THE BUDGET PLAN FOR 4TH QUARTER

Sell in 4th 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

Actual StaticBudget

Variance

Sales $2,457,525 $2,335,000 $122,525 F

Cost of goods sold 1,724,150 1,582,757 141,393 U

Gross margin 733,375 752,243 (18,868) U

Selling and administrative expenses 385,139 360,753 24,386 U

Operating income 348,236 391,490 (43,254) U

Financing costs 2,256 1,880

376 U

Income before taxes 345,980 389,610 (43,630) U

Income taxes 103,794 116,883 (13,089) F

Net income $242,186 $272,727 ($30,541) U

Actual StaticBudget

Variance

Sales $2,457,525 $2,335,000 $122,525 F

Cost of goods sold 1,724,150 1,582,757 141,393 U

Gross margin 733,375 752,243 (18,868) U

Selling and administrative expenses 385,139 360,753 24,386 U

Operating income 348,236 391,490 (43,254) U

Financing costs 2,256 1,880 376 U

Income before taxes 345,980 389,610 (43,630) U

Income taxes 103,794 116,883 (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 REPORTActual Results Static Budget Variances

Machine hours 38,000 35,000 3,000

Variable costs

Indirect labor $86,500 $80,500 $6,000 U

Indirect Materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed Costs

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total overhead costs $383,500 $367,500 $16,000 U

Actual Results Static Budget Variances

Machine hours 38,000 35,000 3,000

Variable costs

Indirect labor $86,500 $80,500 $6,000 U

Indirect Materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed Costs

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total overhead costs $383,500 $367,500 $16,000 U

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 FLEXActual Results Static Budget Variances

Machine hours 38,000 35,000 3,000

Variable costs

Indirect labor $86,500 $80,500 $6,000 U

Indirect Materials 26,000 21,000 5,000 U

Power 15,700 14,000 1,700 U

Maintenance 44,900 42,000 2,900 U

Fixed Costs

Depreciation 80,000 80,000 ---

Maintenance 92,400 92,000 400 U

Supervision 38,000 38,000 ---

Total overhead costs $383,500 $367,500 $16,000 U

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 × AP SP × 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 Results Flexible 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 × AP SP × SQ

Flexible Budget Variance

AQ × SP

Price Variance

Actual Results Flexible 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 base

Inefficient 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?