CHAPTER 5

Information for
Comparison

MA 2 – MANAGING COSTS & FINANCES

Lecturer: Christine Colon, ACCA, MSc
 Information for Comparison

• Management information helps

managers to plan, control and
make decisions

• To do this they need to compare

information to assess
performance and make decisions
 Types of Comparison

Previous Periods

Corresponding Forecasts
periods

Comparisons
Other Areas, products
companies

Budgets
 Comparison With Previous Period

 Comparing one period’s results with the previous

period’s results.
 E.g.
Year 2014 compared to year 2013
Apr-Jun 2014 (qtr 2) compare to Jan – Mar 2014 (qtr
1)
 For management info. could compare for many
years or many periods in order to see a trend –
growth or decline?
Comparison With Corresponding Period

• Comparing month to month or

quarter to quarter results.

• E.g.:
Jan 2014 compare to Jan 2015
Jan–Mar 2014 compare to Jan–Mar
2015

• Give better comparison as it

eliminates seasonal fluctuations
 Comparison by Area or Products

• Comparing results of one

area to another.
• Comparing results of one
product / service to another.
 Budgetary Control Cycle

“Feedback” Budget Agreed

for revision
Of next “Feedback”
budget Expenditure Incurred for revision
Of
performance

Analysis of variances

Obtain reasons for variances.

Appropriate Action
 Corrective actions

• Control  The process whereby management

take decisions in order to attempt to
ensure that an organisation achieves
its objectives

• Feedback control  A control process that takes

place after a variation has
taken place

• Feedforward control  A control process that is

forward looking
 Corrective action taken
in advance to prevent
expected deviations
from budgeted
performance
 Review
What term describes: 'the forecasting of differences
between actual and planned outcomes, and the
implementation of action, before the event, to avoid
such differences'?

A. Feedforward control
B. Variance analysis
C. Budgeting
D. Feedback control
 Review
A variance report comparing actual results achieved
during a month with the budgeted
performance for the month is an example of:

A. control action
B. feedback control
C. feedforward control
D. reporting by exception
 Flexible Budgeting System
a) A flexible budget is:
• A budget which, by recognising cost
behaviour patterns, is designed to
change as volume of activity
changes
b) A fixed budget is:
• set at the beginning of the period
• based on estimated production
• original budget
c) A flexed budget is:
• When the actual results are compared
with the relevant section of the flexible
budget, that which corresponds to the
actual level of activity
 Review
A flexible budget is:

A. a budget showing variable production costs only

B. a budget showing actual costs and revenues in the
budget period
C. a budget which shows the costs and revenues at
different levels of activity
D. a budget that is changed monthly
Analysis of Budget Variances

Report that shows:

 Original fixed budget

 Flexed budget

 Actual results
 Variance Analysis

• A variance is the difference

between budgeted amounts and
actual amounts
• Variance reporting is reporting the
differences between budgets and
actual performance
 Calculating Variances

• A FAVOURABLE (F) variance is when

the business has more money as the
result of the variance

• An ADVERSE (A) variance is when the

business has less money as the result
of the variance

• Variance in %
= Budgeted cost - Actual cost x 100%
Budgeted cost
Flexible A = Adverse variance – Cheese
Company was unable to achieve
Budgeting the budgeted level of activity.

Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 A
Variable costs
direct labor $ 40,000 $ 34,000 $6,000 F
direct materials 30,000 25,500 4,500 F

Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total costs $ 84,000 $ 73,500 $ 10,500
 Flexible Budgeting: Performance Report

Cost Total
Formula Fixed Flexed Actual
Per unit Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
direct labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 A
direct material 3.00 24,000 25,500 1,500 A

Total variable costs $ 7.00 $ 56,000 $ 59,500 3500 A

Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total costs $ 70,000 $ 73,500 3500 A
 Exam type Question
A company’s budgets for a period include the following:

Production output 5,000 units

Variable production overheads $7,500
Fixed production overheads $16,000

Actual production in the period was 5,200 units and actual

overheads were $24,100.

Based on the flexed budget, what was the production

overhead cost variance in the period?

A. $600
B. $300
C. 340
D. $40
 Calculating Variances
Sales Revenue Variances
Two causes of sales revenue variances
• Sales price variance
Actual selling price differ from budgeted
selling price (standard selling price)
• Sales activity variance (sales volume
variance)
Sales volume differ from budgeted volume

Total Sales Variance

Sales Price Variance Sales Activity Variance

 Sales Revenue Variances
Example:
• Gold Ltd has budgeted sales of
400 units @ $2.50 each.
• The actual sales achieved were
600 units @ $2.00 each.
• Calculate:
 Total sales variance
 Sales price variance
 Sales volume variance
 Sales Revenue Variances
Example Answer
 Cost Variances
Two causes of cost variances
• Purchase price / efficiency of usage variance
 Actual cost price differ from budgeted cost price
(standard cost price)
 Actual usage quantity differ from budgeted
usage quantity (standard quantity)
• Activity variance (volume variance)
Actual quantity produced differ from budgeted
quantity
Total Cost Variance

Price/efficiency Variance Activity Variance

MA2 no need to sub-analyze into price variance & efficiency variance

 Cost Variances
Direct Material Example:
• Gold Ltd makes a single product with the
following budgeted material cost per unit: 2kg
of material A at $10/kg.
• The budgeted production units were 900 units
• The actual production details are:
1,000 units produced
• Actual material costs = $20,900
• Calculate:
 Total material cost variance
 Material price/efficiency variance
 Material activity variance
 Cost Variances
Answer for Direct Materials Variance Example
 Possible Causes of Material Variances

• Material price variance

Price variance - reasons for

Favourable Adverse
Cheaper supplier Price increase
Quantity discount Discount withdrawn
Low quality Higher quality
Possible Causes of Material Variances

• Material usage variance

Usage variance - reasons for

Favourable Adverse
More efficient design Less efficient design
Decreased wastage Increased wastage
Better quality material Low quality material
 Review
An adverse material usage variance could be caused by
which of the following?

1. The storeroom supplying less material than is

required by production
2. The purchase of cheap material
3. Poorly maintained machinery
4. A series of short deliveries

A. Items 1 and 2 only

B. Items 2 and3 only
C. Items 3 and 4 only
D. Items 1 and 4 only
 Review
Which of the following situations is likely to cause an
adverse material usage variance?

A. A world shortage of the material used

B. Employing unskilled machine operators
C. Machinery idle time
D. Limited storage space
 Review
Which of the following would help to explain an adverse
material price variance?

(i) The material purchased was of higher quality than

standard
(ii) A reduction in the level of purchases meant that
expected bulk discounts were foregone
(iii) The budgeted price per unit of direct material was
unrealistically high.

A. All of them
B. (i) and (ii) only
C. (ii) and (iii) only
D. (i) and (iii) only
 Cost Variances
Two causes of cost variances
• Purchase price / efficiency of usage variance
 Actual cost price differ from budgeted cost price
(standard cost price)
 Actual usage quantity differ from budgeted
usage quantity (standard quantity)
• Activity variance (volume variance)
Actual quantity produced differ from budgeted
quantity
Total Cost Variance

Price/efficiency Variance Activity Variance

MA2 no need to sub-analyze into price variance & efficiency variance

 Cost Variances
Direct Labour Example:
• Gold Ltd makes a single product with the
following budgeted direct labour cost per
unit:
Direct labour 3hrs at $6/hour.
• The budgeted production units were 500 units
• The actual production details are:
400 units produced
• Actual labour costs = $11,000
• Calculate:
 Total labour cost variance
 Labour price/efficiency variance
 Labour activity variance
 Cost Variances
Answer for Direct Labour Variance Example
 Possible Causes of Labour Variances

• Direct labour rate variance

Rate variance - reasons for

Favourable Adverse
Cheaper grade of labour More expensive grade
used of labour used
Pay increase less than Pay increase more than
budget budget

Lower quality Higher quality

 Review
Which of the following would help to explain a
favourable direct labour rate variance?

(i) Employees were of a lower grade than standard

(ii) The budgeted hourly rate of pay was set
unrealistically high
(iii) A pay increase which had been anticipated in the
budget was not awarded

A. All of them
B. (i) and (ii) only
C. (ii) and om only
D. (i) and (lii) only
 Possible Causes of Labour Variances

• Efficiency variance

Efficiency variance - reasons for

Favourable Adverse
Improved working Worse working
methods conditions
More skilled labour Less skilled labour
used used
New bonus scheme Poor supervision
 Review
Which of the following would help to explain a
favourable direct labour efficiency variance?

(i) Employees were of a lower skill level than specified

in the standard
(ii) Better quality material was easier to process
(iii) Suggestions for improved working methods were
implemented during the period

A. All of them
B. (i) and (ii) only
C. (ii) and (iii) only
D. (i) and (iii) only
 Review
A product has a budgeted labour cost of $12 per unit
and budgeted output of 25,000 units in a period. Actual
costs and output in the period were $304,640 and
25,600 units respectively.

What was the total labour cost variance using the

flexed budget?

A. $2,560 Adv
B. $4,640 Adv
C. $4,640 Fav
D. $2,560 Fav
 Exam type Question
Actual and budgeted costs in a manufacturing unit for a period are as
follows:

Actual ($) Fixed budget ($) Flexed

Budget ($)
Direct costs 58,080 62,920 58,560

Overheads 49,760 47,280 48,720

Using the flexed budget are the cost variances adverse or favourable?

A. Direct costs: Favourable Overheads: Adverse

B. Direct costs: Adverse Overheads: Favourable
C. Direct costs: Adverse Overheads: Adverse
D. Direct costs: Favourable Overheads: Favourable
 Interdependence of Variances

The cause of variances may affect each other in a

corresponding or opposite way.

• Examples
Sales price variance (A)
 Heavy discounting
Sales Volume Variance (F)
 Control Action: Variance Investigation

• Questions to ask before deciding whether or

not to investigate a variance:

 Is the variance controllable?

 Is the expected benefit from control action likely

to exceed the expected cost?

 Is there a reasonable probability of successfully

being able to correct a variance?
 Control Action: Variance Investigation

• Questions to ask before deciding whether or

not to investigate a variance:

 Is the variance significant?

 Is the variance steadily getting worse?

Costs and Benefits of control actions

Control action is only worthwhile if the

expected benefits from the control measure
exceed the cost of implementing them

Control action is more important when

actual results are consistently worse than
expected
 Review
Which of the following factors would affect a decision
as to whether to investigate the variance?

1. Controllability of variance
2. Cost of investigation
3. Personnel involved
4. Trend of variance

A. 2 and 4 only
B. 2, 3 and 4 only
C. 1,2 and 3 only
D. 1,2 and 4 only
 Exception Reporting

Responsibility Accounting
• Variance report relating to own area of
responsibility (area of control)
• Controllable and uncontrollable
variances
• Principle of exception reporting – only
large and potentially significant items are
reported to management and drawn to
their attention
 Review
What is exception reporting?

A. Reporting of exceptional activities within an

organisation
B. Reporting only controllable matters to managers
C. Reporting only of variances which exceed a
certain amount
D. Reporting of all variances to the relevant
manager
MA 2 END OF LECTURE