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Flexible Budgets, Variances, and Management Control: I. Chapter 7. Distinguish a static budget from a flexible budget. Learning Objective 1. Static and Flexible Budgets. Planned level of output at start of the budget period. Based on. Static Budget. Budgeted revenues and cost based on

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Flexible budgets variances and management control i

Flexible Budgets, Variances,and Management Control: I

Chapter 7


Learning objective 1

Distinguish

a static budget

from a flexible budget.

Learning Objective 1


Static and flexible budgets
Static and Flexible Budgets

Planned level of

output at start of

the budget period

Based on

Static Budget

Budgeted revenues

and cost based on

actual level of output

Based on

Flexible Budget


Static budget example
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


Static budget example1
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?


Static budget example2
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.


Static budget example3
Static Budget Example

What was the actual operating income?

Revenues (10,000 × $160) $1,600,000

Less Expenses:

Variable (10,000 × $120) 1,200,000

Fixed 300,000

Actual operating income $ 100,000


Static budget variance example
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.


Static budget variance example1
Static-Budget Variance Example

Static-Budget Based Variance Analysis

(Level 1) in (000)

Static BudgetActualVariance

Suits 13 10 3 U

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


Learning objective 2
Learning Objective 2

Develop a flexible budget

and compute flexible-budget

variances and sales-volume

variances.


Steps in developing flexible budgets
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.


Steps in developing flexible budgets1
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


Steps in developing flexible budgets2
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


Variances
Variances

Level 2 analysis provides information

on the two components of the

static-budget variance.

1. Flexible-budget variance

2. Sales-volume variance


Flexible budget variance
Flexible-Budget Variance

Flexible-Budget Variance

(Level 2) in (000)

Flexible

BudgetActualVariance

Suits 10 10 0

Revenue $1,550 $1,600 $ 50 F

Variable costs 1,150 1,200 50 U

Contribution margin $ 400 $ 400 $ 0

Fixed costs 286 300 14 U

Operating income $ 114 $ 100 $ 14 U


Flexible budget variance1
Flexible-Budget Variance

Actual quantity sold: 10,000 suits

Actual results

operating income

$100,000

Flexible-budget

variance

$14,000 U

Flexible-budget

operating income

$114,000


Flexible budget variance2
Flexible-Budget Variance

Total flexible-budget variance

= Total actual results

– Total flexible budget for actual sales level


Flexible budget variance3
Flexible-Budget Variance

Actual Budgeted

AmountAmount

Selling price $160 $155

Variable cost 120 115

Contribution margin $ 40 $ 40


Flexible budget variance4
Flexible-Budget Variance

Why is the flexible-budget variance $14,000 U?

Selling-price variance $50,000 F

Actual variable costs exceeded

flexible budget variable costs 50,000 U

Actual fixed costs exceeded

flexible budget fixed costs 14,000 U

Total flexible-budget variance $14,000 U


Sales volume variance
Sales-Volume Variance

Sales-Volume Variance

(Level 2) in (000)

Flexible Static Sales-Volume

BudgetBudgetVariance

Suits 10 13 3 U

Revenue $1,550 $2,015 $465 U

Variable costs 1,150 1,495 295 F

Contr. margin $ 400 $ 520 $120 U

Fixed costs 286 286 0

Operating income $ 114 $ 234 $120 U


Sales volume variance1
Sales-Volume Variance

Actual quantity sold: 10,000 suits

Flexible-budget

operating income

$114,000

Sales-volume

variance

$120,000 U

Static-budget

operating income

$234,000


Sales volume variance2
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


Budget variances
Budget Variances

Level 1

Static-budget

variance

$134,000 U

Level 2

Flexible-budget

variance

$14,000 U

Sales-volume

variance

$120,000 U


Learning objective 3
Learning Objective 3

Explain why standard costs are

often used in variance analysis.


Standards
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


Standards1
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


Standards2
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


Learning objective 4
Learning Objective 4

Compute price variances

and efficiency variances

for direct-cost categories.


Actual data
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


Price variance example
Price Variance Example

Direct-material price variance

Actual price – Budgeted price

Actual

quantity

×

=

($15.95 – $16.25) × 42,500 = $12,750 F

=


Price variance example1
Price Variance Example

Direct-labor price variance

Actual price – Budgeted price

Actual

quantity

×

=

($12.90 – $13.00) × 21,500 = $2,150 F

=


Price variance example2
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


Efficiency variance example
Efficiency Variance Example

Direct-material efficiency variance

Actual quantity – Standard quantity

Standard

price

×

=

(42,500 – 40,000) × $16.25 = $40,625 U

=


Efficiency variance example1
Efficiency Variance Example

Direct-labor efficiency variance

Actual quantity – Standard quantity

Standard

price

×

=

(21,500 – 20,000) × $13.00 = $19,500 U

=


Efficiency variance
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


Price and efficiency variance
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


Flexible budget material variance example
Flexible Budget MaterialVariance Example

AQ × BP

42,500 × $16.25

$690,625

BQ × BP

40,000 × $16.25

$650,000

Actual

Cost

$677,875

$12,750 F

$40,625 U

$27,875 U


Flexible budget labor variance example
Flexible Budget LaborVariance Example

AQ × BP

21,500 × $13.00

$279,500

BQ × BP

20,000 × $13.00

$260,000

Actual

Cost

$277,350

$2,150 F

$ 19,500 U

$17,350 U


Variance analysis
Variance Analysis

Level 1

Static-budget variance

Materials $167,125 F

Labor 60,650 F

Total $227,775 F

Level 2

Level 2

Flexible-budget variance

Materials $27,875 U

Labor 17,350 U

Total $45,225 U

Sales-volume variance

Materials $195,000 F

Labor 78,000 F

Total $273,000 F


Variance analysis1
Variance Analysis

Level 2

Flexible-budget variance

Materials $27,875 U

Labor 17,350 U

Total $45,225 U

Level 3

Level 3

Price variance

Materials $12,750 F

Labor 2,150 F

Total $14,900 F

Efficiency variance

Materials $40,625 U

Labor 19,500 U

Total $60,125 U


Learning objective 5
Learning Objective 5

Explain why purchasing

performance measures should

focus on more factors than

just price variances.


Performance measurement using variances
Performance MeasurementUsing 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.


When to investigate variances
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.”


Learning objective 6
Learning Objective 6

Integrate continuous

improvement

into variance analysis.


Continuous improvement
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?


Continuous improvement1

Prior Period Reduction Revised

Budgeted in Budgeted

AmountBudgetAmount

This Period: – – $65.00

Period 1: $65.00 $0.650 $64.35

Period 2: $64.35 $0.644 $63.71

Period 3: $63.71 $0.637 $63.07

Continuous Improvement


Learning objective 7
Learning Objective 7

Perform variance analysis in

activity-based costing systems.


Flexible budgeting and activity based costing
Flexible Budgeting andActivity-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.


Flexible budgeting and activity based costing1
Flexible Budgeting andActivity-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.


Flexible budgeting and activity based costing2

Static Actual

BudgetAmounts

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

Flexible Budgeting and Activity-Based Costing


Flexible budgeting and activity based costing3

Static Actual

BudgetAmounts

Total labor-hours 500 468

Cost per material-handling

labor-hour $14.00 $14.50

Total material-handling

labor cost $7,000 $6,786

Flexible Budgeting and Activity-Based Costing


Flexible budgeting and activity based costing4
Flexible Budgeting andActivity-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


Flexible budgeting and activity based costing5
Flexible Budgeting andActivity-Based Costing

What is the flexible budget for

material-handling labor-hours?

435 hours × $14.00/labor-hour = $6,090

Flexible-budget costs $6,090

Actual costs 6,786

Flexible-budget variance $ 696 U


Price and efficiency variances
Price and Efficiency Variances

Price variance = ($14.50 – $14.00) × 468 = $234 U

Efficiency variance = (468 – 435) × $14.00 = $462 U

Total variance $696 U


Learning objective 8
Learning Objective 8

Describe benchmarking

and how it is used

in cost management.


Benchmarking
Benchmarking

It refers to the continuous process of

measuring products, services, and activities

against the best levels of performance.



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