Operational Budgeting

and Variance Analysis

Topic 5
 Lecture Outline

 1. Variance analysis
 Direct labour variances
 Direct materials variances
 Revenue variances
 Other variance analyses
 When does a variance warrant further investigation?
 2. Benchmarking
 Variance analysis
 Variance analysis allows management to analyse differences in actual
results to the results expected (Budgets).

 The difference referred to as variances. The technique will be

illustrated by considering it in the context of two specific types of
cost variance:

 direct labour cost variance and direct materials variance.

 In addition, an approach that can be taken to analysing the variance

between actual revenue and revenue identified in a budget will be
examined.
 Direct labour variance
 The variance between actual labour cost and labour cost in the budget
comprises two main elements:

a) the labour rate variance

b) the labour efficiency variance.

 A labour rate variance arises when the actual wage rate differs to the
budgeted wage rate.

 A labour efficiency variance results when more or less than the budgeted
time is taken to complete a particular task.
 Direct labour variances - a worked example
 Imagine it has been determined that it should take 50 direct labour
hours to cook 1,000 meat pies.

 Budgeted hourly rate of pay is $12 per hour. Accounting records

indicate that last month $780 was paid to direct labour who took 60
hours to make the 1,000 meat pies. Thus the actual hourly rate = $13
($780/60 = $13.00)
Calculation of labour rate and efficiency variances

Actual labour Actual labour Budgeted labour

hours hours hours
X X X
Actual rate Budgeted rate Budgeted rate

60 hours 60 hours 50 hours

x x x

$ 13.00 $ 12.00 $ 12.00

$780 $720 $600

$120 U labour
$60 U labour
efficiency
rate Variance
Variance
$180 U Labour
Variance
 Direct materials variances
 The variance between actual material cost and material cost in the
budget comprises two main elements:

a) the materials price variance

b) the materials efficiency variance.

 A material rate variance arises when the actual material rate differs to
the budgeted material rate.

 A material efficiency variance results when more or less than the

budgeted material is used to complete a particular task.
Direct materials variances - a worked example

 Imagine that a restaurant kitchen makes trays of lasagne and it has

been determined that each tray should contain 0.5 kilograms of meat
at a cost of $5 per kilogram. Accounting records indicate that during
last month, 1,000 trays of lasagne were produced and 600 kilograms
of meat was used at a total cost of $2,700. Therefore the cost per
kilogram is $4.50 ($2,700/600kg = $4.50)
Calculation of material price and efficiency variances

Actual amount Actual amount Budgeted amount

of materials of materials of materials*
X X X
Actual price Budgeted price Budgeted price

600kgs 600kgs 500kgs

x x x

$4.50 $5.00 $5.00

$2,700 $3,000 $2,500

$300 materials $500 materials

favourable (F) unfavourable (U)
price variance efficiency variance

200 U
 Revenue/sales variance
 The variance between actual revenue and revenue in the budget
comprises two main elements:

a) the selling price variance

b) the selling volume variance.

 A selling price variance arises when the actual rate differs to the
budgeted rate.

 A selling volume variance results when more or less than the budgeted
customers are served in the particular period.
 Revenue variances - a worked example

 Imagine that for a hotel’s most recent quarter, the banqueting department had
budgeted to serve 9,500 guests at an average price of $20 per person.

 From accounting records it has been determined that 8,000 guests were served
at an average price of $21 per person. From this information we can determine
that there is an unfavourable revenue variance of $22,000, i.e., (8,000 X $21) -
(9,500 X $20).

 However, two underlying revenue variances can be uncovered by again applying

the matrix that was used in the labour and materials variance analyses.
Calculation of selling price and sales volume variances

Actual sales Budgeted sales

Actual sales volume
volume volume
X
X X
Actual
Budgeted Budgeted selling
selling price
selling price price

8,000 guests 8,000 guests 9,500 guests

x x x

$21.00 $20.00 $20.00

$168,000 $160,000 $190,000

$8,000 favourable $30,000
selling price unfavourable sales
variance volume variance

$22,000 U revenue
variance
 Other variance analyses

By conducting materials, labour and revenue variance analysis, we have reviewed

three of the most widely applied forms of variance analysis.

There are many other dimensions of a hotel’s performance that could be

subjected to a variance analysis, however. These dimensions include:
variable and fixed overheads,
sales mix (e.g., the proportion of F&B to accommodation sales),
market share,
market size.

All of these analyses can be conducted using a similar approach to that outlined
above.
 When does a variance warrant further
investigation?

 There is no hard rule on this. Managers and organisations exhibit a range of

practices.
 A small unanticipated variance might warrant a senior manager’s attention
more than a larger anticipated variance.
 For items critical to a hotel’s overall performance, a small variance might be
viewed as important. For example, a small room sales volume variance might
be significant.
 Rules such as “investigate all variances greater than $4,000 or 10% of budget”
are frequently applied in practice.
 Benchmarking

 In variance analysis we are concerned with benchmarking actual performance

to budgeted performance. Recent years have seen increased benchmarking
and the use of non-budgetary and also non-financial benchmarks of
performance.
 A significant non-financial benchmark that has been used extensively in the
hospitality industry for many years is occupancy rate. This is a key
performance indicator and some competing hotels have been observed to
share their occupancy level information on a nightly basis.
 The term “benchmarking” is frequently used in the sense of comparing to best
practice. For the many hotel managers that work in a large chain organisation,
data provided by high performing hotels within the chain can provide a
valuable performance benchmark.
 Benchmarking

 If it is important that managers in high performing hotels share the secrets of

their success.

 Care must be taken in the way that management rewards are attached to
relative performance levels.

 If high rewards are attached to relative performance, managers in high

performing units will be reluctant to share information that could improve the
standing of low performers.
 This concludes Topic 5

Go over the questions for this week and bring up any areas that you don’t
understand with your lecturer/tutor.