77 12.1: Introduction

Variance Analysis

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Jerry Feltz, president and owner of Jerry’s Ice Cream, is discussing the results of operations for the year with the company’s management group: Tom, the sales manager; Lynn, the production manager; and Michelle, the treasurer and controller.

Jerry: Good work, everyone! It looks as if our sales this past year exceeded the budget! We were expecting to sell 200,000 gallons of ice cream, but it turns out we sold 210,000 gallons. Credit goes to our sales staff for their hard work!
Tom: Thanks, Jerry. We have a great group of salespeople and a terrific product.
Jerry: I agree. I am concerned, however, about our direct labor and direct materials costs. We expected a 5 percent increase in these costs over the original budget since sales were 5 percent higher than anticipated. However, our cost overruns far exceeded the 5 percent increase. We’ve got to get a handle on both of these costs.
Lynn: This doesn’t sound right. My production crew used fewer materials than was budgeted, and the average time it took to make each unit was also less than expected. This should cause materials and labor costs to be lower than expected, not higher.
Jerry: Michelle, are you sure we have the right information here?
Michelle: Absolutely. Total costs for direct labor and direct materials were higher than budgeted, even after considering the increase in sales.
Jerry: Can you give me more detail as to how this happened? I want to know what caused the increase in costs and how to prevent this from taking place in the future.
Michelle: Can I have a week to pull the information together?
Jerry: You’ve got it.

Jerry is evaluating the performance of his company by comparing actual costs to budgeted costs. This is the control phase of budgeting. We covered the planning phase of budgeting in Chapter 11 by showing how Jerry’s Ice Cream prepared a master budget. The focus of this chapter is on the control phase and how to calculate and analyze cost variances.


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