ACCT1102: Introduction to Management Accounting
Topic 9
Variance Analysis
Textbook reading: Ch. 7.
Topic 9: Variance Analysis and Standard Costing
2
Structure of Topics and Assessments
2. Group Assignment – (to be submitted on 14th of October)
Before Week 9 – prepare the draft financial statements in Excel for which
you will get a formative feedback during the Workshop this
week
End of Week 11 – submission deadline
Topic 9: Variance Analysis
4
Objectives for today
1. Understand static budgets and static-budget variances.
2. Examine the concept of a flexible budget and learn how to develop it.
3. Calculate flexible budget variances and sales-volume variances.
Basic Concepts
1. Variance - the difference between actual results and expected (budgeted) performance.
2. Management by Exception - the practice of focusing attention on areas not operating as
expected (budgeted).
3. A static (master) budget is based on the level of output planned at the start of the budget
period.
4. A static budget variance is the difference between the actual result and the corresponding
static budget amount.
5. A Favorable variance (F) indicates an increase in operating income relative to the budget
amount (for example, higher actual sales or lower costs than budgeted ).
6. An Unfavorable variance (U) indicates a decrease of operating income relative to the
budget amount (for example, lower actual sales or higher costs than budgeted ).
Budget Variance Analysis
5
Basic Concepts
Variances start out with a Level 0 analysis and progress to Levels 1 and 2.
v A Level 0 analysis is the highest level of analysis and is nothing more than the difference
between actual and static-budget operating income.
v A level 1 variance analysis takes the static-budget variance (level 0) and breaks it down by
line item.
v A level 2 variance analysis helps answer questions about WHY there was a shortfall in
operating income.
Budget Variances
6
Level 1 Variance Analysis - Illustrated
7
• A level 1 analysis,
illustrated here, takes the
static-budget variance
(level 0) and breaks it
down by line item.
• Column 2 are the level 1
variances: the
differences between the
static budget and the
actual results.
Level 0 analysis
Level 1
analysis
Level 1 Variance Analysis - Illustrated
8
How useful is this Level 1 variance analysis for evaluating the performance of the responsibility centres?
What is the unfavorable Level 0 variance?
What is driving the unfavorable Level 0 variance?
To what extent are sales volumes the problem?
Is the favorable variance for variable costs reliable?
Need Level 2 variance analysis…
Lecture Quick Check 1
Is a ‘static budget’ good for
evaluating:
a. the profit centre: yes or no ?
b. the revenue centre: yes or no ?
c. variable costs: yes or no ?
d. fixed costs: yes or no ?
e. contribution margin: yes or no ?
Level 1 Variance Analysis - Illustrated
9
How useful is this Level 1 variance analysis for evaluating the performance of the responsibility centres?
What is the unfavorable Level 0 variance?
What is driving the unfavorable Level 0 variance?
To what extent are sales volumes the problem?
Is the favorable variance for variable costs reliable?
Need Level 2 variance analysis…
Lecture Quick Check 1
Is a ‘static budget’ good for
evaluating:
a. the profit centre: no
b. the revenue centre: no
c. variable costs: no
d. fixed costs: yes
e. contribution margin: no
Interactive Excel 9a: Static Budget Variances
10
9a
Data entry in colored cells only. If colour formatting error, scroll up and down to fix. Do not cut and paste cells.
Actual
Results
Static
Budget
Static Budget
Variances
1 2 3 = 1 - 2
Units Sold 10,000 12,000
Revenues 1,850,000 Try
Variable Costs 1,120,000 = correct
Contribution Margin 730,000 = Try again
Fixed Costs 705,000 710,000
Operating Income 25,000 262,000
180 Unit Budgeted Selling Price
99 Unit Budgeted Variable Costs
From BlackBoard download Interactive Excel Activities.xlsx.
Level 2 Variance Analysis - Illustrated
11
• Second column: variances between actual results and the flexible budget - the flexible-budget variances. They help understand
what results should have been for the level of volume compared to what was actually obtained.
• The flexible budget uses budgeted per unit data applied to ACTUAL units. It represents what the budget would have been had the
actual volume been the same as the budgeted volume.
• Fourth column: the difference between the static and the flexible budget - the sales-volume variance. It is how much was
gained or lost as a result of a volume difference between what was originally anticipated and what we actually achieved.
Level 2 Variance Analysis - Illustrated
12
Lecture Quick Check 2
a. How much was the static budget sales price per unit?
b. How much was the flexible budget sales price per unit?
c. How much was the actual sales price per unit?
d. How much was the variance per unit for sales price, and was it favorable or unfavorable?
= $1,440,000 / 12,000 = $120
= $120 (same as static budget)
= $1,250,000 / 10,000 = $125
= $125 - $120 = $5 F
Level 2 Variance Analysis - Illustrated
13
Lecture Quick Check 3
a. How much was the static budget variable cost per unit?
= $1,056,000 / 12,000 = $88
b. How much was the flexible budget variable cost per unit?
= $88 (same as static budget)
c. How much was the actual variable cost per unit?
= $950,100 / 10,000 = $95
d. How much was the variance per unit for variable cost , and was it favorable or unfavorable?
= $88 - $95 = $7 U
Level 2 Variance Analysis - Illustrated
14
Lecture Quick Check 3
a. How much was the static budget variable cost per unit?
= $1,056,000 / 12,000 = $88
b. How much was the flexible budget variable cost per unit?
c. How much was the actual variable cost per unit?
d. How much was the variance per unit for variable cost , and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
15
Lecture Quick Check 3
a. How much was the static budget variable cost per unit?
= $1,056,000 / 12,000 = $88
b. How much was the flexible budget variable cost per unit?
= $88 (same as static budget)
c. How much was the actual variable cost per unit?
d. How much was the variance per unit for variable cost , and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
16
Lecture Quick Check 3
a. How much was the static budget variable cost per unit?
= $1,056,000 / 12,000 = $88
b. How much was the flexible budget variable cost per unit?
= $88 (same as static budget)
c. How much was the actual variable cost per unit?
= $950,100 / 10,000 = $95
d. How much was the variance per unit for variable cost , and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
17
Lecture Quick Check 3
a. How much was the static budget variable cost per unit?
= $1,056,000 / 12,000 = $88
b. How much was the flexible budget variable cost per unit?
= $88 (same as static budget)
c. How much was the actual variable cost per unit?
= $950,100 / 10,000 = $95
d. How much was the variance per unit for variable cost , and was it favorable or unfavorable?
= $88 - $95 = $7 U
Level 2 Variance Analysis - Illustrated
18
Lecture Quick Check 4
a. How much was the static budget for fixed costs?
= $276,000
b. How much was the flexible budget for fixed costs?
= $276,000 (same as static budget)
c. How much was the actual fixed costs?
= $285,000
d. How much was the variance for fixed costs, and was it favorable or unfavorable?
= $276,000 - $285,000 = $9,000 U
Level 2 Variance Analysis - Illustrated
19
Lecture Quick Check 4
a. How much was the static budget for fixed costs?
= $276,000
b. How much was the flexible budget for fixed costs?
c. How much was the actual fixed costs?
d. How much was the variance for fixed costs, and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
20
Lecture Quick Check 4
a. How much was the static budget for fixed costs?
= $276,000
b. How much was the flexible budget for fixed costs?
= $276,000 (same as static budget)
c. How much was the actual fixed costs?
d. How much was the variance for fixed costs, and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
21
Lecture Quick Check 4
a. How much was the static budget for fixed costs?
= $276,000
b. How much was the flexible budget for fixed costs?
= $276,000 (same as static budget)
c. How much was the actual fixed costs?
= $285,000
d. How much was the variance for fixed costs, and was it favorable or unfavorable?
Level 2 Variance Analysis - Illustrated
22
Lecture Quick Check 4
a. How much was the static budget for fixed costs?
= $276,000
b. How much was the flexible budget for fixed costs?
= $276,000 (same as static budget)
c. How much was the actual fixed costs?
= $285,000
d. How much was the variance for fixed costs, and was it favorable or unfavorable?
= $276,000 - $285,000 = $9,000 U
Sales-Volume Variance
The difference between the static-budget and the flexible-budget amounts is called the
sales-volume variance because it arises SOLELY from the difference between the actual
volume and the budgeted volume (from the static budget).
Some possible reasons for an unfavorable Sales-Volume Variance include:
• Failure to execute the sales plan
• Weaker than anticipated demand
• Aggressive competitors taking market share
• Unanticipated market preference away from the product
• Quality problems
23
Interactive Excel 9b: Flexible Budget Variances
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Actual
Results
Flexible Budget
Variances Flexibie Budget
Sales Volume
Variance
Static
Budget
1 2 = 1 - 3 3 4 = 3 - 5 2
Units Sold 10,000 12,000
Revenues 1,850,000 2,160,000
Variable Costs 1,120,000 1,188,000
Contribution Margin 730,000 972,000
Fixed Costs 705,000 710,000
Operating Income 25,000 262,000
0 U 0 U
Flex. Bud. Variance Sales Vol. Variance
U
Static Bud. Variance
Try
Unit Budgeted Selling Price 180 = correct
Unit Budgeted Variable Costs 99 = Try again
Unit Actual Selling Price
Unit Actual Variable Costs
Unit Selling Price - Variance
Unit Variable Costs - Variance
From BlackBoard download Interactive Excel Activities.xlsx.
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
25
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
26
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
27
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
28
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
29
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
30
1. For revenue items, F means actual revenues exceed budgeted revenues. True or
False?
2. For cost items, F means actual costs are less than budgeted costs. True or False?
3. For revenue items, U means actual revenues are less than budgeted revenues. True
or False?
4. For cost items, U means actual costs exceed budgeted costs. True or False?
5. A variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance. True or False?
Lecture Quick Checks
31
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
32
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
33
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
34
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
35
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
36
6. Management by exception is a practice whereby managers focus more closely on
areas that are operating as expected and less closely on areas that are not. True or
False?
7. The static budget is another name for the master budget. True or False?
8. The static budget is based on the level of output planned at the start of the budget
period. True or False?
9. It is called a static budget because the budget is developed around a single (static)
planned output level. True or False?
10.The static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget. True or False?
Lecture Quick Checks
37
An unfavourable sales-volume variance could result from:
a. an inappropriate assignment of labour or machines to specific jobs
b. an inefficiency of a purchasing manager in bargaining with suppliers
c. a decrease in actual selling price compared to anticipated selling price
d. competitors taking market share
Lecture Quick Check 15
38
An unfavourable sales-volume variance could result from:
a. an inappropriate assignment of labour or machines to specific jobs
b. an inefficiency of a purchasing manager in bargaining with suppliers
c. a decrease in actual selling price compared to anticipated selling price
d. competitors taking market share
Lecture Quick Check 15
39
Let’s see in a case study
where variance analysis can
be of use
1. What is your assessment of the method the public works director used to construct the budget?
2. Prepare a flexible budget for the snow plowing department. What does it tell you?
3. What does the flexible-budget variance for drivers tell you?
4. What plan should Mr. Donaldson present to the public works director for making cost
reductions?
Town of Bellington
41
Take 10 minutes to read the case.
Town of Bellington
42
1. What is your assessment of the method the public works director used to construct the
budget?
• The new director computed quarterly budgets as one-fourth of each department’s annual
budget.
• He had analyzed the prior three years’ costs, and, in so doing, had learned that almost all of
them had increased each year, with more rapid increases in the last two years.
• In view of the rapid cost increases during the past two years, he chose to base the current year’s
budget on the prior year’s costs less 3 percent.
• For the snow removal department, he also estimated the cubic miles of snow to be removed,
which he set at an average of the past three years.
Town of Bellington
43
1. What is your assessment of the method the public works director used to construct the
budget?
The budget formulation process has ignored several important considerations:
• The organisation’s activities are highly seasonal, but the quarterly budgets have been derived
by dividing the annual budget by four. Some quarters will look better and some worse due to
seasonality.
• No input from department heads.
• The main aim is to force a cutback in costs.
• Given the inflation, the 3 percent reduction is probably unreasonable.
Town of Bellington
44
2. Prepare a flexible budget for the snow plowing department. What does it tell you?
Town of Bellington
45
2. Prepare a flexible budget for the snow plowing department. What does it tell you?
Town of Bellington
46
Is maintenance
provided by a
third department
at transfer
prices?
Higher usage or
higher prices of
supplies?
3. What does the flexible-budget variance for drivers tell you?
Town of Bellington
47
This is the flex-budget
variance for drivers.
As Mr Donaldson mentioned the drivers’ productivity was above the standard – they increased it. The variance
must then stem from their salaries, and the fact that during heavy storms they work long hours and are paid
50% more for overtime. This is beyond the manger’s control.
4. What plan should Mr. Donaldson present to the public works director for making cost
reductions?
• It should include all the considerations discussed above.
• The variance analysis can really only serve as a basis for initiating some discussions between
the new director and department manager, Mr Donaldson.
• The discussion should attempt to uncover the reasons for the variances and to identify some
action steps.
Town of Bellington
48
49
Questions? We are here to help…
Please use Discussion Board on BlackBoard