Production-Volume Variance and Sales-Volume Variance

Learning Objective 6 Explain the relationship between the sales-volume variance and the production-volume variance

As we complete our study of variance analysis for Webb Company, it helps to step back to see the “big picture” and to link the accounting and performance evaluation functions of standard costing. Exhibit 7-1, first identified a static-budget variance of $93,100 U as the difference between the static budget operating income of $108,000 and the actual operating income of $14,900. Exhibit 7-2 then subdivided the static-budget variance of $93,100 U into a flexible-budget variance of $29,100 U and a sales-volume variance of $64,000 U. In both Chapter 7 and this chapter, we presented more detailed variances that subdivided the flexible budget variance of $29,100 U, whenever possible, into individual flexible-budget variances for the selling price, direct materials, direct manufacturing labor, and variable overhead. For the fixed overhead, we noted that the flexible-budget variance is the same as the spending variance. Where does the production-volume variance belong then? As we shall see, the production-volume variance is a component of the sales-volume variance. Under our assumption of actual production and sales of 10,000 jackets, Webb’s costing system debits to Work-in-Process Control the standard costs of the 10,000 jackets produced. These amounts are then transferred to Finished Goods and finally to Cost of Goods Sold:

<p>A table shows additional data for Webb Company</p>

The table depicts additional data for Webb Company. The details of the table are as follows:

  1. Direct materials (Chapter 7, page 258, entry 1b), 60 dollars per jacket times 10,000 jackets: 600,000 dollars

  2. Direct manufacturing labor (Chapter 7, page 258, entry 2), 16 dollars per jacket times 10,000 jackets: 160,000 dollars

  3. Variable overhead (Chapter 8, page 290, entry 2), 12 dollars per jacket times 10,000 jackets: 120,000 dollars

  4. Fixed overhead (Chapter 8, page 294, entry 2), 23 dollars per jacket times 10,000 jackets: 230,000 dollars

  5. Cost of goods sold at standard cost, 111 dollars per jacket times 10,000 jackets: 1,110,000 dollars

Webb’s costing system also records revenues from the 10,000 jackets sold at the budgeted selling price of $120 per jacket. The net effect on Webb’s budgeted operating income is shown below:

<p>A table shows the net effect on Webb’s budgeted operating income</p>

The table depicts the net effect on Webb&rsquo;s budgeted operating income. The details of the table are as follows:

    1. Revenues at budgeted selling price, 120 dollars per jacket times 10,000 jackets: 1,200,000 dollars

    2. Cost of goods sold at standard cost, 111 dollars per jacket times 10,000 jackets: 1,110,000 dollars

    3. Operating income based on budgeted profit per jacket, 9 dollars per jacket times 10,000 jackets: 90,000 dollars

A crucial point to keep in mind is that under standard costing, fixed overhead costs are allocated to finished goods as each jacket is produced and so appear as if they are a variable cost. That is, in determining the budgeted operating income of $90,000, only $230,000 ($23 per jacket×10,000 jackets) of the fixed overhead costs are considered, whereas the budgeted fixed overhead costs are $276,000. Webb’s accountants then record the $46,000 unfavorable production-volume variance (the difference between the budgeted fixed overhead costs, $276,000, and allocated fixed overhead costs, $230,000, see Journal Entries for Fixed Overhead Costs and Variances, entry 2), as well as the various flexible-budget variances (including the fixed overhead spending variance) that total $29,100 U (see Exhibit 7-2). This results in actual operating income of $14,900 as follows:

<p>A table shows the computations resulting in actual operating income of 14,900 dollars</p>

The table depicts the computations resulting in actual operating income of 14,900 dollars. The details of the table are as follows:

    1. Operating income based on budgeted profit per jacket, 9 dollars per jacket times 10,000 jackets: 90,000 dollars

    2. Unfavorable production-volume variance: 46,000 dollars loss

    3. Flexible-budget operating income (Exhibit 7-2): 44,000 dollars

    4. Unfavorable flexible-budget variance for operating income (Exhibit 7-2): 29,100 dollars loss

    5. Actual operating income (Exhibit 7-2): 14,900 dollars

In contrast, the static-budget operating income of $108,000 (see Chapter 7, Static Budgets and Static-Budget Variances) never appears in Webb’s costing system because standard costing records budgeted revenues, standard costs, and variances only for the 10,000 jackets actually produced and sold, not for the 12,000 jackets that were planned to be produced and sold. As a result, the sales-volume variance of $64,000 U, which is the difference between the static-budget operating income of $108,000 and the flexible-budget operating income of $44,000 (Exhibit 7-2), is never actually recorded under standard costing. Nevertheless, the sales-volume variance is useful because it helps managers understand the lost contribution margin from selling 2,000 fewer jackets (the sales-volume variance assumes fixed costs remain at the budgeted level of $276,000).

The sales-volume variance has two components:

  1. A difference between the operating income reported in the standard-costing system of $90,000 and the flexible-budget operating income of $44,000 (Exhibit 7-2) for the 10,000 actual units produced. This difference arises because Webb’s costing system allocates fixed costs to each unit produced (as if they behave in a variable manner) and so allocates $230,000($23 per unit×10,000 units), rather than the budgeted fixed costs of $276,000. This difference is the production-volume variance of $46,000 U, which is recorded in Webb’s standard costing system.
  2. A difference between the static-budget operating income of $108,000 for 12,000 jackets and the budgeted operating income of $90,000 for 10,000 jackets. This is the Operating-income volume variance of $18,000 U($108,000-$90,000). It reflects the fact that Webb produced and sold 2,000 fewer units than budgeted. This part of the sales volume variance does not appear in Webb’s standard costing system.

In summary, we have the following:

<p>A table shows the sales-volume variance</p>

The table depicts the sales-volume variance. The details of the table are as follows:

1. Production-volume variance: 46,000 dollars U

Plus

2. Operating-income volume variance: 18,000 dollars U

Equals

3. Sales-volume variance: 64,000 dollars U

Although useful from a managerial point of view, the sales-volume variance and the operating-income volume variance are not part of the standard-costing system. The production-volume variance is part of the standard-costing system because Webb must account for the fixed overheads incurred that were not allocated to products. We can now provide a summary (see Exhibit 8-5) that formally disaggregates the static-budget variance of $93,100 U into its components. Note how the comprehensive chart incorporates all of the variances you have studied in Chapters 7 and 8.

Exhibit 8-5

Summary of Levels 1, 2, and 3 Variance Analysis: Webb Company for April 2020

A flowchart shows Webb Company’s summary of levels 1, 2, and 3 variance analysis for April 2020.

Details of the flowchart are as follows:

Level 1: Static-budget variance for operating income dollar 93,100 Unfavorable

Level 2: Flexible-budget variance for operating income dollar 29,100 Unfavorable; Sales-volume variance for operating income dollar 64,000 Unfavorable.

Individual line items of Level 2 flexible-budget variance: Selling price variance dollar 50,000 Favorable; Direct materials variance dollar 21,600 Unfavorable; Direct manufacturing labor variance dollar 38,000 Unfavorable; Variable manufacturing overhead variance dollar 10,500 Unfavorable; and Fixed manufacturing overhead variance dollar 9,000 Unfavorable.

Level 3: Direct materials price variance: dollar 44,400 Favorable; Direct materials efficiency variance: dollar 66,000 Unfavorable; Direct manufacturing labor price variance: dollar 18,000 Unfavorable; Direct manufacturing labor efficiency variance: dollar 20,000 Unfavorable; Variable manufacturing overhead spending variance: dollar 4,500 Favorable; Variable manufacturing overhead efficiency variance: dollar 15,000 Unfavorable; Fixed overhead spending variance: dollar 9,000 Unfavorable; Fixed overhead production volume variance: dollar 46,000 Unfavorable; and Operating income volume variance: dollar 18,000 Unfavorable.

We next describe the use of variance analysis in activity-based costing systems.