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Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
CHAPTER 14:
OPERATIONAL PERFORMANCE MEASUREMENT: SALES, DIRECT-
COST VARIANCES, AND THE ROLE OF NONFINANCIAL
PERFORMANCE MEASURES
QUESTIONS
14-1 A master budget represents forecasted operating profit based on a single output
level (“planned sales”) for an upcoming period. As such, this budget is also
referred to as a static budget.
Pro-forma budgets represent budgeted operating income for various output
levels (production or sales). Pro-forma budgets can be prepared for any output
14-2 Standard costs (and selling prices), and their use in the construction of flexible
budgets (prepared after the current operating period is over), establish targets or
planned amounts as to operating earnings for a period. This information can be
used at the end of the period to determine why actual operating earnings for the
14-3 Management time is scarce. According to the philosophy of management by
exception, managers give primary attention to things (operations, sales
promotions, production, revenue growth, productivity gains, etc.) that are not
“abnormal” (i.e., an “exception”) it may trigger the need for an investigation to
uncover the underlying cause, which in turn may lead to some type of
intervention or change.
14-1
Education.
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
14-4 The performance of a division should not be considered as less than satisfactory
simply because all variances are “unfavorable.” For example, a company
Companies with such standards expect the division to meet the goals in each
and every operation.
14-5 Direct material price variances can be caused by any of the following factors:
purchasing material of a different quality than that envisioned in the standard
material cost; inapplicability of the standard cost per unit of raw material (i.e.,
outdated standards—the market price may have changed); purchasing was done
Purchasing Department. For example, if the Purchasing Department obtains
materials of lower quality than envisioned in the standard (perhaps to secure a
price savings), excessive spoilage and waste may occur during the production
process. Thus, in this case the Purchasing Department (not the Production
Department), would be responsible for the variance.
14-6 Direct labor rate (price) variances could be caused by: highly skilled (and paid)
labor used in place of lower-skilled labor; standard is out of date (e.g., new labor
contract); or, overtime work that is included in direct labor cost (rather than
manufacturing overhead). In some cases, the Production Manager is in the best
14-2
Education.
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
Direct labor efficiency (usage) variances could be caused by: using a different
mix of labor for the task at hand, as compared to the standard mix of labor;
poorly supervised employees; installation of new equipment; machinery and
equipment not maintained according to schedule (which could cause excess
waste and labor-hour consumption); inappropriate labor-hour standard (e.g., the
materials caused excess labor-hour consumption.
One particularly interesting situation that students should be aware of is the
potential for overemphasizing labor efficiency variances when labor is essentially
a short-term fixed cost. In this case, the labor efficiency variance can be largely
attributable to lack of orders (i.e., lack of sales demand), not worker efficiency.
For this reason, some writers suggest that when labor is essentially a short-term
fixed cost, that the labor efficiency variance not be reported for motivation and
control purposes. Otherwise, workers (and managers) may be motivated to
produce excess inventory which in turn would run counter to the JIT philosophy
that the firm may be embracing.
14-7 The answer depends on how overtime premium is treated by the accounting
prospects of the firm. In short, the labels “favorable” and “unfavorable” are
defined solely on the basis of the impact of the variance (positive or negative) on
short-term operating profit. It is a value judgment as to whether such variances
are positive or negative.
14-8 Of the three, for motivation and control purposes, standards based on the
average of recent historical performance are the least desirable. Many firms
prefer to use standards based on attainable performance in their standard cost
14-3
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
14-9 Establishing a standard cost system and identifying variances from the standard
are steps in gaining a better understanding of the operations and improving
operations. The focus of a standard cost system should be on influencing
standard cost system.
14-10 Organizations engage in a variety of processes in order to deliver the stated
value proposition to its targeted customers and in order to achieve its stated
financial objectives. These processes, for expository purposes, might be grouped
into the following: (a) operating processes, (b) customer-management processes,
14-11 A JIT system is very different from a conventional manufacturing system. In a JIT
system, a good or service is produced or delivered only when a customer
requires it. Some describe this as “demand pull” rather than “push.”
JIT production requires a product layout with a continuous flow once
production starts. Underlying the JIT system is a continuous improvement
philosophy of eliminating or reducing delay, error, and waste, such as materials
movement, storage, rework, and waiting time are part of the conventional work
environment.
Financial benefits resulting from a shift to cellular manufacturing, just-in-time
production, or continuous quality improvements may include the following:
14-4
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
reduction in work-in-process inventory levels.
3. Reduced material waste because of reduced damage caused by materials
The adoption of a JIT philosophy affects the organization’s management
accounting and control system in two primary ways:
1. To support the move to JIT, the accounting system needs to monitor
14-12 We might define total customer response time as the amount of time between
the time a customer places an order and the time when that order is received by
the customer. Manufacturing (production) cycle time can be defined as the
assessing process efficiency, based on the relationship between actual
processing time and total production time. In formula form, we can define PCE
as:
viewed, from the perspective of the customer. That is, would the customer be
willing to pay for the indicated activities/time? Does the activity add value in the
eyes of the customer?
14-5
Education.
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
BRIEF EXERCISES
14-13 Total static (master) budget variance = actual operating income static (master)
budget operating income
14-14 Total static (master) budget variance in operating profit = actual operating profit
static (master) budget operating profit
Sales volume variance in operating income = flexible-budget operating income
master budget operating income
Flexible-budget variance = actual operating income flexible-budget operating
income
14-15 Budgeted (Pro-forma) Operating Profit = (cm/unit × #units) FC
14-16 Sales price variance = actual sales volume × (actual budgeted) selling price/unit
= AQ × (AP SP)
14-17 Sales volume variance = budgeted cm/unit × (actual sales volume − master budget
sales volume)
14-6
Education.
Chapter 14 - Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
14-18 Direct materials usage (quantity) variance for PVC = Standard price/lb. × (actual lbs.
used – standard quantity of lbs. that should have been used, given the actual
output for the period)
= SP × (AQ − SQ)
14-19 Purchase-price variance for PVC = actual pounds purchased × (actual – standard)
price/lb.
= AQ × (AP SP)
14-20 Flexible-budget variance for PVC = actual PVC cost for units produced – FB cost
= (actual price/lb. × actual lbs. used) – (actual output × standard #lbs./unit of
output × standard price/lb.)
14-21 Direct labor efficiency variance = standard wage rate/hr. × (actual – standard) direct
labor hours= SP × (AQ SQ)
14-22 Direct labor rate (price) variance = actual hours worked × (actual – standard) wage
rate/hr.
= AQ × (AP SP)
14-7
Education.
EXERCISES
14-23 Flexible Budgets and Operating Income Variance Analysis; Spreadsheet
Application (50 minutes)
1. Flexible- Sales
Budget Flexible Volume Master
Actual Variance Budget Variance Budget
Units 3 ,800 - 0 - 3 ,800 200U 4 ,000
Sales $53 ,200 $3 ,800 U $57 ,000
1$3,000U $60,000
Variable costs:
Manufacturing $19,000 $3,800U $15,200
2$800F $16,000
Selling & Admin. 7 ,700 100U 7 ,600
3 400F 8,000
Fixed costs:
Manufacturing $16,000 $1,000U $15,000
$15,000
Selling & Admin. 10 ,000 1 ,000 U 9 ,000
9,000
1 Budgeted selling price per unit × number of units sold
2 Standard variable manufacturing cost per unit × number of units sold
3 Standard variable selling and administrative expense per unit × number of units
Sales volume variances
In terms of contribution margin: $34,200 $36,000 = $1,800U
Flexible-budget variances
Contribution margin: $26,500 $34,200 = $7,700U
Operating income: $500 $10,200 = $9,700U
14-9
Education.
2. The company reduced its selling price (from $15 per unit to $14 per unit) to compete
in the market, suggesting the pursuit of a cost-leadership, not a differentiation,
competitive strategy for the product. However, the company failed to exercise proper
3.
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