CA7 8 Flex Budgeting

Flexible Budgets, Variances,
and Management Control

Chapter 7 - 8
Learning Objective 1
Distinguish
a static budget
from a flexible budget.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
7-2
Static and Flexible Budgets

Static Budget
Flexible Budget
Based on
Based on
Planned level of
output at start of
the budget period
Budgeted revenues
and cost based on
actual level of output
7-3
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
7-4

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.
What is the static-budget operating income?
7-5

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
costs of $300,000.
7-6

What was the actual operating income?
Revenues (10,000 $160)
Less Expenses:
Variable (10,000 $120)
Fixed
Actual operating income
$1,600,000
1,200,000
300,000
$ 100,000
7-7
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.
7-8
Static-Budget Variance Example

Static-Budget Based Variance Analysis
(Level 1) in (000)
Static Budget Actual Variance
Suits
13
10
3U
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
7-9
Develop a flexible budget
and compute flexible-budget
variances and sales-volume
variances.
7 - 10
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.
7 - 11
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
7 - 12
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
Total costs
$1,436,000
7 - 13
Variances
Level 2 analysis provides information
on the two components of the
static-budget variance.
1. Flexible-budget variance
2. Sales-volume variance
7 - 14
Flexible-Budget Variance
(Level 2) in (000)
Suits
Revenue
Variable costs
Contribution margin
Fixed costs
Operating income
Flexible
Budget
10
$1,550
1,150
$ 400
286
$ 114
Actual
10
$1,600
1,200
$ 400
300
$ 100
Variance
0
$ 50 F
50 U
$ 0
14 U
$ 14 U
7 - 15
Actual quantity sold: 10,000 suits
Flexible-budget
variance
$14,000 U
Actual results
operating income
$100,000
Flexible-budget
operating income
$114,000
7 - 16
Total flexible-budget variance

= Total actual results
Total flexible budget for actual sales level
7 - 17
Selling price
Variable cost
Contribution margin
Actual
Amount
$160
120
$ 40
Budgeted
Amount
$155
115
$ 40
7 - 18
Why is the flexible-budget variance $14,000 U?
Selling-price variance
Actual variable costs exceeded
flexible budget variable costs
Actual fixed costs exceeded
flexible budget fixed costs
Total flexible-budget variance
$50,000 F
50,000 U
14,000 U
$14,000 U
7 - 19
Sales-Volume Variance
Actual quantity sold: 10,000 suits
Sales-volume
variance
$120,000 U
Flexible-budget
operating income
$114,000
Static-budget
operating income
$234,000
7 - 20
Sales-Volume Variance
Actual sales unit Master budgeted sales units
13,000 10,000 = 3,000
Budgeted contribution margin per unit $40
=
Total sales-volume variance $120,000 U
7 - 21
Budget Variances
Level 1
Level 2
Static-budget
variance
$134,000 U
Flexible-budget
variance
$14,000 U
Sales-volume
variance
$120,000 U
7 - 22
Explain why standard costs are
often used in variance analysis.
7 - 23
Standards
Pasadenas budgeted cost for each variable
direct cost item is computed as follows:
Standard input
allowed for
one output unit
Standard cost
per input unit
7 - 24
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
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
7 - 25
Compute price variances
and efficiency variances
for direct-cost categories.
7 - 26
Actual Data
Direct materials purchased and used:
42,500 square yards at $15.95
Cost of direct materials = $677,875
Labor hours: 21,500 at $12.90
Cost of direct manufacturing labor = $277,350
7 - 27
Price Variance Example

Direct-material price variance
Actual price
Budgeted price
($15.95 $16.25) 42,500 = $12,750 F
Actual
quantity
7 - 28

Direct-labor price variance
=
=
Actual price
Budgeted price
Actual
quantity
($12.90 $13.00) 21,500 = $2,150 F
7 - 29

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
7 - 30
Efficiency Variance Example

Direct-material efficiency variance
=
=
Actual quantity
Standard quantity
Standard
price
(42,500 40,000) $16.25 = $40,625 U
7 - 31
Efficiency Variance Example

Direct-labor efficiency variance
=
=
Actual quantity
Standard quantity
Standard
price
(21,500 20,000) $13.00 = $19,500 U
7 - 32
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
7 - 33
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
7 - 34
Flexible Budget Material

Variance Example
Actual
Cost
$677,875
AQ BP
42,500 $16.25
$690,625
$12,750 F
BQ BP
40,000 $16.25
$650,000
$40,625 U
$27,875 U
7 - 35
Flexible Budget Labor

Variance Example
AQ BP
21,500 $13.00
$279,500
Actual
Cost
$277,350
$2,150 F
BQ BP
20,000 $13.00
$260,000
$ 19,500 U
$17,350 U
7 - 36
Variance Analysis
Level 1
Static-budget variance
Materials $167,125 F
Labor
60,650 F
Total
$227,775 F
Level 2
Flexible-budget variance
Materials $27,875 U
Labor
17,350 U
Total
$45,225 U
Level 2
Sales-volume variance
Materials $195,000 F
Labor
78,000 F
Total
$273,000 F
7 - 37
Variance Analysis
Level 2
Materials $27,875 U
Labor
17,350 U
Total
$45,225 U
Level 3
Price variance
Materials $12,750 F
Labor
2,150 F
Total
$14,900 F
Level 3
Efficiency variance
Materials $40,625 U
Labor
19,500 U
Total
$60,125 U
7 - 38
Explain why purchasing
performance measures should
focus on more factors than
just price variances.
7 - 39
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.
7 - 40
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,
whichever is lower.
7 - 41
Perform variance analysis in
activity-based costing systems.
7 - 42
Flexible Budgeting and

Activity-Based Costing
Materials costs and direct manufacturing labor
costs are examples of output-unit level costs.
Batch-level costs are resources sacrificed
on activities that are related to a group of
units of product(s) or service(s) rather than
to each individual unit of product or service.
7 - 43

Denver Co. produces metal planters (MP).
Assume that material-handling labor costs vary
with the number of batches produced rather
than the number of units in a batch.
Material-handling labor costs are direct batch
level costs that vary with the number of batches.
7 - 44

Static
Actual
Budget Amounts
Units produced and sold 18,000
15,660
Batch size
180
174
Number of batches
100
90
Material-handling
labor-hours per batch
5.00
5.20
7 - 45

Total labor-hours
Cost per material-handling
labor-hour
Total material-handling
labor cost
Static
Actual
Budget Amounts
500
468
$14.00
$14.50
$7,000
$6,786
7 - 46

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?
87 batches 5 hours/batch = 435 hours
7 - 47

What is the flexible budget for
material-handling labor-hours?
435 hours $14.00/labor-hour = $6,090

Flexible-budget costs
Actual costs
$6,090
6,786
$ 696 U
7 - 48
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
7 - 49
Explain in what ways the
planning of variable overhead
costs and fixed overhead
costs are similar and in
what ways they differ.
7 - 50
Planning of Variable and

Fixed Overhead Costs
Effective planning of variable overhead costs
involves undertaking only those variable
overhead activities that add value for
customers using the product or service.
The key challenge with planning fixed overhead
is choosing the appropriate level of capacity or
investment that will benefit the company over
an extended time period.
7 - 51
Identify the features of
a standard-costing system.
7 - 52
Standard Costing
Direct Cost
Cost Object
Standard cost
per input unit
Standard input
allowed for
one output unit
7 - 53
Developing Budgeted Variable

Overhead Allocation Rates
Step 1:
Choose the time period used to compute the budget.
Pasadena Co. uses a twelve-month budget period.
Step 2:
Select the cost-allocation base. Pasadena budgets
26,000 labor-hours for a budgeted output of
13,000 suits in year 2004.
7 - 54

Step 3:
Identify the variable overhead costs.
Pasadenas budgeted variable
manufacturing costs for 2004 are $312,000.
Step 4:
Compute the rate per unit of
each cost-allocation base.
$312,000 26,000 hours = $12/hour
7 - 55

What is the budgeted variable overhead
cost rate per output unit (dress suit)?
2.00 hours allowed per output unit $12
budgeted variable overhead cost rate per
input unit = $24 per suit (output unit)
7 - 56
Compute the variable overhead
efficiency variance and
the variable overhead
spending variance.
7 - 57
Variable Overhead
Cost Variances
The following data are for 2004 when
Pasadena produced and sold 10,000 suits:
Output units:
10,000
Labor-hours:
Actual results:
Flexible-budget amount:
21,500
20,000
7 - 58
Variable Overhead
Cost Variances
Labor-hours per output unit:
Actual results:
21,500 10,000 = 2.15
Flexible-budget amount: 20,000 10,000 = 2.00
Variable manufacturing overhead costs:
Actual results:
$244,775
$240,000
7 - 59
Variable Overhead
Cost Variances
cost per labor-hour:
Actual results:
$244,775 21,500 = $11.3849
$240,000 20,000 = $12.00
7 - 60
Variable Overhead
Cost Variances
cost per output unit:
Actual results:
$244,775 10,000 = $24.4775
$240,000 10,000 = $24.00
7 - 61
Flexible-Budget Analysis
The variable overhead flexible-budget variance
measures the difference between the actual
variable overhead costs and the flexible-budget
variable overhead costs.
Actual results: $244,775
Flexible-budget amount $240,000 = $4,775 U
7 - 62
Actual
Costs Incurred
21,500 $11.3849
= $244,775
Budgeted Inputs
Allowed for Actual
Outputs at Budgeted Rate
20,000 $12.00
= $240,000
$4,775 U
7 - 63
Actual Quantity
of Inputs at
Budgeted Rate
21,500 $12.00
= $258,000
Budgeted Inputs
Allowed for Actual
Outputs at Budgeted Rate
20,000 $12.00
= $240,000
$18,000 U
Variable overhead efficiency variance
7 - 64
Actual
Costs
Incurred
21,500 $11.3849
= $244,775
Actual Quantity
of Inputs at
Budgeted Rate
21,500 $12.00
= $258,000
$13,225 F
Variable overhead spending variance
7 - 65
Variable Overhead Variances

$4,775 U
Efficiency variance
$18,000 U
Spending variance
$13,225 F
7 - 66
Financial and Nonfinancial

Performance
Overhead variances are examples of financial
performance measures.
What are examples of nonfinancial measures?
Actual labor time, relative to budgeted time
Actual indirect materials usage per labor-hour,
relative to budgeted indirect materials usage
7 - 67

CA7 8 Flex Budgeting

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Flexible Budgets, Variances,

and Management Control

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Static and Flexible Budgets

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Static Budget Example

Static Budget Example

Static Budget Example

Static Budget Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Static-Budget Variance Example

Static-Budget Variance Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Total flexible-budget variance

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Budgeted contribution margin per unit $40

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Price Variance Example

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

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Price Variance Example

($12.90 $13.00) 21,500 = $2,150 F

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Price Variance Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Efficiency Variance Example

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

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Efficiency Variance Example

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

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Price and Efficiency Variance

Work in Process Control

Flexible Budget Material

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible Budget Labor

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

When to Investigate Variances

Rules of thumb as investigate all variances

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible Budgeting and

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible Budgeting and

Flexible Budgeting and

Flexible Budgeting and

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flexible Budgeting and