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# Variance repoting

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### Variance repoting

1. 1. BILASPUR (C.G.) 495009 DEPARTMENT OF MANAGEMENT STUDIES M.B.A. III SEM. SESSION: 2011-12 SUBJECT: MANAGEMENT CONTROL SYSTEMPRESENTATION TOPIC: “VARIANCE REPORTING ” Submitted To: Submitted By: Dr. B. D. MISHRA NILESH KUMAR RAJPUT Associate Professor M. A. (Eco.); M.B.A.; Ph.D. .
2. 2. CONTENTS1. INTRODOCTION………………………………… ……..012. REVENUE VARIANCES …………………….. ………023. EXPENSE VARIANCES.……. ………………………….044. VARIANCES IN PRACTICE……………………………045. EVALUATION STANDARDS.....................................066. LIMITATIONS ON STANDARDS ………………. …….087. LIMITATIONS OF VARIANCE ANALYSIS ………....10
3. 3. 8. CONCLUSION……………………………………… ..…..129. REFERENCES INTRODUCTION Most company made a monthly analysis of difference between actual and budgeted revenues and expense for each business unit and for the whole organization (some do this quarterly). A more through analysis identifies the cause of the variances and the organization unit responsible. Effective systems identify variances down to the lowest level of management. Variances are hierarchical as shown below:
4. 4. They begin with the total business unit performance, which is divided into revenue varianceand expense variance. Revenue variance is further divided into volume and price variance for the totalbusiness unit and for each marketing responsibility center within the unit. They can be further dividedinto sales area and sales district. Expense variances can be divided between manufacturing expensesand other expenses. Manufacturing expenses can be further subdivided by factories and departmentswithin factories. Therefore, it is possible to identify each variance with the individual manager who isresponsible for it. This type of analysis is a powerful tool, without which the efficacy of profit budgetswould be limited.The profit budget has embedded in it certain expectations about the state of the total industry andabout the companys market share, its selling prices, and its cost structure. Results from variancecomputations are more "actionable" if changes in actual results are analyzed against each of theseexpectations. The analytical frame-work we use to conduct variance analysis incorporate thefollowing ideas:•Identify the key causal factors that affect profits.•Break down the overall profit variances by these key causal factors.•Focus on the profit impact of variation in each causal factor.•Try to calculate the specific, separable impact of each causal factor by varying only that factor whileholding: all other factors constant ("spinning only one dial at a time"). -
5. 5. •Add complexity sequentially one layer at a time, beginning at a very basic "commonsense" level("peel the onion").•Stop the process when the added complexity at a newly created level is not justified by added usefulinsights into the causal factors underlying the overall profit variance. ..-Revenue VariancesRevenue variance includes selling price, volume, and mix variances. The calculation is made for eachproduct/line, and the product line results are then aggregated to calculate the total variance. A positivevariance is favorable, because it indicates that actual profit exceeded budgeted profit, and a negativevariance is unfavourable.Selling Price Variance The selling price variance is calculated by multiplying the difference between the actual priceand standard price by the actual volume.Mix and Volume VarianceOften the mix and volume variances are not separated. The equation for the combined mix and volumevariance is:Mix and volume variance = (Actual volume -Budgeted volume) * Budgeted unit contributionThe volume variance results from selling more units than budgeted .The mix variance results fromselling a different proportion of products from that assumed in the budget. Because products earndifferent contributions per unit, the sale of different proportions of products from those budgeted willresult in a variance. If the business unit has a "richer" mix (i.e. a higher proportion of products with ahigh contribution margin) the actual profit will be higher than budgeted; and if it has a "leaner" mix,the profit will be lower.MiX VarianceThe mix variance for each product is found from the following equation:Mix variance = [(Total actual volume of sales * Budgeted proportion) - (Actual volume of sales)]* Budgeted unit contributionVolume VarianceThe volume variance can be calculated by subtracting the mix variance from the combined mixand volume variance.
6. 6. Volume variance = [(Total actual volume of sales) * (Budgeted percentage)] - [(Budgeted sales) * (Budgeted unit contribution)]Other Revenue AnalysisRevenue variances may be further subdivided. Market Penetration and Industry VolumeMarket PenetrationOne extension of revenue analysis is to separate the mix and volume variance into the amount causedby differences in market share and the amount caused by differences in industry volume. The principleis that the business unit managers are responsible for market share, but they are not responsible for theindustry volume because that is largely influenced by the state of the economy. To make thiscalculation, industry sales data must be available.The following equation is used to separate the effect of market penetration from industry volume onthe mix and volume variance:Market share variance = [(Actual sales) - (Industry volume)] * Budgeted market penetration * Budgeted unit contributionIndustry VolumeThe industry volume variance can also be calculated for each product as follows:Industry variance= (Actual industry volume - Budgeted industry volume) * Budgeted market penetration * Budgeted unit contributionThis calculation of variance due to industry volume is shown in Section D.Expense Variances: It includes: Fixed Costs and Variable CostsFixed Costs
7. 7. Variances between actual and budgeted fixed cost are obtained. Simply by subtraction, since thesecosts are not affected by either the volume of sales or the volume of production.Variable CostsVariable costs are costs that vary directly and proportionately with volume. The budgeted variablemanufacturing costs must be adjusted to the actual volume of production.Variances in PracticeAs discussed above, is relatively straightforward way of identifying the variance that caused actualprofit in a business unit to be different from the budgeted profitability. Some variations from thisapproach are described in this sectionTime period of the ComparisonSome companies use performance for the year to date as the basis for comparison; for the periodended June 30, they would use budgeted and actual amounts for the six months ending on June30, rather than the amounts for June. Other companies compare the budget for the whole yearwith the current estimate of actual performance for the year. The actual amounts for the reportprepared as of June 30 would consist of actual numbers for the first six months plus the bestcurrent estimate of revenues and expenses for the second six months. A comparison for the year to date is not as much influenced by temporary aberrationsthat may be peculiar to the current month and, therefore, that need not be of as much concern tomanagement. On the other hand, it may mask the emergence of an important factor that is nottemporary. A comparison of the annual budget with current expectation of actual performance forthe whole year shows how closely the business unit manager expects to meet the annual profittarget. If performance for the year to date is worse than the budget for the year to date, it ispossible that the deficit will be overcome in the remaining months. On the other hand, forcesthat caused actual performance to be below budget for the year to date may be expected tocontinue for the remainder of the year, which will make the final numbers significantly differentfrom the budgeted amounts. Senior management needs a realistic estimate of the profit for thewhole year, both because it may suggest the need to change the dividend policy, to obtain
8. 8. additional cash, or to change levels of discretionary spending, and also because a currentestimate of the years performance is often provided to financial analysts and other outsideparties. Obtaining a realistic estimate is difficult. Business unit managers tend to be optimistic abouttheir ability to perform in the remaining months because, if they are pessimistic, this casts doubt ontheir ability to manage. To some extent, this tendency can be overcome by placing the burden of proofon business unit managers to show that the current trends in volume, margins, and costs are not goingto continue. Nevertheless, an estimate of the whole year is soft, whereas actual performance is a matterof record. An alternative that lessens this problem is to report performance both for the year to dateand for the year as a whole.Focus on Gross MarginIn many companies, changes in costs or other factors are expected to lead to changes in selling prices,and the task of the marketing manager is to obtain a budgeted gross margin-that is, a constant spreadbetween costs and selling prices. Such a policy is especially important in periods of inflation. Avariance analysis in such a system would not have a selling price variance. Instead, there would be agross margin variance. Unit gross margin is the difference between selling prices andmanufacturing costs. The variance analysis is done by substituting “gross margin “for “selling price” in the price" inthe revenue equations. Gross margin is the difference between actual selling prices and the standardmanufacturing cost. The current standard manufacturing cost should take into account changes inmanufacturing costs that are caused by changes in wage rates and in material prices (and, in somecompanies, significant changes . other input factors, such as electricity in aluminum manufacturing).The standard, rather than the actual, cost is used so that manufacturing inefficiencies do not affect theperformance of the marketing organization.Evaluation StandardsIn management control systems, the formal standards used in the evaluation of reports on actualactivities are of three types: (1) Predetermined standards or budgets,
9. 9. (2) Historical standards, or (3) External standards.(1) Predetermined Standards or Budgets If carefully prepared and coordinated, these are excellent standards. They are the basis againstwhich actual performance is compared in many companies. If the budget numbers are collected in ahaphazard manner, they obviously provide will not a reliable basis for comparison.(2) Historical standards These are records of past actual performance. Results for the current month may be comparedwith the results for last month or with results for the same month a year ago. This type of standard hastwo serious weaknesses: (1) Conditions may have changed between the two periods in a way that invalidates the comparison, and (2) The prior periods performance may not have been acceptable.A supervisor whose spoilage cost is \$500 a month, month after month, is consistent; but we do notknow, without other evidence, whether the performance was consistently good or consistently poor.Despite these inherent weaknesses, historical standards are used in some companies, often becausevalid predetermined standards are not available.(3) External StandardsThese standards derived from the performance of other responsibility centers or of othercompanies in the same industry. The performance of one branch sales office may be comparedwith the performance of other branch sales offices. If conditions in these responsibility centers are similar, such a comparison may provide anacceptable basis for evaluating performance. Some companies identify the company that they believe to be the best managed in theindustry and use numbers from that company-either with the cooperation of that company or frompublished material-as a basis of comparison. This process is called benchmarking. Data for individual companies are available in annual and quarterly reports and in Form10K (Form 10K data are available from the Securities and Exchange Commission and are