THE BUDGET PLAN FOR 4TH QUARTER
Sell in 4th quarter:
• 70,000 pants
• 25,000 jerseys
• 9,000 award jackets
Control inventory
Manage cash
WHAT’S UP?
C&C sold more award jackets than budgeted.
Managers thought that would be a good thing.
Turns out, workers took too long to make the extra
jackets. And they were paid overtime to meet
customer delivery dates.
Net income was $144,800 lower than budgeted,
even though more jackets were sold.
TOTAL VARIANCE
Actual Cost
Incurred
Budgeted Costs
Total Variance
A variance is any difference
between what you expected and
what you achieved.
LET’S LOOK AT SOME VARIANCES
Actual
Static
Budget
Variance
$2,457,525
$2,335,000
$122,525
F
1,724,150
1,582,757
141,393
U
Gross margin
733,375
752,243
(18,868)
U
Selling and administrative expenses
385,139
360,753
24,386
U
Operating income
348,236
391,490
(43,254)
U
2,256
1,880
Income before taxes
345,980
389,610
(43,630)
U
Income taxes
103,794
116,883
(13,089)
F
$242,186
$272,727
($30,541)
U
Sales
Cost of goods sold
Financing costs
Net income
376
A variance is favorable if it increases net income
U
LET’S LOOK AT SOME VARIANCES
Actual
Sales
Static
Budget
Variance
$2,457,525
$2,335,000
$122,525
F
1,724,150
1,582,757
141,393
U
Gross margin
733,375
752,243
(18,868)
U
Selling and administrative expenses
385,139
360,753
24,386
U
Operating income
348,236
391,490
(43,254)
U
2,256
1,880
376
U
Income before taxes
345,980
389,610
(43,630)
U
Income taxes
103,794
116,883
(13,089)
F
$242,186
$272,727
($30,541)
U
Cost of goods sold
Financing costs
Net income
A variance is unfavorable if it decreases net income
YOUR PERFORMANCE REPORT
You are very excited. The month has just
ended and your department has been very
productive. You were able to crank out
38,000 machine hours! That’s 3,000 more
than you budgeted. You figure this must
be good for a bonus, so let’s see how well
you did.
YOUR PERFORMANCE REPORT
Actual Results
Machine hours
Static Budget
Variances
38,000
35,000
3,000
$86,500
$80,500
$6,000
U
Indirect Materials
26,000
21,000
5,000
U
Power
15,700
14,000
1,700
U
Maintenance
44,900
42,000
2,900
U
Depreciation
80,000
80,000
---
Maintenance
92,400
92,000
400
Supervision
38,000
38,000
---
$383,500
$367,500
$16,000
Variable costs
Indirect labor
Fixed Costs
Total overhead costs
U
U
YOUR PERFORMANCE REPORT
Actual Results
Machine hours
Static Budget
38,000
35,000
Variances
3,000
Variable costs
These
variances
because actual
Indirect
labor are unfavorable
$86,500
$80,500
costs were greater than what was budgeted, thus
Indirect Materials
26,000
21,000
lowering net income
$6,000
U
5,000
U
Power
15,700
14,000
1,700
U
Maintenance
44,900
42,000
2,900
U
Depreciation
80,000
80,000
---
Maintenance
92,400
92,000
400
Supervision
38,000
38,000
---
$383,500
$367,500
$16,000
Do these unfavorable variances mean that you
Fixed Costs
have done a poor job controlling costs?
Total overhead costs
U
U
THE QUESTION…
Think about it.
By definition, the total variable costs would
be higher. Working more machine hours
should result in higher costs. But some of
the higher costs could be a result of poor
management as well.
How can we tell the difference?
THE ANSWER…
We have to…
the budget to match the actual
activity level achieved.
FLEXIBLE BUDGETS
Present a budget for any level of activity achieved.
• Variable costs change with activity level.
• Fixed costs remain constant regardless of
activity level, as long as you remain within the
relevant range.
LET’S PRACTICE: FIX THE FLEX
Actual Results
Machine hours
Static Budget
Variances
38,000
35,000
3,000
$86,500
$80,500
$6,000
U
Indirect Materials
26,000
21,000
5,000
U
Power
15,700
14,000
1,700
U
Maintenance
44,900
42,000
2,900
U
Depreciation
80,000
80,000
---
Maintenance
92,400
92,000
400
Supervision
38,000
38,000
---
$383,500
$367,500
$16,000
Variable costs
Indirect labor
Fixed Costs
Total overhead costs
U
U
COMPONENTS OF THE STATIC BUDGET VARIANCE
LET’S LOOK AT EXHIBIT 6-4
SOME GENERAL POINTS…
Always identify a variance as “favorable” (F) or
“unfavorable” (U)
A favorable variance is not necessarily a good
thing, just as an unfavorable variance is not
necessarily a bad thing
Variance analysis provides an opportunity to
benchmark against established standards to
control operations
ANALYZING THE FLEXIBLE BUDGET VARIANCE
PRICE VARIANCE CALCULATION
Actual Results
AQ × AP
Flexible Budget
AQ × SP
SP × SQ
Price Variance
Flexible Budget Variance
or
AQ (AP - SP)
This measures the difference between the
actual price of inputs and the standard
price of inputs
QUANTITY VARIANCE CALCULATION
Actual Results
AQ × AP
Flexible Budget
AQ × SP
Price Variance
SP × SQ
Quantity Variance
Flexible Budget Variance
or
SP (AQ - SQ)
This measures the difference between the
actual quantity of inputs used and the
standard quantity of inputs that should
have been used
DIRECT MATERIALS VARIANCES
C&C’S DIRECT MATERIAL VARIANCES
INTERPRETING DM PRICE VARIANCES
FAVORABLE VARIANCE
Purchased in bulk and
received quantity discount
Purchased lower-quality
goods at a cheaper price
Received discount from
supplier to get business
Suppliers decreased price
UNFAVORABLE VARIANCE
Purchased smaller-thannormal quantity and lost
quantity discounts
Purchased higher-quality
goods at a higher price
Suppliers increased price
Placed rush order with
overnight delivery
INTERPRETING DM QUANTITY VARIANCES
FAVORABLE VARIANCE
Use of higher-quality goods
resulted in reduced waste
Highly-skilled workers
generated a lower scrap
rate
UNFAVORABLE VARIANCE
Use of lower-quality goods
resulted in increased waste
Low-skilled worked generated
a higher scrap rate
Machine problems ruined
some units
Poor supervision allowed
extra scrap and waste
Employee theft
THINGS TO CONSIDER ON MATERIAL VARIANCES
Price variance should be calculated at time of
purchase, quantity variance at time of use
Price and quantity variances may stem from the
same cause
DIRECT LABOR VARIANCES
C&C’s DIRECT LABOR VARIANCES
INTERPRETING DL RATE VARIANCES
FAVORABLE VARIANCE
UNFAVORABLE VARIANCE
Used less skilled (lower
paid) workers
Market wage rates
decreased
Used higher skilled (higher
paid) workers
Employees worked overtime
and received overtime pay
Market wage rates increased
INTERPRETING DL EFFICIENCY VARIANCES
FAVORABLE VARIANCE
Used more highly skilled
(higher paid) workers than
allowed in the standard
Used higher quality
materials that needed less
handling
UNFAVORABLE VARIANCE
New employees were still
learning their jobs
Overtime caused fatigue and
reduced workers’ efficiency
Low quality materials
required longer production
time
Poor supervision resulted in
employees “goofing off”
Excessive machine downtime
VARIABLE OVERHEAD VARIANCES
Variable overhead variances are calculated just
like labor variances
• Variable overhead spending variance
• Variable overhead efficiency variance
VARIABLE OVERHEAD VARIANCES
C&C’s VARIABLE OVERHEAD VARIANCES
INTERPRETING VOH SPENDING VARIANCES
FAVORABLE VARIANCE
Paid less than expected for
variable overhead items
Used variable overhead
items efficiently
UNFAVORABLE VARIANCE
Paid more than expected for
variable overhead items
Used variable overhead items
inefficiently
INTERPRETING VOH EFFICIENCY VARIANCES
FAVORABLE VARIANCE
Efficient use of activity base
UNFAVORABLE VARIANCE
Inefficient use of activity
base
FOH SPENDING VARIANCE
Since fixed costs do not change with changes in
volume, the flexible budget amount for FOH is the
same as the static budget amount
FOH spending variance is the difference between
the actual amount spent and the budgeted
amount.
THIS IS JUST THE BEGINNING…
The calculation of the variances is the easy part
Unless you investigate the cause of the
variance, the whole process is useless
What variances should you investigate? All of
them?