3 for Self-Study Computing variable cost variances. (This problem continues the previous problems for

Problem 10.3 for Self-Study Computing variable cost variances. (This problem continues the previous problems for

self-study.) During the past month, the following events took place at Computer Supply, Inc.:

1. Produced and sold 50,000 laptop computer cases at a sales price of $10 each. (Budgeted sales were 40,000 units at $11.)

2. Standard variable costs per unit (that is, per case) were as follows:

Direct Materials: 2 Pounds at $1 per Pound ...................................................................

Direct Labor: 0.10 Hour at $15 per Hour .........................................................................

Variable Manufacturing Overhead: 0.10 Labor Hour at $5 per Hour .........................

Total ......................................................................................................................................

$4.00 per Case

3. Actual production costs were as follows:

Direct Materials Purchased and Used: 110,000 Pounds at $1.20 .........................

Direct Labor: 6,000 Hours at $14 ................................................................................

Variable Overhead ..............................................................................................................

Compute variable manufacturing cost variances in as much detail as possible. The solution to this self-study problem is at the end of the chapter on page 375.

360 Chapter 10 Prof|t and Cost Center Performance Evaluation

VICTORIA’S GOURMET COFFEE Overview of Variance Analysis

EXHIBIT 10.7

Profit Variance Analysis

Actual (based

Purchasing

Marketing

Flexible Budget

on actual

and

and

Sales (based on actual

sales volume

Production

Administrative

Price sales volume of

of 80,000 units)

Variances

Cost Variances

Variance 80,000 units)

$8,000 F $480,000 Less:

Sales . . . . . . . . . . . . . . . . . . . . . .

Variable Manufacturing Costs . . . . .

160 U 11,200 Contribution Margin . . . . . . . . . . . . .

Variable Marketing Costs . . . . . . . . .

$1,440 U

$7,840 F $175,200 Less: Fixed Manufacturing Costs . . . . . . . .

— 32,200 Fixed Marketing Costs . . . . . . . . . .

1,800 U

— 65,400 Fixed Administrative Costs . . . . . . . .

1,000 F

— 44,800 Operating Profits . . . . . . . . . . . . . . .

Total Profit Variance from Flexible Budget ⫽ $6,200 U

Cost Variance Analysis FLEXIBLE PRODUCTION BUDGET

Standard price (SP) Actual price (AP)

ACTUAL

INPUTS AT STANDARD

times standard quantity (SQ) times actual quantity (AQ)

Standard price (SP)

of input allowed for of input for actual

times actual quantity (AQ)

actual output (that is, 80,000 production output

of input for actual

units produced) (AP ⴛ AQ)

production output

(SP ⴛ SQ) (1)

(SP ⴛ AQ)

(3) Direct Materials

Price Variance

Efficiency Variance

$4,050 U

$1,000 U

Direct Labor

Price Variance

Efficiency Variance

$12,050 F

$19,100 U

Variable Manufacturing Overhead

$6.80 ⫻ 2,000 Mach. Hours $13,500

$6.80 ⫻ 2,100 Mach. Hours

Price Variance

Efficiency Variance

$293,600 Total Variances

$8,780 F

$20,780 U

$12,000 U

Period-to-Period Analysis of Changes in Financial Performance 361

Variable Overhe ad in S er vice Org aniz ations

Variable overhead is often significant for service industry firms, governmental agencies, and nonprofit groups. These types of organizations set standards and perform variance analyses for planning and performance evaluation purposes. For example, a county building department might have a standard for the number of days required to process an application for a building permit. Financial institutions might have a standard for the number of days required to process a loan application. United Parcel Service (UPS) has standards for several delivery tasks, such as a standard of 3 feet per second as the pace at which drivers should walk to a customer’s door.

Example American Parcel Delivery is a parcel service that competes with the U.S. Postal Service and

United Parcel Service. Each driver is responsible for picking up and delivering parcels in a particular geographic area. One major cost is fuel for the pick-up and delivery vans. The firm uses

a fuel efficiency variance to evaluate the performance of drivers. The firm calculates a standard amount of fuel consumption per parcel, whether delivered or picked up, for each territory. These allowances take the population density of the territory into account—allowing more fuel per parcel for sparsely populated territories, less for densely populated territories. Drivers control this variance primarily by scheduling trips to avoid unnecessary driving.

For a particular territory, the standard was 0.08 gallon of fuel per parcel. The driver assigned to this territory handled 1,100 parcels during March; hence, the budget allows 88 gallons ( show the variance calculations below. Note the similarity of these calculations to those presented for direct labor costs in Exhibits 10.5 through 10.7. American Parcel attributes part of this variance to the lower cost per gallon for fuel (not the responsibility of the driver) and part to the additional usage of fuel (the responsibility of the driver).

A M E R I C A N PA R C E L D E L I V E R Y E xa m p l e, Va r i a b l e O ve r h e a d Va r i a n c e --- F u e l C o s t s

Facts Actual:

Output .....................................................................................

1,100 Parcels Picked Up or Delivered

Fuel Required .........................................................................

93 Gallons

Cost per Gallon ......................................................................

$1.58 per Gallon

Standard: Fuel Allowed ..........................................................................

0.08 Gallon per Parcel Picked Up or Delivered

Cost per Gallon ......................................................................

$1.60 per Gallon

Actual

Variance

Flexible Budget $1.60 per Gallon

$1.58 per Gallon

Perio d -to - Perio d An alysis of Chan ge s in Fin ancial Per formance

Financial analysts examine companies’ performance over time. They want to understand why a company’s performance increased or decreased from month to month, quarter to quarter, or year to year. How much of that increase or decrease came from changes in sales? How much from changes in costs? You will certainly perform such analyses yourselves, whether as investors, analysts, consultants, or managers.

The profit and cost variance analysis frameworks that we have discussed in this chapter are good tools for analyzing how companies’ performance changes over time. Here’s how it works. The profit and cost variance analyses compare actual results to expectations, which we and the business world call budgets and standards. To do a period-to-period comparison, replace the expectation (that is, budget or standard) with the first period and the actual with the second period.

362 Chapter 10 Prof|t and Cost Center Performance Evaluation

We call the first period the baseline period and the second period the analysis period. The general framework for comparing two periods, say the years 2007 and 2008, looks like this:

Actual results

Analysis of differences

Actual results

for 2008

between 2007 and 2008

for 2007

Here is a simple example. We start with the actual results for Victoria’s Gourmet Coffee in Exhibit 10.7. We treat those actual results, which are for period 1, as the baseline. We want to compare those results to the actual results for period 2, which is the analysis period. Here are the data to be analyzed. Note that the period 1 data below were presented at the beginning of this chapter and provide the basis for column (1) in Exhibit 10.7.

Period 2 Period 1 *

Actual results

Sales and Production Volume for the Period ............................

90,000 Units 80,000 Units

Sales Price per Unit ........................................................................

Sales per Period ...............................................................................

Variable Manufacturing Costs per Unit .......................................

Total Variable Manufacturing Costs

per Period (unit cost times volume) ......................................

Variable Marketing Costs per Unit ...............................................

Total Variable Marketing Costs

per Period (unit cost times volume) ......................................

Fixed Manufacturing Costs for the Period .................................

Fixed Marketing Costs for the Period ..........................................

44,600 *These are the actual results for period 1 given at the beginning of this chapter.

Fixed Administrative Costs for the Period .................................

The period-to-period quantitative analysis appears in Exhibit 10.8. The explanation at the bottom of Exhibit 10.8 shows how to derive the amounts in the cells of the table. Here is an analysis of the changes.

Column (1) These are the actual amounts for period 2 given above. Column (2) These are the differences in manufacturing costs between periods 1 and 2 that

are due only to the increase in variable manufacturing costs per unit. Note that variable manu- facturing costs per unit increased from $3.82 in period 1 to $4.02 in period 2. This increase of $0.20 ( $18,000 in column (2), row (2). The heading for column (2) in Exhibit 10.8 is ‘‘Change in Operating Profits Because of a Change in Manufacturing Costs.’’ We specify the $18,000 in column (2), row (2) to be a ‘‘decrease’’ in operating profits because increases in costs decrease profits. Also, in column (2), row (5), we show the $8,000 increase in fixed costs from period 1 to period 2 as a decrease in operating profits. Analysts would seek to find answers to the question; ‘‘Why did these costs increase from period 1 to period 2?’’ Possible answers for the variable cost increase include changes in materials, labor, or variable overhead costs due to inflation and decreased efficiency. Fixed cost increases also could be due to inflation, or they could be due to an expansion of capacity to accommodate growth.

Column (3) These are the differences in operating profits between periods 1 and 2 that are due only to the increase in variable marketing and administrative costs per unit. Note that variable marketing costs per unit increased from $0.16 in period 1 to $0.18 in period 2. This increase of $0.02 ( gives the $1,800 decrease in operating profits from the increase in variable marketing costs per unit. This $1,800 appears in column (3), row (3). Also, in column (3), rows (6) and (7), we show the $5,800 increase in fixed marketing costs and $4,100 increase in fixed administrative costs from period 1 to period 2 as decreases in operating profits. Analysts would like to know: ‘‘Why

Period-to-Period Analysis of Changes in Financial Performance 363

VICTORIA’S GOURMET COFFEE Period-to-Period Analysis of Changes in Financial Performance

EXHIBIT 10.8

Change in

Change in

Change in Operating Operating

Change in

Operating Profits

Profits Because of

Profits

Operating Profits

Analysis Because of Change Change in Marketing Because of

Because of Baseline

Period, a in Manufacturing

and Administrative

Change in

Change in Period,

Sales Price

Sales Volume Period 1 a

1 2 3 4 5 6 (1) Sales

b $ 61,000 — c — $ 9,000

increase (2) Variable Manufacturing Costs

$18,000 d 38,200 e

decrease

(3) Variable Marketing Costs

— f $ 1,800

1,600 g 12,800

decrease (4) Contribution Margin

increase (5) Fixed Manufacturing Costs

8,000 h —

decrease

(6) Fixed Marketing Costs

5,800 h —

decrease

(7) Fixed Administrative Costs

4,100 h —

decrease

(8) Operating Profits

increase a Explanations of amounts:

b These sales and cost amounts were given in the text. c $9,000 d $61,000 e $18,000 $38,200 ¼ the increase in variable manufacturing costs only because volume increased ¼ $3.82 variable cost in period 1 times the volume increase

g $1,800 $1,600 ¼ the increase in variable marketing costs only because volume increased ¼ $0.16 variable cost in period 1 times the volume increase h The differences in fixed costs are simple the difference between period 2 fixed costs and period 1 fixed costs.

did these costs increase from period 1 to period 2?’’ A possible answer for the variable marketing cost increase would be changes due to an increase in sales commissions per dollar of sales or increases in distribution costs per unit shipped. Fixed cost increases could be due to inflation, or they could be due to an expansion of capacity to accommodate growth.

Column (4) The sales price increased by $0.10 ( times the 90,000 units sold in period 2 gives the $9,000 increase in operating profits shown in row (1), column (4).

Column (5) This column shows effects of the increase in sales volume. Sales volume increased 10,000 units ( affects three items: sales [column (5), row (1)], variable manufacturing costs [column (5), row (2)], and variable marketing costs [column (5), row (3)]. The amounts shown in column (5) result from multiplying the 10,000 unit increase in volume by the sales price per unit, by the variable manufacturing cost per unit, and by the variable marketing cost per unit. (See footnotes c, e and g for computations.). Note that we use period 1 sales price and variable cost amounts because we are isolating the effects of the volume change independent of the price change. Business analysts use this approach just as we used it in our discussion of sales variances.

364 Chapter 10 Prof|t and Cost Center Performance Evaluation