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Cost Accounting Horngreen, Datar, Foster
Flexible Budgets, Variances, and Management Control: I
Session 7
Cost Accounting Horngreen, Datar, Foster
Learning Objectives
Describe the difference between a static budget and a flexible budget
Develop a flexible budget and compute flexible-budget variances and sales-volume variances
Explain why standard costs are often used in variance analysis
Compute the price and efficiency variances for direct cost categories
Explain why purchasing performance measures should focus on more factors than just price variances
Cost Accounting Horngreen, Datar, Foster
Learning Objective 1
Describe the difference between a static budget and a flexible budget
Cost Accounting Horngreen, Datar, Foster
Static and Flexible Budgets
A static budget is a budget prepared for only one level of activity.• It is based on the level of output planned at the start of the budget
period.• The master budget is an example of a static budget.
A flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period.• A key difference between a flexible budget and a static budget is the
use of the actual output level in the flexible budget.
Cost Accounting Horngreen, Datar, Foster
Static Budget
Assume that Rockville 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
• 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.• The static budget for year 2001 is based on selling 13,000 suits.
What is the static-budget operating income?• Revenues (13,000 × $155) $2,015,000
Variable Expenses (13,000 × $115) - 1,495,000 Fixed Expenses - 286,000 Budgeted operating income $ 234,000
Cost Accounting Horngreen, Datar, Foster
Static Budget
Assume that Rockville 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.
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
Cost Accounting Horngreen, Datar, Foster
Static-Budget Variance
A static-budget variance is the difference between an actual result and a budgeted amount in the static budget.• A favorable variance is a variance that increases operating income
relative to the budgeted amount.• An unfavorable variance is a variance that decreases operating
income relative to the budgeted amount.
Level 0 analysis compares actual operating income with budgeted operating income.• Actual operating income $100,000
Budgeted operating income 234,000 Static-budget variance of operating income $134,000 U
Cost Accounting Horngreen, Datar, Foster
Static-Budget Variance
Level 1 analysis provides more detailed information on the operating income static- budget variance.
Static Budget Based Variance Analysis(Level 1) in (000)
Static Actual Budget Results VarianceSuits 13 10 3 URevenue $2,015 $1,600 $415 UVariable costs 1,495 1,200 296 FContribution margin $ 520 $ 400 $120 UFixed costs 286 300 14 UOperating income $ 234 $ 100 $134 U
Cost Accounting Horngreen, Datar, Foster
Learning Objective 2
Develop a flexible budget and compute flexible-budget variances
and sales-volume variances
Cost Accounting Horngreen, Datar, Foster
Steps in Developing Flexible Budgets
Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.• The budgeted selling price is $155, the budgeted variable cost is
$115 per suit, and the budgeted fixed cost is $286,000.
Cost Accounting Horngreen, Datar, Foster
Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.
Step 2: Determine the actual quantity of output.• In the year 2001, 10,000 suits were produced and sold.
Steps in Developing Flexible Budgets
Cost Accounting Horngreen, Datar, Foster
Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.
Step 2: Determine the actual quantity of output. Step 3: Determine the flexible budget for revenues based
on budgeted selling price and actual quantity of output. • $155 × 10,000 = $1,550,000
Steps in Developing Flexible Budgets
Cost Accounting Horngreen, Datar, Foster
Step 1: Determine budgeted selling price, budgeted variable cost per unit, and budgeted fixed cost.
Step 2: Determine the actual quantity of output. Step 3: Determine the flexible budget for revenues based
on budgeted selling price and actual quantity of output. Step 4: Determine the flexible budget for costs based on
budgeted variable costs per output unit, actual quantity of output, and the budgeted fixed costs.• Flexible budget:
Variable costs 10,000 × $115 $1,150,000 Fixed costs 286,000 Total costs $1,436,000
Steps in Developing Flexible Budgets
Cost Accounting Horngreen, Datar, Foster
Variances
Level 2 analysis provides information on the two components of the static-budget variance.1 Flexible-budget variance2 Sales-volume variance
Cost Accounting Horngreen, Datar, Foster
Flexible-Budget Variance
Flexible-Budget Variance (Level 2) in (000)
Flexible Actual Budget Results VarianceSuits 10 10 0 Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0 UFixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U
Cost Accounting Horngreen, Datar, Foster
Flexible-Budget Variance
The flexible-budget variance pertaining to revenues is often called a selling-price variance because it arises solely from differences between the actual selling price and the budgeted selling price:• Selling-price variance = ($160 – $155) x 10,000 = $50,000 F• Actual selling price exceeds the budgeted amount by $5.
What does this tell you? • Suppose Rockville Co had started an advertising campaign that
led to the increase in the selling price.• If the campaign had costed more than $50,000 it was unprofitable• If the campaign had costed less than $50,000 it was a profitable
one
Cost Accounting Horngreen, Datar, Foster
Sales-Volume Variance
The sales-volume variance is the difference between the static budget for the number of units expected to be sold and the flexible budget for the number of units that were actually sold.
The only difference between the static budget and the flexible budget is the output level upon which the budget is based.
Cost Accounting Horngreen, Datar, Foster
Sales-Volume Variance
Sales-Volume Variance (Level 2) in (000)
Flexible Static Sales-Volume Budget Budget VarianceSuits 10 13 3 URevenue $1,550 $2,015 $465 UVariable costs 1,150 1,495 345 FContr. margin $ 400 $ 520 $120 UFixed costs 286 286 0Operating income $ 114 $ 234 $120 U
Cost Accounting Horngreen, Datar, Foster
Sales-Volume Variance
Actual quantity sold 10,000 suits:
Flexible-budgetoperating income
$114,000
Static-budgetoperating income
$234,000
Sales-volumevariance
$120,000 U
Cost Accounting Horngreen, Datar, Foster
Budget Variances
Static-budget variance $134,000 U
Flexible-budgetvariance
$14,000 U
Level 1
Level 2Sales-volume variance $120,000 U
Cost Accounting Horngreen, Datar, Foster
Remark
The above split-up has been derived by introducing the flexible budget as an intermediate step:
static budget variance (level 1)
= budgeted # of pieces * budgeted $ per piece- actual # of pieces * budgeted $ per piece+ actual # of pieces * budgeted $ per piece- actual # of pieces * actual $ per piece
Formally, a similar split-up could have been derived by developing a „flexible budget 2“ as follows
static budget variance (level 1)
= budgeted # of pieces * budgeted $ per piece- budgeted # of pieces * actual $ per piece+ budgeted # of pieces * actual $ per piece- actual # of pieces * actual $ per piece
Flexible budget variance
Sales volume variance
Zero
Cost Accounting Horngreen, Datar, Foster
Learning Objective 3
Use standard costs in variance analysis
Cost Accounting Horngreen, Datar, Foster
Sources of Information
The two main sources of information about budgeted input prices and budgeted input quantities are:
1 Actual input data from past periods2 Standards developed
Cost Accounting Horngreen, Datar, Foster
Standards
A standard input is a carefully predetermined quantity of inputs (such as pounds of materials or manufacturing labor-hours) required for one unit of output.
A standard cost is a carefully predetermined cost that is based on a norm of efficiency.
Standard costs can relate to units of inputs or units of outputs.
Cost Accounting Horngreen, Datar, Foster
Standards
Rockville’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
×
Cost Accounting Horngreen, Datar, Foster
Standards
The following standards were developed for Rockville Company:
Direct materials:• 4.00 square yards of cloth input allowed per output unit (suit)
purchased at $16.25 standard cost per square yard.• Standard cost per output unit manufactured
= 4.00 × $16.25 = $65.00 Direct manufacturing labor:
• 2.00 manufacturing labor-hours of input allowed per output unit (suit) manufactured at $13.00 standard cost per hour.
• Standard cost per output unit manufactured = 2.00 × $13.00 = $26.00
Cost Accounting Horngreen, Datar, Foster
Learning Objective 4
Compute the price and efficiency variances for direct cost categories
Cost Accounting Horngreen, Datar, Foster
Price and Efficiency Variances
Level 3 analysis separates the flexible-budget variance into price and efficiency variances.The following relates to Rockville Company:• Direct materials purchased and used: 42,500 square yards• Actual price paid per yard: $15.95• Actual direct manufacturing labor hours: 21,500• Actual price paid per hour: $12.90
What is the actual cost of direct materials?• 42,500 × $15.95 = $677,875
What is the actual cost of direct manufacturing labor?• 21,500 × $12.90 = $277,350
Cost Accounting Horngreen, Datar, Foster
Price Variances
A price variance is the difference between the actual price and the budgeted price of inputs multiplied by the actual quantity of inputs.– Input-price variance– Rate variance
Price variance = (Actual price of inputs – Budgeted price of inputs) × Actual quantity of inputs• What is the price variance for direct materials?• ($15.95 – $16.25) × 42,500 = $12,750 F
What is the price variance for direct manufacturing labor?• ($12.90 – $13.00) × 21,500 = $2,150 F
Cost Accounting Horngreen, Datar, Foster
Price Variances
Actual Quantity Actual Quantity of Inputs at of Inputs at Actual Price Budgeted Price 42,500 × $15.95 42,500 × $16.25 = $677,875 = $690,625
$12,750 F
Materials price variance
Cost Accounting Horngreen, Datar, Foster
Price Variances
Actual Quantity Actual Quantity of Inputs at of Inputs at Actual Price Budgeted Price 21,500 × $12.90 21,500 × $13.00 = $277,350 = $279,500
$2,150 F
Labor price variance
Cost Accounting Horngreen, Datar, Foster
Price Variances
What may be some of the possible causes for Rockville’s favorable price variances?– Rockville’s purchasing manager negotiated more skillfully
than was planned.– Labor prices were set without careful analysis of the
market.
Cost Accounting Horngreen, Datar, Foster
Efficiency Variances
The efficiency variance is the difference between the actual and budgeted quantity of inputs used multiplied by the budgeted price of input.• Efficiency variance = (Actual quantity of inputs used – Budgeted
quantity of inputs allowed for actual output) × Budgeted price of inputs
What is the efficiency variance for direct materials?• (42,500 – 40,000) × $16.25 = $40,625 U
What is the efficiency variance for direct manufacturing labor?• (21,500 – 20,000) × $13.00 = $19,500 U
Cost Accounting Horngreen, Datar, Foster
Efficiency Variances
Actual Quantity Budgeted Quantity of Inputs at Allowed for Actual Budgeted Price Outputs at Budgeted Price 42,500 × $16.25 40,000 × $16.25 = $690,625 = $650,000
$40,625 U
Materials efficiency variance
Cost Accounting Horngreen, Datar, Foster
Efficiency Variances
Actual Quantity Budgeted Quantity of Inputs at Allowed for Actual Budgeted Price Outputs at Budgeted Price 21,500 × $13.00 20,000 × $13.00 = $279,500 = $260,000
$19,500 U
Labor efficiency variance
Cost Accounting Horngreen, Datar, Foster
Efficiency Variances
What may be some of the causes for Rockville’s unfavorable efficiency variances?– Rockville’s purchasing manager received lower quality of
materials.– The personnel manager hired underskilled workers.– The maintenance department did not properly maintain
machines.
Cost Accounting Horngreen, Datar, Foster
Price and Efficiency Variances
What is the flexible-budget variance for direct materials?Materials-price variance
$12,750 F + Materials-efficiency
variance $40,625 U = $27,875 U
quantity of input
Priceof input
15.95 16.25
40
42.5
pricevariance:$12,750F
Efficiency variance:$40,625U
Cost Accounting Horngreen, Datar, Foster
Price and Efficiency VariancesDirect laborDirect labor
Quantity of input
Price of input12.9 13
20
21,5
Efficiency variance:$19,500U
Flexible budgetvariance:$2,150F
What is the flexible-budget variance for direct manufacturing labor?Labor-price variance $2,150 F
+ Labor- efficiency variance $19,500 U = $17,350 U
Cost Accounting Horngreen, Datar, Foster
Variance Analysis
Static-budget variance Materials $167,125 FLabor 60,650 F Total $227,775 F
Flexible-budget variance Materials $27,875 U Labor 17,350 UTotal $45,225 U
Sales-volume variance Materials $195,000 F Labor 78,000 FTotal $273,000 F
Level 1
Level 2
Cost Accounting Horngreen, Datar, Foster
Variance Analysis
Flexible-budget variance Materials $27,875 U Labor 17,350 UTotal $45,225 U
Efficiency varianceMaterials $40,625 U Labor 19,500 UTotal $60,125 U
Price varianceMaterials $12,750 FLabor 2,150 F Total $14,900 F
Level 2
Level 3
Cost Accounting Horngreen, Datar, Foster
Learning Objective 5
Explain why purchasing performance measures should focus on more factors than just
price variances
Cost Accounting Horngreen, Datar, Foster
Performance Measurement Using Variances
A key use of variance analysis is in performance evaluation. Two attributes of performance are commonly measured:
1 Effectiveness2 Efficiency
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.
Cost Accounting Horngreen, Datar, Foster
Performance Measurement Using Variances
If any single performance measure, such as a labor efficiency variance, receives excessive emphasis, managers tend to make decisions that maximize their own reported performance in terms of that single performance measure
“what you measure is what you get”.
Cost Accounting Horngreen, Datar, Foster
Multiple Causes of Variances
Often the causes of variances are interrelated. A favorable price variance might be due to lower quality
materials. It is best to always consider possible interdependencies
among variances and to not interpret variances in isolation of each other...
Almost all organizations use a combination of financial and nonfinancial performance measures rather than relying exclusively on either type.
Control may be exercised by observation of workers.