180 Understanding the Numbers
better or worse than expected? Is the company’s marketing support adequate?
Has the competitive landscape changed? Are cost variances the result of man-
agement actions in response to competitive pressures or due to inadequate
control? The answers to these questions may suggest changes in the company’s
strategic and tactical plans to compensate for the variances.
When actual prices and quantities are compared with expected prices
and quantities, an additional level of analysis can be conducted. Exhibit 6.3 il-
lustrates a more in-depth analysis of price and quantity variance. During the
month, the firm realizes a positive variance of $6,000 relating to the cost of
aluminum, one of its production inputs.
This $6,000 variance can then be further decomposed into a price vari-
ance and a quantity variance. The price variance is $21,000 favorable because
of the lower than expected purchase price for aluminum. It is computed by
multiplying the price variance per unit ($3 to $2.80) by the actual pounds uti-
lized (105,000). The quantity variance is $15,000 unfavorable as a result of
lower efficiency in the production process that led to more material usage than
had been expected. This is computed by multiplying the quantity variance
(105,000 to 100,000) by the expected price ($3). This analysis reveals that the
manufacturing process was less efficient than planned in that it utilized more
material to produce its products. This inefficiency was more than offset, how-
ever, by lower prices for direct materials than had been forecasted. The price
variance, therefore, masks the production inefficiency, which would not be re-
vealed without the additional level of analysis.
Comparing actual results with the budget, adjusting plans when neces-
sary, and evaluating the performance of managers are essential elements of
budget control. Many people, however, find the control phase difficult. When
business results are less than expected it may be painful to evaluate the results.
For some it is much easier to look ahead to future periods when things hope-
fully will be better. But frequently, realistic plans for future success can be
made only when management learns from its past mistakes. The control phase
of budgeting provides much of that learning process. Firms must be willing to
evaluate performance carefully, adjusting plans and performance to stay on
track toward achieving goals and objectives.
EXHIBIT 6.3 Price and quantity variance analysis.
Budgeted Actual Variance
Production level in units 20,000 20,000 0
Lbs aluminum/unit 5.00 5.25 0.25 U
Aluminum cost /lb $ 3.00 $ 2.80 $ 0.20 F
Total lbs aluminum 100,000 105,000 5,000 U
Total material cost $300,000 $294,000 $ 6,000 F
Price variance ($3.00 −$2.80)×105,000= $21,000 F
Quantity variance (105,000 −100,000)×$3.00= $15,000 U
Total net variance $ 6,000 F