Flexible Budgets and Standard costs

1. Flexible Budgetsand Standard costs Chapter 23

2. Budgetary Control and Reporting • Develop the budgetfrom planned objectives. • Compareactual with budget andanalyze anydifferences. • Reviseobjectivesand preparea newbudget. Management usesbudgets to monitorand controloperations. • Take corrective andstrategic actions.

3. Purpose of Flexible Budgets Show revenues and expensesthat should have occurred at theactual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

4. Toa budget for different activity levels, we must know how costs behave with changes in activity levels. Total variable costschangein direct proportion to changes in activity. Total fixedcosts remainunchanged within therelevant range. Variable Fixed Preparation of Flexible Budgets P 1

5. Standard costs are Standard Costs C 1 Based on carefullypredetermined amounts. Used for planning materials, labor, and overhead requirements. The expected levelof performance. Benchmarks formeasuring performance.

6. Identifying Standard Costs C 1 Practical standards should be set at levels that are currently attainable with reasonable and efficient effort. ManagerialAccountant Engineer HumanResourcesManager ProductionManager Ideal standards, that are based on perfection, areunattainable and discouraging to most employees.

7. Setting Standard Costs C 1 PriceStandards Direct Materials QuantityStandards RateStandards TimeStandards DirectLabor RateStandards ActivityStandards VariableOverhead

8. Setting Standard Costs C 1 A standard cost card might look like this:

9. Standard Cost Variances Price Variance Quantity Variance The difference betweenthe actual price and thestandard price. The difference betweenthe actualquantityandthe standard quantity. Cost Variance Computation C 2

10. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Cost Variance Computation C 2 Standard quantity is the quantity thatshould have been usedfor the actual good output. Standard price is the amount that should have been paidfor the resources acquired.

11. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Cost Variance Computation C 2 AQ(AP - SP) SP(AQ - SQ) AQ= Actual QuantitySP= Standard PriceAP= Actual PriceSQ= Standard Quantity

12. Labor Cost Variances P 2 ActualHours ActualHoursStandardHours× × × ActualRate StandardRate StandardRate Rate Variance Efficiency Variance AH(AR - SR) SR(AH - SH) AH= Actual HoursSR= Standard RateAR= Actual Rate SH= Standard Hours Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overhead spending variance efficiency variance

13. Labor Cost Variances P 2 Using highly paid skilled workers toperform unskilled tasks results in anunfavorable rate variance. High skill,high rate Low skill,low rate Production managers who make work assignmentsare generally responsible for rate variances.

14. Poorlytrainedworkers Poorqualitymaterials Poorsupervisionof workers Poorlymaintainedequipment Labor Cost Variances P 2 UnfavorableEfficiencyVariance

15. Overhead Standardsand Variances P 3 Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity Estimated total overhead costsEstimated activity POHR =

16. Setting Overhead Standards P 3 Contains a fixedoverhead rate whichdeclines as activitylevel increases. Contains a variableunit rate which staysconstant at all levelsof activity. Overhead Rate Function of activity levelchosen to determine rate. Flexible budgets, showing budgeted amount of overhead for various levels of activity, are used to analyze overhead costs.

17. Controllable andVolume Variances P 3 Overhead cost variance (OCV) Actualoverhead incurred (AOI) Standard overhead applied (SOA) = – Total OverheadVariance (OCV) VolumeVariance ControllableVariance

18. End of Chapter 23