1. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Fundamentals of Variance Analysis Chapter 16

2. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives: 1. Use budgets for performance evaluation. 2. Develop and use flexible budgets. 3.Compute and interpret the sales activity variance. 4. Prepare and use a profit variance analysis. 5.Compute and use variable cost variances. 6.Compute and use fixed cost variances. 7.(Appendix 16A) Understand how to record costs in a standard costing system.

3. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Budgets and Performance Evaluations LO1 Use budgets for performance evaluation. Budgeted income statement, production budget, budgeted cost of goods sold, and supporting budgets Operating Budgets Budgets of financial resources; for example, the cash budget and the budgeted balance sheet Financial Budgets Difference between planned result and actual outcome Variance

4. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Profit Variances Variance that, taken alone, increases operating profit Favorable Variance Variance that, taken alone, reduces operating profit Unfavorable Variance

5. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Example: Budgets Bayou Division Budget and Actual Results August

6. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Example: Budgets, Continued... Bayou Division Budget and Actual Results August

7. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Flexible Budgeting LO2Develop and use flexible budgets. Budget for a single activity level; usually the master budget Static Budget Budget that indicates revenues, costs, and profits for different levels of activity Flexible Budget

8. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Sales Activity Variance LO3Compute and interpret the sales activity variance. The difference between operating profit in the master budget and operating profit in the flexible budget that arises because the actual number of units sold is different from the budgeted number. Sales volume variance:

9. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Profit Variance LO4Prepare and use a profit variance analysis. Analysis of the causes of differences between budgeted profits and the actual profits earned. Profit Variance Analysis Sales price variance Variable production cost variances Marketing and administrative cost variances Fixed production cost variances

10. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Profit Variance Analysis Bayou Division Profit Variance Analysis August Total variance from master budget = $75,500 U Total variance from flexible budget = $30,500 F Sales activity variance

11. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Sales Price Variance ($10.50 - $10) x 80,000 units = $40,000 F * * From the profit variance analysis Difference between the actual selling price and budgeted selling price multiplied by the actual number of units sold. Sales Price Variance

12. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Variable Production Cost Variances A form providing the standard quantities of each input required to produce a unit of output and the standard price for each input. Standard Cost Sheet

13. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Production Cost Variance LO5Compute and use variable cost variances. Actual Actual Inputs at Standard Prices Flexible Production Budget Actual input price (AP) times actual quantity (AQ) of input Standard input price (SP) times actual quantity (AQ) of input Standard input price (SP) times standard quantity (SQ) of input allowed for actual good output AP x AQSP x AQSP x SQ Total variance (1) minus (3) Price variance (1) minus (2) Efficiency variance (2) minus (3) (1) (2)(3)

14. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Production Cost Variance, Continued... Price Variance Difference between actual price and budgeted price Multiply this difference by the actual quantity purchased AP - SP AQ

15. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Production Cost Variance, Continued... Efficiency Variance Difference between the actual quantity used and the budgeted quantity for the actual level of activity. Multiply this difference by the budgeted price per unit. SP AQ - SQ

16. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Direct Materials Variance Frames produced in August80,000 Direct materials Actual materials cost 328,000 lbs @ $0.60/lb $196,800 Price variance AQ AP - SP 328,000 $.60 - $.55= $16,400 U Efficiency variance SP AQ - SQ $.55 328,000 – 320,000= $4,400 U 80,000 x 4 lbs $16,400 U$4,400 U $20,800 U Total material variance

17. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Direct Labor Variance Direct labor Actual direct labor cost 4,400 hours @ $18/hr $79,200 Price variance 4,400 $18 - $20 = $8,800 F AQ AP - SP Efficiency variance $20 4,400 – 4,000 = $8,000 U SP AQ - SQ 80,000 x 0.05 Total direct labor variance $800 F $8,800 F $8,000 U

18. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Variable Overhead Variance Variable overhead Actual variable overhead cost$53,680 Actual overhead- Actual inputs @ standard price or POHR $53,680 - $12 4,400 = $880 U Price variance = $4,800 U Efficiency variance $12 4,400 – 4,000 Total variable overhead variance $5,680 U $4,800 U$880 U

19. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Total Variable Manufacturing Cost Variance Direct Materials $20,800 U16,400 U4,400 U$800 F8,800 F8,000 U Direct Labor Variable Overhead $5,680 U880 U4,800 U PriceEfficiencyTotal $25,680 U Total variable manufacturing cost variance

20. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Fixed Cost Variance LO6Compute and use fixed cost variances. Spending (or budget) Variance Price variance for fixed overhead The difference between budgeted and actual fixed overhead $195,500 – $200,000 = $4,500 F

21. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Production Volume Variance Variance that arises because the volume used to apply fixed overhead differs from the estimated volume used to estimate fixed cost per unit. The difference between budgeted and applied fixed overhead $200,000 budget 100,000 budgeted units = 2 per unit 80,000 units x $2 = $160,000 applied $200,000 budget – $160,000 applied = $40,000 U

22. McGraw-Hill/IrwinCopyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16: END!