w. bentzemba 8021 agenda today points regarding the practice questions update regarding the final...

W. Bentz EMBA 802 1

Agenda TodayAgenda Today

• Points regarding the practice questions

• Update regarding the final input

• Quiz

• Overview of product control system variances

• Comments about the use of selected variances

W. Bentz EMBA 802 2

Much of the remainder of the course is concerned with MANAGEMENT CONTROL SYSTEMS .

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Contribution VariancesContribution Variances

Remember, the purpose of our variance schemes at the management control level are to help to explain why actual results differed from planned results. We do not presume the plan was optimal for either the planned or the realized environments. Rather, we are attempting to shed some light on the reasons for differences.

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Contribution VariancesContribution Variances

Once we have developed a variance scheme and computed some variances, we still need to have some heuristics to guide the process of investigating variances in a cost-effective manner. Variances are defined as either good or bad in terms of their effects on income.

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Managerial PerformanceManagerial Performance

No variance scheme can anticipate operating conditions, market conditions, the actions of competitors, and economic developments. Our inability to anticipate the above forces is even more limited in a global marketplace that is subject to political shocks and natural disasters.

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What we can hope to do is to isolate some common effects that tend to be associated with different centers of responsibility and to provide a starting point for more in-depth analyses of actual performance. Areas in conformance with plan receive less attention than those not in conformance. We are of the opinion that successes should be reviewed along with failures to continuously improve.

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This perspective is entirely consistent with the idea organizations should be managed based on the data. At some level, performance should be analyzed for corrective action and problem-solving solutions. The intent is not to club managers into conformance, but to pursue the continuous cycle of planning, acting, evaluating, replanning, etc.

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Performance DimensionsPerformance Dimensions

For the most part, we have focused on:– Price realization– Sales volumes

• Overall sales volume• Sales mix

– Production (cost) variances• Resource prices• Efficiency of resource usage• Idle capacity cost

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Bentz/Lusch SchemaBentz/Lusch Schema

• We attempt to add the following additional perspectives:– Planning versus performance separation– Strategic versus operating emphasis

• The response has been best among those firms most concerned with positioning in definable markets and concerned with market share.

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Case ICase I (Onion Style)-Plan (Onion Style)-PlanProducts: Total Plain Deluxe

Price $ 11 $ 10 $ 12

Variable costs 6 6 6

Contribution $ 5 $ 4 $ 6

Planned sales-u 10 5 5 u


Planned sales mix 50% 50%

Total sales - 10 units


ExampleExample - Actual - Actual

Products: Total Plain Deluxe

Price $11.2 $ 10 $ 12

Variable costs 6.0 6 6

Contribution $ 5.2 $ 4 $ 6

Actual sales-units 10 4 6 u


Actual sales mix 40% 60%



Calculation of VariancesCalculation of Variances

Actual - Plan = Variance

Contribution

Margin $ 52 - $ 50 = $ 2

Quantity Variances Only:

Plain: (QA - QB)CB = (4 - 5)$4 = -$ 4

Deluxe: (QA - QB)CB = (6 - 5)$6 = + 6

Total: $ 2

Total variance = sum of the product variances.


Decomposition of VarianceDecomposition of Variance

When it is appropriate to consider a mix variance, the total contribution margin variance is divided into an overall volume effect and a mix effect.

Volume:

(TQA - TQB)CB = (10 - 10)$5 = $0


P = Plain, D = DeluxeP = Plain, D = Deluxe

Mix: (QAP - QBP)(CBP-CB) = (4 - 5)($4 - $5)

= -1(-$)1

= +$ 1

(QAD - QBD)(CBD-CB) = (6 - 5)($6 - $5)

= +1($1)

= +$1

Total mix variance = $ 2


Total Quantity VarianceTotal Quantity Variance

Total quantity variance = $ 2

Two variance system:

Overall volume variance $ 0

Mix variance 2

Total quantity variance $ 2

In this very simple case, it is easy to see we sold I more Deluxe unit, and 1 less Plain. The Deluxe units have a higher contribution margin - $2.


Case II - PlanCase II - Plan

Products: Total Plain SoSo Deluxe

Price $10.9 $ 10 $ 11 $ 12

Variable costs 6.0 6 6 6

Contribution $ 4.9 $ 4 $ 5 $ 6

Planned sales 10 3 5 2 u

Contribution $ 49 $ 12 $ 25 $ 12

Planned sales mix 30% 50% 20%



Case II - ActualCase II - Actual

Products: Total Plain SoSo Deluxe

Price $10.8 $ 10 $ 11 $ 12

Variable costs 6.0 6 6 6

Contribution $ 4.8 $ 4 $ 5 $ 6

Actual sales 11 4 5 2 u

Contribution $ 53 $ 16 $ 25 $ 12

Actual sales mix 36.4% 45.4% 18.2%

Total sales - 11 unitsNote: The above amounts are rounded.


Case II Quantity VariancesCase II Quantity Variances

Actual - Plan = Variance

Contribution

Margin $ 53 - $ 49 = $ 4

Quantity Variances Only:

(Actual Q - Budget Q)Product CM

Plain: (QAP - QBP)CBP = (4 - 3)$4 = +$ 4

SoSo: (QAS - QBS)CBS = (5 - 5)$5 = +$ 0

Deluxe: (QAD - QBD)CBD = (2 - 2)$6 = +$ 0

Total of quantity variances $ 4


Quantity VariancesQuantity Variances

The quantity variances measure the effects on income of differences in the sales per the budget and actual sales, product by product. There is no breakdown as to the major causes of the differences. Price differences and cost differences are not reflected in the quantity variances, just the effect of different quantities on total contribution margin.


Decomposition of VarianceDecomposition of Variance

Volume effect:

(TQA - TQB)CB = (11 - 10)$4.9 = $4.9

Mix effect (QAP - QBP)(CBP-CB) :

Pl: (4 - 3.3)($4 - $4.9) = .7(-$0.9) = -$.63

So: (5 - 5.5)($5 - 4.9) = -.5(+$0.1) = -0.05

Dx: (2 - 2.2)($6 - 4.9) = -.2(+$1.1) = -0.22

Total mix variance = -$0.9

Total quantity variance = $4.0


NOTICE!NOTICE!

Because we cannot clearly point to the substitution of one product for another in Case II, the most useful measure is the overall impact of selling a slightly different mix of products. Normally, one can get some overall sense of the shifts taking place, and a measure of the overall mix variance, but emphasizing individual mix variance elements may not be worth the additional cost and time.


RememberRemember

Conditions under which the mix variance is more likely to be useful:

1. Contribution margins must vary from product to product to get a mix variance.

2. The products compete for limited production, promotion or distribution resources. Thus, a constraint limits total sales in some way.


RememberRemember

3. The products are substitutes for one another in the view of consumers. So if a group of consumers choose among cars, small trucks, or sport-utility vehicles, then they are substitutes for comparison purposes. Substitution is by the consumer in this case.


Conversely,Conversely,

Conditions under which an overall volume variance is apt to be useful:

1. A mix variance is used to estimate the effects of shifts in the mix of products sold. The two variances must go together to explain the total variance.

2. Contribution margins vary little across products, and managers have little interest in individual quantity variances.


Market Share VariancesMarket Share Variances

The addition of market share variances represent a small step. The idea is to separate the rising (falling) tide effect associated with changes in the overall market for a product, and to determine how the firm did relative to the market. The specification of a market share goal is key to this process.



In addition, we provide for the possibility that other factors may influence the ability of the firm to deliver product. There is more subjectivity here, but the idea is to estimate the effect of production problems or distribution problems on profitability. Of course, lost sales are not the complete story, if products have varying contributions margins.



Suppose the goal is to keep 10% of a market. To our previous illustration, add the information that the market is 100 units, and our target share is 10% of the total market. Further, assume the market increases to 110 units, but we sell 12 units. How well did we perform?



Market share performance variance:

(12 - 10%{110})$4.90 = $4.90

or (12/110 - .10){110}$4.90 = $4.90

Market size planning variance:

(11 - 10%){100} $4.90 = $4.90


Market share planningMarket share planning

If subsequent conditions indicate we should have planned for a different market share, we can calculate a market share planning variance.

[(SR - SP)MR]CP

where SR is the share per the revised plan, and

SP is the share per the ex-ante plan.


Market share performance variance


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