable manufacturing costs – DM, DL, Var. OH included in unit inventory cost Fixed OH expensed in period incurred Production volume variance will be an adjustment when reconciling absorption and variable costing incomes

Direct Material Variances –When Purchases Do Not Equal Use Price Variance Purchase price variance (when purchased) Quantity (Efficiency) Variance – based on use By computing price variance when purchased, variance is reported earlier 8

Direct Material Variances AP x AQ SP x AQ pur. |__________________| Price Variance SP x AQ used SP x SQ |______________| Quantity Variance 9

Marketing Variances Marketing Variances For revenues, the opposite holds true. FAVORABLE: Actual > Standard UNFAVORABLE: Actual < Standard Marketing Variances Price variance (Difference in sales prices) Quantity variance (Difference in sales volumes) Sales mix variance (Results from selling a different proportion of products than planned) Sales volume (Difference in volume sold) 7

Marketing Variances Price – Result of this variance lets management know how successful their price strategy was Did they have to lower their price to sell products? Or were customers willing to pay a price premium? Person who sets prices is responsible

Marketing Variances Quantity – Mix – details consumer preferences for products, especially when the products are substitutes Favorable (unfavorable) if consumers shift to a higher (lower) priced (CM) product Must evaluate why customers chose one product over another Marketing probably responsible

Marketing Variances Quantity: Sales (volume) Variance: This variance tells us whether we sold more units than planned. Favorable variance results if we sold more volume than planned. Person responsible for generating demand for overall product is responsible (probably marketing)

Marketing Variances AP x AQ SP x AQ SP x SQ |__________________| |_____________| Price Variance Quantity Variance |_________________________________| Total Marketing Variance 12

Sales Volume Variance Sales volume variance can be broken down into: Change in market share due to industry volume: Tells us how much of our increased (decreased) sales is due to a bigger (smaller) overall market for our products Our managers generally cannot control the overall industry volume. Change in market share due to market share: Tells us how much of our change in profits is due to increases or decreases in our hold on the market Our managers should be able to control this variance.

Marketing Variances Quantity Variance: Sales mix variance = (Actual quantity sold – quantity that would have been sold at the standard mix) x Standard CM Sales quantity variance = (Quantity that would have been sold at the standard mix – budgeted sales quantity) x Standard CM

Production Mix and Yield Variances Direct materials or direct labor efficiency variances can be broken down into: Mix variance Arises from a change in the inputs (different materials or labor used) Standard price x (actual quantity x actual input at the standard mix) Yield variance Arises from the difference in expected results and actual results Standard price x (actual input used at the standard mix – standard input allowed)

Variance Analysis in Nonmanufacturing Industries Measures used: professional staff hours, room nights, seat miles, patient days Goal – control labor and occupancy costs per sales dollar Efficiency – must have a reliable measure of output activity that is linked to input Routine tasks are better suited to variance analysis

Management of Variance Analysis Variances will vary by company and industry Impact of variance should be high Controllability of variance should be considered Management by exception can be practiced

Management of Variance Analysis Management by exception – allows managers to focus only on those variances which are truly out of the ordinary Management by exception allows managers to focus on certain areas Maximizes return on management Variance analysis should be performed often in order to make corrections as early as possible – at least every month if possible

Uses of Variance Analysis Calculation of variances do not explain causes Variances should be investigated Often reasons for variances are explained beside the calculated variance Favorable variances are not always good Unfavorable variances are not always bad It is not good to net variances Netting of variances may cancel out large favorable variances against large unfavorable variances

Three Conditions Necessary to Use Standard Costs There must be a way to measure outputs. A predetermined standard of performance must exist. There must be an ability to use variance information as feedback to make corrections and improvements.

Variance Analysis Cycle

Limitations on Standards Don’t hold people accountable for too many variances. Make sure you determine the cause of the variances; do not just mindlessly calculate them. Any variance is only as good as the standards or planned activity to which actual is compared!!!!!! Changing conditions may warrant changing the standards. Variances should always be used for feedback and continuous improvement.