1. MCS UNS chapter 6 :Variance Analysis

2. Course Map – Where are we?
Organizing for Performance
Chp 3
Chps 12 & 13
Boundary Systems
Chps 13
Belief Systems
What to Control
Chp 4
Risks to be
Avoided
Core Values
Core Values
Building and Evaluating Budgets
Chps 5, 6, 7
Today’s Topic
Business Strategy
Chp 2 Chp 14
Measuring Performance
Chps 8 & 9
Strategic
Uncertainties
Critical Perf
Variables
Internal Controls
Chp 13
Interactive Control Systems
Chp 10
Diagnostic Control Systems
Chp 10
Designing Employee Goals and Incentives
Chp 11
4 LEVERS OF CONTROL

3. Chp 6 - Evaluating Strategic Profit Performance
Introduction
Variance Analysis Overview – Theory behind ‘Crunching the Numbers’
Disadvantages and Advantages of Variance Analysis

4. Monitoring the Business Strategy
Diagnostic Function
Used to evaluate:
Effectiveness – extent to which we met our desired goals; compare actual to expected
Efficiency – level of resources used to achieve specific outputs

5. Two Components of Strategic Profitability (or Value Creation)
Profit (loss) from competitive effectiveness
(revenue variance)
+ Profit (loss) from competitive efficiency
(cost variance)

6. Variance Analysis
Variance – difference between actual and expected (budgeted) performance
Favorable variance – actual profit is higher than planned
Unfavorable variance – actual profit is lower than planned

7. Three Conditions necessary in order to Evaluate
There must be an 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.

8. Variance Analysis Cycle

9. Strategic Profitability Analysis
A tool used to evaluate the success of a business in generating profit from the implementation of its strategy
Composed of:
Analysis of competitive effectiveness
Analysis of operating efficiencies

10. Strategic Profitability Analysis

11. Strategic Variance Analysis
Total Variance
Competitive Effectiveness
Competitive Efficiency
REVENUE
COST
Sales Price
Market Size
Production Efficiency
Nonvariable Spending
Market Share
Product Mix
Production Spending

12. Pros & Cons of Strategic Analysis
Advantages
Disadvantages

13. Competitive Effectiveness
Must be able to set and implement market strategy
Used for profit centers and stand alone businesses
Measured by two output indicators:
Market share growth
Price premium

14. Market Share Variances
Change in profits due to our market share:
Tells us how much of our change in profits is due to increases or decreases in our hold on the market
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

15. Revenue Variances Increase in profit due to changes in selling prices
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?
Increase in profit due to changes in product mix
Results from selling a different proportion of products than planned
Must evaluate why customers chose one product over another
Increase in profit due to changes in volume
This variance tells us whether we sold more units than planned.

16. Operating Efficiencies
How many resources were consumed to achieve the actual outputs?
This analysis can be used for any type of business unit; including cost centers.
Revenue variances tell us about performance in the market, and spending and efficiency variances inform us about how well managers used their internal capabilities of the business.
Good to benchmark

17. Flexible Budget
Flexible budget – budget made out for many levels of activities
To calculate operating efficiencies, we must use the budget for our actual level of activity, not the static budget (if different from actual)
Static – 100,000 units, actual – 102,000 units
Must make out a new budget for 102,000 units to compare actual to budget

18. Variable Costs
Materials and labor can often be broken down into price and quantity variances. Texts also call these spending and efficiency variances.
Materials Spending variance - Tells if you spent more or less than standard price per unit of material
Causes and responsibility for variance

19. Variable Costs
Materials Efficiency variance –tells whether you used more or less materials than the standard called for
Causes and responsibility for variance
Labor Spending variance -tells if you spent more or less than standard price per unit on labor
Labor Efficiency variance –tells whether you used more or less labor hours than the standard called for

20. Nonvariable costs Spending variance: Planned cost – Actual cost
Committed fixed costs
Discretionary fixed costs
Activity-Based costs
Volume variance - Impact on profits due to changes in cost-driver activity
Efficiency variance – Impact on profits due to changes in efficiency
Spending variance – Impact on profits due to changes in cost of resources

21. Cost Center and Discretionary Cost Center
The hallmark of two centers should be understood in terms of the following factors:
Budget preparation
Type control
Performance measurement

22. 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

23. Uses 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
Any variance is only as good as the standards or planned activity to which actual is compared!!!!!!

24. Evaluation Standards
Predetermined standards – carefully determined standards can be established using ideal circumstances, practical circumstances, or some other basis.
Ideal standards will show a lot of unfavorable variances.
Historical standards – often past inefficiencies passed on
External standards – benchmarks
Comparison to other companies in industry
Can be obtained from private sources for a fee
Some library sources

25. Strategic Variance Analysis Exercise
You are the new controller for a firm and are asked to analyze these nonvariable cost variances:
Advertising shows an unfavorable variance
Are you concerned?
R&D spending is far below budget
Should you reward the R&D manager?
Employee training has a large negative variance
Should you fire the HR Manager?

26. Summary - Strategic Variance Analysis
It is an imperfect control tool
In reality, it is not important if the variance is U (unfavorable) or F (favorable)
What is key is that managers are asking the right questions and then pursuing appropriate action