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©2014 Pearson Education. All rights reserved.
CHAPTER 8:
PERFORMANCE EVALUATION
©2014 Pearson Education. All rights reserved.
Learning Objectives
1. Explain static budgets and static-budget variances
2. Develop flexible budgets and compute flexible-
budget variances and sales-volume variances
3. Compute price variances and efficiency variances
for direct-cost categories
4. Plan for variable and fixed overhead costs and
calculate budgeted variable and fixed overhead
cost rates
©2014 Pearson Education. All rights reserved.
Learning Objectives
5. Partition the variable overhead flexible-budget
variance into variable overhead efficiency and
spending variances
6. Compute the fixed overhead flexible-budget (or
spending) variance and the fixed overhead
production-volume variance
7. Show how the variance analysis approach
reconciles the actual results for a period with the
results expected for that period
8. Understand how managers use variances
©2014 Pearson Education. All rights reserved.
Learning Objective 1
Explain Static Budgets and Static-
Budget Variances
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Basic Concepts
A variance is the difference between actual results
and expected performance
Management by exception is the practice of
focusing management attention on areas that are
not operating as expected and devoting less time to
areas operating as expected
The static budget is based on the level of output
planned at the start of the budget period
©2014 Pearson Education. All rights reserved.
Static-Budget Variance
The static-budget variance is the difference
between the actual result and the corresponding
budgeted amount in the static budget
A favorable variance results when actual revenues
exceed budgeted amounts or when actual costs are less
than budgeted costs
An unfavorable variance results when actual revenues
are less than budgeted amounts or when actual costs
exceed budgeted costs
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Learning Objective 2
Develop Flexible Budgets and
Compute Flexible-Budget Variances
and Sales-Volume Variances
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Flexible Budget
Calculates budgeted revenues and budgeted costs
based on the actual output in the budget period
Companies develop their flexible budgets in three
steps:
1. Identify the actual quantity of output
2. Calculate the flexible budget for revenues based on
budgeted selling price and actual quantity of output
3. Calculate the flexible budget for costs based on
budgeted variable cost per output unit, actual
quantity of output, and budgeted fixed costs
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Sales-Volume Variance
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Flexible-Budget Variance
The flexible-budget variance for revenues is called
the selling-price variance because it arises solely
from the difference between the actual selling price
and the budgeted selling price
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Learning Objective 3
Compute Price Variances and
Efficiency Variances for Direct-Cost
Categories
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Subdivision of Flexible-Budgets
Variance for Direct-Cost Inputs
A price variance that reflects the difference
between an actual input price and a budgeted
input price
An efficiency variance that reflects the difference
between an actual input quantity and a budgeted
input quantity
©2014 Pearson Education. All rights reserved.
Obtaining Budgeted Input Prices
and Quantities
Three main sources for information on budgeted input
prices and quantities:
Actual input data from past periods
Data from other companies that have similar
processes
Standards developed by a company
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Actual Input Data from Past Periods
Advantages:
They represent quantities and prices that are real,
rather than hypothetical
They can serve as benchmarks for continuous
improvement
Past data are typically available at low cost
Disadvantages:
Past data can include inefficiencies such as wastage of
direct materials
They also do not incorporate any changes expected for
the budget period
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Data from Other Companies that
Have Similar Processes
Advantages:
The budget numbers represent competitive benchmarks
from other companies
Disadvantages:
Input-price and input-quantity data from other
companies are often not available or may not be
comparable to a particular company’s situation
©2014 Pearson Education. All rights reserved.
Standards Developed by a
Company
Advantages:
Standard times aim to exclude past inefficiencies
They take into account changes expected to occur in the
budget period
Disadvantages:
Since they are not based on achieved benchmarks,
standards might be infeasible and lead to unhappiness
among workers
©2014 Pearson Education. All rights reserved.
Standard
A standard input is a carefully determined quantity
of input
A standard price is a carefully determined price
that a company expects to pay for a unit of input
A standard cost is a carefully determined cost of a
unit of output
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Price Variances
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Efficiency Variances
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Columnar Presentation of Variance
Analysis
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Learning Objective 4
Plan for Variable and Fixed
Overhead Costs and Calculate
Budgeted Variable and Fixed
Overhead Cost Rates
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Planning Overhead Costs
Variable overhead—as efficiently as possible, plan
only essential activities
Fixed overhead—as efficiently as possible, plan
only essential activities, especially because fixed
costs are predetermined well before the budget
period begins
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Standard Costing
Traces direct costs to output by multiplying the
standard prices or rate by the standard quantities
of inputs allowed for actual outputs produced
Allocates overhead costs on the basis of the
standard overhead-cost rates times the standard
quantities of the allocation bases allowed for the
actual outputs produced
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Developing Budgeted Variable
Overhead Cost-Allocation Rates
Choose the period to use for the budget
Select the cost-allocation bases to use in allocating variable overhead costs to output produced
Identify the variable overhead costs associated with each cost-allocation base
Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced
©2014 Pearson Education. All rights reserved.
Developing Budgeted Fixed
Overhead Cost-Allocation Rates
Choose the period to use for the budget
Select the cost-allocation bases to use in allocating fixed overhead costs to output produced
Identify the fixed overhead costs associated with each cost-allocation base
Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced
©2014 Pearson Education. All rights reserved.
Learning Objective 5
Partition the Variable Overhead
Flexible-Budget Variance into
Variable Overhead Efficiency and
Spending Variances
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Variable Overhead Flexible-
Budget Variance
Reveals how much variable overhead costs differed
from the flexible budget amount
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Variable Overhead Efficiency
Variance
The measure captures the actual use of the driver
relative to the amount budgeted to be used for the
actual output level
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Variable Overhead Spending
Variance
The variance captures both the unexpected changes
in price as well as the efficiency of use of variable
overhead items such as energy and indirect
materials
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Variable Overhead Variance
Analysis
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Learning Objective 6
Compute the Fixed Overhead Flexible-
Budget (Or Spending) Variance and
the Fixed Overhead Production-Volume
Variance
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Fixed Overhead Flexible-Budget
Variance
It is the difference between actual fixed overhead
costs and fixed overhead costs in the flexible
budget
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Fixed Overhead Spending
Variance
It informs managers of the difference between
actual spending on fixed overhead and the planned
amount of spending in the master budget
It highlights to managers the sources of unexpected
changes in resources expended to acquire capacity
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Production-Volume Variance
Also known as denominator-level variance
Arises only for fixed costs
It is an indicator of the use of capacity
A favorable variance indicates that overhead is
overallocated; if unfavorable, the overhead is
underallocated
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Fixed Overhead
Variance Analysis
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Learning Objective 7
Show How the Variance Analysis
Approach Reconciles the Actual
Results for a Period with the Results
Expected for that Period
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Integrated Variance Analysis (Variable
Overhead-Panel A)
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Integrated Variance Analysis (Fixed
Overhead-Panel B)
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Summary of Variance Analysis
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Learning Objective 8
Understand How Managers Use
Variances
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Multiple Causes of Variances
Managers must not interpret variances in isolation
of each other
The causes of variances in one part of the value
chain can be the result of decisions made in another
part of the value chain
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When to Investigate Variances
A standard is a range of possible acceptable input
quantities, costs, output quantities, or prices
Managers should expect small variances to arise in
this range
They frequently investigate variances based on
subjective judgments or rules of thumb
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Performance Measurement Using
Variances
Two attributes of performance are commonly
evaluated:
Effectiveness
Efficiency
Managers must be sure they understand the causes
of a variance before using it for performance
evaluation
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Organization Learning
The goal of variance analysis is for managers to
understand why variances arise, to learn, and to
improve future performance
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Continuous Improvement
Managers can also use variance analysis to create
a virtuous cycle of continuous improvement
This can be done by repeatedly identifying causes
of variances, initiating corrective actions, and
evaluating results of actions
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Financial and Nonfinancial
Performance Measures
Companies use a combination of financial and
nonfinancial performance measures for planning
and control
They are also used to evaluate the performance of
managers
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Cost Variances in Nonmanufacturing
Settings
Nonmanufacturing and service sector companies can
benefit from the use of variance analysis
Managers can also use variance analysis to
examine the overhead costs of the
nonmanufacturing areas of the company
Also used to make decisions about pricing,
managing costs, and product mix in such companies
©2014 Pearson Education. All rights reserved.
Impact of Information Technology
on Variances
Modern information technology promotes the
increased use of standard-costing systems for
product costing and control
Following technology has helped many companies
improve their performance:
Total quality management systems
Computer-integrated manufacturing (CIM) systems
Enterprise resource planning (ERP) systems
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