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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

Flexible Budgets andVariance Analysis

Chapter 8

Learning objective 1
Learning Objective 1

  • Distinguish between flexible

  • budgets and master

  • (static) budgets.

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
Master Budget Variance: Sales

The variances of actual results

from the master budget are called

master (static) budget variances.






$62,000 U

Master budget variance expenses
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
Objective 2

  • Use flexible-budget formulas

  • to construct a flexible budget

  • based on the volume of sales.

Flexible budget
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
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
Objective 3

  • Prepare an activity-based

  • flexible budget.

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
Objective 4

  • Explain the performance

  • evaluation relationship

  • between master (static)

  • budgets and flexible budgets.

Evaluation of financial performance
Evaluation of Financial Performance

Comparing the

flexible budget

to actual results

accomplishes an



evaluation purpose.

Evaluation of financial performance1
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 performance2
Evaluation of Financial Performance

Flexible-budget variances

Activity-level variances

Evaluation of financial performance3



at actual





for actual






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

Evaluation of financial performance4
Evaluation of Financial Performance



for actual








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
Objective 5

  • Compute flexible-budget

  • variances and

  • sales-activity variances.

Isolating the causes of 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 variances1
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.

Flexible budget variances







$5,970 Unfavorable

Flexible-budget variances

Flexible-Budget Variances

Total flexible-budget variance

= Total actual results

– Total flexible-budget planned results

Sales activity variances
Sales-Activity Variances

Total sales-activity variance


Actual sales unit – Master budgeted sales units


Budgeted contribution margin per unit

Sales activity variances1





$18,400 Unfavorable

Activity-level variances

Sales-Activity Variances

(9,000 – 7,000) × $9.20

Objective 6
Objective 6

  • Compute and interpret price

  • and usage variances for inputs

  • based on cost-driver activity.

Setting standards
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
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
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.

Trade offs among variances
Trade-Offs Among Variances

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 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
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
Flexible-Budget Variance in Detail

Standard per unit of output:

Direct Direct


Std. inputs expected 5 pounds ½ hour

Std. price expected $ 2 $16

Std. cost expected $10 $ 8

Variances from material and labor standards
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:


Direct labor

Hours used: 3,750

Actual price (rate): $16.40

Total actual cost:


Variances from material and labor standards1
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

Variances from material and labor standards2







$80 Favorable

Direct material flexible-budget variance

Variances from Material and Labor Standards

Variances from material and labor standards3
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

Variances from material and labor standards4







$5,500 Unfavorable

Direct labor flexible-budget variance

Variances from Material and Labor Standards

Price and usage variances
Price and Usage Variances

Price variance:

(Actual price – Standard Price)

× Actual quantity

Usage variance:

(Actual quantity – Standard quantity)

× Standard price

Price variance computations
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
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
Favorable or Unfavorable Variance?

To determine whether

a variance is favorable

or unfavorable, use

logic rather than

memorizing a formula.

Direct materials flexible budget variance










$3,680 F

$3,600 U

Direct material flexible-budget variance

$80 F

Direct Materials FlexibleBudget Variance

Direct labor flexible budget variance










$1,500 U

$4,000 U

Direct labor flexible-budget variance

$5,500 U

Direct Labor FlexibleBudget Variance

Interpretation of price and usage variances
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
Objective 7

  • Compute variable overhead

  • spending and efficiency

  • variances.

Variable overhead efficiency variance
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 overhead spending variance
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.

Variable overhead example
Variable Overhead Example

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

Variable overhead example1
Variable Overhead Example

Actual variable overhead = $4,700

Variable overhead allowed

= $.60 × 7,000 units = $4,200

$500 unfavorable variance

Variable overhead example2
Variable Overhead Example

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