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Flexible Budget and Standard Costing for Performance Control

TOPIC 10. Flexible Budget and Standard Costing for Performance Control. Flexible Budget Introduction…. Budget can provide a useful basis for exercising control over the business. Budget represents the plan of the business. We do things according to what we plan.

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Flexible Budget and Standard Costing for Performance Control

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  1. TOPIC 10 Flexible Budget and Standard Costing for Performance Control yus/sem1/2004/2005

  2. Flexible BudgetIntroduction….. • Budget can provide a useful basis for exercising control over the business. • Budget represents the plan of the business. • We do things according to what we plan. • We compare our performance with what we plan. • Then, we exercise control by finding out where and why things did not go according to our plan. • One reason why things may not have gone according to plan is that the plans may in reality prove to be unachievable and it needs to be revised. yus/sem1/2004/2005

  3. Cont…. • Budgets may prove to be totally unrealistic targets for a variety of reasons: • Unexpected changes in the commercial environment • Reduction in demand for services or product • Increase or decrease in price or cost of product and material used • Thus we have to flexing the budget (adjusting the budget) before comparison of the actual performance with the budget can be done. yus/sem1/2004/2005

  4. Comparing the actual result • Can be done using fixed budget basis or flexible budget basis • Fixed budget basis means that the actual result are compared with the original budgets • Flexible budget is an original budget that has been amended to take into account the actual level of activity • A flexible budget provides estimates of what costs should be for any level of activity within a specified range. yus/sem1/2004/2005

  5. Example: The following are the budgeted and actual profit and loss accounts for Bexter Ltd.for the month of May: yus/sem1/2004/2005

  6. Comparison results • The budgeted profits was not achieved. • The performance looks bad • The business is out of control • However, cost of labor was less then budgeted, which is good • But still, senior management must find where things when wrong and why? What is the problem in the comparing process??? yus/sem1/2004/2005

  7. The problem is….. • The actual level of output was not as budgeted • The actual level of output was 10% less then budgeted figure. • We cannot say that there were labor cost saving of RM2,500 or increased in direct material costs of RM 150. yus/sem1/2004/2005

  8. Flexing the budgeting figure… • More valid comparison between flexed budget and actual. • Change the volume of production and sales to reflect the volume which actually occurred • Only variable item is changed when the volume changed Flexed Budget 900 units 90,000 (36,000) 36,000 meters (18,000) 4,500 hours 16,000 yus/sem1/2004/2005

  9. Comparison results • The budgeted profits was achieved. • Is the performance good???? • Sales increase because increase in selling price ( RM94,500/900 units = RM105) • Cost of material increase – unit used is higher then budgeted • However, labor was efficient – less hour consumed then budgeted yus/sem1/2004/2005

  10. STANDARD COSTING yus/sem1/2004/2005

  11. STANDARD COSTINGIntroduction……. • Standard costing, along with budgeting is one of the key aspects of planning and control • Standard costing is a sophisticated form of budgeting based on predetermined costs for cost elements such as direct labor or direct material • In standard costing, expected (or standard) sales or costs are compared against actual sales or costs • Any different between them (called variances) are then investigated. yus/sem1/2004/2005

  12. Nature of Standard Costing • Standard costing was originally developed in manufacturing business in order to control costs • It is a predetermined calculation of cost that should be incurred in making the product. • For example; a table to be made may requires 8 hours of direct labor and 3 meters of wood. This becomes the standard quantities for making a table • After a table is made, the actual direct labor and direct material used will be compared with the standard costs. • The differences, then, will be investigated. yus/sem1/2004/2005

  13. Purpose of Standards • To Improve Planning and Control • To Facilitate Product Costing yus/sem1/2004/2005

  14. Information required to operate standard costing…. • Direct material; type, quantity and price • Direct labor;grade, numbers and rates of pay • Variable overhead • Fixed overhead yus/sem1/2004/2005

  15. Example 1: • Alan Carpenter runs a furniture business. In May he makes a Dining table. Below are the detail quantity and costs incurred to make the 1 unit of dining table • Direct material used: 3 meters of wood • Direct labor hours spend: 8 hours • Cost for 1 meter wood RM25 • Cost for 1 hour labor= RM8 • Variable overheads = RM5 x 8 hours • Variable overhead was absorbs on the basis of direct labor hours • Fixed overhead RM240 for 10 unit tables • Calculate the standard costs per unit to make the dining table. yus/sem1/2004/2005

  16. Standard Cost Sheet Dining table Standard Standard Standard Description Price Usage Cost Direct materials RM25 x 3m. = RM75 Direct labor RM8 x 8 hours = RM64 Variable overheads RM5 x 8 hours = RM40 Fixed Overheads costs =RM24 Total Standard unit cost RM 203 yus/sem1/2004/2005

  17. Comparing Standard cost and Actual Cost • Control on costs can be made by comparing standard cost with actual cost incurred • When our actual price/costs and actual quantity vary from standard, we will have price and quantity variances. • Price variances are caused when the standard price differ from the actual price • Quantity variances are caused when standard quantity differ from the actual quantity used. • Favorable variances are where we have done better than expected • Unfavorable variance are where we have done worse than expected yus/sem1/2004/2005

  18. Type of variances • Variance of Direct Material Cost • Price and quantity used • Variance of Direct Labor Cost • Rate and efficiency variances • Cost Variances • Variance of Variable Overheads Cost • Expenditure and efficiency • Variance of Fixed Overheads Cost • Sales Variance • Price and Sales volume yus/sem1/2004/2005

  19. Example: • The following information has been taken from the record of the Frost Production for the year to 31 March 2004 • Budget costs per unit output: • Direct material (15 kg x RM2/kg) = RM30 • Direct labor (10 hours x RM4/hour) = RM40 • Variable overheads cost (10 hours x RM1/hour) = RM10 • The following budgeted data are also relevant: • The budgeted production level was 100 units • Total standard direct labor hours was amounted to 1000 • Total budgeted variable overhead was estimated to be RM1000 • Total budgeted fixed overhead was RM2000 • The product can be sold at RM150/unit • Actual costs: • Direct material RM2100 • Direct labor RM4000 • Variable overhead RM1000 • Fixed overhead RM1600 • Total actual cost RM8700 • Note: 90 unit were produced in 800 actual labor hours, and the total actual quantity of direct materials consumed was 1400kg. 90 units were sold at RM160/unit • Prepare fixed budget for 100 unit and flexing the budget for 90 units produced and sold • Calculate cost and sale variances yus/sem1/2004/2005

  20. Total sales variance Selling price variance Sales volume profit variance Sales Variance • Selling Price (PV)= (Actual selling price per unit – standard selling price per unit) x actual units sold • Sale volume profit = (total quantity sold – budgeted quantity sold) x standard profit per unit* *standard profit per unit = selling price per unit – standard cost per unit • Total sales variance = selling price variance + (-) sales volume profit variance yus/sem1/2004/2005

  21. Sales Variance • Selling Price (PV)= (Actual selling price per unit – standard selling price per unit) x actual units sold = (RM160 – RM150) x 90 units = RM10 x 90 units = RM900 (F) • Sale volume profit = (total quantity sold – budgeted quantity sold ) x standard profit per unit* = (90 units –100 units) x RM50 = 10 units x RM50 = RM500 (U) *standard profit per unit = budgeted selling price per unit – standard cost per unit RM150- RM100 = RM50 yus/sem1/2004/2005

  22. Variance of Direct Material Cost • Price (PV)= (Actual cost per unit – standard cost per unit) x Total actual quantity used • Quantity (QV) = (total quantity used – standard quantity for actual production ) x standard cost • Total Cost =( standard cost for actual production – actual cost of material used in production) yus/sem1/2004/2005

  23. Price (PV)= (Actual cost per unit – standard cost per unit) x Total actual quantity used = (Actual cost/actual Qtty – RM2 ) x 1400kg = (RM2100/1400kg – RM2 )x 1400kg = (RM1.50 – RM2) x 1400kg = RM700 (F) Quantity (QV) = (total quantity used – standard quantity for actual production ) x standard cost = (1400kg – 15kg x90 unit ) x RM2 = (1400kg – 1350kg) x RM2 = (50kg) x RM2 = RM100 (U) yus/sem1/2004/2005

  24. Total Cost Variance =( standard cost for actual production – actual cost of material used in production) = (RM2 x 15kg x 90 units) – RM2100 = RM2700 – RM2100 = RM600 ATAU Total Cost Variance = Price Variance -/+ Quantity Variance = RM700 (F) – RM 100 (U) = RM600 yus/sem1/2004/2005

  25. Variance of Direct Labor Cost • Rate (RV)= (Actual hourly rate – standard hourly rate) x Total actual hour work • = (total hour worked – standard hour worked for actual production ) x standard hourly rate • Total Cost = (actual hour work x actual rate) – (Standard hour for actual production x standard rate) Efficiency (EV) yus/sem1/2004/2005

  26. Rate (RV)= (Actual hourly rate – standard hourly rate) x Total actual hour work = (Actual cost/actual hour – RM4 ) x 800 hours = (RM4000/800 hours – RM4 )x 800 hours = (RM5 – RM4) x 800 hours = RM800 (U) = (total hour worked – standard hour worked for actual production ) x standard hourly rate Efficiency (EV) = (800 hours – 10 hours x 90 units ) x RM4 = (800 hours – 900 hours) x RM4 = (100 hours) x RM4 = RM400 (F) yus/sem1/2004/2005

  27. Total Cost = (actual hour work x actual rate) – (Standard hour for actual production x standard rate) = (800 hours x RM5 ) – (10 hours x 90 units) x RM4 = RM 4000 – RM3600 = RM400 (U) ATAU Total Cost Variance = Rate Variance -/+ Efficiency Variance = RM800 (U) -+ RM 400 (F) = RM400 (U) yus/sem1/2004/2005

  28. Conclusion • A standard cost id the planned cost of a particular unit or process • Standard costs are usually based on what is reasonably attainable • Actual costs are then compared with standard costs • Corrective action is taken if there are any unplanned trends • Variance analysis is an arithmetical exercise that enables differences between actual and standard cost to be broken down into the elements of cost • The variances help in tracing the main cause of differences between actual and budgeted results, but they do not explain what has actually happened yus/sem1/2004/2005

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