Management Accounting: Understanding Variances, Benchmarking and Flexible Budgeting | Lecture notes Management Accounting

Management Accounting

Chapter 15:

variance: the difference between an actual result and a budgeted amount

benchmark: a point of references from which comparisons may be made (the budgeted amount)

standard: a carefully predetermined amount; it usually expresses on a per unit basis

In practice, there is not a precise dividing line between a budgeted amount and a standard amount.

Management by exception: the practice of concentrating on areas not operating as anticipated and

giving less attention to areas operating as expected

static budget: a budget that is based on one level of output; it is not adjusted or altered after it is

set, regardless of ensuing changes in actual output (or actual revenue and cost drivers), developed at

the start of the budget period based on the planned output level for the period

flexible budget: adjusted in accordance with ensuing changes in actual output (or actual revenues

and cost drivers), calculated at the end of the period when the actual output is known.

Can differ in their level of detail.

Favorable variance: denoted F, is a variance that increases operating income relative to the

budgeted amount

unfavorable variance: denoted U, a variance that decreases operating income relative to the

budgeted amount

The term level followed by a number denotes the amount of detail indicated by the variance(s)

isolated.

Flexible-budget variances and sales-volume variances:

flexible-budget variance: the difference between the actual results and the flexible-budget amount

for the actual levels of the revenue and cost drivers

sales-volume variance: the difference between the flexible-budget amount and the static-budget

amount; unit selling prices, unit variable costs and fixed costs are held constant

The flexible-budget variance pertaining to revenues is often called selling-price variance: it arises

solely from differences between the actual selling price and the budgeted selling price

Price variances and efficiency variances for inputs:

The flexible-budget variance (Level 2) captures the difference between the actual results and the

flexible budget. The sources of this variance (as regards costs) are the individual differences

between actual and budgeted prices or quantities for inputs. The next two variances we discuss –

price variances and efficiency variances for inputs – analyze such differences. This information

helps managers to better understand past performance and to plan for future performance. We call

this a level 3 analysis as it takes a more detailed analysis of the level two variances.

Price variance: the difference between the actual price and the budgeted price multiplied by the

actual quantity of input in question (such as direct materials purchased or used); sometimes also

called input-price variance or rate variances

efficiency variance: the difference between the actual quantity of input used and the budgeted

quantity of input that should have been used, multiplied by the budgeted price; sometimes called

input-efficiency variances or usage variance

Level 1 Static-budget variance

Level 2 Flexible-budget variance Sales-volume variance

Level 3 Price variance Efficiency variance

standard input: a carefully predetermined quantity of input (such as kilograms of materials or

hours of labor time) required for one unit of output

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Management Accounting Chapter 15: variance: the difference between an actual result and a budgeted amount benchmark: a point of references from which comparisons may be made (the budgeted amount) standard: a carefully predetermined amount; it usually expresses on a per unit basis In practice, there is not a precise dividing line between a budgeted amount and a standard amount. Management by exception: the practice of concentrating on areas not operating as anticipated and giving less attention to areas operating as expected static budget: a budget that is based on one level of output; it is not adjusted or altered after it is set, regardless of ensuing changes in actual output (or actual revenue and cost drivers), developed at the start of the budget period based on the planned output level for the period flexible budget: adjusted in accordance with ensuing changes in actual output (or actual revenues and cost drivers), calculated at the end of the period when the actual output is known. Can differ in their level of detail. Favorable variance: denoted F, is a variance that increases operating income relative to the budgeted amount unfavorable variance: denoted U, a variance that decreases operating income relative to the budgeted amount The term level followed by a number denotes the amount of detail indicated by the variance(s) isolated. Flexible-budget variances and sales-volume variances: flexible-budget variance: the difference between the actual results and the flexible-budget amount for the actual levels of the revenue and cost drivers sales-volume variance: the difference between the flexible-budget amount and the static-budget amount; unit selling prices, unit variable costs and fixed costs are held constant The flexible-budget variance pertaining to revenues is often called selling-price variance: it arises solely from differences between the actual selling price and the budgeted selling price Price variances and efficiency variances for inputs: The flexible-budget variance (Level 2) captures the difference between the actual results and the flexible budget. The sources of this variance (as regards costs) are the individual differences between actual and budgeted prices or quantities for inputs. The next two variances we discuss – price variances and efficiency variances for inputs – analyze such differences. This information helps managers to better understand past performance and to plan for future performance. We call this a level 3 analysis as it takes a more detailed analysis of the level two variances. Price variance: the difference between the actual price and the budgeted price multiplied by the actual quantity of input in question (such as direct materials purchased or used); sometimes also called input-price variance or rate variances efficiency variance: the difference between the actual quantity of input used and the budgeted quantity of input that should have been used, multiplied by the budgeted price; sometimes called input-efficiency variances or usage variance Level 1 Static-budget variance Level 2 Flexible-budget variance Sales-volume variance Level 3 Price variance Efficiency variance standard input: a carefully predetermined quantity of input (such as kilograms of materials or hours of labor time) required for one unit of output

standard cost: a carefully predetermined cost The breakdown of the flexible-budget variance into its price and efficiency components is important when evaluating individual managers. The cause of price and efficiency variances can be interrelated therefore do not interpret these variances in isolation from each other. Management uses of variances: A key use of variance analysis is in performance evaluation. Two attributes of performance are commonly measured: Effectiveness: the degree to which a predetermined objective or target is met Efficiency: the relative amount of inputs used to achieve a given level of output If any single performance measure receives excessive emphasis, managers tend to make decisions that maximize their own reported performance in terms of that single performance measure. Variances and flexible budgets ca be used to measure specific types of performance goals such as continuous improvement. Continuous improvement budgeted cost: a budget cost that is successively reduced over succeeding time periods By using continuous improvement budgeted costs, an organization signals the importance of constantly seeking ways to reduce total costs. Products in the initial months of their production may have higher budgeted improvement rates than those that have been in production longer. The cause of variance in one part of the value chain can be actions taken in other parts of the value chain. Note how improvements in early stages of the value chain can sizably reduce the magnitude of variances in subsequent stages of the value chain. The most important task in variance analysis is to understand why variances arise and than to use that knowledge to promote learning and improve performance. When should the causes of variances be investigated? Rule of thumb, cost-benefit analysis Almost all organizations use a combination of financial and non-financial performance measures rather than relying exclusively on either type. Flexible budgeting and activity based costing Benchmarking and variance analysis: benchmarking: often used to refer to the continuous process of measuring products, services and activities against the best levels of performance

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