PART 1

Financial Planning,
Performance and
Control
Section B - Performance Management
(25% - Levels A, B, and C)
Section B, Performance Management, is 25% of the exam, another large part. Section B covers Operational
Control (management-by-exception approach) in U.7 and Management Control (management-by-objectives
approach) in U.8. Factors to be analyzed for control and performance evaluation include revenues, costs,
profits, and investment in assets. Variance analysis based on flexible budgets and standard costs is heavily
tested, as is responsibility accounting for revenue, cost, contribution, and profit centers. The balanced
scorecard is included in this coverage, as are quality considerations.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 1

Introduction
PERFORMANCE EVALUATION AND CONTROL
Performance evaluation is the process by which managers at all levels gain information about the performance
of tasks within the firm and judge that performance against pre established criteria as set out in budgets, plans,
and goals. Performance evaluation is applied for each of the three management functions: operations,
marketing, and finance.

Operational Control (management-by-exception approach) versus Management Control (management-by-

objectives approach)
Operational control means the evaluation of operating level employees by mid-level managers.
Operational control,
 which focuses on detailed short-term performance measures,
 has a management-by-exception approach; that is, it identifies units or individuals whose performance
does not comply with expectations so that the problem can be promptly corrected.
Operational Control Issues:
Standard Costing and Variance Measures (unit 7)
 Analyze performance against operational goals
 Direct Materials Variances
 Direct Labor Variances
 Overhead Variances
 Sales Variances
 Mix and Yield Variances

CMA EXAM: For variances you need to be able to both calculate the variances and interpret the information
that you get through variance analysis. This will require the memorization of the variance formulas, but also an
understanding of what each formula is calculating.
Mathematically, the majority of the questions will come from variance analysis and performance measurement
parts of this section. A number of variances are covered, and you need to know not only how to calculate them,
but also what they mean and who can affect them. While the variance topic may seem large and overwhelming
at first, when it is broken down into its Individual elements it will become easier.

Management control refers to the evaluation by upper-level managers of the performance of mid-level
managers. Management control focuses on higher- level managers and long-term, strategic issues.
Management control Issues:
Responsibility Accounting and Performance Measures (unit 8)
 Responsibility Centers
 Contribution and Segment Reporting
 Common Costs
 Transfer Pricing
 Performance measures & Financial Measures(ROI, Rl and EVA)
 The Balanced Scorecard

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 2

CMA EXAM: The performance measurement portions focus on a few performance measures, specifically
Return on Investment (ROI) and Residual Income (Rl). Fur these measurements you need to know what they
are, how they are calculated and how they are used. You also need to be able to identify the weaknesses that
are inherent in each one. Responsibility accounting is the breaking down of costs into those costs that can be
controlled by the manager and those that cannot be controlled by the manager. There are a number of different
cost classifications and allocation methods within this section that you need to be aware of.
Transfer pricing is a topic that you need to know from both a theoretical standpoint and a numerical one as
well. The questions may require you to understand the issues that company faces in establishing the transfer
price as well as being able to calculate an acceptable transfer price under certain situations.
The final topic covered in this Section is performance feedback, and more specifically the balanced scorecard,
you need to know conceptually what the balanced scorecard is and how it works as well as be familiar with Its
application.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 3

 STUDY UNIT SEVEN
COST AND VARIANCE MEASURES
Introduction
In Chapter 2, you saw how budgets assist managers in their function as planners. We now turn to how budgets
- specifically flexible budgets - are used to evaluate feedback on variances, aiding managers in their control
function. Feedback enables managers to compare actual results-that is, what is happening-with planned
performance-what should have been happening according to plans. Flexible budgets and variances help
managers gain insights into why the actual results differ from the planned performance. That "why" is what this
chapter is about.Controlling operations assists managers in attaining the budgeted goals they set out to
accomplish. Assessing operating results provides feedback to managers and helps them gain insights into the
causes that led to the operating results. By learning from the past, managers can control the future.
The Use of standards
 To set performance expectations,
 evaluate and control operations,
 motivate employees, and encourage efforts toward their goals.
 allows a manager to identify the cost to manufacture and sell a product or provide a service,
 to find causes and attributes of cost overruns or efficient operations, and
 to manage by exception.

THE USE OF VARIANCES

Each variance we compute is the difference between an amount based on an actual result and the
corresponding budgeted amount-that is, the actual amount of something and the amount it was supposed to be
according to the budget. The budgeted amount is a point of reference from which comparisons may be made.
 Variance analysis enables management by exception: Variance analysis enables management by
exception, the practice of giving attention primarily to significant deviations from expectations (whether
favorable or unfavorable) and areas not operating as expected (such as a shortfall in sales of a
product) and giving less attention to areas operating as expected. Attending to operations not
performing within expected limits is likely to yield the best ratio of the benefits of investigation to costs.
 Variance analysis assigns responsibility: The purpose of identifying and assigning responsibility for
variances is to determine who is likely to have information that will enable management to find
solutions. The constructive approach is to promote learning and continuous improvement in
manufacturing operations, not to assign blame.
 Variances will guide managers to seek explanations and to take early corrective action, ensuring that
future operations will be as planned.
 Sometimes variances suggest a change in strategy. Excessive defect rates for a new product may
suggest a flawed product design. Executives may then want to reevaluate their product strategies.
 Variances may signify that standards need to be reevaluated. Management is signaled that corrective
action may be needed.
 Variances assist managers in their planning and control decisions.
 Variances used in performance evaluation (discussed in more detail later).
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 4
This chapter explores the uses of budgets and standard costing systems in operations. We will start our
discussion with comparing actual results with master static budget followed by introducing flexible budget.

EVALUATING OPERATING RESULTS: STATIC BUDGETS AND FLEXIBLE BUDGETS

Two aspects of operations are generally of interest to management in assessing operations: effectiveness in
attaining goals and efficiency in carrying out operations.

Effectiveness and Efficiency

An
An
operation
operation
is effective if
is efficient if it
it has attained
has not wasted
or exceeded
resources.
its goals.

An operation may be effective but inefficient,

and it may be efficient but ineffective.

The master budget, or static budget, discussed in Chapter 2, is based on the level of output planned at the start
of the budget period. It’s static in the sense that the budget is developed for a single planned output level. When
variances are computed from a static budget at the end of the period, adjustments are not made to the
budgeted amounts for the actual output level in the budget period.
A master budget delineates the desired operating results for the period and is a common starting point in
assessing the effectiveness of operations.

Assessing Effectiveness
Hmm! Comparing
actual results with
Master budgets are the master budget will help
prepared for a me determine my
single activity level. effectiveness.

Comparing actual
results with the
master budget
reveals operating
income variances.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 5

Assessing Effectiveness
An important short-term goal for a company is to earn the budgeted operating income for the period. A
company's effectiveness is often measured by comparing the actual amount of operating income earned to the
amount in the master budget.

Accounting System at Webb

Webb manufactures and sells a designer jacket that requires tailoring and many hand operations. Sales are
made to distributors who sell to independent clothing stores and retail chains. Webb's only costs are
manufacturing costs; it incurs no costs in other value chain functions such as marketing and distribution. We
assume that all units manufactured in April 2003are sold in April 2003. There are no beginning inventories or
ending inventories. Webb has three variable-cost categories. The budgeted variable cost per jacket for each
category is

Variable Cost
Cost Category per Jacket
Direct materials costs $60
Direct manufacturing labor costs 16
Variable manufacturing overhead costs 12
Total variable costs $88

The number of units manufactured is the cost driver for direct materials, direct manufacturing labor, and
variable manufacturing overhead. The relevant range for the cost driver is from 0 to 12,000 jackets.

The budgeted fixed manufacturing costs are

for production between 0 and 12,000 jackets. $276,000
The budgeted selling price is $120 per jacket.
The static budget for April 2003 is based on selling 12,000 jackets.
Actual sales for April 2003 were 10,000 jackets.
Exhibit 7-1, column 3, presents the static budget for Webb Company for April 2003
In this book, "level" followed by a number denotes the amount of detail shown by a variance analysis. Level 0
reports the least detail Level 1 offers more information, and so on. We will use the example of Webb Company
to illustrate static budgets and flexible budgets and their related variances.
Favorable variance vs. unfavorable variance
A favorable variance-denoted F in this book - has the effect of increasing operating income relative to the
budgeted amount. For revenue items, F means actual revenues exceed budgeted revenues. For cost items, F
means actual costs are less than budgeted costs.
An unfavorable variance-denoted U in this book-has the effect of decreasing operating income relative to the
budgeted amount.
The significance of variances depends not only on their amount but also on their direction, frequency, and
trend. Moreover,
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 6
STATIC-BUDGET VARIANCES
A static-budget variance is the difference between an actual result and the corresponding budgeted amount in
the static budget. Exhibit 7-1 shows the Level 0 and Level 1 variance analyses for April 2003. Level 0 gives the
least detailed comparison of the actual and budgeted operating income.
The unfavorable variance of $93,100 in Exhibit 7-1 for Level 0 is simply the result of subtracting the static-
budget operating income of the $108,000 from the actual operating income of $14,900:
Static- budget
variance for = Actual Static- budget
operating income result - amount
=$14,900 - $108,000
=$93,100, or $93,100 U
The difference between the actual operating income and the master static budget operating income is the
operating income variance--a measure of the effectiveness of the period.
Webb Company was not effective in attaining its goal for the period; its operation fell 86 percent short of its
budgeted operating income.
EXHIBIT 7-1 Static-Budget-Based Variance Analysis for Webb Company for April2003a

LEVEL 0 ANALYSIS
Actual operating income $14,000
Budgeted operating income 108,000
Static-budget variance for operating income $93,100U
Level1 analysis in Exhibit 7-1 provides managers with more detailed information on the static-budget variance for operating
income of $93,100 U. The additional information added in Level 1 indicates how each of the line items of operating income _
revenues, individual variable costs, and fixed costs - add up to the static-budget variance of $93,100. The budgeted
contribution margin percentage of 26.7% decreases to 24.0% for the actual results.
LEVEL 1 ANALYSIS
Actual Static-Budget
Results Variances Static Budget
(1) (2)=(1)-(3) (3)

Units sold 10,000 (2,000) U 12,000

Revenues $ 1,250,000 $ (190,000) U $ 1,440,000
Variable costs
Direct materials $ 621,600 $ (98,400) F $ 720,000
Direct manufacturing labor $ 198,000 $ 6,000 U $ 192,000
Variable manufacturing overhead $ 130,500 $ (13,500) F $ 144,000
Total variable costs $ 950,100 $ (105,900) F $ 1,056,000
Contribution margin $ 299,900 24.0% $ (84,100) U $ 384,000
Fixed costs $ 285,000 $ 9,000 U $ 276,000
Operating income $ 14,900 $ (93,100) U $ 108,000

$93,000 U

Static Budget variance

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 7
a F,= favorable effect on operating income; U = unfavorable effect on operating income.
b Contribution margin percentage = $299,900.,. $1,250,000 = 24.0%
c Contribution margin percentage = $384,000.,. $1,440,000 = 26.7%

In addition to the operating income variance, Exhibit 7-1 reports the difference between the master budget and
the actual operating result for each reported item such as units sold, sales, and others. One notable item is the
variance that actual sales deviated from the master budget by 2000 units or $ 190,000-a decrease from the
budgeted amount of 16.7percent in units and 13.2 percent in sales dollars.

Exhibit 7-1 also reports that the variable expense incurred in April is $950,100 less than the budgeted amount-a
favorable variance. This comparison probably would lead us to conclude that the primary reason for Webb
failure to be effective in earning its budgeted net income is the shortfall in sales. The shortfall is so large that
even with a good control of expenses, as evidenced by the substantial favorable variance in variable expenses,
the firm still suffers a substantial decrease in operating income and, as a result, failed to be effective in earning
the budgeted $108,000 in operating income .

Flexible Budget

The Flexible Budget

The relevant question is . . .
“How much of the favorable cost variance is
due to lower activity, and how much is due to
good cost control?”
To answer the question, we must
the budget to the
actual activity.
A will
help me evaluate efficiency.

The Flexible Budget

A flexible budget is a budget that adjusts revenues and expenses for changes in output achieved.
In this chapter we emphasize flexible budgets. A flexible budget calculates budgeted revenues and budgeted
costs based on the actual output level in the budget period. A flexible budget is calculated at the end of the
period when the actual output is known; a static budget is developed at the start of the budget period based on
the planned output level for the period. As we show, a flexible budget enables managers to compute variances
that provide more information than the information from variances in a static budget.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 8

STEPS IN DEVELOPING A FLEXIBLE BUDGET
The flexible budget is prepared at the end of the period (April 2003) after the actual output level of 10,000
jackets is known. The flexible budget is the budget that Webb would have prepared at the start of the budget
period had it correctly forecast the actual output level of 10,000 jackets. In preparing the flexible budget:
1. The budgeted selling price is the same $120 per jacket used in preparing the static budget.
2. The budgeted variable costs are the same $88 per jacket used in the static budget.
3. The budgeted fixed costs are the same static budget amount of $276,000 (because the 10,000
jackets produced falls within the relevant range of 0 to 12,000 jackets for which fixed costs are
$276,000).

The only difference between the static budget and the flexible budget is that the static budget is prepared for
the planned output of 12,000 jackets, whereas the flexible budget is based on the actual output of 10,000
jackets: The static budget is being "flexed" or adapted from 12,000 jackets to 10,000 jackets. In preparing the
flexible budget for 10,000 jackets, all costs are assumed to be either variable or fixed with respect to the
number of jackets produced.
Webb develops its flexible budget in three steps.
Step 1: Identify the Actual Quantity of Output. In April 2003, Webb produced and sold 10,000 jackets.
Step 2: Calculate the Flexible Budget for Revenues Based on Budgeted Selling Price and Actual Quantity of
Output.
Flexible-budget revenues = $120 per jacket x 10,000 jackets
= $1,200,000
Step 3: Calculate the Flexible Budget for Costs Based on Budgeted Variable Cost per Output Unit, Actual
Quantity of Output, and Budgeted Fixed Costs.
Flexible-budget variable costs
Direct materials, $60 per jacket x 10,000 jackets $ 600,000
Direct manufacturing labor, $16 per jacket x 10,000 jackets 160,000
Variable manufacturing overhead, $12 per jacket x 10,000 jackets 120,000
Total flexible-budget variable costs 880,000
Flexible-budget fixed costs 276,000
Flexible-budget total costs $1,156,000

Question: If the flexible budget (FB) is based on actual output, which isn't known until the end of the
period, how can it be a budget?
Answer: The FB shows the costs that should have been incurred (the budgeted costs) to achieve the
actual output level. The FB is the budget we would have made at the beginning of the period if we had
perfectly predicted the actual output level.

These three steps enable Webb to prepare a flexible budget as shown in Exhibit 7-2, column 3. Webb uses the
flexible budget to move to a Level 2 variance analysis that further subdivides the $93,100 unfavorable static-
budget variance for operating income.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 9

Assessing Efficiency: FLEXIBLE-BUDGET VARIANCES AND SALES-VOLUME
VARIANCES
With the help of a flexible budget, we can separate the difference between the operating result and the master
budget into two variances: the flexible budget variance and the sales volume variance.
Exhibit7-2 shows the Level 2 flexible-budget-based variance analysis for Webb. The Level 2 variances
subdivide the Level 1 $93,100 unfavorable static-budget variance for operating income into two parts: a flexible-
budget variance of $29,100 U and a sales-volume variance of $64,000 U.

Static-budget variance
Level 1
$93,100 U
Actual vs. Master static

Level 2

Flexible-budget variance Sales-volume variance

$29,100 U $64,000 U
The flexible budget variance is the difference between The sales volume variance is the difference between
the operating result and the flexible budget amount at the flexible budget and the master or static budget
the actual output level of the period. A flexible budget and it measures the effect of changes in units of sales
variance measures efficiency in resources to in using on sales, expenses, contribution margins, and
input attain the operating results of the period. operating income.

What useful information comes from subdividing the static-budget variance into its two components?
Remember, Webb actually produced and sold 10,000 jackets, although the static budget had anticipated an
output of 12,000 jackets. Managers would like to know how much of the static-budget variance is due to

Flexible-budget variance Sales-volume variance

$29,100 U $64,000 U
Actual vs. FB MB vs.FB
how much of the static-budget variance is due to inaccurate forecasting of output units sold
Webb's performance for 2003 Sales-volume variances arise solely from the
because they compare actual revenues to budgeted differences between the budgeted output level used
revenues and actual costs to budgeted costs for the to develop the static budget and the actual output
same 10,000 jackets of output. level used to develop the flexible budget.

Creating a flexible budget makes it possible for managers to learn these two amounts.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 10

Sales-Volume Variances
Keep in mind the flexible-budget amounts in column 3 of Exhibit 7-2 and the static budget amounts in column 5
are both computed using budgeted selling prices, budgeted variable cost per jacket, and budgeted fixed costs.
The only distinction is that the flexible budget amount is calculated using the actual output level, whereas the
static-budget amount is calculated using the budgeted output level. The difference between these two amounts
is called the sales-volume variance because it represents the difference caused solely by the difference in the
10,000 actual quantity (or volume) of jackets sold and the 12,000 quantity of jackets expected to be sold in the
static budget.

Sales-volume Flexible- budget Static- budget

variance for = amount amount
operating income

= $44,000 - $108,000
= -$64,000, or $64,000 U
In our Webb example, this sales-volume variance for operating income arises solely because of inaccurate
forecasting of output units sold: Webb sold only 10,000 jackets, 2,000 fewer than the budgeted 12,000 jackets.
Note particularly, budgeted selling price and budgeted variable cost per unit are held constant in computing
sales-volume variances. Hence:

Sales volume variance = Budgeted CM per unit X (Actual Units sold - static-budget units sold)
for operating income

Sales volume Budgeted selling Budgeted variable Actual units Static-budget

variance for = price cost per unit - cost per unit x units sold - units sold
operating income

= ($120 per jacket - $88 per jacket) x (10,000 jackets - 12,000 jackets)
= $32 per jacket x (-2,000 jackets)
= -$64,000, or $64,000 U

Note that the operating income sales volume variance is the same as the contribution margin sales volume
variance. This happens because fixed expenses in the master budget and the flexible budget usually do not
change. Thus, an alternative way to compute the operating income sales volume variance is to multiply the
difference in units of sales actually sold and in the master (static) budget by the master budget contribution
margin per unit.

Sales volume variance Interpretation

Significant sales volume variances can have serious implications for strategic management. A significant
unfavorable sales volume variance can indicate that the market is smaller than the level planed when the firm
set its strategy and the goal for the period. The firm might need to modify or abandon its strategy.
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 11
 An insignificant sale volume variance can indicate that the firm's strategy and operating plans are on track to
attain its goals. A significant favorable sales volume variance can indicate that the firm needs to pursue a more
aggressive strategy or operating goal.
Webb's unfavorable sales-volume variance could be due to one or more of the following:
1. The overall demand for jackets is not growing at the rates that were anticipated.
2. Competitors are taking away market share from Webb.
3. Webb did not adapt quickly to changes in customer preferences and tastes.
4. Quality problems developed that led to customer dissatisfaction with Webb's jackets.
5. Budgeted sales targets were set without careful analysis of market conditions.

How Webb responds to the unfavorable sales-volume variance will be influenced by what is presumed to be the
cause of the variance. For example, if Webb believes the variance was caused by market-related reasons
(reasons 1 or 2), the sales manager would be in the best position to explain what happened and to suggest
corrective actions, such as sales promotions, that may be needed. If however, the unfavorable variance was
caused by quality problems, the manufacturing manager would be in the best position to analyze the causes
and to suggest strategies for improvement, such as changes in the manufacturing process or investments in
new machines

EXHIBIT 7 – 2 level 2 Flexible-Budget-Based Variance Analysis for Webb Company for April 2003a

Actual Flexible-Budget Sales-Volume

Results Variances Flexible Budget Variances Static Budget
(1) (2)=(1)-(3) (3) (4)=(3)-(5) (5)
Units sold 10,000 - 10,000 (2,000)U 12,000
Revenues $ 1,250,000 50,000 F $ 1,200,000 (240,000)U $ 1,440,000
Variable costs
Direct materials $ 621,600 21,600U $ 600,000 (120,000)F $ 720,000
Direct manufacturing labor $ 198,000 38,000U $ 160,000 (32,000)F $ 192,000
Variable manufacturing overhead $ 130,500 10,500U $ 120,000 (24,000)F $ 144,000
Total variable costs $ 950,100 70,100U $ 880,000 (176,000)F $ 1,056,000
Contribution margin $ 299,900 (20,100)U $ 320,000 (64,000)U $ 384,000
Fixed costs $ 285,000 9,000U $ 276,000 0 $ 276,000
Operating income $ 14,900 (29,100)U $ 44,000 (64,000)U $ 108,000

$29,100U $64,000U
Flexible-budget variance Sales-volume variance
$93,100U
Static-budget variance

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 12

Flexible-Budget Variances (Operating Income Flexible Budget Variance)
Operating income flexible budget variances measure efficiencies in operations that are primarily internal to the
firm.
Factors contributing to operating income flexible budget variances include

 deviations in selling prices,

 variable costs, and
 Fixed costs.

Management is likely to have controls or influences on these factors. Substantial or continuous unfavorable
operating income flexible budget variances can diminish the feasibility of the strategy and jeopardize its
continuation.

The first three columns of Exhibit 7-2 compare actual results with flexible-budget amounts. Flexible-budget
variances are in column 2 for each line item in the income statement:

Flexible- budget = Actual _ Flexible- budget

Variance results amount

The operating income line in Exhibit 7-2 shows the flexible-budget variance is $29,100 U ($14,900 - $44,000).
The $29,100 U arises because actual selling price, variable cost per unit, and fixed costs differ from their
budgeted amounts. The actual and budgeted amounts for the selling price and variable cost per unit are

Actual Amount Budgeted Amount

Selling price $125.00 ($1,250,000 ÷10,000 jackets) $120.00 ($1,200,000÷ 10,000 jackets)
Variable cost per jacket $ 95.01 ($ 950,100÷10,000 jackets) $ 88.00 ($ 880,000710,000 jackets)

Selling Price variance

The flexible-budget variance for revenues is called the selling-price variance because it arises solely from
differences between the actual selling price and the budgeted selling price:

Selling-price Actual Budgeted Actual

variance = selling price - selling price x units sold

= ($125perjacket - $120 per jacket) x 10,000 jackets

= $50, 000, or $50, 000 F

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 13

Variable cost variance
The flexible-budget variance for variable costs is unfavorable for the actual output of 10,000 jackets. It's
unfavorable because either
(a) Webb used more quantities of inputs (such as direct manufacturing labor-hours) relative to the
budgeted quantities of inputs, or
(b)Webb incurred higher prices per unit for the inputs (such as the wage rate per direct manufacturing
labor-hour) relative to the budgeted prices per unit for the inputs, or
(c)both (a) and (b).
Higher input quantities relative to the budget and/or higher input prices relative to the budget could be the result
of Webb deciding to produce a superior product to what was planned in the budget, or the result of
inefficiencies in Webb's manufacturing and purchasing, or both. You should always think of variance analysis as
providing suggestions for further investigation rather than as establishing conclusive evidence of good or bad
performance.

Need for Further Analysis of the Variable Expense Flexible Budget Variance
Different factors may drive each of these variances. An aggregated total amount, such as the total variable
expense flexible budget variance can mask poor performance in one or more of the cost components or
operating divisions, especially when there are offsetting materials, labor and manufacturing overhead

Fixed cost variance

The actual fixed costs of $285,000 are $9,000 more than the budgeted amount of $276,000. This higher fixed
cost decreases operating income, making this flexible-budget variance unfavorable.

PRICEVARIANCES AND EFFICIENCY VARIANCES FOR DIRECT-COST INPUTS

(DM&DL)
We now illustrate how the Level 2 flexible-budget variance for direct-cost inputs can be further subdivided into
two more detailed variances, which are Level 3 variances:
1. A price variance that reflects the difference between an actual input price and a budgeted input price
2. An efficiency variance that reflects the difference between an actual input quantity and a budgeted input
quantity
Managers generally have more control over efficiency variances than price variances. That's because the
quantity of inputs used is primarily affected by factors inside the company, whereas price changes are
primarily due to market forces outside the company.

The information available from these Level 3 variances helps managers better understand past performance
and better plan for future performance.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 14

Obtaining Budgeted Input Price and Budgeted Input Quantities
To calculate price and efficiency variances, Webb needs to obtain budgeted input prices and budgeted input
quantities. Webb's three main sources of information are
1. Actual input data from past periods.
2. Data from other companies that have similar processes.
3. Standards developed by Webb
1. Actual input data from past periods.
Most companies have past data on actual input prices and actual input quantities. These past prices
and quantities could be used as the budgeted prices and quantities in a flexible budget. Past data are
typically available at low cost. Nevertheless, there are limitations to using this source of data: (i) past
data can include inefficiencies, and (ii) past data do not incorporate any expected changes for the
budget period.
2. Data from other companies that have similar processes.
The main limitation of using this source is that input price and input quantity data from other companies
may not be available.
3. Standards developed by Webb. A standard is a carefully determined price, cost, or quantity. A standard is
usually expressed on a per unit basis. Consider how Webb determines its standards. Using engineering
studies, Webb conducts a detailed breakdown of the steps required to make a jacket.
Each step is assigned a standard time based on work performed by a skilled operator using equipment
operating in an efficient manner.
There are two advantages of using standard times:
(i) they aim to exclude past inefficiencies, and
(ii) they aim to take into account changes expected to occur in the budget period.
An example of (ii) is the decision for leasing of new sewing machines that operate at a faster
speed and enable output to be produced with lower defect rates.
Standards for DM & DL

The standard manufacturing labor cost for each jacket is computed by multiplying the standard time
allowed to produce a jacket by the standard wage rate that Webb expects to pay its operators.
Similarly, Webb determines the standard quantity of square yards of cloth required by a skilled operator
to make each jacket, the standard price per square yard of cloth, and (by multiplying them together) the
standard direct material cost of a jacket.

The term "standard" refers to many different things. Always clarify its meaning and how it is being used.
 A standard input is a carefully determined quantity of input - such as square yards of cloth or direct
manufacturing labor-hours - required for one unit of output, such as a jacket.
 A standard price is a carefully determined price that a company expects to pay for a unit of input. In the
Webb example, the standard wage rate is an example of a standard price of a direct manufacturing
labor-hour.
 A standard cost is a carefully determined cost of a unit of output - for example the standard direct
manufacturing labor cost of a jacket at Webb.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 15

Standard cost per output unit for Standard input allowed Standard price
each variable direct-cost input = for one output unit X per unit input unit

Standard cost per jacket for each Standard input allowed Standard price
variable direct-cost input = for one output unit x per input unit

Standard direct material cost per jacket: 2 square yards of cloth input allowed per output unit (jacket)
manufactured, at $30 standard price per square yard
Standard direct material cost per jacket = 2 square yards x $30 per square yard = $60
Standard direct manufacturing labor cost per jacket: 0.8 manufacturing labor-hour of input allowed per output
unit manufactured, at $20 standard price per hour.
Standard direct manufacturing labor cost per jacket = 0.8 hour x $20 per hour = $16

"Budget" vs. "Standard"

How are the words "budget" and "standard" related? Budget is the broader term. As the description above
indicates, budgeted input prices, budgeted input quantities, and budgeted costs need not be based on
standards. However, when standards are used to obtain budgeted input quantities and budgeted input prices,
the terms "standard" and "budget" mean the same thing and are used interchangeably. In its standard costing
system, Webb uses standards that are attainable through efficient operations but allow for normal disruptions.

Data for Calculating Webb's Price Variances and Efficiency Variances

Consider Webb's two direct-cost categories. The actual cost for each of these categories for the 10,000 jackets
manufactured and sold in April 2003 is
Direct material purchased and used
1. Square yards of cloth input purchased and used 22,200
2. Actual price incurred per square yard $28
3. Direct material costs (22,200 x $28) [Exhibit 7-2, column 1] $621,600
Direct manufacturing labor
1. Direct manufacturing labor-hours 9,000
2. Actual price incurred per direct manufacturing labor-hour $22
3. Direct manufacturing labor costs (9,000 x$22) [Exhibit 7-2, column 1] $198,000
Price variance vs. Efficiency variance
 A price variance is the difference between the actual price and the budgeted price multiplied by the
actual quantity of input, such as direct material purchased or used.
o A price variances is sometimes called an input-price variance or rate variance, especially when
referring to a price variance for direct labor.
 An efficiency variance is the difference between the actual quantity of input used - such as square
yards of cloth of direct materials - and the budgeted quantity of input that should have been used to
produce the actual output, multiplied by the budgeted price.
o An efficiency variance is sometimes called a usage variance.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 16

Exhibit 7-3 shows how the price variance and the efficiency variance subdivide the flexible budget variance.
Consider the panel for direct materials.
 The direct material flexible-budget variance of$21,600 U is the difference between the actual costs
incurred (actual input quantity x actual price) shown in column 1 and the flexible budget (budgeted input
quantity allowed for actual output x budgeted price) shown in column 3.
o Column 2 (actual input quantity x budgeted price) is inserted between column 1 and column 3.
The difference between columns 1 and 2 is the price variance of $44,400 F because the same
actual input quantity is multiplied by the actual price in column 1 and the budgeted price in
column 2.
o The difference between columns 2 and 3 is the efficiency variance of $66,000 U because the
same budgeted price is multiplied by the actual input quantity in column 2 and the budgeted
input quantity allowed for actual output in column 3. See how the direct material price variance,
$44,400 F, plus the direct material efficiency variance, $66,000 U, equals the direct material
flexible-budget variance, $21,600 U.
We next discuss the price variances and the efficiency variances in greater detail.

Price Variances
The formula for computing the price variance is

Price variance = (Actual price of input – Budgeted (Std) price of input) X Actual quantity of input
DM Price variance = ( AP – SP ) x AQ
DL Price variance = ( AR – SR ) x AH
AP: Actual Price, AR : Actual Rate, SP: Std. Price, SR: Std Rate, AQ: Actual Quantity, AH: Actual Hours.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 17

Price variances for Webb's two direct-cost categories are

Direct-Cost Actual price Budgeted price Actual quantity Price

Category of input - of input X of input = Variance
Direct material ($28per sq. yard - $30per sq. yard) x 22,200square yards = $44,400 F
Direct manufacturing ($22per hour - $20per hour) x 9,000hours = 18,000 U
labor

Interpreting the Direct material price variance

Possible causes of a favorable direct materials price variance are:
For example, Webb's favorable direct material price variance could be due to one or more of the following:
 An unexpected price change for the materials, changes in freight costs, variation in grades of the
purchased items, rush orders, or other causes.
 Webb's purchasing manager negotiated the direct material price more skillfully than was planned for in
the budget.
 The purchasing manager changed to a lower-price supplier.
 Webb's purchasing manager bought in larger quantities than the quantities budgeted, thereby obtaining
quantity discounts.
 Direct material prices decreased unexpectedly due to, say, industry oversupply.
 Budgeted purchase prices for direct material were set without careful analysis of market conditions.
 The purchasing manager received unfavorable terms on factors other than price (such as lower quality
material).

Responsibility of the variance

Generally speaking, the purchasing department is often the office most likely to provide an explanation or the
responsibility for materials price variances, as the purchasing manager has control over the price paid for
goods.
However, someone other than the purchasing manager could be responsible for a material price variance.
Production may be scheduled in such a way, for example, that the purchasing manger must request express
delivery. In these cases the production manager should be held responsible for the resulting price variance.
Company’s response
How Webb responds to a material price variance will be vitally affected by what is presumed to be the cause of
the variance. Assume Webb's managers attribute the favorable variance to the purchasing manager ordering in
larger quantities than budgeted, thereby receiving quantity discounts. Webb could examine if purchasing in
these larger quantities resulted in higher storage costs. If the increase in storage and inventory holding costs
exceeds the quantity discounts, purchasing in larger quantities is not beneficial. For this reason some
companies have reduced their materials storage to prevent their purchasing managers from ordering in larger
quantities.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 18

Interpreting the Direct labor Rate Variance
Possible causes of an unfavorable direct labor price variance are:
 Different rate for example a increase in labor rates, The firm's inability to pay the same hourly wage as
specified in the standard cost sheet.
 Different labor skills, the firm's inability to use the same skill-level workers as specified in the standard
cost sheet.
 The standard being set without detailed analysis of labor compensation.

Responsibility of the variance

The personnel department usually is responsible for direct labor rate variances. Production supervisors,
however, could be responsible for the variance if it chooses to use employees with a different skill level than
that specified in the standard cost sheet.

Efficiency Variance
For any actual level of output, the efficiency variance is the difference between the input that was actually used
and the input that should have been used to produce the actual output, holding input price constant at the
budgeted price:

Efficiency Actual Budgeted quantity

Variance = quantity of - of input allowed X Budgeted (std) price of input
input used for actual output
DM Quantity (Efficiency) Variance = (AQ - SQ) X SP
DL Efficiency Variance = (AH - SH) X SR

The idea here is that a company is inefficient if it uses a larger quantity of input than the budgeted quantity for
the actual output units produced; the company is efficient if it uses fewer inputs than budgeted for the actual
output units produced.

The efficiency variances for each of Webb's direct-cost categories are

Actual Budgeted quantity

Direct-Cost quantity of - of input allowed x Budgeted price = Efficiency
Category input used for actual output of input variance
Direct material [22,200 sq. yds. - (10,000units x 2 sq. yds. unit)] x $30per sq. yard
= (22,200sq. yds. - 20,000sq. yds.) x $30per sq. yard = $66,000U
Direct manuf.labor [9,000hours - (10,000unitsx 0.8 hour/unit)] x $20per hour
= (9,000hours - 8,000hours) x $20per hour = 20,000U

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 19

Note: distinguish inputs from output
The flexible budget for inputs is based on the budgeted quantity of inputs allowed for actual output level (BOlA).
To understand BQIA in the Webb example, distinguish inputs (square yards of cloth, direct manufacturing labor-
hours) from output (jackets).BQIA is computed by multiplying the actual quantity of output produced times how
much of each input should have been used per output unit.

General conclusion
The two manufacturing efficiency variances - direct material efficiency variance and direct manufacturing labor
efficiency variance - are unfavorable because more input was used than was budgeted, resulting in a decrease
in operating income.

Interpreting the Direct Materials Usage (quantity) Variance

 Using faulty machines or other production factors,
 Using Inferior material quality or substitutions of the material for other materials
 Inadequate training or inexperienced employees,
 Poor supervision

Responsibility of the variance

Generally speaking, it is the responsibility of the production department to see that material usage is kept in line
with standards. There may be times, however, when the purchasing department is responsible for an
unfavorable material usage (quantity) variance by buying inferior material.

Interpreting the Direct labor Efficiency Variance

 Employees or supervisors are new on the job or inadequately trained, Webb's personnel manager hired
underskilled workers. or Supervision is inadequate.
 Undermotivated workers
 Employee skill levels are different from those specified in the standard cost Sheet.
 Scheduling is poor, Webb's production scheduler inefficiently scheduled work, resulting in more
manufacturing labor time than budgeted being used per jacket. Or Batch sizes are different from the
standard size.
 Using faulty equipment, causing breakdowns and work interruptions
 Materials are different from those specified.
 Machines or equipment are not in proper working condition, Webb's Maintenance Department did not
properly maintain machines, resulting in more manufacturing labor time than budgeted being used per
jacket.
 Insufficient demand for the company’s product accompanied with fixed labor contracts, with the intent of
the company to keep every worker busy.
 Budgeted time standards were set too tight without careful analysis of the operating conditions and the
employees' skills.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 20

Company’s response
Suppose Webb's managers determine that the unfavorable variance is due to poor machine maintenance.
Webb may then have a team consisting of plant engineers and machine operators develop a future
maintenance schedule so that there will be fewer breakdowns adversely affecting labor time and product
quality.

Responsibility of the variance

A direct labor efficiency variance usually is the responsibility of the production department. There may be times,
however, when the purchasing department is responsible for an unfavorable direct labor Efficiency Variance by
buying inferior material.

Summary of Variances
Exhibit 7-4 is a summary of the Level 2, and 3 variances. Note how the variances in Level 3 aggregate to the
variances in Level 2 and how the variances in Level 2 aggregate to the variances in Level 1.
The variances show why actual operating income is $14,900 when the static budget operating income is
$108,000. Recall, a favorable variance has the effect of increasing operating income relative to the static
budget, and an unfavorable variance has the effect of decreasing operating income relative to the static budget.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 21

MANAGEMENT USES OF VARIANCES
Performance Measurement Using Variances
Variance analysis is often used for performance evaluation. Two attributes of performance are commonly
evaluated:
• Effectiveness: the degree to which a predetermined objective or target is met.
• Efficiency: the relative amount of inputs used to achieve a given output level. The fewer the inputs used
for a given level of output or the greater the output for a given level of input, the greater the efficiency.

Be careful to understand the causes of a variance before using it for performance evaluation.
Suppose a Webb purchasing manager has just negotiated a deal that results in a favorable price variance for
direct material. The deal could have achieved a favorable variance for any or all of three reasons:
1. The purchasing manager bargained effectively with suppliers.
2. The purchasing manager secured a discount for buying in bulk with fewer purchase orders. Alas,
buying larger quantities than necessary for the short run resulted in excessive inventory.
3. The purchasing manager accepted a bid from the lowest-priced supplier after only minimal effort to
check that the supplier monitored the quality of the material before shipping it.
If the purchasing manager's performance is evaluated solely on price variances, then the evaluation will be
positive. Reason 1 would support this favorable conclusion - the purchasing manager bargained effectively.
Reasons 2 and 3 have short-run gains, buying in bulk or making less effort to check the supplier's quality-
monitoring procedures. However, these short-run gains could be offset by higher inventory storage costs or
higher inspection costs and defect rates on Webb's production line, leading to unfavorable direct manufacturing
labor and direct materials efficiency variances.
Companies are increasingly evaluating performance based on the effect a manager's action has had on the
total costs of the company as a whole. In the purchasing manager example, Webb may ultimately lose more
money because of reasons 2 and 3 than it gains from the favorable price variance. Do not automatically
interpret a favorable variance as "good news. "
A benefit of variance analysis is that it highlights individual aspects of performance. However, if any single
performance measure (for example, a labor efficiency variance or a consumer rating report) receives excessive
emphasis, managers will tend to make decisions that make that particular performance measure look good.
These actions may conflict with the company's overall goals, inhibiting them from being achieved. This faulty
perspective on performance usually arises when top management designs a performance evaluation and
reward system that does not emphasize total company objectives.
Multiple Causes of Variances and Organization Learning
Variances often affect one another. For example, an unfavorable direct material efficiency variance may be
related to a favorable direct material price variance due to a purchasing manager buying lower-priced, lower-
quality materials. Do 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 of the company or even in
another company. Consider an unfavorable direct material efficiency variance on Webb's production line.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 22

Possible operational causes of this variance across the value chain of the company are
1. Poor design of products or processes,
2. Poor work on the production line,
3. Underskilled labor force,
4. Inappropriate assignment of labor or machines to specific jobs, and
5. Congestion due to scheduling a large number of rush orders from Webb's sales representatives.
6. Webb's suppliers do not manufacture cloth materials of uniformly high quality. Item6 describes an even
broader perspective on the cause of the unfavorable direct material efficiency variance by considering
actions taken in the supply chain of companies.
The focus of variance analysis is to understand why variances arise and how to use that understanding to learn
and to improve performance. For instance, to reduce the unfavorable direct material efficiency variance, a
company may seek improvements in product design, in the quality of supplied materials, and in the commitment
of the manufacturing labor force to do the job right the first time, among other improvements. Sometimes an
unfavorable direct material efficiency variance may signal a need to change product strategy, perhaps because
the product cannot be made at a low enough cost. Variance analysis should not be a tool to "play the blame
game" (that is, seeking a person to blame for every unfavorable variance). Rather, it should help the company
learn about what happened and how to perform better.
A delicate balance needs to be struck between the two uses of variances we have discussed: performance
evaluation and organization learning.
Variance analysis is helpful for performance evaluation, but an overemphasis on performance evaluation and
meeting individual variance targets can undermine learning and continuous improvement. Why? Because
achieving the standard becomes an end in and of itself. As a result, managers will seek targets that are easy to
attain rather than targets that are challenging and that require creativity and resourcefulness. For example, if
performance evaluation is overemphasized, Webb's manufacturing manager will prefer a standard that allows
workers ample time to manufacture a jacket; he will have little incentive to improve processes and methods to
reduce manufacturing time and cost.
An overemphasis on performance evaluation may also cause managers to take actions to achieve the budget
and avoid an unfavorable variance, even if such actions could hurt the company in the long run. For example,
the manufacturing manager may push workers to produce jackets within the time allowed, even if this action
could lead to poorer quality jackets being produced. Such negative impacts are less likely to occur if variance
analysis is seen as a way of promoting organization learning. Managers will then be more willing to experiment
with ways to reduce manufacturing costs and will also be less likely to compromise quality to avoid unfavorable
variances.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 23

 OVERHEAD VARIANCES
Overhead costs are a big part of the costs of many companies. Chemical, paper, and steel companies incur
large costs to construct and maintain their physical plant and equipment: These costs are part of their
overhead costs.
This chapter shows how flexible budgets and variance analysis can help managers plan and control the
overhead costs of their companies. In this chapter, we focus on the indirect-cost categories of variable
manufacturing overhead and fixed manufacturing overhead. And we explain why managers should be careful
when interpreting variances based on overhead cost concepts developed primarily for financial reporting
purposes.

Explain in what ways the planning of variable overhead costs and fixed overhead costs are similar and
in what ways they differ.

Standard Costs for Planning of Variable & Fixed

Factory Overhead Overhead Costs
Variable Fixed
Overhead Overhead
Effective planning of variable overhead costs
involves undertaking only those variable
Energy
 Energy costs
costs Factory
 Factory managers’
managers’
salaries overhead activities that add value for
Indirect
 Indirect materials
materials salaries
Indirect
 Indirect labor
labor Plant
 Plant and
and equipment
equipment customers using the product or service.
Equipment
 Equipment repair
repair depreciation
depreciation The key challenge with planning fixed overhead
and
and maintenance
maintenance Plant
 Plant security
security guards
guards
is choosing the appropriate level of capacity or
Insurance
 Insurance and
and property
property
taxes
taxes for
for factory
factory investment that will benefit the company over
building
building and
and equipment
equipment an extended time period.

Comprehensive example
Maria Lopez is the newly appointed president of Laser Products. She is examining the May 2004 results for the
Aerospace Products Division. This division manufactures wing parts for satellites. Lopez's current concern is
with manufacturing overhead costs at the Aerospace Products Division. Both variable manufacturing overhead
costs and fixed manufacturing overhead costs are allocated to the wing parts on the basis of laser-cutting-
hours.

The Budgeted cost rates are variable manufacturing overhead of $200 per hour and fixed manufacturing
overhead of $240 per hour.

The budgeted laser-cutting time per wing part is 1.5 hours.

Budgeted production and sales for May 2004 is 5,000 wing parts. Budgeted fixed manufacturing overhead
costs for May 2004 is $1,800,000.

Required
1. Compute the spending variance and the efficiency variance for variable manufacturing overhead.
2. Compute the spending variance and the production-volume variance for flexed manufacturing
overhead.
3. Give two explanations for each of the variances calculated in requirements 1 and 2.
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 24
 The variable manufacturing overhead variance.
When the flexible budget for variable overhead is developed, an overhead efficiency variance and an overhead
spending variance can be computed.

 Variable Overhead Flexible-Budget Variance measures the difference between actual variable overhead
costs incurred and flexible-budget variable overhead amounts

Variable Overhead Actual Costs Flexible-budget

flexible-budget variance = incurred - amount

 The variable overhead efficiency variance

 Evaluates the actual quantity of the cost-allocation base used relative to the budgeted quantity of the
cost-allocation base.
 A function of the selected activity measure. It does not reflect overhead control.
 Variable Overhead Efficiency Variance is the difference between actual quantity of the cost-allocation
base used and budgeted quantity of the cost per unit of the cost-allocation base

{ }X
Variable Actual quantity of Budgeted quantity of Budgeted variable
Overhead variable overhead variable overhead cost- overhead cost
Efficiency = cost-allocation base - allocation base allowed per unit of
Variance used for actual output for actual output cost-allocation base

 The variable overhead spending variance

 Results from paying more or less than expected for overhead items such as supplies and utilities.
 Evaluates the actual cost per unit of the cost-allocation base relative to the budgeted cost per unit of
the cost-allocation base.
 Variable Overhead Spending Variance is the difference between actual and budgeted variable
overhead cost per unit of the cost-allocation base, multiplied by actual quantity of variable
overhead cost-allocation base used for actual output

{ }X
Variable Actual variable Budgeted variable Actual quantity of
Overhead overhead cost overhead cost variable overhead
Spending = per unit of - per unit of cost-allocation base
Variance cost-allocation base cost-allocation base used for actual output

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 25

SOLUTION
1. and 2. See Exhibit 8-7.
3. a. Variable manufacturing overhead spending variance, $201,600 F. One possible reason for this variance is
that actual prices of individual items included in variable overhead (such a cutting fluids) are lower than
budgeted prices. A second possible reason is that the percentage increase in the actual quantity usage of
individual items in the variable overhead cost pool is less than the percentage increase in machine-hours
compared to the flexible budget.

b. Variable manufacturing overhead efficiency variance, $240,000 U. One possible reason for this variance is
inadequate maintenance of laser machines, causing them to take more laser time per wing part. A second
possible reason is use of undermotivated, inexperienced, or underskilled workers with the laser-cutting
machines, resulting in more laser-time per wing part.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 26

 The fixed manufacturing overhead variance.
Production-volume variance
Production-Volume Variance is the difference between budgeted fixed overhead and fixed overhead allocated
on the basis of actual output produced
 This variance is also known as the Denominator-Level Variance or the Output-Level Overhead
Variance
 Interpretation of this variance is difficult due to the nature of the costs involved and how they are
budgeted
 Fixed costs are by definition somewhat inflexible. While market conditions may cause production to flex
up or down, the associated fixed costs remain the same
 Fixed costs may be set years in advance, and may be difficult to change quickly
Contradiction: Despite this, examination of the fixed overhead budget formulae reveals that it is budgeted
similar to a variable cost
Results from
 The inability to operate at the activity budgeted for the period.
 Management decisions
 Unexpected changes in market demand
 Unforeseen problems in manufacturing operations

Production-Volume Budgeted Fixed Overhead allocated using

Variance = Fixed Overhead - budgeted input allowed for
actual output units produced

 Fixed Overhead Flexible-Budget Variance is the difference between actual fixed overhead costs and
fixed overhead costs in the flexible budget
This is the same amount for the Fixed Overhead Spending Variance

Fixed Overhead
flexible-budget variance = Actual Costs
incurred - Flexible-budget
amount

Spending Variance
Results from
 Paying more or less than expected for overhead items.
 Ineffective budget procedures
 Inadequate control of costs
 Misclassification of cost items

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 27

c. Fixed manufacturing overhead spending variance, $32,200 U. One possible reason for this variance is
that the actual prices of individual items in the fixed-cost pool unexpectedly increased from the prices budgeted
(such as an unexpected increase in machine leasing costs). A second possible reason is misclassification of
items as fixed that are in fact variable.

d. Production-volume variance, $72,000 U. Actual production of wing parts is 4,800 units, compared with the
5,000 units budgeted. One possible reason for this variance is demand factors, such as a decline in an
aerospace program that led to a decline in the demand for aircraft parts. A second possible reason is supply
factors, such as a production stoppage

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 28

(Total variable overhead variance)= Over/under allocated VOH=VOH FB Variance
Variable overhead = Actual costs - Flexible-budget
flexible- budget variance incurred amount

FB VOH variance = Spending variance + Efficiency Variance

Variable OH Spending Variance

Variable Actual variable Budgeted variable Actual quantity of
Overhead = overhead cost per - overhead cost per x variable overhead
Spending unit of cost-allocation base unit of cost-allocation base cost-allocation base
variance used for actual output

Variable overhead = (AH X AR) – (AH X SR)

spending variance

Or, in factored form:

AH (AR-SR)

Variable OH efficiency variance

Actual quantity of Budgeted quantity of

Variable variable overhead variable overhead Budgeted variable
Overhead = cost-allocation base - cost-allocation base X overhead cost per unit
efficiency used for actual allowed for of cost-allocation base
variance output actual output

Variable overhead
efficiency variance = (AH X SR) – (SHXSR)

Or, in factored form:

SR(AH - SH)

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 29

(Total fixed overhead variance)= Over/under allocated FOH=
Fixed OH FB variance ( Spending FOH variance) + Production Volume Variance

Fixed OH FB variance= Spending FOH variance

Fixed overhead = Actual costs Flexible-budget
flexible-budget variance incurred - amount

Budget Actual fixed – Budgeted fixed

Variance= overhead cost overhead cost

Also equal,
Fixed overhead = Actual costs – Flexible-budget
spending variance incurred amount

Volume Variance
Volume = Fixed component of the (Denominator _ Standard hours)
variance predetermined overhead rate X hours allowed

Production volume = Budgeted Fixed overhead allocated using

Variance fixed - budgeted input allowed for
Overhead actual output units produced

The formula can also be expressed in terms of the budgeted fixed cost per output unit:
Production volume = Budgeted Fixed overhead allocated using
Variance fixed - budgeted cost per output unit
Overhead allowed for actual output produced

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 30

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 31
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 32
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 33
PARTIAL AND TOTAL FACTOR PRODUCTIVITY
• Fabro, Inc. produced 1,500 units of Product RX-6 last week. The inputs to the production
process for Product RX-6 were as follows:
• 450 pounds of Direct Material A at a cost of $1.50 per pound
• 300 pounds of Direct Material Z at a cost of $2.75 per pound
• 300 labor hours at a cost of $15.00 per hour
What is the total factor productivity for Product RX-6?
• Total factor productivity equals units of output divided by the cost of all inputs.
• Hence, the total factor productivity equals 0.25 units per dollar input {1,500 units ÷ [(450
pounds of A × $1.50) + (300 pounds of Z × $2.75) + (300 hours ×$15)]}.
What is the partial productivity for DM for Product RX-6?
• A partial productivity measure is the ratio of output quantity to input quantity for a single
factor of production.
• The partial productivity for the DM, Hence, the partial productivity equals 1.00 unit per
dollar input {1,500 units ÷ [(450 pounds of A × $1.50) + (300 pounds of Z × $2.75)]}.

Prepared by: Sameh.Y.El-lithy. CMA,CIA. 34