ACCA F5 Performance Management - 2010 - Study text - Emile Woolf Publishing
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Chapter 11: Advanced variance analysis
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The planning variance for materials price is $7 - $6 per kilo = $1 per kilo. It is an
adverse variance, because the ex-post standard for materials price is more costly
than the ex-ante standard.
The planning variance for materials usage is 5 kilos – 4 kilos = 1 kilo per unit
produced, which is 4,000 kilos in total for 4,000 units produced. It is a favourable
variance, because the ex-post standard for materials usage per unit is less costly
than the ex-ante standard.
Planning variance caused by the material price difference
Unfortunately, there are two methods of calculating the planning variances for price
and usage.
Planning variance for materials price
(1) Method 1: Price planning variance per kilo × Standard usage in ex-post standard
(2)
Method 2: Price planning variance per kilo × Standard usage in ex-ante standard
Planning variance for materials usage
(3) Method 1: Usage planning variance = Planning variance per unit produced ×
Standard price in ex-ante standard
(4)
Method 2: Usage planning variance = Planning variance per unit produced ×
Standard price in ex-post standard
To avoid double-counting, method (1) for the material price planning variance must
be used with method 1 for the materials usage planning variance. Similarly method
(2) for the material price planning variance must be used with method 2 for the
materials usage planning variance.
In the example above:
Planning Method 1 Method 2
variance
$ $
Price
$1 per kilo (A)
×
16,000 kilos
16,000 (A)
$1 per kilo (A) ×
20,000 kilos
20,000 (A)
Usage
4,000 kilos (F)
× $6
24,000
(F)
4,000 kilos (F)
× $7
28,000 (F)
Total 8,000
(F) 8,000
(F)
A final example of planning and operational variances will be used to summarise
the rules.
Example
Redco manufactures product K, which at the start of the budget period had a
standard direct labour cost per unit of: 0.3 hours per unit
× $16 per hour = $4.80.
Actual output during a month is 10,000 units of product K, and these took hours to
make. The actual direct labour cost was $.
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Due to an unexpected pay agreement with the direct labour employees, the
standard rate per hour is revised to $20. In addition, since the pay rise is linked to a
productivity agreement, the standard time per unit of product K is reduced to 0.25
hours. The revised standard labour cost for product K is therefore:
0.25 hours
× $20 per hour = $5.
Actual output during a subsequent month is 10,000 units of product K, and these
took 2,650 hours to make. The actual direct labour cost was $51,600.
Required:
(a)
Analyse the total direct labour variance into operational variances and a
planning variance.
(b)
Then analyse the total planning variance into a planning variance for labour
rate and a planning variance for labour efficiency.
Answer
Operational variances
These are calculated by comparing actual results with the ex-post standard.
Labour rate variance (operational variance)
$
2,650 hours should cost (× $20)
53,000
They did cost 51,600
Direct labour rate variance 1,400 (F)
Labour efficiency variance (operational variance) hours
10,000 units should take (× 0.25 hours)
2,500
They did take 2,650
Efficiency variance in hours 150 (A)
Standard direct labour rate per hour $20
Direct labour efficiency
variance in $ $3,000 (A)
Total planning variance
$
Ex ante
standard
10,000 units
× 0.30 hours = 3,000 hours × $16 per hour
48,000
Ex post
standard
10,000 units
× 0.25 hours = 2,500 hours × $20 per hour
50,000
Total planning variance for labour 2,000
(A)
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The planning variance is adverse because the ex post standard cost is higher than
the ex ante standard cost.
Summary, planning and operational variances $
Operational variances
Lasbour rate 1,400 (F)
Labour efficiency 3,000 (A)
Total operational variances 1,600 (A)
Labour cost planning variance: total 2,000 (A)
Total labour cost variances 3,600 (A)
The total variance is the difference between the ex ante standard labour cost (=
$48,000) and actual labour costs ($51,600).
Analysing the total planning variance
The total planning variance can be calculated in two ways:
Planning Method 1 Method 2
variance
$ $
Rate
$4 per hour (A)
×
2,500 hours
10,000 (A)
$4 per hour (A) ×
3,000 hours
12,000 (A)
Efficiency
500 hours (F)
×
$16 per hour 8,000 (F)
500 hours (F) × $20
per hour 10,000 (F)
Total 2,000
(A)
2,000
(A)
2.7 Advantages and disadvantages of using planning and operational
variances
There are several advantages and disadvantages to using planning and operational
variances.
Advantages
They identify variances due to poor planning and put a realistic value to
variances resulting from operations.
Planning variances can be used to update standard costs and revise budgets.
The performance of managers is assessed on ‘realistic’ variance calculations,
using ex post standard costs that are more realistic than ex ante standard costs.
Disadvantages
They are based on the assumption that planning will be inaccurate or unrealistic.
This should occur only occasionally, not regularly.
It takes time and effort to prepare ex post standard costs and to revise budgets.
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Managers might try to blame poor results on poor planning and not on their
operational performance.
2.8 Manipulation issues in revising budgets
When variances are reported as planning and operational variances, operational
managers are likely to be:
made accountable for operational variances
not made accountable for planning variances.
It is not possible to take control action to rectify the causes of planning variances
(except perhaps by improving planning procedures next year).
If managers are help responsible for operational variances but not planning
variances, there will be a temptation to ‘manipulate’ the standard cost or budget by
revising it so that:
the ‘ex post’ standard cost is higher than the ex ante standard cost (so there will
be an adverse planning variance)
the revised budgeted profit is lower than the ex ante budget profit (so there will
be an adverse planning variance).
By revising the standard cost or budget in this way, to create adverse planning
variances, the operational variances will be improved. Any adverse operational
variance using the ex ante standard will be:
reduced using the ex post standard, or
possibly turned into a favourable variance using the ex post standard.
This risk, that operational managers improving their operational variances by
revising the standard cost or budget, should be kept under control. There are two
ways that this might be done:
A revision to the standard cost or budget should be permitted only in
circumstances where the reasons for the change in the standard cost or budget
are outside the control of operational management. For example, a revision to
materials prices maybe allowed if the market price of a key raw material (such as
the cost of oil or the cost of a commodity) increases to a level far in excess of the
budgeted price.
Changes that may be subject to management influence and control should not be
included in a revision to the budget.
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Market size and market share variances
The meaning of market size and market share variances
Market size variance
Market share variance
Performance measurement and market size and market share variances
3 Market size and market share variances
3.1 The meaning of market size and market share variances
Just as standard cost variances can be analysed into planning and operational
variances by preparing an ex post standard cost, sales volume variances can be
analysed into planning and operational variances by producing an ex post sales
budget.
However, in analysing a sales volume variance:
the planning variance for sales volume is called a market size variance and
the operational variance for sales volume is called the market share variance.
However, a market size and a market share variance can be calculated without any
requirement to revise the sales budget.
When a budget is prepared for sales volume, the estimate of sales volume is based
on several estimates or assumptions:
There maybe an estimate of the total size of the market for the product during
the period. This is the estimated amount of sales in total for the market or
market segment, including the sales made by competitors.
Within this estimate of total market size, the entity may budget the share of the
market that it will obtain.
For example, a company may estimate that the total market size for a product in the
next year will be 100,000 units or $2 million, and it may estimate that it will obtain
30% of the total market. Its sales budget for the year would therefore be 30,000 units
or $600,000.
Actual sales might be just 28,000 units. The reasons could be either that:
The total market size was less than 100,000 units (market size variance), or
The market share obtained by the company was less than 30% (market share
variance)
A value can be calculated for the market size and market share variances and the
sum of these two variances will be equal to the total sales volume variance for the
period.
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Controllability of market size and market share variances
It might also be assumed that:
The total size of the market is a factor that is largely outside a company’s control.
However the market share obtained by a company is controllable to some extent
by management, through marketing activities such as advertising, direct selling,
distribution arrangements, after-sales service and price incentives (bulk order
discounts, competitive pricing, and so on).
3.2 Market size variance
A market size variance is the effect on sales volume (and so on contribution or
profit) if the actual total size of the market is:
larger than expected (favourable market size variance), or
smaller than expected (adverse market size variance).
The total difference between the budgeted total market size and the actual total
market size is calculated initially either in (1) units of sale or (2) sales revenue at
standard selling prices.
It is assumed that the company should achieve its budgeted market share.
The market size variance for the company is therefore (in units or in sales
revenue at standard sales price) the difference in the total market size multiplied
by the estimated market share.
This is then converted into an amount of standard contribution or standard
profit, using the same method used to calculate the sales volume variance.
Example
Colorco set the following sales budget:
Sales of Product Y = 43,000 units
Contribution per unit = $20
Colorco estimates that the total size of the market in the budget period will be
700,000 units. It budgets to have a market share of 10% or 70,000 units.
Actual sales results for the period were as follows:
Sales of Product Y by Colorco = 58,000 units
Total market sales of Product Y = 645,000 units
In retrospect, it is accepted that the budget should have been based on a total
market share of 645,000 units.
Required
Calculate the market size variance for the year.
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Answer
Market size variance units
Ex ante (budgeted) total market size 700,000
Ex post (actual) total market size 645,000
Total difference 55,000 (A)
Budgeted market share 10%
Market size variance (units) 5,500 (A)
Standard contribution per unit $20
Market size variance in $ contribution $110,000 (A)
3.3 Market share variance
A market share variance is calculated by taking the actual total market size (the ex
post estimate of the market size) and comparing:
the expected sales volume, if the budgeted market share had been achieved, and
actual sales volume.
This variance (in sales units or in sales revenue at standard sales price) is converted
into a contribution or profit variance using the same method used to calculate the
sales volume variance.
Example
Colorco set the following sales budget:
Sales of Product Y = 43,000 units
Contribution per unit = $20
Colorco estimates that the total size of the market in the budget period will be
700,000 units. It budgets to have a market share of 10% or 70,000 units.
Actual sales results for the period were as follows:
Sales of Product Y by Colorco = 58,000 units
Total market sales of Product Y = 645,000 units
In retrospect, it is accepted that the budget should have been based on a total
market share of 645,000 units.
Required
Calculate the market share variance for the year.
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Answer
Market share variance
units
Ex post (actual) total market size 645,000
Budgeted market share 10%
units
Expected sales if budgeted market share achieved 64,500
Actual sales 58,000
Market shae variance (units) 6,500 (A)
Standard contribution per unit $20
Market share variance in $ contribution $130,000 (A)
Summary
$
Market size variance 110,000 (A)
Market share variance 130,000 (A)
Total sales volume variance (70,000 units – 58,000 units)
× $20
per unit
240,000 (A)
The market size variance and the market share variance together add up to the total
sales volume variance for the period.
A final example is given below.
Example
The sales budget of Brunco was based on the following estimates:
Total size of market: 200,000 units
Expected market share: 25%
Standard contribution per unit $40
At the end of the year it was estimated that the actual size of the market during the
year had been 260,000 units.
Actual sales in the year were 61,000 units.
Required
Calculate for the year:
(a) the total sales volume variance
(b) the market size variance
(c) the market share variance.
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Answer
units
Budgeted sales volume (25% × 200,000)
50,000
Actual sales volume 61,000
Sales volume variance in units 11,000 (F)
Standard contribution per unit $40
Sales volume variance in $ contribution $440,000 (F)
Market size variance units
Ex ante (budgeted) total market size 200,000
Ex post (actual) total market size 260,000
Total difference 60,000 (F)
Budgeted market share 25%
Market size variance (in units) 15,000 (F)
Standard contribution per unit $40
Market size variance in $ contribution $600,000 (F)
Market share variance
units
Ex post (actual) total market size 260,000
Budgeted market share 25%
units
Expected sales if budgeted market share achieved 65,000
Actual sales 61,000
Market share variance (units) 4,000 (A)
Standard contribution per unit $40
Market share variance in $ contribution $160,000 (A)
Summary
$
Market size variance 600,000 (F)
Market share variance 160,000 (A)
Total sales volume variance 440,000 (F)
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3.4 Performance measurement and market size and market share variances
For your examination, you must be able to interpret and comment on market size
and market share variances, as well as calculate them correctly. Variances are
intended to provide indicators of performance, for the purposes of performance
assessment and management control.
Market size and market share variances, together with the sales price variance, can
indicate how well or badly a company is performing given current conditions in its
market. As a general guide, it is useful to remember that in a competitive market,
management:
are unlikely to have any control over the total market size, but
could have some control over market share, by means of marketing measures
such as improved selling methods and sales price initiatives.
To assess a company’s performance, it might therefore be useful to look at:
whether the total market size is bigger or smaller than budgeted, and
whether the company has achieved a larger or smaller share of the market than
budgeted.
Losing market share in a growing market could be a cause for concern and a sign of
poor performance. Gaining market share in a shrinking market could indicate
excellent performance in difficult business conditions.
Example
A company reported the following variances for the year just ended:
Sales price variance: $145,000 (A)
Sales volume variance: $180,000 (A)
Market size variance: $290,000 (A)
Market share variance: $110,000 (F)
The company operates in a highly competitive market, but the market has been
affected by an economic recession and a significant fall in total demand. During the
year it achieved a 25% share of the total market. One competitor went into
liquidation during the year.
How might performance be assessed on the basis of this information?
Answer
The market has been badly affected by an economic recession and the company has
reported an adverse sales price variance and an adverse sales volume variance,
totalling $325,000(A). Actual profit is therefore $325,000 less than budgeted profit
because sales prices and sales volume were worse than expected.