Comparing Actual Results to Planned Results

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Comparing Actual Results to Planned Results
Performance Assessment Lecture 2

• Budget comparisons and variances

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Resource Materials for this unit

• Related to previous lecture from electronic
  reserve list
• 3 Budgeting as a competitive advantage, by
  Kathryn Jehle, Strategic Finance, Vol. 81, No. 4,
  Oct. 1999, pp. 54-57.
• 4 Who Needs Budgets? By Jeremy Hope and Robin
  Fraser Harvard Business Review, Vol. 81, No. 2,
  Feb 2003
• 5 Using the Balanced Scorecard as a Strategic
  Management System, by Robert S. Kaplan and David
  P. Norton, Harvard Business Review, Vol. 74, No.
  1, Jan-Feb 1996.

Strongly recommended!
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Resource Materials for this unit

• Additional materials available AICPA Modules
• A-2 Developing comprehensive performance
  indicators
• A-3 Applying the balanced scorecard
• Optional Articles
• 11 How Strategic Performance Management is
  Helping Companies Create Business Value, by Omar
  Aguilar, Strategic Finance, January 2003, pp. 1-5
• 12 Nonfinancial Performance Measures in the
  Healthcare Industry, by B Ballou, D.L. Heitger
  R. Tabor, Management Accounting Quarterly, Fall
  2003, p.11-16.

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Budget Target

• On a regular basis, actual performance should be
  compared to the budget

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Flexibility is necessary

• Most budgets are out-of-date within the first
  month as unforeseen events occur

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Comparing to Budget

• The starting point for control is to compare
  actual outcomes to the plan
• Software makes it easy
• Terminology Static vs. Flexible Budgets

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Budget Comparison Report
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Flexible Budget

• This is the budget we would have prepared HAD WE
  ONLY KNOWN the number of units that would be sold
  or produced

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Flexible Budget Example

• Budget assumptions
• 20 per unit sales price
• 10 per unit variable costs
• Anticipated sales 1,000 units per month
• Fixed costs 3,000 per month
• Static budget for month
• Sales revenue 20,000
• COGS 10,000
• Fixed costs 3,000
• Profit 7,000

1,000 units 20
1,000 units 10
Remember fixed variable costs?
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Flexible Budget Example

• What if actual sales were 1,100 units at 19.182
  each and the variable manufacturing costs were
  9.50 each? Actual fixed cost 3,100

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Flexible Budget Example

• What if actual sales were 1,100 units at 19.182
  each and the variable manufacturing costs were 9
  each? Actual fixed cost 3,100

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Compared to original budget

• Note that if we did our budget comparison based
  on the original sales level, the department looks
  good when it really wasnt on target

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We can further analyze the variances

• Sales volume variance
• Variance caused by selling more or less than
  planned
• Formula (actual units planned units)
  planned selling price per unit
• Another definition Difference between master
  budget and flexible budget

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We can further analyze the variances

• Sales price variance
• Variance caused when sales price per unit is
  different than we planned
• Formula(actual unit price budgeted unit
  price) units sold
• Alternate definition Difference between flexible
  budget and actual

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Sales revenue variances
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Our example
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Easier than formulas?

• Sales volume variance
• (actual units planned units) planned selling
  price per unit
• Sales price variance
• (actual unit price budgeted unit price) units
  sold

Note Some companies use contribution margin per
unit instead of selling price to compute these
variances.
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Drilling down further . . .

• Sales volume variance can be further analyzed
• Are sales more or less than expected because we
  sold a different mix of products than we planned?
• The selling price for each product might also be
  different than we planned

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Sales Mix Example

• Using our same problem, assume that the original
  budget was for 500 units at 30 and 500 units at
  10 for an average price of 20 (or 20,000 in
  total)
• If we really sold 500 units at 29 and 600 units
  at 11 we would have total revenue of 21,100
• 21,100/1,100 units the average price of
  19.182 that we used originally

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Sales-related variances
Sales Mix Variance
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Sales-related variances
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Sales-related variances
Sales Mix Variance 900 U
Sales volume variance 1,100 F
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Production Variances

• The most common variances computed automatically
  are production-related variances
• This is usually called a STANDARD COSTING SYSTEM
• All inventory costs are recorded at budgeted
  amounts (the standard amounts)
• Variance accounts pick up the differences between
  budget and actual

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Production Variances

• Direct materials
• Price variance
• Quantity variance
• Direct labor
• Rate variance
• Efficiency variance

• Variable overhead
• Spending variance
• Efficiency variance
• Fixed overhead
• Budget variance
• Volume variance

The computations are similar to what we
illustrated for sales. You change one element at
a time and, from the difference, determine the
impact on costs (instead of sales)
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Production variances
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Direct Labor Example

• Based on efficiency studies, we should be able to
  make one widget in
• ½ hour (manufacturing labor) hours
• 20 per hour for manufacturing worker
• Therefore, the standard DL cost per widget
  10
• Assume actual production 2,000 widgets
• 1,200 direct labor hours
• Average rate of pay 19 per hour

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DL variance example
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DL variance example - solution
Rate Variance 1,200 F
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Practice problem set 10

• 1. Go back to Exercise 3 White Glow Company
  (page 82)
• Compute the sales volume variance and the sales
  price variance for January, February and March
• 2. Prepare to discuss the two scenarios (should
  make some notes, underscore, etc.
• Due Tuesday March 22 (after spring break)
• Reminder HW 4 is due that day too

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Scenario 1 City of Shortview

• The city of Shortview hired its first city
  manager. She favored a management by
  objectives philosophy and accordingly set up
  many profit responsibility centers including the
  sanitation department, a city utility, and a
  repair shop.
• For many months, the sanitation manager had been
  complaining to the utility manager about wires
  being too low at one point of the road. There
  was barely clearance for large sanitation trucks.
  The sanitation manager asked the repair shop to
  raise the wire. The repair manager estimated the
  cost to be 20,000 and asked which department
  should be charged. Both the sanitation
  department and the utility department refused to
  accept the charge so the repair department
  refused to do the work.
• Late one day the top of a sanitation truck caught
  the wires and ripped them down knocking out power
  to 5,000 homes. The repair department made an
  emergency repair at a cost of 26,000. In
  addition, the city lost 4,000 in utility income
  because of the disruption of services. An
  investigation disclosed that the sanitation truck
  had failed to clamp down its top properly. The
  extra 2 inches of height caused the wire to be
  caught.
• Both the sanitation and the utility managers
  argued strenuously about who should bear the
  26,000 cost. Moreover, the utility manager
  demanded reimbursement from the sanitation
  department of the 4,000 of lost utility income.
• If you were the city controller in charge of the
  responsibility accounting system, which
  department would you charge for the costs?

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Scenario 2 Michael Machine Tool

• The Michael Machine Tool Company is currently
  suffering from a business slump. Production is
  at a 10-year low. The company has a nucleus of
  skilled tool-and-die workers who could find
  employment elsewhere if they were laid off.
  Three of these workers have been transferred
  temporarily to the building and grounds
  department where they have been doing menial
  tasks such as washing walls and sweeping floors.
  They have been earning their regular wage rate of
  15 per hour. Their wages have been charged to
  the building and grounds department. The
  supervisor of building and grounds has just
  confronted the controller Look at the cockeyed
  performance report you pencil pushers have given
  me. The helpers line reads
• Actual Budget VarianceWages of
  helpers 7,800 5,200 2,600 unfavorable
• This is just another example of how unrealistic
  you bookkeepers are! Those tool-and-die people
  are loafing on the job because they know we wont
  lay them off. The regular hourly rate for my
  three helpers is 10 each. Now that my regular
  helpers are laid off, my work in piling up, so
  that when they return theyll either have to put
  in overtime or Ill have to get part-time help to
  catch up with things. Instead of charging me 15
  per hour, you should charge about 8 -- thats
  all those tool-and-die slobs are worth at their
  best.
• If you were the controller, what you do now?
  Would you handle the accounting for these wages
  any differently?

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Solutions for in-class examples
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Flexible Budget Example

• What if actual sales were 1,100 units at 19.182
  each and the variable manufacturing costs were 9
  each? Actual fixed cost 3,100

20 each 1,100
22,000
10 each 1,100
11,000
3,000
8,000
Fixed cost same as original budget
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Easier than formulas?

• Sales volume variance
• (actual units planned units) planned selling
  price per unit
• (1,100 units actual - 1,000 units planned) 20
  planned selling price 2,000 F
• Sales price variance
• (actual unit price budgeted unit price) units
  sold
• (19.182 actual price - 20 budget) 1,100 units
  sold 900 U