Budgeting and Standard Cost

7/30/2019 Budgeting and Standard Cost

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AF5231Managerial Accounting &

Information SystemsBudgeting & Standard Costing

NOT Required:PP. 567 - 569,

Supplementary Note,Appendices 12A, B

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AGENDA

Nature & Purpose of Standard CostsThe Master Budget

Characteristics of a good budgetary system

Budget application of decision control

Static and Flexible Budgets

Variance Analysis

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Standard Costs

StandardCosts are

Predetermined.

Used for planning labor, materialand overhead requirements.

Benchmarks formeasuring performance.

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To Facilitate product costingPlanning future operations

Monitoring current operationsMotivating manager and employee behaviorEvaluating Performance

Purpose of Standards


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Historical data Use

the

cost

predicted

by

the

costfunctionasstandardcost.

Task analysis /Engineering estimate Analyzetheproduction

process

to

determine

how

muchaproductshouldcost.

Sources for Setting Standards

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Ideal standards demand

maximum efficiency and can beachieved only if everythingoperates perfectly.

Currently attainable/Practicalstandards can be achieved underefficient operating conditions.

Kaizen standards reflect aplanned improvement and are atype of currently attainablestandard.

Establishing Standards

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Are standards thesame as budgets?

A budget is set for

total costs.

Standards vs. Budgets

A standard is a perunit cost.

Standards are often

used whenpreparing budgets.

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The Master BudgetFunctions of budgets Translateanorganizationsstrategiesintoaformalized

financialplan

Assembleknowledge

&

communicate

among

managers

(decisionmanagement)

Defineareasofresponsibilityandmeasureperformance(decisioncontrol)

A master budget is Acomprehensiveplanfortheupcomingaccountingperiod.

Usuallyprepared

for

aone

year

period.

Comprisedofacollectionofbudgets,startingfromsalestobalancesheet.


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Master Budget Components

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Characteristics of aGood Budgetary System

Frequent feedback on performance

Monetary and non-monetary incentives

Participative Budgeting

Realistic Standards

Controllability of CostsMultiple Measures of Performance

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Frequent Feedback on Performance

Enable managers to take corrective

actions and change plans promptly.Management by exception is oftenadopted. Managerswillonlyinvestigatesignificant

variancesonareaswhichrequirestheirattention.

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Monetary & Non-monetaryIncentives

Incentive are the means that are usedto encourage goal congruent behavior.

Incentive can be both positive andnegative Positive:Bonus,stockoptions

Negative:Dismissal


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Facilitate managers to get involvedinto the budgetary process.

Advantages: Managerscanobtainasenseofresponsibility

Enhancesgoalcongruence

Managers

will

work

harder

to

achieve

these

objectivesasitsbeingsetbythem

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Problems: Settingstandardsthatareeithertoohighortoo

low.

Intentionallyunderestimaterevenueandoverestimatecost (paddingthebudget)

Buildingslack(budgetaryslack)intothebudget

Pseudoparticipation

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Realistic Standards

Budgets should be developed based on

realistic conditions and expectations.It should reflect operating realities: Actualactivitylevels

Seasonalvariations,efficienciesandgeneraleconomictrends

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Cost Controllability

Managers should be accountable forcosts in which they can control in orderto maintain fairness in performanceevaluation.


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Applications to Decision ControlLine Item Budget

Authorize

managers

to

spend

only

up

to

the

specified

amountoneachlineitem.

Advantages:

Tight control reduces opportunities for managers totake actions inconsistent with firm goals

Disadvantages:

Inflexible in responding to unanticipated needs Little incentive for cost savings

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Applications to Decision ControlBudget Lapsing

A

requirement

that

funds

allocated

for

a

particular

yearcannotbecarriedovertothefollowingyear.

Advantages:

Tighter control than budgets that do not lapse

Prevents risk-averse managers from accumulatingfunds

Disadvantages: Encourages wasteful spending near end of fiscal year

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Static vs. Flexible BudgetStatic Budget Abudgetpreparedforasinglelevelofsalesvolume.

Prepared

at

the

beginning

of

the

year. Example:Masterbudget

Static budgets are good planning devices, butusing static budgets for control (performanceevaluation) purposes can be problematic.

Static Budget Variances Difference

between

actual

results

&

the

static

budget.

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Static vs. Flexible BudgetFlexible Budget Abudgetpreparedforamultiplelevelsofsalesvolume.

Preparedatthebeg.oftheyearforplanningpurposesand

at

the

end

of

the

year

for

performance

evaluation.

Flexible budgets are usually used for controlpurposes by expressing the static budgetunder the actual output level. Managersperformanceisinsulatedfromoutputvolume

changes.

Flexible budget Variances Differencesbetweenactualresults&theflexiblebudget


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Flexible Budget - Example

Fixed costs areexpressed as atotal amount.

Variable costs are expressed as aconstant amount per hour.

$40,000 10,000 hours is$4.00 per hour.

CheeseCo

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$4.00 per hour 8,000 hours = $32,000

CheeseCo

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Total fixed costsdo not change in

the relevantrange.

CheeseCo

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Flexible Budget - ExampleCheeseCo


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Variance Analysis Cycle

Prepare standardcost performance

report

Analyzevariances

Begin

Identify

questions

Receive

explanations

Take

correctiveactions

Conduct nextperiods

operations

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Management by Exception

DirectMaterial

Managers focus on quantities and coststhat exceed standards, a practice known as

management by exception.

Type of Product Cost

Amount

Direct

Labor

Manufacturing

Overhead

Standard

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Standard Cost Variances

Cost

Standard

This variance is unfavorablebecause the actual cost

exceeds the standard cost.

A standard cost var iance is the amount by whichan actual cost d iffers from the standard cost.

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Price Variance

The difference between

the actual price and thestandard price

Quantity Variance

The difference between

the actual quantity andthe standard quantity


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General Model for Variance Analysis

Actual Quantity Actual Quantity Standard Quant ity Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Standard price is the amount that shouldhave been paid for the resources acquired.

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Actual Quantity Actual Quantity Standard Quant ity Actual Price Standard Price Standard Price


Standard quantity is the quantity of input

allowed for the actual good output.Standard input per unit of output

times amount of good output.

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AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard PriceAP = Actual Price SQ = Standard Quanti ty


Actual Quanti ty Actual Quanti ty Standard Quanti ty

Actual Price Standard Price Standard Price

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AP x AQ (ActualQuantity at ActualPrice) (1)

SP x AQ (ActualQuantity atStandard Price) (2)

SP x SQ (StandardQuantity atStandard Price)

(3)

Price Variance(1) (2)

Usage Variance(2) (3)

Total Variance(1) (3)

DM Price and Usage Variances


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Glacier Peak Outfitters has the followingdirect material standard for the fiberfill in

its mountain parka.

0.1 kg. of fiberfill per parka at $5.00 per kg.

Last month 210 kgs of fiberfill werepurchased and used to make 2,000 parkas.

The material cost a total of $1,029.

Material Variances Example

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Price variance Quantity variance

Actual Quantity Actual Quantity Standard Quantity Actual Price Standard Price Standard Price

Material Variances Summary

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Suppose only 190 kgs of fiberfill were usedto make 2,000 parkas. What is thematerials quantity variance? Remember

that the standards call for 0.1 kg offiberfill per parka at a cost of $5 per kg offiberfill.

a.$50F

b.$50U

c.

$100

Fd.$100U

Concept Check

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Hanson Inc. has the following material

standard to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Last week 2,800 pounds of material werepurchased at a total cost of $10,920, and1,700 pounds were used to make 1,000

Zippies.

DM Variances Continued

Zippy


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Hanson purchased andused 1,700 pounds.

How are the variances

computed if the amountpurchased differs from

the amount used?

The price variance iscomputed on the entire

quantity purchased.

The quantity varianceis computed only on

the quantity used.


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Actual Quant ity Actual QuantityPurchased Purchased

Actual Price Standard Price

2,800 lbs. 2,800 lbs.

$3.90 per lb. $4.00 per lb.

= $10,920 = $11,200

Price variance$280 favorable

Price variance increasesbecause quantity

purchased increases.

Zippy


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Actual Quant ityUsed Standard Quantity

Standard Price Standard Price

1,700 lbs. 1,500 lbs.

$4.00 per lb. $4.00 per lb.

= $6,800 = $6,000

Quantity variance$800 unfavorable

Quantity variance is

unchanged becauseactual and standard

quantities are unchanged.

Zippy


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Interpretation of DM Variance

Price Variance Usage Variance

Causes

Paying higher or lowerprices than planned

Losing or gainingquantity discounts

Buying higher/lowerquality material

Greater or lower yieldfrom material

The use of high/lowerquality materials

Greater/lower rate ofscrap than anticipated.

Responsibility The Purchasing Manager The Production Manager


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AH x AR (ActualHours at ActualRate) (1)

AH x SR (ActualHours at StandardRate) (2)

SH x SR

(Standard Hours atStandard Rate) (3)

Rate Variance(1) (2)

EfficiencyVariance(2) (3)

Total Variance(1) (3)

DL Rate and Efficiency Variance

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Remarks on DL VariancesRate Variance is conceptually similar to

the Price Variance (General Model) Salaryisnotmeasuredbypricebutbyrateinstead

($x/hour)

Efficiency Variance is conceptually similarto Quantity Variance (General Model)

The

measure

of

quantity

of

labor

used

refers

to

efficiencyoflabor.

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Hanson Inc. has the following direct laborstandard to manufacture one Zippy:

1.5 standard hours per Zippy at $12.00 perdirect labor hour

Last week 1,550 direct labor hours wereworked at a total labor cost of $18,910

to make 1,000 Zippies.

Labor Variances Example

Zippy

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Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate

Labor Variances Summary

Rate variance Efficiency variance

Zippy


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Interpretation of DL VariancesRate Variance Efficiency Variance

Causes

1.Labor demand/supply2.Higher wages due to

wage award

3.Use of higher/lowergrade of worker

4.Payment of unplannedovertime or bonus

1.Use incorrect labor grade2.Poor staff supervision

3. Incorrectmaterial/machineproblems

4.Lack of staff training

ResponsibilityFor (1) UncontrollableThe Production Manager

The Human ResourceManager

The Production Manager

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Significance of Cost Variances

Size of variance Dollaramount

Percentageofstandard

Recurring variances

Trends

Controllability

Favorable variances

Costs and benefits ofinvestigation

What clues help me

to determine thevariances that I

should investigate?

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Statistical Control Charts

1 2 3 4 5 6 7 8 9

Variance Measurements

Favorable Limit

Unfavorable Limit

Desired Value

Warning signals for investigation

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Advantages of Standard Costs

Management byexception

Improved cost control

and performanceevaluation

Better Information

for planning anddecision making

Possible reductionsin production costs

Advantages


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PotentialProblems

Emphasis onnegative mayimpact morale.

Emphasizing standardsmay exclude other

important objectives.

Favorable variancesmay bemisinterpreted.

Continuousimprovementmay be moreimportant than

meeting standards.

Standard costreports maynot be timely.

Incentives to buildinventories.

Disadvantages of Standard Costs

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The End

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Budgeting and Standard Cost