After studying this chapter, you will be able to:
As we know, it is not enough just to make plans. We need to check periodically to see whether everything is going according to plan and whether any corrective actions are necessary. For example, we might review a day’s activities. Did we accomplish what we set out to do? Do we need to change our schedule for the next day? Similarly, large organizations compare actual revenues, costs, and profits with budgeted amounts to determine whether they need to make changes to their products, marketing policies, production processes, or purchasing procedures. In this chapter, we focus on short-term measures of control. We begin by discussing the role of budgets in the control process. We then present the mechanics of variance analysis, a technique firms use to determine why actual revenues, costs, and profit differ from their budgeted amounts. Variance analysis helps organizations determine whether their people and processes are performing as expected. It also helps organizations motivate their employees and improve future planning decisions. Finally, we discuss how organizations can use nonfinancial measures, in addition to variance analysis, to help control operations.
Learning Objective 1
Understand how companies use budgets for control.
Budgets As the Basis for Control
Learning Objective 2
Perform variance analysis.
How to Calculate Variances
Total Profit Variance = Actual Profit - Master Budget Profit
Breaking Down the Total Profit Variance
Sales Volume Variance
Sales Volume Variance = Flexible Budget Profit - Master Budget Profit
= (Actual Sales Quantity - Budgeted Sales Quantity)
x Budgeted Unit Contribution Margin
Flexible Budget Variance
Flexible Budget Variance = Actual Profit - Flexible Budget Profit
Components of the Flexible Budget Variance
Sales Price Variance
Sales Price Variance = Actual Revenue - Flexible Budget Revenue
= (Actual Sales Price x Actual Sales Quantity)
- (Budgeted Sales Price x Actual Sales Quantity)
= (Actual Sales Price - Budgeted Sales Price)
x Actual Sales Quantity
Fixed Cost Variance
Fixed Cost Spending Variance = Budgeted Fixed Costs - Actual Fixed Costs
Variable Cost Variances
Input Quantity and Price Variances
Learning Objective 3
Interpret variances to determine possible corrective actions.
Interpreting and Using Variances
General Rules for Analyzing Variances
Investigate All Large Variances
Trends in Variances
Linking Variances—The Big Picture
Making Control Decisions in Response to Variances
Learning Objective 4
Explain how nonfinancial measures complement variance analysis.
Nonfinancial Measures and Process Control
Nonfinancial Measures and Aligning Goals
CHAPTER 8 REVIEW QUESTIONS
1. A budget is the benchmark for evaluating actual performance.
2. An unfavorable variance means that actual revenue exceeds budgeted revenue or actual cost was less than budgeted cost.
3. We use a master budget to decompose the total profit variance into two major components: the sales volume variance and the flexible budget variance.
4. In variance analysis, we are particularly interested in the budget at the actual level of sales, or the flexible budget.
5. Variance could arise because budgets or standards are either too tight or too loose.
6. Relevance and Specificity are the two primary reasons organization use nonfinancial measure as well as financial measures for control measures.
1. Total profit variance equals:
2. Suppose actual profit before taxes is $9,900 and master budget profit before taxes is $8,000, what is the total profit variance:
3. Using a flexible budget, we break down total profit variance into two major components:
4. Which is not a main reason why variances could arise?
5. (Actual Sales Price X Actual Sales Quantity) - (Budgeted Sales Price X Actual Sales Quantity) =
6. What is not a characteristic of a budget reconciliation report?
7. Firms use budgets for control for which of the following reasons:
8. Smith's Tool Company manufactures tools for multiple uses. For the month of May, Smith budgeted to manufacture and sell 10,000 tools at a price of $52. Smith's management estimated the unit variable cost at $32 and budgeted fixed costs of $50,000 for the month. During May, Smith actually sold 9,200 tools, earning $470,000 in revenue. In addition, Smith's actual total variable and fixed costs amounted to $282,000 and $46,000. What is the sales price variance?
9. Smith's Tool Company manufactures tools for multiple uses. For the month of May, Smith budgeted to manufacture and sell 10,000 tools at a price of $52. Smith's management estimated the unit variable cost at $32 and budgeted fixed costs of $50,000 for the month. During May, Smith actually sold 9,200 tools, earning $470,000 in revenue. In addition, Smith's actual total variable and fixed costs amounted to $282,000 and $46,000. What is the variable cost variance?
10. Smith's Tool Company manufactures tools for multiple uses. For the month of May, Smith budgeted to manufacture and sell 10,000 tools at a price of $52. Smith's management estimated the unit variable cost at $32 and budgeted fixed costs of $50,000 for the month. During May, Smith actually sold 9,200 tools, earning $470,000 in revenue. In addition, Smith's actual total variable and fixed costs amounted to $282,000 and $46,000. What is the fixed cost variance?
1. Match the items below by entering the appropriate code letter in the space provided.
A. Sales Price Variance F. Budget Reconciliation Report
B. Input Price Variance G. Sales Volume Variance
C. Flexible Budget H. Unfavorable Variance
D. Purchase Price Variance I. Input Quantity Variance
E. Total Profit Variance J. Variance
____ 1. A report that uses variances to reconcile the difference between master budget profit and actual profit.
____ 2. A difference between an actual result and a budgeted amount that leads to a decrease in profit.
____ 3. The difference between an actual result and a budgeted amount.
____ 4. A budget that is based on actual level of sales.
____ 5. Actual profit less master budget profit.
____ 6. Flexible budget profit less master budget profit.
____ 7. Profit effect associated with the difference between the budgeted and actual input quantity used.
____ 8. Actual revenue less flexible budget revenue.
____ 9. The difference between the budgeted and actual price of materials multiplied by the actual quantity of materials purchased.
____ 10. Profit effect associated with the difference between the budgeted and actual price of an input.
1. Suppose a local pastry factory purchased 800 pounds of materials (flour) during April at a total of $1,040. Recall that the factory actually used 675 pounds to make the 400 pastries during April and that it budgets to pay $1.10 per pound of materials.
What was the local pastry factory's purchase price variance for April?
2. Suppose a local pastry factory, for the most recent month, budgeted to purchase and use 525 pounds of flour at $1.05 per pound. Budgeted output was 3,000 strawberry pastries (i.e. the factory budgets to make 3 pastries per pound of flour). The factory actually purchased and used 650 pound of flour at $0.99 per pound; actual output for the month was 3,500 strawberry pastries.
What were the local pastry factory's flour price and quantity variances for the most recent month?
CHAPTER 8 REVIEW QUESTIONS ANSWER KEY
1. L01 – True
2. L02 – False
3. L02 – False
4. L02 – True
5. L03 – True
6. L04 – False
1. L02 – C
2. L02 – D
3. L02 – A
4. L03 – B
5. L02 – C
6. L03 – D
7. L01 – D
8. L02: – C [$470,000 - (9,200 X $52)] = $8,400 Unfavorable
9. L02 – B [(9,200 x 32)- $282,000 = $12,400 Favorable
10. L02 – A ($50,000- $46,000 = $4,000 Favorable)
1. F 6. G
2. H 7. I
3. J 8. A
4. C 9. D
5. E 10. B
1. (Appendix A)
Purchase price variance = (Budgeted input price – Actual input price) × Actual quantity purchased.
Moreover, we know that the unit cost is $1.30 ($1,040/800) for the amount of materials purchased.
Applying the formula, we have:
($160) = (1.10 – 1.30) × 800 pounds.
Thus, the purchase price variance for March is $160 U.
SHORT PROBLEMS (CONT.)
To calculate the flour price and quantity variances, we need to know: (1) the flexible budget for flour; (2) the “as if” budget for flour with actual efficiencies; and (3) the actual results. The table below provides the required computations and accompanying variances.
“As if” budget2
1 $643.13 = 3,500 pastries in actual output × .18 (= 525/3,000) pounds of flour budgeted per pastries × $1.05 budgeted cost per pound.
2 $682.50 = 650 pounds of flour actually used × $1.05 budgeted cost per pound.
3 $643.50 = 650 pounds of flour actually used × $0.99 actual cost per pound.
Thus, the factory's flour price and quantity variances were $39.00 F and $39.37 U, respectively, for the most recent week.
The flour quantity variance is unfavorable because the factory actually made 3,500/650 = 5.4 pastries per pound of flour rather than the budgeted 5.7 pastries per pound of flour.
Note: To calculate the flexible budget amount, we need to start with actual output, which equals 3,500 strawberry pastries. Since the factory budgets to make 3 pastries per pound of flour, the flexible budget quantity for flour = 3,500/3 = 1,167 pounds of flour.
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