Flexible Budgets, Variances,
and Management Control: I
Chapter 7
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
7-1
Learning Objective 1
Distinguish
a static budget
from a flexible budget.
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7-2
Static and Flexible Budgets
Static Budget
Flexible Budget
Based on
Based on
Planned level of
output at start of
the budget period
Budgeted revenues
and cost based on
actual level of output
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7-3
Static Budget Example
Assume that Pasadena 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
24
Total variable costs
$115
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7-4
Static Budget Example
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.
Variable and fixed period costs are ignored.
The static budget for year 2004 is based
on selling 13,000 suits.
What is the static-budget operating income?
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Static Budget Example
Revenues (13,000 × $155)
$2,015,000
Less Expenses:
Variable (13,000 × $115)
1,495,000
Fixed
286,000
Budgeted operating income
$ 234,000
Assume that Pasadena 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.
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7-6
Static Budget Example
What was the actual operating income?
Revenues (10,000 × $160)
Less Expenses:
Variable (10,000 × $120)
Fixed
Actual operating income
$1,600,000
1,200,000
300,000
$ 100,000
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7-7
Static-Budget Variance Example
What is the static-budget variance of
operating income?
Actual operating income
$100,000
Budgeted operating income
234,000
Static-budget variance of
operating income
$134,000 U
This is a Level 0 variance analysis.
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7-8
Static-Budget Variance Example
Static-Budget Based Variance Analysis
(Level 1) in (000)
Static Budget Actual Variance
Suits
13
10
3U
Revenue
$2,015
$1,600
$415 U
Variable costs
1,495
1,200
296 F
Contribution margin $ 520
$ 400
$120 U
Fixed costs
286
300
14 U
Operating income
$ 234
$ 100
$134 U
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7-9
Learning Objective 2
Develop a flexible budget
and compute flexible-budget
variances and sales-volume
variances.
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7 - 10
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
Step 2:
Determine the actual quantity of output.
In the year 2004, 10,000 suits were
produced 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
Step 4:
Determine the flexible budget for costs.
Variable costs: 10,000 × $115 = $1,150,000
Fixed costs
286,000
Total costs
$1,436,000
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7 - 13
Variances
Level 2 analysis provides information
on the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance
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Flexible-Budget Variance
Flexible-Budget Variance
(Level 2) in (000)
Suits
Revenue
Variable costs
Contribution margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Actual
10
$1,600
1,200
$ 400
300
$ 100
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Variance
0
$ 50 F
50 U
$ 0
14 U
$ 14 U
7 - 15
Flexible-Budget Variance
Actual quantity sold: 10,000 suits
Flexible-budget
variance
$14,000 U
Actual results
operating income
$100,000
Flexible-budget
operating income
$114,000
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7 - 16
Flexible-Budget Variance
Total flexible-budget variance
= Total actual results
– Total flexible budget for actual sales level
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Flexible-Budget Variance
Selling price
Variable cost
Contribution margin
Actual
Amount
$160
120
$ 40
Budgeted
Amount
$155
115
$ 40
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7 - 18
Flexible-Budget Variance
Why is the flexible-budget variance $14,000 U?
Selling-price variance
Actual variable costs exceeded
flexible budget variable costs
Actual fixed costs exceeded
flexible budget fixed costs
Total flexible-budget variance
$50,000 F
50,000 U
14,000 U
$14,000 U
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Sales-Volume Variance
Sales-Volume Variance
(Level 2) in (000)
Suits
Revenue
Variable costs
Contr. margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Static Sales-Volume
Budget
Variance
13
3U
$2,015
$465 U
1,495
295 F
$ 520
$120 U
286
0
$ 234
$120 U
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7 - 20
Sales-Volume Variance
Actual quantity sold: 10,000 suits
Sales-volume
variance
$120,000 U
Flexible-budget
operating income
$114,000
Static-budget
operating income
$234,000
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7 - 21
Sales-Volume Variance
Actual sales unit – Master budgeted sales units
13,000 – 10,000 = 3,000
×
Budgeted contribution margin per unit $40
=
Total sales-volume variance $120,000 U
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Budget Variances
Level 1
Level 2
Static-budget
variance
$134,000 U
Flexible-budget
variance
$14,000 U
Sales-volume
variance
$120,000 U
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7 - 23
Learning Objective 3
Explain why standard costs are
often used in variance analysis.
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7 - 24
Standards
Pasadena’s budgeted cost for each variable
direct cost item is computed as follows:
×
Standard input
allowed for
one output unit
Standard cost
per input unit
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7 - 25
Standards
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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7 - 26
Standards
2.00 manufacturing labor-hours of input
allowed per output unit at $13.00 standard
cost per hour.
Standard cost per output unit
2.00 × $13.00 = $26.00
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7 - 27
Learning Objective 4
Compute price variances
and efficiency variances
for direct-cost categories.
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7 - 28
Actual Data
Direct materials purchased and used:
42,500 square yards at $15.95
Cost of direct materials = $677,875
Labor hours: 21,500 at $12.90
Cost of direct manufacturing labor = $277,350
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7 - 29
Price Variance Example
Direct-material price variance
=
Actual price –
Budgeted price
=
($15.95 – $16.25) × 42,500 = $12,750 F
×
Actual
quantity
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7 - 30
Price Variance Example
Direct-labor price variance
=
=
Actual price –
Budgeted price
×
Actual
quantity
($12.90 – $13.00) × 21,500 = $2,150 F
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7 - 31
Price Variance Example
What is the journal entry when the materials price
variance is isolated at the time of purchase?
Materials Control
690,625
Direct-Materials Price Variance
12,750
Accounts Payable Control
677,875
To record direct materials purchased
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7 - 32
Efficiency 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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7 - 33
Efficiency 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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7 - 34
Efficiency Variance
What is the journal entry to record materials used?
Work in Process Control
650,000
Direct-Materials Efficiency Variance 40,625
Materials Control
690,625
To record direct materials used
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Price and Efficiency Variance
What is the journal entry for direct manufacturing labor?
Work in Process Control
260,000
Direct Manufacturing
Labor Efficiency Variance 19,500
Direct-Manufacturing
Labor Price Variance
2,150
Wages Payable
277,350
To record liability for direct manufacturing labor
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7 - 36
Flexible Budget Material
Variance Example
Actual
Cost
$677,875
AQ × BP
42,500 × $16.25
$690,625
$12,750 F
BQ × BP
40,000 × $16.25
$650,000
$40,625 U
$27,875 U
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Flexible Budget Labor
Variance Example
AQ × BP
21,500 × $13.00
$279,500
Actual
Cost
$277,350
$2,150 F
BQ × BP
20,000 × $13.00
$260,000
$ 19,500 U
$17,350 U
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Variance Analysis
Level 1
Static-budget variance
Materials $167,125 F
Labor
60,650 F
Total
$227,775 F
Level 2
Flexible-budget variance
Materials $27,875 U
Labor
17,350 U
Total
$45,225 U
Level 2
Sales-volume variance
Materials $195,000 F
Labor
78,000 F
Total
$273,000 F
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7 - 39
Variance Analysis
Level 2
Flexible-budget variance
Materials $27,875 U
Labor
17,350 U
Total
$45,225 U
Level 3
Price variance
Materials $12,750 F
Labor
2,150 F
Total
$14,900 F
Level 3
Efficiency variance
Materials $40,625 U
Labor
19,500 U
Total
$60,125 U
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7 - 40
Learning Objective 5
Explain why purchasing
performance measures should
focus on more factors than
just price variances.
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7 - 41
Performance Measurement
Using Variances
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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7 - 42
When to Investigate Variances
When should variances be investigated?
Subjective judgments
Rules of thumb as “investigate all variances
exceeding $10,000 or 25% of expected cost,
whichever is lower.”
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7 - 43
Learning Objective 6
Integrate continuous
improvement
into variance analysis.
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Continuous Improvement
Assume that the budgeted direct materials cost for
each suit that Pasadena Co. manufactures is $65.
Pasadena Co. wants to implement continuous
improvement budgets based on a target 1%
materials cost reduction each period.
What should the budgeted cost be for the
next 3 subsequent periods?
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7 - 45
Continuous Improvement
Prior Period
Budgeted
Amount
This Period:
–
Period 1:
$65.00
Period 2:
$64.35
Period 3:
$63.71
Reduction
in
Budget
–
$0.650
$0.644
$0.637
Revised
Budgeted
Amount
$65.00
$64.35
$63.71
$63.07
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7 - 46
Learning Objective 7
Perform variance analysis in
activity-based costing systems.
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Flexible Budgeting and
Activity-Based Costing
Materials costs and direct manufacturing labor
costs are examples of output-unit level costs.
Batch-level costs are resources sacrificed
on activities that are related to a group of
units of product(s) or service(s) rather than
to each individual unit of product or service.
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Flexible Budgeting and
Activity-Based Costing
Denver Co. produces metal planters (MP).
Assume that material-handling labor costs vary
with the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batch
level costs that vary with the number of batches.
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Flexible Budgeting and
Activity-Based Costing
Static
Actual
Budget Amounts
Units produced and sold 18,000
15,660
Batch size
180
174
Number of batches
100
90
Material-handling
labor-hours per batch
5.00
5.20
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Flexible Budgeting and
Activity-Based Costing
Total labor-hours
Cost per material-handling
labor-hour
Total material-handling
labor cost
Static
Actual
Budget Amounts
500
468
$14.00
$14.50
$7,000
$6,786
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Flexible Budgeting and
Activity-Based Costing
How many batches should have been employed
to produce the actual output units?
15,660 units ÷ 180 units per batch = 87 batches
How many material-handling hours
should have been used?
87 batches × 5 hours/batch = 435 hours
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Flexible Budgeting and
Activity-Based Costing
What is the flexible budget for
material-handling labor-hours?
435 hours × $14.00/labor-hour = $6,090
Flexible-budget costs
Actual costs
Flexible-budget variance
$6,090
6,786
$ 696 U
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Price and Efficiency Variances
Price variance = ($14.50 – $14.00) × 468 = $234 U
Efficiency variance = (468 – 435) × $14.00 = $462 U
Total variance
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$696 U
7 - 54
End of Chapter 7
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