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Flexible Budgets, Variances, and Management Control: I

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  1. Flexible Budgets, Variances,and Management Control: I Chapter 7

  2. Distinguish a static budget from a flexible budget. Learning Objective 1

  3. 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

  4. 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

  5. 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?

  6. 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.

  7. 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

  8. 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.

  9. 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

  10. Learning Objective 2 Develop a flexible budget and compute flexible-budget variances and sales-volume variances.

  11. 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.

  12. 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

  13. 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

  14. Variances Level 2 analysis provides information on the two components of the static-budget variance. 1. Flexible-budget variance 2. Sales-volume variance

  15. 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

  16. 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

  17. Flexible-Budget Variance Total flexible-budget variance = Total actual results – Total flexible budget for actual sales level

  18. Flexible-Budget Variance Actual Budgeted AmountAmount Selling price $160 $155 Variable cost 120 115 Contribution margin $ 40 $ 40

  19. 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

  20. 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

  21. 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

  22. 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

  23. Budget Variances Level 1 Static-budget variance $134,000 U Level 2 Flexible-budget variance $14,000 U Sales-volume variance $120,000 U

  24. Learning Objective 3 Explain why standard costs are often used in variance analysis.

  25. 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

  26. 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

  27. 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

  28. Learning Objective 4 Compute price variances and efficiency variances for direct-cost categories.

  29. 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

  30. Price Variance Example Direct-material price variance Actual price – Budgeted price Actual quantity × = ($15.95 – $16.25) × 42,500 = $12,750 F =

  31. Price Variance Example Direct-labor price variance Actual price – Budgeted price Actual quantity × = ($12.90 – $13.00) × 21,500 = $2,150 F =

  32. 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

  33. Efficiency Variance Example Direct-material efficiency variance Actual quantity – Standard quantity Standard price × = (42,500 – 40,000) × $16.25 = $40,625 U =

  34. Efficiency Variance Example Direct-labor efficiency variance Actual quantity – Standard quantity Standard price × = (21,500 – 20,000) × $13.00 = $19,500 U =

  35. 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

  36. 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

  37. 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

  38. 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

  39. 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

  40. 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

  41. Learning Objective 5 Explain why purchasing performance measures should focus on more factors than just price variances.

  42. 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.

  43. 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.”

  44. Learning Objective 6 Integrate continuous improvement into variance analysis.

  45. 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?

  46. 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

  47. Learning Objective 7 Perform variance analysis in activity-based costing systems.

  48. 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.

  49. 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.

  50. 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