1. 1 Chapter 21 Analyzing Other Variances

2. 2 Text Coverage of Variances  Chapters 19 & 20: Production cost variances.  Chapter 21: Revenue, gross margin, and other expense variances.

3. 3 Definition of Variances  Variance = difference between actual and budgeted amount of any revenue or expense item or of margin (i.e., gross margin or contribution margin).  Unfavorable (favorable) variance makes income lower (higher) than budgeted.

4. 4 Interpreting Variances  Favorable or unfavorable do not connote value judgments about management performance only the algebraic impact.  A starting point to understand why actual differs from budget.

5. 5 Marketing variances  Responsibility of the marketing department (manager).  Marketing’s objectives:  Generating budgeted GM (through generation of and pricing of sales above std cost).  Keeping marketing expenses (e.g., marketing department salaries, advertising) within its expense budget.  Marketing expense variance = budgeted marketing expense(s) – actual marketing expense(s).

6. 6 Definitions  Gross margin = Sales revenue – cost of sales.  Total sales revenue = sum of the multiplications of each products (unit sales volume) * (unit sales price).  Total cost of sales = sum of multiplications of each products (unit sales volume) * (unit production cost).

7. 7 Marketing Responsibilities  Sales volumes and sales prices.  Not production costs (i.e., variances).  Therefore, GM Variances are calculated using standard cost per unit and not actual.  Total gross margin variance = actual gross margin – budgeted gross margin.  Actual and budgeted gross margins are based on standard unit production cost.

8. 8 Gross Margin Variance Decomposition  3 components of GM variances: Unit margin variance. Unit margin variance. Sales volume variance. Sales volume variance. Product mix variance. Product mix variance.

9. 9 Unit margin variance  Arises from actual gross margin per unit differing from budgeted gross margin.  =  unit margin * actual volume.  Where  = an actual – budgeted amount.

10. 10 Sales volume variance  Arises from actual sales volume in units differing from budgeted sales volume.  =  volume * budgeted unit margin.

11. 11 Product mix variance  Does not apply to company with only one product line.  Arises because some products have higher margins than other products and actual product mix (i.e., the actual proportions of products sold) differs from budgeted mix.

12. 12 Breakdown of Sales Volume Variance  Into 2 components: Industry volume variance and market share variance.  Industry volume variance =  Industry volume * budgeted market share * budgeted unit margin.  Market share = (a company’s sales)  (total industry sales).  May reflect general economic conditions beyond the control of the company’s marketing department.

13. 13 Market share variance   Market share * Actual industry volume * budgeted unit margin.  More likely to be considered controllable by the company’s marketing department.

14. 14 Possible decomposition of unit margin variance  Portions attributable to:  General price movements.  Company’s pricing tactics.

15. 15 Other uses of the mix concept  A mix variance can be developed whenever a cost or a revenue item is broken down into components and components have different unit prices (or labor rates).

16. 16 Summary  Overall goal of variance analysis:  Explain difference between actual and budgeted net income.  Actual net income is a function of actual sales volume.  Budgeted net income is a function of budgeted sales volume.

17. 17 Summary (continued)  Overall variances (actual NI - budgeted NI): Gross margin variance: Gross margin variance: Sales volume (industry volume & market share), unit margin, product mix.Sales volume (industry volume & market share), unit margin, product mix. Production variances. Production variances. DM (price & usage), DL (rate & efficiency), Overhead (production volume & spending).DM (price & usage), DL (rate & efficiency), Overhead (production volume & spending). SG&A expense variances SG&A expense variances Usually just listed, some may be decomposed into volume & spending.Usually just listed, some may be decomposed into volume & spending.

18. 18 Tips on Variance Analysis  Focus on purpose of analysis. Identify causes of overall income variance. Identify causes of overall income variance.  Don’t get lost in details.  Decompose variances:  Assign/trace variances to individual managers.  Variance calculations themselves do not explain performance.  Tendency to pay closer attention to unfav variances.  Distinguish between controllable and non-controllable variances.

19. 19 Tips … (Continued)  Budgeted amounts may have been based on assumed conditions that differ from actual.  Variances reflect operating managers forecasting abilities and personalities.  Would former accountants or former sales managers set more conservative budgets?  Automatically equating favorable (unfavorable) variances to good (poor) performance may lead to unjustified appraisal judgements.  [Analysis of variance may show accounting was wrong.]