FLEXIBLE BUDGETS, VARIANCES

CHAPTER 7FLEXIBLE BUDGETS, VARIANCES, AND

MANAGEMENT CONTROL: I

7-1 Management by exception is the practice of concentrating on areas not operating as expected and giving less attention to areas operating as expected. Variance analysis helps managers identify areas not operating as expected. The larger the variance, the more likely an area is not operating as expected.

7.2 Two sources of information about budgeted amounts are (a) past amounts and (b) detailed engineering studies.

7.3 A favorable variance––denoted F––is a variance that increases operating income relative to the budgeted amount. An unfavorable variance––denoted U––is a variance that decreases operating income relative to the budgeted amount.

7.4 The key difference is the output level used to set the budget. A static budget is based on the level of output planned at the start of the budget period. A flexible budget is developed using budgeted revenues or cost amounts based on the actual output level in the budget period. The actual level of output is not known until the end of the budget period.

7-5 A Level 2 flexible-budget analysis enables a manager to distinguish how much of the difference between an actual result and a budgeted amount is due to (a) differences between actual and budgeted output levels, and (b) differences between actual and budgeted selling prices, variable costs, and fixed costs.

7-6 The steps in developing a flexible budget are:Step 1: Identify the actual quantity of output.Step 2: Calculate the flexible budget for revenues based on budgeted selling price and actual

quantity of output.Step 3: Calculate the flexible budget for costs based on budgeted variable costs per output

unit, actual quantity of output, and budgeted fixed costs.

7-7 Four reasons for using standard costs are:(i) cost management,(ii) pricing decisions,(iii) budgetary planning and control, and(iv) financial statement preparation.

7-8 A manager should subdivide the flexible-budget variance for direct materials into a price variance (that reflects the difference between actual and budgeted prices of direct materials) and an efficiency variance (that reflects the difference between the actual and budgeted quantities of direct materials used to produce actual output). The individual causes of these variances can then

7-1

be investigated, recognizing possible interdependencies across these individual causes.7-9 Possible causes of a favorable materials price variance are:• purchasing officer negotiated more skillfully than was planned in the budget,• purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantity

discounts,• materials prices decreased unexpectedly due to, say, industry oversupply,• budgeted purchase prices were set without careful analysis of the market, and• purchasing manager received unfavorable terms on nonpurchase price factors (such as lower

quality materials).

7-10 Direct materials price variances are often computed at the time of purchase of materials, while direct materials efficiency variances are often computed at the time of usage of materials. Purchasing managers are typically responsible for price variances, while production managers are typically responsible for usage variances.

7-11 Budgeted costs can be successively reduced over consecutive time periods to incorporate continuous improvement. The chapter uses the phrase continuous improvement budgeted costs to describe this approach.

7-12 An individual business function, such as production, is interdependent with other business functions. Factors outside of production can explain why variances arise in the production area. For example:• poor design of products or processes can lead to a sizable number of defects,• marketing personnel making promises for delivery times that require a large number of rush

orders can create production-scheduling difficulties, and• purchase of poor-quality materials by the purchasing manager can result in defects and waste.

7.13 The plant supervisor likely has good grounds for complaint if the plant accountant puts excessive emphasis on using variances to pin blame. The key value of variances is to help understand why actual results differ from budgeted amounts and then to use that knowledge to promote learning and continuous improvement.

7.14 Variances can be calculated at the activity level as well as at the company level. For example, a price variance and an efficiency variance can be computed for an activity area.

7.15 Evidence on the costs of other companies is one input managers can use in setting the performance measure for next year. However, caution should be taken before choosing such an amount as next year's performance measure. It is important to understand why cost differences across companies exist and whether these differences can be eliminated. It is also important to examine when planned changes (in, say, technology) next year make even the current low-cost producer not a demanding enough hurdle.

7-2

7-16 (20-30 min.) Flexible budget.

Actual Results (1)

Flexible-Budget

Variances(2) = (1) –

(3)

FlexibleBudget

(3)

Sales- Volume

Variances(4) =(3)–(5)

Static Budget

(5)

Units sold 2,800 G 0 2,800 200

U 3,000G

Revenues $313,600a $ 5,600 F $ 308,000b $22,000 U $330,000c

Variable costs 229,600 d 22,400 U 207,200e 14,800 F 222,000f

Contribution margin 84,000 16,800 U 100,800 7,200 U 108,000Fixed costs 50,000 G 4,000 F 54,000G 0 54,000G

Operating income $ 34,000 $12,800 U $ 46,800 $ 7,200 U $ 54,000

$12,800 U $ 7,200 UTotal flexible-budget variance Total sales-volume variance

$20,000 U

Total static-budget variancea $112 × 2,800 = $313,600b $110 × 2,800 = $308,000c $110 × 3,000 = $330,000d Given. Unit variable cost = $229,600 ÷ 2,800 = $82 per tiree $74 × 2,800 = $207,200f $74 × 3,000 = $222,000G Given

2. The key information items are:

Actual BudgetedUnitsUnit selling priceUnit variable costFixed costs

2,800$ 112$ 82$50,000

3,000$ 110$ 74$54,000

The total static-budget variance in operating income is $20,000 U. There is both an unfavorable total flexible-budget variance ($12,800) and an unfavorable sales-volume variance ($7,200).

The unfavorable sales-volume variance arises solely because actual units manufactured and sold were 200 less than the budgeted 3,000 units. The unfavorable flexible-budget variance of $12,800 in operating income is due primarily to the $8 increase in unit variable costs. This increase in unit variable costs is only partially offset by the $2 increase in unit selling price and the $4,000 decrease in fixed costs.

7-3

7-17 (15 min.) Flexible budget.

The existing performance report is a Level 1 analysis, based on a static budget. It makes no adjustment for changes in output levels. The budgeted output level is 10,000 units––direct materials of $400,000 in the static budget ÷ budgeted direct materials cost per attaché case of $40.

The following is a Level 2 analysis that presents a flexible-budget variance and a sales-volume variance of each direct cost category:

ActualResults

(1)

Flexible-Budget


(3)

FlexibleBudget

(3)

Sales-Volume


(5)

StaticBudget

(5)

Output unitsDirect materialsDirect manufacturing laborDirect marketing laborTotal direct costs

8,800 $364,000 78,000 110,000 $552,000

0 $12,000 U

7,600 U 4,400 U$24,000 U

8,800 $352,000 70,400 105,600 $528,000

1,200 U$48,000 F

9,600 F 14,400 F$72,000 F

10,000 $400,000 80,000 120,000 $600,000

$24,000 U $72,000 F Flexible-budget variance Sales-volume variance

$48,000 FStatic-budget variance

The Level 1 analysis shows total direct costs have a $48,000 favorable variance. However, the Level 2 analysis reveals that this favorable variance is due to the reduction in output of 1,200 units from the budgeted 10,000 units. Once this reduction in output is taken into account (via a flexible budget), the flexible-budget variance shows each direct cost category to have an unfavorable variance indicating less efficient use of each direct cost item than was budgeted, or the use of more costly direct cost items than was budgeted, or both.

Each direct cost category has an actual unit variable cost that exceeds its budgeted unit cost:

Actual BudgetedUnitsDirect materialsDirect manufacturing laborDirect marketing labor

8,800$41.36$ 8.86$12.50

10,000$40$ 8$12

Analysis of price and efficiency variances for each cost category could assist in further identifying the causes of these more aggregated (Level 2) variances.

7-4

7-18 (10 min.) Flexible budget.1.

Total static-budgetvariance

= Actual results –Static-budget

amount= $6,556,000 – $3,150,000= $3,406,000 F

2. Total flexible-budget

variance=

Actualresults

–Flexible-budget

amount= $6,556,000 – $6,930,000= $ 374,000 U

Total sales-volumevariance

=Flexible-budget

amount–

Static-budgetamount

= $6,930,000 – $3,150,000= $3,780,000 F

3.

The total flexible-budget variance is $374,000 unfavorable. This arises because for the actual output level: (a) selling prices were lower than budgeted, or (b) variable costs were higher than budgeted, or (c) fixed costs were higher than budgeted, or (d) some combination of (a), (b), and (c).

7-5

$374,000 U

Total flexible-budget variance $3,780,000 F

Total sales-volume variance

$3,406,000 F

Total static-budget variance

7-19 (20-30 min.) Price and efficiency variances.

1. The key information items are:

Actual BudgetedOutput units (scones)Input units (pounds of pumpkin)Cost per input unit

60,800 16,000

$0.82

60,00015,000$0.89

Peterson budgets to obtain 4 pumpkin scones from each pound of pumpkin.The flexible-budget variance is $408 F.

ActualResults

(1)

Flexible-Budget

Variance(2) = (1) –

(3)

FlexibleBudget

(3)

Sales-Volume

Variance(4) = (3) –

(5)

StaticBudget

(5)Pumpkin costs $13,120a $408 F $13,528b $178 U $13,350c

a 16,000 × $0.82 = $13,120b 60,800 × 0.25 × $0.89 = $13,528c 60,000 × 0.25 × $0.89 = $13,350

2.Actual Costs

Incurred(Actual Input Qty.

× Actual Price)Actual Input Qty.× Budgeted Price

Flexible Budget(Budgeted Input Qty. Allowed for Actual Output

× Budgeted Price)

$13,120a $14,240b $13,528c

$1,120 F $712 UPrice variance Efficiency variance

$408 FFlexible-budget variance

a 16,000 × $0.82 = $13,120b 16,000 × $0.89 = $14,240c 60,800 × 0.25 × $0.89 = $13,528

3. The favorable flexible-budget variance of $408 has two offsetting components:(a) favorable price variance of $1,120––reflects the $0.82 actual purchase cost being

lower than the $0.89 budgeted purchase cost per pound.(b) unfavorable efficiency variance of $712–-reflects the actual materials yield of

3.80 scones per pound of pumpkin (60,800 ÷ 16,000 = 3.80) being less than the budgeted yield of 4.00 (60,000 ÷ 15,000 = 4.00). (The company used more pumpkins (materials) to make the scones than was budgeted.)

One explanation may be that Peterson purchased lower quality pumpkins at a lower cost per pound.7-20 (15 min.) Materials and manufacturing labor variances.

7-6

Actual CostsIncurred

(Actual Input Qty.× Actual Price)

Actual Input Qty.× Budgeted Price

Flexible Budget(Budgeted InputQty. Allowed for Actual Output

× Budgeted Price)

DirectMaterials

$200,000 $214,000 $225,000

$14,000 F $11,000 F Price variance Efficiency variance

$25,000 FFlexible-budget variance

Direct $90,000 $86,000 $80,000Manufacturing

$4,000 U $6,000 ULabor Price variance Efficiency variance

$10,000 UFlexible-budget variance

Excel SolutionFlexible Budgets, Variances,

and Management ControlGreat Homes, Inc.

Direct Original Data Direct Manufacturing

Materials LaborCost Incurred (Actual Input x Actual Prices) $200,000 $90,000

Actual Inputs x Standard Prices 214,000 86,000 Standard Inputs Allowed for

Actual Output x Standard Prices 225,000 80,000

Variance CalculationsDirect Materials Direct Labor

Manuf.Price Variance 14,000 F 4,000 U

Efficiency Variance 11,000 F 6,000 UFlexible Budget Variance 25,000 F 10,000 U

Direct Materials Direct LaborPrice Variance 14,000 F 4,000 U

Efficiency Variance 11,000 F 6,000 UFlexible Budget Variance 25,000 F 10,000 U

Total Budget Variance 15,000 F

7-21 (30 min.) Price and efficiency variances.

7-7

1.

ActualResults

(1)

FlexibleBudget

Variances(2)=(1)–(3)

FlexibleBudget

(3)Direct materials $429,000 $57,750 U $371,250Direct labor 99,200 9,200 U 90,000

Actual ResultsDirect materials: 8,580,000a minutes × $0.05 per minute= $429,000Direct labor: 1,600 hours × $62 per minute = $99,200

a 7,800,000 minutes × 110% purchase = 8,580,000

CellOne commits to purchase 110% of the budgeted amount of time. Due to the forward commitment of time purchase, the actual time purchased will be the same as the budgeted amount of time to be purchased.

Flexible Budget

Direct materials: 8,250,000a × $0.045 = $371,250Direct labor: 1,500 × $60 = $90,000

a 7,500,000 minutes × 110% to be purchased = 8,250,000 minutesb 7,500,000 minutes sold ÷ 5,000 minutes per hour = 1,500 hours

2.

ActualIncurred


(1)


(2)

Flexible Budget(Budgeted InputQty. Allowed forActual Output

× Budgeted Price)(3)

(8,580,000 × $0.05) (8,580,000 × $0.045) (8,250,000 × $0.045)Direct materials $429,000 $386,100 $371,250

$42,900 U $14,850 U Price variance Efficiency variance

$57,750 U Flexible-budget variance

7-8

7-21 (Cont’d.)

Direct (1,600 × $62) (1,600 × $60) (1,500 × $60)Labor $99,200 $96,000 $90,000

$3,200 U $6,000 U Price variance Efficiency variance


Students may question why the flexible budget is 8,250,000 minutes. Had the "actual output" of 7,500,000 minutes been used in the static budget, CellOne would have planned to purchase 8,250,000 (7,500,000 × 1.10) minutes.

7-9

7-22 (30-40 min.) Flexible budgets, variance analysis.

1. Variance Analysis of Flanagan Company for May

Level 0 AnalysisActual operating income (see calculations below) $ 49,000Budgeted operating income (see calculations below) 100,000Static-budget variance of operating income $ 51,000 U

Level 1 Analysis

ActualResults

(1)

Static-Budget


(3)

StaticBudget

(3)Units soldRevenues Variable costsContribution marginFixed costsOperating income

23,000 $874,000 630,000 244,000

195,000 $ 49,000

3,000 F$ 74,000 F 130,000 U

56,000 U 5,000 F$ 51,000 U

20,000 $800,000a

500,000 b

300,000 200,000 $100,000

$51,000 UTotal static-budget variance

Level 2 Analysis

ActualResults

(1)

Flexible-Budget

Variances(2) =(1) – (3)

FlexibleBudget

(3)

Sales-Volume

Variances(4) = (3) – (5)

StaticBudget

(5)Units soldRevenueVariable costsContribution marginFixed costsOperating income

23,000 $874,000 630,000 244,000 195,000 $ 49,000

0 $ 46,000 U 55,000 U 101,000 U 5,000 F$ 96,000 U

23,000 $920,000c

575,000 d

345,000 200,000 $145,000

3,000 F$120,000 F 75,000 U 45,000 F 0 $ 45,000 F

20,000 $800,000 500,000 300,000 200,000 $100,000

$96,000 U $45,000 FTotal flexible-budget Total sales-volume

variance variance$51,000 U

Total static-budget variancea$40 × 20,000 = $800,000 b$25 × 20,000 = $500,000c$40 × 23,000 = $920,000d$25 × 23,000 = $575,000

7-10

7-22 (Cont’d.)

2. Flexible budget variance for revenues, $46,000 U. Cause: The actual selling price per unit is $38 ($874,000 ÷ 23,000) compared to a budgeted $40 per unit. This reduction in selling price may explain the 15% increase in unit sales (23,000 versus the budgeted 20,000).Flexible budget variance for variable costs, $55,000 U. Reason: Variable costs may have exceeded the budget for many reasons, including individual price increases in materials and supplies and possible inefficiencies because of the 15% spurt in production.Flexible budget variance for fixed costs, $5,000 F. Reason: Fixed cost could be less than the budget because of delays in planned salary increases, adjustments in insurance coverage, or other reasons.

7-23 (25 - 30 min.) Flexible budget preparation and analysis.

1. Variance Analysis for Bank Management Printers for September 2004

Level 1 AnalysisActualResults

(1)

Static-BudgetVariances

(2) = (1) – (3)

StaticBudget

(3)Units soldRevenue

12,000 $252,000a

3,000 U$ 48,000 U

15,000 $300,000c

Variable costs 84,000 d 36,000 F 120,000 f

Contribution marginFixed costsOperating income

168,000 150,000 $ 18,000

12,000 U 5,000 U$ 17,000 U

180,000 145,000 $ 35,000

$17,000 U Total static-budget variance

2. Level 2 Analysis

ActualResults

(1)

Flexible-Budget

Variances(2) = (1) – (3)

FlexibleBudget

(3)

SalesVolume

Variances(4) = (3) – (5)

StaticBudget

(5)Units sold 12,000 0 12,000 3,000 U 15,000 Revenue $252,000a $12,000 F $240,000b $60,000 U $300,000c

Variable costs 84,000 d 12,000 F 96,000 e 24,000 F 120,000 f

Contribution margin 168,000 24,000 F 144,000 36,000 U 180,000Fixed costs 150,000 5,000 U 145,000 0 145,000

Operating income $ 18,000 $19,000 F $ (1,000 ) $36,000 U $ 35,000

7-11

7-23 (Cont’d.)

$19,000 F $36,000 UTotal flexible-budget Total sales-volume

variance variance $17,000 U


a 12,000 × $21 = $252,000 d 12,000 × $7 =$ 84,000b 12,000 × $20 = $240,000 e 12,000 × $8 =$ 96,000c 15,000 × $20 = $300,000 f 15,000 × $8 = $120,000

3. Level 2 analysis provides a breakdown of the static-budget variance into a flexible-budget variance and a sales-volume variance. The primary reason for the static-budget variance being unfavorable ($17,000 U) is the reduction in unit volume from the budgeted 15,000 to an actual 12,000. One explanation for this reduction is the increase in selling price from a budgeted $20 to an actual $21. Operating management was able to reduce variable costs by $12,000 relative to the flexible budget. This reduction could be a sign of efficient management. Alternatively, it could be due to using lower quality materials (which in turn adversely affected unit volume).

7-24 (30 min.) Flexible budget, working backward.1.

ActualResults

(1)

Flexible-Budget

Variances(2)=(1)−(3)

FlexibleBudget

(3)

Sales-VolumeVariances(4)=(3)−(5)

Static Budget

(5)Units Sold 650,000 0 650,000 50,000 F 600,000Revenues $3,575,000 $1,300,000 F $2,275,000a $175,000 F $2,100,000

Variable costs 2,575,000 1,275,000

U 1,300,000 b 100,000 U 1,200,000Contribution margin 1,000,000 25,000 F 975,000 75,000 F 900,000

Fixed costs 700,000 100,000

U 600,000 0 600,000

Operating income $ 300,000$ 75,000

U $ 375,000 $ 75,000 F $ 300,000

7-12

7-24 (Cont’d.)

a 650,000 × $3.50 = $2,275,000b 650,000 × $2.00 = 1,300,000

2. Actual selling price: $3,575,000 ÷ 650,000 = $5.50Budgeted selling price: 2,100,000 ÷ 600,000 = 3.50Actual variable cost per unit: 2,575,000 ÷ 650,000 = 3.96Budgeted variable cost per unit: 1,200,000 ÷ 600,000 = 2.00

3. The CEO’s reaction was inappropriate. A zero total static-budget variance may be due to offsetting total flexible-budget and total sales-volume variances. In this case, these two variances exactly offset each other:

Total flexible-budget variance $75,000 UnfavorableTotal sales-volume variance $75,000 Favorable

A closer look at the variance components reveals some major deviations from plan. Actual variable costs increased from $2.00 to $3.96, causing an unfavorable flexible-budget variable cost variance of $1,275,000. Such an increase could be a result of, for example, a jump in platinum prices. Specialty Balls was able to pass most of the increase in costs onto their customers − average selling price went up about 57%, bringing about an offsetting favorable flexible-budget revenue variance in the amount of $1,300,000. An increase in the actual number of units sold also contributed to more favorable results. Although such an increase in quantity in the face of a price increase may appear counter-intuitive, customers may have forecast higher future platinum prices and therefore decided to stock up.

4. The most important lesson learned here is that a superficial examination of summary level data (Levels 0 and 1) may be insufficient. It is imperative to scrutinize data at a more detailed level (Level 2). Had Specialty Balls not been able to pass costs on to customers, losses would have been considerable.

7-13

$75,000 UTotal flexible-budget variance

$75,000 FTotal sales volume variance

$0 Total static-budget variance

7-25 (30 min.) Price and efficiency variances, journal entries.

1. Direct materials and direct manufacturing labor are analyzed in turn:





× Budgeted Price)

DirectMaterials

(100,000 × $3.10a)$310,000

Purchases Usage (100,000 × $3.00) (98,073 × $3.00)

$300,000 $294,219(9,810 × 10 × $3.00)

$294,300

$10,000 U $81 FPrice variance Efficiency variance

DirectManufacturingLabor

(4,900 × $21b)$102,900

(4,900 × $20)$98,000

(9,810 × 0.5 × $20) or(4,905 × $20)

$98,100

$4,900 U $100 FPrice variance Efficiency variance

a. $310,000 ÷ 100,000 = $3.10 b. $102,900 ÷ 4,900 = $21

2. Direct Materials Control 300,000Direct Materials Price Variance 10,000 Accounts Payable or Cash Control 310,000

Work-in-Process Control 294,300 Materials Control 294,219 Direct Materials Efficiency Variance 81

Work-in-Process Control 98,100Direct Manuf. Labor Price Variance 4,900 Wages Payable Control 102,900

Direct Manuf. Labor Efficiency Variance 100

3. Some students’ comments will be immersed in conjecture about higher prices for materials, better quality materials, higher grade labor, better efficiency in use of materials, and so forth. A possibility is that approximately the same labor force, paid somewhat more, is taking slightly less time with better materials and causing less waste and spoilage.

7-14

7-25 (Cont’d.)

A key point in this problem is that all of these efficiency variances are likely to be insignificant. They are so small as to be nearly meaningless. Fluctuations about standards are bound to occur in a random fashion. Practically, from a control viewpoint, a standard is a band or range of acceptable performance rather than a single-figure measure.

4. The purchasing point is where responsibility for price variances is found most often. The production point is where responsibility for efficiency variances is found most often. Chemical Inc. may calculate variances at different points in time to tie in with these different responsibility areas.

7-15

7-26 (20 min.) Continuous improvement. (continuation of 7-25)

1. Standard quantity input amounts per output unit are:Direct

Materials(pounds)

DirectManufacturing Labor

(hours)JanuaryFebruary (Jan. × 0.997)March (Feb. × 0.997)

10.00009.97009.9400

0.50000.49850.4970

2. The answer to requirement 1 of Question 7-25 is identical except for the flexible- budget amount.




Flexible Budget(Budgeted Input Qty. Allowed

for Actual Output × Budgeted Price)

DirectMaterials

(100,000 × $3.10a)$310,000

Purchases Usage (100,000 × $3.00) (98,073 × $3.00)

$300,000 $294,219(9,810 × 9.940 × $3.00)

$292,534

$10,000 U $1,685 UPrice variance Efficiency variance

DirectManuf.Labor

(4,900 × $21b)$102,900

(4,900 × $20)$98,000

(9,810 × 0.497 × $20) $97,511

$4,900 U $489 UPrice variance Efficiency variance

a $310,000 ÷ 100,000 = $3.10 b $102,900 ÷ 4,900 = $21

Using continuous improvement standards sets a tougher benchmark. The efficiency variances for January (from Exercise 7-25) and March (from Exercise 7-26) are:

January March

Direct materialsDirect manufacturing labor

$ 81 F$100 F

$1,685 U$ 489 U

Note that the question assumes the continuous improvement applies only to quantity inputs. An alternative approach is to have continuous improvement apply to budgeted input cost per output unit ($30 for direct materials in January and $10 for direct manufacturing labor in January). This approach is more difficult to incorporate in a Level 2 variance analysis, as Level 2 requires separate amounts for quantity inputs and the cost per input.

7-16

7-27 (20−30 min.) Materials and manufacturing labor variances, standardcosts.

1. Direct Materials





× Budgeted Price)

(37,000 sq. yds. × $10.20)$377,400

(37,000 sq. yds. × $10.00)$370,000

(20,000 × 2 × $10.00(40,000 sq. yds. × $10.00)

$400,000

$7,400 U $30,000 F Price variance Efficiency variance


The unfavorable materials price variance may be unrelated to the favorable materials efficiency variance. For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials price per square yard due to reduced competition. Similarly, the favorable materials efficiency variance may be unrelated to the unfavorable materials price variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input price may be due to higher quality materials being purchased. Less material was used than budgeted due to the high quality of the materials.

Direct Manufacturing Labor





× Budgeted Price)

(9,000 hrs. × $19.60)$176,400

(9,000 hrs. × $20.00)$180,000

(20,000 × 0.5 × $20.00)(10,000 hrs. × $20.00)

$200,000

$3,600 F $20,000 FPrice variance Efficiency variance


7-17

7-27 (Cont’d.)

The favorable labor price variance may be due to, say, (a) a reduction in labor rates due to a recession, or (b) the standard being set without detailed analysis of labor compensation. The favorable labor efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labor to be more productive, or (c) the use of higher quality materials.

2.

Control Point





× Budgeted Price)

Purchasing (60,000 sq. yds.× $10.20)$612,000

(60,000 sq. yds. × $10.00)$600,000

$12,000 U Price variance

Production (37,000 sq.yds.× $10.00)$370,000

(20,000 × 2 × $10.00)$400,000

$30,000 F Efficiency variance

7-18

7-28 (15−25 min.) Journal entries and T-accounts (continuation of 7-27).

a. Work-in-Process Control 400,000Direct Materials Price Variance 7,400

Accounts Payable Control 377,400To record purchase of direct materials.

b. Work-in-Process Control 400,000Direct Materials Efficiency Variance 30,000Materials Control 377,400

To record direct materials used.

b. Work-in-Process Control 200,000Direct Manufacturing Labor Price Variance 3,600Direct Manufacturing Labor Efficiency Variance 20,000Wages Payable Control 176,400

To record liability and allocation of direct labor costs.

Materials ControlDirect MaterialsPrice Variance

Direct MaterialsEfficiency Variance

(a) 377,400 (a) 7,400 (a) 30,000

Work-in-Process ControlDirect Manufacturing Labor

Price Variance

Direct Manufacturing Labor

Efficiency Variance(b) 400,000(c) 200,000

(b) 3,600 (b) 20,000

Wages Payable Control Accounts Payable Control(b) 176,400 377,400 (a)

Requirement 2 from Exercise 7-27:The following journal entries pertain to the measurement of price variances when materials of 600,000 are purchased:

a1. Materials Control 600,000Direct Materials Price Variance 12,000

Accounts Payable Control 612,000To record direct materials purchased.

a2. Work-in-Process Control 400,000Materials Control 370,000Direct Materials Efficiency Variance 30,000

To record direct materials used.

7-19

7-28 (Cont’d.)

Materials ControlDirect MaterialsPrice Variance

(a1) 600,000 (a2) 370,000 (a1) 12,000

Accounts Payable Control Work-in-Process Control(a1) 612,000 (a2) 400,000

Direct MaterialsEfficiency Variance

(a2) 30,000

The difference between standard costing and normal costing for direct cost items is:

Standard Costs Normal CostsDirect Costs Standard price(s)

× Standard inputallowed for actual outputs achieved

Actual price(s)× Actual input

These journal entries differ from the normal costing entries because Work-in-Process Control is no longer carried at “actual” costs. Furthermore, Materials Control can also be carried at standard unit prices rather than actual unit prices. Finally, variances appear for direct materials and direct manufacturing labor under standard costing but not under normal costing.

7-20

7-29 (25 min.) Flexible budget (continuation of 7-27 and 7-28).

The manager’s glee may be warranted, but the magnitude of the favorable variances may be deceptively large. Furthermore, if the manager had aimed at a scheduled production of 24,000 units, he or she may be troubled at the inability to obtain that output target. A more detailed analysis underscores the fact that the world of variances may be divided into three general parts: price, efficiency, and what is labeled here as a sales-volume variance. Failure to pinpoint these three categories muddies the analytical task. The clearer analysis follows (in dollars):


(Actual Input Qty.

× Actual Price)Actual Input Qty.× Budgeted Price


× Budgeted Price)Static

BudgetDirect Materials $377,400 $370,000 $400,000 $480,000

(a) $7,400 U (b) $30,000 F (c) $80,000 F

Direct ManufacturingLabor $176,400 $180,000 $200,000 $240,000

(a) $3,600 F (b) $20,000 F (c) $40,000 F

(a) Price variance(b) Efficiency variance(c) Sales-volume variance

The sales-volume variances are favorable here in the sense that less cost would be expected solely because the output level is less than budgeted. However, this is an example of how variances must be interpreted cautiously. The general manager may be incensed at the failure to reach scheduled production (it may mean fewer sales) even though the 20,000 units were turned out with supreme efficiency. Sometimes this phenomenon is called being efficient but ineffective, where effectiveness is defined as the ability to reach original targets and efficiency is the optimal relationship of inputs to any given outputs. Note that a target can be reached in an efficient or inefficient way; similarly, as this problem illustrates, a target can be missed but the given output can be attained efficiently.

7-21

7-30 (45-50 min.) Activity-based costing, flexible-budget variances for finance function activities.

1. ReceivablesReceivables is an output unit level activity. Its flexible-budget variance can be calculated as follows:

= –

= ($0.75 × 948,000) – ($0.639 × 948,000)= $711,000 – $605,772= $105,228 U

PayablesPayables is a batch level activity.

Static-budget Amounts Actual Amounts

a. Number of deliveries 1,000,000 948,000b. Batch size (units per batch) 5 4.468c. Number of batches (a ÷ b) 200,000 212,175d. Cost per batch $2.90 $2.80e. Total payables activity cost (c × d) $580,000 $594,090

Step 1: The number of batches in which payables should have been processed = 948,000 actual units ÷ 5 budgeted units per batch = 189,600 batches

Step 2: The flexible-budget amount for payables = 189,600 batches × $2.90 budgeted cost per batch = $549,840

The flexible-budget variance can be computed as follows:

Flexible-budget variance = Actual costs – Flexible-budget costs

= (212,175 × $2.80) – (189,600 × $2.90)

= $594,090 – $549,840 = $44,250 UTravel expensesTravel expenses is a batch level activity.

Static-Budget Amounts Actual Amounts

a. Number of deliveries 1,000,000 948,000b. Batch size (units per batch) 500 501.587c. Number of batches (a ÷ b) 2,000 1,890d. Cost per batch $7.60 $7.40e. Total travel expenses activity cost (c × d) $15,200 $13,9867-30 (Cont’d.)

7-22

Step 1: The number of batches in which the travel expense should have been processed = 948,000 actual units ÷ 500 budgeted units per batch = 1,896 batches

Step 2: The flexible-budget amount for travel expenses = 1,896 batches × $7.60 budgeted cost per batch= $14,410

The flexible budget variance can be calculated as follows:Flexible budget variance = Actual costs – Flexible-budget costs

= (1,890 × $7.40) – (1,896 × $7.60)= $13,986 – $14,410 = $424 F

2. The flexible budget variances can be subdivided into price and efficiency variances.

Price variance = – ×

Efficiency variance = – ×

Receivables

Price Variance = ($0.750 – $0.639) × 948,000 = $105,228 U

Efficiency variance= (948,000 – 948,000) × $0.639 = $0

PayablesPrice variance = ($2.80 – $2.90 ) × 212,175

= $21,218 FEfficiency variance= (212,175 – 189,600) × $2.90

= $65,468 U

Travel expensesPrice variance = ($7.40 – $7.60) × 1,890

= $378 FEfficiency variance= (1,890 – 1,896) × $7.60

= $46 F

7-23

7-31 (20 min.) Finance function activities, benchmarking (continuation of 7-30).

1. The key new insight is how Bouquets.com compares with “world-class” organizations. At face value, there is much room for improvement. The per unit cost differences are dramatic:

Bouquets.com 2004 2004 “World-Class”

Budgeted Actual Cost Performance Receivables $0.639 $0.75 $0.10 per remittancePayables $2.900 $2.80 $0.71 per invoiceTravel $7.600 $7.40 $1.58 per travel claim

2. For any meaningful comparison, the figures being compared must be comparable. Sanchez should first determine whether there is an “apples to apples” comparison with these figures. Are costs of the finance department activities measured the same across Bouquets.com and the company with “world-class” cost performance? Suppose Bouquets.com allocates other costs into the finance area (such as the President’s salary), while the $1.58 per travel claim figure is for finance department costs only.

Sanchez should consider whether the benchmark company also obtain information on why the large cost differences occur. For example, is it because the “world-class” performer is using new technologies in the finance area? If this is the case, then is Sanchez willing to invest in new technologies in the same way that "world-class” finance function organizations do? If not, then the $1.58 benchmark could be unattainable, no matter how hard and smart the travel claim processing group performs.

In addition, Sanchez should consider whether the benchmark company provides a valid comparison point. The benchmark company is a world-class retail company that has traditional retail and Internet-based retail functions. Bouquets.com is an Internet company. Costs and activities of Internet companies are going to differ from those of traditional retailers.

7-24

7-32 (30 min.) Flexible budget, direct materials and direct manufacturing labor variances.

Flexible- Sales-1. Actual Budget Flexible Volume Static

Results Variances Budget Variances Budget

(1) (2) = (1) – (3) (3) (4) = (3) – (5) (5)Units sold 6,000a 0 6,000 1,000 F 5,000a

Direct materials $ 594,000 $ 6,000 F $ 600,000 b $100,000 U $ 500,000c

Direct manufacturing labor 950,000a 10,000 F 960,000d 160,000 U 800,000e

Fixed costs 1,005,000 a 5,000 U 1,000,000a 0 1,000,000a

Total costs $2,549,000 $11,000 F $2,560,000 $260,000 U $2,300,000

$11,000 F $260,000 UFlexible-budget variance Sales-volume variance

$249,000 UStatic-budget variance

a Givenb $100 × 6,000 = $600,000c $100 × 5,000 = $500,000d $160 × 6,000 = $960,000e $160 × 5,000 = $800,000

2.Flexible Budget(Budgeted Input

Actual Incurred Qty. Allowed for(Actual Input Qty. Actual Input Qty. Actual Output × × Actual Price) × Budgeted Price Budgeted Price)

Direct materials $594,000a $540,000b $600,000c

$54,000 U $60,000 F Price variance Efficiency variance


7-25

7-32 (Cont’d.)

Direct manufacturing labor $950,000d $1,000,000e $960,000f

$50,000 F $40,000 UPrice variance Efficiency variance


a 54,000 pounds × $11/pound = $594,000b 54,000 pounds × $10/pound = $540,000c 6,000 statues × 10 pounds/statue ×$10/pound = 60,000 pounds × $10/pound = $600,000d 25,000 pounds × $38/pound = $950,000e 25,000 pounds × $40/pound = $1,000,000f 6,000 statues × 4 hours/statue × $40/hour = 24,000 hours × $40/hour = $960,000

7-26

7-33 (50 min.) Static budget, flexible budget, service sector, professional labor efficiency and effectiveness.

Static Budget1. Revenue (90 × 0.5% × $200,000) $90,000

Variable costs:Professional labor (6 × $40 × 90) 21,600Loan filing fees ($100 × 90) 9,000Credit-worthiness checks ($120 × 90) 10,800Courier mailings ($50 × 90) 4,500 Total variable costs 45,900

Contribution margin 44,100Fixed costs 31,000Operating income $13,100

2. Flexible budget for November 2004:Revenue (120 × 0.5% × $200,000) $120,000Variable costs:

Professional labor (6 × $40 × 120) 28,800Loan filing fees ($100 × 120) 12,000Credit-worthiness checks ($120 × 120) 14,400Courier mailings ($50 × 120) 6,000

Total variable costs 61,200Contribution margin 58,800Fixed costs 31,000Operating income $ 27,800

Level 2 AnalysisFlexible- Sales-

Actual Budget Flexible Volume StaticResults Variances Budget Variances Budget

(1) (1) – (3) (3) (3) – (5) (5)

Loans 120 0 120 30 F 90Revenue $134,400 $14,400 F $120,000 $30,000 $90,000Variable costs:Professional labor 36,288 7,488 U 28,800 7,200 U 21,600

Loan filing fees 12,000 0 12,000 3,000 U 9,000Credit-worthiness checks 15,000 600 U 14,400 3,600 U 10,800Courier mailings 6,480 480 U 6,000 1,500 U 4,500Total variable costs 69,768 8,568 U 61,200 15,300 U 45,900

Contribution margin 64,632 5,832 F 58,800 14,700 F 44,100Fixed costs 33,500 2,500 U 31,000 0 31,000Operating income $ 31,132 $ 3,332 F $ 27,800 $14,700 $13,100

7-27

7-33 (Cont’d.)

$3,332 F $14,700 F Total flexible- Total sales-budget variance volume variance

$18,032 F Total static-budget variance

3. Flexible Budget

Actual Costs (Budgeted InputIncurred Qty. Allowed for

(Actual Input Qty. Actual Input Qty. Actual Output× Actual Price) × Budgeted Price × Budgeted Price)

(1) (2) (3) (120 × 7.2 × $42) (120 × 7.2 × $40) (120 × 6.0 × $40) 864 hrs. × $42/hr. 864 hrs. × $40/hr. 720 hrs. ×$40/hr.

$36,288 $34,560 $28,800



4. Effectiveness refers to the degree to which a predetermined objective is accomplished. One objective of Meridian Finance professional labor is to maximize loan-based revenue (0.5% of loan amount × number of loans). The professional staff has increased loans from a budgeted 90 to 120, a significant increase. Additionally, the average loan amount increased from a budgeted $200,000 to $224,000. The result is an increase in revenue from the budgeted $90,000 to actual $134,400.

With both a higher number of loans and a higher average amount per loan, there was an increase in the effectiveness of professional labor in November 2004.

7-28

7-34 (60 min.) Comprehensive variance analysis, responsibility issues.

1a. Actual selling price = $82.00Budgeted selling price = $80.00Actual sales volume = 4,850 unitsSelling price variance = (Actual sales price − Budgeted sales price) × Actual units = ($82 − $80) × 4,850 = $9,700 Favorable

1b. Development of Flexible Budget

Budgeted Unit

AmountsActual Volume

Flexible BudgetAmount

Revenues $80.00 4,850 $388,000Variable costs

DM−Frames $2.20/oz. × 3.00 oz. 6.60a 4,850 32,010

DM−Lenses $3.10/oz. × 6.00 oz. 18.60b 4,850 90,210

Direct manuf. labor $15.00/hr. × 1.20 hrs. 18.00c 4,850 87,300 Total variable manufacturing costs $209,520Fixed manufacturing costs 75,000Total manufacturing cost 284,520

Gross margin $103,480

a$33,000 ÷ 5,000 units; b$93,000 ÷ 5,000 units; c$90,000 ÷ 5,000 units

ActualResults

(1)

Flexible-Budget

Variances(2)=(1)-(3)

FlexibleBudget

(3)

Sales -Volume

Variance(4)=(3)-(5)

StaticBudget

(5)Units sold 4,850 4,850 5,000

Revenues $397,700 $ 9,700 F $388,000 $ 12,000 U $400,000Variable costs DM−frames 37,248 5,238 U 32,010 990 F 33,000 DM−lens 100,492 10,282 U 90,210 2,790 F 93,000 Direct labor 96,903 9,603 U 87,300 2,700 F 90,000 Total variable costs 234,643 25,123 U 209,520 6,480 F 216,000Fixed manuf. costs 72,265 2,735 F 75,000 0 75,000Total costs 306,908 22,388 U 284,520 6,480 F 291,000Gross margin $ 90,792 $12,688 U $103,480 $ 5,520 U $109,000

7-29

7-34 (Cont’d.)

1c. Price and Efficiency Variances

DM−Frames−Actual ounces used = 3.20 per unit × 4,850 units = 15,520 oz.Price per oz = $37,248/15,520 = $2.40

DM−Lenses−Actual ounces used = 7.00 per unit × 4,850 units = 33,950 oz.Price per oz = $100,492/33,950 = $2.96

Direct Labor−Actual labor hours = $96,903/14.80 = 6,547.5 hoursLabor hours per unit = 6,547.5/4,850 units = 1.35 hours per unit


(Actual Input Qty. × Actual Price)

(1)

Actual Input Qty. × Budgeted Price

(2)



DirectMaterials:Frames

(4,850 × 3.2 × $2.40)$37,248

(4,850 × 3.2 × $2.20)$34,144

(4,850 × 3.00 × $2.20)$32,010


DirectMaterials:Lenses

(4,850 × 7.0 × $2.96)$100,492

(4,850 × 7.0 × $3.10)$105,245

(4,850 × 6.00 × $3.10)$90,210

$4,753 F $15,035 UPrice variance Efficiency variance

DirectManuf.Labor

(4,850 × 1.35 × $14.80)$96,903

(4,850 × 1.35 × $15.00)$98,212.50

(4,850 × 1.20 × $15.00)$87,300

$1,309.50 F $10,912.50 UPrice variance Efficiency variance

7-30

7-34 (Cont’d.)

Possible explanations for price variances are:(a) Purchasing and labor negotiations.(b) Quality of frames and lenses purchased.(c) Standards set incorrectly.

Possible explanations for efficiency variance are:(a) Higher materials usage due to lower quality frames and lenses purchased at lower price.(b) Lesser trained workers hired at lower rates result in higher materials usage and lower

labor efficiency.(c) Standards set incorrectly.

7-35 (60 min.) Continuous improvement.

1. Monthly StandardsDec.2001

Jan.2002

Feb.2002

Frames 3.00 oz 2.985 2.970075(3.00 × 0.995)

Lenses 6.00 oz 5.97 5.94015(6.00 × 0.995)

These are expressed in physical terms, assuming a constant standard price ($2.20 for frames and $3.10 for lenses), we can express these in dollars:

Dec.2001

Jan.2002

Feb.2002

Frames $6.60 $6.567 $6.534165

Lenses 18.60 18.507 18.414465

2. Pros: a. Puts in a culture of continuous improvement.b. Can be flexible by allowing for different percentages to apply to different materials and to different stages in life cycle.

Cons: a. Difficult to have 0.995 forever - you can't ever get down to zero material.b. Far too incremental in perspective. A competitor may do a major redesign or use a new material that drops costs dramatically.

7-31

7-36 (30 min.) Level 2 variance analysis, solve for unknowns.

1. Budgeted selling price = 000,600

000,800,4$ = $ 8.00 per cap

Actual selling price = 000,500

000,000,5$ = $10.00 per cap

2.unitper cost

variableBudgeted =

000,600

000,800,1$ = $3.00 per unit

unitper cost

variableActual =

000,500

000,400,1$ = $2.80 per unit

3., 4., 5. and 6.

ActualResults

(1)

Flexible-Budget

Variances(2)=(1)−(3)

FlexibleBudget

(3)

Sales -Volume

Variance(4)=(3)−(5)

StaticBudget

(5)Units sold 500,000 0 500,000 100,000 U 600,000

Revenues (sales) $5,000,000 $1,000,000 F $4,000,000 $800,000 U $4,800,000Variable costs 1,400,000 100,000 F 1,500,000 300,000 F 1,800,000

Contribution margin 3,600,000 1,100,000 F 2,500,000 500,000 U 3,000,000

Fixed costs 1,150,000 150,000 U 1,000,000 0 1,000,000

Operating income $2,450,000 $ 950,000 F $1,500,000 $500,000 U $2,000,000

3. Flexible-budget operating income = $1,500,000

4. Total flexible-budget variance = $950,000 F

5. Total sales-volume variance = $500,000 U

6. Total static-budget variance = $450,000 F

7-32

$500, 000 UTotal sales-volume variance

$950, 000 FTotal flexible-budget variance

$450, 000 FTotal static-budget variance

7-37 (30 min.) Direct labor and direct materials variances, missing data.

1. Flexible Budget(Budgeted Input

Actual Costs Qty. Allowed for Incurred (Actual Actual Input Qty. Actual Output

Input Qty.× Actual Price) × Budgeted Price × Budgeted Price) Direct manufacturing labor $368,000a $384,000b $360,000c

$16,000 F $24,000 U Price variance Efficiency variance


a Given (or 32,000 hours × $11.50/hour)b 32,000 hours × $12/hour = $384,000c 6,000 units × 5 hours/unit × $12/hour = $360,000

2. Unfavorable direct materials efficiency variance of $12,500 indicates that more pounds of direct materials were actually used than the budgeted quantity allowed for actual output.

= price budgeted poundper $2

varianceefficiency $12,500

= 6,250 pounds

Budgeted pounds allowed for the output achieved = 6,000 × 20 = 120,000 poundsActual pounds of direct materials used = 120,000 + 6,250 = 126,250 pounds

3. Actual price paid per pound = 150,000

$292,500

= $1.95 per pound

4. Actual Costs Incurred Actual Input ×(Actual Input × Actual Price) Budgeted Price

$292,500a $300,000b

$7,500 F Price variance

a Givenb 150,000 pounds × $2/pound = $300,000

7-33

7-38 (60 min.) Comprehensive variance analysis review. 1. Actual Results

Units sold (80% × 1,500,000) 1,200,000Selling price per unit $3.70Revenues (1,200,000 × $3.70) $4,440,000Direct materials purchased and used:

Direct materials per unit $0.80Total direct materials cost (1,200,000 × $0.80) $960,000

Direct manufacturing labor:Actual manufacturing rate per hour $ 15Labor productivity per hour in units 250Manufacturing labor-hours of input (1,200,000 ÷ 250) 4,800Total direct manufacturing labor costs (4,800 × $15) $72,000

Direct marketing costs:Direct marketing cost per unit $0.30Total direct marketing costs (1,200,000 × $0.30) $360,000

Fixed costs ($900,000 − $30,000) $870,000Static Budgeted AmountsUnits sold 1,500,000Selling price per unit $4.00Revenues (1,500,000 × $4.00) $6,000,000Direct materials purchased and used:

Direct materials per unit $0.85Total direct materials costs (1,500,000 × $0.85) $1,275,000

Direct manufacturing labor:Direct manufacturing rate per hour $15.00Labor productivity per hour in units 300Manufacturing labor-hours of input (1,500,000 ÷ 300) 5,000Total direct manufacturing labor cost (5,000 × $15.00) $75,000

Direct marketing costs:Direct marketing cost per unit $0.30Total direct marketing cost (1,500,000 × $0.30) $450,000

Fixed costs $900,000

Actual Static-Budgeted Results Amounts

Revenues $4,440,000 $6,000,000Variable costsDirect materials 960,000 1,275,000Direct manufacturing labor 72,000 75,000Direct marketing costs 360,000 450,000Total variable costs 1,392,000 1,800,000

Contribution margin 3,048,000 4,200,000Fixed costs 870,000 900,000Operating income $2,178,000 $3,300,000

7-34

7-38 (Cont’d.)2. Actual operating income $2,178,000

Static-budget operating income 3,300,000Total static-budget variance $1,122,000 U

3., 4., 5. and 6.

ActualResults

Flexible-Budget

VariancesFlexibleBudget

Sales-VolumeVariances

StaticBudget

Units sold 1,200,000 0 1,200,000 300,000 1,500,000

Revenues

Variable costs

Direct materials

Direct manuf. labor

Direct marketing costs

Total variable costs

$4,440,000

960,000

72,000

360,000

1,392,000

$360,000 U

60,000 F

12,000 U

0

48,000 F

$4,800,000

1,020,000

60,000

360,000

1,440,000

$1,200,000 U

255,000 F

15,000 F

90,000 F

360,000 F

$6,000,000

1,275,000

75,000

450,000

1,800,000

Contribution margin 3,048,000 312,000 U 3,360,000 840,000 U 4,200,000

Fixed costs 870,000 30,000 F 900,000 0 900,000

Operating income $2,178,000 $282,000 U $2,460,000 $ 840,000 U $3,300,000

7. and 8.


(Actual Input Qty. × Actual Price)

Actual Input Qty. × Budgeted Price


× Budgeted Price)

Direct.

Manuf.

Labor

(4,800 × $15.00)

$72,000

(4,800 × $15.00)

$72,000

(*4,000 × $15.00)

$60,000

$0 $12,000 U

Price variance Efficiency variance

* 1,200,000 units ÷ 300 direct manufacturing labor standard productivity rate per hour.

7-35

$840, 000 UTotal sales-volume

variance

$282, 000 UTotal flexible-budget

variance$1,122,000 U



7-39 (20–30 min.) Direct materials and manufacturing laborvariances, solving unknowns.

All given items are designated by an asterisk.

Direct ManufacturingLabor



(1,900 × $21)$39,900



× Budgeted Price)

(1,900 × $20*)$38,000

(4,000* × 0.5* × $20*)$40,000

$1,900 U* $2,000 F* Price variance Efficiency variance

Purchases Usage Direct (13,000 × $5.25) (13,000 × $5*) (12,500 × $5*) (4,000* × 3* × $5*)Materials $68,250* $65,000 $62,500 $60,000

$3,250 U* $2,500 U*Price variance Efficiency variance

1. 4,000 units × 0.5 hours/unit = 2,000 hours2. Flexible budget – Efficiency variance = $40,000 – $2,000 = $38,000

$38,000 ÷ Budgeted price of $20/hour = 1,900 hours 3. $38,000 + Price variance, $1,900 = $39,900, the actual direct manuf. labor cost

Actual rate = Actual cost ÷ Actual hours = $39,000 ÷ 1,900 hours = $21/hour

4. Standard qty. of direct materials = 4,000 units × 3 pounds/unit = 12,000 pounds5. Flexible budget + Dir. matls. effcy. var. = $60,000 + $2,500 = $62,500

Actual quantity used = $62,500 ÷ Budgeted price per lb = $62,500 ÷ $5/lb = 12,500 lbs

6. Actual cost of material, $68,250 – Price variance, $3,250 = $65,000Actual qty. of materials purchased = $65,000 ÷ Budgeted price, $5/lb = 13,000 lbs.

7. Actual direct materials price = $68,250 ÷ 13,000 lbs = $5.25 per lb.

7-36

7-40 (30 min.) Comprehensive variance analysis.

1. Computing unit selling prices and unit costs of inputs:Actual selling price = $3,555,000 ÷ 450,000

= $7.90Budgeting selling price = $3,200,000 ÷ 400,000

= $8.00= × = ($7.90/unit – $8.00/unit) × 450,000 units= $45,000 U

2., 3., and 4.The actual and budgeted unit costs are:

Actual BudgetedDirect materials

Cookie mixMilk chocolate

Almonds

$0.02 ($93,000 ÷ 4,650,000) 0.20 ($532,000 ÷ 2,660,000) 0.50 ($240,000 ÷ 480,000)

$0.02 0.15 0.50

Direct manuf. laborMixingBaking

14.40 ($108,000 ÷ 450,000 × 60)18.00 ($240,000 ÷ 800,000 × 60)

14.4018.00

The actual output achieved is 450,000 pounds of chocolate nut supreme.

7-37

7-40 (Cont’d.)

The direct cost price and efficiency variances are:



(1)

PriceVariance

(2)=(1)–(3)

ActualInput Qty.× Budgeted

Price(3)

EfficiencyVariance

(4)=(3)–(5)

Flex. Budget (Budgeted Input Qty. Allowed forActual Output


Direct materialsCookie mix $ 93,000 $ 0 $ 93,000a $ 3,000 U $ 90,000h

Milk chocolate 532,000 133,000 U 399,000b 61,500 U 337,500i

Almonds 240,000 0 240,000c 15,000 U 225,000j

$865,000 $133,000 U $732,000 $79,500 U $652,500Direct manuf. labor costs

Mixing $108,000 $ 0 $108,000d $ 0 $108,000k

Baking 240,000 0 240,000e 30,000 F 270,000l

$348,000 $ 0 $348,000 $30,000 F $378,000

a $0.02 × 4,650,000 = $93,000b $0.15 × 2,660,000 = $399,000c $0.50 × 480,000 = $240,000d $14.40 × (450,000 ÷ 60) = $108,000e $18.00 × (800,000 ÷ 60) = $240,000h $0.02 × 10 × 450,000 = $90,000i $0.15 × 5 × 450,000 = $337,500j $0.50 × 1 × 450,000 = $225,000k $14.40 × (450,000 ÷ 60) = $108,000l $18.00 × (450,000 ÷ 30) = $270,000

Comments on the variances include:

• Selling price variance. This may arise from a proactive decision to reduce price to expand market share or from a reaction to a price reduction by a competitor. It could also arise from unplanned price discounting by salespeople.

• Material price variance. The $0.05 increase in the price per ounce of milk chocolate could arise from uncontrollable market factors or from poor contract negotiations by Aunt Molly’s.

• Material efficiency variance. For all three material inputs, usage is greater than budgeted. Possible reasons include lower quality inputs, use of lower quality workers, and the mixing and baking equipment not being maintained in a fully operational mode.

• Labor efficiency variance. The favorable efficiency variance for baking could be due to workers eliminating nonvalue-added steps in production.

7-38

7-41 (30 min.) Flexible budgeting, activity-based costing, variance analysis.

Static-budget

Amounts Actual Amounts1. a. Units of TGC produced and sold 30,000 22,500

b. Batch size (units per batch) 250 225c. Number of batches (a ÷ b) 120 100d. Cleaning labor-hours per batch 3 3.5e. Total cleaning labor-hours (c × d) 360 350f. Cost per cleaning labor-hour $14 $12.50g. Total cleaning labor cost (e × f) $5,040 $4,375

Step 1: The number of batches in which the actual output units should have been produced:22,500 actual units ÷ 250 budgeted batch size = 90 batches

Step 2: The number of cleaning labor-hours that should have been used: 3 budgeted hours per batch × 90 batches = 270 cleaning labor-hours

Step 3: The flexible-budget amount for cleaning labor-hours: 270 cleaning labor-hours × budgeted cost per cleaning labor-hours, $14 = $3,780

Flexible-budget variance = Actual costs – Flexible-budget costs= (350 × $12.50) – (270 × $14)= $4,375 – $3,780 = $595 U

2. Price variance = – ×

= ($14.00 – $12.50) × 350 = $525 F

Efficiency variance = – × Budgeted price of input

= (350 – 270) × $14 = $1,120 U

The unfavorable flexible-budget variance of $595 is comprised of two offsetting amounts.

• Price variance of $525 F due to the actual cost of $12.50 per hour being fewer than the budgeted $14.00 per hour.

• Efficiency variance of $1,120 U due to the (1) actual batch size of 225 units beingbelow the budgeted size of 250 units, and (2) higher actual cleaning labor-hours perbatch of 3.5 hours instead of budgeted cleaning labor-hours per batch of 3 hours.

Toymaster should investigate various explanations as to why this occurred.

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7-42 (30 min.) Flexible budgeting, activity-based costing, variance analysis.

Static-budget Amounts Actual Amounts

1. a. Units of cakes produced and sold 240,000 330,000b. Average batch size (cakes per batch) 6,000 10,000c. Number of batches (a ÷ b) 40 33d. Changeover labor-hours per batch 20 24e. Total changeover labor-hours (c × d) 800 792f. Cost per changeover labor-hours $20 $21g. Total changeover labor cost (e × f) $16,000 $16,632

Step 1: The number of batches in which the actual output units should have been produced:330,000 actual units of output ÷ 6,000 budgeted batch size = 55 batches

Step 2: The number of changeover labor-hours that should have been used:

20 budgeted changeover-hours x 55 batches = 1,100 changeover-hours.

Step 3: The flexible-budget amount for changeover hours:

1,100 changeover-hours × $20 budgeted cost per changeover-hour = $22,000.

Flexible-budget variance = Actual costs – Flexible-budget costs= (792 × $21) – (1,100 × $20)= $16,632 – $22,000 = $5,368 F

2. Price variance = – ×

= ($21 – $20) × 792 = $1 × 792 = $792 U

Efficiency variance = – ×

= (792 – 1,100) × $20 = 308 × $20 = $6,160 F

The favorable flexible-budget variance of $5,368 is comprised of two offsetting amounts:

• Price variance of $792 U due to actual changeover labor cost of $21 per hour exceeding the $20 budgeted rate.

• Efficiency variance of $6,160 F due to the actual batch size of 10,000 being sizably above the budgeted batch size of 6,000. Efficiency variance is favorable because less batches were required to produce 330,000 cakes even though actual changeover labor-hours of 24 per batch were higher than the budgeted changeover-hours per batch of 20 hours.

7-42 (Cont’d.)

3. Explanations for the price variance of $792 U include:

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• More highly trained workers hired to make changeovers.• Change in labor market required unexpected increase in labor rates to retain workers.• Budgeted amounts were set without adequate analysis.

Explanations for the efficiency variance of $6,160 F include:

• More highly trained workers were able to produce larger batch sizes.• More automated machinery was acquired.• Budgeted amounts were set without adequate analysis.

7-43 (30–40 min.) Procurement costs, variance analysis, ethics.

1. Purchase price variances can be computed for each country.

= ×

Hergovia= ($13.30a – $12.00) × 250,000= $325,000 U

a $3,325,000 ÷ 250,000 = $13.30

On a per-unit basis, there is a $10.60 payment to the shoe manufacturer and a $2.70 payment for “other costs.”

Tanistan= ($11.65a – $12.00) × 900,000= $315,000 F

a $10,485,000 ÷ 900,000 = $11.65

On a per-unit basis, there is a $9.60 payment to the shoe manufacturer and a $2.05 payment for “other costs.”

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7-43 (Cont’d.)

2. The organization structure is:

Daley and Mullins face many ethical issues:(a) Reliability of cost information to be presented to the board of directors. There are

minimal or questionable receipts for $675,000 in Hergovia and $1,845,000 in Tanistan.(b) Potential existence of kickback payments in both Hergovia and Tanistan.(c) Employment of young children (many of them under 15 years).

Should Daley and Mullins be forthright and present all their concerns on (a), (b), and (c)?Both Daley and Mullins face the dilemma that any discussion of (a), (b), or (c) will raise

questions about their own behavior at the time the acquisitions were made. Board members may ask “When did they first know about (a), (b), and (c)?,” and “Why did they not undertake examination of these issues at the time they supported the acquisitions?”

3. Mullins has very high standards of ethical conduct to meet––see Exhibit 1-7 of the text. He should not make presentations to the Board based on information he has strong doubts about. If he decides to make the presentation, all his concerns and caveats should be presented.

He should require detailed documentation for all payments. No future payments should be made without adequate documentation.

Investigation of kickback allegations should be made, however difficult that may be. Mullins should be able to show he made a good-faith effort to ensure kickback payments are not an ongoing practice in Hergovia or Tanistan.

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7-44 (30 min.) Price and efficiency variances, problems in standard setting, benchmarking.

1. Budgeted direct materials input per shirt = 400 rolls ÷ 4,000 shirts= 0.10 roll of clothBudgeted direct manuf. labor-hours per shirt (1,000 hours ÷ 4,000 shirts) = 0.25 hoursBudgeted direct materials cost ($20,000 ÷ 400) = $50 per rollBudgeted direct manufacturing labor cost per hour ($18,000 ÷ 1,000) = $18 per hourActual output achieved = 4,488 shirts

Flexible BudgetActual Costs (Budgeted Input Incurred Qty. Allowed for

(Actual Input Qty. Actual Input Qty. Actual Output× Actual Price) × Budgeted Price × Budgeted Price)

Direct (408 × $50) (4,488 × 0.10 × $50)Materials $20,196 $20,400 $22,440

$204 F $2,040 F Price variance Efficiency variance

DirectManufacturing (1,020 × $18) (4,488 × 0.25 × $18)Labor $18,462 $18,360 $20,196

$102 U $1,836 F Price variance Efficiency variance

2. Actions employees may have taken include:(a) Adding steps that are not necessary in working on a shirt.(b) Taking more time on each step than is necessary.(c) Creating problem situations so that the budgeted amount of average downtime will

be overstated.(d) Creating defects in shirts so that the budgeted amount of average rework will be

overstated.Employees may take these actions for several possible reasons.

(a) They may be paid on a piece-rate basis with incentives for above-budgeted production.

(b) They may want to create a relaxed work atmosphere, and less demanding standardcan reduce stress.

(c) They have a “them vs. us” mentality rather than a partnership perspective.(d) They may want to gain all the benefits that ensue from superior performance (job

security, wage rate increases) without putting in the extra effort required.This behavior is unethical if it is deliberately designed to undermine the credibility of the standards used at Savannah Fashions.

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7-44 (Cont’d.)

3. Savannah could use Benchmarking Clearing House information in several ways:(a) For pricing and product emphasis purposes. Savannah should avoid getting into a

pricing war with a competitor who has a sizably lower cost structure.(b) As indicators of areas where Savannah is either highly cost-competitive or highly

cost-noncompetitive.(c) As performance targets for motivating and evaluating managers and workers.

4. Main pros of Benchmarking Clearing House information:(a) Highlights to Savannah in a direct way how it may or may not be cost-competitive.(b) Provides a “reality check” to many internal positions about efficiency or

effectiveness.Main cons are:

(a) Savannah may not be comparable to companies in the database.(b) Cost data about other companies may not be reliable.(c) Cost of Benchmarking Clearing House reports.

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Chapter 7 Internet Exercise

The Internet exercise is available to students only on the Prentice Hall Companion Website www.prenhall.com/horngren. Students can click on Cost Accounting, 11th ed., and access the Internet Exercise for the chapter, which links to the Web site of a company or organization. The Internet Exercise on the Web will be updated periodically so that it is current with the latest information available on the subject organization's Web site. A printout copy of the Internet exercise for this chapter as of early 2002 appears below.

The solution to the Internet exercise, which will also be updated periodically, is available to instructors from the Companion Website's faculty view. To access the solution, click on Cost Accounting, 11th ed., Faculty link, and then register once to obtain your password through the online form. After the initial registration, you will have a personal login ID and password to use to log in. A printout of the solution to the Internet exercise for this chapter as of early 2002 follows. The exercise and solution provide instructors with an idea of the content of the Internet exercise for this chapter.

Internet ExerciseAmerican Airlines just finished removing two rows of seats from every coach cabin on each of its aircraft. The company's "More Room Throughout Coach" program is meant to entice more passengers to fly American, and its success or failure will be measured by its impact on the bottom line.

Go to the SEC's Edgar site, http://www.sec.gov/edgar.shtml, and click on the "Search for Company Filings" link, followed by "Search the EDGAR Archives." Search for American Airlines, and open the 10-K405 filed on March 22, 2001. American's 10-K includes its year 2000 financial statements.

1a. Two important benchmarks for measuring airline performance are revenues per available seat mile (RASM) and cost per available seat mile (CASM). RASM is passenger revenue divided by total available seat miles, and it measures how successfully an airline is at marketing its seats. American reported 161.03 billion available seat miles in 2000, and 161.211 billion seat miles in 1999. Calculate American's RASM and CASM for 1999 and 2000.

1b. Are these the results you would expect, given that American reduced the number of seats per aircraft?

1c. Calculate American's operating margin per available seat mile (RASM-CASM). Has their "More Room Throughout Coach" program paid off?

1d. In evaluating American's "More Room Throughout Coach" program, what additional information would you want to consider?

2. Calculate CASM for each of American's operating expenses in 1999 and 2000. In which expense categories did American experience an unfavorable variance?

3a. Two of American's most significant costs are salaries and fuels. Use actual 1999 CASM to calculate flexible-budget amounts for these accounts for 2000, and calculate the variance from actual costs.

3b. What contributed to the increase in American Airlines’ fuel cost?

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http://www.prenhall.com/horngren

http://www.sec.gov/edgar.shtml

Internet Exercise (Cont’d.)Solution to Internet Exercise

1a. 2000 1999

RASM $0.1017 $0.0912CASM $0.1048 $0.0950

Calculations:2000 1999

RASM $16,377/161,030 = $0.1017 $14,707/161,211 = $0.0912CASM $16,873/161,030 = $0.1048 $15,318/161,211 = $0.0950

1b. In light of American Airline’s decision to remove two rows of seats from each aircraft, we would expect both RASM and CASM to increase.

1c. 2000 1999

RASM $0.1017 $0.0912CASM $0.1048 $0.0950Operating margin per available seat mile ($0.0031) ($0.0038)

Calculations:Operating margin per available seat mile = RASM – CASMOperating margin per available seat mile increased slightly in 2000, so the “More Room Throughout Coach” program appears to have paid off based on this metric.

1d. We would consider cost and volume variances and becnhmark changes in performance against competitors.

2.Expenses 2000 1999 VarianceWages, salaries and benefits

$0.0395 $0.0356 $0.0039 U

Aircraft fuel $0.0147 $0.0101 $0.0046 UDepreciation and amortization $0.0066 $0.0061 $0.0005 UCommissions to agents $0.0060 $0.0068 $0.0008 FOther rentals and landing fees $0.0057 $0.0054 $0.0003 UMaintenance, materials and repairs $0.0056 $0.0052 $0.0004 UFood service $0.0048 $0.0046 $0.0002 UAircraft rentals $0.0035 $0.0036 $0.0001 FOther operating expenses $0.0184 $0.0178 $0.0006 U

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Internet Exercise (Cont’d.)

Calculations: 2000 1999

Wages, salaries and benefits $6,354/161,030 $5,747/161,211Aircraft fuel $2,372/161,030 $1,622/161,211Depreciation and amortization $1,068/161,030 $977/161,211Commissions to agents $ 973/161,030 $1,090/161,211Other rentals and landing fees $ 919/161,030 $867/161,211Maintenance, materials and repairs $ 899/161,030 $833/161,211Food service $ 769/161,030 $734/161,211Aircraft rentals $ 561/161,030 $582/161,211Other operating expenses $2,958/161,030 $2,866/161,211

3a.

CASM-19992000

Budgeted Cost2000

Actual Cost VarianceWages, salaries and benefits $0.0356 $5,733 million $6,354 million $621 million UAircraft fuel $0.0101 $1,626 million $2,372 million $746 million U

Calculations:Budgeted Cost for 2000:Wages, salaries and benefits $0.0356 × 161,030 = $5,733 millionAircraft fuel $0.0101 × 161,030 = $1,626 million

3b.

The primary causes for the unfavorable variance was a 42.2% increase in fuel prices and a 3.0% increase in fuel consumption.

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Chapter 7 Video Case

The video case can be discussed using only the case write up in the chapter. Alternatively, instructors can have students view the videotape of the company that is the subject of the case. The videotape can be obtained by contacting your Prentice Hall representative. The case questions challenge students to apply the concepts learned in the chapter to a specific business situation.

McDONALD’S CORPORATION: FLEXIBLE BUDGETS, STANDARDS, AND VARIANCES.

1a. Direct materials efficiency variance report. This report measures how well the stores controlled the use of food items. Also, direct materials price variance report, which measures the actual cost per pound of input versus the budgeted cost.

2a. Direct labor efficiency variance report. This report could be used to send people home early from their shifts if there are too many workers for the actual sales levels being experienced at the store.

3a. Employee commitment and satisfaction; employee turnover; numbers of units (e.g., Happy Meals) sold; product waste; customer satisfaction; labor hours; raw food quantities; market share. Nonfinancial measures matter because they can draw attention to areas that may be problems and require action. Often, nonfinancial measures are leading indicators of future financial performance. For example, consistently low scores on cleanliness are likely to turn customers off the store and negatively affect future period revenues. Nonfinancial measures are also relevant when evaluating the performance of store managers.

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Documents

FLEXIBLE BUDGETS, VARIANCES