Chapter 8
Flexible Budgets and
Variance Analysis
8-1
Learning Objective 1
Distinguish between flexible
budgets and master
(static) budgets.
8-2
Static Budgets
Static budget is really just another name for
master budget.
 A master budget is prepared for only one
level of a given type of activity.
 All actual results are compared with the
original budgeted amounts, even if sales
volume is less than originally planned.

8-3
Performance Report
Performance report is a
generic term that usually
means a comparison of
actual results with some
budget.
Variance is a deviation
of an actual amount
from the expected
or budgeted amount.
8-4
Master Budget Variance:
Revenue
The variances of actual results from the
master budget are called master (static)
budget variances.
Actual
Budget
$400,000
$370,000
$380,000
$380,000
Variance
$20,000
$10,000
F
U
8-5
Master Budget Variance:
Expenses
Actual expenses that exceed budgeted expenses
result in unfavorable expense variances.
Actual expenses that are less than budgeted
expenses result in favorable expense variances.
8-6
Objective 2
Use flexible-budget formulas
to construct a flexible budget
based on the volume of sales.
8-7
Flexible Budget

A flexible budget (variable budget) is a
budget that adjusts for changes in sales
volume and other cost-driver activities.
8-8
Flexible Budget Formulas
The flexible budget is based on the same
assumptions of revenue and cost behavior
(within the relevant range) as is the master budget.
The flexible budget incorporates effects on each
cost and revenue caused by changes in activity.
8-9
Objective 3
Prepare an activity-based
flexible budget.
8 - 10
Activity-Based Flexible Budget
An activity-based flexible budget is based
on budgeted costs for each activity and
related cost driver.
 Within each activity center, costs depend
on an appropriate cost driver.
 Activity-based flexible budgets provide
more accurate measures of cost behavior.

8 - 11
Objective 4
Understand the performance
evaluation relationship
between master (static)
budgets and flexible budgets.
8 - 12
Performance Evaluation Using
Flexible Budgets
Comparing the
flexible budget to
actual results
accomplishes an
important
performance
evaluation purpose.
8 - 13
Performance Evaluation Using
Flexible Budgets

1
2
There are basically two reasons why actual
results might differ from the master budget.
Sales and other cost-driver activities were
not the same as originally forecasted.
Revenue or variable costs per unit of
activity and fixed costs per period were not
as expected.
8 - 14
Performance Evaluation Using
Flexible Budgets
The intent of using the flexible budget
for performance evaluation is to isolate
unexpected effects on actual results
that can be corrected if adverse or
enhanced if beneficial.
8 - 15
Objective 5
Compute flexible-budget
variances and sales-activity
variances.
8 - 16
Flexible-Budget Variances
Actual
Results
Flexible
Budget
Flexible Budget Variances
8 - 17
Flexible-Budget Variances
Flexible
Budget
Master
Budget
Activity-Level Variances
8 - 18
Distinguish Between
Effectiveness and Efficiency
Effectiveness is the degree to which
a goal, objective, or target is met.
Efficiency is the degree to which inputs are
used in relation to a given level of outputs.
8 - 19
Isolating the Causes of Variances
Managers use comparisons among actual
results, master budgets, and flexible budgets
to evaluate organizational performance.
 Performance may be effective, efficient,
both, or neither.

8 - 20
Flexible-Budget Variances
Total flexible-budget variance
= Total actual results
– Total flexible budget for actual sales activity level
8 - 21
Sales-Activity Variances
Total sales-activity variance
=
Actual sales units – Master budgeted sales units
×
Budgeted contribution margin per unit
8 - 22
Objective 6
Compute and interpret price
and usage variances for inputs
based on cost-driver activity.
8 - 23
Expectations, Standard Costs,
and Standard Cost Systems

Expectations or standard costs are the
building blocks of a planning and control
system.
8 - 24
Expectations, Standard Costs,
and Standard Cost Systems
An expected cost is the cost that is most
likely to be attained.
 A standard cost is a carefully developed
cost per unit that should be attained.
 Standard cost systems are accounting
systems that value products according to
standard costs only.

8 - 25
Perfection Standards...
or ideal standards, are expressions of the
most efficient performance possible under
the best conceivable conditions, using
existing specifications and equipment.
 No provision is made for waste, spoilage,
machine breakdowns, and the like.
–
8 - 26
Currently Attainable Standards...
are standards based on levels of
performance that can be achieved by
realistic levels of effort.
 Allowances are made for normal defects,
spoilage, waste, and nonproductive time.
–
8 - 27
Trade-Offs Among Variances
Improvements in one area could lead to
improvements in others and vice versa.
 Likewise, substandard performance in one
area may be balanced by superior
performance in others.

8 - 28
When to Investigate Variances
When should variances be investigated?
Knowing exactly when to investigate is
difficult.
Many organizations have developed
such rules of thumb as “investigate all
variances exceeding $5,000 or 25% of
expected cost, whichever is lower”.
8 - 29
Flexible-Budget Variance
Example
Standard per unit of output:
Direct
Material
Std. inputs expected
5 pounds
Std. price expected
$ 2
Std. cost expected
$10
Direct
Labor
½ hour
$16
$ 8
8 - 30
Flexible-Budget Variance
Example
Actual results for 7,000 units produced:
Direct labor
Direct material
Pounds purchased Hours used: 3,750
Actual price
and used: 36,800
Price/pound: $1.90 (rate): $16.40
Total actual
Total actual
cost: $61,500
cost: $69,920
8 - 31
Flexible-Budget Variance
Example
Units of
good output
achieved
Standard
unit price
on input
×
Input allowed
per unit of
output
=
Flexible budget
(or total standard
cost allowed)
×
8 - 32
Flexible-Budget Variance
Example
Standard Direct-Materials Cost Allowed
Units of good
output achieved:
7,000
Standard unit
price on input:
$2 per pound
×
=
Input allowed per
unit of output:
5 pounds
×
Flexible budget (or
total standard cost
allowed): $70,000
8 - 33
Flexible-Budget Variance
Example
Actual
Cost
$69,920
Flexible
Budget
$70,000
Direct material flexible budget variance = $80 F
8 - 34
Flexible-Budget Variance
Example
Standard Direct-Labor Cost Allowed
Units of good
output achieved:
7,000
Standard unit
price on input:
$16 per hour
×
=
Input allowed per
unit of output:
½ hour
×
Flexible budget (or
total standard cost
allowed): $56,000
8 - 35
Flexible-Budget Variance
Example
Actual
Cost
$61,500
Flexible
Budget
$56,000
Direct labor flexible budget variance = $5,500 U
8 - 36
Price Variance Computations
Direct-material price variance
=
Actual price –
Standard price
=
×
Actual
quantity
($1.90 – $2.00) per pound
× 36,800 pounds = $3,680 favorable
8 - 37
Price Variance Computations
=
Direct-labor price variance
Actual price –
Standard price
×
Actual
quantity
=
($16.40 – $16.00) per hour
× 3,750 hours = $1,500 unfavorable
8 - 38
Usage Variance Computations
Direct-material usage variance
=
Actual quantity –
Standard quantity
=
×
Standard
price
[36,800 – (7,000 × 5)] pounds
× $2.00 per pound = $3,600 unfavorable
8 - 39
Usage Variance Computations
=
Direct-labor usage variance
Actual quantity –
Standard quantity
×
Standard
price
=
[3,750 – (7,000 × ½)] hours
× $16 per hour = $4,000 unfavorable
8 - 40
Favorable or Unfavorable
Variance?

To determine
whether a variance
is favorable or
unfavorable, use
logic rather than
memorizing a
formula.
8 - 41
Effects of Inventories
What if production does not equal sales?
 The sales-activity variance then is the
difference between the static budget and the
flexible budget for the number of units sold.
 In contrast, the flexible-budget cost
variances compare actual costs with
flexible-budgeted costs for the number of
units produced.

8 - 42
Objective 7
Compute variable overhead
spending and efficiency
variances.
8 - 43
Variable Overhead Variances
Spending variance
Efficiency variance
8 - 44
Variable-Overhead
Efficiency Variance
When actual cost-driver activity differs from
the standard amount allowed for the actual
output achieved, a variable-overhead
efficiency variance will occur.
8 - 45
Variable-Overhead
Spending Variance...
–
is the difference between the actual variable
overhead and the amount of variable
overhead budgeted for the actual level of
cost-driver activity.
8 - 46
Flexible-Budget Variance
Example
Suppose that Dominion Company’s cost of
supplies, a variable-overhead cost, is
driven by direct-labor hours.
Standard variable overhead rate per unit of output:
$0.60 per unit or $1.20 per direct labor hour
½ hour is allowed per unit of output
8 - 47
Flexible-Budget Variance
Example
Actual variable overhead = $4,700
Variable overhead allowed
= $.60 × 7,000 units = $4,200
$500 unfavorable variance
8 - 48
Price Variance Computations
Variable-overhead efficiency variance
=
Actual direct
labor hours –
Standard hours
=
×
Standard
rate per
hour
(3,750 actual hours – 3,500 standard
hours allowed) × $1.20 per hour
= $300 unfavorable
8 - 49
Price Variance Computations
Variable-overhead spending variance
=
Actual
variable
overhead
=
–
Expected rate per hour
× Actual direct-labor
hours used
($4,700 – ($1.20 × 3,750 hours)
= $200 unfavorable
8 - 50
End of Chapter 8
8 - 51