Page 180 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 8: Management Control through Variance Analysis

Evaluation Standards Notes

Three types of standards are used for evaluating reports of actual activities: (1) Predetermined
standards (2) Historical standards (3) External standards.

Predetermined Standards

Predetermined standards (also called budgets) if carefully planned and coordinated can be
excellent standards. Most companies compare actual performance against predetermined
standards. But if the budgeted numbers are collected in a haphazard manner, this will not
provide a reliable basis for comparison.

Historical Standards

These are records of past actual performance. Results for the current month are compared with
results for the last month or with results for the same month a year ago. There are two
disadvantages of using these types of standards: conditions may be different in the two periods
(this invalidates the comparison), and the prior periods’ performance may not be considered
acceptable performance. Despite the inherent weaknesses, these standards are used by companies
where valid predetermined standards are not available.

External Standards

These standards are derived from the performance of other responsibility centers or of other
companies. The performance of one branch sales office may be compared with the performance
of other branch sales offices. Such a comparison may provide an acceptable basis for evaluation
if the conditions in the responsibility centres are similar.

Full-cost Systems

In a full-cost system, the manufacturing cost of a product includes both variable costs and fixed
costs. Companies under the full-cost system may not be able to make such a separation, or even
if they do it, they have to identify the variance in manufacturing costs that results from the
difference between actual and standard production volume. A ‘production volume variance’ is
developed when actual volume is different from standard volume.

Amount of Detail Information

Revenue variances can be analyzed at various levels: in total; then by volume, mix, price;
analysis of volume and mix variance is done by industry volume and market share. At each
level, the variances of individual products are analyzed. The process of analyzing the variance
from one level to another is called “peeling the onion.” Similarly, additional ‘sales and marketing
variances’ can be calculated, by ‘sales territories,’ by ‘individual sales persons,’ by ‘sales originating
from direct mail,’ by ‘customer calls from other resources’, by ‘sales to individual countries.’
Additional information for manufacturing costs can be developed by calculating variances with
specific input factors, such as wage rents and material prices. These layers of variances correspond
to the hierarchy of the responsibility center managers.

8.4.1 Limitations of Variance Analysis

Variance analysis identifies the occurrence of variance, but it does not tell ‘why’ the variance
occurred. When using variance analysis, it is difficult to decide whether a variance is significant

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