1. Financial and Non-Financial Measures of Operating Efficiency
Chapter 8
Financial and Non-Financial Measures of Operating Efficiency

2. Profit Variance Analysis
Compare budgeted and actual results to isolate the impact of individual input and output factors
Used to
Revise plan assumptions
Evaluate employee performance
LO1: Understand how companies use budgets for control.

3. The Master Budget Benchmark for computing variances
As you know, the master budget specifies in detail
Sales volumes and prices
Input quantities and costs
Planned efficiencies and prices
Capacity costs
Also termed overhead cost
The master budget is like picking a point on the profit line in the CVP graph
LO1: Understand how companies use budgets for control.

4. Cindy’s Master Budget
LO1: Understand how companies use budgets for control.

5. Actual Results Differ
LO1: Understand how companies use budgets for control.

6. Many Possible Sources Variance could be due to Variance analysis
Output quantities and/or prices
Input efficiencies and/or prices
Errors in estimated overhead costs
Variance analysis
Linear decomposition of overall profit variance into above factors
Turns “one dial” at a time
LO1: Understand how companies use budgets for control.

7. $20.95 1
$14.30 2
$6.65 3
$19,950
$14,000 4 1
$3,75 in materials + $10.00* in labor + $0.55 in variable overhead *($10.00 = $20 per hour x 0.50 hours per cake) 2
$ $14.30 3
$3,000 x $6.65 4
$19,950 - $14,000

8. Variance Conventions
LO2: Perform variance analysis. 8

9. Conceptual Approach Master budget Flexible Budget
Flexible budget (actual price)
Flexible budget (act. efficiency)
Actual results
Output Quantity
Budget
Actual
Output Price
Input Efficiency
Input Price
LO2: Perform variance analysis.

10. Structure of Variances
LO2: Perform variance analysis.

11. $58,660
$79,610
$40,040
$45,760
$21,280
$25,270
$14,000
$14,000

12. Sales Volume Variance
Difference between income / contribution in master and flexible budgets
 units × Budgeted UCM = revenue × Budgeted CMR
Flexible budget is at actual output quantity
Sales volume is only change in plan assumption
 Profit difference is due to change in sales volume
Focus on change in CM / income & not revenue
Change in volume changes revenues and variable costs
Fixed costs do not change if volume changes
LO2: Perform variance analysis.

13. Budgeted and Actual Results
Volume of Activity
Profit or Loss ($)
Actual Profit
Budgeted Profit
Profit Variance
Budgeted volume
Actual volume
(Fixed Cost)
Profit Line (per CVP model)
LO2: Perform variance analysis.

14. Flexible Budget Profit
Sales Volume Variance B C A
Volume of Activity
Profit ($)
Actual Profit
Master Budget Profit
Budgeted volume
Actual volume
(Fixed Costs)
Profit Line (per CVP relation)
Flexible Budget Profit
Sales Volume Variance +
Flexible Budget Variance =
Total Profit
Variance
Profit ($)
Volume of Activity
LO2: Perform variance analysis.

15. Sales Volume Variance - Concept
Total Profit Variance
Flexible Budget Variance
Sales Volume Variance
Master budget profit
Actual
profit
Profit in flexible budget
Sales volume variance
Flexible budget variance
Total profit variance
LO2: Perform variance analysis. 15

16. Tabular Format F F U
LO2: Perform variance analysis. 16

17. 1
300
$8.15 2
$2,445 1
3,800 cakes – 3,500 cakes 2
300 x $8.15

18. Flexible Budget Variance
LO2: Perform variance analysis.

19. Cost Variances Cost in flexible budget is the right benchmark
Activity volume the same in flexible budget and actual operations
Can compare line items
Materials
Labor
Overhead costs
LO2: Perform variance analysis.

20. Look Back to the Previous StepF F U
LO2: Perform variance analysis. 20

21. Flexible Budget Variances
LO2: Perform variance analysis.

22. Cost Variances - Concept
Variable Cost
Variance
Quantity Variances
Price Variances
Cost item in flexible budget
Cost item in
actual results
“as if”
cost item
Quantity variance
Price variance
Flexible budget variance for given cost
LO2: Perform variance analysis.

23. Tabular Format
LO2: Perform variance analysis.

24. Variances are Linear Actual Cost Budgeted Cost
LO2: Perform variance analysis.

25. Profit Reconciliation
LO2: Perform variance analysis.

26. Test Your Knowledge! For what purpose is a flexible budget used?
To provide various possible outcomes for management to consider
To adjust input prices so that future variances are eliminated
To insure that profit does not drop below a predetermined level
To identify the sources of variances
A flexible budget helps identify what caused any differences between the budgeted amount allowed at the actual level of sales and the actual amounts incurred.

27. $75,810 actual revenue / 3,800 cakes actually sold
$19.95
$20.95
3,800 2 1
$75,810 actual revenue / 3,800 cakes actually sold 2
($ $20.95) x 3,800 = $3,800 U

28. Interpreting Variances
Investigate all significant variances
Large variance shows poor plan / execution
Examine trends
Consistent sign may be related to plan assumptions
Consider the total picture
Variances ignore interactions
Price-quantity, input substitution
LO3: Interpret variances to determine possible corrective actions.

29. 5 eggs per cake x 3,800 cakes $372 U = [($0.12 - $0.14) x 18,600]
19,000 1 2 3 1
5 eggs per cake x 3,800 cakes 2
$372 U = [($ $0.14) x 18,600] 3
$48 F = [(19,000 – 18,600) x $0.12]

30. Non-financial Controls
Non financial measures better on
Timeliness
Specificity
Non-financial measures used for
Process control
Provide localized feedback for immediate action
Agency control (Chapter 12 & 13)
LO4: Explain how nonfinancial measures complement variance analysis.

31. Test Your Knowledge!
The controller for Navia, Inc. created a budget prior to the current period. At the end of the period, the controller compared the budget with the actual results. For what purpose is the controller using budgets?
Coordination
Control
Variances
Planning
Having a good plan alone is not sufficient. The budget must be compared to actual performance, with any significant differences investigated and changes made as necessary.

32. PURCHASE PRICE VARIANCE
(Appendix A)
PURCHASE PRICE VARIANCE
Appendix A

33. Rationale
We calculated materials price variance based on quantity of materials used
This can differ from quantity purchased
Firms want to know a variance sooner than later
Thus, many calculate the materials price variance on the quantity of materials purchased.
Which approach is better?
“Quantity purchased” is the pure approach and is consistent with a traditional accounting view
We continue to employ “quantity used”
Helps with profit reconciliation
Appendix A

34. (Appendix B and C) MARKETING VARIANCES

35. Appendix B: Market Size and Share
This is a drill down of sales volume variance
Similar in principle to breaking down labor variance into labor rate and labor quantity variances.
Volume (in units or $) = Size × Share
Sales Volume Variance turns both dials
The decomposition turns one dial at a time
Appendix B and C

36. Decomposition: Graphical
Market size variance
Sales volume variance
Actual market size
x Planned market share
x Planned UCM
x Actual market share
Flexible budget profit
Planned market size
Static budget profit
Market share variance
Appendix B and C

37. Example Sales volume variance 17,500 cakes x 20% share
x $6,65/cake = $28,525
Static budget profit
(3,500 cakes)
20,000 cakes
x 20% share
x $6.65/cake = $32,600
20,000
x 19% share
x $6.65/cake = $30,970
Flexible budget profit
(3,800 cakes)
Market size variance
Market share variance
$3,325 F
$1,330 U
Sales volume variance
$1,995 F
Appendix B and C

38. Appendix C: Multiple Products
Thus, far we have considered a 1- product case
Budget was budgeted quantity and UCM. Flexible budget based on actual quantity and budgeted UCM. Thus.
Sales volume variance = (Actual quantity – budgeted quantity) * budgeted UCM
With Multi-product case
Budget at budgeted quantity and budgeted UCM for each product
Flexible budget at actual quantity and budgeted UCM for each product
We can perform analysis in two ways
Analyze each product separately
Appropriate when products are independent
Consider each product as a (total quantity * % share of product)
Useful when products are substitutes / complements
Appendix B and C

39. Multi-product Variance Analysis
Focus on second type of analysis
Recall that in CVP, when we considered multiple products, we used sales mix (% sales of each kind) to calculate Weighted Average Contribution Margin (WACM).
Identical concept used here
Use budgeted total sales (in units) and budgeted WACM to compute master budget
Use actual total sales (in units) and actual WACM in flexible budget
But, this turns two dials – total sales and WACM
Can decompose into a mix effect and a quantity (mix-adjusted total sales) effect
Introduce a “as if” column between master and flexible budget
Appendix B and C

40. Mix and Quantity Variances
Sales quantity variance
Sales volume variance
Actual total sales
x Planned mix
x Planned UCM
x Actual mix
Profit in flexible budget
Planned total sales
Static budget profit
Sales mix variance
Appendix B and C

41. Pacific Telephones
Appendix B and C

42. Sales Volume Variance Sales volume variance Sales quantity variance
201,000 Actual units
x $ Plan WACM
x $ WACM in
flexible budget
Profit in flexible budget
200,000 plan units
x $ plan WACM
Static budget profit
Sales mix variance
$25,075 F
$47,125 U
$22,050 U
Appendix B and C

43. Exercise 8.34
Calculating materials and labor price and quantity variances (LO2).
The Glass Vessel Company has established the following budget for producing one of its hand-blown vases:
In March of the most recent year, Glass Vessel produced 300 vases using 650 pounds of materials. Glass Vessel purchased the 650 pounds of materials for $845. Labor costs for March were $7,200 for 480 hours worked.
Required:
What were Glass Vessel’s materials price and materials quantity variances for March?
What were Glass Vessel’s labor price and labor quantity variances for March?

44. Exercise 8.34 (Continued)
What were Glass Vessel’s materials price and materials quantity variances for March?
To calculate the materials price and quantity variances, we need to know: (1) the flexible budget for materials; (2) the “as if” budget for materials with actual efficiencies; and (3) the actual results. The table below provides the required computations and accompanying variances.

45. Exercise 8.34 (Continued)
What were Glass Vessel’s materials price and materials quantity variances for March?
1 $750 = 300 vases actually produced × 2 pounds of materials budgeted per vase × $1.25 budgeted cost per pound.
2 $ = 650 pounds of materials actually used × $1.25 budgeted cost per pound.
3 Given.
Thus, Glass Vessel’s materials price and quantity variances were $32.50 U and $62.50U, respectively, for March.

46. Exercise 8.34 (Continued)
What were Glass Vessel’s labor price and labor quantity variances for March?
As in part [a], to calculate the labor price and quantity variances, we need to know: (1) the flexible budget for labor; (2) the “as if” budget; and (3) the actual results. The table below provides the required computations and accompanying variances.

47. Exercise 8.34 (Continued)
What were Glass Vessel’s labor price and labor quantity variances for March?
1 $6,750 = 300 vases actually produced × 1.5 hours of labor budgeted per vase × $15.00 budgeted cost per labor hour.
2 $7,200 = 480 hours actually worked × $15 budgeted cost per labor hour.
3 Given.
Thus, Glass Vessel’s labor price and quantity variances were $0 and $450 U, respectively, for March.