1. 1 Budgeting as a control mechanism 1. Budgeted levels are the standards to follow in operation 2. Variance evaluation for performance measurement A variance in budgeting is the difference between an actual result and a budgeted amount.

2. 2 Discussion topic Can unit costs of products (instead of the budgets for cost categories such as direct material, direct labor and MOH) be used as the control tool for production costs? Give your reasons. Guide 1. Standards for operation? 2. Variance evaluation for performance measurement?

3. 3 Variance analysis 1. Variance computation 2. Variance presentation 3. Variance interpretation 4. Variance investigation

4. 4 Types of Variances 1. Cost variances Production costs: * DM * DL * MOH: VMOH + FMOH Non-production costs: * SG&A * R&D 2. Sales variances

5. 5 Cost variance computation: DM 1. Purchase / Direct-material price variance = (PQ * AP) – (PQ*SP) = PQ (AP – SP) 2. Direct-material quantity variance = (AQ* SP) – (SQ* SP) = SP (AQ – SQ) Where PQ = quantity purchased AQ = actual quantity used SQ = standard (i.e. budgeted) quantity allowed AP = actual purchase price SP = standard purchase price

6. 6 Cost variance computation: DL 1. Direct-labor rate variance = (AH*AR) – (AH*SR) = AH (AR – SR) 2. Direct-labor efficiency variance = (AH* SR) – (SH* SR) = SR (AH – SH) Where AH = actual direct-labor hours used SH = standard hours allowed AR = actual rate per direct-labor hour SR = standard rate per direct-labor hour

7. 7 Cost variance computation: VMOH 1. Variable-overhead spending variance = (AH * AVR) – (AH * SVR) = AH (AVR – SVR) Where AH = actual amount of the budget base AVR = actual variable-overhead rate SVR = standard variable-overhead rate 2. Variable-overhead efficiency variance = (AH * SVR) – (SH * SVR) = SVR (AH – SH) Where SH = standard amount of the budget base AH = actual amount of the budget base SVR = standard variable-overhead rate

8. 8 Cost variance computation: FMOH 1. Fixed-overhead budget variance = actual fixed overhead – budgeted fixed overhead 2. Fixed-overhead volume variance = budgeted fixed overhead – applied fixed overhead

9. 9 Sales variance computation 1. Sales-price variance = (actual unit selling price - expected unit selling price)* actual sales volume 2. Sales-volume variance = (actual sales volume - budgeted sales volume) * budgeted unit contribution margin

10. 10 Variance classification Price variance: Quantity variance:

11. 11 Variance interpretation Favorable variance (F) = the variance has a favorable effect on operating income (i.e. good for the company) Unfavorable variance (U) = the variance has an unfavorable effect on operating income (i.e. bad for the company)

12. 12 Variance investigation Variance investigation is to examine the causes of the variances concerned. Group work