UNIT 11

Performance Management
 Mr.Your
Meet Mostafa Araby
Expert Program Instructor
Mr. Mostafa Araby
• Mr. Mostafa is currently working as FP&A manager at Savola
International Group.
• Mr. Mostafa worked as a Senior financial analyst at General Motors
Corporation.
• Extensive knowledge and experience in preparing, analyzing and
consolidating the Income Statement, Balance Sheet & Cash Flow
statement.
• He got his CMA certificate from the Institute of Management
Accountants (IMA) in the U.S. in April 2016.
• Mr. Mostafa has consulting and training experience with several
superior institutions and training centers in Egypt such as Cairo
University, Arab Academy for Science, Technology & Maritime
Transport, Orange, Training Hub, and other institutes.
• IMA guest speaker about “The Importance of Budgeting & Cash
Budget” in March 2019.
• IMA guest speaker about “Cash Flow vs COVID-19” in August 2020.
 • Cost Management • Introduction
Performance Management - Introduction
• Thinking about performance has had a substantial
impact on the management of all organizations. But
how effective are these systems? And how do these
measuring tools impact on our results? This course
gives an extensive knowledge to what performance
management is all about, its benefits and also how it
contributes to controlling and monitoring costs within
a company. It will set out detailed information about
how to measure performance and provide a platform
for discussion on how to implement a more
output/outcome focused approach to organizing and
managing the company’s performance as a whole. The
idea is to get better results from the organization,
teams and individuals by understanding and managing
performance within an agreed framework of planned
goals, standards and competence requirements.
Cost & Variance Measures
❑ Variance Analysis Overview.

❑ Static vs Flexible Budget.

❑ Sales Variances (Price & Sales Volume Variance).

❑ Sales Variances (Mix & Quantity Variance).

❑ DM Variances (Price & Usage Variance).

❑ DL Variances (Price & Efficiency Variance).

Cost & Variance Measures, Cont.

❑ Variable MOH Variances (Spending & Efficiency Variance).

❑ Fixed MOH Variances (Spending & Production Volume Variance).

❑ MFG Input Variances - Level 2 (Mix & Yield Variance).

❑ MFG Input Variances (Mix & Yield Variance).

 Cost • Overview, Cont.
Variance Analysis
Management
Overview
Variance analysis is the process of comparing the
actual expenses and revenues during a certain
period to the budgeted amounts for that same
period. With variance analysis we are able to
determine the reasons why our actual results were
different from the budgeted amounts. Knowing the
reasons will enable us to focus our efforts on the
areas that have been operating less efficiently than
planned.
 • Overview,
Variance Analysis Overview-Standard Cost Cont.

A standard cost is an estimate of the cost the company expects to incur

in the production process. Without a standard cost, the analysis of
actual activities and results is very difficult because the company has no
target (or standard) against which to measure its performance.

The comparison of actual costs to these standard costs allows the

company to analyze its actual costs and also enables the company to
undertake some cost controls. A large variance between the actual cost
and the standard cost alerts management that something may be wrong
and may need attention and action.

Note: In this section, the terms “budget” and “standard” are used
interchangeably and mean the same thing: a planned amount.
 CostAnalysis Overview-Level of Activity
Variance
Management

Using the correct level of production or activity is important when

setting standard costs. If the standard level of activity is set too
high, the workers will have no motivation because they know that,
no matter how hard they work, they will fail to meet the budgeted
level of output. The ideal (also called perfect, or theoretical) level
of output assumes that there will be no breakdowns, no waste, no
time lost to illness, and that the workers are working at maximum
efficiency. While this maximum output may be achieved for short
periods of time, this level of output is not realistic in the long run.
 CostAnalysis Overview-Level of Activity ….
Variance
Management
An alternative to this theoretical level of output is the practical (also called
currently attainable) level of output. The practical level of output is the
level that will be achieved given the normal amount of time lost, normal
amount of waste, and a normal learning curve for employees. The goal is to
use a level that is attainable but difficult to achieve. Such a level will
motivate the workers while at the same time requiring them to work
diligently.

In addition to setting the correct level of output, the standard cost also
needs to be reviewed. Prices may change, the amount of material (or other
activity) required may change, or the production process may change. All of
these fluctuations may require that the standard cost be adjusted.
 Cost
Variance Analysis Overview-Management
Management
By Exception

• Management by exception focuses

attention on the significant variances
from the budget, both favorable and
unfavorable.

• The disadvantage of this method is that

negative trends may be overlooked at
earlier stages.
Static Cost
vs Flexible Budget-Static Budget
Management

A static budget is a fixed budget. It is a budget that is prepared for one specific level of planned
activity, and that level of planned activity does not change, no matter what the actual activity is.

A static budget is easy to prepare, but it is not very useful for control and evaluation purposes if
the actual activity level (such as sales or production) is different from what had been planned.

Variances that result from comparing total actual cost to the fixed budgeted cost are Level 1
variances. These low-level variances are less useful than higher-level variances because low-
level variances give no information about the cause or causes of the variance. It just gives the
variance. Level 1 variances report variances in revenue and cost of sales for sold units only. They
do not report detailed cost variances for all units produced.
 Cost
Static vs Flexible Budget-Static
Management Budget Limitations
While these variances tell us whether we performed better or worse than expected, they do not provide any
information as to why we performed better or worse than expected.

Variances caused by more or fewer sales than planned are not segregated from variances caused by other
factors like the price per unit for example.

Comparison of actual with the master budget focuses on short-term performance instead of long-term success.

Actual Results – Static Budget Amount = Static (or Total) Budget Variance.

Meeting financial targets is only part of the measurement of performance. Manager evaluation should include
not only financial measures but also non-financial measures, like the balanced scorecard (discussed in budget).
Static Cost
vs Flexible Budget-Flexible Budget
Management
A more useful and usable budget is a flexible budget. This is a budget in which budgeted variable revenues
and costs have been adjusted to the total revenue or cost that would be anticipated for the actual level of
activity that has occurred. Normally, fixed costs in the flexible budget are the same as fixed costs in the
static budget. Budgeted fixed costs in the flexible budget are adjusted only if the actual activity level is
outside the relevant range.

Each of the static budget variances can be further broken down into two sub-variances: the flexible budget
variance and the sales volume variance. These are Level 2 variances, because they give us more
information about the static budget variances. These variances are also in income statement format.
Because they are based on the income statement and thus report on revenues and costs for items sold,
these variances are also called sales variances. The term “sales variances” distinguishes them from
manufacturing input variances, which are based on items produced.
Static Cost
vs Flexible Budget-Sales Variances
Management

Static Budget
SP X SQ

Actual Results Flexible Budget

AP X AQ SP X AQ
Flexible Budget Variance
Static Cost
vs Flexible Budget-Flexible Budget Variance
Management

The flexible budget variance on a sales variance report is the difference between the actual
results and the flexible budget.

Actual Results – Flexible Budget Amount = Flexible Budget Variance

The flexible budget variance tells us how much of the static budget variance was caused by
factors other than the difference between actual and budgeted sales volume. For example, the
flexible budget variance on the revenue line indicates how much of the static budget variance
was due to a difference between the actual price charged for each unit sold and the budgeted
price per unit.
Static vs Flexible Budget-Sales Volume Variance
The sales volume variance on a sales variance report is the difference between the flexible budget amount and the static budget amount.

Flexible Budget Amount – Static Budget Amount = Sales Volume Variance

The sales volume variance shows how much of the static budget variance was caused by actual sales volume being different from
budgeted sales volume.

Static Budget Variance = Flexible Budget Variance + Sales Volume Variance

The sales volume variance for a single-product firm can be explained by the fact that the actual level of sales was different from the
budgeted level of sales. We do need to investigate the cause or causes of the sales volume variance, but we don’t need any more variance
detail to do that.

Flexible budget variances identify variances that are caused by something other than the different-than expected sales volume.

In a single-product firm, the flexible budget variance for revenue is fairly easy to investigate. A flexible budget variance for a revenue item
is called a selling price variance because it is caused exclusively by differences between the actual selling price per unit and the budgeted
selling price per unit.
 Cost
Sales Variances
Management
These variances are called sales variances to differentiate them from the manufacturing input variances (covered
later), but we could also call them “income statement variances” because they are based on the income statement
and thus on the amount sold. In contrast, manufacturing input variances are based on the amount produced.

These variances can be calculated for every variable line on the sales variance report, not just for the Revenue line.

• Sales variances are broken down between Flexible Budget Variance and Sales Volume Variance.

• The difference between the Actual and the Flexible Budget is the Flexible Budget Variance (Or Price Variance).

• The difference between the Flexible and the Static Budget is the Sales Volume Variance.

• The difference between the Actual and the Static Budget is the Static Budget Variance.

• The Flexible Budget Variance plus the Sales Volume Variance equals the Static Budget Variance.
 Cost
Sales Variances-Price Variance & Sales Volume Variance
Management

Price Variance = (AP– SP) X AQ

In the formula above, the “AP” stands for the actual price or cost per item sold, the “SP” stands for the
standard price or cost per item sold, and the “AQ” stands for the actual number of units sold.

The Price Variances on a Sales Variance Report represent the variances caused by the actual price or cost
having been different from the standard price or cost for the number of units actually sold.

Sales Volume Variance =(AQ– SQ) X SP

The Sales Volume Variances on a Sales Variance Report represent the variances caused by the number of
units sold having been different from the number of units budgeted to be sold.
 Cost
Sales Variances
Management

Static Budget
SP X SQ
$10 X 10,000
$ 100,000

Actual Results Flexible Budget

AP X AQ ($8 – $10) X 8,000
- 16,000 U
SP X AQ
$8 X 8,000 $10 X 8,000
$ 64,000 $ 80,000
FBV (Price Variance)
(AP – SP) X AQ
 Cost
Sales Variances
Management
Sales Variances
NotesCost
Management
• When calculating variances, we always subtract the budget amount from the actual amount
(Actual – Budget = Variance).
• A favorable variance (represented with the letter F) is a variance that causes actual net operating
income to be higher than the budgeted amount.
• An unfavorable variance (represented with the letter U) is a variance that causes actual net
operating income to be lower than the budgeted amount.
• If net operating income is to be increased, we want revenues to be higher than budgeted (a
positive variance amount) and we want expensed costs to be lower than budgeted (a negative
variance amount). Both of those variances are favorable variances.
• Normally, fixed costs in the flexible budget are the same as fixed costs in the static budget.
Budgeted fixed costs in the flexible budget are adjusted only if the actual activity level is outside
the relevant range.
Problem Solving
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More than One Product is sold

28
 Cost
More Management
than one product sold
A company that sells more than one product (that is, a multiple-product firm) will have a Flexible Budget
Variance similar to that of a single-product firm, but the Flexible Budget Variance is calculated differently
for a multiple-product firm. Furthermore, this multiple-product firm’s Sales Volume Variance is
subdivided into a Sales Mix Variance and a Sales Quantity Variance.
More Cost
than one product sold
Management
More Cost
than one product sold
Management
More Cost
than one product sold
Management
More Cost
than one product sold (Price Variance)
Management
The Selling Price Variance (the Flexible Budget Variance for revenue) for a multiple-product firm is
determined by calculating each product’s individual selling price variance and summing them, as follows.
The amounts come from the Detail Schedule above.

The Selling Price Variance for the revenue line is.

∑ (AP – SP) × AQ

Or

For Product A: ($122 – $115) × 12,500 = $ 87,500 F

For Product B: ($130 – $125) × 7,500 = 37,500 F

Total Selling Price/Flexible Budget Variance $125,000 F

More Cost
than one product sold (Sales Volume Variance)
Management
To calculate the total Sales Volume Variance for the revenue line of the example, use the actual number
of units sold for each product (AQ), the number of units budgeted to be sold for each product (SQ), and
the budgeted sales price for each product (SP).

The Sales Volume Variance for the revenue line is.

∑ (AQ – SQ) × SP

Or

For Product A: (12,500 – 12,000) × $115 = $ 57,500 F

For Product B: (7,500 – 12,000) × $125 = (562,500) U

Sales Volume Variance $(505,000) U

More Cost
than one product sold (Mix & Quantity)
Management
For a multiple-product firm, the Sales Volume Variance is subdivided into the Sales Quantity Variance
and the Sales Mix Variance.

The Sales Quantity Variance represents the portion of the $(505,000) Unfavorable Sales Volume Variance
that occurred because, in total, the number of units sold was different from what was budgeted.

(TAQ – TSQ) × AWSPSM

(20,000 – 24,000) × $120 = $(480,000)U

The Sales Mix Variance represents the portion of the Sales Volume Variance that occurred because the
mix of products sold was different from the budgeted mix.

(WASPAM – WASPSM) X TAQ

($118.75 – $120.00) × 20,000 = $(25,000) U

More Cost
than one product sold (Mix & Quantity)
Management
More Cost
than one product sold (Mix & Quantity)
Management
Problem Solving
Problem Solving

Sales Volume Variance is

Problem Solving

Sales Mix Variance is

Problem Solving

Sales Quantity Variance is

Manufacturing Input Variances

42
 Cost
Manufacturing Input Variances
Management
These variances are called manufacturing input variances because they are calculated for the manufacturing costs (DM,
DL, VOH, FOH) and are based on the amount produced. In contrast, sales variances are based on the amount sold.

For manufacturing inputs we calculate the same variances that we calculate for sales variances (price & Volume) but may
have different names for example (Price = Rate or Spending variance) and (Volume = Quantity, Usage or Efficiency
Variance).

We can divide manufacturing variances to two categories, one for variable manufacturing variances (DM, DL & VOH) and
another category for variable manufacturing variances (FOH).

Note: (for manufacturing Inputs):

• Amount ($) = Quantity × Price.
• Quantity = Level of output × quantity/ finished product.
• Level of output is the number of finished goods.
Variable Manufacturing Input Variances

44
 CostManufacturing Variances (DM, DL & VOH)
Variable
Management

Flexible Budget
SH/unit X AO X SP
2 X 3,000 X $ 2.5
$ 15,000

Actual Results Applied

AH/unit X AO X AP ($2 – $2.5) X 9,000
AH/unit X AO X SP
3 X 3,000 X $ 2 - 4,500 F 3 X 3,000 X $ 2.5
$ 18,000 $ 22,500

(Price/Rate/Spending Variance)
(AP – SP) X AQ
 CostManufacturing Input Variances
Variable
Management
Talking about direct material as an example of variable manufacturing input,
Price (Rate/Spending) Variance = (AP– SP) X AQ

Though it is commonly called the “price variance” for materials, the more complete name for this
variance is the “price usage variance.” The variance is called the “price usage variance” to distinguish it
from the “purchase price variance,” which is calculated for the actual quantity purchased of materials not
only the quantity used. For the sake of brevity, from this point onward “price variance” will be used to
mean the “price usage variance”.

The price variance formula is used to calculate the portion of the total variance that was due to a
difference between what was paid (the actual price) and the amount budgeted to be paid (the standard
price) per unit of direct materials used or purchased (based upon the question).
 CostManufacturing Input Variances
Variable
Management

Quantity (Usage/Efficiency) Variance =(AQ– SQ) X SP

The quantity variance formula is used to calculate the portion of the total variance that was caused
by either too much or too little material having been used, without any reference to the amount of
the variance that was caused by a difference between the actual and the standard price per unit of
the material used.

Because this is a cost, a negative result of these two formulas is a favorable variance and vise versa.

Price variance for DL is called “Rate Variance” and for VOH is called “Spending Variance.

Quantity of usage related to DL or VOH is represented in the number of hours of production.

 CostManufacturing Input Variances
Variable
Management
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3
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Fixed Manufacturing Input Variances

64
 Cost
Fixed Manufacturing Variances (FOH)
Management

Flexible Budget
SH/unit X AO X SP
4 X 3,000 X $ 4
$ 48,000

Actual Results Static

AH/unit X AO X AP $ 40,500 - $ 32,000
SH/unit X SO X SP
3 X 3,000 X $ 4.5 + 8,500 U 4 X 2,000 X $ 4
$ 40,500 $ 32,000

(Spending Variance)
Budget Variance
 Cost
Fixed Factory Overhead Variances
Management
The fixed overhead spending variance, also called the or the budget variance is the difference
between the actual fixed overhead costs incurred and the budgeted fixed overhead (static budget)
amount.
The fixed overhead production-volume variance is the difference between the budgeted amount of
fixed overhead (Static Budget) and the amount of fixed overhead applied (Flexible Budget).
The Fixed Overhead Production-Volume Variance is caused by a difference between the actual
production level and the production level used to calculate the budgeted fixed overhead rate.
If Applied (Flexible Budget) is greater than budgeted fixed factory overhead (Static Budget), that
means we have produced units more than budgeted using the same hours and rate. So, it is a
favorable variance. And vise versa. So, make sure you are interpreting this variance in the correct
way.
The fixed overhead production-volume variance has no connection to any actually incurred costs, so
it is not a comparison between actual and budgeted costs in the way other variances are. Instead, it
is a measure of capacity utilization.
 Cost
Management
Four-Way, Three-Way & Two-Way Analysis
Problem Solving
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More Than One Input

73
More Cost
Than One Input
Management
Thus far we have outlined the variance analysis process when we have only one material input into
the product or only one class of labor.
A total variance, a price variance, and a quantity variance are still calculated in situations where
more than one direct material input or more than one class of labor (each class has different rate of
wage) is used in producing the product. The difference when multiple inputs are used (called a mix
of inputs) is that the quantity variance is broken down into two sub-variances: the mix variance and
the yield variance.
The mix variance shows the portion of the quantity variance that resulted because the actual mix
was different from the standard mix (that is, more of one ingredient was used and less of another
ingredient was used). The yield variance shows the portion of the quantity variance that resulted
because the total actual amount of all ingredients used was different from the total standard
amount.
In a situation with multiple inputs, the price variance is not broken down the way the quantity
variance is.
More Cost
Than One Input
Management
More Cost
Than One Input
Management
Total Variance for the weighted Mix = Total Actual Cost – Total Standard Cost for Actual Output
= 7987.50 – 5250 = 2737.50 Unfavorable
The price variance of a weighted mix is the sum of the price variances for each component of the mix,
each one calculated individually using the formula
(AP – SP) × AQ
We will calculate a price variance for each separate input, and these individual price variances are then
summed to calculate the total materials price variance
Corn Price Variance = (12 – 10) × 375 = 750 U
Wheat Price Variance = (8.5 - 8) × 200 = 100 U
Rice Price Variance = (5.5 - 3) × 325 = 812.5 U
Total Price Variance for the Weighted Mix = 1662.5 U
More Cost
Than One Input
Management
The total materials quantity or labor efficiency variance of a weighted mix is the sum of the quantity variances
for each component of the mix, each one calculated individually.
The below formula is used to calculate the quantity variance for each component of the mix separately. The
individual quantity variances are then summed to calculate the total quantity variance:
(AQ – SQ) × SP
Corn quantity Variance = (375 – 250) × 10 = 1250 U
Wheat quantity Variance = (200 - 250) × 8 = 400 F
Rice quantity Variance = (325 - 250) × 3 = 225 U
Total quantity Variance for the Weighted Mix = 1075 U
Total Price Variance + Total quantity Variance = Total Variance of the Weighted Mix
1662.5 U + 1075 U = 2737.5 U
More Than One Input
Because more than one material is used in the production process, we cannot use the total
materials quantity variance to determine exactly why the variance occurred.
In our example if each ingredient used 300 kg, that means we actually used the same ratio for
each ingredient as planned but the quantity of all ingredients actually used (900 kg) is different
from planned (750 kg). And then, the total quantity variance have occurred exclusively because
a different total volume of materials was used in production being different than planned
(Yield).
And if the actual quantity of all ingredients (750 kg) is maintained as planned but using different
ratios than planned, then the total quantity variance have occurred exclusively because a
different ratios of materials was used in production being different than planned (Mix).
But in our example, we have both (the ratio and the total quantities) actually used are different
than planned. So, the total quantity variance is broken down into two sub-variances: the mix
variance and the yield variance.
More Than One Input
A mix variance could occur if the company’s inventory of wheat is low and it deliberately substitutes corn and
rice for a portion of the wheat required. A mix variance could also occur accidentally if, for example, the wrong
proportions are used when the materials are added to the production process.
A yield variance results from a difference between the total actual quantity of the inputs that were used to
produce the actual output and the total standard quantity of inputs that should have been used to produce
the actual output.
The formula used to calculate the mix variance is a variation of the price variance formula: (AP – SP) × AQ.
And, The formula used to calculate the yield variance is a variation of the quantity variance formula: (AQ –
SQ) × SP. But, instead of using the actual and standard prices for the input, we use weighted average standard
prices.
Note that although the mix variance formula is calculated the same way as we calculate price variance, but it
is not a price variance as we use the standard price for both actual and standard mix.
Note also that although the yield variance formula is calculated the same way as we calculate quantity
variance, but it is not a quantity variance as we use the weighted average standard price of the standard mix
(WASPSM).
More Cost
Than One Input
Management
We calculate the weighted average standard price of the actual mix (WASPAM) and the weighted
average standard price of the standard mix (WASPSM).
The weighted average standard price of the actual mix (WASPAM): the actual quantity used for each
input is multiplied by the standard cost for that input, the products are summed, and the sum is
divided by the total volume of all inputs used. The result is the weighted average standard price of
one unit of the actual mix (WASPAM).
The weighted average standard price that results from this calculation is how much one standard
input should have cost, based on the actual mix used.
The weighted average standard price of the standard mix (WASPSM): The standard quantity of each
input allowed for the actual output is multiplied by the standard cost for each input, the results are
summed, and the sum is divided by the total volume of all inputs allowed for the actual output.
The weighted average standard price for the standard output that results from this calculation is
how much one standard unit of the mix should have cost, based on the standard mix allowed for
the actual output.
More Cost
Than One Input
Management
More Than One Input
As previously mentioned, the mix variance shows the portion of the quantity variance that resulted because
the actual mix was different from the standard mix (that is, more of one ingredient was used and less of
another ingredient was used).
(WASPAM – WASPSM) × TAQ
($ 7.0277 - $ 7) X 900
= $ 25 U
The yield variance shows the portion of the quantity variance that resulted because the total actual amount of
all ingredients used was different from the total standard amount.
(TAQ – TSQ) × WASPSM
(900 - 750) X $ 7
= $ 1050 U
Mix Variance + Yield Variance = Total quantity Variance of the Weighted Mix
$ 25 U + $ 1050 U= $ 1075 U
Problem Solving
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Summary

86
MFG Input Variances Summary
Thank You