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I. GROSS PROFIT VARIANCE ANALYSIS (aka PROFIT VARIANCE ANALYSIS; GROSS PROFIT ANALYSIS) a. Variance Analysis i. Budgets – are used to communicate to employees what an organization’s operational and strategic goals are ii. Variance analysis – is the foundation of any performance evaluation system based on a budget iii. Favorable variance – ↑ income 1. Actual Selling Price> Standard Selling Price 2. Actual Cost Price < Standard Cost Price 3. In relation to Sales, Actual Units > Budgeted Units iv. Unfavorable variance – ↓ income 1. Actual Sales < Standard Sales 2. Actual Costs > Standard Costs 3. In relation to Costs, Actual Units < Budgeted Units v. Management by exception – is the practice of giving attention primarily to significant deviations from expectations (whether favorable or unfavorable); variance analysis enables this. vi. Goal: assignment of responsibility for the variance to those who most likely have information that will enable management to find solutions b. Gross Profit Analysis i. A decline in gross profit can be an indicator of serious problems, so the figure is closely watched. ii. This is designed to pick apart the reasons why the gross profit margin changes from period to period so that management can take steps to bring the gross margin in line with expectations. iii. It involves comparing the gross profit for the period being reviewed to either the budgeted level or the historical average. iv. It describes the total variance from expectations, and then itemizes the exact reasons for the differences so that management can identity specifically what is wrong and proceed to fix it. v. Disadvantage of using gross profit for profit variance analysis: Only covers product-related costs (excludes costs of selling and administration, all financing and other non-operational expenses; does not account for the efficiency of asset usage in creating gross profits) vi. Examples of causes for change in gross profit: 1. Sales prices have changed 2. The unit volume of items sold has changed 3. The mix of products sold has changed, assuming that different products have different gross margins 4. The purchase price of direct materials has changed 5. The amount of direct labor has changed, due to altered efficiency levels 6. The cost of direct labor has changed 7. The amount of fixed overhead incurred has changed 8. The amount of variable overhead incurred has changed vii. Contribution Margin vs Gross Profit 1. Contribution Margin = Sales – Variable Costs 2. Gross Profit = Sales – Variable Costs – Fixed Costs 3. Contribution margin is considered a better measure of product profitability because it deducts from sales revenue only the variable costs that are controllable in terms of fixing responsibility.However, this does not preclude the company from using the gross profit, especially when it uses an absorption costing system than a direct costing system.
1 II. VARIANCES a. Sales Variances i. If sales differ from the amount budgeted, the difference could be attributable to either: 1. Sales Price Variance – is the change in the contribution margin/gross profit attributable solely to the change in selling price while holding quantity constant 2. Sales Volume Variance which is the sum of a. Sales Quantity Variance - is the difference between (1) the budgeted contribution margin/gross profit based on actual unit sales and (2) the budgeted contribution margin/gross profit based on budgeted unit sales assuming that the budgeted sales mix is constant. b. Sales Mix Variance(applicable to companies with more than 1 products) – is the difference between (1) the budgeted contribution/gross profit for the actual mix and actual total unit sales and (2) the budgeted contribution margin/gross profit for the budgeted mix and actual total unit sales. b. Cost of Goods Sold Variances i. If cost of goods sold differs from the amount budgeted, the difference could be attributable to either: 1. Cost Price Variance 2. Cost Volume Variance III.
PROFIT VARIANCE ANALYSIS FORMULAS Current year = Actual Last year = Standard or Budgeted or Average Industry Data Difference = Current year – Last year Average Gross Profit Rate = Gross Profit / Total Quantity Sold 3-way analysis formulas (R. Roque) 1. Volume or Quantity = (Difference in units) X (Last year’s gross profit per unit) Factor 2. Price Factor = (Difference in selling prices) X (Current year’s units 3. Cost Factor
= (Difference in cost prices) X (Current year’s units)
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4-way analysis formulas (R. Roque) or 2-way analysis (F. Agamata) Sales Variance: 1. Price Factor 2. Volume or Quantity Factor
= (Difference in selling prices) X (Current year’s units) = Sales this year – Sales this year @ USP last year = (Difference in units) X (Last year’s selling price) = Sales this year @ USP last year – Sales last year
Cost Variance: 1. Price Factor 2. Volume or Quantity Factor
= (Difference in Cost Prices) X (Current year’s units) = Cost this year – Cost this year @ UC last year = (Difference in units) X (Last year’s cost price) = Cost this year @ UC last year – Cost last year
6-way analysis formulas (R. Roque) or 3-way analysis (F. Agamata)
Only Quantity Factors/Variances are the same under the 4-way (R.Roque) or 2-way (F. Agamata) analysis. Sales Variances: 1. Price Factor 2. Volume or Quantity Factor 3. Price-Volume Factor (R. Roque) or Joint Variance Factor (F. Agamata) Cost Variances:
= (Difference in selling prices) X (Last year’s units)
1. Price Factor 2. Volume or Quantity Factor 3. Price-Volume Factor (R. Roque) or Joint Variance Factor (F. Agamata) Multi-product Profit Analysis 1. Net Profit Price Variance (F. Agamata) made under 2way analysis (F. Agamata)
= (Difference in cost prices) X (Last year’s units)
2. Sales Mix Variance (R. Roque) or Mix Variance (F. Agamata) 3. Final Sales Volume Variance (R. Roque and F. Agamata) or Yield Variance (F. Agamata)
= (Difference in units) X (Last year’s selling price)
= (Difference in selling prices) X (Difference in units)
= (Difference in units) X (Last year’s cost price)
= (Difference in cost prices) X (Difference in units)
= Total Sales Price Variance – Total Cost Price Variance
= Gross Profit this year – Actual Gross Profit this year at last year’s prices = ‘Actual’ gross profit this year at last year’s prices –‘Actual’ gross profit this year at last year’s average gross profit rate = [ (Last year’s sales prices – Last year’s cost prices) X (Current year’s units) ] – [ (Current year’s units) X (Last year’s average gross profit per unit) ] = ‘Actual’ gross profit this year at last year’s average gross profit rate) – Gross Profit Last year = [ (Current year’s units) X (Last year’s average gross profit per unit) ] – Last year’s gross profit
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Problems 1. Sales and Cost Variances. The gross profit of M Corporation given below 2016 2017 P 8,000,000. P 12,000,000. Sales 6,000,000. 10,800,000. Less: Cost of Goods Sold 2,000,000. 1,200,000. Gross Profit P 160. P 250. Unit Sales Price P 120. P 225. Unit Cost 50,000. 48,000. Units Sold
for 2016 and 2017 are Change P 4,000,000. 4,800,000. P P P
(800,000) 90. 105. (2,000)
Required: Gross profit variations analysis, using the: a. Two-way variance analysis (F. Agamata) b. Three-way variance analysis (F. Agamata) Two-way variance analysis: Gross Profit Variance? Sales Variance? Costs Variance? Sales Quantity Variance? Sales Price Variance? Cost Quantity Variance? Cost Price Variance? Quantity Factor? Price Factor? Three-way variance analysis: Sales Quantity Variance? Cost Quantity Variance? Sales Price Variance? Cost Price Variance? Joint Sales Variance? Joint Cost Variance?
2. Sales Variance Ratios. Sales last year of P6 million decreased to P5.4 million but sales price increased by 20%. Required: Sales Price Variance? Sales Quantity Variance? Sales Quantity Variance Ratio?
3. Cost Variance Ratios. Cost of goods sold this year amounting to P9.6 million is 20% higher than that of last year. On the average, cost prices increased by 25%
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Required: Cost Price Variance? Cost Quantity Variance? Cost Quantity Variance Ratio?
4. Sales and Costs Variances with Incomplete Data. The contribution margin of Mel Corporation for 2016 and 2017 are given below:
Sales Less: Variable Costs Contribution Margin
2016 P 8,000,000. 6,000,000. 2,000,000.
The number of units sold increased by 5%. Required: Sales Price Variance? Sales Price Variance Ratio? Sales Quantity Variance? Variable Cost Price Variance? Variable Cost Price Variance Ratio? Variable Cost Quantity Variance?
2017 P 12,000,000. 8,000,000. 4,000,000.
