 Hello and welcome to the session in which we will discuss variance analysis. This topic is important on the CPA exam and your cost accounting course or managerial accounting. And on the CPA exam, it gives students a lot of headaches because we have many variances. We could have up to 12 variances if you really think about it. So students get confused which is which. So in this session, we would look at the sales activity and the price or what we call the price variance or profit variance. If you are studying for your CPA exam or if you're an accounting students, especially if you're studying for your CPA exam, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I don't do that. I don't intend to do that. My resources are a useful addition. You can use them in addition to your CPA review course. I use them use them as a supplement as a vitamin pill. I provide alternative explanation. I provide backup explanation. My resources are aligned with your CPA review course. Your risk to try me is one month of subscription. That's it. If it works for you, you keep it. If it doesn't, that's your loss. Your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well or not while your university doing on the CPA exam. I do have resources for other accounting, finance, audit and other CPA sections. If you haven't connected with me on LinkedIn, please do so. Like this recording, share it with others. Connect with me on Instagram as well as Facebook, Twitter and please connect with me on Reddit. Now, in this session, we're going to be introducing new terms, something called favorable variance and something called unfavorable variance. How do we know? Because I'm going to be defining those or I'm going to be using those. So before I use them, I would like to define them. How do we know if something is favorable or something is unfavorable? When do we say a variance is favorable? It's when the variance that's taken alone, that specific variance increases operating income. If that change increases your operating income. What does that mean? It's mean you either either have more revenues or less expenses. Then it's a favorable variance. What is unfavorable variance? It variance that's taken alone reduces operating profit. When do you reduce your operating profit? It's either when you have less revenues or your expenses went down, your expenses or your costs went up. So to illustrate this concept, the best way to illustrate this concept is to basically draft real quick a budget, a budget, compare the budget to the results and talk about this, analyze them line by line. Now the budget that I'm going to be working with or the budget, the numbers I'm going to be working with here. They're on the PowerPoint slides, but I would like to, I'd like to put them down step by step. This way you see what happens. So let's assume we are dealing with the month of January just for the sake of illustration. So we're going to be looking at sales and sales and sales is 840,000 and for the activity. This is the actual, this is what happened actually. Let me make this a little bit smaller maybe because this is a little bit large. There we go. And we sold, we happened to have sold 80,000 units. So this is for 80,000 units. So the sales was 80,000. Then from the sales, we are going to deduct less variable costs, which is variable manufacturing cost happens to be 329,680. We're going to deduct variable cost that's selling, variable cost that's selling. And that's going to be 68,000. So we have variable cost of total of 397,680. So this is total variable cost. Sales minus variable cost gives us a contribution margin of $442,320. What's this? This is the contribution margin sales minus total variable cost. Now let's list our fixed cost. We have fixed manufacturing cost and it happens to be 195,500 fixed selling cost. It happens to be 132,320. The total fixed cost is 327,820. And our profit is $114,500. This is our profit. So this is the numbers that we're going to be working with. This is what actually happened for that particular month. We said let's consider it month of January. Now we're going to compare this to our budget and specifically to our planning budget, planning or static budget. Our planning budget, sales should have been we budgeted sales of a million dollars. We budgeted variable manufacturing cost of 380. We budgeted variable selling of 90,000. The total was 470 of variable cost. The contribution margin that we planned for was 530,000. Then the fixed cost, fixed manufacturing cost was 200,000. And the fixed selling cost was 140,000, a total of 340. And we planned the profit of 190,000, which is contribution margin minus the fixed cost. I hope you guys following this. So we planned profit of 190,000. So the question becomes what happens? Well, well, I did not tell you this, but I need to tell you this, which is very relevant. What we did is we planned, when we plan our budget, we plan to have sold 100,000 units. Okay. And guess what? We only sold 80,000 unit. So the question is, can we compare this budget to this budget? Can we compare the actual to the planning? And the answer is nothing will stop us. We can compare the budget to the actual to the planning, but what's going to happen? It's going to be in a sense not that meaningful. Why? Because here what you're comparing, you're comparing two level of activities. You planned for 100,000 unit and you actually sold 80,000 unit. Of course, you're going to have overall unfavorable variance. Of course, you're going to have unfavorable variance in the sense that your profit under the actual will be less overall. Why? Because you sold simply less unit. You sold 20,000 unit. So to make such comparison, it will be in a sense useless. Can you make it? Sure. Sure you can. Okay. Let's go ahead and look at such a variance. So if you want to do so, here's the variance between the actual and the master budget. Well, sales revenue is unfavorable. Variable manufacturing cost is favorable. Variable selling cost is favorable. Overall, you have unfavorable contribution margin. Your fixed cost manufacturing was favorable. Fixed selling was favorable. Overall, you are unfavorable 75,500. Once again, this is practically, not practically, in a sense, we're not going to use it. We're not going to use it because it's not that useful for us. So what does that mean? Does it mean we need to throw away our planning budget? No, what we need to do now, we need to flex the budget. And what's flexing the budget? Flexing the budget means taking the activity level to 80,000. So rather than making a budget based on 100,000, we are going to make a budget based on 80,000 units. So we're going to call this, let me do it in a different color, the flexible budget. Okay. Flexible budget. And this budget, this flexible budget, it's going to be based on 80,000 unit. So basically what would have happened if we actually sold 80,000 unit? Well, what was our selling price? What was our budget at selling price? Well, we were planning to get a million dollar. We were planning to get a million dollar. Okay. A million dollar in sales based on a 100,000 unit. So our selling price was $10. Well, if we plan to sell 80,000 unit, our sales should have been 800,000. Well, our variable manufacturing cost was 380,000 based on a 100,000 unit output. That means it's 380. And our variable selling cost was 90,000 based on a 100,000 unit output, 90 pennies. Now what we do is we take 80,000 unit times 380, which is 304,000. Once again, this is 80,000 unit times 380. Then we're going to compute our variable selling price, which happens to be 72,000. And that is 80,000 unit times 0.9, 90 cent per unit. Now we can compute our total variable cost under the flexible budget, 376,000. Our contribution margin is sales minus variable cost, which is 424,000. Then we're going to now list our fixed cost. But before we proceed, that's before we proceed. Let's analyze this. Let's analyze the difference here before we proceed. Let's analyze the difference between the profit, the contribution margin profit, the contribution margin profit. Let's find the difference. So what was the difference? So we were planning to have 530,000 for comparing the flexible to the planning and 424. That's a difference of 106,000. There was a difference in the contribution margin of 106,000. So what caused that difference? What caused that contribution margin difference? Well, one thing and one thing only caused the difference between the flexible budget and the planning budget. So when we find the difference between the flexible budget and the planning budget, we call this difference sales activity variance. And why do we call it sales activity variance? So this is a term you want to be familiar with. Sales activity variance. So the sales activity variance is the difference between the flexible budget and the planning budget. What causes the $106,000 difference? $106,000 difference? It's caused only. The sole cost for it is the number of units sold. Guess what? Under the planning budget, we sold more units. Let me show you. Remember, our selling price per unit is $10. Our variable cost is $380. And our variable manufacturing costs $380. Variable selling price is $90. So per unit, if you look at per unit, $10 minus $380. Clear. $10 selling price minus $3.80 minus 90 pennies. Clear again. $10 minus $3.8 minus $0.9. $5.30 is your contribution margin per unit. And you sold $20,000 unit less times $20,000 unit. $5.30 times $20,000 unit less. That's your variance of $106,000. So the difference between your flexible budget and your planning budget gives you what's called your sales activity variance. So the only thing that explained this is the sales activity variance. Okay. Why? Just because of the sales. So notice here, if you want to, you could compute the difference for each. This is $200,000. You could compute the difference for those two. And you could compute the difference for those two. And when you net them, they net to be $106,000. So this is how we compute the sales activity variance. Okay. So this is one term you need to be familiar with, sales activity variance. Now when it comes to the flexible budget, guess what? The fixed cost should be the same for the fixed manufacturing and the fixed selling. Because the definition of fixed cost is it's fixed in relationship to the activity. So there should be no difference there. Therefore, if you look at the bottom line, if you take 424 minus the fixed cost, minus the fixed cost. Let's go ahead and compute this. The fixed cost is 340. So let's take 424, 424, 424 minus 340. That's going to give you a profit of 84,000. Now if we take 84,000 minus 190,000, the difference between those two is 106. So notice fixed cost is not really relevant in this comparison because the flexible budget and the planning budget, the fixed cost should be the same in a sense. So once again, the only difference in the bottom line between the flexible and the planning budget is it has to do with the sales activity. You sold less unit. Well, you're going to have less profit. How much less profit you're going to have? It's your contribution margin times the less profit. And the opposite would have been true if you sold more units than what you planned for. So now let's now move to the other side of the budget. And now what we're going to be doing, rather than the sales activity, we're going to be looking at the difference. So we're done with the sales activity. Now we're going to be comparing the actual to the flexible, the actual to the flexible. So let's take a look at the difference. Well, the difference in sales, let's start with sales. The difference in sales, the difference in sales is $40,000 and that's favorable. What does it mean favorable? It means if you report sales of 840 versus 800,000, your profit will be higher by 40,000. Therefore, the variance is favorable. So what caused this variance of $40,000? Well, what caused this variance is the selling price. So what caused the $40,000 favorable variance? It's the selling price. So what happened is somehow you had a pricing power. Maybe there was a high demand for your product. Therefore, what happened? Your marketing people up the price, up the price. Okay. So now you have $40,000 more. So let's compare it on a per unit base. Your planning, your selling price was $10. That's what you planned for. But guess what? You sold 800, your sales was $840,000 divided by 80,000 unit. So 840,000 divided by 80,000 unit. You were able to charge your customers $10 on average, $10.50. So that's good. So you had a favorable, favorable, and what we call this, this is the sales price variance. This is the, this column, we're going to call it the sales price variance or the profit variance. Well, you made more profit. Why? Because you were able to sell at a higher price, not because you sold more or less unit. Now this column here is the selling price. Let's compare your variable manufacturing overhead to your, between the flexible and the actual. And here what happened is you should have spent 304, you spent 329. So now what you have is, well, this is unfavorable, not good, not a good, not a good variance. 25,000, 680, and that's you. That's unfavorable variance. Now why did that happen? We'll examine that later when we drill a little bit, a little bit down. All we're focusing here is on the sales variance. Let's look at the variable selling price. Variable selling price, you're supposed to spend $72,000. You spend only $68,000. That's good. So there's a difference of $4,000. And that's a favorable variance because you spend less. Now if you want to, you could compute the contribution margin, the difference between the contribution margin variance. And let's do so. So 424 minus 442, 320, and that's $18,320. So you have more profit, $18,320, which is favorable. Or you could do, you could also net these out, favorable, unfavorable, and favorable. And you'll get to the same figure, which is $18,000, $18,320. So that's basically what we did. We did the sales price variance, sales price variance. Now the only thing we're going to also analyze in this example is the fixed cost variance. Well, to tell you the truth, the fixed cost variance, you should not have any in theory and in practice to a great degree. Why? Because fixed cost is fixed cost within the relevant range and we're assuming within the relevant range. The fixed cost should not change. But let's first compute the figures and we analyze it a little bit further. Your flexible budget is $200,000. You only incur $195,500, which is in a sense, it's good. In a sense, it's good, which is how much it's better by $4,500 favorable. And you plan $140,000, you only spend on the fixed selling, $132,320. So you have also a favorable of $7,680. Now you can, that's also favorable. Now you could also compute the all the favorable, okay? And obviously this is favorable, favorable, favorable. But what happened to the fixed cost? Well, again, the nature of fixed cost, it should be fixed. What could explain this change? What could explain the change? Well, one thing is maybe you forgot, maybe the company forgot to include something or did not do something they were supposed to do. So they did not incur an expenditure that they were supposed to do. Or they maybe anticipated a rate increase, maybe their insurance. They anticipated a rate increase in their insurance and their insurance premium, but it did not happen. So that's why they plan $200,000. They thought, well, the insurance company, they're going to hit us with a rate increase, but it did not happen. That could be the case. But to a great degree, to a great degree, to a great degree, there should not be no change. There should not be no change between the two, between the two, okay? So let's take a look at the overall difference at the profit analysis. $14,500 minus $84,000. The difference is $30,500. Again, you can reconcile and this is obviously favorable. So we did better. And the reason, the main reason why we did better this month is because we were able to sell at a higher price. And that's a little bit unusual for companies to plan for $10,000 and to get $10,50, unless the marketing people, they already know they can get it for $10,50, and they price it for $10,000, so they look good. That beside the point here. But the point here is they were able to do it. And let's reconcile if we take the $30,500. $30,500. We can analyze the numbers. So we have $18,320 favorable just to make sure you can reconcile this $18,320. Then we have $4,500 in the fixed manufacturing favorable and $7,600 in the selling. And if you net these out, they net out to zero. It means you're able to explain everything. So this is basically the sales variance. So I'm going to go back to the PowerPoint slides. I'm just going to go over this. Again, we said this number is really useless in a sense because you're looking at Apple versus Orange here. So this way, this is not very good. This is not very good. Remember the static budget is for a single activity, usually the master budget. Then we learn how to flex the budget. The budget that indicate revenue, cost, and profit at different level of activities. And what we did here is we flexed the budget. The static was 100,000 unit. We flexed it to 80,000. Then we did our analysis. Remember the sales activity variance is the difference between the operating profit and the master budget, and the operating profit and the flexible budget. It's called the sales activity variance. I showed it to you. The variance arise because the actual number of units sold. It has to do with the number of units sold. It has to do with the number of units sold. And this is the sales activity column that I showed you earlier, but this is cleaner. You could examine this. The profit variance analysis is analysis of the causes of the difference between the budgeted profit and the actual profit earned. So what was the budgeted profit? What should have been the budgeted profit and the actual profit? It has to do with sales price variance. This is what we focused on. Fixed production cost variance, variable production cost variance, marketing and administrative cost variance. And this is basically an overall picture what I just showed you. So this is the 75,200 comparing the master budget to the actual budget. And we say you really don't want to use this because if you are asked to do so, that's fine. This is the total variance from the master budget. But I just, in the real world, you don't do it. In the real world, what you do, you prepare a flexible budget. And this is what I did. This is what I did. Then what you do is you start with, if you want to start with the sales activity variance and you analyze the difference. And this is the 106 that was unfavorable because we sold less unit. It has to do with less unit. And whatever we get, favorable or unfavorable, it's going to go down to the bottom line to the profit because the fixed cost, it should not have any effect on the sales activity variance because fixed cost is fixed in terms of sales. Then you could compare the flexible budget to the actual budget. And here what they did in this slide, they broke it down into sales price variance. And we said here, you were able to charge more. Therefore, your sales was higher, although you are selling 80,000 unit. Your variable manufacturing overhead cost was unfavorable. Your variable selling price, which was favorable. And don't worry, we are going to do a little bit more into these figures. But the point that I want you to, the big picture that I want you to start to see is this. Notice what we did in our analysis. I'm going to break it down into two components here. I'm going to break this down into two components. So this is the flexible budget. Basically, the flexible budget is the middle. What we did here, we looked at the quantity. So this is the change in Q quantity because on this side, everything happened because of the quantity. And on this side, everything happened because of the price. And what we're going to be doing later, we're going to be drilling when we do additional analysis. This is just an introduction when we drill into our direct material and into our direct labor into variable manufacturing overhead. We're going to be broken down. We're going to be broken those figures into price and quantity or efficiency and usage variance. So just look at, I want to make sure you understand the big picture. And we'll look at this later. Don't worry about this. Don't worry about this. But this is an overall analysis about the sales activity variance and the profit analysis. If you have any questions, any comments, they all means email me. If you're studying for your CPA, make sure you study hard or for your CMA. Good luck and study hard.