In this course, you will explore how to use accounting to allocate resources and incentivize manager and employee behaviors in using these resources. You will also learn how financial and non-financial accounting information facilitates strategic performance measurement and how to integrate this information to continuously improve strategy. Upon successful completion of this course, you will be able to: • Understand the role of managerial accounting information in common business decisions • Differentiate relevant and irrelevant information • Avoid common pitfalls in business decisions • Prepare a master budget and its key components • Describe the iterative and interrelated nature of budgeting • Evaluate capital investments via a variety of measures • Understand how upper management uses variance analysis • Calculate, interpret, and investigate variances • Understand decentralization and its advantages and disadvantages • Compute and interpret financial performance measures • Communicate the role of non-financial measures and strategic performance measurement systems • Identify issues associated with performance measurement and incentives • Understand the nature and role of subjective performance evaluation This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.
Cost Variance Classification and General Framework
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Do curso por University of Illinois at Urbana-Champaign
Managerial Accounting: Tools for Facilitating and Guiding Business Decisions
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University of Illinois at Urbana-Champaign
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Curso 2 de 7 em Specialization Value Chain Management
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Standard Costing and Variance Analysis
After establishing goals, setting targets, and the budget, upper management uses variance analysis to compare, assess, and investigate differences between actual and expected performance. In this module, you will learn how upper management uses variance analysis to motivate and monitor managers and employees, how to perform variance analysis on any aspect of the organization, and ultimately understand the power of this important tool for planning and control.
Conheça os instrutores
Gary Hecht, Ph.D.Associate Professor of Accountancy
Department of Accountancy, College of Business
[ Music ]
>> So let's explore cost variances.
First of all, we'll talk about variable costs.
And as you recall from previous modules there are usually three
categories of variable costs: direct materials, direct labor,
and variable overhead.
We'll think about each of these types
of variable costs on three levels.
That is we'll have three different types of variances:
spending, efficiency, and activity, or sometimes referred
to as volume variances.
We'll have each of these variances for each type of cost.
So for direct materials,
and even each individual material type,
we'll calculate a spending variance,
an efficiency variance, and an activity variance.
We'll calculate these three variances for direct labor,
as well, and all the different types of labor
that we have in our organization.
And, finally, depending on how we parcel
out the overhead category, we'll have spending, efficiency,
and activity variances for each type of overhead that falls
in the variable category.
When we combine the consideration
of all these different types of cost
with all the different types of variances
that each cost uses we have, kind of, a messy picture here.
But that's ultimately a signaling the complexity
of variance analysis.
At the end of the day we can combine spending, efficiency,
and activity variances for materials
or individual materials, labor or individual types of labor,
and all the variable overhead costs into what's referred
to as a generic static budget variance.
This is the overall difference between actual spending
on each type of cost and what was originally expected
or budgeted.
But the static budget variance broken down leads us
to the spending efficiency and activity variance,
which creates a lot of information to analyze
at the end of a period and use for decision-making purposes.
Now one important distinction is that between variable costs
and fixed costs-and I'll get into the details of the logic
and reasoning later-but fixed cost variances are calculated
in a much more simple manner.
Ultimately we'll have just a generic static budget variance
for fixed costs.
There are some exceptions to this and we'll see
that in a future lesson.
So let's introduce a generic framework
for calculating variable costs.
It will help us to simplify this very complex setting.
I'm a sports-oriented person so I wanted to bring
in a sports-oriented example.
And I could bring in any type of equipment.
A soccer ball, a football, tennis ball, baseball,
but the simplest sports product that I can identify comes
from my favorite sport and that is ice hockey.
So let's think about an ice hockey puck.
It's a single material good
and it would surprise you how complex the production process
is for this process.
But in terms of materials, it's just one thing.
So let's use this example to develop our framework.
[ Pause ]
So when we think about the costs associated with the materials
in an ice hockey puck you can think
about how much we would spend in a month
to create all the hockey pucks that we manufacture.
So at the end of the month we have spent some total dollar
amount on materials for creating all of our ice hockey pucks.
And that's something that we know at the end of the period.
So we would call that actual.
Now that's the total spending.
But let's think about the individual drivers
of this total spending.
Again, just for the materials that the hockey puck is made
of you can think about the input, the raw materials rubber,
and how much we pay for that on a per unit basis.
Now you can measure the raw material in a variety
of ways-let's say it's ounces or grams-and we think
about buying the raw material rubber from a supplier.
And that's going to be in terms
of some dollar amount, per some weight unit.
Ounces or, again, grams.
So that's one driver of the overall cost.
But then we can also think about how much
of the input the raw material we use for each hockey puck.
And so that is in terms of some weight unit, ounces,
per unit produced per puck.
And then the final driver leads to the total amount
of materials dollars we spend in a given timeframe is the number
of pucks that we produce.
And when we multiply each of those individual components
by each other we're left
with the total dollar spent for materials.
So dollars per ounce multiplied
by ounces per puck will yield a dollar per puck figure
in terms of materials costs.
When we multiply that by the number
of pucks we produce we have the total dollar amount
that we have spent.
So these are all actual pieces of information
that we have identified at the end of an accounting period.
Our accounting records tell us how much we paid per ounce,
how many ounces we use per puck, and how many pucks we produced.
But, of course, we have a plan or an expectation,
a static budget, if you will,
where each of those individual components can be presented
on a budgeted or expected basis.
These are our standards.
We can have a standard price, we can have a standard input,
and we can have a standard output.
Same principle applies here.
The standard price is what we expect to pay
for an ounce of rubber.
The raw material.
The standard input is how much of the rubber that we use,
again in ounces, per puck that we produce.
And the standard output is the number of pucks
that we expected to produce.
So in essence we have an analogues line-column-over here.
In the sense that we have a standard price, standard input,
and standard output compared to the actual information
in the left hand column.
When multiplying each of those three components
in the same way we come up with how much our direct material
spending should have been.
What we have budgeted.
Now, if we were to compare these two things
in their aggregation we would see that, oh,
we have spent more direct materials dollars
than we had planned to.
Or, perhaps, we have spent less in any one given month.
But that wouldn't provide you a lot of information.
The reason is there are many different sources
of that overall difference.
You might have paid a different amount for your input,
you might have used a different amount
of input per output then you had expected,
or you might have produced more or less than you though
in terms of number of pucks.
So variance analysis allows us to delve into those details.
So let's move from this static budget column
where everything is expected, everything is budgeted,
and go eventually create the actual column.
So the next column in we'll refer to that
as the flexible budget.
And recall from previous slide
that that is how much we should have spent given what we
actually produced.
So comparing the flexible budget
to the static budget is all expected numbers.
Standard numbers.
Standard price, standard input, but actual output.
It takes into account what we actually produced,
but at the standard price and standard input amounts.
So it tells us what we should have spent given what our actual
production was.
When we multiply the standard price, standard input,
and actual output numbers we get the flexible budget for,
in this case, materials.
The next column in doesn't necessarily have an official
name, I just call it the standard price column.
And in that one we're going to change the next component.
We've already changed standard output to actual output
as we move from right to left.
So we can leave that the same.
Actual output.
But what we haven't done is considered how these standard
input per output differs from the actual input per output.
So let's change that component as we move from column three
to what is in column two and leave everything else the same
so that we can isolate this individual component.
When we multiplied the standard price,
multiplied by the actual input per output,
multiplied by the actual output,
we get a total dollar number there again.
And now our variances fallout from the bottom of the columns.
The difference between the actual
and selling price column totals can be calculated.
The same for the difference between the selling price,
standard price column, and the flexible budget column.
And, finally, the same for the flexible budget
and static budget column.
As you can see what this framework allows is
to see the isolation in the variance analysis
for each individual component.
The difference between the flexible budget column
and the static budget column comes down to the difference
between actual output and standard output.
The different between the two middle columns is focused
on the difference between the actual
and standard input per output.
And the difference between the first two columns is the
difference between the actual price paid for each
of our inputs and the standard price
that we had expected to pay.
So these individual differences that fallout
from this framework are referred to as the spending variance,
the efficiency variance, and the activity variance.
Firms call these things different things,
different labels, depending on their preferences,
but these are generic labels
that I think are useful in most cases.
But, ultimately, what this framework allows us to see is
that there are different reasons or different sources
of an overall difference between the actual amount spent
on materials and what we had planned to spend.
And some of that has to do with each component.
Variances provide us a quantification of each reason
or each source of that variance.
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