What-If Analysis The cost–volume–proft cost–volume–proft analysis analysis discussed discussed in Chapter Chapter 3 provided provided insights insights into how revenues, costs, and profts respond to changes in the quantity o product made and sold. However, that analysis assumed a constant product mix. preadsheet sotwares ma!e it possi"le to consider product mixes #and much more$ so that managers can evaluate alternative strategies. %anagers can explore the e&ects o alternati alternative ve mar!eting, production, and selling strategies. uch alternative proposals can "e evaluated in a what-if analysis The structure structure and inormation inormation required required to prepar prepare e the master "udget "udget can "e used used easily to provide the "asis or what'i analysis. • •
(valuating )ecision'%a!ing *lternativ *lternatives es ensitivity *nalysis
Sensitivity analysis is the process o selectively varying a plan+s or a "udget+s !ey estimates or the purpose o identiying over what range a decision option is preerred. lanners test planning models "y varying the model estimates, to see how it a&ects the plan. - small orecasting errors o an estimate used in the production plan change the plan, we say that the model is sensitive to that estimate. - the perormance consequences #or example, profts$ rom a "ad estimate are severe, planners may want to invest time and resources to improve the accuracy o their estimates. oth what'i and sensitivity analyses use the same model to evaluate uture alternatives. However, the approaches di&er in their purposes. /hat'i'analysis is a process that uses a model to predict the results o varying that model+s !ey parameters or estimates. estimates . ensitivity analysis is the process o selectively varying !ey estimates o a plan or a "udget to identiy over what range a decision option is preer preerred. red. -n this way, sensitivity analysis ena"les planners to identiy estimates critical to the decision under consideratio consideration. n. /hat'i'analysis /hat'i'analysis relies on that model tested via sensitivity analysis
Exercise 10-42 Jeren Company Company is considering considering replacing replacing its its existing cutting machine machine with a new machine that will help reduce its defect rate !elevant information for the two machines includes the following"
Cost item %onthly fxed cost 4aria"le cost per unit ales price per unit
Existing #achine 031,222 0 055
$ew #achine 02,222 02 055
%a& )etermine the sales level, in num"er o units, at which the costs are the same or "oth machines.
%'& )etermine the sales level in dollars at which the use o the new machine results in a 627 proft on sales #proft8sales$ ratio.
a. 9et : = sales level in units at which the costs are the same with "oth machines. Total cost or existing machine ; Total cost o new machine #0 × :$ < 031,222 ; #02 × :$ < 02,222 0: ; =,222 : ; 1,222 units
". 9et > = sales level in dollars at which the use o the new machine results in a 627 proft on sales ratio. 9et : "e the corresponding num"er o units, so that >
=
055 × :
: ; ?C8 @C% per unit – #627 x $A : ; 02,222 8 @65 – #.62 x 55$A : ; 02,2228 B.5 ; ,166 units >; 055 x ,166 ; 0136,25
Variance Analysis •
4ariance analysis – comparison o planned #or "udgeted$ results with actual results
•
4arianceDdi&erence "etween planned and actual results.
•
hould "e investigated to determineE '
/hat caused the variance
'
/hat should "e done to correct that variance
New slide •
udgeted or planned costs can come rom three sourcesE
– tandards esta"lished "y industrial engineers – revious period+s perormance – * "enchmar!Dthe "est in class results achieved "y a competitor
New slide •
The fnancial num"ers are the product o a price and a quantity componentE
– (lanned or )udgeted amount ; standard price per unit F "udgeted quantity – *ctual amount ; actual price per unit F actual quantity
•
4ariance analysis explains the di&erence "etween planned and actual costs "y evaluatingE
– )i&erences "etween planned and actual prices
– )i&erences "etween planned and actual quantities
New slide •
%anagers ocus separately on prices and quantities "ecause in most organiGationsE
– ne department or division is responsi"le or the acquisition o a resource and determining the actual price – * di&erent department uses the resource and determines the quantity
•
* variance is a signal that is part o a control system or monitoring results and thus variances provide a signal that operations did not go as planned.
Basic Variance Analysis 4ariance analysis helps managers understand the source o the di&erences •
- managers learn that specifc actions they too! helped lower the actual costs, then they can o"tain urther cost savings "y repeating those actions on similar Io"s in the uture
•
- the actors causing actual costs to "e higher than expected can "e identifed, then actions may "e ta!en to prevent those actors rom recurring in the uture
•
- cost changes are li!ely to "e permanent, cost inormation can "e updated or uture Io"s
The document summariGing costsDvariously reerred to as "udgeted costs, estimated costs, proIected costs, target costs, or orecasted costs, "ut all identiy the same costsDis called the master 'udget.
The +rst level o variance analysis or a cost item ocuses on the di&erences "etween actual and estimated #master "udget$ costs or the item. The second level o variance analysis decomposes the frst'level variances into a Jexi"le "udget variance and a planning variance. The Jexi"le "udget variance is the di&erence "etween actual costs and Jexi"le "udget costs, which reJect the volume level achieved, rather than planned. The planning variance is the di&erence "etween Jexi"le "udget costs and master "udget costs. ?or varia"le costs, the third level o variance analysis decomposes the Jexi"le "udget component o the second level variance into eKciency #use$ and price #rate$ variances.
First-Level Variances The frst'level variance or a cost item is the dierence 'etween the actual costs and the master 'udget costs or that cost item •
4ariances are favora'le %.& i the actual costs are less than estimated master "udget costs
•
/nfavora'le %/& variances arise when actual costs exceed estimated master "udget costs
Decomposing the Variances •
•
* exi'le 'udget adIusts the orecast in the master "udget or the di&erence "etween planned volume and actual volume Cost di&erences "etween the master and the Jexi"le "udget are called planning variances
– >eJect the di&erence "etween planned output and actual output – *rise entirely "ecause the planned volume o activity was not realiGed
Planning and Flei!le B"dget Variances •
•
.lexi'le 'udget variances are the di&erences "etween the Jexi"le "udget and the actual results ?lexi"le "udget variances reJectE
– uantity variancesDthe di&erence "etween the planned and the actual use rates per unit o output – Cost variancesDthe di&erence "etween the planned and the actual price or cost per unit o the various cost items
#econd and $hird-Level Variances •
•
The second'level variances are the planning variance and the exi'le 'udget variance The direct material Jexi"le "udget variances and direct la"or Jexi"le "udget variances can "e decomposed urther into third-level variances"
– Eciency variances – (rice variances )y classifying exi'le 'udget variances into rate %price& and eciency %3uantity& variances, managers can 'etter understand the factors causing those variances and correct the standards or institute changes that help reduce expenses
Direct %aterial Variances •
:uantity variance ; #*: ' :$ x
/hereE • • •
*: ; actual quantity o materials used : ; standard quantity o materials allowed ; standard price o materials
New slide •
rice variance ; #* ' $ x *:
/hereE •
* ; actual price o materials
•
; standard price o materials
•
*: ; actual quantity o materials used
– The price variance may "e calculated using the quantity purchased rather than the quantity used
/hen the amount o raw material used is di&erent rom the amount o raw material purchased, we defne one more varia"le ( %the actual 3uantity of raw material purchased& $otal &ost' The actual cost o the acquired raw materials ; purchased quantity # PQ$ x actual price # AP$. Price Ad("sted &ost' The cost o acquired materials using the standard price ; purchased quantity # PQ$ x standard price # SP$. Price Ad("sted )"antity' The cost o materials used using the standard price ; quantity used # AQ$ x standard price # SP$. Flei!le B"dget &ost' The cost o the standard quantity o materials ; standard quantity # SQ$ x standard price #SP$.
Direct La!or Variances
• •
(Kciency variance ; #*H ' H$ x > >ate variance ; #*> ' >$ x *H
/hereE • • • •
•
*H ; actual num"er o direct la"or hours *> ; actual wage rate > ; standard rate H ; standard num"er o direct la"or hours allowed The sum o the rate variance and the eKciency variance equals the total Jexi"le "udget direct la"or variance
10-4 The ollowing inormation is availa"le or %andalay CompanyE
Lnit cost
*ctual %aterial purchased )9 Lnits produced %aterial used #:$
65,222 pounds
08 pound
Standard %'udgeted& 32 pound8 unit
1,222h 522 61,522 pounds
0628h
h8 unit
Lnit cost
0668h
M08 pound
!e3uired %a& )etermine the material price variance "ased on the quantity o materials purchased. %'& )etermine the material quantity variance.
%c& )etermine the direct la"or rate variance. %d& )etermine the direct la"or eKciency variance.
a. ecause the quantity purchased di&ers rom the quantity used, the material price variance uses the purchased quantity #:$ instead o the quantity used #*:$. %aterial price variance ; #* – $ N : %aterial price variance ; #0 –0M$ N 65,222 ; #65,222$ ". %aterial quantity variance ; #*: ' :$ x %aterial quantity variance ; #61,522 – #522x32$$ x 0M ; #6M,522$
c. )irect la"or rate variance ; #*> ' >$ x *H ; #062' 066$ x 1,222 ; #1,222$ d. )irect eKciency variance ; #*H ' H$ x > ; #1,222 – #522x$$ x 066 ; 2
10-45 harout Company uses a standard cost system. Oo" 22M is or the manuacturing o 6222 units o the product P. The company+s standards or one unit o product P are as ollowsE
uantity )% )9
62 ounces 5 hours
(rice 058 ounce 0628 h
The Io" required B,=22 ounces o raw material costing 05=,=22. * avora"le la"or rate variance o 01,152 and an unavora"le la"or eKciency variance o 06,222 also were determined or this Io". %a& )etermine the direct material price variance or Io" 22M "ased on the actual quantity o materials used. %'& )etermine the direct material quantity variance or Io" 22M "ased on the actual quantity o materials used. %c& )etermine the actual quantity o direct la"or hours used on Io" 22M. %d& )etermine the actual la"or costs incurred or Io" 22M.
a. %aterial price variance ; #* – $ N *:
; @#5=,=228B,=22$ – 5A x B,=22 ; # ' 5$ x B,=22 ; B,=22 ". %aterial quantity variance ; #*: ' :$ x
; #B,=22 – #62x6,222$$x 5 ; #6222$
c. To get *H
)irect eKciency variance ; #*H ' H$ x > 6222 ; #*H' #5x6222$$ x 62
622 ; *H – 5,222 5,622 ; *H *H ; 5,622 d. )irect la"or rate variance ; #*> ' >$ x *H
#1,152$ ; #*> – 62$ x 5,622 *> ; B.55
*ctual direct la'or cost 6 *! x *7 ; B.55 x 5622 ; 0=M52
10-48 (ach unit o roduct has standard requirements o = pounds o raw material at a price o 015 per pound and 6 hour o direct la"or at 061 per hour. To produce 12,222 units o this product, product actually required 6=, 222 pounds o the raw material costing 01M per pound. The Io" used a total o 6=,222 direct la"or hours costing a total o 06B=,222.
!e3uired %a& )etermine the material price variance or product . %'& )etermine the material quantity variance or product . c& *ssume that the materials used on this Io" were purchased rom a new supplier. /ould you recommend continuing with this new supplierQ /hy or why notQ %d& )etermine the direct la"or rate variance or product . %e& )etermine the direct la"or eKciency variance or product .
a. %aterial price variance ; #* – $ N *:
; #1M – 15$ x 6=2,222 ; 32,222 ". %aterial quantity variance ; #*: ' :$ x
; #6=2,222 – #12,222 x =$$ ; 12,222 c. unavora"le variances, Ro. d. )irect la"or rate variance ; #*> ' >$ x *H
; #66 – 61$ x 6=,222 ; #6=,222$ ? e. )irect eKciency variance ; #*H ' H$ x >
; # 6=,222 ' 12,222$ x 61 ; #1,222$ ?
10-49 *ssem"ly o product 63 requires two unit o component P, one units o component S, and two units o component . Oo" O3M1 produced 112 units o 63. The ollowing inormation pertains to material variances or this Io", analyGed "y componentE
rice variance :uantity 4ariance
P 6222 L 1522 L
Components S M52 ? 6222 L
52 L =22 ?
The actual material prices were 01 more, 03 less, and 06.5 more per unit or components P, S, and , respectively, than their standard material prices per unit. !e3uired %a& )etermine the num"er o materials units consumed o each type o component. %'& )etermine the standard materials price per unit o each type o component.
a. %aterial price variance ; #* – $ N *: *: or P ; 62228 1 ; 522 *: or S ; 'M52 8 '3 ; 152 *: or ; 52 8 6.5 ; 322 ". %aterial quantity variance ; #*: ' :$ x or P ; #522' #1x122$$ 81522 ; 02.2 or S ; #152 – #6x122$$ 8 6222 ; 02.25 or ; #322 ' #1x122$$ 8 '=22 ; 02.615
