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Flexible Budgets and Variance Analysis

Flexible Budgets and Variance Analysis. Chapter 8. Learning Objective 1. Distinguish between flexible budgets and master (static) budgets. Static Budgets. A static budget is prepared for only one level of a given type of activity. All actual results are compared with the

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Flexible Budgets and Variance Analysis

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  1. Flexible Budgets andVariance Analysis Chapter 8

  2. Learning Objective 1 • Distinguish between flexible • budgets and master • (static) budgets.

  3. Static Budgets A static budget is prepared for only one level of a given type of activity. All actual results are compared with the original budgeted amounts, even if sales volume is more or less than originally planned.

  4. Master Budget Variance: Sales The variances of actual results from the master budget are called master (static) budget variances. Actual $217,000 Budget $279,000 Variance $62,000 U

  5. Master Budget Variance: Expenses Actual expenses that exceed budgeted expenses result in unfavorable expense variances. Actual expenses that are less than budgeted expenses result in favorable expense variances.

  6. Objective 2 • Use flexible-budget formulas • to construct a flexible budget • based on the volume of sales.

  7. Flexible Budget A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities.

  8. Flexible Budget Formulas To develop a flexible budget, managers determine revenue and cost behavior (within the relevant range) with respect to cost drivers.

  9. Objective 3 • Prepare an activity-based • flexible budget.

  10. Activity-Based Flexible Budget An activity-based flexible budget is based on budgeted costs for each activity and related cost driver. Within each activity center, costs depend on an appropriate cost driver.

  11. Objective 4 • Explain the performance • evaluation relationship • between master (static) • budgets and flexible budgets.

  12. Evaluation of Financial Performance Comparing the flexible budget to actual results accomplishes an important performance evaluation purpose.

  13. Evaluation of Financial Performance Actual results may differ from the master budget because... 1) sales and other cost-driver activities were not the same as originally forecasted, or 2) revenue or variable costs per unit of activity and fixed costs per period were not as expected.

  14. Evaluation of Financial Performance Flexible-budget variances Activity-level variances

  15. Actual results at actual activity level Flexible budget for actual sales activity Flexible- budget variances Units 7,000 7,000 – Sales $217,000 $217,000 – Variable costs 158,200 152,600 5,670 U Contribution margin $ 58,730 $ 64,400 $5,670 U Fixed costs 70,300 70,000 300 U Operating income $ (11,570) $ (5,600) $5,970 U Evaluation of Financial Performance

  16. Evaluation of Financial Performance Flexible budget for actual sales activity Master budget Sales- activity variances Units 7,000 9,000 2,000 U Sales $217,000 $279,000 $62,000 U Variable costs 152,600 196,200 43,600 F Contribution margin $ 64,400 $ 82,800 $18,400 U Fixed costs 70,000 70,000 – Operating income $ (5,600) $ 12,800 $18,400 U Total master budget variances = $11,570 + $12,800 = $24,370

  17. Objective 5 • Compute flexible-budget • variances and • sales-activity variances.

  18. Isolating the Causes of Variances Managers use comparisons among actual results, master budgets, and flexible budgets to evaluate organizational performance.

  19. Isolating the Causes of Variances Effectiveness is the degree to which a goal, objective, or target is met. Efficiency is the degree to which inputs are used in relation to a given level of outputs. Performance may be effective, efficient, both, or neither.

  20. Actual results $(11,570) Flexible budget $(5,600) $5,970 Unfavorable Flexible-budget variances Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible-budget planned results

  21. Sales-Activity Variances Total sales-activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit

  22. Flexible budget Master budget $18,400 Unfavorable Activity-level variances Sales-Activity Variances (9,000 – 7,000) × $9.20

  23. Objective 6 • Compute and interpret price • and usage variances for inputs • based on cost-driver activity.

  24. Setting Standards An expected cost is the cost that is most likely to be attained. A standard cost is a carefully developed cost per unit that should be attained.

  25. Perfection Standards... or ideal standards, are expressions of the most efficient performance possible under the best conceivable conditions, using existing specifications and equipment. No provision is made for waste, spoilage, machine breakdowns, and the like.

  26. Currently Attainable Standards... are levels of performance that managers can achieve by realistic levels of effort. They make allowances for normal defects, spoilage, waste, and nonproductive time.

  27. Trade-Offs Among Variances Improvements in one area could lead to improvements in others and vice versa. Likewise, substandard performance in one area may be balanced by superior performance in others.

  28. When to Investigate Variances When should management investigate a variance? Many organizations have developed such rules of thumb as “investigate all variances exceeding $5,000 or 25% of expected cost, whichever is lower.”

  29. Comparison with Prior Periods Some organizations compare the most recent budget period’s actual results with last year’s results for the same period.

  30. Flexible-Budget Variance in Detail Standard per unit of output: Direct Direct MaterialLabor Std. inputs expected 5 pounds ½ hour Std. price expected $ 2 $16 Std. cost expected $10 $ 8

  31. Variances from Material and Labor Standards Actual results for 7,000 units produced: Direct material Pounds purchased and used: 36,800 Price/pound: $1.90 Total actual cost: $69,920 Direct labor Hours used: 3,750 Actual price (rate): $16.40 Total actual cost: $61,500

  32. Variances from Material and Labor Standards Standard Direct-Materials Cost Allowed: Units of good output achieved × Input allowed per unit of output × Standard unit price of input = Flexible budget or total standard cost allowed

  33. Actual cost $69,920 Flexible budget $70,000 $80 Favorable Direct material flexible-budget variance Variances from Material and Labor Standards

  34. Variances from Material and Labor Standards Standard Direct-Labor Cost Allowed: Units of good output achieved: 7,000 × Input allowed per unit of output: ½ hour × Standard unit price of input: $16/hour = Flexible budget or total standard cost allowed: $56,000

  35. Actual cost $61,500 Flexible budget $56,000 $5,500 Unfavorable Direct labor flexible-budget variance Variances from Material and Labor Standards

  36. Price and Usage Variances Price variance: (Actual price – Standard Price) × Actual quantity Usage variance: (Actual quantity – Standard quantity) × Standard price

  37. Price Variance Computations Direct material price variance: ($1.90 – $2.00) per pound × 36,800 pounds = $3,680 F Direct labor price variance: ($16.40 – $16.00) per hour × 3,750 hours = $1,500 U

  38. Usage Variance Computations Direct material usage variance: [36,800 – (7,000 × 5)] pounds × $2 per pound = $3,600 U Direct labor usage variance: [3,750 – (7,000 × ½)] hours × $16 per hour = $4,000 U

  39. Favorable or Unfavorable Variance? To determine whether a variance is favorable or unfavorable, use logic rather than memorizing a formula.

  40. Actual cost $69,920 AQ × SP = $73,600 Flexible budget $70,000 $3,680 F $3,600 U Direct material flexible-budget variance $80 F Direct Materials FlexibleBudget Variance

  41. Actual cost $61,500 AH × SP = $60,000 Flexible budget $56,000 $1,500 U $4,000 U Direct labor flexible-budget variance $5,500 U Direct Labor FlexibleBudget Variance

  42. Interpretation of Price and Usage Variances Price and usage variances are helpful because they provide feedback to those responsible for inputs. Managers should not use these variances alone for decision making, control, or evaluation.

  43. Objective 7 • Compute variable overhead • spending and efficiency • variances.

  44. Variable-OverheadEfficiency Variance When actual cost-driver activity differs from the standard amount allowed for the actual output achieved, a variable-overhead efficiency variance will occur.

  45. Variable-OverheadSpending Variance This is the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity.

  46. Variable Overhead Example Suppose that Dominion Company’s cost of supplies, a variable-overhead cost, is driven by direct labor hours. The variable-overhead cost rate of $.60 per unit is equivalent to $1.20 per direct labor hour because each unit of output requires ½ hour of labor

  47. Variable Overhead Example Actual variable overhead = $4,700 Variable overhead allowed = $.60 × 7,000 units = $4,200 $500 unfavorable variance

  48. Variable Overhead Example Variable-overhead efficiency variance: (3,750 act. hours – 3,500 std. hours allowed) × $1.20 per hour = $300 U Variable-overhead spending variance: ($4,700 – ($1.20 × 3,750 actual hours used) = $200 U

  49. End of Chapter 8

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