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 Fundamentals of Variance
Analysis
Chapter 16

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives

LO 16-1 Use budgets for performance evaluation.

LO 16-2 Develop and use flexible budgets.

LO 16-3 Compute and interpret the sales activity variance.

LO 16-4 Prepare and use a profit variance analysis.

LO 16-5 Compute and use variable cost variances.

LO 16-6 Compute and use fixed cost variances.

LO 16-7 (Appendix) Understand how to record costs
in a standard costing system.

16-3
 Using Budgets for
LO
16-1

Performance Evaluation
LO 16-1 Use budgets for performance evaluation.

Operating Budgets
Budgeted income statement, production budget,
budgeted cost of goods sold, and supporting budgets

Financial Budgets
Budgets of financial resources; for example, the
cash budget and the budgeted balance sheet

Variance
Difference between planned result and actual outcome

16-4
LO
16-1

Profit Variance

Favorable Variance
Variance that, taken alone, increases operating profit

Unfavorable Variance
Variance that, taken alone, reduces operating profit

16-5
LO
16-1

Profit Variance
Bayou Division
Budget and Actual Results
August
Master
Actual Variance Budget
Sales (units) 80,000 100,000a
Sales revenue $840,000 $1,000,000
Less: Variable costs
Variable mfg. costs 329,680 380,000b
Variable selling and administrative 68,000 90,000c
Total variable costs $397,680 $ 470,000
Contribution margin $442,320 $ 530,000
Fixed costs:
Fixed manufacturing overhead 195,500 200,000
Fixed selling and administrative costs 132,320 140,000
Total fixed costs $327,820 $ 340,000
Profit $114,500 $ 190,000
a $10.00 per unit b $3.80 per unit c $0.90 per unit

16-6
LO
16-1

Profit Variance
Bayou Division
Budget and Actual Results
August
Master
Actual Variance Budget
Sales (units) 80,000 20,000 U 100,000a
Sales revenue $840,000 $160,000 U $1,000,000
Less: Variable costs
Variable mfg. costs 329,680 50,320 F 380,000b
Variable selling and administrative 68,000 22,000 F 90,000c
Total variable costs $397,680 $ 72,320 F $ 470,000
Contribution margin $442,320 $ 87,680 U $ 530,000
Fixed costs:
Fixed manufacturing overhead 195,500 4,500 F 200,000
Fixed selling and administrative costs 132,320 7,680 F 140,000
Total fixed costs $327,820 $ 12,180 F $ 340,000
Profit $114,500 $ 75,500 U $ 190,000
a $10.00 per unit b $3.80 per unit c $0.90 per unit

16-7
LO
16-2

Flexible Budgeting
LO 16-2 Develop and use flexible budgets.

Static Budget
Budget for a single activity level;
usually the master budget

Flexible Budget
Budget that indicates revenues, costs,
and profits for different levels of activity

16-8
LO
16-3

Sales Activity Variance

LO 16-3 Compute and interpret the sales activity variance.

Sales Activity Variance

The difference between operating profit
in the master budget and operating profit
in the flexible budget that arises because
the actual number of units sold is different
from the budgeted number

16-9
LO
16-3

Sales Activity Variance

Bayou Division
Flexible and Master Budget
August
Flexible Sales-Activity Master
Budget Variance Budget
Sales (units) 80,000 20,000 U 100,000
Sales revenue (@ $10.00 per unit) $800,000 $200,000 U $1,000,000
Less: Variable costs
Variable mfg. costs (@ $3.80 per unit) 304,000 76,000 F 380,000
Variable selling and admin. (@ $0.90 per unit) 72,000 18,000 F 90,000
Total variable costs $376,000 $ 94,000 F $ 470,000
Contribution margin $424,000 $106,000 U $ 530,000
Fixed costs:
Fixed manufacturing overhead 200,000 -0- 200,000
Fixed selling and administrative costs 140,000 -0- 140,000
Total fixed costs $340,000 -0- $ 340,000
Profit $ 84,000 $106,000 U $ 190,000

16-10
LO
16-4

Profit Variance Analysis

LO 16-4 Prepare and use a profit variance analysis.

Profit Variance Analysis

Analysis of the causes of differences between
budgeted profits and the actual profits earned

Sales price variance

Fixed production cost variances

Variable production cost variances

Marketing and administrative cost variances

16-11
LO
16-4

Profit Variance Analysis

Bayou Division
Profit Variance Analysis
August
Marketing Sales Sales
Mfg. and Admin. Price Flexible Activity Master
Actual Variances Variances Variance Budget Variance Budget
Sales (units) 80,000 80,000 100,000
Sales revenue $840,000 $40,000 F $800,000 $200,000 U $1,000,000
Less: Variable costs
Variable manufacturing costsa 329,680 $25,680 U 304,000 76,000 F 380,000
Variable selling and administrative 68,000 $ 4,000 F 72,000 18,000 F 90,000
Contribution margin $442,320 $25.680 U $ 4,000 F $40,000 F $424,000 $106,000 U $ 530,000
Fixed costs:
Fixed manufacturing overhead 195,500 4,500 F 200,000 -0- 200,000
Fixed selling and administrative costs 132,320 7,680 F 140,000 -0- 140,000
Profit $114,500 $21,180 U $11,680 F $40,000 F $ 84,000 $106,000 U $ 190,000

Total variance from flexible

budget = $30,500 F

Total variance from master budget = $75,500 U

a The $25,680 manufacturing variance is explained in detail in LO 16.5.

16-12
LO
16-4

Sales Price Variance

Sales Price Variance

Difference between the actual selling price
and budgeted selling price multiplied by
the actual number of units sold

($10.50 - $10) x 80,000 units = $40,000 F

16-13
LO
16-4

Variable Production Costs

Standard Cost Sheet
A form providing the standard quantities of
each input required to produce a unit of
output and the standard price for each input.
Bayou Division
Standard Cost Sheet Variable Manufacturing Costs
August
Standard Standard Input Standard Cost
Quantity of Input Price or Rate per Unit of
per Unit of Output per Unit of Input Output (frame)

Direct material 4 pounds $0.55 per pound $2.20

Direct labor 0.05 hours $20 per hour 1.00
Variable overhead 0.05 hours $12 per hour 0.60
Total variable manufacturing costs $3.80

16-14
LO
16-5

Variable Cost Variance Analysis

LO 16-5 Compute and use variable cost variances.

(1) (2) (3)

Actual Inputs at Flexible Production
Actual Standard Prices Budget

Actual input price (AP) Standard input price (SP) Standard input price (SP)
times actual quantity times actual quantity times standard quantity
(AQ) of input (AQ) of input (SQ) of input allowed for
actual good output
(AP AQ) (SP AQ) (SP SQ)

Price variance Efficiency variance

(1) (2) (2) (3)

Total variance
(1) (3)

16-15
LO
16-5

Production Cost Variance

Price Variance
Difference between actual price and budgeted price

Multiply this difference by the actual quantity purchased.

Price variance = (AP AQ) (SP AQ)

= AQ(AP SP)

16-16
LO
16-5

Production Efficiency Variance

Efficiency Variance
Difference between the actual quantity used and the
budgeted quantity for the actual level of activity.

Multiply this difference by the budgeted price per unit.

Price variance = (SP AQ) (SP SQ)

= SP(AQ SQ)

16-17
LO
16-5

Direct Materials Variance

(1) (2) (3)
Actual Inputs at Flexible Production
Actual Standard Prices Budget

Actual materials price Standard materials price Standard materials price

(AP = $0.60) (SP = $0.55) (SP = $0.55)
Actual quantity Actual quantity Standard quantity
(AQ = 328,000 pounds) (AQ = 328,000 pounds) (SQ = 320,000 pounds)
of direct materials of direct materials of direct materials
allowed for actual output

AP AQ = $196,800 SP AQ = $180,400 SP SQ = $176,000

Price variance Efficiency variance

$196,800 $180,400 $180,400 $176,000
= $16,400 U = $4,400 U

Total variance
= $16,400 + $4,400 = $20,800 U

16-18
LO
16-5

Direct Labor Variance

(1) (2) (3)
Actual Inputs at Flexible Production
Actual Standard Prices Budget

Actual labor price Standard labor price Standard labor price

(AP = $18) (SP = $20) (SP = $20)
Actual quantity Actual quantity Standard quantity
(AQ = 4,400 hours) (AQ = 4,400 hours) (SQ = 4,000 hours)
of direct labor of direct labor of direct labor
allowed for actual output

AP AQ = $79,200 SP AQ = $88,000 SP SQ = $80,000

Price variance Efficiency variance

$79,200 $88,000 $88,000 $80,000
= $8,800 F = $8,000 U

Total variance
= $8,800 $8,000 = $800 F

16-19
LO
16-5

Variable Overhead Variance

(1) (2) (3)
Actual Inputs at Flexible Production
Actual Standard Prices Budget

Sum of actual Standard variable Standard variable

variable overhead price overhead price (SP = $12)
manufacturing (SP = $12) Standard quantity
overhead costs Actual quantity (SQ = 4,000 hours)
(AQ = 4,400 hours) of the overhead base allowed
of the overhead base for actual output produced

AP AQ = $53,680 SP AQ = $52,800 SP SQ = $48,000

Price variance Efficiency variance

$53,680 $52,800 $52,800 $48,000
= $880 U = $4,800 U

Total variance
= $880 + $4,800 = $5,680 U

16-20
 Variable Manufacturing
LO
16-5

Cost Variance Summary

Price Efficiency Total

Direct materials $16,400 U $4,400 U $20,800 U
Direct labor $ 8,800 F $8,000 U $ 800 F
Variable overhead $ 880 U $4,800 U $ 5,680 U
Total variable manufacturing
cost variance $25,680 U

16-21
LO
16-6

Fixed Cost Variances

LO 16-6 Compute and use fixed cost variances.

Spending (or budget) variance

Price variance for fixed overhead

The difference between budgeted

and actual fixed overhead

$195,500 actual $200,000 budget = $4,500 F

16-22
LO
16-6

Fixed Cost Variances

The difference between budgeted and
applied fixed overhead
Variance that arises because the volume
used to apply fixed overhead differs from
the estimated volume used to estimate
fixed cost per unit.

$200,000 budget $160,000 applied = $40,000 U

$200,000 budget 100,000 budgeted units = $2 per unit

80,000 units $2 per unit = $160,000 applied

16-23
 Appendix: Recording Costs
LO
16-7

in a Standard Cost System

LO 16-7 (Appendix) Understand how to record
costs in a standard costing system.

Work-in-process inventory is debited when direct

materials and direct labor are used at standard.
Work-in-process inventory is debited when
manufacturing overhead is applied at standard.
When the units are finished, work-in-process
inventory is credited and finished goods inventory is
debited.
Variances are usually closed to cost of goods sold.

16-24
End of Chapter 16

16-25