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Flexible Budgets and Variance Analysis. Chapter 8. Learning Objective 1. Distinguish between flexible budgets and master (static) budgets. Static Budgets. A static budget is prepared for only one level of a given type of activity. All actual results are compared with the

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Flexible Budgets and Variance Analysis

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Flexible Budgets andVariance Analysis

Chapter 8

Learning Objective 1

• Distinguish between flexible

• budgets and master

• (static) budgets.

Static Budgets

A static 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 more or less than originally planned.

Master Budget Variance: Sales

The variances of actual results

from the master budget are called

master (static) budget variances.

Actual

\$217,000

Budget

\$279,000

Variance

\$62,000 U

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.

Objective 2

• Use flexible-budget formulas

• to construct a flexible budget

• based on the volume of sales.

Flexible Budget

A flexible budget (variable budget) is a

budget that adjusts for changes in sales

volume and other cost-driver activities.

Flexible Budget Formulas

To develop a flexible budget, managers

determine revenue and cost behavior

(within the relevant range) with

respect to cost drivers.

Objective 3

• Prepare an activity-based

• flexible budget.

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.

Objective 4

• Explain the performance

• evaluation relationship

• between master (static)

• budgets and flexible budgets.

Evaluation of Financial Performance

Comparing the

flexible budget

to actual results

accomplishes an

important

performance

evaluation purpose.

Evaluation of Financial Performance

Actual results may differ from

the master budget because...

1) sales and other cost-driver activities were

not the same as originally forecasted, or

2) revenue or variable costs per unit of activity and

fixed costs per period were not as expected.

Evaluation of Financial Performance

Flexible-budget variances

Activity-level variances

Actual

results

at actual

activity

level

Flexible

budget

for actual

sales

activity

Flexible-

budget

variances

Units 7,000 7,000–

Sales\$217,000\$217,000–

Variable costs 158,200 152,600 5,670 U

Contribution margin\$ 58,730\$ 64,400\$5,670 U

Fixed costs 70,300 70,000 300 U

Operating income\$ (11,570)\$ (5,600)\$5,970 U

Evaluation of Financial Performance

Flexible

budget

for actual

sales

activity

Master

budget

Sales-

activity

variances

Units 7,000 9,000 2,000 U

Sales\$217,000\$279,000\$62,000 U

Variable costs 152,600 196,200 43,600 F

Contribution margin\$ 64,400\$ 82,800\$18,400 U

Fixed costs 70,000 70,000–

Operating income\$ (5,600)\$ 12,800\$18,400 U

Total master budget variances = \$11,570 + \$12,800 = \$24,370

Objective 5

• Compute flexible-budget

• variances and

• sales-activity variances.

Isolating the Causes of Variances

Managers use comparisons among

actual results, master budgets,

and flexible budgets to evaluate

organizational performance.

Isolating the Causes of Variances

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.

Performance may be effective,

efficient, both, or neither.

Actual

results

\$(11,570)

Flexible

budget

\$(5,600)

\$5,970 Unfavorable

Flexible-budget variances

Flexible-Budget Variances

Total flexible-budget variance

= Total actual results

– Total flexible-budget planned results

Sales-Activity Variances

Total sales-activity variance

=

Actual sales unit – Master budgeted sales units

×

Budgeted contribution margin per unit

Flexible

budget

Master

budget

\$18,400 Unfavorable

Activity-level variances

Sales-Activity Variances

(9,000 – 7,000) × \$9.20

Objective 6

• Compute and interpret price

• and usage variances for inputs

• based on cost-driver activity.

Setting Standards

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.

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.

Currently Attainable Standards...

are levels of performance that

managers can achieve by

realistic levels of effort.

They make allowances for normal

defects, spoilage, waste,

and nonproductive time.

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.

When to Investigate Variances

When should management

investigate a variance?

Many organizations have developed

such rules of thumb as “investigate

all variances exceeding \$5,000 or 25%

of expected cost, whichever is lower.”

Comparison with Prior Periods

Some organizations compare the most

recent budget period’s actual results with

last year’s results for the same period.

Flexible-Budget Variance in Detail

Standard per unit of output:

Direct Direct

MaterialLabor

Std. inputs expected5 pounds½ hour

Std. price expected\$ 2\$16

Std. cost expected\$10\$ 8

Variances from Material and Labor Standards

Actual results for 7,000 units produced:

Direct material

Pounds purchased

and used: 36,800

Price/pound: \$1.90

Total actual cost:

\$69,920

Direct labor

Hours used: 3,750

Actual price (rate): \$16.40

Total actual cost:

\$61,500

Variances from Material and Labor Standards

Standard Direct-Materials Cost Allowed:

Units of good output achieved

×

Input allowed per unit of output

×

Standard unit price of input

=

Flexible budget or total

standard cost allowed

Actual

cost

\$69,920

Flexible

budget

\$70,000

\$80 Favorable

Direct material flexible-budget variance

Variances from Material and Labor Standards

Standard Direct-Labor Cost Allowed:

Units of good output achieved: 7,000

×

Input allowed per unit of output: ½ hour

×

Standard unit price of input: \$16/hour

=

Flexible budget or total

standard cost allowed: \$56,000

Actual

cost

\$61,500

Flexible

budget

\$56,000

\$5,500 Unfavorable

Direct labor flexible-budget variance

Price and Usage Variances

Price variance:

(Actual price – Standard Price)

× Actual quantity

Usage variance:

(Actual quantity – Standard quantity)

× Standard price

Price Variance Computations

Direct material price variance:

(\$1.90 – \$2.00) per pound

× 36,800 pounds = \$3,680 F

Direct labor price variance:

(\$16.40 – \$16.00) per hour

× 3,750 hours = \$1,500 U

Usage Variance Computations

Direct material usage variance:

[36,800 – (7,000 × 5)] pounds

× \$2 per pound = \$3,600 U

Direct labor usage variance:

[3,750 – (7,000 × ½)] hours

× \$16 per hour = \$4,000 U

Favorable or Unfavorable Variance?

To determine whether

a variance is favorable

or unfavorable, use

logic rather than

memorizing a formula.

Actual

cost

\$69,920

AQ × SP

=

\$73,600

Flexible

budget

\$70,000

\$3,680 F

\$3,600 U

Direct material flexible-budget variance

\$80 F

Direct Materials FlexibleBudget Variance

Actual

cost

\$61,500

AH × SP

=

\$60,000

Flexible

budget

\$56,000

\$1,500 U

\$4,000 U

Direct labor flexible-budget variance

\$5,500 U

Interpretation of Price and Usage Variances

Price and usage variances are helpful

because they provide feedback

to those responsible for inputs.

Managers should not use these

variances alone for decision

making, control, or evaluation.

Objective 7

• spending and efficiency

• variances.

When actual cost-driver activity differs from

the standard amount allowed for the actual

efficiency variance will occur.

This is the difference between the actual

of variable overhead budgeted for the

actual level of cost-driver activity.

Suppose that Dominion Company’s cost

is driven by direct labor hours.

\$.60 per unit is equivalent to \$1.20

per direct labor hour because each

unit of output requires ½ hour of labor

= \$.60 × 7,000 units = \$4,200

\$500 unfavorable variance