Assume that Custom Electronics makes and sells two models of electrical switches, in- dustrial and standard. Data on the two models for February are shown on the next page.
Although there are several approaches to calculating a sales mix variance, our com- putation allows us to break down the sales activity variance into two components: sales mix and sales quantity. The sales mix variance measures the impact of substitution (it appears that the industrial model has been substituted for the standard model) while the sales quantity variance measures the variance in sales quantity, holding the sales mix constant.
See Exhibit 17.5 for calculations for this example. The sales price variance is unaf- fected by our analysis; the sales activity variance is broken down into the mix and quan- tity variances. By separating the activity variance into its mix and quantity components, we have isolated the pure mix effect by holding constant the quantity effects, and we have isolated the pure quantity effect by holding constant the mix effect.
Source of the Sales Mix Variance. Although we have calculated the mix vari- ance of each product sold to show the exact source, the total mix variance ($4,800 F) is most frequently used. In this example, the favorable mix variance results from the sub- stitution of the higher contribution industrial model for the lower contribution standard model.
The comparison of the master budget, the flexible budget, and actual results also can be used in service and merchandising organizations. The basic framework in Chapter 16 is retained. Merchandising and service organizations focus on marketing and administrative costs to measure efficiency and control costs. The key items to control are labor costs, particularly for service organizations, and occupancy costs per sales-dollar, particularly for merchandising organizations.
The need for analysis of price and efficiency variances in nonmanufacturing settings is increasing. Banks, fast-food outlets, hospitals, consulting firms, retail stores, and many other organizations apply the variance analysis techniques discussed in both Chapter 16 and this chapter to their labor and overhead costs. In some cases, an efficiency variance can be used to analyze variable nonmanufacturing costs; its computation requires a reliable measure of output activity. Ideally, this requires some quantitative input that can be linked to output.
For example, personnel in the purchasing department of Bayou Division are expected to process ten transactions per day. The standard labor cost is $175 per day including benefits. During August, personnel worked 120 staff days and processed 1,130 transactions. The actual labor cost was $20,040. For 1,130 transactions, the number of standard staff-days allowed is 113 (= 1,130 transactions ÷ 10 transactions per day). Favorable price and unfavorable efficiency variances were computed (Exhibit 17.7). The calculations in the exhibit are similar to the ones used for labor variances in manufacturing.
Keeping an Eye on Variances and Standards
We noted at the beginning of Chapter 16 that every organization has its own approach to variance analysis, although virtually all are based on the fundamental model presented here. The variances that will be important for a particular company will depend on the strategic imperatives for the company. What are the essential things that the company must do well to succeed? Once managers are clear on this, they can work with accoun- tants to determine whether the costs of providing specific analyses are sufficiently benefi- cial to warrant the time and effort necessary to complete the calculations. Because of the unique circumstances in each organization, we cannot generalize very much about which variances should be calculated. Managers and accountants in each organization should perform their own cost-benefit analysis to ascertain which calculations are justified.
In deciding how many variances to calculate, it is important to note the impact and controllability of each variance. When considering impact, we ask, Does this variance matter? Is it so small that the best efforts to improve efficiency or control costs would have very little impact even if the efforts were successful? If so, it’s probably not worth the trouble to calculate and analyze. Hence, detailed variance calculations for small overhead items might not be worthwhile.
When considering the controllability of a variance, we ask, Can we do something about it? No matter how great its impact, if nothing can be done about the variance, justifying spending resources to compute and analyze it is difficult. For example, materials purchase price variances are often high-impact items. They are difficult to control, however, because materials prices fluctuate because of market conditions that are outside the control of managers.
In general, high-impact, highly controllable variances should get the most atten- tion, and low-impact, uncontrollable variances should get the least attention. Labor and materials efficiency variances often are highly controllable. With sufficient attention to scheduling, quality of employees, motivation, and incentives, these variances often can be dealt with effectively. An example of a high-impact but difficult-to-control item for many companies has been the cost of energy. Many organizations, from airlines to taxicab companies to steel mills, have been able to do little about rising energy costs in the short run. Over time, of course, they can take actions to reduce energy usage by acquiring energy efficient equipment. In general, the longer the time interval considered, the greater the ability to control an item.
After computing variances, managers and accountants must decide which ones to inves- tigate. Because their time is a scarce resource, managers must set some priorities. This can be done by using cost-benefit analysis. Only the variances for which the benefits of correction exceed the costs of follow-up should be pursued. In general, this is consistent with the management by exception philosophy, which says, in effect, Don’t worry about what is going according to plan; worry about the exceptions.
This is easier said than done, however. It can be almost impossible to predict either the costs or benefits of investigating variances. So, although the principle is straightforward, the application is difficult. In this section, we identify some characteristics that are impor- tant in determining which variances to investigate. Some problems are easily corrected as soon as they are discovered. When a machine is improperly set or a worker needs minor instruction, the investigation cost is low and the benefits are very likely to exceed the costs. This is often true for a usage or efficiency variance, which is reported frequently, often daily, so that immediate corrective action can be taken.
Some variances are not controllable in the short run. Labor price variances that are due to changes in union contracts and overhead spending variances resulting from unplanned utility and property tax rate changes might require little or no follow-up in the short run. Such variances sometimes prompt long-run action, such as moving a plant to a locale with lower wage rates and lower utility and property tax rates. In such cases, the short-run benefits of variance investigation are low, but the long-run benefits could be higher.
Many variances occur because of errors in recording, bookkeeping adjustments, or timing problems. A variance reporting system (and the accounting department) can lose credibility if it makes bookkeeping errors and adjustments. For this reason, the accounting staff must carefully check variance reports before sending them to operating managers.
Standards are estimates. As such, they might not reflect conditions that actually occur, especially when standards are not updated and revised to reflect current conditions. If prices and operating methods are changed frequently, standards could be constantly out of date.
Many companies revise standards once a year. Thus, variances occur because conditions change during the year but the standards do not. When conditions change but are known to be temporary, some companies develop a planned variance. For example, we discussed in Chapter 10 the problems caused by using expected production to allocate fixed overhead using expected activity when a firm has excess capacity. For this reason, some firms use a long-run “normal” volume to allocate fixed production costs. In a year when expected activity will be below normal volume, the company expects, or plans for, an unfavorable volume variance.
Using a planned variance, the company sends managers the right signal about prod- uct costs, but, because they planned for the unfavorable production volume variance, it does not affect the performance evaluation and control activity.
No comments:
Post a Comment