percent variance

Performance evaluation requires managers to have a benchmark to use as a guide for future periods. This benchmark is communicated to managers via a budget for their responsibility center. At the end of the year, managers are evaluated based on the actual figures generated by the responsibility center. Remember that responsibility managers are only responsible for certain numbers and therefore only those numbers should appear on the performance evaluation report. Let’s look at some sample performance evaluation reports for the three types of centers that use them.

Cost Center Performance Evaluation Reports

A cost center performance evaluation report only contains expenses for the segment of the company that the manager is responsible for. Here is an example of a performance evaluation report for the human resources department of a large company.

cost performance report

This performance report contains the expenses for the human resources department of a company. The expenses are listed with both the budget and actual figures. The variance column is the absolute value (no negative numbers) of the difference between the budget figure and the actual figure. Because the absolute values are used, there must be a way to determine if the variance is good or bad. Next to each variance, you need to indicate if the difference is a favorable or unfavorable. For expenses, a favorable variance is one where actual cost is less than budgeted. The department saved money, which is a good thing. Unfavorable variances occur when the company spent more than planned.

When determining if a variance is favorable or unfavorable, look to see if the actual amount is larger or smaller than the budget amount. For salaries, actual is less than budget. Because this is an expense, actual less than budget is favorable.

The percent variance is calculated by dividing the variance by the budgeted amount.

% Variance = Variance / Budget

The percent variance gives the reader perspective. Salaries have a $500 variance but it is only 0.14% of the budget and therefore a very small percentage of the total budget. Office supplies on the other hand are off by $250, but that is a 25% variance. Use percentages to determine which line items are important to investigate further. Typically, a variance of more than 5% should be investigated.

 Revenue Center Performance Reports

A revenue center performance report looks very similar to a cost center performance report.

Revenue Center

Notice that the only difference is the name at the top of the report and that the word “expense” has been replaced with “product”. Make sure to look at each report carefully to determine if you are looking at a cost center report or a revenue center report.

The only difference with a revenue center performance report is the determination of favorable or unfavorable variances. Use the same methodology used in the cost center report. Look to see if the actual amount is greater or less than the budgeted amount. For the Standard Model, actual is more than budget. Here we are discussing revenue. Is higher revenue good or bad? Higher revenue is good, so the $90,000 variance is favorable. The Deluxe Model has sales $20,000 lower than budgeted, which is bad and therefore unfavorable.

A company should not just investigate unfavorable variances. The Executive Model’s sales were 10% higher than budgeted. The national sales director might want to know how the Midwest Region was able to increase sales in order to help boost sales in other regions of the country. Favorable variances are just as important as unfavorable variances.

Profit Center Performance Reports

Because a profit center is evaluated based on revenue and expenses, the performance report will be based on a segment income statement.

Profit center

 This report looks very similar to the cost center and revenue center performance reports. The only difference is the inclusion of revenue and expenses on the report. Pay careful attention to the accounts when determining if the variance is favorable or unfavorable. Remember the rules for revenue and expenses. Ask yourself if the variance is a good thing or a bad thing. For contribution margin and profit (segment margin), when actual is higher than budget that is a positive. The higher your contribution margin and profit, the better. That would be a favorable variance. When contribution margin and profit are less than budgeted, it is unfavorable.

Final Thoughts

The hardest part of the performance evaluation reports is determining if a variance is favorable or unfavorable. Ask yourself one question: Is this change a good thing or a bad thing? That will make the process so much easier.

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