Prepare Performance Reports (Budget Variance)

Prepare performance reports (budget variance)

Contents

Key to resources

Introduction

Performance reports

Correcting variance

Summary

Feedback to activities

Activity 1

Activity 2

This learning guide is based on the following resource(s):
Textbook
Hughes, R, Minogue, D and Senaratne, G (2006) Business Budgeting andAnalysis and Financial Management(3rd edn), National Core Accounting Publications, Bondi

Key to resources

Resource / Textbook
1 / 6.2 Performance reporting pp155–162

Note: Commentary on the textbook is indicated in italics.

Introduction

In this learning guide we will look at how to prepare performance reports.

Specifically you will learn to prepare two different performance reports which clearly indicate the variance between the budget and actual results.

Previously you have learnt that budgets help management in the controlling function. It serves as a measurement of performance as well as setting responsibility and accountability. Measurement of performance is made by comparing the actual results with the budget, analysing the variances and establishing courses of action that will provide better performance in the future.

Performance reports

The performance reports can be presented using horizontal trend, vertical trend or current month and year-to-date analysis.

Horizontal analysis

The base year is the first year and in some cases the budgeted period. Being the base year, it is considered to be 100%.The base year accounts’ values are used as the denominator in comparing the values of the current or latestyear.

Vertical analysis

The base is the sales revenue for each year and assumed to be 100%.It is the basis of the comparison of cost of goods sold, gross profit and net profitvalues.

Current month and year-to-date performance analysis

The base is the budgeted period. The actual results are compared with the budgeted figures, noting the variances as either favourable or unfavourable.

/ Now go to Resource 1
The location of this and all other resources for this learning guide is found in the Key to resourcesat the front of Prepare performance reports.

To read about performance reporting examples go your resource.

Performance reports and the needs of the organisation

Performance reports must be designed and tailor made to suit the needs of the centre of responsibility within the organisation. The responsibility centres attend to the specific performance they are to control. They are the:

revenue centre – charged with the responsibility of earning revenue
cost centre – responsible for using resources efficiently;it is in charge of ensuring operations are performed at a least cost
profit centre – with the duty of controlling the revenue as well as the costs incurred in earning the revenue
investment centre – with the responsibility of looking after the return on invested funds as well as the funds invested.

/ Activity 1

The following information relates to the financial performance of Michael Joseph for the last three years. You are required to prepare for the company both a:

(a)horizontal analysis

and

(b)vertical analysis.

(a)Horizontal trend analysis

Year1 / Year 2 / Year 3
$ / % / $ / % / $ / %
Sales revenue / 60000 / 80000 / 90000
Less: Cost of goods sold / 40000 / 50000 / 55000
Gross profit / 20000 / 30000 / 35000
Less: Operating expenses / 10000 / 15000 / 18000
Net profit / 10000 / 15000 / 17000

(b)Vertical trend analysis

Match the company section with the relevant centre.

Company section / Centre
Materials stores department of a kitchen factory / Profit centre
Sales department of a computer company / Investment centre
Hotels booking office / Revenue centre
A factory outlet shop of a designer fashion chain / Cost centre

Correcting variance

The following chart shows a decision making process determining what corrective action could be taken.

Decision chart for correcting variance

Decision chart adapted from Budgeting Principles 2002 Hart J, Wilson C and Keers B, Pearson Education Australia. Reproduced with permission

Summary

Here you learnt about performance reports, how they are prepared and their significance in the evaluation of process. Performance reports show the strengths or weaknesses of actual performance compared to the anticipated activity. By knowing these differences, management will be able to adopt measures to correct or improve future performance.

Feedback to activities

Activity 1

(a)Horizontal trend analysis

Year1 / Year 2 / Year 3
$ / % / $ / % / $ / %
Sales revenue / 60000 / 100 / 80000 / 33.33 / 90000 / 50
Less: Cost of goods sold / 40000 / 100 / 50000 / 25 / 55000 / 37.50
Gross profit / 20000 / 100 / 30000 / 50 / 35000 / 75
Less: Operating expenses / 10000 / 100 / 15000 / 50 / 18000 / 80
Net profit / 10000 / 100 / 15000 / 50 / 17000 / 70

Note:

The base year is Year 1. All Year 1 accounts are considered to be 100% to which changes for Year 2 and Year 3 accounts are compared. Percentage calculations are shown below.

Year 2

Change / Percentage
Sales 20000 / (20000/60000) × 100 = 33.33%
Cost of goods sold 10000 / (10000/40000) × 100 = 25%
Gross profit10000 / (10000/20000) × 100 = 50%
Operating expenses 5000 / (5000/10000) × 100 = 50%
Net profit 5000 / (5000/10000) × 100 = 50%

Year 3

Change / Percentage
Sales 30000 / (30000/60000) × 100 = 50%
Cost of goods sold 15000 / (15000/40000) × 100 = 37.5%
Gross profit 15000 / (15000/20000) × 100 = 75%
Operating expenses 8000 / (8000/10000) × 100 = 80%
Net profit 7000 / (7000/10000) × 100 = 70%

(b)Vertical trend analysis

Year1 / Year 2 / Year 3
$ / % / $ / % / $ / %
Sales revenue / 60000 / 100 / 80000 / 100 / 90000 / 100
Less: Cost of goods sold / 40000 / 66.67 / 50000 / 62.50 / 55000 / 61.11
Gross profit / 20000 / 33.33 / 30000 / 37.50 / 35000 / 38.89
Less: Operating expenses / 10000 / 16.67 / 15000 / 18.75 / 18000 / 20.00
Net profit / 10000 / 16.66 / 15000 / 18.75 / 17000 / 18.89

Note:

The base is sales revenue for each year. It is considered to be 100%.Cost of goods sold, gross profit, operating expenses and net profit values are compared with the sales value to show the proportion of these accounts tosales.

Calculation of the vertical trend analysis for Years 1, 2 and 3 are as follows:

Year 1

Sales = / 100%
Cost of goods sold (50000/80000) × 100 = / 62.50%
Gross profit (30000/80000) × 100 = / 37.50%
Operating expenses (15000/80000) × 100 = / 18.75%
Net profit (15000 / 80000) × 100 = / 18.75%

Year 3

Sales= / 100%
Cost of goods sold (55000/90000) × 100 = / 61.11%
Gross profit (35000/90000) × 100 = / 38.89%

Activity 2

Materials stores department of a kitchen factory is a cost centre.

Sales department of a computer company is arevenue centre.

Hotel’s booking office is aprofit centre.

A factory outlet shop of a designer fashion chain is an investment centre.

Prepare performance reports (budget variance)1