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# Flexible Budgets and Variance Analysis - PowerPoint PPT Presentation

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 andVariance Analysis

Chapter 8

• Distinguish between flexible

• budgets and master

• (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.

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

Actual expenses that exceed

budgeted expenses result in

unfavorable expense variances.

Actual expenses that are less than

budgeted expenses result in

favorable expense variances.

• Use flexible-budget formulas

• to construct a flexible budget

• based on the volume of sales.

A flexible budget (variable budget) is a

budget that adjusts for changes in sales

volume and other cost-driver activities.

To develop a flexible budget, managers

determine revenue and cost behavior

(within the relevant range) with

respect to cost drivers.

• Prepare an 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.

• Explain the performance

• evaluation relationship

• between master (static)

• budgets and flexible budgets.

Comparing the

flexible budget

to actual results

accomplishes an

important

performance

evaluation purpose.

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.

Flexible-budget variances

Activity-level variances

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

• Compute flexible-budget

• variances and

• sales-activity variances.

Managers use comparisons among

actual results, master budgets,

and flexible budgets to evaluate

organizational performance.

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.

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

Total sales-activity variance

=

Actual sales unit – Master budgeted sales units

×

Budgeted contribution margin per unit

budget

Master

budget

\$18,400 Unfavorable

Activity-level variances

Sales-Activity Variances

(9,000 – 7,000) × \$9.20

• Compute and interpret price

• and usage variances for inputs

• based on cost-driver activity.

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.

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.

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 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.”

Some organizations compare the most

recent budget period’s actual results with

last year’s results for the same period.

Standard per unit of output:

Direct Direct

MaterialLabor

Std. inputs expected 5 pounds ½ hour

Std. price expected \$ 2 \$16

Std. cost expected \$10 \$ 8

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

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

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

cost

\$61,500

Flexible

budget

\$56,000

\$5,500 Unfavorable

Direct labor flexible-budget variance

Variances from Material and Labor Standards

Price variance:

(Actual price – Standard Price)

× Actual quantity

Usage variance:

(Actual quantity – Standard quantity)

× Standard price

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

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

To determine whether

a variance is favorable

or unfavorable, use

logic rather than

memorizing a formula.

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

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

Direct Labor FlexibleBudget Variance

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.

• Compute variable overhead

• spending and efficiency

• variances.

Variable-OverheadEfficiency Variance

When actual cost-driver activity differs from

the standard amount allowed for the actual

output achieved, a variable-overhead

efficiency variance will occur.

Variable-OverheadSpending Variance

This is the difference between the actual

variable overhead and the amount

of variable overhead budgeted for the

actual level of cost-driver activity.

Suppose that Dominion Company’s cost

of supplies, a variable-overhead cost,

is driven by direct labor hours.

The variable-overhead cost rate of

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

per direct labor hour because each

unit of output requires ½ hour of labor

Actual variable overhead = \$4,700

Variable overhead allowed

= \$.60 × 7,000 units = \$4,200

\$500 unfavorable variance

Variable-overhead efficiency variance:

(3,750 act. hours – 3,500 std. hours allowed)

× \$1.20 per hour = \$300 U

Variable-overhead spending variance:

(\$4,700 – (\$1.20 × 3,750 actual hours used)

= \$200 U