Flexible Budgets, Variances, and Management Control: IAccounting/SoSe+2… · Cost Accounting Horngreen, Datar, Foster Static and Flexible Budgets A static budget is a budget prepared

Cost Accounting Horngreen, Datar, Foster

Flexible Budgets, Variances, and Management Control: I

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Static and Flexible Budgets

A static budget is a budget prepared for only one level of activity.• It is based on the level of output planned at the start of the budget

period.• The master budget is an example of a static budget.

A flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achievedin the budget period.• A key difference between a flexible budget and a static budget is the

use of the actual output level in the flexible budget.

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Static BudgetAssume that Rockville Co. manufactures and sells dress suits.

• Budgeted variable costs per suit are as follows: Direct materials cost $ 65 Direct manufacturing labor 26 Variable manufacturing overhead 24Total variable costs $115

• Budgeted selling price is $155 per suit.• Fixed manufacturing costs are expected to be $286,000 within a relevant

range between 9,000 and 13,500 suits.• The static budget for year 2012 is based on selling 13,000 suits.

What is the static-budget operating income?• Revenues (13,000 × $155) $2,015,000

Variable Expenses (13,000 × $115) - 1,495,000 Fixed Expenses - 286,000Budgeted operating income $ 234,000

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Static Budget

Assume that Rockville Co. produced and sold 10,000 suits at $160 each with actual variable costs of $120 per suit and fixed manufacturing costs of $300,000.What was the actual operating income?Revenues (10,000 × $160) $1,600,000 Less Expenses: Variable (10,000 × $120) 1,200,000 Fixed 300,000Actual operating income $ 100,000

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Static-Budget Variance

A static-budget variance is the difference between an actual result and a budgeted amount in the static budget.• A favorable variance is a variance that increases operating income

relative to the budgeted amount.• An unfavorable variance is a variance that decreases operating

income relative to the budgeted amount.

Level 0 analysis compares actual operating income with budgeted operating income.• Actual operating income $100,000

Budgeted operating income 234,000Static-budget variance of operating income $134,000 U

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Static-Budget VarianceLevel 1 analysis provides more detailed information on the operating income static- budget variance.

Static Budget Based Variance Analysis(Level 1) in (000)

Static ActualBudget Results Variance

Suits 13 10 3 URevenue $2,015 $1,600 $415 UVariable costs 1,495 1,200 296 FContribution margin $ 520 $ 400 $120 UFixed costs 286 300 14 UOperating income $ 234 $ 100 $134 U

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Steps in Developing Flexible Budgets

Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.• The budgeted selling price is $155, the budgeted variable cost is

$115 per suit, and the budgeted fixed cost is $286,000.

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Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.Step 2: Determine the actual quantity of output.• In the year 2012, 10,000 suits were produced and sold.


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Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.Step 2: Determine the actual quantity of output.Step 3: Determine the flexible budget for revenues based on budgeted selling price and actual quantity of output. • $155 × 10,000 = $1,550,000


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Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.Step 2: Determine the actual quantity of output.Step 3: Determine the flexible budget for revenues based on budgeted selling price and actual quantity of output.Step 4: Determine the flexible budget for costs based on budgeted variable costs per output unit, actual quantity of output, and the budgeted fixed costs.• Flexible budget:

Variable costs 10,000 × $115 $1,150,000 Fixed costs 286,000 Total costs $1,436,000


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Variances

Level 2 analysis provides information on the two components of the static-budget variance.1 Flexible-budget variance2 Sales-volume variance

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Flexible-Budget Variance

Flexible-Budget Variance (Level 2) in (000)

Flexible ActualBudget Results Variance

Suits 10 10 0 Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0 UFixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U

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Flexible-Budget Variance

The flexible-budget variance pertaining to revenues is often called a selling-price variance because it arises solely from differences between the actual selling price and the budgeted selling price:• Selling-price variance = ($160 – $155) x 10,000 = $50,000 F• Actual selling price exceeds the budgeted amount by $5.

What does this tell you? • Suppose Rockville Co had started an advertising campaign that

led to the increase in the selling price.• If the campaign had cost more than $50,000 it was unprofitable• If the campaign had cost less than $50,000 it was a profitable one

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Sales-Volume Variance

The sales-volume variance is the difference between the static budget for the number of units expected to be sold and the flexible budget for the number of units that were actually sold. The only difference between the static budget and the flexible budget is the output level upon which the budget is based.

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Sales-Volume Variance (Level 2) in (000)Flexible Static Sales-VolumeBudget Budget Variance

Suits 10 13 3 URevenue $1,550 $2,015 $465 UVariable costs 1,150 1,495 345 FContr. margin $ 400 $ 520 $120 UFixed costs 286 286 0Operating income $ 114 $ 234 $120 U

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Actual quantity sold 10,000 suits:

Flexible-budgetoperating income

$114,000

Static-budgetoperating income

$234,000

Sales-volumevariance

$120,000 U

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Budget Variances

Static-budget variance $134,000 U

Flexible-budgetvariance

$14,000 U

Level 1

Level 2Sales-volume

variance $120,000 U

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RemarkThe above split-up has been derived by introducing the flexible budget as an intermediate step:static budget variance (level 1)= budgeted # of units * budgeted $ per unit

- actual # of units * budgeted $ per unit+ actual # of units * budgeted $ per unit- actual # of units * actual $ per unit

Formally, a similar split-up could have been derived by developing a „flexible budget 2“ as followsstatic budget variance (level 1)= budgeted # of units * budgeted $ per unit

- budgeted # of units * actual $ per unit+ budgeted # of unit * actual $ per unit- actual # of units * actual $ per unit

Flexible budget variance

Sales volume varianceZero

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Sources of Information

The two main sources of information about budgeted input prices and budgeted input quantities are:

1 Actual input data from past periods2 Standards developed

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Standards

A standard input is a carefully predetermined quantity of inputs (such as pounds of materials or manufacturing labor-hours) required for one unit of output.A standard cost is a carefully predetermined cost that is based on a norm of efficiency.Standard costs can relate to units of inputs or units of outputs.

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Standards

Rockville’s budgeted cost for each variable direct cost item is computed as follows:

Standard inputallowed for

one output unit

Standard costper input unit×

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Standards

The following standards were developed for Rockville Company:Direct materials:• 4.00 square yards of cloth input allowed per output unit (suit)

purchased at $16.25 standard cost per square yard.• Standard cost per output unit manufactured

= 4.00 × $16.25 = $65.00Direct manufacturing labor:• 2.00 manufacturing labor-hours of input allowed per output unit (suit)

manufactured at $13.00 standard cost per hour.• Standard cost per output unit manufactured

= 2.00 × $13.00 = $26.00

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Price and Efficiency Variances

Level 3 analysis separates the flexible-budget variance into price and efficiency variances.The following relates to Rockville Company:• Direct materials purchased and used: 42,500 square yards• Actual price paid per yard: $15.95• Actual direct manufacturing labor hours: 21,500• Actual price paid per hour: $12.90What is the actual cost of direct materials?• 42,500 × $15.95 = $677,875What is the actual cost of direct manufacturing labor?• 21,500 × $12.90 = $277,350

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Price Variances

A price variance is the difference between the actual price and the budgeted price of inputs multiplied by the actual quantity of inputs.– Input-price variance– Rate variance

Price variance = (Actual price of inputs – Budgeted price of inputs) × Actual quantity of inputs• What is the price variance for direct materials?• ($15.95 – $16.25) × 42,500 = $12,750 FWhat is the price variance for direct manufacturing labor?• ($12.90 – $13.00) × 21,500 = $2,150 F

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Price Variances

Actual Quantity Actual Quantityof Inputs at of Inputs atActual Price Budgeted Price

42,500 × $15.95 42,500 × $16.25= $677,875 = $690,625

$12,750 FMaterials price variance

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Price Variances

Actual Quantity Actual Quantityof Inputs at of Inputs atActual Price Budgeted Price

21,500 × $12.90 21,500 × $13.00= $277,350 = $279,500

$2,150 FLabor price variance

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Price Variances

What may be some of the possible causes for Rockville’s favorable price variances?– Rockville’s purchasing manager negotiated more skillfully

than was planned.– Labor prices were set without careful analysis of the

market.

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Efficiency Variances

The efficiency variance is the difference between the actual and budgeted quantity of inputs used multiplied by the budgeted price of input.• Efficiency variance = (Actual quantity of inputs used – Budgeted

quantity of inputs allowed for actual output) × Budgeted price of inputs

What is the efficiency variance for direct materials?• (42,500 – 40,000) × $16.25 = $40,625 UWhat is the efficiency variance for direct manufacturing labor?• (21,500 – 20,000) × $13.00 = $19,500 U

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Actual Quantity Budgeted Quantityof Inputs at Allowed for Actual

Budgeted Price Outputs at Budgeted Price42,500 × $16.25 40,000 × $16.25

= $690,625 = $650,000

$40,625 UMaterials efficiency variance

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Actual Quantity Budgeted Quantityof Inputs at Allowed for Actual

Budgeted Price Outputs at Budgeted Price21,500 × $13.00 20,000 × $13.00

= $279,500 = $260,000

$19,500 ULabor efficiency variance

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What may be some of the causes for Rockville’s unfavorable efficiency variances?– Rockville’s purchasing manager received lower quality of

materials.– The personnel manager hired underskilled workers.– The maintenance department did not properly maintain

machines.

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Price and Efficiency Variances

What is the flexible-budget variance for direct materials?Materials-price variance

$12,750 F + Materials-efficiency

variance $40,625 U = $27,875 U

quantity of input

Priceof input

15.95 16.25

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42.5

pricevariance:$12,750F

Efficiency variance:$40,625U

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Price and Efficiency VariancesDirect labor

Quantity of input

Price of input12.9 13

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21,5

Efficiency variance:$19,500U

Labor-price variance:$2,150F

What is the flexible-budget variance for direct manufacturing labor?Labor-price variance $2,150 F

+ Labor- efficiency variance $19,500 U = $17,350 U

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Variance Analysis

Static-budget variance Materials $167,125 FLabor 60,650 F Total $227,775 F

Flexible-budget varianceMaterials $27,875 U Labor 17,350 UTotal $45,225 U

Sales-volume varianceMaterials $195,000 F Labor 78,000 FTotal $273,000 F

Level 1

Level 2

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Variance Analysis

Flexible-budget varianceMaterials $27,875 U Labor 17,350 UTotal $45,225 U

Efficiency varianceMaterials $40,625 U Labor 19,500 UTotal $60,125 U

Price varianceMaterials $12,750 FLabor 2,150 FTotal $14,900 F

Level 2

Level 3

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Performance Measurement Using Variances

A key use of variance analysis is in performance evaluation.Two attributes of performance are commonly measured:1 Effectiveness2 Efficiency

Effectiveness is the degree to which a predetermined objective or target is met.Efficiency is the relative amount of inputs used to achieve a given level of output.Variances should not solely be used to evaluate performance.

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Performance Measurement Using Variances

If any single performance measure, such as a labor efficiency variance, receives excessive emphasis, managers tend to make decisions that maximize their own reported performance in terms of that single performance measure“what you measure is what you get”.

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Multiple Causes of Variances

Often the causes of variances are interrelated.A favorable price variance might be due to lower quality materials.It is best to always consider possible interdependencies among variances and to not interpret variances in isolation of each other...Almost all organizations use a combination of financial and nonfinancial performance measures rather than relying exclusively on either type.Control may be exercised by observation of workers.

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True or False ???

A static budget is developed at the end of the period.

A favorable cost variance means that actual costs were less than budgeted costs.

A favorable variance automatically means "good news."

A variance should be interpreted individually, without any consideration of any other variance.

Every variance should always be investigated.

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Pick your Choice:

LRH Inc. has budgeted for sales of 10,000 units of BD at a price of $15 per unit. The actual sales for the period was 9,000 units of BD at $16 per unit. What was the flexible-budget sales amount for LRH? • $135,000• $144,000• $150,000• $160,000

CC Corp. makes a product called LR. The standard time allowed for each unit of LR is 1.2 hours. The standard labor rate per hour is $8. During the current period, CC made 8,000 units of LR, incurring 9,500 hours of labor at a total cost of $77,000. What is the direct labor rate variance for the current period?• $800 Favorable• $800 Unfavorable• $1,000 Favorable• $1,000 Unfavorable

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Documents

Flexible Budgets, Variances, and Management Control: IAccounting/SoSe+2… · Cost Accounting Horngreen, Datar, Foster Static and Flexible Budgets A static budget is a budget prepared