Chap. 7 - Flexible Budgeting - Direct Costs Variances(1)(1)

5/26/2018 Chap. 7 - Flexible Budgeting - Direct Costs Variances(1)(1)

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2012 Pearson Prentice Hall. All rights reserved.

Flexible Budgets,

Direct-Cost Variances,

andManagement Control


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Basic ConceptsVariancedifference between an actual and an

expected (budgeted) amount.

Management by exceptionthe practice of focusingattention on areas not operating as expected(budgeted).

Static (master) budget is based on the output plannedat the start of the budget period.


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Basic Concepts Static-budget variance (Level 0)the difference

between the actual result and the correspondingstatic budget amount

Favorable variance (F)has the effect of increasingoperating income relative to the budget amount

Unfavorable variance (U)has the effect of

decreasing operating income relative to the budgetamount


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VariancesVariances may start out at the top with a Level 0

analysis.

This is the highest level of analysis, a super-macro viewof operating results.

The Level 0 analysis is nothing more than thedifference between actual and static-budget operating

income.


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Variances Further analysis decomposes (breaks down) the Level

0 analysis into progressively smaller and smallercomponents. Answers: How much were we off?

Levels 1, 2, and 3 examine the Level 0 variance intoprogressively more-detailed levels of analysis. Answers: Where and why were we off?


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Level 1 Analysis, Illustrated


7/19 2012 Pearson Prentice Hall. All rights reserved.

Evaluation Level 0 tells the user very little other than how much

contribution margin was off from budget. Level 0 answers the question: How much were we off in

total?

Level 1 gives the user a little more information: itshows which line-items led to the total Level 0

variance. Level 1 answers the question: Where were we off?



Flexible Budget Flexible budgetshifts budgeted revenues and costs

up and down based on actual operating results(activities)

Represents a blending of actual activities andbudgeted dollar amounts

Will allow for preparation of Level 2 and 3 variances Answers the question: Why were we off?


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Level 3 VariancesAll product costs can have Level 3 variances. Direct

materials and direct labor will be handled next.Overhead variances are discussed in detail in a laterchapter.

Both direct materials and direct labor have both priceand efficiency variances, and their formulae are thesame.


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Variance Summary


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(c) 2012 Pearson Prentice Hall. All rights reserved.

Level 3 Variances

Price variance formula:

Efficiency variance formula:

Price Actual Price Budgeted Price Actual Quantity

Variance Of Input Of Input Of InputX= { - }

Efficiency Actual Quantity Budgeted Quantity of Input Budgeted Price

Variance Of Input Used Allowed for Actual Output Of InputX= { - }


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Variances and Journal Entries Each variance may be journalized.

Each variance has its own account.

Favorable variances are credits; unfavorable variancesare debits.

Variance accounts are generally closed into cost ofgoods sold at the end of the period, if immaterial.


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Standard Costing Targets or standards are established for direct material

and direct labor.

The standard costs are recorded in the accountingsystem.

Actual price and usage amounts are compared to thestandard and variances are recorded.


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Standard Costs can be a Useful Tool Price and efficiency variances provide feedback to

initiate corrective actions.

Standards are used to control costs. Managers use variance analysis to evaluate

performance after decisions are implemented.

Part of a continuous improvement program.


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Benchmarking and Variances Benchmarking is the continuous process of comparing

the levels of performance in producing products andservices against the best levels of performance incompeting companies.

Variances can be extended to include comparison toother entities.


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Benchmarking Example: Airlines


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Documents

Chap. 7 - Flexible Budgeting - Direct Costs Variances(1)(1)