Cost And Variance Measures

Variance Analysis

Variances are the differences between the amounts budgeted and the amounts
actually incurred

1)On the cost side:

a) A favorable variance occurs when actual costs are less than standard costs.
b) An unfavorable variance occurs when actual costs are greater than standard costs.

2) On the revenue side:

a) A favorable variance occurs when actual revenues are greater than budgeted revenues.
b) An unfavorable variance occurs when actual revenues are less than budgeted revenues.

Variance analysis enables management by exception, the practice of giving attention primarily to significant
deviations from expectations, Managers must use their judgment to determine the most efficient use of
their limited time.
 Cost And Variance Measures
Variance Analysis

Actual Results  Actual Qty * Actual Price

Static Budget  Standard Qty * Standard Price

Flexible Budget  Actual Qty * Standard Price

Static Budget Variance = Actual Results – Static Budget

Flexible Budget Variance = Actual Results – Flexible Budget

Sales Volume Variance = Flexible Budget – Static Budget

 Cost And Variance Measures
Direct Material Variances
Direct Materials Price Variance
AQ x (AP - SP)
Direct Materials Quantity Variance
SP x (AQ - SQ)
EXAMPLE: Chow Down, Inc., estimated output for the period of 18,000 units. However, actual output was
16,500 units. Standard direct materials per unit were estimated at 7.5, but the actual usage was 6.5 per unit.
The standard price was budgeted at $6.75, but the actual price was $7.00.

DIRECT LABOR VARIANCES

Direct Labor Rate Variance
AQ x (AP - SP)
Direct Labor Efficiency Variance
SP x (AQ - SQ)
EXAMPLE: Chow Down, Inc., estimated output for the period of 18,000 units. However,
actual output was 16,500 units. Standard direct labor was estimated at 3 hours per unit, but
the actual usage was 3.25 hours per unit. The standard rate was $5.50, but the actual rate
was $6.00.
 Cost And Variance Measures
MIX AND YIELD VARIANCES
In some production processes, inputs are substitutable.
Given substitutable inputs, the quantity and efficiency variances for direct materials and direct labor consist
of a mix variance and a yield variance.

EXAMPLE: A retail store budgets its employee hours for the upcoming month as follows:

Budget Hours Actual Hours Standard Wage

Managers 200 220 22
Sales Associates 800 800 14
Warehouse 600 480 8

1. Calculate Mix Variance (SPAM – SPSM) * ATQ

2. Calculate Yield Variance (ATQ – STQ) * SPSM
 Cost And Variance Measures
Variable Overhead Variance

Spending Variance
[ Actual rate * Actual input * Actual Output] – [ standard rate * Actual input * Actual output]

Efficiency Variance
[ standard rate * Actual input * Actual output] – [ Standard rate * Standard input * Actual output]

EXAMPLE: Chow Down, Inc., estimated output for the period of 18,000 units. However, actual output was
16,500 units. Standard processing time is 1.2 machine hours per unit. But actual usage was 1.3 machine
hours per unit. The standard application rate was $8.00 per machine hour, but the actual rate was $10.00
per machine hour.
 Cost And Variance Measures
Fixed Overhead Variance

Spending Variance
[ Actual rate * Actual input * Actual Output] – [ standard rate * standard input * standard output]

Production Volume Variance

[ standard rate * standard input * standard output] – [ Standard rate * Standard input * Actual output]

EXAMPLE: Chow Down, Inc., estimates output for the period of 18,000 units. However, actual output was
16,500 units. Fixed overhead is applied at $25 per unit sold. But actual cost per unit was $26.
 Cost And Variance Measures
Sales Variance

Contribution Margin Variance Consists Of

Sales price variance Sales volume variance

(AP – SP) * AQ (AQ – SQ) * SCM

Sales Volume Variance Consists Of

Sales Quantity Variance = SCM * [ (Total AQ * Budgeted mix %) - Budgeted unit sales ]

Sales Mix Variance = SCM * [AQ - (Total AQ x Budgeted mix %)]

 Cost And Variance Measures
Sales Variance
Plastic Metal Total

Budgeted Selling Price 6 10

Budgeted Variable cost 3 7.5
Budgeted CM 3 2.5
Budgeted Unit Sales 300 200 500

Budget Mix % 60% 40% 100%

Actual Units Sold 260 260 520

Actual Selling Price 6 9.5

1. Calculate all Sales Variance Equations.

(AP – SP) * AQ
AQ – SQ) * SCM
Sales Quantity Variance = SCM * [ (Total AQ * Budgeted mix %) - Budgeted unit sales ]
Sales Mix Variance = SCM * [AQ - (Total AQ x Budgeted mix %)]
 Responsibility Accounting

Decision Making and Decentralization

In a centralized organization, decision making is consolidated so that activities throughout the organization
may be more effectively coordinated from the top.
In a decentralized organization, decision making is at as low a level as possible. The premise is that the
local manager can make more informed decisions than a manager farther from the decision.

Responsibility Centers
Cost center: a maintenance department, is responsible for costs only. A disadvantage of a cost center is
the potential for cost shifting, for example, replacement of variable costs for which a manager is responsible
with fixed costs for which (s)he is not. Service centers exist primarily and sometimes solely to provide
specialized support to other organizational subunits. They are usually operated as cost centers. Cost drivers
are the relevant performance measures.
Revenue center: a sales department, is responsible for revenues only. Revenue drivers are the relevant
performance measures.
profit center: an appliance department in a retail store, is responsible for both
revenues and expenses.
Investment center: a branch office, is responsible for revenues, expenses, and invested capital.
 Responsibility Accounting

Performance Measures and Manager Motivation

What are the Meaning of controllability and Goal congruence?

PERFORMANCE MEASURES - COST, REVENUE, AND PROFIT CENTERS

Cost Centers and Revenue Centers  Variance Analysis.
Profit Centers  Contribution Margin income Statement.
Sales
(-) Variable Production Costs
Manufacturing contribution margin
(-) Variable Selling and admin expenses
contribution margin
Controllable fixed costs
(-) Fixed production costs
(-) Fixed S&A expenses
Short run performance margin
(-) Traceable fixed costs (Dep. – Insurance)
Segment Margin
(-) Allocated Common Costs
Segment Operating income