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Chapter 8

Evaluating Performance
(continue)
The Use of Variance Analysis
MIX AND YIELD VARIANCES FOR MATERIAL
AND LABOR
The quantity (or usage) variance is divided into a mix variance and a yield variance.
 Mix refers to the relative proportion of various ingredients of input factors such as materials and labor.
The material mix variance indicates the impact on material costs of the deviation from the standard
mix. The labor mix variance measures the impact of changes in the labor mix on labor costs
MIX AND YIELD VARIANCES FOR MATERIAL
AND LABOR
 Yield is a measure of productivity.
The material yield variance reflects the impact on material costs of the deviation from the standard
input material allowed for actual production. We compute the material yield variance by holding the
mix constant at the standard amount
Profit Variance Analysis
 Gross profit analysis is determining the causes for the change in gross profit. Any
variances that have an impact on gross profit are reported so corrective steps may be
taken.
 Causes of Profit Variance
 Changes in unit sales price and cost
 Changes in the volume of products sold
 Changes in sales mix
Profit Variance Analysis
NON-MANUFACTURING ACTIVITIES
 When nonmanufacturing activities repeat and result in a homogeneous product, standards may be used.
 The manner of estimating and employing standards can be similar to that applicable with a
manufactured product.
 Variance analysis is used in non-production-oriented companies such as service businesses.
 The cost variances are still the same as in a manufacturing concern, namely, budgeted costs versus
actual costs.
VARIANCES TO EVALUATE MARKETING EFFORT
 Prior to setting a marketing standard in a given trade territory, examine prior, current,
and forecasted conditions for the company itself and that given geographical area.
 Variances in Selling Expenses: The variance in selling costs is equal to the actual cost
versus the flexible budgeted cost.

 The variance is unfavorable by $20,000. Perhaps advertising and travel should be


investigated further.
Sales Personnel Performance
 Actual sales may not be the best measure of sales personnel performance. Profit is
what counts, not sales.
 The evaluation of sales personnel based on the trend in their sales generated over the
years shows signs of improvement. However, not considered here are customers’
market demand, potential markets, product mix, and cost incurrence
 Fixed marketing costs include administrative salaries, wages of warehousing and
shipping personnel, rent, and insurance.
 Variable marketing costs are comprised of processing, storing, and shipping goods,
which tend to fluctuate with sales volume. Also of a variable nature are sales
personnel salaries and commissions, as well as travel and entertainment.
 Profitability per salesperson may be a good measurement yardstick. Sales, less variable
product costs, less selling expenses, per salesperson will give the relevant profitability.
Performance Report (Marketing vs Regional)
Variances in Warehousing Costs
 In warehousing, standards for direct labor may be in terms of cost per item handled,
cost per pound handled, cost per order filled, and cost per shipment.
 Variances in warehousing costs can be calculated by looking at the cost per unit to
store the merchandise and the number of orders anticipated.
VARIANCES IN ADMINISTRATIVE EXPENSES
 As business expands, there is a tendency for administrative expenses to increase
disproportionately and get out of line.
 However, central general and administrative expenses typically are of a fixed-cost
nature, and hence there is less need to monitor these types of costs.
 Here comparison of budgeted to actual costs can be made quarterly or even yearly.
 These comparisons should be done by department or unit of responsibility
CAPITAL EXPENDITURES
 Variance reports are useful in controlling capital expenditures by looking at the actual
versus budgeted costs as well as actual versus budgeted times, for proposals at each
stage of activity.
 Such reports enable managers to take corrective cost-saving action, such as changing
the construction schedule.
 The director of the project is held accountable for the construction cost and time
budget.
 Component elements within the project also should be analyzed.
 We also can compare the expected payback period and actual payback period.
 This assists in measuring operational results and budgeting efficiency. Also, estimated
cash flows of the project can be compared with actual cash flows
VARIANCE ANALYSIS REPORTS

 Variance reports raise questions rather than answering them. For example, is sales
volume down because of deficiencies in sales effort or the manufacturer’s inability to
produce?
 Variance analysis reports may be expressed not only in dollars but also in
percentages, ratios, graphs, and narrative.
VARIANCE ANALYSIS REPORTS
 Performance reports are designed to motivate nonfinancial managers and employees
to change their activities and plans when variances exist. They should be terse and
concentrate on potential difficulties and opportunities.
 A section for comments should be provided so that explanations may be given for
variances.
 Because performance reports depend on the organizational structure, they should be
designed based on the company’s organization chart. Reports designed for a senior vice
president might deal with the entire business operation of the firm and the earnings
derived from it.
 The manufacturing manager would look at the efficiency of the production activity.
 The marketing manager would evaluate the selling and distribution function.
 A plant head would be concerned with the output and earnings generated from the
plant.
 A department head within the plant would be concerned with the output and earnings
generated from the area, as well as with cost control.
VARIANCE ANALYSIS REPORTS
 Performance reports should contain analytical information. To obtain it, source data
such as work orders, material requisitions, and labor cards should be evaluated.
Reasons for inefficiency and excessive costs should be noted, such as those due to
equipment malfunction and low-quality raw materials.
 For labor, the productivity measurement ratio of volume output per direct labor hour
should be computed. Further, the output of the individual or machine should be
compared to the normal output established at the beginning of the reporting period.
Operating efficiency can thus be measured.
 A labor efficiency ratio also can be computed, which is the variation between actual
hours incurred and standard hours.
 With regard to the evaluation of the divisional manager, fixed costs are generally not
controllable by the manager, but variable costs are. There are instances, however,
where variable costs are controllable by those above the division manager’s level.
SUMMARY
9. Evaluating Performance
 Variance analysis is essential for the appraisal of all aspects of the business,
including manufacturing, marketing, and service.
 Variances should be investigated if the benefits outweigh the costs of analyzing and
correcting the source of the variance.
 Variance analysis identifies trouble spots, highlights opportunities, encourages
decision making, and fosters coordination between responsibility units.
 Significant unfavorable variances must be examined for immediate corrective
action must be undertaken to handle the problem. The manager should provide
recommendations.
 If a variance is favorable, an examination should be made of the reasons so that
corporate policy may include the positive aspects found.
 Further, the responsible entity for a favorable variance should be recognized and
rewarded.