Question

is the Variance report useful for evaluating how well revenue and coast are controlled? ch.9 managerial accounting

Answer 1

Most companies create plans and budgets to establish benchmarks for future performance in sales, production, operations, labor, etc. The starting point of these plans and budget are usually estimated cost and revenue figures. The goal is to meet these budgets, but as with all goals - they are not always met. Managers use variance analysis to track the actual performance against these goals. If this analysis is not performed afterwards, then setting budgets is useless.

In other words: after a period (i.e. month, quarter, year) is over managers, management accountants, controllers and other finance professionals calculate (and then analyze) a number of different types of variance. Variance is defined as the difference between the actual values (costs, revenue, head count, ...) and budgeted, planned or standard values.

Favorable and adverse variance

After a variance is calculated, it falls into one of these two categories:

1. Favorable variance (positive; better than planned)
2. Adverse variance (negative; worse than planned)

An example of favorable variance is when actual total costs are lower than planned total costs. An example of adverse variance is when actual revenue is lower than planned.

Note: not all adverse variance is bad and not all favorable variance is good! For example: a variance analysis might show higher production costs than planned (adverse variance). However, a deeper look reveals that the higher costs are a direct consequence of significantly higher sales (favorable variance).

variance report serves as an indicator of our performance against the yearly plan. The two-part nature of the report gives management a look at the recent past - The company's cumulative results from the start of the year - as well as a view into the future - how the company is expected to perform until the end of the year. Equipped with this data they can make the correct decisions.

A variance analysis should be performed on an annual basis by all centers. The purpose of the analysis is to compare the estimated costs of a rate proposal to the actual costs for the same time period. This will aid centers in determining their variance between cost estimates and actuals from year to year.

Cost Variance = Actual Cost - Budget (Standard) Cost

          Variance Analysis is a technique used for:

a.      Cost Control   - Monitor Actual Expenditures against, should cost.

b.     Profit Control - Which a large part is facilitated by cost control.

To be able to do Variance Analysis you need:          

1.     A cost accounting system that records the costs in the format that allows matching against planned cost.

2.     Budgeted costs that are realistic, doable and accepted by those responsible for meeting them.

3.     The best way to develop "should" cost is through defining standard through actual measurement (engineers costs).  When this is done for the whole company, it is called Standard Costing.

4.     Standard Costing is very expensive (i.e. must develop and keep standards up-to-date).  Pay for mass production companies where due to low profit margins cost must be carefully controlled (i.e. Proctor & Gamble, McDonalds, Medical Centers).

5.     Where acceptable historical costs (cost database) are used to specify a should cost:

a.      Last years actual cost plus adjustment for change.

b.     Statistically derived cost function.

The most widely used technique by management to maintain cost and profit control is

                    The Budget

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Usually each of these sectors has specific individual budget that cover areas that management wants to monitor.

     Sales Revenue - By individual product, sales office, customer

     Factory Overhead - Maintenance, Quality Control, Engineering

     General + Administrative - Legal Dept., Human Relations, Public Relations

What Budget Does

1.     Communicates Goal

2.     Defines Constraints

3.     Provides Accountability

4.     Sets Targets to be Met

5.     Provides Systems Perspective

Necessary for Budgets to Work

1.     People have confidence in the budget system being used and budget figures set to be met

2.     Is utilized by management

3.     Management does not use to set blame, but as an indicator for possible action to be taken

4.     Fast feedback of performance to the managers so they can take corrective action

5.     They are not too administratively burdensome

Variance Analysis Involves

1.     Defining the gap between the budget goal and actual performance

2.     Investigating to determine cause

3.     Identifying potential responses

4.     Taking action

Typical variance that are calculated to explain why profit target is not met.

Can either be sales revenue lower, costs higher or a combination of both.

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Flexible Budgets

Flexible Budget is one that provides standards that are

relevant to evaluate performance at any activity level.

This is necessary to make a meaningful evaluation of performance.

Usually used to develop the “should” cost.