The Importance of Variance Analysis in Evaluating Cost and Revenue Performance - Essay Example

Running header: accounting Student’s name: Instructor’s name: Subject code: Date of submission: Executive summary This report analyses the importance of variance analysis in evaluating cost and revenue performance for Barnes scuba diving. In this regard, the report provides calculations of various variances of the company. The report also explains the benefits of using the benefits of using variance analysis as a management control tool to identify the company’s weaknesses and strengths in a bid to take remedial measures where unfavorable variances are noted. In addition, the paper analyses the various variances that have been observed in Barnes scuba diving while suggesting remedial measures that the company should take in a bid to improve its performance. Finally, the paper will look at the limitations the company would face in using variance to analyze the company’s performance. Introduction Barnes Scuba Driving was established in 2000 by two friends James and Rob with an aim of bringing scuba diving into the lives of as many people as possible. As such, Barnes Scuba Diving provides scuba diving courses around Surfers Paradise in Queensland, Australia. The company offers a 3 day program to help beginner scuba divers develop their scuba diving skills. In the last six months, scuba diving has made profits that exceeded the owner’s expectations. Although this is pleasing, they do not know the cause of improvement since this happened despite some issues the business has been experiencing which were expected to negatively affect the business. This report provides an analysis of the company’s revenue and cost performance with an aim of identifying the causes of variances and suggests measures that could be employed to improve business performance. In so doing, the report will also explain the benefits and limitations of using variance analysis for Barnes scuba diving. Explanation of the benefits of using variance analysis to evaluate Barnes Scuba Diving’s revenue and cost performance It is clear that although the business has performed better than expected, James and Rob do not know why the actual results have differed with the budget results. This implies that even if the business had performed poorly, they would not establish where the problem is and hence the business would continue on a negative trend until it probably goes under. Furthermore, if they wanted to invest in a bid to improve their business, they would not know which areas of the business to invest in. As such, variance analysis by their friend is a tool that will help one in gaining a better understanding of the business in terms of its areas of weaknesses as well as its strength areas so that one can make sound decisions regarding the business. Variance analysis will help in maintaining control over Barnes scuba diving costs/expenses through monitoring of the planned costs against the actual costs. In this regard, it will help the company in spotting trends, issues, threat and opportunities in a bid to plan for both short term and long term success. Variance analysis will enable Barnes scuba diving to analyse the budgeted costs and revenue against actual results hence acting as a tool of control. In this regard, variance analysis has helped in discovering that not only did the company increase its prices hence resulting to increased revenue but also the fact that costs also increased significantly. After discovering these variances, it will be possible for the business to investigate their causes and hence mitigate them in case they are adverse or improve on them in case they are desirable. This means that Scuba diving will be able to adjust its business goals and objectives as well as strategies thus leading to better performance in future. For Barnes scuba diving, variance analysis will act as a managerial control tool with the owners taking remedial actions in a bid to achieve their desired goals whenever the actual performance varies from the planned performance as in the present scenario. It will help in monitoring Barnes scuba diving’s business efficiency hence helping identify areas of weakness in which case the business will be assured of better performance in future. In addition, Barnes scuba diving will be able to use variance analysis for prediction or forecasting on the business’s future performance. By using patterns of past performance, the business will be able to construct a theory of future performance. The variances in data will be placed in a context that will allow the business identify factors such as seasonal changes as causing the variances. This way, the business can be better prepared to deal with the causes of variance in future hence resulting in better performance for the business. Evaluation of Barnes scuba diving revenue and cost performance for the six months ended 30th June 2013; There was a significant increase in the company’s revenue from the budgeted revenue of $630,000 to $756,000. This variance is associated to two factors. First, the company increased the price it charges for each course from $350 per student to $375 per student for every course. There was also a significant in the number of courses the business offered from what it had budgeted. While it had budgeted for 300 courses, it offered 336 courses thus significantly increasing the revenue. Barnes scuba diving costs were also noted to have increased significantly. Some causes of the cost increases and hence variances included the following; i) The increased price in the cost of cards as well as the additional 403 certificate cards that had to be reordered caused the price of a card to significantly increase from $18 per card to $23.39 hence the variance. ii) The cost of replacing the manuals owing to the bad quality associated with the new printer significantly increased the cost of a manual by 25% from the standard costs despite the new manuals being produced at a lower cost thus the variance. iii) The increased number of participants meant increased costs while the price of log books was increased 10% hence the variance. iv) The cost associated with the small T-shirts hence leading to increased prices and hence the variance. v) The bad weather and the decision to increase rate of labour is associated with labor variances vi) The increase in number of students, the increased length of travel and the increased cost of petrol caused the variance in petrol prices vii) Depreciation variance is attributed to depreciating an item that had already been fully depreciated while increase in indirect costs was associated with problems encountered with water manuals, Logbooks and T-shirts. As can be seen, some variances are interdependent. The general increase in revenue and costs can be attributed to increase in the number of courses while indirect costs are dependent on the increase in other costs. As such, in a bid to control the costs, Barnes should come up with remedial measures for the problems associated with the costs. For instance, the administrative assistant should always ensure correct spelling for certificates are given while the use of new printer could be halted. Such steps will help in bringing costs down and hence take advantage of the increased volumes and prices to realize more profits. Steps that Barnes scuba diving should undertake to improve its performance include; i) Marketing in a bid to further increase the number of causes and hence revenue ii) Ensuring the company always provides correct names and spelling for certificates to avoid replacement costs iii) Reverting back to using original printer for manuals in a bid to eliminate manual replacement costs iv) Introduce a policy of charging for every log book lost to finance replacement costs v) Reverting back to its original T-shirt supplier once the supplier goes back to operations in a bid to cut on the increased T shirt costs as well as the replacement costs vi) Revert back to the original roads once road construction is over in a bid to bring down petrol costs vii) Ensure correct accounting standards are followed to avoid such problems as was found in depreciation thus bringing down depreciation costs viii) The above remedial measures are expected to significantly reduce indirect costs since they are correlated. The limitations James and Rob should be aware of when using variance analysis for performance evaluation of. In conducting variance analysis, James and Rob should be aware of the following limitations that affect; (a) The Barnes Scuba Diving business as a whole;- -Variances are prepared at the end of the period and are released long after the period end. As such, information on variance reports may be so outdated that it becomes useless. To be useful, such reports should be prepared and released on a timely manner. - It can be that positive variances are as bad as and even worse than negative variances. Favorable variance for materials for instance may mean that a poor quality has been used as in the case of printer hence resulting in poor quality and hence customer dissatisfaction -the company may insist on meeting the standards while excluding important goals including quality, timely delivery and customer satisfaction -Meeting the standards may cause laxity instead of emphasizing on continued improvement in a bid to survive in a competitive business environment. (b) Individual employees within Barnes Scuba Diving -if they will be insensitive and result to using variance as a club, employees’ morale may suffer. Failing to give employees positive reinforcement by focusing on negative and failing to achieve favorable variance, subordinates might result to covering up unfavorable variances by taking actions not in the company’s best interests in a bid to achieve favorable variances. -Labor quantity and efficiency variances assume that the production process is labor paced and that if labor works faster, production would go up which does not apply for Barnes scuba diving. In addition, insisting on labor efficiency variances may create pressure to build excess pressure for the staff which may affect the quality of courses offered leading to lower quality and hence customer dissatisfaction. Conclusion As has been explained above, Barnes scuba diving has experienced variances in its costs and revenue for the last six months. The variances have been established to have been caused by increases in courses volumes as well as increases in prices and costs. It has been established that variance analysis will be useful to the company as a management control tool for identifying weaknesses and taking remedial measures to control costs and hence improve performance. However, the company should be aware of the inherent limitations that arise from using variance analysis if it is to achieve its intended purpose. References: Jabez, N2011, Managerial and cost accounting, London, Rutledge. Appendices Item Standard quantity Standard price Direct materials Certification cards 1800cards $18.00/ card Open water manuals 1800 manuals $12.00/manual Dive log books 1800log books $8.00/log book T-shirts/sweater 1800 t shirts/sweaters $15.00/sweater Direct labour Instructor’s labor 7200 hrs $30.00/direct labour hour Variable overheads Petrol 9000 km $0.8 per km Advertising 600 courses $30 per course Indirect materials 300 courses $0.2/$ of direct material Administration costs 300 courses $5.1/direct labour hour Actual Budget Variance- Favorable/(Unfavorable Sales units 336 300 Sales $756,000 $630,000 $126,000 Direct materials Certificates $47,172 $32,400 $(14,772) Open water manuals $23,940 $21,600 $(2,340) Dive log books $20,402 $14,400 $(6,002) T shirt/sweater $47,174 $27,000 $(20,174) Direct labour Instructors labor $268,800 $216,000 ($52,800) Variable overheads Petrol $12,096 $7,200 ($4,896) Advertising $16,128 $18,000 $1,872 Indirect materials $34,673 $19,080 ($15,593) Administration costs $28,560 $36,720 $8,160 Total contribution margin $257,055 $237,600 $19,455 Fixed overhead Advertising $10,000 $12,000 ($2,000) Rent $18,000 $9,000 ($9,000) Insurance $13,000 $11,000 ($2,000) Depreciation $15,000 $20,000 $5,000 Other $9,000 $10,000 $1,000 Net Profit $192,055 $175,000 $17,055 c) i Sales volume variance (Actual Unit Sold - Budgeted Unit Sales)   x   Standard Profit Per unit Standard profit per course =net profit/number of courses =$175,000/300 =$583.33/course Sales volume variance = (actual courses – budgeted courses) × standard profit per unit = (336-300) ×583.33 =$21,000 ii) Selling price variance =   (Actual price – Standard price)× actual units sold = (375×6- 350×6) ×336 =$50,400 iii) Quantity and price variance for direct materials Item Formula Quantity variance Certificates =(actual quantity* standard price)- (standard quantity* standard price) (2016*18)- (1800*18) =$3,888 Open water manuals =(actual quantity* standard price)- (standard quantity* standard price) (2016*12) – (1800*12) =$2,592 Dive log books =(actual quantity* standard price)- (standard quantity* standard price) (2016*8)- (1800*8) = $1,728 T shirt/sweater =(actual quantity* standard price)- (standard quantity* standard price) (2016*15)-(1800*15) =$3,240 Price variance Certificates =(Actual quantity *Actual price)- (Actual quantity *Standard price) = (2016*23.39)- (2016*18) = $10,884 Open water manuals =(Actual quantity *Actual price)- (Actual quantity *Standard price) = (2016* 11.875)-(2016*12) = $-252 Dive log books =(Actual quantity *Actual price)- (Actual quantity *Standard price) =(2016*10.12)-(2016*8) = $4,274 T shirt/sweater =(Actual quantity *Actual price)- (Actual quantity *Standard price) =(2016*23.39)- (2016*15) =$16,934 iv) Rate and efficiency variances for direct labour; Rate variance =(Actual quantity*Actual rate)- Actual quantity* Standard rate) = (8,064*33.33)- (8064 *30) =$28,800 Efficiency variance =(actual hours*standard rate)-(Standard hours*standard rate) =(8064*33.33)- (7200*30) = $52,800 v) Spending and efficiency variances for each variable overhead category; Item formula Spending variance Petrol =(actual overhead expenditure-(Actual hours* standard overhead rate per hour) ($12096-(10080*0.8) =$4,032 Advertising =(actual overhead expenditure-(Actual hours* standard overhead rate per hour) $16,128- (600*30) =($1,872) Indirect materials =(actual overhead expenditure-(Actual hours* standard overhead rate per hour) $34673- (27737.6) =$6935.4 Administration costs =(actual overhead expenditure-(Actual hours* standard overhead rate per hour) $28,560-(8064*5.1) =-$12,566.4 Efficiency variance Petrol =(std hours* std hourly overhead rate)- Actual hours*standard variable overhead rate 7200-(10080*0.8) = $864 Advertising =(std hours* std hourly overhead rate)- Actual hours*standard variable overhead rate $18,000- (336*30) =$7,920 Indirect materials =(std hours* std hourly overhead rate)- Actual hours*standard variable overhead rate $19,080- (27,737.6) =-$8657.6 Administration costs =(std hours* std hourly overhead rate)- Actual hours*standard variable overhead rate $36,720- (336* 5.1) =26,438.4 vi) Spending variance for each fixed overhead category Advertising =Actual fixed overheads- Budgeted fixed overheads =$10,000-120000 =-$2000 Rent =Actual fixed overheads- Budgeted fixed overheads =$18000-9000 =$9000 Insurance =Actual fixed overheads- Budgeted fixed overheads =$13,000-11000 =$2000 Depreciation =Actual fixed overheads- Budgeted fixed overheads =$15,000-20000 =-$5000 Other =Actual fixed overheads- Budgeted fixed overheads =$9,000-10,000 =-$1000 Read More