Flexible Budgets andStandard Costs Chapter 23 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT
Objectives 1. Prepare a flexible budget for the statement of financial performance 2. Prepare a financial performance report 3. Identify the benefits of standard costing 4. Calculate standard cost variances for direct material and direct labour 5. Analyse manufacturing overhead in a standard cost system 6. Record transactions at standard cost 7. Prepare a standard cost statement of financial performance for management
Prepare a flexible budget for the statement of financial performance. Objective 1
Static versus Flexible Budgets Kool-Time Pools Comparison of Actual Results with Static Budget For the Month Ended June 30, 2004 Actual Static Results Budget Variance Pools 10 8 2 F Revenues $120,000 $ 96,000 $24,000 F Expenses 105,000 84,000$21,000 U Net Profit $ 15,000 $ 12,000 $ 3,000 F
Static versus Flexible Budgets Static Budget (8 Pools) Expected Output Volume Only
Static versus Flexible Budgets Flexible Budget (5 Pools) (8 Pools) (11 Pools) Range of Output Volumes
Flexible Budgets Budgeted sales price per pool is $12,000. Budgeted variable expenses per pool are $8,000. Total budgeted fixed cost is $20,000. What are the flexible budgets for Kool-Time Pools when expected volume is 5, 8, and 11 pools?
Flexible Budgets Kool-Time Pools Flexible Budgets Units 5 8 11 Sales revenue $60,000 $ 96,000 $132,000 Variable expenses 40,000 64,000 88,000 Fixed expenses 20,000 20,000 20,000 Net Profit $ 0 $ 12,000 $ 24,000
Graphing the FlexibleBudget Formula Total cost line $84,000 Variable cost $8,000 per pool installed $60,000 Fixed cost $20,000 per month $20,000
Graphing the FlexibleBudget Formula The flexible budget graph shows budgeted expenses for 10 pools. Variable expenses $ 80,000 Fixed expenses 20,000 Total expenses $100,000 June actual expenses were $105,000. They exceeded the budgeted by $5,000.
Prepare a financial performance report. Objective 2
Kool-Time Pools Performance Report Actual Flexible Static ResultsBudgetBudget Pools 10 10 8 Revenues $120,000 $120,000 $ 96,000 Variable expenses 83,000 80,000 64,000 Fixed expenses 22,000 20,000 20,000 Total expenses 105,000 100,000 84,000 Net Profit $ 15,000 $ 20,000 $ 12,000
Kool-Time Pools Performance Report Actual Results $15,000 Flexible Budget $20,000 Static Budget $12,000 $8,000 F $5,000 U Flexible Budget Variance Sales Volume Variance
Kool-Time Pools Performance Report Actual Results $15,000 Static Budget $12,000 $3,000 F Static Budget Variance
The Flexible Budgetand Variance Analysis • The flexible budget varianceis the difference between what the company spent at the actual level of output and what it should have spent to obtain the actual level of output. • It highlights the difference between actual costs and flexible budget costs.
The Flexible Budgetand Variance Analysis • Kool-Time Pools actually incurred $83,000 of variable costs to install the 10 pools. • This was $3,000 more than the $80,000 budgeted variable cost for 10 pools. • Kool-Time Pools also spent $2,000 more than budgeted on fixed expenses ($22,000 – $20,000).
Identify the benefits of standard costs. Objective 3
Benefits of Standard Costs • Standard costs are carefully predetermined costs. • They help managers plan by providing the unit amounts, which are the building blocks of budgeting. • They help simplify record keeping. • Standard quantity often is referred to as the quantity that should have been used.
Benefits of Standard Costs • Standards costs are different to flexible budgets because; • Flexible budgets keep fixed costs constant, within the relevant range. • Standard costs are on a per unit basis and allocate an amount of fixed costs to each unit.
Calculate standard cost variances for direct materials and direct labour. Objective 4
Direct Material andDirect Labour Variances • Price,or rate, which measures how well the business keeps unit prices of materials and labour within standards. • Efficiency, or quantity, which measures whether the quantity of materials or labour used to make the actual number of outputs is within the budget.
Price Variance... • is the difference between the actual price and standard price of inputs used multiplied by the actual quantity of inputs. • Price variance = (Actual quantity × Actual price) – (Actual quantity × Standard price) or... • Actual quantity × (AP – SP)
Efficiency Variance... • is the difference between the actual and standard quantity of inputs allowed multiplied by the standard price of input. • Efficiency variance = (Actual quantity × Standard price) – (Standard quantity × Standard price) or... • Standard price × (AQ – SQ)
Example of Standard Costing Variance analysis begins with a total variance to be explained – in this example, $5,000. Actual variable expenses $ 83,000 Flexible budget – 80,000 Difference 3,000 Actual fixed expenses were $2,000 more than budgeted.
Materials Variances Standards Direct materials cost was $2.00 per cubic metre. SQ of materials allowed (gunite) was 1,000 cubic metre per pool. Actual Results (10 pools were built) AP paid per cubic metre = $1.93 AQ of materials used = 11,969 cubic feet
Materials Variances Price variance: 11,969 ($1.93 – $2.00) = $838 favourable Efficiency variance: $2.00 (11,969 – 10,000) = $3,938 unfavourable Flexible budget variance: $838 – $3938 = $3,100 unfavourable
Materials Variances • Actual cost incurred: (Actual inputs × Actual price) = 11,969 × $1.93 = $22,100 • Standard cost of actual inputs: (Actual inputs × Standard price) = 11,969 × $2 = $23,938 • Flexible budget: (Standard inputs × Standard price) = 10,000 × $2 = $20,000
Labour Variances Standards Direct labour cost was $4,200 per pool. SP (rate) was $10.50 per hour. Standard hours per pool was 400. Actual Results (10 pools were built) AP (actual rate) was $11.00 per hour. AQ (actual hours) was 3,800.
Labour Variances Price (or rate) variance: 3,800($11.00 – $10.50) = $1,900 unfavourable Efficiency variance: $10.50(3,800 – 4,000) = $2,100 favourable Flexible budget variance: $2,100 – $1,900 = $200 favourable
Labour Variances • Actual cost incurred: (Actual inputs × Actual price) = 3,800 × $11 = $41,800 • Standard cost of actual inputs: (Actual inputs × Standard price) = 3,800 × $10.50 = $39,900 • Flexible budget: (Standard inputs× Standard price) = 4,000 × $10.50 = $42,000
Flexible Budget Variancesfor Materials and Labour Flexible budget variance for materials $3,100 U Flexible budget variance for labour 200 F Total variances $2,900 U Total flexible budget variance $5,000 U Materials and labour variances 2,900 U Flexible budget overhead variances $2,100*U *Flexible budget man. O/H variance $1,300 U *Marketing and admin. O/H variance $ 800 U (see Exhibit 23-9 page 1005 textbook)
Analyse manufacturing overhead in a standard cost system. Objective 5
Manufacturing Overhead Variances • The flexible budget variance for manufacturing overhead shows whether managers are keeping total overhead costs within the budgeted amount for the actual production of the period (actual – flexible). • The production volume variance (this is a new concept and not part of the total flexible budget variance ) arises when actual production differs from the level in the static budget (allocated – flexible).
Allocating Overhead to Production • Kool-Time Pools allocates manufacturing overhead to production based on standard direct labour hours for the actual number of outputs. • The static budget, which is based on expected output of 8 pools, is known at the beginning of the period.
Allocating Overhead to Production Standards Variable overhead cost was $800 per pool. Standard hours per pool were 400. Fixed overhead cost was $12,000. Actual Results (10 pools were built) Actual variable overhead was $9,000. Actual hours were 3,800 fixed overhead was $12,300 and total overhead was $21,300.
Allocating Overhead to Production • In a standard cost system, manufacturing overhead is allocated to production based on a predetermined overhead rate. • Most companies base their predetermined overhead rates on amounts from the static (master) budget which is known at the beginning of the year (month).
Allocating Overhead to Production Kool-Time Pools Budget Data for the Month Ended June 30, 2004 Budget type Static Flexible Pools 8 10 Standard direct labour hours 3,200 4,000 Overhead cost: Variable $ 6,400 $ 8,000 Fixed 12,000 12,000 Total $18,400 $20,000
Allocating Overhead to Production Standard variable overhead rate per hour: $6,400 ÷ 3,200 = $2.00 Standard fixed overhead rate per hour: $12,000 ÷ 3,200 = $3.75 Total overhead rate per hour: $2.00 + $3.75 = $5.75
Total ManufacturingOverhead Variance... • is the amount of underallocated or overallocated manufacturing overhead. • This is the difference between actual manufacturing overhead and allocated manufacturing overhead.
Total ManufacturingOverhead Variance How much standard overhead is allocated to production? 4,000 × $2.00 $ 8,000 variable 4,000 × $3.75 15,000 fixed Total $23,000 Total manufacturing overhead cost variance is allocated minus actual: $23,000 – $21,300 = $1,700 favourable
Total ManufacturingOverhead Variance • The total manufacturing overhead variance is split into the manufacturing flexiblebudgetvariance and the productionvolumevariance: • Flexible budget overhead for actual production = $12,000 + (4,000 × $2) = $20,000.
Overhead Flexible Budget Variance Kool-Time Pools – a comparison of actual results with the flexible budget overhead for actual production: Actual ResultsFlexible BudgetVariance Pools 10 10 Overhead cost: Variable $ 9,000 $ 8,000 $1,000 U Fixed 12,300 12,000 $ 300 U Total $21,300 $20,000 $1,300 U Overhead flexible variance is $1,300 unfavourable.
Production Volume Variance... • is the difference between the fixed overhead cost in the flexible budget for actual production and the standard fixed overhead allocated to production. • 4,000 × $3.75 = $15,000 allocated. • How much is the volume variance? • $12,000 – $15,000 = $3,000 favourable volume variance. • It is because they produced more than expected and therefore allocated more fixed overhead to production.
Flexible Budget Variance Flexible budget variance: $5,000 U Materials $3,100 U Labour 200 F Marketing and admin. variance 800 U Flexible budget man. overhead variance 1,300 U Total $5,000 U
Total Variances • Why was actual profit $5,000 less than the flexible budget for 10 pools? • Variable costs exceeded the flexible budget by $3,000 and actual fixed costs exceeded the static budget by $2,000. • See exhibit 23-9 page 1005 textbook
Record transactions at standard cost. Objective 6
Standard Costs in the Accounts What is the entry to record the purchase of 11,969 cubic metres of materials (actual price paid was $1.93 per cubic foot and the standard being $2.00/cubic metre)? Materials Inventory 23,938 Direct Materials Price Variance 838 Accounts Payable 23,100 To record purchases of direct materials
Standard Costs in the Accounts What is the entry to record the transfer of 11,969 actual cubic metres of materials to work in process inventory? (All at $2 SP) Work in Process Inventory 20,000* Direct Materials Efficiency Variance 3,938 Materials Inventory 23,938 To record use of materials *10,000 SQ × $2 SP
Standard Costs in the Accounts • Notice that in these entries direct materials price variance is recorded at the time of purchase. • An unfavourable variance has a debit balance which increases the expense. • A favourable variance has a credit balance in the accounts and is a reduction in expenses.
Standard Costs in the Accounts Manufacturing Overhead 21,300 Accounts Payable, Accumulated Depreciation, and Other accounts 21,300 To record actual overhead costs incurred See Exhibit 23-14 page 1013 textbook