Slide 1

ANALYZING AND REPORTING FINANCIAL STATEMENTS> > > > > > > > 1CHARACTERISTICS OF A GOOD REPORTING SYSTEMIt identifies the variances of actual performance from the budget according to the factors that caused them and the organization unit responsible;It includes an annual forecast;It includes an explanation of:The reason for variancesThe action being taken to correct any unfavorable variancesThe time required for any corrective action to be effective

2VARIANCE ANALYSISAn important part of standard cost accounting is avariance analysis, which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understandwhy costs were different from what was plannedand take appropriate action to correct the situation.3Prepare standard cost performance reportConduct next periods operations

Analyze variances

Identifyquestions

Receive explanationsTakecorrective actionsBegin

Variance Analysis Process4a. Variance by Causal factorA variance analysis will be meaningful only if variances are reported separately in terms of the factors that caused them and the organization unit responsible (revenue variances from cost variances; and revenue variances from selling price variances, mix and volume variances, mix variance, volume variance, & market penetration & industry volume)An effective report shows the causes for the variances and the impact of each of them on profits5Variance by Causal factorVariances are analytical framework used to conduct variance analysis which incorporates the ff:identify key causal factors that affect profitsbreak down overall profit variances by these key causal factorstry to calculate specific, impact of each causal factor by varying on that factor while holding all others constant (spin one dial at a time)add complexity sequentially, one layer at a time, beginning at basic level (peel the onion)stop process when added complexity is not justified by added useful insights into causal factors6b. Annual ForecastBudget performance reports should, if feasible, show a current annual forecast for two following reasons:- management needs to know the significance of the variances;- management needs an up-to-date estimate of annual profits for planning purposes7c. Reasons, Action, & TimingIf the budget performance report will be the basis for controlling company activities, it must know the reason for significant variances, the action being taken to correct unfavorable situations, and the expected timing of each corrective action.Analysis of Variance:DIRECT COST SYSTEMA standard direct cost system is one that assigns only variable manufacturing costs to products, and fixed manufacturing costs are charged as expenses of the current period.

Revenue VariancesPrice variance [actual price standard price * (actual volume)]Mix and volume variance[actual volume budgeted volume * (budgeted unit contribution)]Mix variance[actual volume of sales (total actual volume of sales * budgeted proportion) * budgeted unit of contribution)]Volume variance[(total actual volume of sales)(budgeted percentage) (budgeted sales)][budgeted unit contribution]Revenue VariancesMarket penetration and industry volume- separate mix and volume variance into amount caused by differences in market share and amount caused by differences in industry volumeMarket share variance[actual sales industry volume] * budgeted market penetration * budgeted unit contributionIndustry volume variance(actual industry volume budgetary industry volume) * budgeted market penetration * budgeted unit contributionCost VariancesFixed costs- variances between actual and budgeted fixed costs can be obtained simply by subtraction since these costs are not affected by volume of sales or volume of productionVariable costs- vary directly and proportionately with volume- budgeted variable manufacturing costs may be adjusted to actual volume of production- volume used to adjust budgeted variable manufacturing expense is manufacturing volume not sales volume which was used in finding revenue variancesReporting variancesSummary of variances onlyComparison of actual with budgeted costsAnalysis of Variance:FULL COST SYSTEMUnder a full cost system, both the variable and fixed manufacturing cost are assigned to the product produced; both costs are included in inventory at standard cost/unit Price variance is computed the same with the direct cost system; mix and volume variance is also the same except that the standard unit gross profit is substituted for the standard unit contribution.Material and labor variances are also the same as in the direct cost system, only the overhead expense variances that are different

Analysis of Variance:FULL COST SYSTEMAbsorbed cost the amount of material, labor, and overhead costs absorbed (included) in the cost of the goods produced. These goods are transferred to inventory at their full standard costBudgeted cost is the unit budgeted cost multiplied by the units produced.-spending variance spent more or less than the budgeted overhead in production-volume variance produced more or less than the standard volume(revenue variances/cost variances)15Use of Variance CalculationsVariances can be analyzed in such a way as to identify the responsible organizational unit and the causes of the variance with a precision that is limited only by the depth with which the original budget was prepared.For the management to know the causes of variances and to take corrective actions and how long it is going to takeLIMITATIONS OF VARIANCE ANALYSISalthough variances identify where a variance occurs, it doesn't tell why the variance occurred or what is being done about itdecide whether a variance is significantas performance reports become more highly aggregated, offsetting variances might mislead the readeras variances become more highly aggregated, managers become more dependent on accompanying explanationsreports show only what has happened, they don't show future effects of actions manager has takenvariances only measure what you set standards for (doesn't measure morale)Annual Profit Budget, 2013Product A (1,200)Product B (1,200)Product C (1,200)Total profit budgetUnitTotalUnitTotalUnitTotalAnnualMonthlySalesP1.00P1,200P2.00P2,400P3.00P3,600P7,200P600Standard Variable Cost Material0.506000.708401.501,8003,240270 Labor0.101200.151800.1012042035 Variable overhead0.202400.253000.2024078065 Total variable cost0.809601.101,3201.8021604,440370ContributionP0.202400.901,0801.2014402,760230Fixed costs: Fixed overhead30030030090075 Selling expense20020020060050 Administrative expense10010010030025 Total fixed costs6006006001,800150Profit before taxesP(360)P480P840P960P80Actual Sales for January, 2013ProductUnit sales

Selling pricePeso salesA100P0.90P90B2002.05410C1502.50375Total450P875Sales Price Variance(Direct Cost System)ProductABCTotalActual volume (units)100200150Actual priceP.90P2.05P2.50Budget price1.002.003.00Actual over/(under) budget(.10)0.05(0.50)Favorable/(unfavorable) price variance(10)10(75)(75)Mix and volume variance (Direct Cost System)(1)(2)(3)(4)(5)(6)ProductActual volumeBudgeted volumeDifference (2) (3)ContributionVariance (4)x(5)A100100---B2001001000.9090C150100501.2060Total450300P150Mix variance (Direct Cost System)(1)(2)(3)(4)(5)(6)ProductBudgeted proportionBudgeted mix at actual volumeActual salesDifference (3)-(4)Unit contributionVarianceA1/3150100(50)P.20(10)B1/315020060.9045C1/3150150-___Total45045035 Volume variance (Direct Cost System)(1)(2)(3)(4)(5)(6)ProductBudgeted mix at actual volumeBudgeted volumeDifference (2)-(3)Unit contributionVolume VarianceA15010050P.20P10B15010050.9045C150100501.2060Total450300150115Revenue variance by product (Direct Cost System)ProductABCTotalPrice varianceP(10)P10P(75)P(75)Mix variance(10)45-35Volume variance104560115Total10100(15)75Market penetration and industry volume (Sales volume) (Direct Cost System)ProductABCTotalEstimated industry volume (units): Annual10,0006,00020,00036,000 Monthly8335001,6673,000Budgeted market penetration12%20%6%10%Budgeted volume (units): Annual1,2001,2001,2003,600 Monthly100100100300Market penetration and industry volume (Actual sales) (Direct Cost System)ProductABCTotalIndustry volume1,0001,0001,0003,000Actual sales100200150450Market penetration10%20%15%15%Market penetration variance (Direct Cost System)ProductABCTotal(1) Actual sales (units)100200150450(2) Budgeted penetration at industry volume12020060380(3) Difference (1-2)(20)-9070(4) Unit contribution (budget)0.200.901.20___(5) Variance due to market penetration (3 x 4)(4.00)-108.00104Industry volume variance (Direct Cost System)ProductABCTotal(1) Actual industry volume1,0001,0001,0003,000(2) Budgeted industry volume8335001,6673,000(3) Difference (1-2)167500(667)-(4) Budgeted market penetration12%20%6%(5) (3 x 4)20100(40)(6) Contribution unit0.200.901.20(7) Total (5 x 6)4.0090.00(48.00)P46Fixed-cost variances/ Manufacturing Expense variances (Direct Cost System)ActualBudgetFavorable/(unfavorable) varianceFixed overheadP75P75P-Selling expense5550(5)Administrative expense3025(5)Total160150(10)ProductTotalActualFavorable/ (unfavorable) variancesABCMaterialP75P84P300P459P470(P11)Labor1518205365(12)Overhead (variable)3030401009010Total120132360612625(13)SUMMARY PERFORMANCE REPORT, January 2013Actual profitP132Budgeted profit80Division variance52 Analysis of variance favorable/(unfavorable)Revenue variances: PriceP(75) Mix35 Volume115 Net revenue variances75Variable-cost variances: Material(11) Labor(12) Variable overhead10 Net variable cost variances:(13)Fixed-cost variances: Selling expense(5) Administrative expense(5) Net fixed-cost variances(10)Division variance52PERFORMANCE REPORT (Direct cost system)ActualBudgetActual better/ (worse) than budgetSalesP875P950P(75)Standard variable cost of sales570570-Material variance11(11)Labor variance12(12)Variable overhead variance(10)10 Total variable cost583570(13) Contribution292380(88)Fixed manufacturing cost 7575- Gross profit217305(88)Selling expense5550(5)Administrative expense3025(5)Profit at actual volume and mix132230P(98)Mix varianceP35Volume variance115Division variance52PERFORMANCE REPORT (Full cost system)ActualBudgetActual better/ (worse) than budgetSalesP875.00950.00P(75.00)Standard cost of sales682.5+682.5+-Spending variances(13.00)(13.00)Volume variance (overhead)42.542.5 Gross profit222.00267.50(45.50)Selling expense55.0050.00(5.00)Administrative expense30.0025.00(5.00)ProfitP137.00P192.50(55.50)Mix variance35.00Volume variance (revenue)77.50Net varianceP57.00THE PROFIT BUDGET IN THE CONTROL PROCESS> > > > > > > > Profit budget as Control mechanismIt functions as early warning devices so management can take appropriate actions when necessaryThe budget system is used to help management appraise the performance of the individual managerLIMITATIONS OF THE PROFIT BUDGETAs a basis for performance appraisalProfits are affected by so many complex variables that it is impossible to provide an exact answer to the question: How much should this profit earn this year?In arriving at a profit budget, it is necessary to predict the conditions that will exist during the coming year, some of w/c are entirely beyond the control of the profit center manager economic climate and the competitive situationFactors Affecting Performance AppraisalThe degree of discretion that the divisional manager can exercise;The degree to which the critical performance variables can be influenced by the divisional manager;The degree of uncertainty that exists with respect to the critical performance variables;The time span of the impact of the managers decisions.PROFIT BUDGET ADMINISTRATIONTight Control*The profit goal of a divisional manager is considered to be a firm commitment against w/c he/she will be measured and evaluatedLoose Control*The budget is used essentially as a communication and planning toolModified Administration*A continuum between entirely tight and entirely loose controlSupplementary Control TechniqueOrganization ArrangementsAppropriate staff offices may be assigned the responsibility for monitoring divisional activity in their respective fieldsHave a several members of senior executive groups, each division having one executive from the groupA committee of senior executives, w/o line of authority, may review divisional activity periodicallyDivide the company into groups of divisions, each headed by a group executive responsible for the operations of the divisions within groups Periodic Financial EvaluationA time period adequate for fair evaluation should be established for each profit center where evaluation took place at the end of this period;When a manager leaves a division, a terminal evaluation would normally be made;Whenever top management becomes concerned about a particular profit center, an evaluation of performance could be requested;Have a periodic evaluation.

Non financial measures (General Electric Company, 1950s)Management by ObjectivesIt is a formal system in that each manager is required to take certain prescribed actions and to complete certain written documentsThe process involves 5 steps:a. The manager discusses with the subordinate the subordinates description of his own job;b. The manager and the subordinate agree to short-term performance targets;c. The manager and the subordinate discuss periodically the progress made toward meeting the targets;d. The manager and the subordinate agree to a series of checkpoints that will be used to measure progress;e. At the end of a defined period (usually one year), the manager discusses with the subordinate an assessment of the results of the subordinates efforts.CASE ANALYSIS:BONDSVILLE MANUFACTURING COMPANYPRINCIPAL CHARACTERS:James Smith Bondsvilles presidentWilliam Haywood Bondsvilles controllerFrederick Strong Manager of the Budget Department

PRODUCT LINES:Cotton textilesKnitted goodsArtificial fibersWoolen goodsArtificial leathersPRODUCT LINESEach line was produced in a separate plant and was marketed by a separate organization headed by one divisional manager. The corporate staff specifically the Sales staff vice president and manufacturing vice president were responsible only for helping the divisions when needed though they had been operating managers for several years and consequently, they exercised considerable direct control over their functional areas in the division.CONTROLLERS OFFICEBasic accounting records were maintained at the divisional officeDivisional balance sheet and profit and loss accounts were submitted to the central office monthlyThe central office prescribes the companys accounting systems, consolidated all the accounts, and published a company wide balance sheet and profitEach division has its own accounting officeEach plant manager had a cost analystThe company used a standard cost system to control material and labor and a flexible budget to control manufacturing overheadBUDGET PREPARATIONEach divisional manager was responsible for preparing and submitting a profit budget in December to cover the succeeding yearSales department first prepared an estimate of annual sales to be approved by the divisional manager, and everyone reporting to the divisional manager are responsible for preparing the budgets based on the indicated volume of salesThe plant budget was based on standard costs for material and direct labor, and the flexible budget for manufacturing overheadThe budget then will be submitted for the approval of the approval committeeThe budget will be the basis for evaluating actual profit performanceBUDGET REPORTSEach month a report was prepared for each division showing actual profits compared to budget and will be submitted to the central staff for review of the corporate budget department where a brief analysis of each report indicating points to be brought to managements attention was prepared.