Budgeting and Budgetary Control: by Jan F. Jacobs

Budgeting and Budgetary Control
by Jan F. Jacobs
Ir Jan Franciscus Jacobs (BK T.H. Twente 1974)

Independent
This paper can be downloaded from the

Social Science Research Network Electronic Paper Collection:
http://ssrn.com/abstract=400120
Summary Jan F. Jacobs
Budgeting and Budgetary Control
Summary
Operational management needs to know the causes of off-standard perform-

ance in order to improve operations. The knowledge of variances (real result
versus budget) will aid control, at least if and when these variances are under-
stood well enough. The only criterion for the calculation of a variance is its
usefulness. Of course variances must be calculated immediately after the event
and one should act upon them adequately.
Budget processes in many cases actually exemplify what is harming com-
panies instead of helping them. Jensen, 2001, describes what is happening in
practice (re SSRN_ID267651). Measuring performance, by whether or not
achieving set targets for the period or missing them, is ridiculous. Budgets and
targets mean nothing without thorough detailed budgetary control; how should
it be conducted?
Variance analysis, the way it is taught at many schools and universities, in
accordance with a wide variety of textbooks, is put to the test. This paper pre-
sents a few examples, with quotes from various textbooks and examinations.
Problem definitions are quoted literally. Working-outs as explained by famous
writers/lecturers/consultants are given where necessary and otherwise they are
available at the quoted places in literature. The author's opinion is that these
working-outs cannot stand the test. Anyway my opinion is not important, the
reader decides. I give my elaboration in full detail, in reaction to the corre-
sponding working-out published in well-known textbooks/examination papers,
and may the best one prevail. Of course the elaborations of others and myself
have a lot in common, but the discrepancies are at stake. Wrong, incomplete,
unclear analyses will lead to mismanagement. In literature a so-called Dutch
method is advocated versus what is supposed to be the American way to han-
dle variance analysis i.e. solving the problem of budgeting and budgetary con-
trol. The author's opinion is that only one calculating method can be the right
one. Only the best integral working-out is the essential base to better (opera-
tional) management.
Of course variance analysis is but a means to an end. A deeper understand-
ing of the state of the company is the ultimate goal of all representations in
budgeting and budgetary control. Management's task is to find the reasons for
the variances and to take proper action to bring operations into line with the
budget. Maybe the variances and trends indicate that the standards need
amendment.
A strategic investment proposal is also a budget. The realised results ex
post (not just future cash flows resulting out of an investment today), should
be analysed in full detail; re Neither EVA® nor CVA®, but NVA
http://ssrn.com/abstract=366561.
http://ssrn.com/abstract=400120 2
1 Introduction Jan F. Jacobs
1 Introduction
Monitoring and evaluating in fact is learning. There is no alternative to budg-

eting and budgetary control. Monitoring/evaluating should become a second
nature to any operational manager.1 Realised results ex post must be compared
to the (necessary) estimates ex ante. The problem definition is dead simple.
Likewise, in theory, the way to the solution is also simple. However, in prac-
tice, working-outs are often not beyond dispute as they should be. The va-
riances must be reported quickly enough to the right people. Clear and com-
plete. Adverse and favourable variances, each in full detail, altogether the
whole story, inclusive cause and effect. Proven data. Do not believe anything.
Demand to see everything. Do not jump to conclusions. Be aware of possible
relationships between the variances. A favourable material price variance can
be more than offset by adverse material usage and labour variances caused by
poor quality material, which simultaneously may be the very reason for the
material price being a pleasant surprise.
What has not (yet) been analysed in full detail is 'terra incognita'. It is an
absolute necessity: finding the very causes of the total difference between on
the one hand the reality ex post and on the other the standard or actual budget.
If more unfit products than standard is allowed, to give an example, it often
does not amount to just the wasted costs in production; the lost turnover in the
period under consideration indicates what the adverse unfit products variance
or process loss variance really is in many cases. Or, the other way round, what
is the total, after selling all products that are fit for use, of the favourable proc-
ess loss variance, if the number of unfit products is actually less than the stan-
dard allowed? Notably process loss variances are often being treated in a too
fragmentarily way. Yet variance analysis is acknowledged to be an important
subject matter to which whole chapters are devoted in many textbooks regard-
ing management accounting.
Working-outs must be both effective (doing right things) and efficient (do-
ing things right). Totals that fit - just these total amounts - do not give any
guarantee. The analysis has to be correct in all respects, not just in total but
also in each and every detail. Imagine a certain variance is set too high whilst
another one is set equally too low. The grand total will be still correct, but
such an analysis is not satisfactory. With respect to budgeting and budgetary
control, everything stands or falls on how it is implemented in practice. In
numerous textbooks, in curricula of schools and universities, by numerous
authors, the realised result i.e. the result ex post, is being compared to the real-
ised trading profit. That is incomplete; it is just one aspect of the reality. There
is much more. Of course any analysis has to be worthwhile. Pay attention to
each and every detail. Seemingly no difference, in case the result meets the
budget, just then, one must be wary of possible variances cancelling each other
out. Behind the variances are people. Who is losing money and who is earning
money? The latter people deserve a pat on the back. Maybe one can claim
certain losses to third parties, on condition one is able to prove it.
1
One should precisely measure the real results. Compare these measurements to the standard
and/or actual budget(s). Locate the variances and study main differences thoroughly. Last but
not least, implement and follow-up the necessary actions.
An enterprise is the addition sum of a series of businesses. Get a start with

budgeting and budgetary control in just one business or a small part of a busi-
ness; a single department, one or two products or even just one raw material,
merely a part of a particular unit-cost. It is possible to master one example
thoroughly and quickly. As soon as one has enough experience, one can add
another product, another department, another business. Never stop asking,
discuss the matter with your employees and refuse either to confirm or deny
any variance unless you know and understand it fully as part of the whole.
Remember, for the time being, the rest is 'terra incognita'.
Although budgeting processes are widespread in accounting systems that
are used in all sorts of relationships between the organisation and the outside
world, the purpose of this paper is to explain the use of budgeting and budget-
ary control within companies in order to help economists - and those who run
the firm2 - to perform their job better. See sidebar, "The three financial per-
spectives of enterprise of which only one is visible" for more on the notion
'within companies' (i.e. in fact running a business, but without rendering ac-
count to 'the outside world'). See Jensen, 2001, re SSRN_ID267651, 'Paying
People to Lie: The Truth About the Budgeting Process', for how most budget
processes are actually implemented in many companies.
The three financial perspectives of enterprise of which only one is visible

Recently, companies' year reports tend to have a wider scope in reaction to the
growing notion that traditional financial accounts are covering just a part of
the whole reality. Of course, it is not a matter of pence, but of principles and a
lot more. Information about various aspects like milieu, corporate governance
and social responsibility, is always desirable. Maybe principles and whatever
are more important than money. Widening the information spectrum is a wel-
come development, generally speaking, but information about the game can-
not step into the result. Information about financial performance acts as a
guiding principle, internally (management accounting) for the management
(per company unit, for short periods) and externally (financial accounting) for
the financial markets (allocation of funds to this enterprise), but also for the
authorities that govern the societies these enterprises belong to. It is important
to know whether these enterprises are doing better or worse for reasons of
policy making. Think of, for instance, governmental measures regarding tax,
employment, the environment, knowledge, etcetera. As it appears from the
IASC framework for the preparation and presentation of financial statements,
the objective is a fair presentation, to give a true and fair view, to provide
faithful information about the financial position, performance and changes in
financial position of the enterprise, that is useful to a wide range of users in
making economic decisions. The annual accounts have to faithfully reproduce
the one and only reality, according to the law in the Netherlands (Part 9,
Book 2 of the Netherlands Civil Code) and also in other countries, for instance
the UK.3 There may be no real difference really, besides the detail, between
the external, published reports on the one hand and on the other internal
2
As well as students and scholars of business administration and business economics.
3
In the UK, the Companies Act requires that accounts should show a true and fair view.
documents. Though it may not be officially recognised, it is common knowl-

edge that there are vast differences. In fact there are three separate financial
perspectives for any enterprise:
1. The fiscal reality, which is a secret between the taxpayer and the exchequer
The fiscal profit figure is calculated mostly on the basis of HC (Historical
Costs) and even the exchequer knows, it is no more than just a basis of levying
that which has been counted in this artificial way.4 By way of setting higher or
lower tax rates and by special arrangements, the exchequer is trying to keep in
close touch with the reality. The same applies mutatis mutandis to the actually
published profit figures in relation to changing pay-out ratios.
2. The reality according to the accounts (US-GAAP and other practices) that
are published in various countries
Notwithstanding all efforts of the IASC (International Accounting Standards
Committee), there are still many book-keeping methods, each with its own
peculiarities. Also the new IASB rules, set by the International Accounting
Standards Board, to be put into practice from 2005 on, do not meet reality.
Senior executives in discussion with Wall Street analysts are presenting a
more or less acceptable cast or image of the reality. Deflections are acceptable
beforehand. As a matter of fact, as long as one is not right of beam, the pub-
lished accounts will do. Telling the whole truth (presupposition it exists) is not
recommendable in the first place, because everyone - including the enemies -
is listening. The truth is often embarrassing. The organisation is a self-reliant
organism. Third parties, including the shareholders, operate mainly on the
basis of trust. Who wants to hear everything?
3. The one and only right internal periodical account
The existing valuation conventions including the resolutions of the IASC are
just a part of the reality. Though an item is in conformity with laws and rules,
it is not necessarily the one and only truth. 'De jure' correct is often different
from 'de facto' right. Fiscal accounts and the accounts to be published (finan-
cial accounting) are different in each country because of different laws and
rules. And no wonder; many people have an interest in this since it can influ-
ence such important matters as the levels of wages and prices, taxation and
dividends. It is obvious that there is much diversity of opinion everywhere.
A responsible manager of an entire enterprise or a single profit-center has
to know what the existing total value is and the added value, in other words
the capital together with the profit. The yield i.e. profit divided by capital,
must be reliably known within a known margin of accuracy, under specified
conditions, to be able to give guidance.5 The internal documents may be kept
secret in my opinion, if that is necessary to enhance the truth. What an enter-
4
Historical costs are fiscally acknowledged. Apart from that they do not have much signifi-
cance. The assessment of accruals (unexpired costs, recorded in the closing balance sheet), the
application of completely arbitrary allocation rules, and ignoring the time-value of money,
impart HC-accounting as not being relevant otherwise than in 'de jure' accounts.
5
One needs to know the tolerances. If the tolerance in the handle-bar is too big or unknown,
who dares to go for a bicycle ride? Which daredevil, not knowing enough about the toler-
ances, gets it into his head to manage a company?
prise likes to publish or has to publish according to law, rules and regulations,
is (in the author's opinion) quite another story.6 Verified internal profit and
yield-figures - information produced for management decisions within the
firm - are the most important considerations for the management of a com-
pany. What does the top executive say in the published reports of the com-
pany, if he doesn't fully understand what has happened himself?
The profit for any given period is the increased value at the end of that pe-
riod with regard to the initial value. The profit is an 'after the fact' figure.
When one is looking at an entire year one looks back at the annual profit fig-
ure with one's back to the future as it were, while the enterprise may well be
heading straight for a disaster. Thus considered, profit figures are of little use.
Profit, however, is not just the consolidated annual profit of a group, but it
mainly consists of the detail profits of one specific activity or company unit
for short periods. Knowledge of these profits is essential to give guidance and
to be able to adjust. In the end good management is about creating increased
value, it is as simple as that. The total of the profit for a period is the sum of its
parts. The profit on each product in that period is a part. Regarding the profit
in addition to its composition - the profit contribution for each company unit,
for each product (or group of products) and for each customer (or group of
customers) - who would not want to be well informed on these matters?
One can compare a company with a gang of skaters in a tournament. Some
of them choose longer and others shorter distances. Different products, activi-
ties, units, divisions. The total result of the gang in the tournament is the addi-
tion sum of individual achievements. A year-ride, 13 rounds of 4 weeks each.
Lap-times. From lap to lap, how many fingers of the coach go up, down? Ac-
celeration and slowing-down during a race can be calculated by measuring the
lap-times. Without knowing the lap-times, it is difficult to say anything mean-
ingful about accelerations and decelerations during the course of the race.
An enterprise is the addition sum of a series of businesses. All those busi-
nesses have their own budgets, which altogether constitute the master budget.
Neither imposed budgets nor mutual accepted budgets are prepared without
appropriate control. Budgetary control goes into every detail. At each level,
the budgetary control has to be executed by an expert, who has no bias what-
soever regarding the outcomes. A strictly neutral audit is the aim. Not ruthless,
but with patience and giving special attention. The making of mistakes, by the
people who are responsible for the variances found, is explicitly allowed. The
base is eager to learn. Once bitten, twice shy. Having said this, unmasking will
follow for whoever keeps busy by 'gaming the system', 'managing the num-
bers', 'cooking the books', 'accounting irregularities' or some other intolerable
way of acting. The subject matter is detecting the state of the company; keep-
ing all sorts of important information hidden is out of the question.
6
The having gone bankrupt companies showed annual accounts authorised by the accountant
until the end. A lawyer who saw a lot of bankruptcies happen once said: "the audit by a char-
tered accountant guarantees only that the figures are added up correctly; there is no guarantee
whatsoever that the figures are indeed correct, in conformity with the reality.
2 An Example with Extracts from R.M.S. Wilson and Wai Fong Chua Jan F. Jacobs
2 An Example with Extracts from R.M.S. Wilson and Wai Fong Chua
Unfortunately concerning various variances that are stated and calculated by

way of some definition and respectively some formulae, the contents do not fit
the description, which should be expected to be quite normal. For instance
'sales volume variance' is frequently not clearly presented. At times it looks
like someone tries to hide the variances from view. Concealing variances and
all kinds of formulae, is not acceptable practice.
In textbook ISBN 0412436108, entitled Managerial Accounting - Method and

Meaning, 2nd edition, 1998, by R.M.S. Wilson and Wai Fong Chua, the fol-
lowing example is found.
"Assume budgeted sales of a company's two products for a forthcoming period

were as follows:
Product A 500 units at € 2.00 per unit
Product B 700 units at € 1.50 per unit
and their costs were:

Product A € 1.75 per unit
Product B € 1.30 per unit
Actual sales for the period were:

Product A 560 units at € 1.95 per unit
Product B 710 units at € 1.40 per unit
(R.M.S. Wilson and Wai Fong Chua, 1998, p. 334)."
It applies the standard product mix A : B = 5 : 7 and the market of course has a
particular total volume of which this company has a share of x %. The standard
situation is given as follows, culminating into a standard result of € 265/period
(in general 265 money units).
Market share x % A B Total

Sales volume [number] 500 700 1200
Selling price apiece 2.00 1.50
Variable costs apiece 1.75 1.30
Contribution margin apiece 0.25 0.20
Contribution margin in total 125 140 265
Fixed costs 0
Result 265
This is the applied budget.
Actually it is given 560 units A and 710 units B, the total number ap-
peared to be 1270 units.
Growth market share? Growth total market?
It applies until further notice A : B = 5 : 7 (500 : 700 = 529 : 741).7
Market share y % A B Total

Sales volume 529 741 1270
Contribution margin in total 132.25 148.20 280.45
Fixed costs 0
Result 280.45
Sales volume variance: 280.45 -/- 265 = 15.45
Alternative representation:

Difference in numbers 29 + 41 +
Sales volume variance 7.25 8.20 15.45
Consequently it applies:
Reference A B Total
From now on, this is the NEW reference; this is expected to be attainable
actually and - without any other variance - exactly this should be realised.
Note: R.M.S. Wilson and Wai Fong Chua define: the addition sum of
the 'quantity variance' together with the mix variance is 'sales
volume variance'. What's in a name? 'Quantity' and 'sales vol-
ume' are interchangeable notions; the basic idea is a number or
size or level. 'Sales volume variance' (see above) is synony-
mous (be wary just the words!) to the 'sales quantity variance'
or in short 'quantity variance' as is meant by R.M.S. Wilson and
Wai Fong Chua.
7
One may assume 500 : 1200 = y : 1270 it follows y = 529.16666…
It should be specified explicitly, if anything else applies.
R.M.S. Wilson and Wai Fong Chua compare
A B Total
The realised sales volume 560 710 1270
to
The standard budgeted sales volume 500 700 1200
and they claim
A 60 more
B 10 more
would be the extra sales volume.
R.M.S. Wilson and Wai Fong Chua calculate
A 60 more @ € 0.25 = € 15 favourable

B 10 more @ € 0.20 = € 2 favourable
in total € 17 + which they define to be 'sales volume variance' i.e. the
resulting addition sum of both the above mentioned sales volume vari-
ance and the mix variance.
Mix variance A B Total

Sales volume realised 560 710 1270
versus
Sales volume NEW reference 529 741 1270
so it holds
A 31 more @ € 0.25 = € 7.75 favourable
B 31 less @ € 0.20 = € 6.20 adverse
in total € 1.55 +.
This appears to be the mix variance.

One is gaining € 1.55 because of the shift in the assortment.
R.M.S. Wilson and Wai Fong Chua do not acknowledge this mix vari-
ance; they claim the mix variance would be € 13 + but in the author's
opinion that cannot be correct.
"Sales volume variance:
Quantity variance = 265 - [2,086/2,050 x 265] = +4
Mix variance = 269 - [(560 x 0.25) + (710 x 0.20)] = + 13
------
Sales volume variance + 17
(R.M.S. Wilson and Wai Fong Chua, 1998, p. 334)."
Even arithmetically it does not fit (265 - [2,086/2,050 x 265] = - 5) and what is
'quantity variance + 4' meant to be? The amounts 2,086 and 2,050 indicate
turnover. Normally variance analysis is analysing the difference in profit i.e.
the figure at the bottom line. Of course one can also analyse the difference in
turnover. The standard situation is culminating into a standard result of € 265
and the standard total turnover is € 2,050 (500 units A at € 2.00 per unit plus
700 units B at € 1.50 per unit).

Sales volume [number] 500 700 1200
Turnover in total 1,000 1,050 2,050
This is the budget with regard to the top line of the profit and loss ac-
count. Actually the total number appeared to be 1270 units. It applies un-
til further notice A : B = 5 : 7 (500 : 700 = 529 : 741).

Turnover in total 1,058 1,111.50 2,169.50
Turnover variance: 2,169.50 -/- 2,050 = 119.50
Alternative representation:

Difference in numbers 29 + 41 +
Turnover variance 58.00 61.50 119.50
What's in a name? Turnover variance is based on sales volume variance or the

reverse; here, sales volume variance emerges into the turnover variance. Nor-
mally sales volume variance measures the difference in profit, not in turnover.
"Quantity variance = 265 - [2,086/2,050 x 265] = + 4 (R.M.S. Wilson and Wai

Fong Chua, 1998, p. 334)."
What is meant by 'quantity variance = + 4'? The amount 2,086 (actual sales
revenue) includes sales prices variance!
"Actual sales revenue = [(560 x 1.95) + (710 x 1.40)] = 2,086 (R.M.S. Wilson
and Wai Fong Chua, 1998, p. 334)." This amount 2,086 raises unanswered
questions.
"Expected profit on actual sales is calculated as though profit increases or de-

creases proportionately with changes in the level of sales (R.M.S. Wilson and
Wai Fong Chua, 1998, p. 334)." These words are indeed correct, so:
1200 level 265 budgeted profit on budgeted sales
1270 level x expected profit on actual sales
1200 : 265 = 1270 : x
x = 280.458333…
Volume or quantity
or level variance:
1200 level 265
1270 level 280.45 (due to rounding-off actual sales levels A and B)
plus mix variance
amounts to 282 standard profit on actual sales
A mix variance of 13 favourable is definitely not correct. The standard propor-

tion is 500 products A to 700 products B, 1.00 to 1.40, so in case of 1270
products in total, it is 529 products A to 741 products B (741/529 = 700/500 is
1.40; see fig. 1 below). One product A more than 529 results in one product B
less than 741 (in total it still is 1270 products). Each product A more promises
0.25 contribution margin extra whereas each product B less gives in 0.20, to-
tally 0.05 contribution margin favourable per one product A more and simul-
taneously one product B less. In order to reach to 13 + mix variance totally, it
would require 13/0.05 is 260 products A more (in total 529 + 260 = 789 prod-
ucts A) and thereby equally 260 products B less (in total 741 -/- 260 = 481
products B).
There are actually 31 products A more and consequently 31 products B less

i.e. 31 * 0.05 resulting in 1.55 +; see above.
fig. 1 the proportion 700/500 = 1050/750 = 741/529 = 1.40
The base is 529 products A and 741 products B, whereas in total 1270 prod-
ucts; the standard proportion is 5 : 7 isn't it? The actual levels are 560 products
A respectively 710 products B. There can be no other conclusion: the mix
variance relates to 31 more products A and consequently 31 less products B.
Furthermore it holds:
Sales prices variance A B Total
Actual numbers 560 710
Multiplied by (standard) 2.00 1.50
To be expected (reference) 1,120 1,065
Actual 1,092 994
Adverse (-/-)/favourable (+) 28 -/- 71 -/- 99 -/-
There are no other price variances.
By way of an extra check, one can calculate:

Contribution margins variance A B Total
Actual numbers 560 710
Multiplied by (standard) 0.25 0.20
To be expected (reference) 140 142
Actual 112 71
Adverse (-/-)/favourable (+) 28 -/- 71 -/- 99 -/-
Normally, the contribution margins variance is the resulting variance of both

the sales prices variance and the variable costs variance. Here the latter is zero.
In Dutch, there are the definitions 'afzetverschil' and so-called 'zuiver afzetver-
schil', indicating that definitions are merely words and phrases. What exactly
is a particular variance meant to be? Of course all variances have to fit mutu-
ally. One cannot miss a single money unit. A deeper understanding of what is
going on is the ultimate goal of all representations in budgeting and budgetary
control. The various definitions and formulae, given by R.M.S. Wilson and
Wai Fong Chua amongst many other writers in so many textbooks, lead to
more confusion, rather than making the picture clearer.
In summary:
Originally budgeted 265.00 the standard result
Sales volume variance8 15.45 +
(market growth/extra market share?)
---------
280.45
Mix variance 1.55 +
---------
Attainable result 282.00
This is the readjusted budget, on the

basis of the actual numbers of sold
products A and B.
Furthermore, just a price variance.
Sales prices variance 99.00 -/-

---------
Actual result 183.00
QED
8
Or sales quantity variance or sales level variance.
3 A Few Examples with Extracts from T. Lucey Jan F. Jacobs
3 A Few Examples with Extracts from T. Lucey
With extracts from T. Lucey, Management Accounting, 4th edition, 1996,

p. 199, a product is made by mixing and processing three ingredients P, N and
Q with the following standard proportions and standard prices.
P 50 % € 20 per tonne
N 40 % € 25 per tonne
Q 10 % € 42 per tonne
Standard process loss is 5 %.
In a period the output was 93.1 tonnes and the inputs were as follows:
Actual usage Actual price €
P 49 tonnes € 16 per tonne 49 · 16 = 784
N 43 tonnes € 27 per tonne 43 · 27 = 1,161
Q 8 tonnes € 48 per tonne 8 · 48 = 384
-------
2,329
Calculate all relevant material variances.
Working-out:
€
0.50 tonne P @ € 20/tonne = 10
0.40 tonne N @ € 25/tonne = 10
0.10 tonne Q @ € 42/tonne = 4.20
-------
24.20
1 tonne of input at standard produces 0.95 tonne of output, so Standard

Cost/Unit (tonne of output) is 24.20/0.95 = 25.473684…
93.1 tonnes @ € 25.473684… = € 2,371.60 Budgeted costs, the reference

€ 2,329.00 Actual costs
--------------
€ 42.60 Total difference, favourable
The overall objective of variance analysis is to subdivide the total difference

between on the one hand budgeted (expected) costs (here 'costs', normally
results at the bottom line are to be analysed) and on the other actual costs. To-
tal difference amounts to € 42.60 favourable.
What are the causes of off-standard performance? There are price changes
besides a change in the mix and there is also a difference in total quantity.
Interleaf
The author agrees with Lucey about the outcomes of the so-called 'individual
price method' presented by him, the mere total outcomes, not his way of com-
puting the various sub-variances nor his description of problems raised by so-
called conventional analyses. Lucey defines conventional analysis in the way
he does and next he criticizes his own definitions/presuppositions. If conven-
tional analyses ignore the technical qualities of production processes or
wrongly assume linear substitutability between material inputs, regardless of
specs, all the way down to "a mix consisting of one material only, the cheapest
(Lucey, 1996, p. 203)!", then everything is losing ground. Possible changes in
the mix are limited usually. All kinds of extremes are production impossibili-
ties. On may assume that the data stays between particular limits, which are
set by technical and/or other constraints. Values that are not real do not appear
in active analyses. Linearity, alike many other things for instance given data,
precise numbers and values, is normally the base; it is not necessary to repeat
all what is generally accepted as being normal. However, anything else and
non-linearity especially must be specified explicitly if that has to be consid-
ered as being normal. The starting question is, what is normal in all respects?
The normal, standard budget does not have to represent the optimum position;
sometimes maybe it is, but standard is not always equal to optimum. Lucey
describes particular circumstances, in which "there would seem to be little
value in calculating the sub-variances (Lucey, 1996, p. 203)." As if the unity
between the total variance on the one hand and on the other all the sub-
variances can be disaggregated. Never, in my opinion, should this unity be
tampered with. "The conventional analysis abstracts any differences between
actual and standard prices first, and then uses standard price for the mix and
yield variances (Lucey, 1996, p. 203)." Why first? Though some price vari-
ances can be calculated immediately, it is to be preferred to calculate other
price variances at the end. The difference between standard and actual prices
indicate an advantage or a disadvantage per hour or per item; how many hours
have actually been spent or items have actually been used up, follows from -
in general - the efficiency variances. The author prefers to calculate the effi-
ciency variances first, which logically result in the specified data that is neces-
sary to complete the price variances. The mechanical application of formulae
(if it is synonym to 'conventional analysis' as meant by Lucey, we agree on
this point completely) indeed is unlikely to produce information that assists
management. A thorough analysis of all variances must be made. Neither in a
mechanical way nor by extensively using formulae. At first it is a matter of
understanding the process being considered. Definitely not acting in either
rigid way. Textbooks are swarming with definitions, formulae, ratios and all
kinds of schemes indicating the relation between various variances. Any not
fully understood variance, resulting from a rigid numerical technique, is up for
discussion. The proof should be given for each and every variance together
with a proven specification in detail. No variances can be taken seriously
without proof. It is easy enough to present some figures and then to manipu-
late them using all kinds of numerical techniques to get one or other desired
outcome. Such techniques must be distinguished from proper calculations.
Calculations ought to have outcomes that are incontestable. If a standard turns

out to be out of date, then a new standard, a complete new standard budget
must be calculated. Standards should be attainable under current, normal
working conditions, if everything goes reasonably well. Managers and work-
ers should participate in setting the standards, amounting to the plan, indicat-
ing the way to the goal. Besides up-to-date standard budgets, often actual
budgets also have to be considered, without which a thorough analysis cannot
be made.
Concerning the numbers in variance analyses: most numbers have a certain
accuracy and a certain reliability and often there are also various presup-
positions. It can all be described exactly in each and every detail resulting in
significant variances. Only after taking care of the significance of all the nu-
merical data involved, can variance analysis prove its usefulness.
A variance is, until further notice, just a number. A ratio is a quotient. What
is the significance of any variance and respectively any ratio? Volume vari-
ance of such or so is a name, no meaning. What is behind the names? What
and how about the values of the variances? What is the purpose? Watch out.
Be careful, working with variances. Variances of what exactly?
Lucey presents an 'alternative method for mix and yield variances' using
definitions concerning weighted average prices.9 Alternative approaches may
produce the same total mix and yield variances. However, it is not just the
totals that must fit, each individual variance must be stated in any detail too, in
the one and only correct way.10 "The 'correct' variances are those which assist
management to make the right decisions (Lucey, 1996, p. 202)." Of course,
this quote is true in the sense that the only criterion for the calculation of a
variance is its usefulness. However, in order to make right decisions, the vari-
ances have to demonstrate all relevant matters, clearly and completely, and
naturally proven correct. "No one method of calculating variances or any
given variance is more correct than any other (Lucey, 1996, p. 202)." This
quote is certainly not correct. Of course one can draft every desired variance in
order to please or cheat someone, claiming an adverse variance to a third party
for instance. Maybe the real working-out is prepared solely for the internal use
of the managers of the firm, to help them to manage. Suppose in the latter case
there were different possible statements, it can be this, it could be that, that in
itself would be misleading information. Good management is not imaginable,
anytime, anywhere, with variance analyses one chooses.
9
There is the saying: “de weg naar het faillissement is geplaveid met gemiddelden i.e. the way
into bankruptcy has been paved by averages.” And what is the meaning of variances that have
been calculated in the meant alternative way?
10
If a number, any number, is not proven correct then it might be wrong.
Working-out
93.1 tonnes output/0.95 = 98 tonnes in production, to be expected.

This is quite normal. However, actually it holds:
P 49 tonnes
N 43 tonnes
Q 8 tonnes
Totally 100 tonnes, 2 tonnes more than to be expected.
The mix is 50 % P, 40 % N and 10 % Q and at 100 tonnes total quantity versus

98 tonnes, it applies:
P N Q
100 tonnes 50.00 40.00 10.00
98 tonnes 49.00 39.20 9.80
------- ------- -------
1.00 more 0.80 more 0.20 more
Multiplied by € 20/tonne € 25/tonne € 42/tonne
Adverse (-/-)
Favourable (+) € 20.00 -/- € 20.00 -/- € 8.40 -/-
Totally 2 tonnes more than strictly necessary have been used up, resulting in
either an adverse material usage variance or an adverse yield variance. Cause
and effect! More material used is the effect, maybe a poor yield is the only
cause. In that case it is indeed an adverse yield variance. However, it can be
any inefficiency, caused by whatever reason.
Material usage ('yield' or generally 'efficiency') variance is € 48.40 -/-.
According to Lucey: the 'usage variance' is merely the total of the mix and the
yield variances. What's in a name?
P 50 % 0.50 · 98 = 49.00 tonnes P

N 40 % 0.40 · 98 = 39.20 tonnes N
Q 10 % 0.10 · 98 = 9.80 tonnes Q
These tonnes P, N and Q are to be expected in case of a normal mix, if, as and
when indeed 98 tonnes have been used up. Actually 100 tonnes have been
used up and without any change in the mix, one would have expected:
P N Q
100 tonnes 50.00 40.00 10.00
From now on, this is the NEW reference (in case of a normal mix).
Versus actual data, it applies:

P N Q
Reference 50.00 40.00 10.00
Actual 49.00 43.00 8.00
1.00 less 3.00 more 2.00 less
Adverse (-/-)
Favourable (+) € 20.00 + € 75.00 -/- € 84.00 +
Mix variance is € 29.00 +.
Note: In some textbooks, the addition sum of the yield variance together with
the mix variance is defined as the 'usage variance' regarding direct ma-
terials. What's in a name?
P N Q
Actual 49.00 43.00 8.00
To be expected € 980.00 € 1,075.00 € 336.00
Actual € 784.00 € 1,161.00 € 384.00
Adverse (-/-)
Favourable (+) € 196.00 + € 86.00 -/- € 48.00 -/-
Price variance is € 62 +.
The variances altogether make up the total difference.
Material usage (or 'yield' or just 'efficiency') variance (€ 48.40 -/-) plus mix
variance (€ 29.00 +) plus price variance (€ 62 +) = € 42.60 +.
QED
A properly developed standard costing system is a tool of management. The

base is Standard Costing culminating into the Standard Budget (SB, contain-
ing all standard unit-costs). Of course the SB will be replaced by an Actual
Budget (AB) whenever necessary. SB and/or AB is nothing but a plan, which
is the guideline through all levels of management down to the shop floor and
thereby it is an instrument to delegate, it increases motivation and the bottom
line, the attainable result, indicates the goal that is clear-cut to everyone. Once
the SB is agreed to, it is not too much to say that one can come to a continual
improvement of everything (value analysis or value engineering not only dur-
ing the design stages of a product but throughout production), resulting in up-
dated SBs ending up in increasing period profits during almost the total life
cycle. The crucial question: when does one have to stop? This will enable the
company to switch to entirely new technology with new capacity and a new
SB instead.
The SB, eventually the AB, as well as the Realised Result (RR) and all re-
ported variances must be crystal clear; even for laymen to see at a glance what
it is all about. That is because anyone, from top management to the shop floor,
has at first to understand fully what went well and respectively what went
wrong, so that one can learn the do's and don'ts. The traditional variances as
well as the so-called planning (portion uncontrollable by operational manage-
ment) and operational variances as described in literature are not clear enough.
With extracts from T. Lucey (ISBN 1858051800), the working-outs of a few
examples are given underneath, in order to illustrate what is meant by neces-
sarily clear statements.
Lucey, 1996, p. 209, Example 3
Standard Budget (SB) Realised Result (RR)

Production 12,000 products A Production 11,200 products A
Sales 12,000 products A Sales 11,200 products A
€ €
Sales 12,000 @ € 16 apiece 192,000 Sales 11,200 @ € 17 apiece 190,400
less less
Materials Materials
12,000 x 4 kgs @ € 1/kg 48,000 44,800 kgs 50,400
Direct labour Direct labour
12,000 x 2 hours @ € 2.50/hour 60,000 21,000 hours 50,400
Variable overheads Variable overheads
12,000 x 2 hours @ € 1.50/hour 36,000 21,000 hours 39,200
---------- ----------
Contribution 48,000 Contribution 50,400
less less
Fixed costs 25,000 Fixed costs 28,400
---------- ----------
Profit 23,000 Profit 22,000
Extracts from the Standard Cost Card for the products A are:
€
- Material 4 kgs @ € 1/kg 4
- Direct labour 2 hours @ € 2.50/hour 5
- Variable overheads 2 hours @ € 1.50/hour 3
---------------
Standard marginal cost 12
Standard fixed cost € 25,000/12,000 products 2.08333…
---------------
Standard unit-cost 14.08333…
Profit margin apiece = € 16 -/- € 14.08333… = € 1.91666…
Profit = 12,000 products A x € 1.91666…/product A = € 23,000
Standard contribution margin apiece = € 16 -/- € 12 = € 4
Calculate all relevant variances and show the reconciliation between SB-profit
and RR-profit; the difference i.e. profit variance is € 1,000 adverse.
Standard is 12,000 products A and there are 11,200 products A actually; it

appears that 800 products A have not been produced (indicating an adverse
capacity usage variance) and these 800 non-existing products A cannot be sold
either, so one encounters less profit.
Capacity usage variance:

800 products A x 2.08333… standard fixed cost apiece = 1,667 -/- [1]
More or less profit:

800 products A x 1.91666… profit margin apiece = 1,533 -/- [2]
In the period under consideration, 11,200 products A have been produced. So,
it is to be expected quite normally:
11,200 x 4 kgs material = 44,800 kgs This is the reference
44,800 kgs Actually used up
--------------
0 kgs Zero difference
11,200 x 2 hours direct labour = 22,400 hrs This is the reference

21,000 hrs Actually used up
--------------
1,400 hrs x € 2.50/hr = € 3,500 +
11,200 x 2 hours variable overheads = 22,400 hrs This is the reference

21,000 hrs Actually used up
--------------
1,400 hrs x € 1.50/hr = € 2,100 +
Efficiency variances, totally € 5,600 + [3]
Finally, the various bills arrive. What is the reference? This is the very first
question. Be sure, you know the reference! What do you expect? Without
knowing the reference, how to answer: is the actual data a pleasant or unpleas-
ant surprise?
Firstly, acknowledge the references before opening the envelopes containing

the bills.
44,800 kgs material @ € 1/kg = € 44,800 This is the reference

€ 50,400 Actual
-----------
€ 5,600 -/-
21,000 hrs direct labour @ € 2.50/hr = € 52,500 This is the reference

€ 50,400 Actual
-----------
€ 2,100 +
21,000 hrs var. overheads @ € 1.50/hr = € 31,500 This is the reference

€ 39,200 Actual
-----------
€ 7,700 -/-
And there are price variances with regard to both the selling price and the
fixed costs:
11,200 products A sold @ € 16 apiece = € 179,200 This is the reference
€ 190,400 Actual
------------
€ 11,200 +
Fixed costs = € 25,000 This is the reference

€ 28,400 Actual
------------
€ 3,400 -/-
Price variances, totally € 3,400 -/- [4]
The various sub-variances, either positive or negative, are up for discussion.

Who or what to blame and who deserves a compliment?
Grand total: [1] + [2] + [3] + [4] = € 1,000 -/-
QED
Note: No formula has been used explicitly. No more is necessary than just
common sense in order to read and understand this reconciliation be-
tween SB-profit and RR-profit. It is the base for better management.
A raw material, Zeta, is used in the production of Alpha and an extract from
the standard cost card for Alpha showing the rates of usage and expected price
is as follows.
Per unit 10 kgs of Zeta @ € 6/kg = € 60 standard material cost.
During the current period 270 units of Alpha were produced and the usage was
2,850 kgs with an actual material cost of € 16,530. Due to world-wide price
movements Zeta was freely available at € 5.50/kg during the period.
SB: 270 x 10 kgs of Zeta @ € 6/kg = € 16,200 standard material cost
AB: 270 x 10 kgs of Zeta @ € 5.50/kg = € 14,850 material cost, reference
The difference between SB and AB is 2,700 times € 0.50 (€ 6/kg versus

€ 5.50/kg) = € 1,350.
2,700 kgs of Zeta, i.e. the reference (unchanged)

2,850 kgs of Zeta has been used up
----------------------
150 kgs of Zeta @ € 5.50/kg = € 825 -/- adverse efficiency variance [1]
Efficiency, material usage, what's in a name?
2,850 kgs of Zeta @ € 5.50/kg = € 15,675 AB-price is the NEW reference

€ 16,530 actual material cost
-----------
€ 855 -/- adverse price variance [2]
Total variance: [1] + [2] = € 1,680 -/- is the difference between AB and RR
i.e. € 14,850 respectively € 16,530.
QED
In a four week period Acme Ltd budgeted to make and sell 8,000 units of its
single product with a budget as follows:
SB budget for four week period, 20 days each 400 units

€
Production and Sales 8,000 units at € 15 each 120,000
less Variable costs 8,000 units at € 5 each 40,000
----------
Contribution 80,000
less Fixed costs 45,000
----------
Profit 35,000
€
Fixed costs € 45,000/8,000 units = 5.625
Variable costs 5
---------
Standard unit-cost 10.625
Selling price apiece € 15 minus standard unit-cost € 10.625 = € 4.375 profit

margin apiece.
Standard period profit = 8,000 units x € 4.375 profit margin apiece = € 35,000.
Due to storm damage there was an external power line failure and 3 days pro-
duction out of the possible (normal) 20 days were lost. The actual results were:
RR for the four week period under consideration

€
----------
Contribution 71,500
----------
Profit 26,500
There has been no change in either selling price, variable costs or fixed costs;
the only difference is the loss of 3 days, which is equal to missing 1,200 units.
AB for the four week period under consideration, 17 days

€
----------
Contribution 68,000
----------
Profit 23,000
Normal is 8,000 units in a four week period. Now 3 days are lost, 3 x 400 =
1,200 units have not been produced and consequently these 1,200 units are the
cause for both an adverse capacity usage variance and the loss of 1,200 times
the profit margin apiece.
1,200 x € 5.625 fixed costs apiece = € 6,750 -/- capacity usage variance
1,200 x € 4.375 profit margin apiece = € 5,250 -/- less profit
The difference between SB and AB is totally € 12,000 less profit (€ 35,000

profit respectively € 23,000 profit).
The NEW reference is 6,800 units whereas one actually encounters 7,150
units, so 350 units more than to be expected, giving a favourable capacity us-
age variance and also extra 350 times the profit margin apiece.
350 x € 5.625 fixed costs apiece = € 1,968.75 + capacity usage variance
350 x € 4.375 profit margin apiece = € 1,531.25 + extra profit
The difference between AB and RR is totally € 3,500 more profit (€ 23,000

profit respectively € 26,500 profit).
QED
Note: No formulae, no definitions, no new notions. It is clear that the opera-

tional people are accountable for the difference between AB and RR,
which is controllable by them. The cause for the difference between
SB and AB is often an external one, as it is here, the mentioned power
line failure.
4 Dispute Vernooij - Jacobs Jan F. Jacobs
4 Dispute Vernooij11 - Jacobs
Capacity usage variance is literally the variance that is raised by another than
standard (or otherwise expected) level of capacity usage. In case of propor-
tional variable costs, only fixed costs are left over in order to compute the ca-
pacity usage variance. And then, Vernooij claims that the actual hours spent
must be compared to the standard hours spent, at what price/hour?12 The cal-
culation base is the number of items being in force, to the author's opinion.
According to Vernooij, hours are the calculation base.
Often, but not always, the dispute is irrelevant with regard to the outcome be-
cause one can calculate either items or hours, ending up in the same answers.
Capacity usage variance/period is a certain number of hours/period more or
less multiplied by the (fixed) price/hour. Ditto, the corresponding number of
products/period more or less multiplied by the fixed part of the standard unit-
cost. It is given:
 heterogeneous mass production
 a items/hour products A
 b items/hour products B
 a for example is 5, so 12 minutes apiece
 b for example is 4, so 15 minutes apiece
The author, similarly supposedly everyone (yet not Vernooij?) has to know
how many products A and how many products B are at hand, which necessary
data can be transformed (if one likes to do so) into the corresponding amount
of hours for both the items A and B. One cannot say anything about the al-
lowed time (amount of hours) without knowing how many products A and B.
The latter is truly the base. Whereas numbers of products can be transformed
into allowed hours, there is no difference really; calculating capacity usage
variance is possible in one way (just counting products) or the other (counting
allowed hours). However, counting products is to be preferred above counting
hours. Spent hours can be caused by more reasons. Hours even are not always
an option. For instance, considering the standard fixed costs per period of a
sales department; these fixed costs divided by the normal amount of products
per period are part of the integral standard unit-cost. More or less products
sold in a particular period (spent hours do not matter at all and allowed time
cannot be determined either) end up in the capacity usage variance for the pe-
riod of the sales department under consideration.
11
Dr. A.T.J. Vernooij is affiliated to the Vrije Universiteit Amsterdam and he acts as a mem-
ber of Examination Committees.
12
The fixed part of the standard price/hour, in my opinion. Variable capacity costs, for in-
stance the variable costs related to a machine, are on a par with the variable costs of materials
to compute the materials usage variance. In either case it is a matter of efficiency; more or less
usage of something (kgs, hours, m2, m3, whatever) than strictly necessary. The standard
amount that is allowed is the standard amount apiece multiplied by the number of items being
in force, both in the standard as well as actual budget and in the ex post accounts. The calcula-
tion base again and again is the number of items being in force.
Example with extracts from an exemplary problem that was given at the
MBA-Examination in December 1994.13
Original text in Dutch:

De firma Van Tienen fabriceert een industrieel product in massa. Er is geen
voorraadvorming. De normale verkoop is vastgesteld op 8.000 eenheden per
jaar. Bij de begroting voor 1993 is men er van uitgegaan dat de verkoop 9.000
eenheden zou bedragen. Achteraf blijkt deze verwachting niet uitgekomen te
zijn. De verkoop in 1993 bedroeg 6.000 eenheden. In de kostprijs is een be-
drag voor constante kosten opgenomen van 15 min. à € 80,- per uur. Over
1993 levert de administratie op dat de constante machinekosten € 167.000,-
hebben bedragen bij een werkelijke inschakeling van 1.700 uur.
The following translation is limited to the essential data.

Homogeneous mass production, so one single product only. All production
will be sold, no supply of products. The normal amount of sales is 8,000 prod-
ucts annually. The budget for 1993 indicates that 9,000 products will be sold
in that particular year. The facts are that only 6,000 products have been sold in
1993 and the fixed machine costs ex post are € 167,000 whilst 1,700 machine
hours have been used up. The standard unit-cost for the product at hand im-
plies fixed costs '15 minutes at € 80/hour'.
Standard Budget/year (this applies each year)

8,000 products
2,000 hours (1 product requires 15 minutes) at € 80/hour = € 160,000
Ditto: 8,000 products at € 20 apiece = € 160,000
It holds: 1 product is identical to 15 minutes. To the left and to the right, per
product as well as per hour, the same outcome follows.
Actual Budget for 1993

9,000 products
2,250 hours
250 hours more (Actual Budget versus Standard Budget)
250 hours more at € 80/hour = € 20,000 +
i.e. the expected favourable capacity usage variance
Ditto: 1,000 products more at € 20/product = € 20,000 +
The correct answer is € 20,000 + capacity usage variance, calculated either via
products or hours. According to Vernooij, the calculation via products ends up
in the correct answer only because ex ante there happen to include no effi-
ciency variances or words of the same purport; by the way the claim made by
Vernooij is not that clear. To put my criticism crystal clear: the whole idea of
Vernooij is good for nothing. It is indeed totally wrong.
13
MBA is an important examination in the Netherlands, joined in by many candidates.
Realised Result in 1993

6,000 products
1,500 hours
500 hours less (Realised Result versus Standard Budget)
500 hours less at € 80/hour = € 40,000 -/-
i.e. the realised adverse capacity usage variance
Ditto: 2,000 products less at € 20/product = € 40,000 -/-
It still holds: 1 product is identical to 15 minutes. To the left and to the right,
per product as well as per hour, the same outcome follows.
Counting hours:
(1,700 -/- 2,000) hours x € 80/hour = € 24,000 -/- adverse capacity usage vari-
ance. This is the only right way to compute, according to Vernooij. Below is
the author's proof that this computation is as wrong as wrong can be.
Counting products:
(6,000 -/- 8,000) products x € 20/product = € 40,000 -/- adverse capacity usage
variance. This outcome would be wrong, according to Vernooij.
In 1993, 1,700 hours have been used up. The disappointment is 200 hours, an
unpleasant surprise. The available work could have been done, normally it had
to be done in the course of 1,500 hours. One was allowed to spend 1,500 hours
for 6,000 products at 15 minutes apiece normally. There are 200 hours lost,
indeed 200 more than strictly necessary used up hours. Who or what to blame?
The issue is inefficiency with regard to the machine hours. One has spent 200
hours more at € 0/hour variable machine costs, ending up in a zero efficiency
variance with regard to the machine hours.
To acknowledge the spending of machine hours, more than strictly neces-
sary, as the making of a favourable capacity usage variance is wrong. In the
way Vernooij computes, using even more hours would result in still higher
positive capacity usage variances. Vernooij will present a gain if and when for
instance 2,500 hours would have been used up. Note: just optically! It is not
real money, it is fictitious, where should the money come from?
An hour that has not been used up because there was no work means less
capacity usage. The rest is a matter of efficiency; here only efficiency, gener-
ally speaking there can still be other reasons for using more or less hours.
The computation by Vernooij compares the used up hours (1,700) that have
been spent at 6,000 products to the standard amount of 2,000 hours belonging
to 8,000 products from the standard budget (another amount!). This is by no
means just a little error; it is contradictory to logic. Vernooij is calculating
(1,700 hours minus 2,000 hours) at € 80/hour = € 24,000 adverse. Something
out of the reality belonging to the realised 6,000 products is directly related to
something out of the standard budget, which was written for 8,000 products.
Vernooij is 'comparing' apples to oranges. Vernooij is counting hours without
looking at all to the realised products; he goes by the standard 1 product is
identical to 15 minutes. Moreover, not the hours but the products are the cost-
carriers. Only € 120,000 fixed costs are being covered, i.e. 6,000 products at
€ 20 fixed costs/product. In reality the fixed costs are € 167,000 (given data).
Until further notice, € 7,000 apparently is the adverse price variance regarding
the fixed costs, being the difference between € 167,000 (real) and € 160,000
(standard, reference). The proven right capacity usage variance is € 40,000 -/-
i.e. the fixed costs being uncovered, which is a real loss. The adverse capacity
usage variance € 24,000 which amount is advocated by Vernooij is definitely
wrong. Vernooij does not specify the redeeming of the fixed costs. Vernooij is
hiding the facts from view, not checking the money involved; he is missing
money.
"De formule (Wp -/- Np) x Cs/Np levert de som van efficiencyresultaat en be-
zettingsresultaat op. Het correcte antwoord, berekend aan de hand van het
aantal producten, is gebaseerd op het feit dat er bij de voorcalculatorische
budgetanalyse geen efficiencyresultaten optreden. Daarom leidt een foute be-
rekening toch tot een goede uitkomst i.e. The formula (Wp -/- Np) x Cs/Np
gives the addition sum of the efficiency variance and the capacity usage vari-
ance. Correct outcomes in ex ante budgets via counting products instead of
hours are based on the fact that efficiency variances are nil ex ante. Therefore
a wrong computation ends up yet in the right answer (Vernooij, Accounting,
no. 1183, p. 387)." This is an allegation without proof. Underneath the claim
of Vernooij has been critically analysed.
Wp = Real amount of products/period

Np = Normal amount of products/period
Cs = Normal fixed costs/period
Ex ante, there are indeed no efficiency variances whatsoever, but it is not cor-
rect to state that 'therefore' a wrong computation ends up in the right answer.
The formula: W  /  N 
C
N
is well-known in literature and Vernooij claims that this 'variant' emerges into
the addition sum of efficiency variance and capacity usage variance and not
into the capacity usage variance only.
The right formula, according to Vernooij, is (Wu -/- Nu) x Cs/Nu
Wu = Real amount of hours spent during the period

Nu = Normal amount of hours/period
Cs = Normal fixed costs/period
Vernooij computes as follows, using (Wu -/- Nu) x Cs/Nu:
(9,000/4 -/- 2,000) hours at € 80/hour = € 20,000 positive

and
(1,700 -/- 2,000) hours at € 80/hour = € 24,000,- negative
Using (Wp -/- Np) x Cs/Np, the calculation does not always emerge in the
right outcome, according to Vernooij (Vernooij, Accounting, no. 1183,
p. 387).
(9,000 -/- 8,000) products at € 20/product = € 20,000 positive

(this outcome is correct)
and
(6,000 -/- 8,000) products at € 20/product = € 40,000 negative
(this outcome is wrong, according to Vernooij)
Cs = C is the normal fixed costs/period (no dispute).
From a calculation in products, one can be switch over to calculating hours

and vice versa, without any change in outcomes as long as one calculates ex-
actly. The (correct) calculation itself creates no difference at all. Vernooij is
misinterpreting symbol W in the formula. W is not the real amount of hours
spent but the amount of hours, which is necessary in view of the real volume
of production at standard usage rate. W in hours is not just W but Wt i.e. the
allowed amount of hours. It holds:
capacity usage variance = Wt  /  N alternative  

C
N alternative
In hours: (1,500 -/- 2,000) hours at € 80/hour = € 40,000 negative
In products: (6,000 -/- 8,000) products at € 20/product = € 40,000 negative
C = Normal fixed costs/period = € 160,000/period

W = Real amount of (a.o.) products/period = 6,000 products/period
N = Normal a.o. products/period = 8,000 products/period
C/N = (€ 160,000/period)/(8,000 products/period) = € 20/product
Nalternative = Normal a.o. products/period x Normal a.o. hours/product

It applies: 8,000 products/period x 0.25 hours/product = 2,000 hours/period
C/Nalternative = (€ 160,000/period)/(2,000 hours/period) = € 80/hour
Wt = Real a.o. products/period x Normal a.o. hours/product
As already stated, the calculation base is the amount of products. Only via the
amount of products, does one arrive at the relevant amount of hours.
Furthermore, it applies:
efficiency variance = Wt  /  Wu   variable costs/hour
Wu = Real a.o. hours/period
What are the costs of working with the machines in an inefficient way? The costs
of one hour, more than strictly necessary according to the standards being in
force, are the variable costs/hour. Because the fixed costs/hour are fixed, isn't
it? Regardless of whether or not the machines are being or not being used, the
fixed costs are indeed fixed.
Counting products, the formula for the capacity usage variance reads:
capacity usage variance = W  /  N  

C
N
or in the notation according to Vernooij:
capacity usage variance = (Wp -/- Np) x Cs/Np
This formula concerns the capacity usage variance only and definitely not ef-
ficiency variance nor any other variance.
By writing down and calculating
Wu  /  N alternative  
C
N alternative
with explicitly Wu instead of Wt, one is missing something whilst calculating

the capacity usage variance (mistake 1)
Wt  /  Wu  
C
N alternative
As soon as one mistake has been made, a second mistake has to follow in or-
der to correct the first one. Two times minus is plus again.
By calculating (mistake 2)
efficiency variance = Wt  /  Wu   total costs/hour
everything fits again.
In this way of calculating the efficiency variance it is typical for such a second
mistake to make up for what went wrong before. At first the capacity usage
variance is calculated incorrectly (mistake 1) and consequently another mis-
take must follow, a wrong calculation of the efficiency variance (mistake 2),
and finally the addition sum of both capacity usage variance and efficiency
variance does fit again. Be aware, just the addition sum does fit, yet not its
lowest terms.
Vernooij claims with certainty that (Wp -/- Np) x Cs/Np emerges into the ca-
pacity usage variance and the efficiency variance too, the latter is not equal to
zero necessarily and consequently Vernooij is rejecting this formula. Accord-
ing to Vernooij, counting products instead of counting hours is "een foute
berekening i.e. a faulty calculation (Vernooij, Accounting, no. 1183, p. 387)"
that only in particular situations it arrives at the right outcomes. This is non-
sense. The formula (Wp -/- Np) x Cs/Np gives the capacity usage variance
solely. With regard to the above quoted MBA-Examination problem defini-
tion: (6,000 -/- 8,000) x € 20/product = € 40,000 adverse capacity usage vari-
ance, which is the one and only correct answer. The 'solution' as advocated by
Vernooij, resulting in € 24,000 adverse capacity usage variance, leaving room
for € 16,000 adverse efficiency variance, is completely wrong. The cynical
verdict by Vernooij, to judge right what is proven wrong and to condemn what
is proven correct, aggrieves numerous candidates at various examinations.
5 Analysing Variances, What and How? Jan F. Jacobs
5 Analysing Variances, What and How?
Each and every analysis of variances starts with the Standard Budget (SB)
within which standard unit-costs are stated. Without knowing standard unit-
costs, one can hardly perform sound budgetary control. Almost any period
may be special, being divergent from SB, and consequently an Actual Budget
(AB) will be needed in order to analyse correctly. Alike SB, also AB applies
ex ante, it is the pre-calculation of the differences versus SB. Notably more or
less volume of either production and/or sales will be the key matter of such an
updated AB. Ex post, it is known how everything has been actually developed.
That appears from the statement Real Result (RR) i.e. the good old book-
keeping records or, as it is called nowadays, the IMIS, the Integrated Man-
agement Information System.
It holds: STANDARD Total Sales/STANDARD period -/- STANDARD Total

Costs/STANDARD period = STANDARD Result/STANDARD period.
'Per STANDARD period' can apply 'in general', for instance annually and then
it applies for a series of consecutive years; last year, this year, next year. It
holds for total sales as well as total costs and profit, per year, for any year.
Under consideration, being analysed, is a particular year. Calculated variances,
for instance capacity usage variance, efficiency variance and price variance, in
[money units/annual period], are related to that particular year.
If something is not clear, it is advisable to write down everything in each
and every detail, including dimensions. Correct formulae, pure calculations
stand the dimensions check, naturally. The other way round, checking dimen-
sions exposes faulty, improper calculations. Be aware, two times minus is plus
again. It starts with a profound mistake, followed by a second mistake that is
correcting the first one, and finally nothing is left over. That everything fits in
the end is merely the result of the lasting existence of both a plus and a minus.
There are mountains and there are valleys and a mountainous district exists on
behalf of the perpetual existence of both mountains and valleys. A mountain-
ous district, though flat on balance, is not a plateau since the mountains and
valleys continue to exist. The two consecutive faults, in mutual conjunction
with one another, ending up in the correct outcome, stay what they are, indeed
two faults. Economic literature is swarming with numerical enumerations of
this kind, which are up for discussion. Not in the least because this might be
the very cause of a lot of confusion of thoughts, especially by those who are at
the beginning of study economics.
If everything is clear, for instance what specific period is meant, of course
one can omit the 'per period' notation. Writing down things for briefness' sake
is done everywhere, also in pure sciences like mathematics and physics, if and
when dispute is not present.
STANDARD Sales -/- STANDARD Costs = STANDARD Result.
Written down in this way, clearly it is meant 'en masse'.
5 Analysing Variances, What and How? Jan F. Jacobs
However, 'apiece' is possible too.
STANDARD Sales price apiece -/- STANDARD Unit-cost = STANDARD

Profit margin apiece.
and
STANDARD Amount of products/STANDARD period * STANDARD Profit

margin apiece = STANDARD Result/STANDARD period.
If it is clear what the period is:
STANDARD Amount of products * STANDARD Profit margin apiece =

STANDARD Result.
Regarding the SB, the STANDARD situation, make sure that calculations are
made 'en masse' and 'apiece' always. In verification of outcomes, seeking mu-
tual affirmation. To the left and to the right, it must fit.
In the STANDARD situation, a lot cannot be seen. Many things are the
same, they fall over each other. For instance, STANDARD Total profit (of the
entity) is equal to STANDARD Total profit margin (recorded by the sales de-
partment).14 This is because ex ante there happen to be no efficiency and price
variances, in fact no variances at all. In other words: Total sales minus Total
costs is identical to the profit margin apiece multiplied by the amount of prod-
ucts.
Besides the SB, often an AB is present too. Sometimes AB can be written
already at the beginning, at least partly. Beforehand it is known that produc-
tion and/or sales will not be in conformity with set standards. Most likely AB
cannot be completed until the end of the period under consideration.
In literature all kinds of budgets are being introduced and these are ques-
tioned in exemplary problems and examinations, however, very often it is not
that clear what is really meant, what situation exactly between on the one hand
SB and on the other RR. No matter which division, ultimately the whole dif-
ference between SB and RR as well as between SB and AB must be exposed.
Cutting the whole into pieces. Meaningful variances, with correct names, the
contents must fit the description. Budget variances, not knowing exactly what
budget, whilst containing other variances like some but not all price variances,
end up into a hopeless muddle. Under the headline 'price variances' logically
all price variances should be specified. Students and scholars must be able to
understand everything perfectly and in practice, the variances must be ex-
plained standing on a box in the canteen, to anyone.
14
Be aware of names and definitions. In economics, an unequivocal vocabulary does not exist.
Often different notions appear under the same name, and not seldom one and the same notion
is identified by different names too.
6 Sheer Bad Education Jan F. Jacobs
6 Sheer Bad Education
Definitions and redundant formulae. Soulless tuition, not inspiring. See nu-
merous textbooks and curricula.
Sales variance, budget variance, production costs result. Mixed budget.
Flexible budget. 'Pre-calculated' budget. Real budget. Who does see the wood
for the trees? No wonder, one cannot keep the track. It is quite reasonable that
one is talking round and round the subject matter.
It is not necessary to introduce new meanings for words that are mentioned
in any good dictionary. Surely that is one of the reasons why things are going
badly on a massive scale, with regard to budgeting and budgetary control.
Volume variance, to give an example, can be the variance of a particular vol-
ume indeed, but it may also represent any combination of for instance market
size variance and market share variance, introducing the notions 'size' and
'share' with various meanings leaving room for misunderstanding. Formulae?
One can do without them. Just a few notions are necessary, the very basics like
efficiency variance has to do with used quantities, there are fixed costs (to be
redeemed by the normal rush of business) and variable costs, just such general
definitions. More than these well-known notions is not really necessary. What
one encounters in many textbooks is pure ballast, giving more trouble than
comfort. The phrase 'efficiency variance' is normally used in case of direct
wages, but it is 'usage variance' when direct materials are involved and 'vol-
ume variance' can be a variance in quantity with regard to fixed overhead,
whereas exactly the same is called 'efficiency variance' again in case of vari-
able overhead. Price variances, sometimes it is a 'price variance' indeed, but it
can be named also 'rate variance' or 'expenditure variance'. It applies for no-
tions, formulae and all kinds of aids and appliances: the fewer the better. The
person calculating the variances has to permanently keep control of everything
he is calculating. As distinct from the messing around with all those variances
by definition, demonstrated by so many writers in so many textbooks. Faults,
errors and mistakes are dangerous because they may usher in wrong conclu-
sions.
There are fixed costs and variable costs, existing almost always and conse-
quently there is talk of so-called mixed budgeting i.e. a budget within which
variable costs besides fixed costs are present. The allowed variable costs self-
evidently are dependent on the (planned) volume of production. This will hap-
pen almost anywhere, anytime; not just in the case of proportionally variable
costs. It is nonsense to speak - again another notion - about 'flexible' budgeting
if and when non-proportional variable costs are budgeted. Is mixed budgeting
supposed to be not flexible? And flexible budgeting is not mixed either?
6 Sheer Bad Education Jan F. Jacobs
Quote from university material for reflection:15

Flexible budgeting
Each period, a 'pre-calculated' budget is calculated, on the basis of the ex-
pected level of production. The real budget is calculated ex post, on the basis
of the actual level of production.
'Pre-calculated' budget is a tautology. "Real budget" (?). The first mentioned

budget, isn't it real too? In the ex ante budget, planned orders are stated; pre-
calculation. Ex post, from the after-calculation, it appears how many orders
were actually present. The variable costs related to the real level of production
are of course included within the real costs. One cannot see the allowed
variable costs apart from the real orders in production. The same applies for
allowed time, allowed usage of material, allowed waste, and so on and so
forth. One has to acknowledge this link always, if not, one perpetrates a
blunder. The real orders in production only are up to redeeming the fixed
costs. With respect to budgeting and budgetary control, a lot is going on badly
in practice. That's no wonder, since numerous textbooks do not present the
variances clearly. Using unnecessary words, notions, definitions, formulae,
whereas common sense is the key notion. Students can learn what and how
easily. Just realise that there are usually fixed and variable costs, besides a
normal rush of business culminating into standard unit-costs and altogether the
SB (Standard Budget); flexible, mixed, whatever. It all starts with knowing the
references. For each and every single item, it's the very first question. What
should it be? What is it one can expect? What is not a surprise? And actually it
is? That difference is the variance one is seeking. Formulae? One can do
without them. In particular those variances, which are not ready at hand;
logical thinking only, starting with the reference involved, will lead to what
the variance is (fact-finding first), after which the underlying cause, can be
exposed. In literature, a so-called Dutch method is proclaimed versus a
method that is called the American way besides still various other approaches.
However, always just one method, neither Dutch nor American or whatever,
can be the right one. The base is logical thinking, common sense. All ex ante
budgets as well as ex post statements have to be crystal clear. Industrial
accountancies that are not transparent are good for nothing. Always, one
working-out is correct, just one, presenting not only totals correctly, but
stating all sub-variances in each and every detail, clearly and completely.
Working-outs that are not clear, which do not speak for themselves, which are
not proven, should be expelled, before they hurt people and harm their
businesses.
15
Twente University: Bedrijfseconomie voor CT&M (186050), Inleiding Bedrijfseconomie
voor W&M (186001); responsible lecturer Dr Ir I.C. Kerssens-van Drongelen.
7 Worked Examples - 1. Post Electric Company Jan F. Jacobs
7 Worked Examples
1. Post Electric Company
With extracts from R.M.S. Wilson and Wai Fong Chua, 1998, p. 577.
The Standard Budget for 1992, Post Electric Company, reads:
Standard Budget (SB)

Meters Generators
Market size [number] 800,000 200,000
Market share 10 % [number] 80,000 20,000
Sales, € 30/meter and € 150/generator € 2,400,000 € 3,000,000
Variable costs € 15/meter and € 40/generator € 1,200,000 € 800,000
--------------- ---------------
Contribution € 1,200,000 € 2,200,000
Total Sales € 5,400,000

Total variable costs € 2,000,000
---------------
Contribution, total € 3,400,000
G & A expenses € 1,500,000
---------------
SB-Profit € 1,900,000
Realised Result (RR)

Meters Generators
Market share [number] 65,000 25,000
Variable costs € 16/meter and € 42/generator € 1,040,000 € 1,050,000
--------------- ---------------
Contribution € 845,000 € 2,775,000

---------------
G & A expenses € 1,650,000
---------------
RR-Profit € 1,970,000
How to present the best analysis of the 1992 operating result?
Market size, measured by the total volume of the two products involved has
been reduced by 5 %; that is 1,000,000 = 800,000 meters plus 200,000 genera-
tors as it was whereas it is 950,000 = 700,000 meters plus 250,000 generators.
Without any further change, this would have resulted in € 51.3 million total
market turnover. Indeed 5 % less than the original € 54 million market size,
measured in money units. Market size changes are limited to proportions, no
matter which measuring-staff one chooses. Besides the market size, also the
market mix has been changed, resulting in a newly defined market, measured
both in numbers of sold products and in money units.
Meters Generators In total

800,000 200,000 1,000,000 € 54 million
10 % 80,000 x 30 20,000 x 150 100,000 € 5.4 million
Size -/- 40,000 -/- 10,000 -/- 5 %
-/- 40,000 x 30 -/- 10,000 x 150
-/- 1,200,000 -/- 1,500,000 -/- € 2.7 million
760,000 190,000 950,000 € 51.3 million
Mix -/- 60,000 + 60,000
-/- 60,000 x 30 + 60,000 x 150
-/- 1,800,000 + 9,000,000 + € 7.2 million
700,000 250,000 950,000 € 58.5 million
10 % 70,000 x 30 25,000 x 150 95,000 € 5.85 million
The market share was 10 % and normally one may expect that a company is
following the market in trying to keep its relative position. The SB is outdated,
and Actual Budget will be the new standard until further notice.
Actual Budget (AB)

Meters Generators
Market share 10 % [number] 70,000 25,000
Variable costs € 15/meter and € 40/generator € 1,050,000 € 1,000,000
--------------- ---------------
Contribution € 1,050,000 € 2,750,000

---------------
G & A expenses € 1,500,000
---------------
AB-Profit € 2,300,000
The difference between AB and SB is € 400,000 more profit (€ 2.3 million

profit versus € 1.9 million profit).
Meters Generators In total

80,000 20,000 100,000
Size -/- 4,000 -/- 1,000 -/- 5 %
-/- 4,000 x 15 -/- 1,000 x 110
-/- 60,000 -/- 110,000 -/- 170,000
76,000 19,000 95,000
Mix -/- 6,000 + 6,000
-/- 6,000 x 15 + 6,000 x 110
-/- 90,000 + 660,000 + 570,000
70,000 25,000 95,000 AB
Above, the whole market, Size resp. Mix Totally + 400,000
Standard budgeted profit € 1,900,000 and by now attainable € 2,300,000.

Beyond, Post Electric Company, also Size resp. Mix.
70 : 95 = x : 90 x = 66,316
25 : 95 = y : 90 y = 23,684
70,000 25,000 95,000 AB

Size -/- 3,684 -/- 1,316
-/- 3,684 x 15 -/- 1,316 x 110
-/- 55,260 -/- 144,760 -/- 200,020
66,316 23,684 90,000
Mix -/- 1,316 + 1,316
-/- 1,316 x 15 + 1,316 x 110
-/- 19,740 + 144,760 + 125,020
65,000 25,000 90,000 RR
Totally -/- 75,000
Profit still attainable € 2,225,000
Post Electric Company is loosing € 170,000 due to an adverse general market

size variance (the whole market) plus once more € 200,020 due to an adverse
specific market size variance (the companies market share) and one is gaining
€ 570,000 due to a favourable market mix variance in general plus € 125,020
favourable specific market mix variance extra for Post Electric Company.
Meters Generators
Size -/- 60,000 -/- 110,000 -/- 170,000 General effect
Mix -/- 90,000 + 660,000 + 570,000 General effect
Size -/- 55,260 -/- 144,760 -/- 200,020 Specific effect
Mix -/- 19,740 + 144,760 + 125,020 Specific effect
-------------- --------------
16
-/- 225,000 + 550,000 17
16
Volume variance, according to R.M.S. Wilson and Wai Fong Chua, 1998, p. 580.
17
Volume variance, according to R.M.S. Wilson and Wai Fong Chua, 1998, p. 581.
The difference between € 2,225,000 (the profit that is still attainable) and
€ 1,970,000 Realised Result is to be explained easily by price variances only.
65,000 meters sold at € 29 each versus € 30 standard price, ergo

65,000 times € 1 is € 65,000 -/- adverse price variance, sales price
65,000 meters produced at € 16 each versus € 15 standard variable costs, ergo

65,000 times € 1 is € 65,000 -/- adverse price variance, variable costs
25,000 generators sold at € 153 each versus € 150 standard price, ergo
25,000 times € 3 is € 75,000 + favourable price variance, sales price
25,000 generators produced at € 42 each versus € 40 standard variable costs,

ergo 25,000 times € 2 is € 50,000 -/- adverse price variance, variable costs
Finally € 1,650,000 G & A expenses actual versus € 1,500,000 standard budg-

eted results in € 150,000 -/- adverse price variance, G & A expenses.
Price variances, in total € 255,000 -/-.
Profit still attainable € 2,225,000 (see above) in conjunction with total price
variances results in € 1,970,000 Realised Result.
In summary:
€ 1,900,000 Profit according to Standard Budget

€ 400,000 Extra profit due to following market changes (both size and
mix), general effect
--------------
€ 2,300,000
€ 75,000 Less profit (€ 200,020 -/- Size and € 125,020 + Mix) due to
changes in the market share (both size and mix) for Post Elec-
tric Company
--------------
€ 2,225,000 Profit still attainable
€ 255,000 Adverse total price variances
--------------
€ 1,970,000 Realised Result
QED
7 Worked Examples - 2. Pi Ltd Jan F. Jacobs
2. Pi Ltd
With extracts from R.M.S. Wilson and Wai Fong Chua, 1998, p. 582.
"Pi Ltd operates a system of standard costs. For a given four-week period,
budgeted for sales of 10,000 units at € 5 per unit, actual sales were 9,000 units
at € 5.125 per unit. Costs relating to that period were as follows:
Standard Actual
€ €
Materials 25,000 25,740
Wages (direct labour) 7,500 7,087.50
Variable overhead 1,000 925
Semi-variable overhead 270 243
Fixed overhead 2,000 1,881
Standard hours 50,000 -
Actual hours - 40,500
Notes:
(i) The standard material input is 25 kg per unit at € 0.10 per kg. The ac-
tual material content of each unit was 26 kg at € 0.11 per kg.
(ii) The standard wages per unit are 5 hours at € 0.15 per hour; actual
wages were 4.5 hours at € 0.175 per hour.
(iii) Mixed indirect costs consist of five-ninths fixed expense and four-
ninths variable expense.
(iv) There were no opening stocks and the whole production for the pe-
riod was sold.
(v) The four-week period was a normal period.
You are required to draft a statement reconciling the standard net profit for the
period with the net profit actually realized (R.M.S. Wilson and Wai Fong
Chua, 1998, pp. 582)."
Standard Budget (SB)

€
Sales 10,000 units at € 5 per unit 50,000
Costs:
- materials 10,000 units x 25 kg x € 0.10/kg 25,000
- direct labour 10,000 units x 5 hours x € 0.15/hr 7,500
- variable overhead 10,000 units x 5 hours x € 0.02/hr 1,000
- mixed ov., variable 10,000 units x 5 hours x € 0.0024/hr 120
- mixed ov., fixed 50,000 hours x € 0.003/hr 150
- fixed overhead, 50,000 hours x € 0.04/hr 2,000
-------- +
35,770
--------- -/-
14,230
Per unit:
€
- materials 25 kg x € 0.10/kg 2.500 variable
- direct labour 5 hours x € 0.15/hr .750 variable
- variable overhead 5 hours x € 0.02/hr .100 variable
- mixed ov., variable 5 hours x € 0.0024/hr .012 variable
- mixed ov., fixed € 150/10,000 products .015 fixed
- fixed overhead, € 2,000/10,000 products .200 fixed
----------
Standard unit-cost € 3.577
Standard selling price € 5 minus € 3.577 standard unit-cost results in € 1.423

standard profit margin.
Realised Result (RR)

€
Sales 9,000 units at € 5.125 per unit 46,125
Costs:
- materials 234,000 kg x € 0.11/kg 25,740
- direct labour 40,500 hours x € 0.175/hr 7,087.50
- variable overhead 925
- mixed overhead, totally 243
- fixed overhead 1,881
-------------- +
35,876.50
------------- -/-
10,248.50
Calculate all relevant variances and show the reconciliation between SB-profit
and RR-profit; the difference i.e. profit variance is € 3,981.50 adverse.
To produce and sell 9,000 units of the mentioned product, it is obvious that
9,000 times 5 hours each, so totally 45,000 hours are needed, if and when eve-
rything conforms to set standards. It is by all means possible that more or less
hours were actually needed, but if so, it is quite clear that more or less spent
hours have nothing to do with the 9,000 units produced and sold as such, but
with the level of (in)efficiency of the processes involved. To produce 9,000
units of the product, 9,000 times 25 kgs materials each, so totally 225,000 kgs
materials are needed, which is the reference due to set standards. More or less
kgs usage of materials results in an adverse respectively a favourable effi-
ciency variance with regard to materials. Kgs, hours, m2, m3, whatever, it is
exactly the same with any quantity. Below, efficiency variances are demon-
strated all along the line.
Efficiency variances
9,000 units x 25 kgs = 225,000 kgs i.e. the reference
234,000 kgs actual
---------------
materials 9,000 kgs more x € 0.10/kg = € 900 -/-
9,000 units x 5 hours = 45,000 hours i.e. the reference

40,500 hours actual
---------------
direct labour 4,500 hours less x € 0.15/hr = € 675 +

40,500 hours actual
---------------
variable overhead 4,500 hours less x € 0.02/hr = € 90 +

40,500 hours actual
---------------
mixed ov., variable 4,500 hours less x € 0.0024/hr = € 10.80 +
Efficiency variances, totally 124.20 -/- [1]
Capacity usage variances

1,000 units have not been produced and these non-existing units have not been
sold either. Therefore a part of the capacity was idle. The very reason is a lack
of work. That results in the capacity usage variance. It is the only reason be-
hind this variance. Of course capacity will not be used also owing to various
other reasons. In case of a high level of efficiency (see above) less capacity
than allowed is used indeed, but then efficiency is the reason, and less hours is
the mere consequence. Loss of units upstream, to name another reason behind,
more than allowed to set standards, will lead to adverse capacity usage vari-
ances - just optically - all the way downstream. One will encounter idle capac-
ity downstream, that is the effect, the reason behind however is the variance
concerning unfit products. Cause and effect. Variances should be measured
and named by the cause.18 Just counting the (total) effect regardless of the va-
riety of reasons behind that can exist, will most likely lead to faults.
Whereas 1,000 units do not exist, the remaining 9,000 units only are up to
redeeming the fixed costs. Here, the capacity usage variance measures the
remaining part of the fixed costs, which indeed is a real loss.
1,000 units x .015/unit mixed overhead, in part fixed costs = 15 -/-
1,000 units x .200/unit overhead fixed costs = 200 -/-
Capacity usage variances, totally 215 -/- [2]
18
The contents must fit the description. Not all names are equally appropriate.
Price variances
Finally the various bills arrive. First question: what is the reference? What
exactly is to be expected? What is not a surprise, either pleasant or unpleasant?
234,000 kgs x € 0.10/kg = € 23,400 i.e. the reference

€ 25,740 actual
---------------
materials € 2,340 -/-
40,500 hours x € 0.15/hr = € 6,075 i.e. the reference

€ 7,087.50 actual
---------------
direct labour € 1,012.50 -/-
40,500 hours x € 0.02/hr = € 810 i.e. the reference

€ 925 actual
---------------
variable overhead € 115 -/-
40,500 hours x € 0.0024/hr = € 97.20 mixed overhead, variable

€ 150 mixed overhead, fixed
--------------- +
€ 247.20 i.e. the reference
€ 243 actual
---------------
mixed overhead, totally € 4.20 +
€ 2,000 i.e. the reference

€ 1,881 actual
---------------
fixed overhead € 119 +
The 9,000 units sold at € 5.125 each versus € 5 standard results in € 1,125 ex-
tra profit; the price variance due to sales price is € 1,125 +.
Price variances, totally 2,219.30 -/- [3]
1,000 units, neither produced nor sold, cause a loss of 1,000 x € 1.423 profit
margin each, totally € 1,423 -/- [4]
Grand total: [1] + [2] + [3] + [4] = € 3,981.50 -/-

QED
Note: Once again, not any formula has been used explicitly. Only a transpar-
ent reconciliation between SB-profit and RR-profit, presenting a clear
picture in view of the facts as they are in each and every detail, is the
essential base to better operational management.
References Jan F. Jacobs
References
Beckman H. e.a., Bedrijfseconomie in hoofdlijnen, Wolters Noordhoff, Gro-

ningen, 2001.
Blommaert, A.M.M. en J.M.J. Blommaert, Bedrijfseconomische Analyses,

EPN, Houten, 2000.
Boer, P. de, M.P. Brouwers en W. Koetzier, Basisboek Bedrijfseconomie,

Wolters Noordhoff, Groningen, 1988.
Bulte, J., J. Dijksma en R. van der Wal, Management Accounting, Wolters

Noordhoff, Groningen, 1995.
Epe, P. en W. Koetzier, Management Accounting, Wolters Noordhoff, Gro-

ningen, 2001.
Halem, C. van en A. van der Pol, Kosten en kosten, Calculatieve bestuurlijke

informatie, Wolters Noordhoff, Groningen, 1996.
Jacobs, J.F., Bedrijfseconomie voor iedereen, JBA-Databank, Enschede, 1996.
Jacobs, J.F., Neither EVA® nor CVA®, but NVA, Measuring Financial Per-
formance, Uninterrupted, from Start to Finish, Working Paper, Social Science
Research Network, http://ssrn.com/abstract=366561, 2003.
Jensen, M.C., Paying People to Lie: The Truth About the Budgeting Process,
Harvard Business School Working Paper 01-072, Harvard Business School
Negotiations and Markets Research Paper No. 01-01, Social Science Research
Network, SSRN_ID267651, 2001.
Lucey, T., Management Accounting, 4th edition, Letts Educational, London,

1996.
Tijhaar, W.A., Bedrijfseconomie, Wolters Noordhoff, Groningen, 1995.
Tijhaar, W.A., Bedrijfseconomie, Opgaven voor hbo, Wolters Noordhoff,

Groningen, 1995.
Vernooij, A.T.J., Verkoopresultaat en budgetresultaat, Accounting, formerly

TBA, 99e volume, October 1995, no. 1183, pp. 383-389.
Wilson, R.M.S. and Wai Fong Chua, Managerial Accounting - Method and
Meaning, 2nd edition, repr. by International Thomson Publishing, London,
Boston, 1998.

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Budgeting and Budgetary Control

Ir Jan Franciscus Jacobs (BK T.H. Twente 1974)

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Budgeting and Budgetary Control

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documents. Though it may not be officially recognised, it is common knowl-

Unfortunately concerning various variances that are stated and calculated by

In textbook ISBN 0412436108, entitled Managerial Accounting - Method and

"Assume budgeted sales of a company's two products for a forthcoming period

and their costs were:

Actual sales for the period were:

(R.M.S. Wilson and Wai Fong Chua, 1998, p. 334)."

Market share x % A B Total

This is the applied budget.

Growth market share? Growth total market?

It applies until further notice A : B = 5 : 7 (500 : 700 = 529 : 741).7

Market share y % A B Total

Sales volume variance: 280.45 -/- 265 = 15.45

Market share y % A B Total

R.M.S. Wilson and Wai Fong Chua compare

R.M.S. Wilson and Wai Fong Chua calculate

A 60 more @ € 0.25 = € 15 favourable

Mix variance A B Total

This appears to be the mix variance.

Market share x % A B Total

Market share y % A B Total

Turnover variance: 2,169.50 -/- 2,050 = 119.50

Market share y % A B Total

What's in a name? Turnover variance is based on sales volume variance or the

"Quantity variance = 265 - [2,086/2,050 x 265] = + 4 (R.M.S. Wilson and Wai

"Expected profit on actual sales is calculated as though profit increases or de-

A mix variance of 13 favourable is definitely not correct. The standard propor-

There are actually 31 products A more and consequently 31 products B less

fig. 1 the proportion 700/500 = 1050/750 = 741/529 = 1.40

There are no other price variances.

By way of an extra check, one can calculate:

Normally, the contribution margins variance is the resulting variance of both

This is the readjusted budget, on the

Furthermore, just a price variance.

Sales prices variance 99.00 -/-

3 A Few Examples with Extracts from T. Lucey

With extracts from T. Lucey, Management Accounting, 4th edition, 1996,

Standard process loss is 5 %.

Calculate all relevant material variances.

1 tonne of input at standard produces 0.95 tonne of output, so Standard

93.1 tonnes @ € 25.473684… = € 2,371.60 Budgeted costs, the reference

The overall objective of variance analysis is to subdivide the total difference

Calculations ought to have outcomes that are incontestable. If a standard turns

93.1 tonnes output/0.95 = 98 tonnes in production, to be expected.

Totally 100 tonnes, 2 tonnes more than to be expected.

The mix is 50 % P, 40 % N and 10 % Q and at 100 tonnes total quantity versus

Material usage ('yield' or generally 'efficiency') variance is € 48.40 -/-.

P 50 % 0.50 · 98 = 49.00 tonnes P

Versus actual data, it applies:

Mix variance is € 29.00 +.

The variances altogether make up the total difference.