Flexible Budgets, Variances, and
Management Control: I
Cost Accounting
Horngreen, Datar, Foster
1
Static and Flexible Budgets
ƒ A static budget is a budget prepared for only one level of
activity.
• It is based on the level of output planned at the start of the budget
period.
• The master budget is an example of a static budget.
ƒ A flexible budget is developed using budgeted revenues or
cost amounts based on the level of output actually achieved
in the budget period.
• A key difference between a flexible budget and a static budget is the
use of the actual output level in the flexible budget.
Cost Accounting
Horngreen, Datar, Foster
2
Static Budget
Assume that Rockville 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
• 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.
• The static budget for year 2012 is based on selling 13,000 suits.
What is the static-budget operating income?
• Revenues (13,000 × $155)
Variable Expenses (13,000 × $115)
Fixed Expenses
Budgeted operating income
Cost Accounting
$2,015,000
- 1,495,000
- 286,000
$ 234,000
Horngreen, Datar, Foster
3
Static Budget
ƒ Assume that Rockville 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.
ƒ What was the actual operating income?
ƒ Revenues (10,000 × $160)
$1,600,000
Less Expenses:
Variable (10,000 × $120)
1,200,000
Fixed
300,000
Actual operating income
$ 100,000
Cost Accounting
Horngreen, Datar, Foster
4
Static-Budget Variance
ƒ A static-budget variance is the difference between an actual
result and a budgeted amount in the static budget.
• A favorable variance is a variance that increases operating income
relative to the budgeted amount.
• An unfavorable variance is a variance that decreases operating
income relative to the budgeted amount.
ƒ Level 0 analysis compares actual operating income with
budgeted operating income.
• Actual operating income
Budgeted operating income
Static-budget variance of operating income
Cost Accounting
Horngreen, Datar, Foster
$100,000
234,000
$134,000 U
5
Static-Budget Variance
ƒ Level 1 analysis provides more detailed information on the operating
income static- budget variance.
Static Budget Based Variance Analysis
(Level 1) in (000)
Static
Actual
Budget
Results
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
Cost Accounting
Horngreen, Datar, Foster
6
Steps in Developing Flexible Budgets
ƒ Step 1: Determine budgeted selling price,
budgeted variable cost per unit, and budgeted fixed cost.
• The budgeted selling price is $155, the budgeted variable cost is
$115 per suit, and the budgeted fixed cost is $286,000.
Cost Accounting
Horngreen, Datar, Foster
7
Steps in Developing Flexible Budgets
ƒ Step 1: Determine budgeted selling price,
budgeted variable cost per unit, and budgeted fixed cost.
ƒ Step 2: Determine the actual quantity of output.
• In the year 2012, 10,000 suits were produced and sold.
Cost Accounting
Horngreen, Datar, Foster
8
Steps in Developing Flexible Budgets
ƒ Step 1: Determine budgeted selling price,
budgeted variable cost per unit, and budgeted fixed cost.
ƒ Step 2: Determine the actual quantity of output.
ƒ Step 3: Determine the flexible budget for revenues based
on budgeted selling price and actual quantity of output.
• $155 × 10,000 = $1,550,000
Cost Accounting
Horngreen, Datar, Foster
9
Steps in Developing Flexible Budgets
ƒ Step 1: Determine budgeted selling price,
budgeted variable cost per unit, and budgeted fixed cost.
ƒ Step 2: Determine the actual quantity of output.
ƒ Step 3: Determine the flexible budget for revenues based
on budgeted selling price and actual quantity of output.
ƒ Step 4: Determine the flexible budget for costs based on
budgeted variable costs per output unit, actual quantity of
output, and the budgeted fixed costs.
• Flexible budget:
Variable costs 10,000 × $115
Fixed costs
Total costs
Cost Accounting
$1,150,000
286,000
$1,436,000
Horngreen, Datar, Foster
10
Variances
ƒ Level 2 analysis provides information on the two
components of the static-budget variance.
1 Flexible-budget variance
2 Sales-volume variance
Cost Accounting
Horngreen, Datar, Foster
11
Flexible-Budget Variance
Flexible-Budget Variance
(Level 2) in (000)
Flexible
Actual
Budget
Results
Suits
10
10
Revenue
$1,550
$1,600
1,200
Variable costs
1,150
Contribution margin
$ 400
$ 400
Fixed costs
286
300
Operating income
$ 114
$ 100
Cost Accounting
Horngreen, Datar, Foster
Variance
0
$ 50 F
50 U
$ 0U
14 U
$ 14 U
12
Flexible-Budget Variance
ƒ The flexible-budget variance pertaining to revenues is
often called a selling-price variance because it arises
solely from differences between the actual selling price
and the budgeted selling price:
• Selling-price variance = ($160 – $155) x 10,000 = $50,000 F
• Actual selling price exceeds the budgeted amount by $5.
ƒ What does this tell you?
• Suppose Rockville Co had started an advertising campaign that
led to the increase in the selling price.
• If the campaign had cost more than $50,000 it was unprofitable
• If the campaign had cost less than $50,000 it was a profitable one
Cost Accounting
Horngreen, Datar, Foster
13
Sales-Volume Variance
ƒ The sales-volume variance is the difference between the
static budget for the number of units expected to be sold
and the flexible budget for the number of units that were
actually sold.
ƒ The only difference between the static budget and the
flexible budget is the output level upon which the budget is
based.
Cost Accounting
Horngreen, Datar, Foster
14
Sales-Volume Variance
Sales-Volume Variance
(Level 2) in (000)
Flexible
Static
Budget
Budget
Suits
10
13
Revenue
$1,550
$2,015
1,495
Variable costs
1,150
Contr. margin
$ 400
$ 520
286
Fixed costs
286
Operating income $ 114
$ 234
Cost Accounting
Sales-Volume
Variance
3U
$465 U
345 F
$120 U
0
$120 U
Horngreen, Datar, Foster
15
Sales-Volume Variance
Actual quantity sold 10,000 suits:
Sales-volume
variance
$120,000 U
Cost Accounting
Flexible-budget
operating income
$114,000
Static-budget
operating income
$234,000
Horngreen, Datar, Foster
16
Budget Variances
Level 1
Level 2
Static-budget variance
$134,000 U
Flexible-budget
variance
$14,000 U
Cost Accounting
Sales-volume
variance
$120,000 U
Horngreen, Datar, Foster
17
Remark
ƒ The above split-up has been derived by introducing the flexible
budget as an intermediate step:
static budget variance (level 1)
= budgeted # of units * budgeted $ per unit
Sales volume variance
- actual # of units * budgeted $ per unit
Zero
+ actual # of units * budgeted $ per unit
Flexible budget variance
- actual # of units * actual $ per unit
ƒ Formally, a similar split-up could have been derived by developing
a „flexible budget 2“ as follows
static budget variance (level 1)
= budgeted # of units * budgeted $ per unit
- budgeted # of units * actual $ per unit
+ budgeted # of unit * actual $ per unit
- actual # of units * actual $ per unit
Cost Accounting
Horngreen, Datar, Foster
18
Sources of Information
ƒ The two main sources of information about budgeted input
prices and budgeted input quantities are:
1 Actual input data from past periods
2 Standards developed
Cost Accounting
Horngreen, Datar, Foster
19
Standards
ƒ A standard input is a carefully predetermined quantity of
inputs (such as pounds of materials or manufacturing laborhours) required for one unit of output.
ƒ A standard cost is a carefully predetermined cost that is
based on a norm of efficiency.
ƒ Standard costs can relate to units of inputs or units of
outputs.
Cost Accounting
Horngreen, Datar, Foster
20
Standards
Rockville’s budgeted cost for each variable direct cost
item is computed as follows:
Standard input
allowed for
one output unit
Cost Accounting
×
Standard cost
per input unit
Horngreen, Datar, Foster
21
Standards
ƒ The following standards were developed for Rockville
Company:
ƒ Direct materials:
• 4.00 square yards of cloth input allowed per output unit (suit)
purchased at $16.25 standard cost per square yard.
• Standard cost per output unit manufactured
= 4.00 × $16.25 = $65.00
ƒ Direct manufacturing labor:
• 2.00 manufacturing labor-hours of input allowed per output unit (suit)
manufactured at $13.00 standard cost per hour.
• Standard cost per output unit manufactured
= 2.00 × $13.00 = $26.00
Cost Accounting
Horngreen, Datar, Foster
22
Price and Efficiency Variances
ƒ Level 3 analysis separates the flexible-budget variance into
price and efficiency variances.
The following relates to Rockville Company:
• Direct materials purchased and used:
42,500 square yards
• Actual price paid per yard:
$15.95
• Actual direct manufacturing labor hours: 21,500
• Actual price paid per hour:
$12.90
What is the actual cost of direct materials?
• 42,500 × $15.95 = $677,875
What is the actual cost of direct manufacturing labor?
• 21,500 × $12.90 = $277,350
Cost Accounting
Horngreen, Datar, Foster
23
Price Variances
ƒ A price variance is the difference between the actual price
and the budgeted price of inputs multiplied by the actual
quantity of inputs.
– Input-price variance
– Rate variance
ƒ Price variance = (Actual price of inputs
– Budgeted price of inputs) × Actual quantity of inputs
• What is the price variance for direct materials?
• ($15.95 – $16.25) × 42,500 = $12,750 F
What is the price variance for direct manufacturing labor?
• ($12.90 – $13.00) × 21,500 = $2,150 F
Cost Accounting
Horngreen, Datar, Foster
24
Price Variances
Actual Quantity
of Inputs at
Actual Price
42,500 × $15.95
= $677,875
Actual Quantity
of Inputs at
Budgeted Price
42,500 × $16.25
= $690,625
$12,750 F
Materials price variance
Cost Accounting
Horngreen, Datar, Foster
25
Price Variances
Actual Quantity
of Inputs at
Actual Price
21,500 × $12.90
= $277,350
Actual Quantity
of Inputs at
Budgeted Price
21,500 × $13.00
= $279,500
$2,150 F
Labor price variance
Cost Accounting
Horngreen, Datar, Foster
26
Price Variances
ƒ What may be some of the possible causes for Rockville’s
favorable price variances?
– Rockville’s purchasing manager negotiated more skillfully
than was planned.
– Labor prices were set without careful analysis of the
market.
Cost Accounting
Horngreen, Datar, Foster
27
Efficiency Variances
ƒ The efficiency variance is the difference between the
actual and budgeted quantity of inputs used multiplied by
the budgeted price of input.
• Efficiency variance = (Actual quantity of inputs used – Budgeted
quantity of inputs allowed for actual output) × Budgeted price of
inputs
What is the efficiency variance for direct materials?
• (42,500 – 40,000) × $16.25 = $40,625 U
What is the efficiency variance for direct manufacturing labor?
• (21,500 – 20,000) × $13.00 = $19,500 U
Cost Accounting
Horngreen, Datar, Foster
28
Efficiency Variances
Actual Quantity
of Inputs at
Budgeted Price
42,500 × $16.25
= $690,625
Budgeted Quantity
Allowed for Actual
Outputs at Budgeted Price
40,000 × $16.25
= $650,000
$40,625 U
Materials efficiency variance
Cost Accounting
Horngreen, Datar, Foster
29
Efficiency Variances
Actual Quantity
of Inputs at
Budgeted Price
21,500 × $13.00
= $279,500
Budgeted Quantity
Allowed for Actual
Outputs at Budgeted Price
20,000 × $13.00
= $260,000
$19,500 U
Labor efficiency variance
Cost Accounting
Horngreen, Datar, Foster
30
Efficiency Variances
ƒ What may be some of the causes for Rockville’s
unfavorable efficiency variances?
– Rockville’s purchasing manager received lower quality of
materials.
– The personnel manager hired underskilled workers.
– The maintenance department did not properly maintain
machines.
Cost Accounting
Horngreen, Datar, Foster
31
Price and Efficiency Variances
ƒ What is the flexiblequantity of input
budget variance for direct
Efficiency variance:
materials?
$40,625U
Materials-price variance
$12,750 F
+ Materials-efficiency
variance $40,625 U
= $27,875 U
42.5
40
price
variance:
$12,750F
15.95 16.25
Cost Accounting
Horngreen, Datar, Foster
Price
of input
32
Price and Efficiency Variances
ƒ What is the flexible-budget
variance for direct
manufacturing labor?
Labor-price variance $2,150 F
+ Labor- efficiency variance
$19,500 U = $17,350 U
Direct labor
Quantity of input
Efficiency variance:
$19,500U
21,5
20
Labor
-price
variance:
$2,150F
12.9 13 Price of input
Cost Accounting
Horngreen, Datar, Foster
33
Variance Analysis
Level 1
Level 2
Static-budget variance
Materials $167,125 F
Labor
60,650 F
Total
$227,775 F
Flexible-budget variance
Materials $27,875 U
Labor
17,350 U
Total
$45,225 U
Cost Accounting
Sales-volume variance
Materials $195,000 F
Labor
78,000 F
Total
$273,000 F
Horngreen, Datar, Foster
34
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
Cost Accounting
Efficiency variance
Materials $40,625 U
Labor
19,500 U
Total
$60,125 U
Horngreen, Datar, Foster
35
Performance Measurement Using
Variances
ƒ A key use of variance analysis is in performance evaluation.
ƒ Two attributes of performance are commonly measured:
1 Effectiveness
2 Efficiency
ƒ Effectiveness is the degree to which a predetermined
objective or target is met.
ƒ Efficiency is the relative amount of inputs used to achieve a
given level of output.
ƒ Variances should not solely be used to evaluate
performance.
Cost Accounting
Horngreen, Datar, Foster
36
Performance Measurement Using
Variances
ƒ If any single performance measure, such as a labor
efficiency variance, receives excessive emphasis, managers
tend to make decisions that maximize their own reported
performance in terms of that single performance measure
ƒ “what you measure is what you get”.
Cost Accounting
Horngreen, Datar, Foster
37
Multiple Causes of Variances
ƒ Often the causes of variances are interrelated.
ƒ A favorable price variance might be due to lower quality
materials.
ƒ It is best to always consider possible interdependencies
among variances and to not interpret variances in isolation
of each other...
ƒ Almost all organizations use a combination of financial and
nonfinancial performance measures rather than relying
exclusively on either type.
ƒ Control may be exercised by observation of workers.
Cost Accounting
Horngreen, Datar, Foster
38
True or False ???
ƒ A static budget is developed at the end of the period.
ƒ A favorable cost variance means that actual costs were less
than budgeted costs.
ƒ A favorable variance automatically means "good news."
ƒ A variance should be interpreted individually, without any
consideration of any other variance.
ƒ Every variance should always be investigated.
Cost Accounting
Horngreen, Datar, Foster
39
Pick your Choice:
ƒ
ƒ
LRH Inc. has budgeted for sales of 10,000 units of BD at a price of $15 per unit.
The actual sales for the period was 9,000 units of BD at $16 per unit. What was
the flexible-budget sales amount for LRH?
• $135,000
• $144,000
• $150,000
• $160,000
CC Corp. makes a product called LR. The standard time allowed for each unit of
LR is 1.2 hours. The standard labor rate per hour is $8. During the current
period, CC made 8,000 units of LR, incurring 9,500 hours of labor at a total cost
of $77,000. What is the direct labor rate variance for the current period?
• $800 Favorable
• $800 Unfavorable
• $1,000 Favorable
• $1,000 Unfavorable
Cost Accounting
Horngreen, Datar, Foster
40