Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
14-1
Chapter 14
Operational Performance Measurement: Sales, Direct-Cost
Variances, and the Role of Nonfinancial Performance Measures
Teaching Notes for Case
Case 14-1: Pet Groom & Clean Case
Summary of Key Data for the analysis
Pet Groom & Clean
Supporting Data Actual Budget
Number of Customers 10,500 10,000
% TuWedTh 30% 20%
% FriSatMon 70% 80%
Price
TueWedTh 18.00$ 25.00$
FriSatMon 30.00$ 25.00$
Materials Cost
TueWedTh 2.20$ 2.00$
FriSatMon 2.20$ 2.00$
employee hours per year 2,250 2,500
Variable expense per clean 1.85$ 1.50$
Wage rate 13.50$ 12.00$
Number of employees 3 3
First step: Analyze Total Sales and the effect of price and volume changes for both the Tuesday-
Thursday and the Friday-Monday periods. The results show that the decrease in price for the Tuesday-
Thursday period was a net advantage: the price reduction caused a negative price variance of $22,050,
but the volume variance was greater, at $28,750 (this takes into account both the increase in total number
of service units sold and the shift in demand from 20% to 30% for the Tuesday-Thursday period).
An increase in price for the Friday-Monday period resulted in a positive price variance of $36,750 for
this period’s sales, while the shift in demand from this period to the Tuesday-Thursday period (a
reduction from 80% to 70% of total sales) resulted in a $16,250 volume variance. After considering
variable costs, the net effect of the volume and sales price variances for 2010 was a positive $20,950, all
of which was controllable by David, and therefore appropriate for his performance evaluation.
First: Sales Volume Effects on Costs Controlable by David (Higher volume means higher costs & vice versa)
Analysis of Sales Sales Disc Sales Price Flexible Volume Master Total Controllable
Gross Sales: Actual Variance Variance Budget Variance Budget Variance by David
TueWedTh 56,700$ (22,050)$ 78,750$ 28,750$ 50,000$
FriSatMon 220,500 36,750 183,750 (16,250) 200,000
Total 277,200$ 14,700$ 262,500$ 12,500$ 250,000$ 27,200$ 27,200$
Flexible Volume Master
Variable, Controllable Costs Budget Variance Budget
Materials 21,000$ (1,000)$ 20,000$
Labor 94,500 (4,500)$ 90,000
Other Variable Expenses 15,750$ (750)$ 15,000$
Total 131,250$ (6,250)$ 125,000$ (6,250)$ (6,250)$
Contribution Margin Volume Variance 20,950$ 20,950$
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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Second step: Analyze other expenses, some of which are controllable by David and others are not.
Training expenses are controllable by David since he chooses how much time each of his staff spends in
training. Note that the amount of training cost is below budget, thus saving costs for David, but the
downside is that David has not met the expected amount of training time per staff (6 hours per staff), and
training is important for the long-term success of the company. This favorable cost variance also has that
negative impact. In contrast, David chose to spend over the budget on advertising. The unfavorable cost
variance is the result, but there is also the favorable effect of building customer awareness for the
company, a long-term benefit. Employee benefits cost is considered controllable since it is tied directly to
direct labor. The other costs categories are allocated from corporate, so they are not controllable by
David. Thus of the total unfavorable variance of $18,145 for other expenses, only a small positive
variance of $325 can be fairly attributed to David’s performance.
Second: Analysis of Other Expenses
Controllable Not Master Total Controllable
Non-controllable Costs Actual by David controllable Budget Variance by David
Training Expenses 2,750$ 1,750$ 4,500$
Advertising 3,200 (1,200) 2,000
Service Development 27,720 (2,720) 25,000
Accounting and insurance 13,750 (1,750) 12,000
Taxes 7,500 (1,000) 6,500
Management overhead 65,500 (13,000) 52,500
Employee benefits 18,225 (225) (225) 18,000
Total 138,645$ 325$ (18,695)$ 120,500$ (18,145)$ 325$
The third and final step is to analyze the variable costs, all of which are controllable by David. The
following shows that the materials variance is unfavorable at $2,100, when the flexible budget is
compared to the actual costs for materials. The actual cost of materials is $2.20 per service rather than the
$2.00 budgeted. The results are analyzed in a similar way for other variable expenses which were
budgeted at $1.50 per service but were actually $1.85 per service, resulting in an unfavorable variance of
$3,675. The labor variance can be divided into the rate variance ($10,125 unfavorable) and a usage
variance ($13,500 favorable), because we calculate the flexible budget ($94,500 = $9 × 10,500) and the
cost of actual input at the standard labor rate ($81,000 = 2,250 × 3 × $12). Overall, David has not done a
very good job of controlling variable costs, and the net unfavorable variance of $2,400 illustrates this.
Note that the difference between the actual net income and budgeted net income of $405 can be
determined by adding the three variances in each of the three steps. The total variance controllable by
David is a favorable amount of $18,875 because such a large portion of the $18,145 unfavorable variance
for other expenses could not be fairly attributed to his performance. Thus, overall, David can fairly
expect a positive evaluation and receipt of a bonus for his performance.
Third: Flexible Budget for Controllable Operating Costs; All controllable by David
Price/Rate Actual Input Usage Flexible Total
Actual Variance** @Std rate Variance** Budget Variance
Materials 23,100$ 21,000$ (2,100)$ (2,100)$
Labor 91,125$ (10,125)$ 81,000 13,500 94,500 3,375$ 3,375$
Other Variable Expenses 19,425$ 15,750$ (3,675)$ (3,675)$
Total 133,650$ 131,250$ (2,400)$ (2,400)$ (2,400)$
Total difference between budgeted and actual profit $20,950-$18,145-$2,400= $405 405$
Portion of Total Difference Controllable by David $20,950+ $325-$2,400 = $18,875 18,875$
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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Teaching Notes for Readings
Reading 14-1: D. Johnsen and P. Sopariwala, “Standard costing is alive and Well at Parker
Brass,” Management Accounting Quarterly (Winter 2000), pp. 12-20.
The Brass Products Division at Parker Hannifin Corporation is a world-class manufactures of tube and
brass fittings, valves, hose, and hose fittings. Despite the introduction of popular new costing systems, the
Brass Product Division at Parker Hannifin Corporation is still using a traditional standard costing system
and making it work.
Discussion Questions:
1. What features in the firm’s standard costing that make it a success?
Among features that the Brass Products Division at Parker Hannifin Corporation introduced into its
standard costing systems and variance analyses are:
• Disaggregated product line information – Earnings statements are prepared for each product line.
Product line managers are required to provide an explanation for variances exceeding 5% of sales
and to put together a plan of action to correct the detected problem.
• Timely product cost information – Variance reports are generated the day after the last part has
• Employee training and empowerment – Meetings are held with the hourly employees to explain
variances and earnings statements for their product lines.
2. In addition to variances seen in the textbook Parker Brass created several new variances.
Describe these variances. Why are these variance added at Parker Brass?
The firm has created three new variances to adapt its standard costing system to its particular business
environment:
• Standard run quantity variance – to explain situations where the size of a lot is less than the
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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Reading 14-2: C. B. Cheatham and L. R. Cheatham, “Redesigning Cost Systems: Is Standard
Costing Obsolete?” Accounting Horizons (December 1996), pp. 23-31.
The article shows some new ways to analyze standard cost data, going beyond the traditional emphasis on
production costs variances that focus on price and efficiency. Variances for product quality are developed
and explained, as well as sales variances based on sales orders received and orders actually shipped.
There is also a discussion of how to incorporate activity-based costing, and continuous standard
improvement, including benchmarking and target costing.
The main premise of the article is that standard cost systems are the most common cost systems in
use, and while there are a number of limitations to these systems, a careful and creative effort can
transform them into more useful cost systems.
Discussion Questions:
1. What are the main criticisms of traditional standard cost systems?
The main criticisms mentioned in the article include an over-emphasis on price and efficiency to the
exclusion of other CSFs such as quality, timeliness, and customer satisfaction. Other criticisms include
2. What is meant by “push through” production? Is it preferred to “pull through” production, and
why?
Push-through production is associated with plants that work from large amounts of raw materials and
work-in-process to move work from operation to operation, with specialized work roles. The objective
is to fill the warehouse with finished products to meet potential demands. In contrast, the pull-through
3. What are the best ways to make standard cost systems more dynamic?
The article suggests that standard cost systems can be made more dynamic through regular review and
4. Should a firm follow the suggestions make in this article to add additional variances to its
standard costing system?
The article makes some good suggestions for expanding the role and use of standard costing, to
include new variances such as the raw materials and finished goods inventory variances, the quality
variance, and the sales order variance. Each of the variances provides potentially useful additional
information overload with additional variances.
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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Reading 14-3: T. Mitchell and M. Thomas, “Can Variance Analysis Make Media Marketing
Managers More Accountable?” Management Accounting Quarterly (Fall 2005), pp. 51-61.
This article discusses, within the context of a marketing application, an alternative method for
decomposing a total standard cost variance. The authors posit that in such applications the joint variance
(that in conventional practice is assumed to be small) can be significant in amount and therefore
invalidate conventional methods that include the joint price-cost variance as part of the price variance.
However, the treatment proposed by the authors for the joint price-quantity variance differs from the
“three–variance” solution found in some cost/managerial accounting texts.
Discussion Questions:
1. Explain what is meant by the term “joint variance” as this term is used in standard cost systems
used for control purposes.
Any variable cost (e.g., labor) is a function of two factors: price (p) and quantity (q). Thus, if during a
given period there is a flexible-budget variance for a given variable cost, that variance can
theoretically be decomposed into a price and quantity variance, thereby attributing a portion of the
(This term is used because this portion of the total cost variance is “jointly” a function of p and q
being different from planned levels.) Some textbooks include a discussion of the decomposition of the
total cost variance as: a pure price variance, a pure quantity (efficiency) variance, and a joint price-
quantity variance.
2. Explain what the authors of this article mean when they describe their proposed approach for
standard cost variance decomposition as a “geometric solution.”
The authors argue that even the three-variance approach discussed in some textbooks (see (1) above)
is fundamentally flawed in the sense that does not consistently produce accurate results. As a practical
matter, however, the authors admit that this issue is of practical importance only when standards are
“loose” and so-called joint variances are large.
As noted by the authors, the “joint price–quantity” variance is sometimes called the “unexplained
represented as the “correct” way to decompose a standard cost variance and it is against this model
that conventional practice (two-variance approach) and the alternative (three-variance approach) can
be compared.
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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3. Explain the term “Minimum Potential Performance Budget” model. How is this concept
employed in the variance decomposition process recommended by the authors?
The “minimum potential performance budget” is a concept that can be used to implement the
“geometric solution” presented by the authors (see (2) above). That is, it is proposed as a method to
On page 56 of the article, the authors note that the three-variance solution inflates at least one of the
two primary variances in three of the four cases. The two-variance solution distorts one or both of the
two primary variances in three of the four cases.
4. What are the primary advantages and primary disadvantages of the variance-decomposition
model recommended by the authors of this paper?
These are listed in the article (see Case/Readings Supplement, page 14-30):
Advantages
• the model can be applied to non-manufacturing contexts, such as the two-variable media-
Disadvantages
• the underlying concept, based on geometric relationships, may not be intuitive to some
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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Reading 14-4: Helping Students See the ‘Big Picture of Variance Analysis by Neal VanZante,
Management Accounting Quarterly, Vol. 8, No. 3 (Spring 2007), pp. 39-47.
This paper presents two examples that can be used to reinforce concepts and procedures students learn in
text Chapters 14 through 16. The first example, Fernandez Company, can be used as a comprehensive
review of all three chapters; the second example, Roger Company, can be used in conjunction with
Chapter 14 if additional coverage of the joint price-quantity variance for direct materials (DM) is desired.
The Fernandez Company example requires students to first calculate the total flexible budget variance (in
operating income) for a period and then breakdown this variance into its constituent parts (selling price
variance, various cost variances, etc.).
Discussion Questions:
1. What is meant by the total operating-income variance for a given accounting period? What
alternative names are there to describe this variance?
As described both in the text (Chapter 14) and this article, the total operating income variance for any
given period is the difference between actual operating income and the operating income reflected in
the master (static) budget for the same period. This variance is also referred to as the master budget
15, and 16.
2. What would be a first-level breakdown of the total variance described above in (1)?
As implied by this question, the total operating-income variance for a period can be broken down into
finer and finer components. A first-level breakdown of the total variance would be to calculate a sales
volume variance and a total flexible-budget variance. (For the single-product case, this point is
fixed cost.
3. How can the total flexible-budget variance be broken down (i.e., what are the constituent parts
of this total variance)?
As illustrated in the article and in the text (viz., Exhibits 14.2 and 14.4), the total flexible-budget
variance for a period is equal to the difference between actual results (revenue, variable costs, and
fixed costs) and flexible-budget results. As such, volume is held constant while we let selling price
regarding short-term spending.
Chapter 14 – Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial
Performance Measures
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4. Explain the total sales volume variance for a period. How can this total variance be
decomposed?
As indicated both in the article and the textbook, the sales volume variance for a single-product firm
represents the effect on operating income of selling more or fewer units than was envisioned when the
master budget was prepared. Because this variance is basically calculated as the difference between
can be further decomposed into a mix and quantity variance, the latter of which can be further
decomposed (into a market share and market size variance) using the methods discussed in the article
or the text (Chapter 16).
5. Explain the meaning of the joint price-quantity variance that is the basis for the discussion in
the Roger Company case.
When there is a mix of resource inputs (e.g., labor and materials) and the actual mix of resources
consumed differs from the budgeted mix, it is possible to further breakdown the quantity (efficiency)