THE BUDGET PLAN FOR 4 TH QUARTER Sell in 4 th quarter: 70,000 pants 25,000 jerseys 9,000 award jackets Control inventory Manage cash

WHAT’S UP? C&C sold more award jackets than budgeted. Managers thought that would be a good thing. Turns out, workers took too long to make the extra jackets. And they were paid overtime to meet customer delivery dates. Net income was $144,800 lower than budgeted, even though more jackets were sold.

TOTAL VARIANCE Actual Cost Incurred Budgeted Costs Total Variance A variance is any difference between what you expected and what you achieved.

LET’S LOOK AT SOME VARIANCES A variance is favorable if it increases net income ActualStatic Budget Variance Sales$2,457,525$2,335,000$122,525F Cost of goods sold1,724,1501,582,757141,393U Gross margin733,375752,243(18,868)U Selling and administrative expenses385,139360,75324,386U Operating income348,236391,490(43,254)U Financing costs2,2561, U Income before taxes345,980389,610(43,630)U Income taxes103,794116,883(13,089)F Net income$242,186$272,727($30,541)U

ActualStatic Budget Variance Sales$2,457,525$2,335,000$122,525F Cost of goods sold1,724,1501,582,757141,393U Gross margin733,375752,243(18,868)U Selling and administrative expenses385,139360,75324,386U Operating income348,236391,490(43,254)U Financing costs2,2561,880376U Income before taxes345,980389,610(43,630)U Income taxes103,794116,883(13,089)F Net income$242,186$272,727($30,541)U LET’S LOOK AT SOME VARIANCES A variance is unfavorable if it decreases net income

YOUR PERFORMANCE REPORT You are very excited. The month has just ended and your department has been very productive. You were able to crank out 38,000 machine hours! That’s 3,000 more than you budgeted. You figure this must be good for a bonus, so let’s see how well you did.

YOUR PERFORMANCE REPORT Actual ResultsStatic BudgetVariances Machine hours38,00035,0003,000 Variable costs Indirect labor$86,500$80,500$6,000U Indirect Materials26,00021,0005,000U Power15,70014,0001,700U Maintenance44,90042,0002,900U Fixed Costs Depreciation80, Maintenance92,40092,000400U Supervision38, Total overhead costs$383,500$367,500$16,000U

Actual ResultsStatic BudgetVariances Machine hours38,00035,0003,000 Variable costs Indirect labor$86,500$80,500$6,000U Indirect Materials26,00021,0005,000U Power15,70014,0001,700U Maintenance44,90042,0002,900U Fixed Costs Depreciation80, Maintenance92,40092,000400U Supervision38, Total overhead costs$383,500$367,500$16,000U YOUR PERFORMANCE REPORT These variances are unfavorable because actual costs were greater than what was budgeted, thus lowering net income Do these unfavorable variances mean that you have done a poor job controlling costs?

THE QUESTION… Think about it. By definition, the total variable costs would be higher. Working more machine hours should result in higher costs. But some of the higher costs could be a result of poor management as well. How can we tell the difference?

THE ANSWER… We have to… the budget to match the actual activity level achieved.

FLEXIBLE BUDGETS Present a budget for any level of activity achieved. Variable costs change with activity level. Fixed costs remain constant regardless of activity level, as long as you remain within the relevant range.

LET’S PRACTICE: FIX THE FLEX Actual ResultsStatic BudgetVariances Machine hours38,00035,0003,000 Variable costs Indirect labor$86,500$80,500$6,000U Indirect Materials26,00021,0005,000U Power15,70014,0001,700U Maintenance44,90042,0002,900U Fixed Costs Depreciation80, Maintenance92,40092,000400U Supervision38, Total overhead costs$383,500$367,500$16,000U

COMPONENTS OF THE STATIC BUDGET VARIANCE

LET’S LOOK AT EXHIBIT 6-4

SOME GENERAL POINTS… Always identify a variance as “favorable” (F) or “unfavorable” (U) A favorable variance is not necessarily a good thing, just as an unfavorable variance is not necessarily a bad thing Variance analysis provides an opportunity to benchmark against established standards to control operations

ANALYZING THE FLEXIBLE BUDGET VARIANCE

PRICE VARIANCE CALCULATION AQ × APSP × SQ Flexible Budget Variance AQ × SP or AQ (AP - SP) Price Variance This measures the difference between the actual price of inputs and the standard price of inputs Actual ResultsFlexible Budget

QUANTITY VARIANCE CALCULATION or SP (AQ - SQ) This measures the difference between the actual quantity of inputs used and the standard quantity of inputs that should have been used AQ × APSP × SQ Flexible Budget Variance AQ × SP Price Variance Actual ResultsFlexible Budget Quantity Variance

DIRECT MATERIALS VARIANCES

C&C’S DIRECT MATERIAL VARIANCES

INTERPRETING DM PRICE VARIANCES Purchased in bulk and received quantity discount Purchased lower-quality goods at a cheaper price Received discount from supplier to get business Suppliers decreased price Purchased smaller-than- normal quantity and lost quantity discounts Purchased higher-quality goods at a higher price Suppliers increased price Placed rush order with overnight delivery FAVORABLE VARIANCE UNFAVORABLE VARIANCE

INTERPRETING DM QUANTITY VARIANCES Use of higher-quality goods resulted in reduced waste Highly-skilled workers generated a lower scrap rate Use of lower-quality goods resulted in increased waste Low-skilled worked generated a higher scrap rate Machine problems ruined some units Poor supervision allowed extra scrap and waste Employee theft FAVORABLE VARIANCE UNFAVORABLE VARIANCE

THINGS TO CONSIDER ON MATERIAL VARIANCES Price variance should be calculated at time of purchase, quantity variance at time of use Price and quantity variances may stem from the same cause

DIRECT LABOR VARIANCES

C&C’s DIRECT LABOR VARIANCES

INTERPRETING DL RATE VARIANCES Used less skilled (lower paid) workers Market wage rates decreased Used higher skilled (higher paid) workers Employees worked overtime and received overtime pay Market wage rates increased FAVORABLE VARIANCE UNFAVORABLE VARIANCE

INTERPRETING DL EFFICIENCY VARIANCES Used more highly skilled (higher paid) workers than allowed in the standard Used higher quality materials that needed less handling New employees were still learning their jobs Overtime caused fatigue and reduced workers’ efficiency Low quality materials required longer production time Poor supervision resulted in employees “goofing off” Excessive machine downtime FAVORABLE VARIANCE UNFAVORABLE VARIANCE

VARIABLE OVERHEAD VARIANCES Variable overhead variances are calculated just like labor variances Variable overhead spending variance Variable overhead efficiency variance

VARIABLE OVERHEAD VARIANCES

C&C’s VARIABLE OVERHEAD VARIANCES

INTERPRETING VOH SPENDING VARIANCES Paid less than expected for variable overhead items Used variable overhead items efficiently Paid more than expected for variable overhead items Used variable overhead items inefficiently FAVORABLE VARIANCE UNFAVORABLE VARIANCE

INTERPRETING VOH EFFICIENCY VARIANCES Efficient use of activity baseInefficient use of activity base FAVORABLE VARIANCE UNFAVORABLE VARIANCE

FOH SPENDING VARIANCE Since fixed costs do not change with changes in volume, the flexible budget amount for FOH is the same as the static budget amount FOH spending variance is the difference between the actual amount spent and the budgeted amount.

THIS IS JUST THE BEGINNING… The calculation of the variances is the easy part Unless you investigate the cause of the variance, the whole process is useless What variances should you investigate? All of them?