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publishing as Prentice Hall 8-1

 Chapter 8

Flexible Budgets and

Variance Analysis

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 Chapter 8 Learning Objectives

When you have finished studying this chapter,

you should be able to:
1. Identify variances and label them as favorable
or unfavorable.
2. Distinguish between flexible budgets and
static budgets.
3. Use flexible-budget formulas to construct a
flexible budget.
4. Compute and interpret static-budget variances,
flexible-budget variances, and sales-activity
variances.
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 Chapter 8 Learning Objectives

5. Understand how the setting of standards

affects the computation and interpretation of
variances.

6. Compute and interpret price and quantity

variances for materials and labor.

7. Compute variable overhead spending and

efficiency variances.

8. Compute the fixed-overhead spending

variance.

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 Learning
Objective 1 Favorable and Unfavorable Variances

Favorable variances arise when actual

results exceed budgeted.

Unfavorable variances arise when

actual results fall below budgeted.

Favorable (F) versus Unfavorable (U) Variances

Profits Revenue Costs

Actual > Expected F F U
Actual < Expected U U F
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Types of Favorable and Unfavorable Variances

Favorable profit variances arise when

actual profits exceed budgeted profits.
Unfavorable profit variance occurs when
actual profit falls below budgeted profit.

Actual revenues that exceed budgeted

revenues result in favorable revenue
variances, and actual revenues that fall
short of budgeted revenues result in
unfavorable revenue variances.
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Types of Favorable and Unfavorable Variances

When actual costs exceed budgeted costs,

we have unfavorable cost variances; when
actual costs are less than budgeted costs,
we have favorable cost variances.

The favorable and unfavorable labels

indicate only the directional relationships
summarized in the charts—they do not
indicate that the explanation for the
variance is necessarily good or bad.

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 Favorable or Unfavorable
Variance?
To determine whether a variance is
favorable or unfavorable,
use logic rather than memorizing a formula.

A price A quantity variance

variance is is favorable if the
favorable if the actual quantity
actual price is used is less than
less than the the standard
standard. quantity allowed.

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 Learning
Objective 2 Static and Flexible Budgets

A static budget is prepared for

only one expected level of activity.

A budget that adjusts to different

levels of activity is a flexible budget
(sometimes called a variable budget).

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 Learning
Objective 3 Flexible Budget Formulas

To develop a flexible budget, managers

determine revenue and cost behavior
(within the relevant range) with
respect to cost drivers.

Note that the static budget is just

the flexible budget for a single
assumed level of activity.

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 Activity-Based Flexible Budget

An activity-based flexible budget

is based on budgeted costs for
each activity and related cost driver.

For each activity, costs

depend on a different cost driver.

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Activity-Based Flexible Budget

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 Learning Static-Budget Variances and
Objective 4
Flexible-Budget Variances

Differences between actual results and the

static budget for the original planned level
of output are static-budget variances.

Differences between actual results and the

flexible budget for the actual level of output
achieved are flexible-budget variances.

Flexible budget variances reflect how actual

results deviate from what was expected, given
the achieved activity level.

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 Static-Budget Variances and
Flexible-Budget Variances

Actual results may differ from

the master budget because...

sales and other cost-driver activities were

not the same as originally forecasted

revenue or variable costs per unit of activity

and fixed costs per period were not as expected.

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Evaluation of Financial Performance

Actual Flexible Sales -

results budget Activity
at actual Flexible- for actual
Variance Static
activity budget sales
level* variances activity (4) = Budget
(3)–(5) (5)
(1) (2) = (1)-(3) (3)

Units 7,000 – 7,000 2,000U 9,000

Sales $217,000 – $217,000 $62,000 U $279,000
Variable costs 158,200 5,670 U 152,600 43,600 F 196,200
Contribution margin $ 58,730 $ 5,670 U $ 64,400 $18,400 U $ 82,800
Fixed costs 70,300 300 U 70,000 – 70,000
Operating income $ (11,570) $5,970 U $(5,600) $18,400 U $ 12,800

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 Flexible-Budget Variances

Flexible-budget variance
= Actual results – Flexible-budget

Sales-activity variances:
The activity-level variances when sales is
used as the cost driver.

Activity-level variances:
The differences between the static budget
amounts and the flexible budget amounts.

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 Sales-Activity Variances

Sales –
activity Actual unit - Contribution
income Static budget units margin per unit
variance

(9,000 – 7,000) $9.20

$18,400 Unfavorable

Falling short of the sales target by 2,000 units explains

$18,400 of the shortfall of income relative to the amount
initially budgeted.

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 Learning Role of Standards in
Objective 5
Determining Variances

Static-budget variances and flexible-

budget variances depend on the costs
used in the budget formulas.
Budget formula costs are standard
costs—costs that should be achieved.
Standard costs are defined in different
ways by different companies.
The level at which standards are set will
affect the variances generated and the
incentives created.
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 Setting Standards

A standard cost is a An expected cost is the

carefully developed cost per cost that is most likely
unit that should be attained. to be attained.

Perfection (ideal) standards are expressions of the

Most efficient performance possible under the best
conceivable conditions, using existing specifications
and equipment. No provision is made for waste,
spoilage, machine breakdowns, and the like.

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Currently Attainable Standards

Currently Attainable Standards . . .

are levels of performance that

managers can achieve by
realistic levels of effort.

They make allowances for normal

defects, spoilage, waste,
and nonproductive time.

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 Trade-Offs Among Variances

Improvements in one area could lead to

improvements in others and vice versa.

Likewise, substandard performance

in one area may be balanced by
superior performance in others.

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When to Investigate Variances

When should management

investigate a variance?

Many organizations have developed

such rules of thumb as “investigate
all variances exceeding either
$5,000 or 15% of expected cost.”

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Isolating the Causes of Variances

Effectiveness is the degree to which

a goal, objective, or target is met.

Efficiency is the degree to which

inputs are used in relation to
a given level of outputs.

Performance may be effective,

efficient, both, or neither.

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 Comparison with Prior Periods

Some organizations compare the most

recent budget period’s actual results with
last year’s results for the same period.

Even comparisons with the prior

month’s actual results may not be
as useful as comparisons with an
up-to-date flexible budget.

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 Flexible-Budget Variance in Detail

Flexible-budget amounts based on $10 per unit of output

for direct materials and $8 per unit for direct labor.

Standard per unit of output:

Std. inputs Std. price Flexible
expected expected Budget Amount

Direct Material 5 pounds $ 2 /pound $10

Direct Labor ½ hour $16/hour $ 8

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 Variances for Material and Labor
Standards

Standard Costs Allowed:

Direct material Direct labor

Cost allowed Cost allowed
7,000 units X 7,000 units X 1/2 hour
5 pounds X $2.00 per X $16.00 per hour =
pound = $56,000
$70,000

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 Variances for Material and Labor
Standards

Actual results for 7,000 units produced:

Direct material Direct labor

Pounds purchased Hours used: 3,750 X
and used: 36,800 Actual price (rate)
Price/pound X $1.90 X $16.40
= Total actual cost = Total actual cost
$69,920 $61,500

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 Variances for Material and Labor
Standards

Flexible Budget or Total Standard Cost Allowed

=
Units of good output achieved

×
Input allowed per unit of output
×
Standard unit price of input
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 Variances for Material and Labor
Standards
Flexible-budget cost is the standard quantity allowed for
the actual level of activity multiplied by the standard
price per unit.

Flexible-budget variances for direct material and direct

labor: $80 F and $5,500 U, respectively.

(1) (2) (3)

Flexible
Actual Flexible Budget
Costs Budget Variance
Direct Materials $69,920 *$70,000 $ 80 F
Direct Labor 61,500 **$56,000 $5,500 U
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 Learning
Objective 6 Price and Quantity Variances

(Actual price – Standard Price) × Actual quantity used

(Actual quantity used – standard quantity allowed

for actual output) × Standard price

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Quantity (Usage) Variance
Computations

[36,800 – (7,000 × 5)] pounds

× $2 per pound = $3,600 U

[3,750 – (7,000 × ½)] hours

× $16 per hour = $4,000 U

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Price Variance Computations

($1.90 – $2.00) per pound

× 36,800 pounds = $3,680 F

($16.40 – $16.00) per hour

× 3,750 hours = $1,500 U

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 Direct Materials Flexible Budget
Variance

The sum of the direct-labor price and quantity variances

equals the direct-labor flexible-budget variance.
Similarly, the sum of the direct-materials price and
quantity variances equals the total direct-materials
flexible-budget variance.

Direct-Labor Direct-Materials
Flexible-budget variance: Flexible-budget variance:

$1,500 unfavorable
$3,680 favorable
+ $4,000
unfavorable + $3,600 unfavorable

= $5,500 = $80 favorable

unfavorable
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 Interpretation of Price and
Quantity Variances
By dividing flexible-budget variances into price
and quantity variances, managers can be better
evaluated on variances that they can control.

Price and quantity variances are helpful

because they provide feedback to
those responsible for managing inputs.

Managers should not use these

variances alone for decision
making, control, or evaluation.
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 Learning Variable-Overhead Spending
Objective 7
and Efficiency Variances

A variable-overhead efficiency variance occurs when

actual cost-driver activity differs from the standard
amount allowed for the actual output achieved.

A variable-overhead spending variance occurs when

the difference between the actual variable overhead
and the amount of variable overhead budgeted
for the actual level of cost-driver activity.

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 Variable-Overhead Variances

variable- actual standard standard

- X
overhead cost-driver cost-driver variable-overhead
efficiency
variance
= activity activity
allowed
rate per
cost-driver unit

variable- actual standard actual

overhead
spending
variance
= variable
overhead - variable-overhead
rate per unit
of cost-driver
X cost-driver
activity
used

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 Learning
Objective 8 Fixed Overhead Spending Variance

The flexible budget based on actual use of the

cost driver and the flexible budget based on
standard use of the cost driver are always the
same because fixed overhead does not vary
with the level of use of the cost driver.

Therefore . . .
The difference between actual fixed
overhead and budgeted fixed overhead
is the fixed overhead spending variance.

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