Cost Accounting, Chapter 7 11ch07

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Flexible Budgets, Variances,

and Management Control: I

Flexible Budgets, Variances,

and Management Control: I

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Distinguish

a static budget

from a flexible budget.

Learning Objective 1

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Static and Flexible Budgets

Static Budget

Planned level of output at start of the budget period Based on

Flexible Budget

Budgeted revenues and cost based on actual level of output Based on

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Static Budget Example

Assume that Pasadena Co. manufactures and sells dress suits.

Budgeted variable costs per suit are as follows: Direct materials cost $ 65 Direct manufacturing labor 26 Variable manufacturing overhead 24 Total variable costs $115

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Static Budget Example

Budgeted selling price is $155 per suit. Fixed manufacturing costs are expected

to be $286,000 within a relevant range between 9,000 and 13,500 suits.

Variable and fixed period costs are ignored. The static budget for year 2004 is based

on selling 13,000 suits.

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Static Budget Example

Revenues (13,000 × $155) $2,015,000 Less Expenses:

Variable (13,000 × $115) 1,495,000

Fixed 286,000 Budgeted operating income $ 234,000

Assume that Pasadena Co. produced and sold 10,000 suits at $160 each with actual variable costs of $120 per suit and fixed manufacturing

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Static Budget Example

Revenues (10,000 × $160) $1,600,000 Less Expenses:

Variable (10,000 × $120) 1,200,000 Fixed 300,000 Actual operating income $ 100,000 What was the actual operating income?

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Static-Budget Variance Example

What is the static-budget variance of operating income?

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

operating income $134,000 U This is a Level 0 variance analysis.

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Static-Budget Variance Example

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

Static Budget Actual Variance Suits 13 10 3 U Revenue $2,015 $1,600 $415 U Variable costs 1,495 1,200 296 F Contribution margin $ 520 $ 400 $120 U Fixed costs 286 300 14 U Operating income $ 234 $ 100 $134 U

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Learning Objective 2

Develop a flexible budget

and compute flexible-budget

variances and sales-volume

variances.

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Steps in Developing

Flexible Budgets

Steps in Developing

Flexible Budgets

Step 1:

Determine budgeted selling price, variable cost per unit, and budgeted fixed cost.

Budgeted selling price is $155, variable cost is $115 per suit, and the budgeted fixed cost is $286,000.

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Steps in Developing

Flexible Budgets

Steps in Developing

Flexible Budgets

Step 2:

Determine the actual quantity of output. In the year 2004, 10,000 suits were

produced and sold.

Step 3:

Determine the flexible budget for revenues. $155 × 10,000 = $1,550,000

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Steps in Developing

Flexible Budgets

Steps in Developing

Flexible Budgets

Step 4:

Determine the flexible budget for costs. Variable costs: 10,000 × $115 = $1,150,000 Fixed costs 286,000

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Variances

Level 2 analysis provides information on the two components of the

static-budget variance. 1. Flexible-budget variance

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Flexible-Budget Variance

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

Flexible

Budget Actual Variance Suits 10 10 0 Revenue $1,550 $1,600 $ 50 F Variable costs 1,150 1,200 50 U Contribution margin $ 400 $ 400 $ 0 Fixed costs 286 300 14 U Operating income $ 114 $ 100 $ 14 U

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Flexible-Budget Variance

Actual quantity sold: 10,000 suits

Flexible-budget variance

$14,000 U

Actual results operating income

$100,000

Flexible-budget operating income

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Flexible-Budget Variance

Total flexible-budget variance = Total actual results

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Flexible-Budget Variance

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

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Total sales-volume variance $120,000 U

=

Actual sales unit – Master budgeted sales units 13,000 – 10,000 = 3,000

_×

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Budget Variances

Static-budget variance $134,000 U

Flexible-budget variance

$14,000 U Level 1

Sales-volume variance $120,000 U Level 2

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Learning Objective 3

Explain why standard costs are

often used in variance analysis.

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Standards

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

Standard input allowed for one output unit

Standard cost per input unit

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Standards

4.00 square yards allowed per output unit at $16.25 standard cost per square yard.

Standard cost per output unit 4.00 × $16.25 = $65.00

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Standards

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

cost per hour.

Standard cost per output unit 2.00 × $13.00 = $26.00

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Learning Objective 4

Compute price variances

and efficiency variances

for direct-cost categories.

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Actual Data

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

Labor hours: 21,500 at $12.90 Cost of direct materials = $677,875

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Price Variance Example

Direct-material price variance Actual price –

Budgeted price

×

Actual quantity

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

=

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Price Variance Example

Direct-labor price variance Actual price –

Budgeted price

×

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

=

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Price Variance Example

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

Materials Control 690,625

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

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Efficiency Variance Example

Direct-material efficiency variance Actual quantity

– Standard quantity

×

Standard

price

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

=

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Efficiency Variance Example

Direct-labor efficiency variance Actual quantity

– Standard quantity

×

Standard

price

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

=

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Efficiency Variance

What is the journal entry to record materials used? Work in Process Control 650,000

Direct-Materials Efficiency Variance 40,625

Materials Control 690,625 To record direct materials used

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Price and Efficiency Variance

What is the journal entry for direct manufacturing labor? Work in Process Control 260,000

Direct Manufacturing

Labor Efficiency Variance 19,500 Direct-Manufacturing

Labor Price Variance 2,150 Wages Payable 277,350 To record liability for direct manufacturing labor

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Flexible Budget Material

Variance Example

Flexible Budget Material

Variance Example

Actual Cost $677,875

BQ × BP

40,000 × $16.25 $650,000

AQ × BP

42,500 × $16.25 $690,625

$12,750 F $40,625 U $27,875 U

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Flexible Budget Labor

Variance Example

Flexible Budget Labor

Variance Example

Actual Cost $277,350

BQ × BP

20,000 × $13.00 $260,000

AQ × BP

21,500 × $13.00 $279,500

$2,150 F $ 19,500 U $17,350 U

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Static-budget variance Materials $167,125 F Labor 60,650 F Total $227,775 F Flexible-budget variance

Materials $27,875 U Labor 17,350 U Total $45,225 U

Sales-volume variance Materials $195,000 F Labor 78,000 F Total $273,000 F Level 1

Level 2

Variance Analysis

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Flexible-budget variance Materials $27,875 U Labor 17,350 U Total $45,225 U Price variance

Materials $12,750 F Labor 2,150 F

Efficiency variance Materials $40,625 U Labor 19,500 U Level 2

Level 3

Variance Analysis

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Learning Objective 5

Explain why purchasing

performance measures should

focus on more factors than

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Performance Measurement

Using Variances

Performance Measurement

Using Variances

Effectiveness is the degree to which a predetermined objective or target is met.

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

Variances should not solely be used to evaluate performance.

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When to Investigate Variances

When should variances be investigated? Subjective judgments

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

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Learning Objective 6

Integrate continuous

improvement

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Continuous Improvement

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

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

materials cost reduction each period. What should the budgeted cost be for the

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Continuous Improvement

Prior Period Reduction Revised Budgeted in Budgeted

Amount Budget Amount

This Period: – – $65.00

Period 1: $65.00 $0.650 $64.35

Period 2: $64.35 $0.644 $63.71

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Learning Objective 7

Perform variance analysis in

activity-based costing systems.

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Flexible Budgeting and

Flexible Budgeting and

Activity-Based Costing

Flexible Budgeting and

Activity-Based Costing

What is the flexible budget for material-handling labor-hours?

435 hours × $14.00/labor-hour = $6,090 Flexible-budget costs $6,090 Actual costs 6,786 Flexible-budget variance $ 696 U

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Price and Efficiency Variances

Price variance = ($14.50 – $14.00) × 468 = $234 U Efficiency variance = (468 – 435) × $14.00 = $462 U Total variance $696 U

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Learning Objective 8

Describe benchmarking

and how it is used

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Benchmarking

It refers to the continuous process of

measuring products, services, and activities against the best levels of performance.

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End of Chapter 7

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Flexible Budgeting and

Activity-Based Costing

Flexible Budgeting and

Activity-Based Costing

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

15,660 units ÷ 180 units per batch = 87 batches How many material-handling hours

should have been used?

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Flexible Budgeting and

Activity-Based Costing

Flexible Budgeting and

Activity-Based Costing

What is the flexible budget for material-handling labor-hours?

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

Flexible-budget costs $6,090

Actual costs 6,786

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Price and Efficiency Variances

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

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

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Learning Objective 8

Describe benchmarking

and how it is used

in cost management.

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Benchmarking

It refers to the continuous process of

measuring products, services, and activities against the best levels of performance.

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