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7 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Flexible Budgets, Variances,and Management Control: IFlexible Budgets, Variances,and Management Control: I
Budgeting Lecture
2
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Static and Flexible BudgetsStatic and Flexible Budgets
Static BudgetPlanned level ofoutput at start ofthe budget period
Based on
Flexible BudgetBudgeted revenuesand cost based on
actual level of output
Based on
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Static Budget ExampleStatic Budget Example
Assume that Pasadena Co. manufacturesand sells dress suits.
Budgeted variable costs per suit are as follows:Direct materials cost $ 65Direct manufacturing labor 26Variable manufacturing overhead 24Total variable costs $115
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Static Budget ExampleStatic Budget Example
Budgeted selling price is $155 per suit.
Fixed manufacturing costs are expectedto be $286,000 within a relevant range
between 9,000 and 13,500 suits.
Variable and fixed period costs are ignored.
The static budget for year 2004 is basedon selling 13,000 suits.
What is the static-budget operating income?
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Static Budget ExampleStatic Budget Example
Revenues (13,000 × $155) $2,015,000Less Expenses:Variable (13,000 × $115) 1,495,000Fixed 286,000Budgeted operating income $ 234,000
Assume that Pasadena Co. produced and sold10,000 suits at $160 each with actual variablecosts of $120 per suit and fixed manufacturing
costs of $300,000.
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Static Budget ExampleStatic Budget Example
Revenues (10,000 × $160) $1,600,000 Less Expenses: Variable (10,000 × $120) 1,200,000 Fixed 300,000 Actual operating income $ 100,000
What was the actual operating income?
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Static-Budget Variance ExampleStatic-Budget Variance Example
What is the static-budget variance ofoperating income?
Actual operating income $100,000Budgeted operating income 234,000Static-budget variance of operating income $134,000 U
This is a Level 0 variance analysis.
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Static-Budget Variance ExampleStatic-Budget Variance Example
Static-Budget Based Variance Analysis(Level 1) in (000) Static Budget Actual 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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Learning Objective 2Learning Objective 2
Develop a flexible budgetand compute flexible-budgetvariances and sales-volume
variances.
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Steps in Developing Flexible Budgets
Steps in Developing Flexible Budgets
Step 1:Determine budgeted selling price, variable
cost per unit, and budgeted fixed cost.
Budgeted selling price is $155,variable cost is $115 per suit, and
the budgeted fixed cost is $286,000.
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Steps in Developing Flexible Budgets
Steps in Developing Flexible Budgets
Step 2:Determine the actual quantity of output.
In the year 2004, 10,000 suits wereproduced and sold.
Step 3:Determine the flexible budget for revenues.
$155 × 10,000 = $1,550,000
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Steps in Developing Flexible Budgets
Steps in Developing Flexible Budgets
Step 4:Determine the flexible budget for costs.
Variable costs: 10,000 × $115 = $1,150,000Fixed costs 286,000Total costs $1,436,000
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VariancesVariances
Level 2 analysis provides informationon the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance
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Flexible-Budget VarianceFlexible-Budget Variance
Flexible-Budget Variance(Level 2) in (000) Flexible
Budget Actual VarianceSuits 10 10 0Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0Fixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U
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Flexible-Budget VarianceFlexible-Budget Variance
Actual quantity sold: 10,000 suits
Flexible-budgetvariance
$14,000 U
Actual resultsoperating income
$100,000
Flexible-budgetoperating income
$114,000
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Flexible-Budget VarianceFlexible-Budget Variance
Total flexible-budget variance= Total actual results
– Total flexible budget for actual sales level
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Flexible-Budget VarianceFlexible-Budget Variance
Actual Budgeted Amount Amount
Selling price $160 $155Variable cost 120 115Contribution margin $ 40 $ 40
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Flexible-Budget VarianceFlexible-Budget Variance
Why is the flexible-budget variance $14,000 U?
Selling-price variance $50,000 F
Actual variable costs exceededflexible budget variable costs 50,000 U
Actual fixed costs exceededflexible budget fixed costs 14,000 U
Total flexible-budget variance $14,000 U
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Sales-Volume VarianceSales-Volume Variance
Sales-Volume Variance(Level 2) in (000) Flexible Static Sales-Volume
Budget Budget VarianceSuits 10 13 3 URevenue $1,550 $2,015 $465 UVariable costs 1,150 1,495 295 FContr. margin $ 400 $ 520 $120 UFixed costs 286 286 0Operating income $ 114 $ 234 $120 U
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Sales-Volume VarianceSales-Volume Variance
Actual quantity sold: 10,000 suits
Sales-volumevariance
$120,000 U
Flexible-budgetoperating income
$114,000
Static-budgetoperating income
$234,000
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Sales-Volume VarianceSales-Volume Variance
Total sales-volume variance $120,000 U
=
Actual sales unit – Master budgeted sales units13,000 – 10,000 = 3,000×
Budgeted contribution margin per unit $40
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Budget VariancesBudget Variances
Static-budgetvariance
$134,000 U
Flexible-budgetvariance
$14,000 U
Level 1
Sales-volumevariance
$120,000 ULevel 2
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Learning Objective 3Learning Objective 3
Explain why standard costs areoften used in variance analysis.
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StandardsStandards
Pasadena’s budgeted cost for each variabledirect cost item is computed as follows:
Standard inputallowed for
one output unit
Standard costper input unit
×
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StandardsStandards
4.00 square yards allowed per output unit at $16.25 standard cost per square yard.
Standard cost per output unit 4.00 × $16.25 = $65.00
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StandardsStandards
2.00 manufacturing labor-hours of inputallowed per output unit at $13.00 standard
cost per hour.
Standard cost per output unit2.00 × $13.00 = $26.00
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Learning Objective 4Learning Objective 4
Compute price variancesand efficiency variances
for direct-cost categories.
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Actual DataActual Data
Direct materials purchased and used:42,500 square yards at $15.95
Labor hours: 21,500 at $12.90
Cost of direct materials = $677,875
Cost of direct manufacturing labor = $277,350
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Price Variance ExamplePrice Variance Example
Direct-material price variance
Actual price – Budgeted price
× Actualquantity
($15.95 – $16.25) × 42,500 = $12,750 F=
=
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Price Variance ExamplePrice Variance Example
Direct-labor price variance
Actual price – Budgeted price
× Actualquantity
($12.90 – $13.00) × 21,500 = $2,150 F=
=
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Price Variance ExamplePrice Variance Example
What is the journal entry when the materials pricevariance is isolated at the time of purchase?
Materials Control 690,625Direct-Materials Price Variance 12,750Accounts Payable Control 677,875To record direct materials purchased
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Efficiency Variance ExampleEfficiency Variance Example
Direct-material efficiency variance
Actual quantity – Standard
quantity× Standard
price
(42,500 – 40,000) × $16.25 = $40,625 U=
=
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Efficiency Variance ExampleEfficiency Variance Example
Direct-labor efficiency variance
Actual quantity – Standard
quantity× Standard
price
(21,500 – 20,000) × $13.00 = $19,500 U=
=
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Efficiency VarianceEfficiency Variance
What is the journal entry to record materials used?
Work in Process Control 650,000Direct-Materials Efficiency Variance 40,625
Materials Control 690,625To record direct materials used
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Price and Efficiency VariancePrice and Efficiency Variance
What is the journal entry for direct manufacturing labor?
Work in Process Control 260,000Direct ManufacturingLabor Efficiency Variance 19,500
Direct-ManufacturingLabor Price Variance 2,150Wages Payable 277,350
To record liability for direct manufacturing labor
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Flexible Budget MaterialVariance Example
Flexible Budget MaterialVariance Example
ActualCost
$677,875
BQ × BP40,000 × $16.25
$650,000
AQ × BP42,500 × $16.25
$690,625
$12,750 F $40,625 U
$27,875 U
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Flexible Budget LaborVariance Example
Flexible Budget LaborVariance Example
ActualCost
$277,350
BQ × BP20,000 × $13.00
$260,000
AQ × BP21,500 × $13.00
$279,500
$2,150 F $ 19,500 U
$17,350 U
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Static-budget varianceMaterials $167,125 FLabor 60,650 FTotal $227,775 F
Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U
Sales-volume varianceMaterials $195,000 FLabor 78,000 FTotal $273,000 F
Level 1
Level 2
Variance AnalysisVariance Analysis
Level 2
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Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U
Price varianceMaterials $12,750 FLabor 2,150 FTotal $14,900 F
Efficiency varianceMaterials $40,625 ULabor 19,500 UTotal $60,125 U
Level 2
Level 3
Variance AnalysisVariance Analysis
Level 3
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Learning Objective 5Learning Objective 5
Explain why purchasingperformance measures should
focus on more factors thanjust price variances.
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Performance MeasurementUsing Variances
Performance MeasurementUsing Variances
Effectiveness is the degree to which apredetermined objective or target is met.
Efficiency is the relative amount of inputsused to achieve a given level of output.
Variances should not solely be used toevaluate performance.
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When to Investigate VariancesWhen to Investigate Variances
When should variances be investigated?
Subjective judgments
Rules of thumb as “investigate all variancesexceeding $10,000 or 25% of expected cost,
whichever is lower.”
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Continuous ImprovementContinuous Improvement
Assume that the budgeted direct materials cost foreach suit that Pasadena Co. manufactures is $65.
Pasadena Co. wants to implement continuousimprovement budgets based on a target 1%
materials cost reduction each period.
What should the budgeted cost be for thenext 3 subsequent periods?
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Continuous ImprovementContinuous Improvement
Prior Period Reduction Revised Budgeted in Budgeted
Amount Budget AmountThis Period: – – $65.00Period 1: $65.00 $0.650 $64.35Period 2: $64.35 $0.644 $63.71Period 3: $63.71 $0.637 $63.07
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Flexible Budgeting andActivity-Based CostingFlexible Budgeting andActivity-Based Costing
Materials costs and direct manufacturing laborcosts are examples of output-unit level costs.
Batch-level costs are resources sacrificedon activities that are related to a group of
units of product(s) or service(s) rather thanto each individual unit of product or service.
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Flexible Budgeting andActivity-Based CostingFlexible Budgeting andActivity-Based Costing
Denver Co. produces metal planters (MP).
Assume that material-handling labor costs varywith the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batchlevel costs that vary with the number of batches.
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Flexible Budgeting and Activity-Based Costing
Flexible Budgeting and Activity-Based Costing
Static ActualBudget Amounts
Units produced and sold 18,000 15,660Batch size 180 174Number of batches 100 90Material-handling labor-hours per batch 5.00 5.20
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Flexible Budgeting and Activity-Based Costing
Flexible Budgeting and Activity-Based Costing
Static ActualBudget Amounts
Total labor-hours 500 468Cost per material-handling labor-hour $14.00 $14.50Total material-handling
labor cost $7,000 $6,786
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Flexible Budgeting andActivity-Based CostingFlexible Budgeting andActivity-Based Costing
How many batches should have been employedto produce the actual output units?
15,660 units ÷ 180 units per batch = 87 batches
How many material-handling hoursshould have been used?
87 batches × 5 hours/batch = 435 hours
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Flexible Budgeting andActivity-Based CostingFlexible Budgeting andActivity-Based Costing
What is the flexible budget formaterial-handling labor-hours?
435 hours × $14.00/labor-hour = $6,090
Flexible-budget costs $6,090 Actual costs 6,786 Flexible-budget variance $ 696 U
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Price and Efficiency VariancesPrice and Efficiency Variances
Price variance = ($14.50 – $14.00) × 468 = $234 U
Efficiency variance = (468 – 435) × $14.00 = $462 U
Total variance $696 U