Management Accounting

Chapter 15:

variance: the difference between an actual result and a budgeted amount

benchmark: a point of references from which comparisons may be made (the budgeted amount)
standard: a carefully predetermined amount; it usually expresses on a per unit basis
In practice, there is not a precise dividing line between a budgeted amount and a standard amount.
Management by exception: the practice of concentrating on areas not operating as anticipated and
giving less attention to areas operating as expected

static budget: a budget that is based on one level of output; it is not adjusted or altered after it is
set, regardless of ensuing changes in actual output (or actual revenue and cost drivers), developed at
the start of the budget period based on the planned output level for the period
flexible budget: adjusted in accordance with ensuing changes in actual output (or actual revenues
and cost drivers), calculated at the end of the period when the actual output is known.
Can differ in their level of detail.
Favorable variance: denoted F, is a variance that increases operating income relative to the
budgeted amount
unfavorable variance: denoted U, a variance that decreases operating income relative to the
budgeted amount
The term level followed by a number denotes the amount of detail indicated by the variance(s)
isolated.

Flexible-budget variances and sales-volume variances:

flexible-budget variance: the difference between the actual results and the flexible-budget amount
for the actual levels of the revenue and cost drivers
sales-volume variance: the difference between the flexible-budget amount and the static-budget
amount; unit selling prices, unit variable costs and fixed costs are held constant
The flexible-budget variance pertaining to revenues is often called selling-price variance: it arises
solely from differences between the actual selling price and the budgeted selling price

Price variances and efficiency variances for inputs:

The flexible-budget variance (Level 2) captures the difference between the actual results and the
flexible budget. The sources of this variance (as regards costs) are the individual differences
between actual and budgeted prices or quantities for inputs. The next two variances we discuss –
price variances and efficiency variances for inputs – analyze such differences. This information
helps managers to better understand past performance and to plan for future performance. We call
this a level 3 analysis as it takes a more detailed analysis of the level two variances.
Price variance: the difference between the actual price and the budgeted price multiplied by the
actual quantity of input in question (such as direct materials purchased or used); sometimes also
called input-price variance or rate variances
efficiency variance: the difference between the actual quantity of input used and the budgeted
quantity of input that should have been used, multiplied by the budgeted price; sometimes called
input-efficiency variances or usage variance

Level 1 Static-budget variance

Level 2 Flexible-budget variance Sales-volume variance
Level 3 Price variance Efficiency variance

standard input: a carefully predetermined quantity of input (such as kilograms of materials or

hours of labor time) required for one unit of output
standard cost: a carefully predetermined cost

The breakdown of the flexible-budget variance into its price and efficiency components is important
when evaluating individual managers.
The cause of price and efficiency variances can be interrelated therefore do not interpret these
variances in isolation from each other.

Management uses of variances:

A key use of variance analysis is in performance evaluation. Two attributes of performance are
commonly measured:
Effectiveness: the degree to which a predetermined objective or target is met
Efficiency: the relative amount of inputs used to achieve a given level of output

If any single performance measure receives excessive emphasis, managers tend to make decisions
that maximize their own reported performance in terms of that single performance measure.

Variances and flexible budgets ca be used to measure specific types of performance goals such as
continuous improvement.
Continuous improvement budgeted cost: a budget cost that is successively reduced over
succeeding time periods
By using continuous improvement budgeted costs, an organization signals the importance of
constantly seeking ways to reduce total costs.
Products in the initial months of their production may have higher budgeted improvement rates
than those that have been in production longer.

The cause of variance in one part of the value chain can be actions taken in other parts of the value
chain. Note how improvements in early stages of the value chain can sizably reduce the magnitude
of variances in subsequent stages of the value chain.
The most important task in variance analysis is to understand why variances arise and than to use
that knowledge to promote learning and improve performance.

When should the causes of variances be investigated? Rule of thumb, cost-benefit analysis

Almost all organizations use a combination of financial and non-financial performance measures
rather than relying exclusively on either type.

Flexible budgeting and activity based costing

Benchmarking and variance analysis:

benchmarking: often used to refer to the continuous process of measuring products, services and
activities against the best levels of performance