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# Flexible Budgets, Variances, and Management Control: I - PowerPoint PPT Presentation

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

Chapter 7

a static budget

from a flexible budget.

Learning Objective 1

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

and sells dress suits.

Budgeted variable costs per suit are as follows:

Direct materials cost \$ 65

Direct manufacturing labor 26

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.

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?

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.

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

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 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

Develop a flexible budget

and compute flexible-budget

variances and sales-volume

variances.

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.

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

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

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

(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

Actual quantity sold: 10,000 suits

Actual results

operating income

\$100,000

Flexible-budget

variance

\$14,000 U

Flexible-budget

operating income

\$114,000

Total flexible-budget variance

= Total actual results

– Total flexible budget for actual sales level

Actual Budgeted

AmountAmount

Selling price \$160 \$155

Variable cost 120 115

Contribution margin \$ 40 \$ 40

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

(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

Actual quantity sold: 10,000 suits

Flexible-budget

operating income

\$114,000

Sales-volume

variance

\$120,000 U

Static-budget

operating income

\$234,000

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

Level 1

Static-budget

variance

\$134,000 U

Level 2

Flexible-budget

variance

\$14,000 U

Sales-volume

variance

\$120,000 U

Explain why standard costs are

often used in variance analysis.

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

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

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

Compute price variances

and efficiency variances

for direct-cost categories.

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

Direct-material price variance

Actual price – Budgeted price

Actual

quantity

×

=

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

=

Direct-labor price variance

Actual price – Budgeted price

Actual

quantity

×

=

(\$12.90 – \$13.00) × 21,500 = \$2,150 F

=

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

Direct-material efficiency variance

Actual quantity – Standard quantity

Standard

price

×

=

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

=

Direct-labor efficiency variance

Actual quantity – Standard quantity

Standard

price

×

=

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

=

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

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 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 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

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

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

performance measures should

focus on more factors than

just price 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 should variances be investigated?

Subjective judgments

Rules of thumb as “investigate all variances

exceeding \$10,000 or 25% of expected cost,

whichever is lower.”

Integrate continuous

improvement

into variance analysis.

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?

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

Perform variance analysis in

activity-based costing systems.

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 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.

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

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

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

Total variance \$696 U

Describe benchmarking

and how it is used

in cost management.

It refers to the continuous process of

measuring products, services, and activities

against the best levels of performance.