Flexible Budgets, Variances, and Management Control: I

7 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible Budgets, Variances,and Management Control: IFlexible Budgets, Variances,and Management Control: I

Chapter 7


Distinguish

a static budget

from a flexible budget.

Learning Objective 1Learning Objective 1


Static and Flexible BudgetsStatic and Flexible Budgets

Static BudgetPlanned level ofoutput at start ofthe budget period

Based on

Flexible BudgetBudgeted revenuesand cost based on

actual level of output

Based on


Static Budget ExampleStatic Budget Example

Assume that Pasadena Co. manufacturesand sells dress suits.

Budgeted variable costs per suit are as follows:Direct materials cost $ 65

Direct manufacturing labor 26Variable manufacturing overhead 24

Total variable costs $115



Budgeted selling price is $155 per suit.

Fixed manufacturing costs are expectedto 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 basedon selling 13,000 suits.

What is the static-budget operating income?



Revenues (13,000 × $155) $2,015,000Less Expenses:Variable (13,000 × $115) 1,495,000Fixed 286,000Budgeted operating income $ 234,000

Assume that Pasadena Co. produced and sold10,000 suits at $160 each with actual variablecosts of $120 per suit and fixed manufacturing

costs of $300,000.



Revenues (10,000 × $160) $1,600,000 Less Expenses: Variable (10,000 × $120) 1,200,000 Fixed 300,000 Actual operating income $ 100,000

What was the actual operating income?


Static-Budget Variance ExampleStatic-Budget Variance Example

What is the static-budget variance ofoperating income?

Actual operating income $100,000Budgeted operating income 234,000Static-budget variance of operating income $134,000 U

This is a Level 0 variance analysis.


Static-Budget Variance ExampleStatic-Budget Variance Example

Static-Budget Based Variance Analysis(Level 1) in (000) Static Budget Actual Variance

Suits 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



Develop a flexible budgetand compute flexible-budgetvariances and sales-volume

variances.


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.




Step 2:Determine the actual quantity of output.

In the year 2004, 10,000 suits wereproduced and sold.

Step 3:Determine the flexible budget for revenues.

$155 × 10,000 = $1,550,000




Step 4:Determine the flexible budget for costs.

Variable costs: 10,000 × $115 = $1,150,000Fixed costs 286,000Total costs $1,436,000


VariancesVariances

Level 2 analysis provides informationon the two components of the

static-budget variance.

1. Flexible-budget variance

2. Sales-volume variance


Flexible-Budget VarianceFlexible-Budget Variance

Flexible-Budget Variance(Level 2) in (000)

Flexible Budget Actual Variance

Suits 10 10 0Revenue $1,550 $1,600 $ 50 FVariable costs 1,150 1,200 50 UContribution margin $ 400 $ 400 $ 0Fixed costs 286 300 14 UOperating income $ 114 $ 100 $ 14 U



Actual quantity sold: 10,000 suits

Flexible-budgetvariance

$14,000 U

Actual resultsoperating income

$100,000

Flexible-budgetoperating income

$114,000



Total flexible-budget variance= Total actual results

– Total flexible budget for actual sales level



Actual Budgeted Amount Amount

Selling price $160 $155Variable cost 120 115Contribution margin $ 40 $ 40



Why is the flexible-budget variance $14,000 U?

Selling-price variance $50,000 F

Actual variable costs exceededflexible budget variable costs 50,000 U

Actual fixed costs exceededflexible budget fixed costs 14,000 U

Total flexible-budget variance $14,000 U


Sales-Volume VarianceSales-Volume Variance

Sales-Volume Variance(Level 2) in (000)

Flexible Static Sales-VolumeBudget Budget Variance

Suits 10 13 3 URevenue $1,550 $2,015 $465 UVariable costs 1,150 1,495 295 FContr. margin $ 400 $ 520 $120 UFixed costs 286 286 0Operating income $ 114 $ 234 $120 U



Actual quantity sold: 10,000 suits

Sales-volumevariance

$120,000 U

Flexible-budgetoperating income

$114,000

Static-budgetoperating income

$234,000



Total sales-volume variance $120,000 U

=

Actual sales unit – Master budgeted sales units13,000 – 10,000 = 3,000×

Budgeted contribution margin per unit $40


Budget VariancesBudget Variances

Static-budgetvariance

$134,000 U

Flexible-budgetvariance

$14,000 U

Level 1

Sales-volumevariance

$120,000 ULevel 2



Explain why standard costs areoften used in variance analysis.


StandardsStandards

Pasadena’s budgeted cost for each variabledirect cost item is computed as follows:

Standard inputallowed for

one output unit

Standard costper input unit

×


StandardsStandards

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


StandardsStandards

2.00 manufacturing labor-hours of inputallowed per output unit at $13.00 standard

cost per hour.

Standard cost per output unit2.00 × $13.00 = $26.00



Compute price variancesand efficiency variances

for direct-cost categories.


Actual DataActual Data

Direct materials purchased and used:42,500 square yards at $15.95

Labor hours: 21,500 at $12.90

Cost of direct materials = $677,875

Cost of direct manufacturing labor = $277,350


Price Variance ExamplePrice Variance Example

Direct-material price variance

Actual price – Budgeted price

× Actualquantity

($15.95 – $16.25) × 42,500 = $12,750 F=

=



Direct-labor price variance

Actual price – Budgeted price

× Actualquantity

($12.90 – $13.00) × 21,500 = $2,150 F=

=



What is the journal entry when the materials pricevariance is isolated at the time of purchase?

Materials Control 690,625Direct-Materials Price Variance 12,750Accounts Payable Control 677,875To record direct materials purchased


Efficiency Variance ExampleEfficiency Variance Example

Direct-material efficiency variance

Actual quantity – Standard

quantity× Standard

price

(42,500 – 40,000) × $16.25 = $40,625 U=

=


Efficiency Variance ExampleEfficiency Variance Example

Direct-labor efficiency variance

Actual quantity – Standard

quantity× Standard

price

(21,500 – 20,000) × $13.00 = $19,500 U=

=


Efficiency VarianceEfficiency Variance

What is the journal entry to record materials used?

Work in Process Control 650,000Direct-Materials Efficiency Variance 40,625

Materials Control 690,625To record direct materials used


Price and Efficiency VariancePrice and Efficiency Variance

What is the journal entry for direct manufacturing labor?

Work in Process Control 260,000Direct ManufacturingLabor Efficiency Variance 19,500

Direct-ManufacturingLabor Price Variance 2,150Wages Payable 277,350

To record liability for direct manufacturing labor


Flexible Budget MaterialVariance Example

Flexible Budget MaterialVariance Example

ActualCost

$677,875

BQ × BP40,000 × $16.25

$650,000

AQ × BP42,500 × $16.25

$690,625

$12,750 F $40,625 U

$27,875 U


Flexible Budget LaborVariance Example

Flexible Budget LaborVariance Example

ActualCost

$277,350

BQ × BP20,000 × $13.00

$260,000

AQ × BP21,500 × $13.00

$279,500

$2,150 F $ 19,500 U

$17,350 U


Static-budget varianceMaterials $167,125 FLabor 60,650 FTotal $227,775 F

Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U

Sales-volume varianceMaterials $195,000 FLabor 78,000 FTotal $273,000 F

Level 1

Level 2

Variance AnalysisVariance Analysis

Level 2


Flexible-budget varianceMaterials $27,875 ULabor 17,350 UTotal $45,225 U

Price varianceMaterials $12,750 FLabor 2,150 FTotal $14,900 F

Efficiency varianceMaterials $40,625 ULabor 19,500 UTotal $60,125 U

Level 2

Level 3

Variance AnalysisVariance Analysis

Level 3



Explain why purchasingperformance measures should

focus on more factors thanjust price variances.


Performance MeasurementUsing Variances

Performance MeasurementUsing Variances

Effectiveness is the degree to which apredetermined objective or target is met.

Efficiency is the relative amount of inputsused to achieve a given level of output.

Variances should not solely be used toevaluate performance.


When to Investigate VariancesWhen to Investigate Variances

When should variances be investigated?

Subjective judgments

Rules of thumb as “investigate all variancesexceeding $10,000 or 25% of expected cost,

whichever is lower.”



Integrate continuousimprovement

into variance analysis.


Continuous ImprovementContinuous Improvement

Assume that the budgeted direct materials cost foreach suit that Pasadena Co. manufactures is $65.

Pasadena Co. wants to implement continuousimprovement budgets based on a target 1%

materials cost reduction each period.

What should the budgeted cost be for thenext 3 subsequent periods?


Continuous ImprovementContinuous Improvement

Prior Period Reduction Revised Budgeted in

Budgeted Amount Budget

AmountThis Period: – – $65.00Period 1: $65.00 $0.650

$64.35Period 2: $64.35 $0.644

$63.71Period 3: $63.71 $0.637

$63.07



Perform variance analysis inactivity-based costing systems.


Flexible Budgeting andActivity-Based CostingFlexible Budgeting andActivity-Based Costing

Materials costs and direct manufacturing laborcosts are examples of output-unit level costs.

Batch-level costs are resources sacrificedon activities that are related to a group of

units of product(s) or service(s) rather thanto each individual unit of product or service.



Denver Co. produces metal planters (MP).

Assume that material-handling labor costs varywith the number of batches produced rather

than the number of units in a batch.

Material-handling labor costs are direct batchlevel costs that vary with the number of batches.


Flexible Budgeting and Activity-Based Costing


Static ActualBudget Amounts

Units produced and sold 18,000 15,660Batch size 180 174Number of batches 100 90Material-handling labor-hours per batch 5.00 5.20




Static Actual

Budget AmountsTotal labor-hours 500

468Cost per material-handling labor-hour

$14.00 $14.50Total material-handling

labor cost$7,000 $6,786



How many batches should have been employedto produce the actual output units?

15,660 units ÷ 180 units per batch = 87 batches

How many material-handling hoursshould have been used?

87 batches × 5 hours/batch = 435 hours



What is the flexible budget formaterial-handling labor-hours?

435 hours × $14.00/labor-hour = $6,090

Flexible-budget costs $6,090 Actual costs 6,786 Flexible-budget variance $ 696 U


Price and Efficiency VariancesPrice and Efficiency Variances

Price variance = ($14.50 – $14.00) × 468 = $234 U

Efficiency variance = (468 – 435) × $14.00 = $462 U

Total variance $696 U



Describe benchmarkingand how it is used

in cost management.


BenchmarkingBenchmarking

It refers to the continuous process ofmeasuring products, services, and activities

against the best levels of performance.


End of Chapter 7End of Chapter 7

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Flexible Budgets, Variances, and Management Control: I