Analyzing Financial Performance Reports Management Control Systems Chapter 10 August 2014 Iwan Pudjanegara, SE. MM.

Variances/Differences BU managers report their financial performance to senior management regularly, usually monthly. The formal reports consists of a comparison of actual revenues and costs with budgeted amounts. The differences between those two amounts is called variances. August 2014 Iwan Pudjanegara, SE. MM.

Calculating Variances The Analytical Framework to conduct variances analysis : Identify the key factors that affect profits. Break down the overall profit variances by key factors. Focus on the profit impact of variation in each factor. ...cont’d August 2014 Iwan Pudjanegara, SE. MM.

Calculating Variances The Analytical Framework to conduct variances analysis : .............cont’d Try to calculate the specific, separable impact of each factor by varying only that factor while holding all other factors constant. Add complexity sequentially, one layer at time, beginning at a very basic “commonsense” level. ...cont’d August 2014 Iwan Pudjanegara, SE. MM.

Calculating Variances The Analytical Framework to conduct variances analysis : .............cont’d Stop the process when the added complexity at a newly created level is not justified by added useful insights into the factors underlying the overall profit variance. August 2014 Iwan Pudjanegara, SE. MM.

Revenue Variances A positive variance is favorable, because it indicates that actual profit exceeded budgeted profit. A negative variance is unfavorable. August 2014 Iwan Pudjanegara, SE. MM.

Revenue Variances Selling Price Variance Mix and Volume Variance Is (Actual Price – Budget Price) x Actual Volume Mix and Volume Variance Is (Actual Volume – Budgeted Volume) x Budgeted unit contribution August 2014 Iwan Pudjanegara, SE. MM.

Revenue Variances Mix Variance Volume Variance Is [(Actual volume of sales) – (Total actual volume of sales x Budgeted proportion) x Budgeted unit contribution] Volume Variance Is [(Total actual volume of sales) x (% Budgeted) – (Budgeted sales)] x (Budgeted unit contribution) August 2014 Iwan Pudjanegara, SE. MM.

Revenue Variances Other Revenue Analysis Classify by product Calculated from Price variance, Mix variance, and Volume variance. Market Penetration/Market Share Variance Is [(Actual sales) – (Industry volume)] x Budgeted market penetration x Budgeted unit contribution August 2014 Iwan Pudjanegara, SE. MM.

Revenue Variances Industry Volume Variance Is (Actual industry volume – Budgeted industry volume) x Budgeted market penetration x Budgeted unit contribution August 2014 Iwan Pudjanegara, SE. MM.

Expense Variances Fixed Costs Variances between actual and budgeted fixed costs are obtained simply by subtraction, since these costs are not affected by either the volume of sales or the volume of production. August 2014 Iwan Pudjanegara, SE. MM.

Expense Variances Variable Costs Variable costs are costs that vary directly and proportionately with volume. The budgeted variable manufacturing costs must be adjusted to the actual volume of production. August 2014 Iwan Pudjanegara, SE. MM.

Expense Variances The budgeted manufacturing expense is adjusted to the amount that should have been spent at the actual level of production (standard cost of each product x volume of production for that product). The volume that is used to adjust the budgeted variable manufacturing expense is the manufacturing volume, not the sales volume. August 2014 Iwan Pudjanegara, SE. MM.

Variations in Practice Time Period of the Comparison Some companies use performance for the year to date as the basis for comparison. Other companies compare the budget for the whole year with the current estimate of actual performance for the year. August 2014 Iwan Pudjanegara, SE. MM.

Variations in Practice Focus on Gross Margin Unit gross margin is the difference between selling prices and manufacturing costs. The variance analysis is done by substituting “gross margin” for “selling price” in the revenue equations. August 2014 Iwan Pudjanegara, SE. MM.

Variations in Practice Evaluation Standards 3 types of the formal standards used in the evaluation of reports on actual activities are : Predetemined Standards or Budgets Historical Standards External Standards August 2014 Iwan Pudjanegara, SE. MM.

Variations in Practice Limitations on Standards: The standard was not set properly. Although it was set properly in light of conditions existing at the time, changed conditions have made the standard obsolete. (obsolete = usang, kuno) August 2014 Iwan Pudjanegara, SE. MM.

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. If the ending inventory is higher than the beginning inventory, some of the fixed overhead costs incurred in the period remain in inventory rather than flowing through to cost of sales. August 2014 Iwan Pudjanegara, SE. MM.

Variations in Practice Engineered and Discretionary Costs A favorable variance in engineered costs is usually an indication of good performance (the lower the cost, the better the performance). 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. August 2014 Iwan Pudjanegara, SE. MM.

Limitations of Variance Analysis It does not tell why the variance occurred or what is being done about it. To decide whether a variance is significant. As the performance reports become more highly aggregated, offsetting variances might mislead the reader. The reports show only what has happened. They do not show the future effects of actions that the manager has taken. August 2014 Iwan Pudjanegara, SE. MM.

Management Action The monthly profit report should contain no major surprises. One of the most important benefits of formal reporting is that it provides the desirable pressure on subordinate managers to take corrective actions on their own initiative. August 2014 Iwan Pudjanegara, SE. MM.