Flexible Budgets,

Direct-Cost Variances,
and
Management Control

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1. Understand static budgets and static-
budget variances
2. Examine the concept of a flexible budget
and learn how to develop it
3. Calculate flexible-budget variances and
sales-volume variances
4. Explain why standard costs are often used
in variance analysis

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5. Compute price variances and efficiency
variances for direct-cost categories.
6. Understand how managers use variances
7. Describe benchmarking and explain its role
in cost management

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 Variancedifference between actual results
and expected (budgeted) performance.
Management by exceptionthe practice of
focusing attention on areas not operating as
expected (budgeted).
Static (master) budget is based on the output
planned at the start of the budget period.

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 Static-budget variancethe difference
between the actual result and the
corresponding static budget amount
Favorable variance (F)has the effect of
increasing operating income relative to the
budget amount
Unfavorable variance (U)has the effect of
decreasing operating income relative to the
budget amount

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 Variances may start out at the top with a
Level 0 analysis.
This is the highest level of analysis, a super-
macro view of operating results.
The Level 0 analysis is nothing more than the
difference between actual and static-budget
operating income.

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 Further analysis decomposes (breaks down)
the Level 0 analysis into progressively
smaller and smaller components.
Answers: How much were we off?
Levels 1, 2, and 3 examine the Level 0
variance into progressively more-detailed
levels of analysis.
Answers: Where and why were we off?

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 Level 0 tells the user very little other than
how much operating income was off from
budget.
Level 0 answers the question: How much were we
off in total?
Level 1 gives the user a little more
information: it shows which line-items led
to the total Level 0 variance.
Level 1 answers the question: Where were we
off?

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 Flexible budgetshifts budgeted revenues
and costs up and down based on actual
operating results (activities)
Represents a blending of actual activities and
budgeted dollar amounts
Will allow for preparation of Level 2 and 3
variances
Answers the question: Why were we off?

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Some possible reasons we might incur an
unfavorable Sales-Volume Variance include:
1.Failure to execute the sales plan
2.Weaker than anticipated demand
3.Aggressive competitors taking market share
4.Unanticipated market preference away from
the product
5.Quality problems

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 All product costs can have Level 3 variances.
Direct materials and direct labor will be
handled next. Overhead variances are
discussed in detail in a later chapter.
Direct materials and direct labor both have
price and efficiency variances, and their
formulae are the same.

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 Price variance formula:

Efficiency variance formula:

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Budgeted input prices and budgeted input
quantities can be obtained from a number of
sources including actual input data from past
periods, data from other companies that have
similar processes and standards developed by
the firm itself.
A standard is a carefully determined price,
cost or quantity that is used as a benchmark
for judging performance.

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 Each variance may be journalized.
Each variance has its own account.
Favorable variances are credits; unfavorable
variances are debits.
Variance accounts are generally closed into
cost of goods sold at the end of the period, if
immaterial.

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 Targets or standards are established for
direct material and direct labor.
The standard costs are recorded in the
accounting system.
Actual price and usage amounts are
compared to the standard and variances are
recorded.

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 Price and efficiency variances provide
feedback to initiate corrective actions.
Standards are used to control costs.
Managers use variance analysis to evaluate
performance after decisions are
implemented.
Part of a continuous improvement program.

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 Benchmarking is the continuous process of
comparing the levels of performance in
producing products and services against the
best levels of performance in competing
companies.
Variances can be extended to include
comparison to other entities.

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Terms to Learn Page Number Reference
Benchmarking Page 267
Budgeted performance Page 249
Direct materials mix variance Page 272
Direct materials yield variance Page 272
Effectiveness Page 265
Efficiency Page 265
Efficiency variance Page 258
Favorable variance Page 251
Flexible budget Page 252
Flexible-budget variance Page 253
Management by exception Page 249
Price variance Page 258
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Terms to Learn Page Number Reference
Rate variance Page 258
Sales-volume variance Page 253
Selling-price variance Page 255
Standard Page 257
Standard cost Page 257
Standard input Page 257
Standard price Page 257
Static budget Page 251
Static-budget variance Page 251
Unfavorable variance Page 251

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Terms to Learn Page Number Reference
Usage variance Page 258
Variance Page 249

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