Analyzing financial performance
-
Upload
puneet-mathur -
Category
Economy & Finance
-
view
128 -
download
0
description
Transcript of Analyzing financial performance
1
Analyzing Financial Performance Reports
2
Topics
• Post-budget control
• The need for computing variances
• Variance as a control measure
• The different types of variances
• Using variances to evaluate performance
3
Need for comparing actual to budgeted
• Even the best run organization cannot make perfect
forecasts.
• Forecasts always contain errors – random and non-random.
• How should we assess the performance of a responsibility
center manager when the budgeted performance does not
match actual performance.
• Through variance analysis, a control mechanism.
• Variance analysis would reveal what caused the deviations
and what should be done in future.
4
Variances
• Traditionally, variances or deviation of actual
from budgeted numbers is done at periodic
intervals
• Is this adequate?
• Recent approach: do such analysis on a routine
basis or as a continuous improvement
approach
5
Variances
• Computing variances is simple; it should be
extended from top to the lowest levels of
management to develop a true understanding
of the causes.
• The variance should be broken into its different
elements – revenue, expenses, etc.
6
Before we proceed, let us briefly go over a few basic cost/managerial concepts
• The following costs:
• Standard cost
• Fixed cost
• Variable cost
• Are standard cost same as budgets?
7
Standard Costs
• Standards are benchmarks.
• In the context of manufacturing or services, standard
costs represent each major input (e.g. raw materials,
labor time) that a product or service must use.
• Cost standards refer to how much you should pay for
an item or service.
• It is a management by exception concept.
8
•Budget for a single unit•Each unit has standards for:
Standard Costs
Copyright (c) 2009 Prentice Hall. All rights reserved. 8
9
Fixed costs
• A cost that remains constant, in total,
regardless of changes in the level of activity.
• Examples: rent, investment in machinery,
building
• Consequently, more the level of activity,
smaller the fixed cost per unit of activity or vice
versa.
10
Variable Costs
• Variable cost is cost that varies, in total, in direct
proportion to changes in the level of activity.
• Example: as units produced increases, raw
material usage, direct labor costs will go up
proportionately.
• Total costs rises and falls with the level of
activity.
11
Price Standards
Copyright (c) 2009 Prentice Hall. All rights reserved. 11
12
Quantity Standards
Copyright (c) 2009 Prentice Hall. All rights reserved. 12
13
Price Standard Quantity Standard
Direct Materials
Responsibility: Production managers
Responsibility: Production managers & engineers
Factors: Purchase price, discounts, delivery, credit policy
Factors: Product specifications, spoilage, production scheduling
Direct Labor Responsibility: Human resource managers
Responsibility: Production managers & engineers
Factors: Wage rate, payroll taxes, fringe benefits
Factors: Time requirements
Manufacturing Overhead
Responsibility: Production managers Factors: Nature and amount of resources needed for support activities
Summary of Standard Setting Issues
Copyright (c) 2009 Prentice Hall. All rights reserved. 13
14
Helps managers:
• In budget preparation
• Target levels of performance
• Identify performance standards
• Set sales prices
• Decrease accounting costs
Benefits of Standard Costs
Copyright (c) 2009 Prentice Hall. All rights reserved. 14
15
Cost behavior
• Remember: Costs – both fixed and variable
work only within a relevant range.
• For example, whether you produce 10 units or
100,000 units, will the variable cost per unit
remain the same? No.
• Many costs might also have a fixed and
variable components. E.g. Telephone bill
16
Basic Variance Analysis
• Analyzing the factors that caused the actual
and budgeted (costs, revenues, production
units, etc.) is called variance analysis.
• Usually, variance analysis is separated into two
categories – quantity and price.
• This is because the same individual may not be
responsible for both quantity and price.
17
A basic variance model – Price and Quantity variances
Actual Quantity Actual Quantity Standard Quantityof inputs of inputs allowed for outputat Actual Price at Standard Price at Standard Price
(AQ x AP) (AQ X SP) (SQ x SP) (1) (2) (3)
Price Variance1-2
Materials PriceVarianceLabor rate varianceVariable overhead spending variance
Quantity Variance2 -3Materials Quantity VarianceLabor efficiency varianceVariable overhead efficiencyvariance
Total Variance
18
Let us use the following data from Colonial Pewter Co.
Std. Qty Std. Price Std. Cost
Inputs or Hours or Rate
(1) (2) (1) x (2)
Direct materials 3 pound $ 4.00 $12.00
Direct Labor 2.5 hours 14.00 35.00
Variable Mfg. overhead 2.5 hours 3.00 7.50
Total std. cost per unit $54.50
Standard cost of direct materials per unit of product = 3 lbs x $4 per lb = $12 per unit.Purchasing records show that in June, 6,500 lbs. of pewter were purchased at a cost of $3.80 per pound. The cost included freight and handling. All of the materials purchased was used during June to manufacture 2,000 lbs of pewter bookends. Using the data, let us computer price and quantity variances.
19
Price and Quantity variances for Colonial Pewter
Actual Quantity Actual Quantity Standard Quantity
of inputs of inputs allowed for output
at Actual Price at Standard Price at Standard Price
(AQ x AP) (AQ X SP) (SQ x SP) (1) (2) (3)
6,500 pounds x $3.80 6,500 lbs. x $4.00 6,000 lbs. x per lb. = $24,700 = $26,000 $4.00 = $24,000
Total Variance = $700 U
Price variance = $1,300 F Quantity Variance = $2,000 U
20
Interpretation
• First, $24,700 refers to the actual total cost of the pewter that was
purchased during June.
• Second, $26,000 refers to what the pewter would have cost if it had
been purchased in the standard price of $4.00 a pound rather than
the actual price of $3.80 per pound.
• Difference between first and second, $1,300 is the price variance.
• Third, $24,000 represents cost of Pewter if it were purchased at
standard price and if standard quantity had been used.
• The difference between second and third is the quantity variance.
21
In the previous example, the quantity of pewter purchased was 6,500 lbs. and the Quantity used in production was also 6,500 lbs. But, such occurrences are rare. More common is, the quantity purchased will be greater than quantity used and the excess quantity will be carried out as ending inventory to the next period. How would you compute variances under such conditions?
Let us look at the next slide. Out of 6,500 lbs. purchased, only 5,000 lbs. were used (Standard lbs. allowed for the production is 4,800 lbs = 1,600 units x 3 lbs. per unit). Usually, price variance is computed as soon as purchases are made while quantity variance may overlap into more than one period.
22
Price and Quantity variances when quantity purchased and used differ
Actual Quantity Actual Quantity Standard Quantity
of inputs of inputs allowed for output
at Actual Price at Standard Price at Standard Price
(AQ x AP) (AQ X SP) (SQ x SP) (1) (2) (3)6,500 pounds x $3.80 6,500 lbs. x $4.00 4,800 lbs.
x per lb. = $24,700 = $26,000 $4.00 = $19,200
Price variance = $1,300 F
Quantity Variance = $800 U
5,000 lbs. x 4.00 per pound = $20,000
23
Revenue variances
• Unlike cost variances, revenue variances focus
on
• selling prices and how
• Volume of sales and
• Mix (of various products)
Impact revenue and profitability
24
Selling Price Variance
• What causes selling price variance?
• Difference between the price you set (budgeted
price) and the actual price at which you sell
(using actual volume of sales).
25
Sales Price Variance
• Three products – A, B, and C
• The budgeted prices are $1.00, 2.00, and 3.00
respectively
• Actual selling price was $0.90, 2.05, and 2.50
respectively.
• Actual volume of sales in units – 100, 200, and 150
respectively.
• Sales price variance is = [100 (1.00 -0.90) + 200 (2.00 –
2.05) + 150 (3.00 – 2.50)] = 75
26
Mix and Volume Variance
• The firm sells several products (mix) and the volume of
sales for each is different.
• If we do not separate the mix and volume into separate
components (to get a general overview), then the
equation to compute a combined mix/volume variance is
• Mix/Vol. variance = [Actual Vol. – Bud. Volume] *
Budgeted contribution
• Contribution = Selling price – variable costs only
27
Combined Mix and Volume Variance
Product 1
Actual Volume
2
Bud. Volume
3
Difference 4
(2-3)
Unit contribution
5
Variance 6
(4-5)A 100 100 0 -- --B 200 100 100 $0.90 $90.00C 150 100 50 1.2 $60.00
Total 450 300 150
The$150 variance is favorable in this example because the actual sales volume for the three products combined was more than what was budgeted
28
Now, if you want to separate the mix and volume variances by each product -
• We can find this by using the following equation:
Mix variance = [(Act. Vol. of sales) – (total act vol of sales * budgeted proportion)] *
Budgeted unit contribution
Volume variance is easy to compute; We already computed the
combined variance. From this, subtract the mix variance to be
computed using above equation
29
Mix Variance
Product 1
Bud. Proportion
2
Bud. Mix at Actual Volume
(3)Actual Sales
4
Difference 5
(4-3)
Unit contribution
6
Variance 7
(5) * (6)A 1/3 150 100 -50 0.2 -10B 1/3 150 200 50 $0.90 45C 1/3 150 150 0
Total 0 450 450 0 1.1 35
• See Column 3 and 4 – A higher proportion of B was sold while a lower proportion A was sold to A.• Since the contribution margin for B is higher (0.90) compared to A (0.20), the mix variance is favorable (35)
30
Volume variance separated from mix variance
• We already computed the combined mix/volume
variance (three slides earlier). It is 150.
• The mix variance we just computed is 35.
• Therefore, volume variance =
150 - 35 = 115
• Formula for volume variance =
• [(Total Act Vol of Sales) * (Budgeted Proportion) –
Budgeted Sales] * Budgeted Unit contribution
31
Isolation of Variances
• At what point should variances be isolated and
brought to the attention of the management?
• Earlier the better.
• What should management do?
• Variances should be viewed as ‘red flags.”
• Seek explanations for the reasons behind
variances and then decide, responsibility, course
of action.
32
Other relevant issues of Variance Analysis –Time period comparison
Is comparison of annual budgets with annual
performance reports better than,
• Quarterly budgets with quarterly performance
comparisons?
• Or, shorter period comparisons?
• It depends on the objectives of the decision
maker.
33
Other relevant issues of Variance Analysis –selling price or gross margin?
• We computed revenue variances based on
selling prices. Is this realistic?
• Does selling price remain constant throughout
the year?
• And, if not, a better approach would be to focus
on gross margin (selling price- cost per unit)
than on sales prices to compute variances.
34
Who is generally responsible for monitoring and taking action on variances?
• One who can control the variance.
• Example:
• Purchase manager for purchase price
variance and
• Production manager for quantity variance.
35
Flexible-Budget Variance in Detail
Standard per unit of output:Standard per unit of output:
DirectDirect Direct Direct MaterialMaterial LabourLabour
Std. inputs expectedStd. inputs expected 5 kg5 kg ½ hour½ hourStd. price expectedStd. price expected $ 2$ 2 $16$16Std. cost expectedStd. cost expected $10$10 $ 8$ 8
36
Variances from Material and Labour Standards
Actual results for 7,000 units produced:Actual results for 7,000 units produced:
Direct materialDirect materialKgs purchasedKgs purchased
and used: 36,800and used: 36,800Price/kg: $1.90Price/kg: $1.90
Total actual cost:Total actual cost:$69,920$69,920
Direct labourDirect labourHours used: 3,750Hours used: 3,750
Actual price (rate): $16.40Actual price (rate): $16.40Total actual cost:Total actual cost:
$61,500$61,500
37
Variances from Material and Labour Standards
Flexible budget or totalFlexible budget or totalstandard cost allowed: $70,000standard cost allowed: $70,000
Units of good output achieved: 7,000Units of good output achieved: 7,000
Input allowed per unit of output: 5 kgsInput allowed per unit of output: 5 kgs
Standard unit price of input: $2/kgStandard unit price of input: $2/kg
××
××
==
Standard Direct-Materials Cost Allowed:Standard Direct-Materials Cost Allowed:
38
Variances from Material and Labour Standards
Direct material flexible-budget varianceDirect material flexible-budget variance
ActualActualcostcost
$69,920$69,920
FlexibleFlexiblebudgetbudget$70,000$70,000
$80 Favourable$80 Favourable
39
Variances from Material and Labour Standards
Flexible budget or totalFlexible budget or totalstandard cost allowed: $56,000standard cost allowed: $56,000
Units of good output achieved: 7,000Units of good output achieved: 7,000
Input allowed per unit of output: ½ hourInput allowed per unit of output: ½ hour
Standard unit price of input: $16/hourStandard unit price of input: $16/hour
××
××
==
Standard Direct-Labour Cost Allowed:Standard Direct-Labour Cost Allowed:
40
Variances from Material and Labour Standards
Direct labour flexible-budget varianceDirect labour flexible-budget variance
ActualActualcostcost
$61,500$61,500
FlexibleFlexiblebudgetbudget$56,000$56,000
$5,500 Unfavorable$5,500 Unfavorable
41
Price and Usage Variances
(Actual quantity – (Actual quantity – StandardStandard quantity) quantity)× × StandardStandard price price
(Actual price – (Actual price – StandardStandard Price) Price)× Actual quantity × Actual quantity
42
Price Variance Computations
($16.40 – $16.00) per hour($16.40 – $16.00) per hour× 3,750 hours = $1,500 U× 3,750 hours = $1,500 U
($1.90 – $2.00) per kg($1.90 – $2.00) per kg× 36,800 kg = $3,680 F× 36,800 kg = $3,680 F
43
Usage Variance Computations
[3,750 – (7,000 × ½)] hours[3,750 – (7,000 × ½)] hours× $16 per hour = $4,000 U× $16 per hour = $4,000 U
[36,800 – (7,000 × 5)] kg[36,800 – (7,000 × 5)] kg× $2 per kg = $3,600 U× $2 per kg = $3,600 U
44
Favourable or Unfavourable Variance?
To determine whethera variance is favourable
or unfavourable, uselogic rather than
memorizing a formula.
45
Direct Materials Variances
• Price Variance—the cost difference
attributable to the difference between the
standard price of one unit of material and the
actual price of one unit of material.
• Quantity Variance—the cost difference
attributable to the difference between the
standard amount and the actual amount in
one unit of the product during the period.
46
Direct Materials Flexible Budget Variance
Direct material flexible-budget varianceDirect material flexible-budget variance
ActualActualcostcost
$69,920$69,920
FlexibleFlexiblebudgetbudget$70,000$70,000
$80 F$80 F
AQ × SPAQ × SP==
$73,600$73,600
$3,680 F
(Price variance)$3,600 U
(Usage variance)
47
Direct Labor Variances
•The standard is based on current wage
rates, adjusted for anticipated changes
such as cost of living adjustments.
•The rate standard also generally includes
employer payroll taxes, and fringe benefits
such as paid holidays and vacations.
48
Direct Labor Variance
AH X AR = X1
AH x SR = X2
SH x SR = X3
Where:
AH = actual hoursAR = actual rateSH = standard hoursSR = standard rate
Note: This is essentially the same formula as for materials, exceptwe substitute hours for quantity, and rate for price.
49
Direct Labour Flexible Budget Variance
Direct labour flexible-budget varianceDirect labour flexible-budget variance
ActualActualcostcost
$61,500$61,500
FlexibleFlexiblebudgetbudget$56,000$56,000
$5,500 U$5,500 U
AH × SPAH × SP==
$60,000$60,000
$1,500 U
(Price variance)$4,000 U
(Usage variance)
50
Interpretation of Price and Usage Variances
Price and usage variances are helpfulPrice and usage variances are helpfulbecause they provide feedbackbecause they provide feedbackto those responsible for inputs.to those responsible for inputs.
Managers should not use theseManagers should not use thesevariances alone for decisionvariances alone for decision
making, control, or evaluation making, control, or evaluation possibility of trade-offspossibility of trade-offs
51
Overhead Variance
• The total overhead variance can be broken into a
controllable variance and a overhead volume
variance.
• The formula is:
• Actual OH – Budgeted OH = Controllable variance
• Fixed OH rate x (Normal capacity hours – standard
hours allowed) = overhead volume variance
52
Three Kinds of Overhead
• Budgeted overhead—number we came up with at
the beginning of the year.
• Use for one thing—to calculate rate for the year
(actually we use it for calculating variance)
• Actual overhead—this is what we actually spent,
this number comes from the general ledger).
• Overhead applied—budgeted overhead rate x
base.
53
Overhead Variance
• The controllable variance tells whether spending
on individual overhead items was controlled or
not.
• The volume variance relates to whether overhead
was over or under applied due to differences in
budgeted base and actual base.
• i.e. did we us too many overhead hours (if it is
the base) or fewer than we estimated?
54
Variable-Overhead Efficiency Variance
When actual cost-driver activity differs fromWhen actual cost-driver activity differs fromthe standard amount allowed for the actualthe standard amount allowed for the actual
output achieved, a output achieved, a variable-overheadvariable-overheadefficiency varianceefficiency variance will occur. will occur.
55
Variable-Overhead Spending Variance
This is the difference between the actualvariable overhead and the amount
of variable overhead budgeted for theactual level of cost-driver activity.
56
Variable Overhead Example
The variable-overhead cost rate of$.60 per unit is equivalent to $1.20per direct labour hour because each
unit of output requires ½ hour of labour
Suppose that Dominion Company’s costof supplies, a variable-overhead cost,
is driven by direct labour hours.
57
Variable Overhead Example
Actual variable overhead = $4,700
Variable overhead allowed= $.60 × 7,000 units = $4,200
$500 unfavourable variance
58
Variable Overhead Example
($4,700 – ($1.20 × 3,750 actual hours used)= $200 U
(3,750 act. hours – 3,500 std. hours allowed)× $1.20 per hour = $300 U
59
Who is Responsible?
• Materials price variance—usually the purchasing
agent
• Materials quantity variance—usually the
production supervisor
• Labor rate variance—usually the personnel
director
• Labor efficiency variance—usually the production
supervisor
60
Who is Responsible?
• Overhead variances
• Over or under spending on specific overhead items
• Use of more or less of the base than anticipated.
For example if the base is direct labor hours, then
additional hours used incur additional fringe benefit
costs, one component of the overhead pool.
61
Reporting Variances
• Report variances to appropriate levels of
management as soon as possible.
• The form, content, and frequency of variance
reports varies considerably among companies.
• In income statements prepared for management,
cost of goods sold is stated at standard costs and
the variances are disclosed separately.