Flexible budgets and budget variances
First, let us consider the following example:
Standard Cost Sheet
Product: Widget
Direct materials
Direct labor
Variable overhead
Fixed overhead
Standard cost per unit
2 lbs.
0.5 hrs.
0.5 hrs.
0.5 hrs.
@ $4.00
@ $20.00
@ $ 3.00
@ $25.00
Additional data:
Variable selling, general, and administration
Fixed selling, general, and administration
$ 8.00
10.00
1.50
12.50
$ 32.00
$3.00
$2.00
Operating Data
Budgeted units of production and sales
Actual units manufactured and sold
Selling price per unit (budgeted and actual)
Direct materials
purchased and used
Direct labor
Variable overhead
Fixed overhead
Total manufacturing cost
18,000 lbs. @$4.50
3,800 hrs. @22.00
Variable SG&A
Fixed SG&A
Total SG&A
10,000
8,000
$60 per unit
$81,000
83,600
11,800
128,000
$304,400
$ 24,000
16,000
$ 40,000
On the next page is the static budget.
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Budgeted units
10,000
Sales
Variable Costs
Direct Materials
Direct Labor
Variable OH
Fixed OH
Selling and Admin
Variable
Fixed
$600,000
$80,000
100,000
15,000
125,000
320,000
30,000
20,000
Operating Income
50,000
$230,000
The flexible budget is…
Actual units
8,000
Sales
Variable Costs
Direct Materials
Direct Labor
Variable OH
Fixed OH
Selling and Admin
Variable
Fixed
Operating Income
$480,000
$64,000
80,000
12,000
125,000
281,000
24,000
20,000
44,000
$155,000
On the next page, we compare the actual results, the flexible budget, and
the static budget.
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Units
Sales
Variable Costs
Direct Materials
Direct Labor
Variable OH
Fixed OH
Selling and Admin
Variable
Fixed
Master
Actual
Flexible
(static)
Budget
Results Variance
Budget Variance
8,000
- F
8,000
2,000 U
10,000
$480,000
$- F $480,000 $120,000 U $600,000
$81,000 $17,000 U
83,600
3,600 U
11,800
200 F
$64,000
80,000
12,000
$16,000 F
20,000 F
3,000 F
$80,000
100,000
15,000
128,000
3,000 U
125,000
- F
125,000
304,400
23,400 U
281,000
39,000 F
320,000
24,000
- F
24,000
6,000 F
30,000
16,000
4,000 F
20,000
- F
20,000
40,000
4,000 F
44,000
6,000 F
50,000
Operating Income $135,600 $19,400 U $155,000 $75,000 U $230,000
We will now proceed to “variance analysis.” As I mentioned in class, this
analysis above is called a level 0 analysis. I don’t care if you know that term.
It relates to the overall variances between flexible budget and actual
results and between the static budget and flexible budget. We will be
primarily concerned with the flexible budget variances here (the
differences between the flexible budget and actual results). We will break
each of these (actually, only materials, labor, variable overhead) into a
price/rate/spending variance and an efficiency/usage variance. Which it is
depends to which variance we are referring. Materials have price and usage
variances, Labor has rate and efficiency (sometimes called usage) variances,
and Variable overhead has spending (since there is not a “real” rate out
there) and efficiency variances. In addition, we will have two variances for
fixed overhead. A spending variance and a production volume variance.
Let’s begin with direct materials and direct labor. Recall that SOMETIMES
direct materials has a different amount used than purchased. If that is the
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case, then you must compute the price variance based upon the actual
amount of materials purchased and the usage variance based upon the actual
amount USED.
The general model for breaking down materials, labor, and variable overhead
variances was shown in class.
Actual Quantity
X
Actual Price
AQ X AP
Actual Quantity
X
Standard Price
AQ X SP
Rate, price, spending
variance
Standard Quantity
X
Standard Price
SQ X SP
Usage or efficiency
variance
Let us begin by breaking down the direct materials flexible budget variance
of $17,000 U between the actual results and the flexible budget into a price
variance and a usage variance.
The actual price spent for materials was $4.50 per pound (sometimes you
are not given this breakdown) and the quantity used was 18,000 pounds
(again, for this case amount purchased and used are the same). The
Standard price per pound is $4.00 and the quantity that we would have
expected to use under the flexible budget (our standard) would have been 2
pounds per unit X 8,000 units actually produced or 16,000 pounds. This
yields the following price and usage variances:
AQ X AP
18,000 X 4.50
$81,000
AQ X SP
18,000 X $4.00
$72,000
$9,000 U
Price variance
SQ X SP
2 X 8,000 X $4.00
$64,000
$8,000 U
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Usage variance
Notice that the flexible budget variance of $17,000 U is the SUM of the
price and the usage variances ($9,000 U and $8,000 U respectively).
Now let’s explain the $3,600 U direct labor variance. The standard labor
rate is $20 per labor hour and the flexible budget (standard) usage for the
8,000 units produced would be .5 X 8,000 = 4,000 hours. We actually
incurred labor costs of $83,600 which relate 3,800 labor hours used at a
labor rate of $22.00 per hour.
AQ X AR
3,800 X 22.00
$83,600
AQ X SR
SQ X SR
3,800 X $20.00 .5 X 8,000 X $20.00
$76,000
$80,000
$7,600 U
Rate variance
$4,000 F
Efficiency variance
Adding these two variances together we get $3,600 U for the flexible
budget variance.
The variable overhead variance is similar to the labor variance and if variable
overhead is based upon labor hours, as in this case, the efficiency variance
will be proportionate (and the same sign) as the direct labor efficiency
variance. Actual variable overhead costs were $11,800. Note that there is
not ACTUAL RATE. The actual driver (as with direct labor) was 3,800 labor
hours and the standard hours allowed for producing 8,000 units was .5 X
8,000 = 4,000 hours. The standard rate per hour is $3.00.
Actual variable
OH
$11,800
AQ X SR
3,800 X $3.00
$11,400
$400 U
Spending variance
SQ X SR
.5 X 8,000 X $3.00
$12,000
$600 F
Efficiency variance
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The flexible budget variance for variable overhead was $200 F which equals
$400 U plus $600 F.
Finally, we consider the fixed overhead variances. These are a bit different.
First, let us define a couple of things. The flexible budget overhead for
variable overhead is the number to the far right in the figure above
($12,000). That is because it is based upon the ACTUAL quantity produced.
For fixed overhead, though, the ACTUAL quantity and the BUDGETED
quantity (10,000 units) should yield the SAME fixed overhead since the cost
is fixed. That is why fixed overhead ALWAYS has a zero sales volume
variance… The number of units produced or sold is, theoretically, irrelevant.
So the flexible budget will be the same as the static budget amount and will
be based upon the number of units budgeted. We call that the denominator
level of activity. Budgeted fixed overhead is $25.00 X .5 hours per unit X
10,000 units or $125,000. Note, as a sideline, that the fixed overhead rate
(FOHR) plus the variable overhead rate (VOHR) is equal to the
predetermined overhead rate from chapter 4 (POHR). That is total
estimated overhead divided by total activity (in this case, total estimated
direct labor hours). The first variance (and the only one relevant to the
budget analysis) for fixed overhead is the fixed overhead spending variance.
That is just the difference between the actual fixed overhead costs and the
flexible budget (and, therefore, the static budget). That is $128,000 $125,000 = $3,000 U. It is unfavorable since the actual cost is $3,000
more than the budgeted cost.
Finally, we compute the fixed overhead production volume variance. For this,
we PRETEND that the fixed overhead rate works like the variable overhead
rate. The fixed overhead rate is given here as $25.00. Fixed overhead is
applied based upon this number and the number of labor hours. In other
words, applied fixed overhead was $25 X .5 X 8,000 since we only
manufactured 8,000 units. So applied fixed overhead would, in a standard
costing system, be $100,000. Since the flexible budget fixed overhead was
$125,000, we have an unfavorable variance (underproduction) of $25,000 U
for our production volume variance. The two fixed overhead variances are
shown below:
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Actual fixed OH
$128,000
Flexible budget
SQ X FOHR
Denominator Q X FOHR
.5 X 8,000 X $25.00
.5 X 10,000 X $25.00
$100,000
$125,000
$3,000 U
$25,000 U
Spending variance
Production volume
variance
Notice that the $25,000 unfavorable variance DOES NOT SHOW UP
anywhere on the level 0 variance analysis. The $3,000 unfavorable variance
is the TOTAL variance (difference) between our actual results for fixed
overhead and our flexible budget. There is no difference between our
flexible budget and our static budget.
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