CHAPTER 8: PERFORMANCE EVALUATION Pearson Education. All rights reserved.

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1 CHAPTER 8: PERFORMANCE EVALUATION

2 Learning Objectives 1. Explain static budgets and static-budget variances 2. Develop flexible budgets and compute flexiblebudget variances and sales-volume variances 3. Compute price variances and efficiency variances for direct-cost categories 4. Plan for variable and fixed overhead costs and calculate budgeted variable and fixed overhead cost rates

3 Learning Objectives 5. Partition the variable overhead flexible-budget variance into variable overhead efficiency and spending variances 6. Compute the fixed overhead flexible-budget (or spending) variance and the fixed overhead production-volume variance 7. Show how the variance analysis approach reconciles the actual results for a period with the results expected for that period 8. Understand how managers use variances

4 Explain Static Budgets and Static- Budget Variances Learning Objective 1

5 Basic Concepts A variance is the difference between actual results and expected performance Management by exception is the practice of focusing management attention on areas that are not operating as expected and devoting less time to areas operating as expected The static budget is based on the level of output planned at the start of the budget period

6 Static-Budget Variance The static-budget variance is the difference between the actual result and the corresponding budgeted amount in the static budget A favorable variance results when actual revenues exceed budgeted amounts or when actual costs are less than budgeted costs An unfavorable variance results when actual revenues are less than budgeted amounts or when actual costs exceed budgeted costs

7 Develop Flexible Budgets and Compute Flexible-Budget Variances and Sales-Volume Variances Learning Objective 2

8 Flexible Budget Calculates budgeted revenues and budgeted costs based on the actual output in the budget period Companies develop their flexible budgets in three steps: 1. Identify the actual quantity of output 2. Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output 3. Calculate the flexible budget for costs based on budgeted variable cost per output unit, actual quantity of output, and budgeted fixed costs

9 Sales-Volume Variance

10 Flexible-Budget Variance The flexible-budget variance for revenues is called the selling-price variance because it arises solely from the difference between the actual selling price and the budgeted selling price

11 Compute Price Variances and Efficiency Variances for Direct-Cost Categories Learning Objective 3

12 Subdivision of Flexible-Budgets Variance for Direct-Cost Inputs A price variance that reflects the difference between an actual input price and a budgeted input price An efficiency variance that reflects the difference between an actual input quantity and a budgeted input quantity

13 Obtaining Budgeted Input Prices and Quantities Three main sources for information on budgeted input prices and quantities: Actual input data from past periods Data from other companies that have similar processes Standards developed by a company

14 Actual Input Data from Past Periods Advantages: They represent quantities and prices that are real, rather than hypothetical They can serve as benchmarks for continuous improvement Past data are typically available at low cost Disadvantages: Past data can include inefficiencies such as wastage of direct materials They also do not incorporate any changes expected for the budget period

15 Data from Other Companies that Have Similar Processes Advantages: The budget numbers represent competitive benchmarks from other companies Disadvantages: Input-price and input-quantity data from other companies are often not available or may not be comparable to a particular company s situation

16 Standards Developed by a Company Advantages: Standard times aim to exclude past inefficiencies They take into account changes expected to occur in the budget period Disadvantages: Since they are not based on achieved benchmarks, standards might be infeasible and lead to unhappiness among workers

17 Standard A standard input is a carefully determined quantity of input A standard price is a carefully determined price that a company expects to pay for a unit of input A standard cost is a carefully determined cost of a unit of output

18 Price Variances

19 Efficiency Variances

20 Columnar Presentation of Variance Analysis

21 Plan for Variable and Fixed Overhead Costs and Calculate Budgeted Variable and Fixed Overhead Cost Rates Learning Objective 4

22 Planning Overhead Costs Variable overhead as efficiently as possible, plan only essential activities Fixed overhead as efficiently as possible, plan only essential activities, especially because fixed costs are predetermined well before the budget period begins

23 Standard Costing Traces direct costs to output by multiplying the standard prices or rate by the standard quantities of inputs allowed for actual outputs produced Allocates overhead costs on the basis of the standard overhead-cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced

24 Developing Budgeted Variable Overhead Cost-Allocation Rates Choose the period to use for the budget Select the cost-allocation bases to use in allocating variable overhead costs to output produced Identify the variable overhead costs associated with each cost-allocation base Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced

25 Developing Budgeted Fixed Overhead Cost-Allocation Rates Choose the period to use for the budget Select the cost-allocation bases to use in allocating fixed overhead costs to output produced Identify the fixed overhead costs associated with each costallocation base Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced

26 Partition the Variable Overhead Flexible-Budget Variance into Variable Overhead Efficiency and Spending Variances Learning Objective 5

27 Variable Overhead Flexible- Budget Variance Reveals how much variable overhead costs differed from the flexible budget amount

28 Variable Overhead Efficiency Variance The measure captures the actual use of the driver relative to the amount budgeted to be used for the actual output level

29 Variable Overhead Spending Variance The variance captures both the unexpected changes in price as well as the efficiency of use of variable overhead items such as energy and indirect materials

30 Variable Overhead Variance Analysis

31 Compute the Fixed Overhead Flexible- Budget (Or Spending) Variance and the Fixed Overhead Production-Volume Variance Learning Objective 6

32 Fixed Overhead Flexible-Budget Variance It is the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget

33 Fixed Overhead Spending Variance It informs managers of the difference between actual spending on fixed overhead and the planned amount of spending in the master budget It highlights to managers the sources of unexpected changes in resources expended to acquire capacity

34 Production-Volume Variance Also known as denominator-level variance Arises only for fixed costs It is an indicator of the use of capacity A favorable variance indicates that overhead is overallocated; if unfavorable, the overhead is underallocated

35 Fixed Overhead Variance Analysis

36 Show How the Variance Analysis Approach Reconciles the Actual Results for a Period with the Results Expected for that Period Learning Objective 7

37 Integrated Variance Analysis (Variable Overhead-Panel A)

38 Integrated Variance Analysis (Fixed Overhead-Panel B)

39 Summary of Variance Analysis

40 Understand How Managers Use Variances Learning Objective 8

41 Multiple Causes of Variances Managers must not interpret variances in isolation of each other The causes of variances in one part of the value chain can be the result of decisions made in another part of the value chain

42 When to Investigate Variances A standard is a range of possible acceptable input quantities, costs, output quantities, or prices Managers should expect small variances to arise in this range They frequently investigate variances based on subjective judgments or rules of thumb

43 Performance Measurement Using Variances Two attributes of performance are commonly evaluated: Effectiveness Efficiency Managers must be sure they understand the causes of a variance before using it for performance evaluation

44 Organization Learning The goal of variance analysis is for managers to understand why variances arise, to learn, and to improve future performance

45 Continuous Improvement Managers can also use variance analysis to create a virtuous cycle of continuous improvement This can be done by repeatedly identifying causes of variances, initiating corrective actions, and evaluating results of actions

46 Financial and Nonfinancial Performance Measures Companies use a combination of financial and nonfinancial performance measures for planning and control They are also used to evaluate the performance of managers

47 Cost Variances in Nonmanufacturing Settings Nonmanufacturing and service sector companies can benefit from the use of variance analysis Managers can also use variance analysis to examine the overhead costs of the nonmanufacturing areas of the company Also used to make decisions about pricing, managing costs, and product mix in such companies

48 Impact of Information Technology on Variances Modern information technology promotes the increased use of standard-costing systems for product costing and control Following technology has helped many companies improve their performance: Total quality management systems Computer-integrated manufacturing (CIM) systems Enterprise resource planning (ERP) systems