Chapter 16: Fundamentals of Variance Analysis
In Chapter 13 we discussed the development of the master budget as a first step in the budgetary planning and control cycle. The budgeting process provides a means to coordinate activities among units of the organization, to communicate the organization’s goals to individual units, and to ensure adequate resources are available to carry out planned activities. While this planning aspect of the budget is important, it is not the only role budgets can play. In the control and evaluation activity, the performance of units and managers is evaluated and actions are taken in an attempt to improve performance. As we discussed in Chapter 14, evaluation requires a benchmark against which to measure performance. One benchmark for measuring performance is the budget. In this chapter, and in Chapter 17, we use the budgets to evaluate performance.
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Fundamentals of Variance AnalysisChapter 16Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinUsing Budgets for Performance EvaluationL.O. 1 Use budgets for performance evaluation. Operating budgets: Budgeted income statement, production budget, budgeted cost of goods sold, and supporting budgets Financial budgets: Budgets of financial resources; for example, the cash budget and the budgeted balance sheet Variance: Difference between planned result and actual outcome16 - *Profit VarianceLO1Bayou DivisionBudget and Actual ResultsAugustSales (units)Sales revenueLess: Variable costs Variable mfg. costs Variable selling and administrativeTotal variable costsContribution marginFixed costs: Fixed manufacturing overhead Fixed selling and administrative costsTotal fixed costsProfit 80,000$840,000 329,680 68,000$397,680$442,320 195,500 132,320$327,820$114,500 20,000 U$160,000 U 50,320 F 22,000 F$ 72,320 F$ 87,680 U 4,500 F 7,680 F$ 12,180 F$ 75,500 U 100,000a$1,000,000 380,000b 90,000c$ 470,000$ 530,000 200,000 140,000$ 340,000$ 190,000ActualVarianceMasterBudgeta $10.00 per unit b $3.80 per unit c $0.90 per unit16 - *Flexible BudgetingL.O. 2 Develop and use flexible budgets. Static budget: Budget for a single activity level; usually the master budget Flexible budget: Budget that indicates revenues, costs, and profits for different levels of activity16 - *Sales Activity VarianceL.O. 3 Compute and interpret the sales activity variance. 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 number16 - *Profit Variance AnalysisL.O. 4 Prepare and use a profit variance analysis. Profit variance analysis: Analysis of the causes of differences between budgeted profits and the actual profits earnedSales price varianceFixed production cost variancesVariable production cost variancesMarketing and administrative cost variances16 - *Profit Variance AnalysisSales (units)Sales revenueLess: Variable costs Variable manufacturing costsa Variable selling and administrativeContribution marginFixed costs: Fixed manufacturing overhead Fixed selling and administrative costsProfit$25,680 U $25.680 U 4,500 F $21,180 UMfg.Variances$ 4,000 F$ 4,000 F 7,680 F$11,680 FMarketingand Admin.VariancesActual 80,000$840,000 329,680 68,000$442,320 195,500 132,320$114,500$40,000 F $40,000 F $40,000 FSalesPriceVariance 80,000$800,000 304,000 72,000$424,000 200,000 140,000$ 84,000FlexibleBudget$200,000 U 76,000 F 18,000 F$106,000 U -0- -0- $106,000 U SalesActivityVariance 100,000$1,000,000 380,000 90,000$ 530,000 200,000 140,000$ 190,000MasterBudgetBayou DivisionProfit Variance AnalysisAugustTotal variance from flexiblebudget = $30,500 FTotal variance from master budget = $75,500 ULO4a The $25,680 manufacturing variance is explained in detail in L.O. 5.16 - *Variable Production CostsLO4 Standard cost sheet: A form providing the standard quantities of each input required to produce a unit of output and the standard price for each input.Direct materialDirect laborVariable overheadTotal variable manufacturing costs4 pounds0.05 hours0.05 hours$0.55 per pound$20 per hour$12 per hour$2.20 1.00 0.60$3.80StandardQuantity of Inputper Unit of OutputStandard InputPrice or Rateper Unit of InputStandard Costper Unit ofOutput (frame)Bayou DivisionStandard Cost Sheet – Variable Manufacturing CostsAugust16 - *Variable Cost Variance AnalysisL.O. 5 Compute and use variable cost variances.(1)Actual(AP × AQ)(2)Actual Inputs atStandard Prices(SP × AQ)(3)Flexible ProductionBudget(SP × SQ)Total variance(1) – (3)Actual input price (AP)times actual quantity(AQ) of inputStandard input price (SP)times actual quantity(AQ) of inputStandard input price (SP)times standard quantity(SQ) of input allowed foractual good outputPrice variance(1) – (2)Efficiency variance(2) – (3)16 - *Direct Materials VarianceLO5(1)Actual(2)Actual Inputs atStandard Prices(3)Flexible ProductionBudgetActual materials price(AP = $0.60)× Actual quantity(AQ = 328,000 pounds)of direct materialsStandard materials price(SP = $0.55)× Actual quantity(AQ = 328,000 pounds)of direct materialsStandard materials price(SP = $0.55)× Standard quantity(SQ = 320,000 pounds)of direct materialsallowed for actual outputAP × AQ = $196,800SP × AQ = $180,400SP × SQ = $176,000Total variance= $16,400 + $4,400 = $20,800 UPrice variance$196,800 – $180,400= $16,400 UEfficiency variance$180,400 – $176,000= $4,400 U16 - *Direct Labor VarianceLO5(1)Actual(2)Actual Inputs atStandard Prices(3)Flexible ProductionBudgetActual labor price(AP = $18)× Actual quantity(AQ = 4,400 hours)of direct laborStandard labor price(SP = $20)× Actual quantity(AQ = 4,400 hours)of direct laborStandard labor price(SP = $20)× Standard quantity(SQ = 4,000 hours)of direct laborallowed for actual outputAP × AQ = $79,200SP × AQ = $88,000SP × SQ = $80,000Total variance= $8,800 – $8,000 = $800 FPrice variance$79,200 – $88,000= $8,800 FEfficiency variance$88,000 – $80,000= $8,000 U16 - *Variable Overhead VarianceLO5(1)Actual(2)Actual Inputs atStandard Prices(3)Flexible ProductionBudgetSum of actualvariablemanufacturingoverhead costsStandard variableoverhead price(SP = $12)× Actual quantity(AQ = 4,400 hours)of the overhead baseStandard variableoverhead price (SP = $12)× Standard quantity(SQ = 4,000 hours)of the overhead base allowedfor actual output producedAP × AQ = $53,680SP × AQ = $52,800SP × SQ = $48,000Total variance= $880 + $4,800 = $5,680 UPrice variance$53,680– $52,800= $880 UEfficiency variance$52,800– $48,000= $4,800 U16 - *Variable Manufacturing Cost Variance SummaryLO5Direct materialsDirect laborVariable overheadTotal variable manufacturing cost variance$16,400 U$ 8,800 F$ 880 U$4,400 U$8,000 U$4,800 U$20,800 U$ 800 F$ 5,680 U$25,680 UPriceEfficiencyTotal16 - *Fixed Cost VariancesL.O. 6 Compute and use fixed cost variances. Spending (or budget) variance Price variance for fixed overhead The difference between budgeted and actual fixed overhead $195,500 actual – $200,000 budget = $4,500 F16 - *Fixed Cost VariancesLO6 The difference between budgeted and applied fixed overhead Variance that arises because the volume used to apply fixed overhead differs from the estimated volume used to estimate fixed cost per unit. $200,000 budget – $160,000 applied = $40,000 U$200,000 budget ÷ 100,000 budgeted units = $2 per unit80,000 units × $2 per unit = $160,000 applied16 - *Appendix: Recording Costs in a Standard Cost SystemL.O. 7 (Appendix) Understand how to record costs in a standard costing system. Work-in-process inventory is debited when direct materials and direct labor are used at standard. Work-in-process inventory is debited when manufacturing overhead is applied at standard. When the units are finished, work-in-process inventory is credited and finished goods inventory is debited. Variances are usually closed to cost of goods sold. 16 - *End of Chapter 16Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
