Performance Report Combining Activity Variances with Revenue and Spending Variances
Note two numbers in particular in the performance report—the activity variance for net operating income of $13,710 F (favorable) and the overall revenue and spending variance for net operating income of $9,280 U (unfavorable). It is worth repeating what those two numbers mean. The $13,710 favorable activity variance occurred because actual activity (1,100 client-visits) was greater than the budgeted level of activity (1,000 client-visits). The $9,280 unfavorable overall revenue and spending variance occurred because the profit was not as large as it should have been for the actual level of activity for the period. These two different variances mean very different things and call for different types of actions. To generate a favorable activity variance for net operating income, managers must take actions to increase client-visits. To generate a favorable overall revenue and spending variance, managers must take actions to protect selling prices, increase operating efficiency, and reduce the prices of inputs.
The performance report in Exhibit 9–7 provides much more useful information to managers than the simple comparison of budgeted to actual results in Exhibit 9–3 . In Exhibit 9–3 , the effects of changes in activity were jumbled together with the effects of how well prices were controlled and operations were managed. The performance report in Exhibit 9–7 clearly separates these effects, allowing managers to take a much more focused approach in evaluating operations.
To get a better idea of how the performance report accomplishes this task, look at hairstyling supplies in the performance report. In the planning budget, this cost was $1,500, whereas the actual cost for the period was $1,620. In the comparison of the planning budget to actual results in Exhibit 9–3 , this difference is shown as an unfavorable variance of $120. Exhibit 9–3 uses a static planning budget approach that compares actual costs at one level of activity to budgeted costs at a different level of activity. As we said before, this is like comparing apples to oranges. This variance is actually a mixture of two very different effects. This becomes clear in the performance report in Exhibit 9–7 . The difference between the budgeted amount and the actual results is composed of two different variances—an unfavorable activity variance of $150 and a favorable spending variance of$30. The activity variance occurs because activity was greater than anticipated in the planning budget, which naturally resulted in a higher total cost for this variable cost. The favorable spending variance occurred because less was spent on hairstyling supplies than one would have expected, given the actual level of activity for the month.
The flexible budget performance report in Exhibit 9–7 provides a more valid assessment of performance than simply comparing static planning budget costs to actual costs because actual costs are compared to what costs should have been at the actual level of activity. In other words, apples are compared to apples. When this is done, we see that the spending variance for hairstyling supplies is $30 F (favorable) rather than $120 U (unfavorable) as it was in the original static planning budget performance report (see Exhibit 9–3 ). In some cases, as with hairstyling supplies in Rick’s report, an unfavorable static planning budget variance may be transformed into a favorable revenue or spending variance when an increase in activity is properly taken into account. The following discussion took place the next day at Rick’s salon.