Planning and operational variances

A planning and operational approach to variance analysis divides the total

variance into those variances which have arisen because of inaccurate planning
or faulty standards (planning variances) and those variances which have been
caused by adverse or favourable operational performance, compared with a
standard which has been revised in hindsight (operational variances).
Basically, the planning and operational approach attempts to divide a total
variance (which has been calculated conventionally) into a group of variances
which have arisen because of inaccurate planning or faulty standards
(planning variances) and a group of variances which have been caused by
adverse or favourable operational performance (operational variances,
surprisingly enough!).

A planning variance (or revision variance) compares an original standard

with a revised standard that should or would have been used if planners had
known in advance what was going to happen.
An operational variance (or operating variance) compares an actual result
with the revised standard

Planning and operational variances are based on the principle that variances
ought to be reported by taking as the main starting point, not the original
standard, but a standard which can be seen, in hindsight, to be the optimum
that should have been achievable.
Exponents of this approach argue that the monetary value of variances ought to
be a realistic reflection ofwhat the causes of the variances have cost the
organisation. In other words they should show the cash (and profit) gained or
lost as a consequence of operating results being different to what should have
been achieved. Variances can be valued in this way by comparing actual
results with a realistic standard or budget. Such variances are called
operational variances.
Planning variances arise because the original standard and revised more
realistic standards are different and have nothing to do with operational
performance. In most cases, it is unlikely that anything could be done about
planning variances: they are not controllable by operational managers but by
senior management.
In other words the cause of a total variance might be one or both of:
• Adverse or favourable operational performance (operational variance)
• Inaccurate planning, or faulty standards (planning variance)

Total cost planning and operational variances

At the beginning of 20X0, WB set a standard marginal cost for its major
product of N25 per unit. The standard cost is recalculated once each year.
Actual production costs during August 20X0 were N304,000, when 8,000 units
were made. With the benefit of hindsight, the management of WB realises that a
more realistic standard cost for current conditions would be N40 per unit. The
planned standard cost of N25 is unrealistically low.
Required
Calculate the planning and operational variances.

Planning price and usage variances

We can also split the total planning variance into two. For example, if two
planning errors have been made, one affecting price and one usage, the effect of
each can be analysed.

Example planning price and usage variances

The standard materials cost of a product is 5 kgs * N7.50 per kg = N37.50.
Actual production of 10,000 units used 54,400 kgs at a cost of N410,000. In
retrospect it was realised that the standard materials cost should have been 5.3
kgs per unit at a cost of N8 per kg.
Required
Calculate the materials planning variances in as much detail as possible

Operational variances for labour and overheads

Precisely the same argument applies to the calculation of operational variances
for labour and overheads, and the examples already given should be sufficient
to enable you to do the next question

A new product requires three hours of labour per unit at a standard rate of N6
per hour. In a particular month the budget is to produce 500 units. Actual results
were as follows.
Hours worked 1,700
Production 540 units
Wages cost N105,000
Within minutes of production starting it was realised that the job was extremely
messy and the labour force could therefore claim an extra 250 per hour in 'dirty
money'.
Required
Calculate planning and operational variances in as much detail as possible.

Planning and operational sales variances

Our final calculations in this section deal with planning and operational sales
variances.

Example: Planning and operational sales variances

Dimsek budgeted to make and sell 400 units of its product, the role, in the four-
week period no 8, as follows.

KSO budgeted to sell 10,000 units of a new product during 20X0. The budgeted
sales price was N10 per unit, and the variable cost N3 per unit.
Although actual sales in 20X0 were 10,000 units and variable costs of sales
were N30,000, sales revenue was only N5 per unit. With the benefit of
hindsight, it is realised that the budgeted sales price of N10 was hopelessly
optimistic, and a price of N4.50 per unit would have been much more realistic.
Required
Calculate planning and operational variances

Example: revised budget

A company produces Widgets and Splodgets which are fairly standardised
products. The following information relates to period 1.
The standard selling price of Widgets is N50 each and Splodgets N100 each. In
period 1, there was a special promotion on Splodgets with a 5% discount being
offered. All units produced are sold and no
inventory is held.
To produce a Widget they use 5 kg of X and in period 1, their plans were based
on a cost of X of N3 per
kg. Due to market movements the actual price changed and if they had
purchased efficiently the cost would have be N4.50 per kg. Production of
Widgets was 2,000 units.
A Splodget uses raw material Z but again the price of this can change rapidly. It
was thought that Z would cost N30 per tonne but in fact they only paid $25 per
tonne and if they had purchased correctly the cost would have been less as it
was freely available at only N23 per tonne. It usually takes 1.5 tonnes of Z to
produce 1 Splodget and 500 Splodgets are usually produced.
Each Widget takes 3 hours to produce and each Splodget 2 hours. Labour is
paid N5 per hour. At the start of period 1, management negotiated a job security
package with the workforce in exchange for a promised
5% increase in efficiency – that is, that the workers would increase output per
hour by 5%.
Fixed overheads are usually N12,000 every period and variable overheads are
N3 per labour hour.
Required
Produce the original budget and a revised budget allowing for controllable
factors in a suitable format.